Roboadvice – the automation of wealth management services – continues to put pricing and product pressure on the industry. Traditionally, financial advisors assess their fees as a percentage (1-2%) of the individual portfolio amounts they manage. Portfolio minimums have safeguarded the work expended by advisors in relation to the percentage fees earned. Roboadvisors like Betterment or Acorns feature lower barriers for customers as a result of their digitally native infrastructure, and thus low minimum balance requirements for a fixed set of portfolios - which require little human input. This not only enhanced B2C business for such Robos (i.e., individual investors opening accounts), but also B2B business (i.e., other financial firms using roboadvice powered platforms on behalf of clients). Betterment recently acknowledged dropping its $100k portfolio minimums for its 40bps premium service which gives retail clients the flexibility to customize their exposure in certain asset classes. We see this move in two ways, (1) to cater to the customers demanding greater flexibility, and (2) attracting and capturing customers from the ever-present competition, such as Acorns, Wealthfront, and Schwab.
Roboadvice is close to our hearts as one of the first themes, but for digital lenders, to erode the walls around the most expensive parts of financial services. Between Mint.com in 2007 and our world in 2019 is an ocean of difference. We highlight three symptoms that show just how far we have come. First, Schwab announced a new pricing model for its digital wealth and financial planning offering. Core robo portfolios will remain free by earning interest on the cash allocation (listen up stablecoins!), while the human-augmented service will cost $30 per month with a $300 onboarding fee. While prior attempts at paying directly for planning services were attempted unsuccessfully by Learnvest, and Robinhood has a freemium model where a subscription fees earn you a margin account, Schwab is a way-bigger fish.
We've pointed recently to the importance of understanding subscription as a shift from selling a manufactured product for a price (even if it is financed over time) to filling a consumer demand holistically. Subscriptions don't have lockups, can't take excess economic rents if your account grows from $100,000 to $500,000, and shift the business risk back to the business. They also squarely place Schwab among the likes of Apple, Google, Netflix, Microsoft, Salesforce and other *modern* consumer companies. Goodbye 1.5% on a minimum $1 million in assets for overpriced private equity and IPO access.
For now, $30 will only get you traditional money management. But if Bitwise and Abra get their way -- among dozens of other high quality companies -- investment infrastructure and associated choices will be changing entirely. Bitwise, a crypto-index fund with a passive approach, had authored a stellar document linked below describing the state of digital asset markets. In it, they show how to separate the 95% of noise in fake, manufactured crypto exchange volume created by bots to game rankings from the 10 real exchanges on which demonstrable human activity is taking place. We are building in the age of the Internet, and with that comes fake traffic, fake news, fake Twitter followers, and fake financial products. This document, and efforts by folks like Messari and DASA, is clearing the way for digital-native assets to actually work. None of this ecosystem, from investors to products to allocations to exchanges to crypto regulation, even existed in 2007.
So where is it going? One example is Abra, which has grown from a pure Bitcoin wallet to a provider of a synthetic asset allocation built using contracts-for-difference. While CFDs may not be accepted in all jurisdictions, don't look at manufacturing but at the customer. If a user can access stocks, bonds, real estate, private equity, gold, commodities, Bitcoin, tokens, banking accounts, loans and payments all from an app, that is the Holy Grail. And that is what the next 10 years is all about. The custodians and broker/dealers that have traditionally supported investment businesses, from Fidelity to Schwab, will move to integrate, own and support digital assets as well. And in that environment, solutions will not need derivatives to offer what is the most sensible package for the consumer. It will just be on your phone.
Once in a while we land on Coinmarketcap's crypto exchange ranking, and choose "Reported" volumes instead of "Adjusted" ones. In that world, everything is topsy turvy. Binance is no longer on the top, and BitMax, Bithumb and other unmentionables float around the meniscus. The answer as to why this happens is called "Transaction Mining", and was a big deal halfway through last year. This practice is not really mining, as much as it is churning. Normally, an exchange charges a fee to the buyer and seller for facilitating a trade on its platform. In this case, however, the exchange also pays the trader a rebate in the form of its own token. The more you trade, the more of the exchange's proprietary token you receive. And some tokens, like Binance's BNB, have become valuable to the tune of $2 billion.
