DIGITAL IS INEVITABLE: THE BLOCKCHAIN THESIS REVISITED
Blockchain Coinvestors Letter from London
Vol. 2, No. 1, January 2023
Happy to new year to you all, we hope you had a nice holiday break and were able to relax with friends and family.
In the spirit of starting anew, for this week’s Letter from London, we wanted to revisit our core thesis – the raison d'être for our first blockchain investments, which date back to 2014. The past year was a difficult one in equities, bonds, and public token markets and accordingly many openly question whether the technology industry is simply the result of a sustained low interest rate environment. As early-stage technology investors, we must continuously re-underwrite our investment thesis. Below we share highlights of the that process with you all.
Our investment thesis stated as simply as possible is the following:
We are amid an accelerating transition to a digitalized society
The 1990’s Internet digitalized communications and content, representing the greatest ever value creation event
However, without natively digital assets, monies, and commodities, we lacked the tools for digitalized commerce
Blockchain is the technological innovation that allows for digital peer-to-peer interactions natively on the internet
Digital commerce is inevitable, and all the world’s financial infrastructure will be upgraded
All transactions in a digital economy will ultimately settle on blockchains
Within this thesis, we underwrite a bull, base, and bear case for blockchain technology adoption.
The Bull Case – the settlement layer for all global economic activity
Our bull case is that blockchains will form the base layer – that is the ultimate settlement layer – for all global economic activity. In this regard, blockchain technology will disrupt virtually all industries horizontally, from gaming to art to social media. Any digital interaction where value is exchanged or an interaction is catalogued – as loosely defined as from a single tweet to a vote in an election – will ultimately be recorded on a public ledger system we define as a blockchain. This is worth a moment of consideration. Why would every valuable transaction not be recorded? Since we all transact, all of the time, you can see why this would be so transformative to every industry, business and individual.
In this case blockchain technology is as disruptive as the 1990’s Internet was to global communication and information. In the early 1990s it was considered a crazy idea that every business would have its own website – “why would a local bakery have a website?” skeptics asked, what do they have to do with technology. It was difficult at the time to see how all communication in a digital economy would be digitalized, representing a true paradigm shift in the consumption of information.
Today we argue the same process is underway with regards to commerce. Consequently, to some it seems equally as preposterous today that in the coming decades every business will settle its digital transactions on a blockchain. Even further, we see a path for the broad proliferation of tokens and even business specific app-chains in the digital economy.
The Base Case – an overhaul of the world’s financial infrastructure
Perhaps blockchains do not achieve breakout adoption as the Internet did. Maybe they fail to scale to levels that can withstand trillion-dollar economy-scale activity, or the consumer experience can’t rival what can be provided within the ‘walled gardens’ of today’s technology giants, such as Meta or Alphabet. Instead, broad swaths of the digital economy remain sequestered within the centralized servers of large American multi-national technology giants.
In our base case, we still see blockchains as overhauling the world’s financial architecture, providing the much-needed upgrade to the ‘pipes’ of the global financial system. The current system remains stubbornly analog, inefficient, and costly; these costs are ultimately borne by businesses and consumers.
Blockchain based systems allow for immediate settlement, efficient compliance, and frictionless transfer of value. For this reason, we see blockchain as underpinning the digitalization of all of the world’s monies, assets, and commodities.
In this case the reduction in transaction costs – both financial and human capital – will drive adoption. Fewer intermediaries will drastically lower the friction in transacting, leading to a new standard for how we interact with assets.
In our base case we would expect a broad bifurcation of the digital asset economy – loosely distinguished between the regulated and unregulated. To participate in the regulated digital asset economy, there will be a compliance layer that serves as the gatekeeper to participation. Put simply, to interact with any financial products in the regulated layer, the entity would need to undergo standard KYC and AML screening. In effect, this compliance layer will allow the largest pockets of capital and most regulated financial institutions to participate.
However, we also expect there to remain a vibrant and growing unregulated sphere – similar to how today’s DeFi ecosystem is already emerging. This sector will remain truly decentralized and rapidly innovating.
The Bear Case – payments, remittances, and store of value for emerging economies
In our bear case, blockchain never achieves widespread adoption in the financial markets of ‘developed’ economies – or those economies traditionally associated with financial innovation. Whether through coordinated government regulation to stifle adoption, or perhaps through regulatory capture by large incumbent financial players, in our bear case blockchain technology never receives the institutional backing necessary for institutional adoption.
In this case, blockchain remains cornered off to the emerging economies, where consumers are all too familiar with exorbitant transaction fees and unstable currencies. Consumer demand for access to dollar-backed stablecoins and efficient payment channels drives adoption. In the developed economies, where Visa, Apple Pay, and Venmo are already present and strong currencies persist, consumers don’t find much rationale for a blockchain based system.
