Section VII

Section VII

The Investment Outlook


Hypothesizing about cultural and economic impacts at scale.

“The truth was, their revolution was not about an idea. It was about how you manage things.”

—BBC filmmaker Adam Curtis re: Occupy Wall Street.[242]

We have presented Bitcoin as an innovation in organization design. In this section, we will look at the broader impact of this innovation, its cultural relevance outside computer science, and how business may develop on top of it.

Cultural-historical timing is apt

Ward Cunningham is the engineer who coined the metaphor “technical debt,” and he draws a parallel between poor choices in software development and financial debt:[243]

“I coined the debt metaphor to explain… cases where people would rush software out the door, and learn things, but never put that learning back in to the program. That, by analogy, was borrowing money thinking you never had to pay it back. Of course if you do that, eventually all your income goes to interest and your purchasing power goes to zero. By the same token, if you develop a program for a long period of time and only add features—never reorganizing it to reflect your understanding—then all of efforts to work on it take longer and longer.”

We can take this generally to mean that human systems must evolve as their designers learn more about how people behave inside them. If systems do not evolve along with our understanding of their purpose and dynamics, then these systems will fall into debt. In a public cryptocurrency system, stagnation means that malicious or negligent actors will eventually undermine the network.

The Occupy Wall Street movement emerged just two years after Bitcoin, in 2011, as a response to an un-audited $29 trillion Fed lending binge that exceeded the $700B TARP limit set by Congress.[244] It can be said that OWS protested the origination of public debt by managers of the system.

Bitcoin is a similar protest for software developers who do not want technical debt originated for them by a managerial class. Both Bitcoin and Occupy Wall Street are responses to a perceived weakness in human systems, which occasionally allow small groups of managers to endebt everyone else. Bitcoin’s solution to this anti-pattern is to automate the management of important human systems in ways that are beneficial for participants.

Dilution of institutional boundaries may ensue

To understand the impact of Bitcoin, we return to Coase, and his theory that firms exist to reduce the transaction costs of specialists who collaborate in business. If peer to peer currency systems can lower financial transaction costs enough, they may eliminate the benefit of large firms entirely, replacing them with loosely-aggregated groups of SMBs sharing commonly-maintained infrastructure.

Coase writes that such a development would have massive societal impact, namely to subvert intellectual property laws and undermine the economics of large institutions:

"I showed in ‘The Nature of the Firm’ that, in the absence of transaction costs, there is no economic basis for the existence of the firm. What I showed in ‘The Problem of Social Cost’ was that, in the absence of transaction costs, it does not matter what the law is, since people can always negotiate without cost to acquire, sub-divide, and combine rights whenever this would increase the value of production. In such a world the institutions which make up the economic system have neither substance nor purpose. Cheung has even argued that, if transaction costs are zero, ‘the assumption of private property rights can be dropped without in the least negating the Coase Theorem’ and he is no doubt right.”[245]

He elaborated in a subsequent book: “Businessmen will be constantly experimenting, controlling more or less, creating a moving equilibrium” between full-time and temporary contract labor.[246] These impacts are also consistent with the stated goals of Satoshi Nakamoto and the Cypherpunks, whose resistance to institutional authority is rooted in a resentment for the managerial class and for the laws that protect and incentivize proprietary software.

Timothy May, the Intel executive and an original cypherpunk, predicted in 1992:

“Just as the technology of printing altered and reduced the power of medieval guilds and the social power structure, so too will cryptologic methods fundamentally alter the nature of corporations and of government interference in economic transactions. Combined with emerging information markets, crypto anarchy will create a liquid market for any and all material which can be put into words and pictures. And just as a seemingly minor invention like barbed wire made possible the fencing-off of vast ranches and farms, thus altering forever the concepts of land and property rights in the frontier West, so too will the seemingly minor discovery out of an arcane branch of mathematics come to be the wire clippers which dismantle the barbed wire around intellectual property.”[247]

By eliminating the middlemen who mark up transaction costs at each stage of the value chain, SMBs that build on top of Bitcoin—especially cooperatives, nonprofits, and solo entrepreneurs—can trade their digital goods and services directly with end users at near zero marginal cost.[248]

What cryptocurrency-based independent employment looks like

Individual entrepreneurs or small groups of developers can monetize free and open source projects in a number of ways. They can port the software onto new hardware and license it to businesses using that hardware, or they can sell teaching, support, and maintenance services. Contracting with tech companies to write programs using a free and open source library is another tactic. Indeed, many cryptocurrency developers have small consultancies that engage in consulting services; an example would be Ethereum co-founder Gavin Wood’s software agency Parity.