The positive way to look at this practice is to say that it is "growth hacking" the exchange rankings, thereby creating more visibility for high ranking platforms. Imagine you are trying to maximize visitors to your website. Well, you might practice some search optimization techniques, get back links from blogs, and perhaps even pay for some fake ones. Or, you are growing a social media audience, and decide to cheat by buying fake followers to create the impression of engagement. These techniques -- while misleading -- are merely meant to get you noticed, and then real activity can begin. Traditional banks offer $250 rebates to sign up for a new account or credit card all the time! And in the case of crypto exchanges last year, a number of them used transaction mining to growth hack the rankings, spread around their token, and have now switched to more accepted pricing models.
But Bitmax, and its $1.4 billion of mined volume per day, seems an extreme. The negative way to look at this practice is to compare it to churning an account. If a financial advisor with a fiduciary duty directs trades in a client's account in order to generate fees and create the impression of activity, they are breaking the law. In such an example, the financial advisor has full control of the account. You may say that crypto exchanges are optional, and that the decision to churn trades in order to generate/mine exchange tokens is voluntary. Sure. But if bot-driven advertising can swing an American election, certainly misleading financial incentives can skew how people make investment decisions. The belief that the exchange token is worth something -- backed by little other than promises that it will be worth more once other people have it -- leads to destructive financial activity. To us, this looks a lot like a digital-first version of churning driven by a suspect financial promotion.
Here's a conundrum. You don't have a bank account and therefore cannot set up a digital payment option. Now try ordering and paying for an Uber! This example reveals a simple truth: digital services -- and in particular digital financial services -- can be regressive (benefit the haves, hurt the have-nots). As countries like the United Kingdom, China, India and the Nordics move towards demonetization, driven by technology and policy, the social and structural implications of getting rid of cash could make things a lot worse for the most vulnerable. Based on a recent UK report linked below, lowest grade workers and the unemployed use cash 49% of the time for their purchases, while those in the highest professional occupations use cash only 39% of the time. And conversely, card use is split at 37% (low income) vs. 44% (high income).
Weird. Fintech is supposed to be a democratizing force that allows anyone, regardless of account size, to access quality financial product. Let's stick with the UK for a clean analysis. If you look at penetration of mobile devices, 85% of the populace owned a smartphone in 2017, massively up from 52% in 2012. So that means, generally speaking, most people have some payment-enabled digital hardware that they can lug around in their pocket. And yet that device is not the financial key (yet) for the unbanked and underbanked. Why? One hypothesis is to look closer at the rails on which money travels, and their interoperability.
The first is paper cash. It requires no intermediaries, at least in concept, and therefore 100% of the population is able to "self custody" a little bit of it under their bed, and use it for commerce. The second is banking. Banking intermediates the financial system, and allows for modern services to function and thrive. But it also has an onboarding cost, set by the banking industry's risk tolerance, set by the legislator and the regulator, which may be prohibitive to some share of the population. It excludes "bad risks" by design. Banking also introduces costs into moving money around, which must be covered through business activity, and often warps into unethical economic rents (i.e., overdraft fees). When we talk about mobile payments, what we are really talking about is extending the banking system into the population that has adopted mobile phones -- and this excludes unbanked mobile users. As homework, we suggest the reader think about WeChat (mobile UX, media industry intermediation, government rails) and Bitcoin (mobile UX, hardware industry intermediation, blockchain rails) as being a solution to avoiding the regressive outcome.