Instead, blockchains become useful and critical infrastructure for cross border remittances, micro payments and a means for consumers in emerging economies to access stores of value – whether a natively digital currency such as Bitcoin or Ethereum, or simply through dollar-backed stablecoins. Consumers in emerging economies find the benefits of blockchain-based systems salient and immediate.
Where Do We Stand Today?
14 years after Satoshi’s seminal white paper ignited the blockchain industry, which case seems most likely today?
Our team’s assessment of the data is that we are firmly on track for our base case and the bull case is still likely in the long run. The bear case seems all but certain at this point based on the latest data from emerging economies.
To summarize our assessment:
High global Internet penetration has paved a path for rapid digitalization of commerce
Early adoption is fastest in emerging economies and with digital natives in developed economies
Digital natives influence will grow as they constitute a larger share of the population
The largest financial institutions in developed economies are leaning in
We expect rapid and promising innovation around scaling blockchains and user experience
Successful Early Innings
At the time of 2001 dotcom crash, less than 7% of the globe was online. Fast forward to today, more than half of the global population has used the internet in the last three months – for North America, internet penetration is higher than 90%.
This penetration makes distribution in a digital economy rapid and scalable. Put simply, the pipes have already been laid for the digitalization of the economy – we don’t need to lay broadband lines across the oceans again – we are already connected. Products can be sold to anyone with a mobile phone and a data connection. Unlike in the industrial revolution, where emerging economies were not able to rapidly adopt technology, this digital transformation allows for subsequent digitalization waves to be adopted at nearly the same pace as in developed economies. For instance, e-commerce is growing as fast in emerging economies as in developed economies.
Equally as important, the early adopters today of cryptocurrencies are the consumers in emerging economies and the digital natives in developed countries. As we noted in the Letter from London Vol. 1, No. 4, according to Chainalysis, of the top 20 countries ranked by cryptocurrency adoption, only one is a developed economy (the USA). Without revisiting that topic in detail here, the use cases driving today’s adoption are payments, remittances and store of value– all to which blockchain provides immediate and salient benefits to consumers in emerging economies.
In the developed economies, the digital native generation is driving adoption. Digital natives – that is the Generation Zs and Millennials who came of age with the internet – fully expect their interactions to be natively digital. Why wouldn’t money and assets be digital as well?
Taking the Next Steps
We expect two key catalysts for adoption to materialize in the medium term: an already progressing demographic shift and institutional adoption. Digital natives are expected to constitute more than 50% of the US workforce by the end of the decade, as they rapidly replace their parents – the baby boomers – who are retiring at a steady pace. The larger presence of this demographic will reverberate throughout not only the economy, but also in our political systems as they become a more concrete and important voting force.
Similarly, the world’s largest companies and financial institutions will not sit idly by. Quite to the contrary, they are leaning in and investing heavily in blockchain technology. As we noted in Letter from London Vol. 1, No. 3, the largest public companies and financial institutions have made significant investments in blockchain companies and in building out dedicated teams and staff. Without revisiting that analysis here, it’s safe to say that they are skating to where the puck is moving. This has been well underway for several years now: in Deloitte’s Global Blockchain Survey with executives from 1,000 banks, more than 95% of respondents indicated they planned to make some level of investment in blockchain technology.
End Game
To achieve our bull case, blockchain technology must breakout from the scalability trilemma – that is the inherent design trade-off present between scalability, decentralization, and security. Moreover, user experience must rise to the convenience associated with today’s technology companies. This is essential for blockchain to underpin the next generation of social media, gaming, and other non-financial use cases.
Innovation continues at a rapid pace in the blockchain industry; as we noted in Letter from London Vol. 1, No. 4, recent breakthroughs in rollup technology – both with regards to optimistic and zero-knowledge based approaches – have the potential to allow for rapid and cheap transactions to take place in an execution layer, while retaining the security and decentralization of the base layer, or the layer 1 blockchain. Moreover, several of the leading protocols are launching with account abstraction – technical jargon that essentially means that the self-custody consumer experience will be drastically improved and simplified.
While nothing is certain in venture investing, we are optimistic this technology will develop and continue to improve. To think otherwise would be to ignore the history of technological innovation. 40 years ago, the cost of computers was sufficiently high that most experts wrote off the potential of the personal computer – how would the average person ever afford one? 30 years later Steve Jobs was launching the iPhone, effectively a supercomputer compared to early computer iterations that could fit in your pocket. It's hard for us not to be optimistic.
Concluding Thoughts: Digital is Inevitable
Taken as a whole, we remain tethered to our bull case and highly confident in our base case. The 1990’s internet successfully ignited the digitalization of information, a process which continues to this day. The generations raised in a digital age simply expect the convenience and simplicity of digitalization. As they continue to age and form the core of the population in developed economies, the demand for natively digital products will grow exponentially. Until quite recently however, we lacked the tools for natively digital commerce. Information could move rapidly but monies, assets, and commodities remained stubbornly analog.