Older FOSS projects provide insights into the future of Bitcoin. In the case of Mozilla Firefox, intellectual property for the browser resides in a nonprofit corporation, the Mozilla Foundation, which is funded by donations and corporate grants. Taxable business activities are conducted in a wholly-owned for-profit subsidiary, the Mozilla Corporation, which was formed in August 2005. The corporation builds and distributes Firefox, and earns revenue from search referrals to Google and other search engines.[249] This “dual entity” structure, with a foundation and a corporation, has been mimicked in other open source projects, including Bitcoin, which is maintained by a group of developers known as “Bitcoin Core,” some of whom have formed a commercial entity called Blockstream, which builds enterprise applications on top of Bitcoin for profit.

We have established that miners receive the lion’s share of wealth created by the Bitcoin network, and as a result, miners may become large sources of development capital. Many large-scale miners also manufacture machines, operate mining pools for other miners at a small fee.

Bounty-hunting is another approach to software entrepreneurship. Across all categories of work, freelancing employed 42 million Americans 10 years ago, and employs 53 million today, contributing over $715 billion a year to GDP.[250] An increasing number of freelance platforms are offering work per-job, or in software terms, paying per problem solved.

Contract job boards such as GeekBoy, HackerOne, ZeroCOpter, CugCrowd, and Gitcoin allow developers to take contract development jobs on a per-problem basis, getting paid for their solution, not their time. Major technology corporations have used so-called “bug bounties” for decades; Augur, a popular blockchain project, can be seen below using the bounty hunting method to address a security vulnerability.

image16

Figure 19. Augur is just one of many cryptocurrency projects using bounty-based employment to effect quality assurance.
(Souce:Twitter[251])

Perhaps the best implementation of a bitcoin-based bounty hunting system is BitHub, created by cypherpunk and Signal Messenger creator Moxie Marlinspike. BitHub does two things for Signal Messenger, which is free and open source software:

  1. It allows Signal Messenger to take donations in bitcoin
  2. It pays out this bitcoin to developers who fix bugs

In this way, existing products and services can hire and retain high-quality engineering talent, on a completely pseudonymous basis, and totally ad hoc, simply by offering a Bitcoin payment. Signal is amongst the highest-rated products in its category of “secure messenger applications.” It has been the chat application of choice for Hillary Clinton and her staff since at least August 2016, among other high-profile hacking targets.[252] [253]

image20

Figure 20. Bitcoiners are proud of their incentive system, which accomplished large-scale work without financing or incorporation. Bitcoin is often characterized as a “honeybadger” for its rugged characteristics.
(Source: Twitter.[254])

Investigating the altcoin business model

Because Bitcoin develops slowly in the “bazaar,” and has no marketing department, it can appear from the outside fairly chaotic, and by all appearances “worse” than privately-developed alternatives. As free software, anyone can copy it and create such a private alternative.

Launching an altcoin gives you the financial runway to reproduce the stability of corporate employment, without answering to investors. (Just miners and users!) What is the distinction?

In a cryptocurrency context, a “scam” is a project which:

  1. Will not grow or retain its developer pool, forestalling any chance at viral growth or stability.
  2. Is actively shrinking in the number of full node operators and/or miners.
  3. Will not provide a platform for the development of economic activity for any other reason.

Not all network operators are intentional scammers. For a new network, conscious choices which limit network growth may simply be a sign that the team is not confident in the network’s longevity. Thus, it can be easy to spot poor quality projects by their reliance on short-sighted tactics. While there is no firm litmus test for the viability of a project, the following characteristics can be considered red flags:

  • The network is operated primarily by one incorporated entity.
  • Any component of its software is proprietary.
  • Decisions about code commits are closed to outside contributors.
  • Development process is private; only insiders know how decisions are made.
  • The project is free and open source, but multiple implementations are politically unviable.