When digital music assailed the music labels, their first response was to sue teenagers for peer-to-peer file sharing and to hire technologists to write Digital Rights Management software. DVDs bought in Asia wouldn't play in American DVD players, and so on. For finance, as blockchain nips at the ankles of storied industry, much of the response has been to (a) bring sovereign power to bear on the misfits, chasing them around to jurisdictions like Bermuda and Malta, and (b) hire technologists to build up enterprise control of crypto assets for issuance and trading. Symptoms of this abound -- from London Stock Exchange putting $20 million into Nivaura, to Swiss private bank Julius Baer entering the space, to regulators of various risk-tolerance drawing lines in the sand around token activities.
This is all good progress, we think, but it is an intermediate step to the Spotify (or Google or Netflix) of finance. Let us dwell on a distinction for a moment. Fintech players democratized access to financial products -- see our many earlier entries on amassing consumers through attention platforms at discounted prices. Those financial products, however, are still institutionally manufactured. But when you look at music or film today, an increasingly large portion of our attention is going to creator-generated content that sits on Youtube and Twitch. We all watch Game of Thrones (i.e., made by the Goldman Sachs of content production), but we also see Gary Vaynerchuk and Joe Rogan endlessly peddling their hustle -- without traditional institutional backing. The same point can be made about Uber drivers.
Decentralized finance is the latest iteration of the crypto theme, and its core premise is that the manufacturing of financial products across the whole stack will be done by individual creators, or aggregated to scale via crowd cooperation driven by DAO governance like Aragon. For the more traditional readers of this newsletter, these words sound like nonsense, but they are not. Payments is the simplest use-case, and already has a decentralized product that works to this day: Bitcoin. Lending, Trading, and Derivatives -- intermediated by software networks and not by legal issuers -- are starting to come online. The tracker below shows some of the smaller independent projects, the maturity of which reminds us of Ethereum's dApp tracker in early 2017.
The other reading we encourage you to do is check out Multicoin Capital's report on crypto exchange Binance, its BNB token, and decentralization plans. Facebook and Amazon, companies whose value has been built over 20 years, are locked into a public shareholder structure that will disallow them from burning down the house and giving all the value away to users. Not so for a multi-billion dollar phenomenon built in a few years, where the largest existential danger is legal sanction to the billionaire founders for unregistered securities dealing. Atomizing the economic value of a quickly-built monopoly into software running on millions of computers, such that it cannot be shut down or controlled (e.g., Pirate Bay), could be the chassis of real, at-scale decentralized finance. Right now though, this theme is struggling to get off-the-ground with meaningful volumes, so a heroic event will be necessary to properly kick things off.
SoFi has thrown two bricks through the window of the finance industry this week. The first is a set of no-fee Exchange Traded Funds (ETFs) to be distributed through its proprietary roboadvisor and third party brokers like Fidelity and Schwab. SoFi is the second meaningful institution -- after Fidelity -- to price beta exposure to public markets at zero. We think back to Napster and the collapse of music prices to zero as distribution channels shifted from (a) buying records to (b) "piracy", i.e., kids trading songs with each other on the web. It's not that the cost of manufacturing the song, or the ETF, is nothing. Rather, when distributed to millions of users, the fixed cost trends towards nothing and the variable cost is de-minimis.
The business model implication for Music was to give away the very core offering, and to charge for t-shirst, concerts, and the convenience of using Spotify's neat interface. The business model implication for investment management is to give away the very core offering, and to charge for asset allocation, planning, and a subscription to an easy-to-use financial services bundle. There is more to be said about hiding monetization, about making it hard to see and quantify. Arguably, Google, Facebook and the other web companies have made this trade-off opaque; we get the core offering for free, and pay invisible, unfelt things that aggregate into monstrous compromises. Similar dangers lurk here -- from Robinhood's liquidity selling to algo traders to Fidelity's "infrastructure fee" of 15 bps to mutual funds on its brokerage shelf. Money will be made somewhere, and as a mere human consumer, you likely won't see how.
