by Blake LaFayette on September 8, 2016
As our first installment in a series of publications on the blockchain space, we deemed it informative to gather observations around the innovation economy in Silicon Valley, assess opportunities for a new generation of blockchain-enabled systems, and present our thoughts on how the space will develop. To compliment this, below we’re including a deck detailing our initial findings. This reflects a culmination of several weeks of secondary research and conversations with founders, investors, and early adopters. As we continue our research, our theses with regards to timing, infrastructure developments, and use-cases continue to evolve – we hope you find this to be a meaningful summary piece as you explore this rapidly changing space.
It is hard to picture a society without centralized order. Governments, central banks, corporations, and financial institutions all play vital roles in organizing economic activity, enforcing rules, and establishing a sense of trust and order in our lives. With each technological leap forward – mechanization in the industrial revolution, electric-powered Fordism at the turn of the 20th century, and personalized computing and the Internet in recent years – power structures have evolved in response to paradigmatic shifts in.
To illustrate this, let’s deconstruct the contemporary shift to web-based tools. The Internet has enabled a multitude of players to bring our physical world online, and subsequently build platforms for search, P2P marketplaces, conversational interfaces, social media, etc. As a whole, the tech industry has been focused on either improving processes for centralized organizations or enabling distributed interactions via centralized mediums. Hence, the Internet has democratized the open transfer of information, goods, and services. These interactions have increasingly become dominated by large platforms such as Google, Amazon, Facebook, Apple, and Oracle, reinforcing society’s natural affinity for centrally controlled organization.
The valley is known for perpetuating contrarian views which challenge the status quo. The integral role tech companies have played in establishing global organization is therefore counterintuitive. Has centralized authority prevailed because it’s the optimal solution, or rather because it is familiar and straightforward in establishing order? A closer look at the underpinnings of our economy suggests the latter, with centralized services such as escrow, tax filings, bank reconciliation, clearinghouses, accounting, records storage, and countless others relying on painstakingly manual processes. Oftentimes, inefficient processes inflate the cost and latency of transactions while injecting security risks.
In an effort to combat limitations of such internal systems, attempts towards achieving distributed computing have been in the works since the early 80’s, with incumbents such as NASDAQ long demonstrating interest. Blockchain is simply the latest manifestation. Depending upon your level of knowledge and buy-in to recent blockchain hype, you may be an advocate of fully decentralized autonomous organizations (DAOs, made infamous by a recent “hack” of one particular version built on Ethereum), the use of distributed ledgers for certain use-cases such as Bitcoin, securities trading, voting, and land registry, or simply be wondering what the technology is in the first place.
For those of you in the latter camp, a blockchain is simply a data structure that makes it possible to create a digital ledger of transactions and share it among all of the computers in a participating network. Thus, it is sometimes referred to as a peer-to-peer ‘distributed ledger’, and is a tamper proof, public or private, network-hosted record of all consensus verified transactions. Think of Bitcoin as the initial proof of concept for blockchain and posterchild for cryptocurrencies, made famous by regulatory disputes, high-profile hacks, venture investment, and price volatility. To learn more, I’d recommend watching this 6-minute introductory video, reading WSJ’s business-oriented CIO explainer, or looking through CoinDesk’s Q1 2016 report for updated trends and insights.
The recent rise in interest for blockchain is likely due to an oversaturation and consolidation of Bitcoin companies, the narrow market for cryptocurrencies, and the recognition of broader applications of the underlying bitcoin technology, blockchain. In any case, Q1 2016 marked the first quarter in which investment in blockchain startups surpassed that of bitcoin companies, with notable participation from corporate VCs and financial strategics. Moreover, bitcoin companies such as BitFury are pivoting towards offering blockchain solutions at an accelerating pace in order to capture the market’s shift beyond bitcoin.
Consequently as of Q1 2016, seven of the ten highest-funded startups in the space now operate hybrid – i.e. offering a mix of bitcoin and blockchain services – or blockchain-dedicated business models.
Many thought-leaders in the space, including Andreessen Horowitz’s Marc Andreessen and 21’s Balaji Srinivasan, liken the bitcoin blockchain of today to the Internet in the 1990s – a mysterious and undervalued technology that lacked initial mainstream adoption. Yet rather than attributing its slow adoption to a low number of “killer apps” driving usage, our initial research suggests a need for more stable and scalable infrastructure to support the . This refers to those companies building services on top of existing blockchain protocols, most commonly the Bitcoin blockchain or Ethereum smart contracts, in order to deliver solutions for use-cases such as digital authentication, cross-border payments, or securities trading. In a recent piece, famed entrepreneur and investor Joi Ito writes: “I don’t think today’s blockchain is the Internet in 1996 – it’s probably more like the Internet in 1990 or the late 80’s – we haven’t agreed on the IP protocol and there is no Cisco or PSINet.” Lacking adequate focus on improving today’s immature infrastructure, Mr. Ito warns of the possibility that irresponsible deployments will off-put adoption, and that a poor underlying architecture will reduce applications to mere improvements upon narrow use-cases.
Taking a closer look at recent developments in the space, fundraising data offers compelling support for this view. In Q1 2016, the two largest rounds of financing went to infrastructure companies Digital Asset Holdings (abbr. DAH; $62M Series A) and Blockstream ($55M Series A). DAH along with groups making a name by Hence, open-source efforts such as the Linux Foundation’s Hyperledger Project and Ethereum become increasingly significant in enabling collective advances and standardization of protocols. Blockstream offers a particularly compelling solution with its “sidechain” product, intended to enable interoperability between blockchains. As with the Lightning Network’s introduction of payment channels, sidechains will prove critical in improving the scalability of the bitcoin blockchain by compressing transactions to increase throughput.
Two additional developments warrant recognition: (1) product offerings from tech giants, such as IBM, Intel, and Microsoft, and (2) the emergence of three dominant protocols, the Bitcoin Blockchain, Ethereum Smart Contract, and Ripple Consensus Ledger. Many blockchain companies operating within the application layer currently build upon one of these three protocols, with many enterprise blockchain platforms such as Microsoft’s Blockchain as a Service offering cloud-based developer environments for several open-source protocols. Further expanding this assessment of protocols, we encounter an emerging divide between permissioned and permissionless blockchains – colloquially, private vs. public – which subsequently may be either open-source or proprietary.
After speaking with several founders in the space, the consensus appears to point towards open-source as the most effective mechanism by which to encourage widespread adoption and the development of powerful use-cases for blockchain technology. However, many industry consortia groups increasingly operating proprietary solutions built on open-source protocols, such as R3 CEV, are likely to continue strong traction as financial institutions seek to mitigate their risk profile while reducing buy-in costs until the infrastructure becomes more widely proven for its security and scalability.
Given these findings, truly revolutionary deployments of blockchain such as in voting, property title registry, escrow, accounting automation, and digital asset registry are likely at least 12-24 months away, with financial services similarly reducing their risk profile by adopting private protocols in low-risk data areas in the short term. In an effort to consolidate an outlook for the market, the CBDO of DAH noted, “If 2015 was the year we work up to blockchain, 2016 is the year people are running their proof of concepts. 2017 is when you’ll see the first live applications. 2020 is when you’ll see significant adoption, and in 2025 we’ll see a tipping point in some markets. That’s 10 years out.” Our research suggests a similar vision, with a clear emphasis upon developing widely accepted infrastructure in the short-term to help ensure the success of early applications.