Obstacles to altcoin competition

Bitcoin is a complex codebase which contains 12 years of brilliant engineering. Starting from scratch means re-encountering many of the same problems all over again; forking and attempting to work on an unfamiliar code base can mean endless frustration, as one learns its peculiarities. The biggest challenge to competing with Bitcoin is catching up to thousands of hours of contributions it has received.

Accelerating past the normal pace of open allocation requires some new tricks, because the usual speed-ups—raising money, paying fat salaries, and central planning often end up reducing developer draw and hardware draw, not increasing it.

DACs, or decentralized autonomous companies, are an attempt at overcoming this problem using the usual corporate carrots—resource planning, a salary and stable employment—but without the dreaded human managers. This may enable project velocity to increase without the introduction of undesirable qualities, but the efficacy of this approach remains to be seen.

DAC-operated cryptocurrency networks are interesting to the extent that they fulfill the following requirements:

  1. Are similar to Bitcoin in architecture, with Proof-of-Work securing the base layer.
  2. Coins are exchangeable for Bitcoin without a trusted central party in an “atomic swap.” [255]
  3. Is resistant to fork attacks from large ASIC miners, with plenty of hashrate or fork-resistant mechanisms.[256]
  4. Can use hybrid PoW/PoS to improve the fairness of human consensus.
  5. Have some mechanism by which the contributor base may scale to the point where development velocity exceed Bitcoin’s.
  6. Isn’t controlled by a dictator, which reduces the fun and freedom of open allocation, killing developer draw.
  7. Has a talented team which can attract a lot of engineers and excitement to test limits of team scale.

Where value accumulates for investors

Who benefits from the forces at work in public cryptocurrency networks? The following points represent outstanding opportunities for capital.

  • Given: Bitcoin is a self-organizing infrastructure project which provides flexible employment and intellectual stimulation for technologists.
  • Insight: For these reasons, bitcoins themselves are valued collectibles within the technologist demographic, which is a critical and growing segment of the workforce. As infrastructure improves, perceived value increases.
  • Given: Owing to Bitcoin’s 10-year head start and brilliant contributor base, its development will out-pace all but a few exceptionally competent projects. The few projects which survive will do so by innovating on top Bitcoin’s incentive model to speed development velocity without introducing technical debt, “catching up” with Bitcoin in functionality and network security.
  • Insight: Over time, the entire value of the asset class will collapse into a select handful of undervalued cryptocurrencies, which have used DAC or hybrid consensus governance to increase project velocity to the point of competitiveness with Bitcoin.
  • Given: In a large and secure cryptocurrency network, miners are equivalent to Galbraith’s shareholders: “irrelevant fixtures” to its development, but owners nonetheless.
  • Insight: Mining OEMs, large-scale mine operators, and mining-related service providers will accumulate the vast majority of wealth created by Bitcoin and other cryptocurrency networks during the issuance period, despite expending far fewer human resources than the software developers who volunteer contributions.
  • Given: The speed, cheap costs of operation, and settlement finality characteristic of “layer 2” point-to-point networks, built on top of base-layer cryptocurrencies, will make them ideal for retail and e-commerce payments as competitors to Visa, Mastercard, and Paypal. (Lightning Network has been well-explained already by others.[257] [258] [259])
  • Insight: There will be many competing L2 networks built by both FOSS groups (such as Lightning) and private commercial interests (such as ICE). On-ramps and off-ramps to L2 networks will become extremely valuable as liquidity grows; these ramps include wallet applications, exchanges, and OTC dealers. Secondarily, these ramps will serve as natural portals for e-commerce activity.
  • Given: As cryptocurrency transaction volume increases, major platforms like Apple iTunes and Google Play will continue to block cryptocurrency apps and digital collectibles from their devices, protecting their in-app Apple Pay and Google Pay purchasing frameworks, which developers on those platforms are required to use to sell digital goods.[260] This payment-framework apartheid will create demand for third party privacy smartphones running Linux-based, GNU, or BSD operating systems, and which natively run cryptocurrency protocols. (Already, at least one such distribution has appeared.[261])
  • Insight: After ASIC miners, smartphones will be the second most valuable category of cryptocurrency-specific devices whose prices are denominated in cryptocurrency. These devices will become highly-valued distribution and aggregation points for products and services offered by “entrepreneurial joiners” who integrate with, and build atop, Bitcoin and other networks.
  • Given: Forced to compete with free software developed by large self-organizing masses of volunteers, and gaining nothing but unnecessary costs from their strict full-time hierarchy, major SAAS companies will suffer financially, forcing consolidation and layoffs. Many of these companies will launch competing “blockchain” based systems, but they will be too expensive and insecure for practical use. This may cause unexpected frustration for large software companies.
  • Insight: We expect a private equity boom in the early 2020s, in which tokenized debt financing is used to finance a wave of hostile bust-up takeovers, unbundling large public technology companies, laying off elements of their technostructure, and reorganizing their teams to function autonomously on an open allocation basis. New digital financial products will be issued which entitle investors to streams of income from individual teams, products, or services within the formerly-unified company. In this way, public stocks will become baskets of “atomic equities” that represent the performance of each constituent unit in a given value chain; divisions between corporate entities and jurisdictions will cease to be relevant factors in the issuance of public and private securities. This activity will be pioneered by engineer-led investment groups, not incumbent underwriters, who will not be able to retain the necessary engineering talent to undertake such activities.