The second brick from SoFi is an agreement with Coinbase to power SoFi Invest's crypto currency trading within the lender's digital app. Targeting Robinhood and Revolut with this move, SoFi is delivering on the vision of a broad cross-sell of financial products to a captive Milliennial audience. Coinbase needs the trading, as its revenue is highly correlated with crypto asset prices. The exchange has been fairly indiscriminately listing coins, like the divisive Ripple XRP, to get its 2017 groove back. Maybe the rumored Facebook coin will do the trick. What we want to point out further is that the CEO of SoFi is the former COO of Twitter. Jack Dorsey, the CEO of Twitter and Square is a well-advertised Bitcoin and Lightning network supporter. Square controls Cash, the most popular (sorry Venmo) peer-to-peer money movement app in the United States. In 2018, the app facilitated $166 million of Bitcoin sales. These bits of data tell us one thing -- SoFi, Twitter and Square share a fact base, institutional talent overlap, and a likely vision for the future.
We're Americans worried for Americans. We just won't understand the future coming, and then the whole tilt of the world will shift. Take Samsung, dropping two known but very meaningful bits of information. The first is foldable phones. The only note we've made of these devices has been to compare them to pizza boxes -- most prototypes look preposterous, have issues with cameras, and are prohibitively expensive. And that's still true -- Samsung's foldable phone is pretty expanded, but bizarre when folded. But no more bizarre than cellphones from the 1980s! The other meaningful companies working on bendable screens and phones are all in Asia, because the manufacturing capability and hardware innovation for this stuff has been outsourced long ago. Huawei, Xiomi and others will all champion this form factor -- and Americans won't get it.
Second, Samsung also confirmed that the Galaxy S10 phone line will be crypto-native, allowing for private key storage. We think the absolute largest roadblock to economic activity using cryptocurrency is the barrier to entry in user experience (followed closely by financial instrument packaging and bank buy-in). Having a mobile experience that allows you to interact with the decentralized web and its applications without downloading or thinking about software management is massive. Players like HTC and Sirin are also in the game, but we point to Samsung Pay as a meaningful differentiator. There should be no difference -- from the customer view -- in using a credit card in Samsung Pay wallet, and using a self-custodied digital asset. Same use case, same ease of use. And if every merchant that takes Samsung Pay takes crypto, well, you get the idea.
Thereafter, dominant phone apps like Facebook can also step up, tokenizing aspects of their services for a global install base. Collectibles, financial instruments and health records quickly follow. We worry, again, that Americans -- who don't want to use QR codes and can't stop swiping their credit cards -- will simply shrug this off. Skepticism is the antidote to innovation. But there is also plenty to be skeptical about. In particular, for normal people, the endless security worries about everything from the physical device being stolen to your crypto assets being 51% attacked (looking at you ETC) are a legitimate black swan. Not dealing with that at the protocol level will mean the rise of walled gardens, yet again. Just consider how the wild anonymity of the early Internet in the 1990s faded into protected, authenticated, verified Instagram influencers. Yikes!
You know by now that JP Morgan launched a crypto asset called JPM coin. You've probably seen the self-satisfied memes showing Jamie Dimon publicly hating on Bitcoin, contrasted with his own massive bank launching its proprietary, closed cryptocurrency (leveraging open source software created by others) within a year -- and claiming it is a meaningful invention. Perhaps you've read that this is a first-of-its-kind symptom demonstrating that banks are finally coming into crypto. Cool, huh! Yet all of these reactions are mostly irrelevant to thinking about what's happened.
First things first. JPM has started production deployment of an internal blockchain (i.e., for its clients and divisions), which they have been developing openly for years, applied to multiple use-cases from international payments, to corporate issuance, to trading and other capital markets businesses. This is a no-brainer, and the totality of such projects should create $250 billion of industry-wide enterprise value in cost-savings over the next 10 years. The new thing is that they have added a token into this blockchain that carries digital scarcity, and can therefore be used for international value transfer. As an aside, the UBS utility settlement coin pioneered this type of asset over a year ago, led at the time by Alex Baitlin, who has since left to found smart crypto-custody company Trustology (backed by ConsenSys and Two Sigma).