Now, with blockchain technology, economic activity too can be natively digital on the internet. And that could be enough. That is, if blockchain allows for an overhaul of the world’s financial architecture, massive value will be unlocked through reduced friction and cost, and increased liquidity and trust.
Yet blockchain could achieve breakout adoption and form the base layer of the entire digital economy – from art to gaming to social media. We see the constant churn of technological innovation continuing to scale blockchains and improve user experience, in a similar fashion to the previous computing revolution.
We will continue to re-underwrite our investment thesis as more data becomes available. Nevertheless, recent market events have done little to shake our conviction in the inevitability of digital, and blockchain technology’s role in that transformation.
We hope you enjoyed these summarized thoughts. Please email me with any questions.
Thank you for reading,
Mitch Mechigian
Partner, London
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Direct Investing in the Mid Stage
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Why Digital is Inevitable
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ABOUT BLOCKCHAIN COINVESTORS
Launched in 2014, our vision is that digital monies, commodities and assets are inevitable and all of the world’s financial infrastructure must be upgraded. Our mission is to provide broad coverage of the emerging unicorns and fastest growth blockchain companies and crypto projects. Our investment strategy is now in its 9th year and has to date invested in more than 40 pure play blockchain venture funds in the Americas, Asia and Europe; and in a combined portfolio of 400+ blockchain and crypto projects including approximately 55% of all blockchain unicorns. Our funds rank in the top decile amongst all funds in their respective categories on both Pitchbook and Preqin. Headquartered in San Francisco with a presence in Grand Cayman, London, New York, Zug and Zurich, the alternative investment management firm was co-founded by Alison Davis and Matthew Le Merle.
FUND PERFORMANCE
The Blockchain Coinvestors Fund of Funds strategy was created to provide diverse coverage of the best blockchain pure play venture funds in the Americas, Asia, and Europe. Blockchain Coinvestors Funds I and II have already experienced significant appreciation. Almost all of our fund investments are performing as top quartile against the Cambridge Associates Venture Benchmark. Fund I Net TVPI is 4.55x with an IRR of 59.8% and is one of the highest performing fund of funds in the world according to Pitchbook and Preqin. Fund II shows equally impressive early results with Net TVPI of 1.39x and an IRR of 30.9%. Fund III closed at the end of 2022 and will begin reporting this year. Our newest fund of funds - Fund VII - is now in formation. Email us at ir@blockchaincoinvestors.com to learn more.
BLOCKCHAIN COINVESTORS FUNDS
Blockchain Coinvestors’ goals are to provide broad coverage of the emerging unicorns and fastest growth blockchain companies and to capture superior returns from investing in the leading blockchain venture partnerships. Our funds are open to investors that meet the Qualified Client definition with a minimum subscription level of $250,000 at the discretion of the Manager.
Blockchain Coinvestors Fund IV (Early Stage Token) provides direct access to promising private stage token projects accessing our relationships with many of the world’s leading blockchain investors. We leverage asymmetrical information from our 40+ VC Funds to pick the most attractive opportunities. This is a continuation of the direct token investing strategy of the Fund Manager that has included private stage investments in Acala, Filecoin, NEAR, Polkadot, Structure, and others.
Blockchain Coinvestors VI (Mid Stage Growth) provides direct exposure to the emerging category leaders in the blockchain and crypto ecosystem. The fund leverages our unique sustainable competitive advantage (USCA) in blockchain, web3, and fintech to create a concentrated portfolio of between 20 and 30 investments with attractive return profiles and visible paths to liquidity. The fund assesses the more than 400 blockchain and crypto projects in which we are direct and indirect investors and employs a robust investment framework to select investment opportunities into the leading mid stage growth rounds - typically Series B, C and D. This is a continuation of the mid stage investing strategy of the Fund Manager that has included investments in Bitwise, Brex, InfiniteWorld, Securitize, Uphold, Wyre, and others.
Please visit the Blockchain Coinvestors website to learn more about our offerings. You can also reach our Investor Relations team directly at ir@blockchaincoinvestors.com.
BLOCKCHAIN COINVESTORS SWISS
We are excited to announce that Blockchain Coinvestors Funds are now available through Swiss certificates for those of our non-US investors who prefer this approach. The underlying fund is the same, however, our Zurich based team at Blockchain Coinvestors Swiss, who will introduce in future weeks, can provide detailed information regarding this investment option. Email us at mlemerle@blockchaincoinvestors.com to learn more.
BLOCKCHAIN COINVESTORS ANGELLIST SYNDICATE
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