The passing of the last insight would amount to the disintermediation of big capital, an idea that has been discussed favorably on social media, as expressed in Figure 21 below.

image14

Figure 21. Antipathy for corporate managers and venture capitalists runs deep in the Bitcoin community.
(Source: Twitter[262])

Things investors should generally avoid

  • Initial coin offerings (ICOs). As we have discussed, cryptocurrency projects only qualify as good platforms for business if they earn volunteer contributions. Pre-minting tokens and selling them to “investors,” with a rich stash held back for the “team,” creates strong incentives for technical debt and command-and-control management which eventually drives out the best talent, crushing the utility of the network and the price of the coin.
  • ICO advisors and diversified ICO coin “funds.” The market leader, Bitcoin, has exhibited extreme virality amongst software developers, miners, and retail investors. It has strong network effects. Very few projects will survive alongside Bitcoin, and they will be successful for reasons recounted in this essay—reasons that most ICO launchers would find surprising and counter-intuitive. Over-diversification will kill most cryptocurrency investment funds, who will miss out on market beta by holding too little bitcoin.
  • Venture-backed cryptocurrencies and private blockchains. The 10-year investment horizon for venture capital funds limits long-term thinking, because companies are forced to dazzle investors each time they recapitalize. This “fundraising treadmill” feeds marketing narratives and “wow” features that generate technical debt. As we’ve learned, such systems cannot compete with the costs of open allocation non-commercial projects.

Categorizing coins for investment

In this paper we have discussed the context and origins of hacker culture, the free software movement, cypherpunks, and the currency system Bitcoin which is characteristic of these origins. We believe there are a substantial number of people who value Bitcoin strongly for the reasons mentioned.

Which coins are also valuable? Developing criteria from the narrative above is fairly straightforward. To someone who values Bitcoin, altcoins are valuable if it they meet the criteria in Section VI, but with alternative techniques. Coins become less valuable as they adhere more towards traditional, hierarchical, corporate software development processes. Here is how we categorize coins:

image10

Figure 22. Plotting the investability of cryptocurrency projects based on organizational design. Bitcoin and Ethereum can be said to be in the lower-right and lower-left quadrants respectively. Private chains such as Ripple would appear in the upper-left. Hybrid PoW/PoS chains are in the upper-right hand corner.

  1. The top-left quadrant: A non-starter for investors; it is pure speculation on corporate-style projects which will inevitably rank lower in developer draw and higher in transaction costs, with more bugs and less stability than FOSS permissionless blockchains.
  2. The lower-right quadrant: Bitcoin appears here, along with similar open allocation FOSS forks of Bitcoin. While the fork may begin with one developer, others quickly join if they see differentiation characteristics in the new fork.
  3. The lower-left quadrant: Reflects the reality of many FOSS permissionless blockchains, which may have begun life in the lower-right quadrant. Ethereum seems to be migrating from the lower-right to the lower-left. These quadrants are generally investible, but the migration towards the lower-left is considered to be a negative attribute for a permissionless chain.
  4. The top-right quadrant: Meaningful attempts at innovation on top of Bitcoin are here, in the form of accelerating project velocity with automated governance, and without introducing the flaws of centralization (namely, technical debt and lack of open allocation). Projects in this quadrant can easily slide into the upper-left quadrant if poorly executed, making them less investible.