Who should worry about the inevitable but welcome growing competitive landscape of bankcoins? First of all, consortia players like Ripple and SWIFT (partnered with R3) cannot be happy with the development, since JPM funnels a meaningful portion of the cross-border B2B money movement flow already -- $6 trillion per day. What's odd also is that half a year ago JPM was planning to spin out another proprietary blockchain project (Quorum), since other banks were refusing to use it. The internal value generation within the firm of essentially having a cloud-like solution for value transfer must be sufficiently large to alienate others.
On top of that, let's clarify what bankcoins are. Money supply is divided into M1 (cash and checking), M2 (very liquid cash equivalents), and M3 (more engineered cash equivalents). Bitcoin wants to be cash/M1, which is very hard given that to print money is to be sovereign -- see David Siegel's primer on money in the links below. So in the US, M1 is around $3 trillion. But the delta to M3 is another $10+ trillion, and includes things like money market funds, overnight obligations between investment banks (hey there corpse of Lehman Brothers), repurchase agreements, and other gargantuan liquidity instruments manufactured by banks. In fact, M3 is so obtuse and large that the Federal Reserve stopped publicly tracking it in 2006, and the data only exists on a synthetic basis from ShadowStats. This is what JPM coin is at its core. This is what all stablecoins -- tethered as cash sweep into their respective proprietary exchanges -- can ever become. A paltry $10 trillion.
Two extreme things just happened in the land of Crypto. The first concerns the Quadriga exchange, whose CEO has died while traveling in India -- while also being the only person with key access to $130 million of customer funds on various blockchains. This means the permanent loss of customer assets. Tactical comments like using multi-sig wallets or not trading on a subscale exchange are besides the point. The key takeaway is that this new-fangled crypto banking has a wildly unpalatable feature. The second extreme thing is Jack Dorsey, who loosely-speaking controls Twitter (millions in audience) and Square (millions in payments), participated in Bitcoin's "lighting torch". This is a process by which one Twitter user sends a few pennies worth of BTC to another user through the developing Lightning Network, facilitated by posting a lightning network invoice in a tweet (there's even a conspiracy theory that Twitter expanded its character limit to accommodate these invoices). So if Bitcoin is money, then it's moving like never before.
Let's pause for a moment to consider how innovations become reality. We recommend the following frameworks: (1) the book Why Greatness Cannot Be Planned: the Myth of the Objective and (2) Epsilon Theory's discussion about seeing change in the Zeitgeist, both linked below. Boiling things down, the book concludes that it is not objective maximization that gets us to great outcomes (i.e., let's develop a new money or a new artificial intelligence) but the search for novel, disagreeable, controversial outcomes. The more new or bizarre something seems, the more likely the discovery will open up a search space for entirely new directions. From that perspective, the examples of Crypto extremes above point to the most compelling stepping stones to the future. That they are made through market evolution (from on-chain transactions to Lightning) and demonstrate some version of natural selection (exchanges without multisig wallets will die) is more promising than a corporate initiative into making practicable enterprise solutions to save cost.
On the Zeitgeist point, the essence is that an astute observer understands when the meta-game changes. We are certainly seeing this in politics, with the US pivoting away from a Bush vs. Clinton each trying to satisfy political donors, into a Trump vs. Ocasio-Cortez trying to satisfy their social media audiences and the machine learning algorithms that deliver information. More practically, we can see a zeitgeist shift in the role of technology. Whereas tech used to be the supporting Shield in financial services, today it is the aggressive Sword. This pivot is obvious when looking at Fintech's share of venture capital and comparing it to the share of the stock market in financial services companies. You can see below that what started out as 5% of venture and 23% of public equities has converged in the mid-teens. Once Fintechs started being built like Silicon Valley startups, the relative value shifted out of traditional financials into private capital. When we allow China and Ant Financial into the equation, private fintech venture is now over-indexed relative to the public markets. The soil in which things grow has become different.