Conclusion: what is driving the cryptocurrency phenomenon?

Bitcoin has been largely characterized as a digital currency system built in protest to Central Banking. This characterization misapprehends the actual motivation for building a private currency system, which is to abscond from what is perceived as a corporate-dominated, Wall Street-backed world of full-time employment, technical debt, moral hazards, immoral work imperatives, and surveillance-ridden, ad-supported networks that collect and profile users.

To developers, adoption of Bitcoin and cryptocurrency symbolizes an exit (or partial exit) of the corporate-financial employment system in favor of open allocation work, done on a peer-to-peer basis, in exchange for a currency that is anticipated to increase in value.

Freelancing and solo entrepreneurship are already popular in Silicon Valley and amongst Millennial and Gen-X workers because these lifestyles afford them self-directed, voluntary work. Highly-skilled technology workers are already fed up with big tech, the drive for profit, and the spectre of technical debt. The leverage is increasingly on the side of the individual engineers; this is why the Uber executive quoted in the Preface fears the company may be “fucked” if it “can’t hire any good engineers.”

This “exiting” of the mainstream employment system is why some members of the investor class may intuit Bitcoin as a threat:

  1. If technologists exit the corporate-financial system en masse, the reduction in available technical labor would stymie the technical development of public companies, banks, and governments, whose services are increasingly digital.
  2. If technologists build a cheap, private, and reliable “alternative financial system,” and if such a system cannot be regulated or taxed out of existence, then business activity will flow naturally into such a system to realize lower transaction costs. This draws value out of existing forex, equities, real assets, crushing the margins of existing financial services.

We believe these points provide critical insight into Warren Buffett’s classification of Bitcoin as “rat poison,” which is similar in tone to the reaction of Steve Ballmer to Linux, when he characterized it as a “cancer” that would destroy the Windows OS. To the administrators of expensive, proprietary monopolies, free and open source systems are deadly.

Charlie Munger’s assertion that cryptocurrencies are “turds,” also quoted in the Preface, is a more nuanced and less threatened reaction than his business partner’s. Cryptocurrency appears to be a “worse” currency system than the existing system, but it’s also clear that this “worse” substitute is interesting to young people; it simply confounds Munger that “worse is better” when a financial system is built in software instead of paper. He has probably never developed software, or encountered New Jersey Style, but that’s no fault of his.

Summary

For the last 50 years, technologists have been motivated to create a culture of software development that exists outside institutional boundaries. Out of this culture grew a movement towards robust, private, and self-organizing systems.

This vision is embodied in Bitcoin, which lays the groundwork for ways of working in information technology businesses, without a bureaucracy. Given what we know about the moral quality of the Cypherpunks’ struggle against institutional oversight, it’s easy to see why a sense of righteousness might be on display in the most fervent Bitcoin advocacy groups. In short, William Shatner got it right with his assessment in 2014:

image11

Figure 23. If hackers can be deemed programming snobs (and we think they can) then William Shatner’s assessment of Bitcoin in 2014 was highly perceptive.
(Source: Twitter[263])

Far from being a novelty or prototype, Bitcoin has shown itself to be a threatening alternative to present-day organizational conventions and to the large commercial businesses that rely on them. It may spur a radical unbundling of corporate business as it lowers transaction costs for the institutions that adopt it. While the effects of such unbundling are unpredictable, value seems most likely to accumulate in cryptocurrency services businesses; in hardware makers and operators that rent computing resources to the network; and in building businesses on the layer 2 networks.

In the final part of this essay, we have looked at the potential impact of Bitcoin’s success, and expectations about its price. We’ve examined why most altcoins are doomed and we have provided guidance on investments to avoid, and hypothesized where value will accumulate for savvy allocators.

To learn more about specific investment strategies in the cryptocurrency asset class, or to view industry news through our investment lens, please sign up for the Iterative Capital newsletter