We have seen an unusual amount of soul searching in the Crypto community in the beginning of 2019. Crypto assets, which the more detail-oriented thinkers in the space see as fundamentally improving, continue to bleed out. Nearly 90% of decentralized applications have less than 1000 users. In response, the priesthood of the movement must find new language to motivate global open source development and continued investment. Given the type of person that has a following in the crypto space (Millennial, male, developer, international, math/econ overindexed), their stories and investment theses are rooted in Bayesian thinking, macro economics, and formal logic. The stories create a sense of data-backed philosophical inevitability, but as Nic Carter and Felipe Pereira point out (links and charts below), these are just meta-stories for why followers should keep following, and the direction in which they should go. You can think of these stories as marching orders for the army of disruption.
The two examples we will call out are (1) Pantera Capital's Open Finance and (2) the debate around crypto law. In the former, the argument is that the "primitives" (i.e., Lego pieces) of the financial system are being open sourced and built in a permissionless, global manner. New generation versions of timeless services like banking, lending, and investing will grow outside finance on parallel rails and be better than the existing system. We agree with the vector of change, though deeply question short term practicality and the framing from which the argument is made (i.e., protocol maximalism). A symptom of this change can already be seen in the repurposing of ICO offering platforms and liquidity into STO brokers and exchanges -- e.g., $400M marketcap biotech company Agenus is using Atomic Capital to launch a token that gets a royalty payment on a cancer treatment which is still in clinical trials. Or take SWIFT's trial implementation of R3's Corda to combat Ripple.
The second discussion is around norms that have emerged in the ecosystem, harking back to questions about whether "Code is Law". As we have seen from the regulatory blowback and the application of sovereign power, Law is Law (and jail is jail). The crypto-anarchist revolutionary fervor ended up being statistically incorrect in the short term, and a new narrative is needed to keep marching. We see these debates as similar to a Constitutional Moment, with online personalities jockeying to be Jeffersonian-framers of how the future should be negotiated and governed. Linked below is a piece by Vlad Zamfir on proposed norms (like keeping Crypto within the legal bounds of the real world and not intentionally breaking blockchains), and it is worth reading to understand what this community believes and how it reasons. No other part of Fitnech, but for AI ethics perhaps, does this much thinking and narrative building about itself. This is why it is a fundamental Black Swan threat to the financial industry, whose narrative has been rotting since 2008.
2019 has started off with a bang in capital markets blockchain -- (1) a $20 million investment by Nasdaq in enterprise blockchain FX player Symbiont, on the heels of Baakt and ErisX, (2) a Security Token Realized conference well attended by financial services execs from companies like State Street, of which 70%+ owned BTC, (3) and meaningful technical developments and financial products from folks like Tokeny, Securitize, Templum, Atomic Capital and others. But let us shift to another leg of the crypto stool this year, which is staking-as-a-service. We recommend reading the Coindesk op-ed from Michael Casey linked below, which outlines how a transition from proof-of-work to proof-of-stake in Ethereum (if it ever happens) could lead to the intermediation of crypto deposit holding on behalf of consumers. If investors get paid for outsourcing private key management to custodians, argues Casey, we re-create the fractional banking system with its pitfalls, like counterparty risk and incentive trends towards leverage.
We agree, but aren't immediately put off by the comparison because credit is the lifeblood of inter-temporal economic decision making. Staking reminds us of two things from traditional finance -- capital requirements for banks, and interest-bearing deposits within those banks. As soon as users realize that they should be getting some interest return from their outsourced cryptocurrency accounts at exchanges or custodians, there should be broad competition around this product. If Coinbase offers 3% while Binance offers 4% of staking rewards (or vice versa), the consumer choice becomes more clear. This is exactly what banks compete on in terms of attracting deposits.
Users can already get an interest rate on their crypto for margin lending, up to 7% or so depending on the token. As an aside -- that margin lending may be a bad deal for the lender, since you are powering the short-selling of the capital asset you hold. You could also compare staking returns to dividends that corporations pay to their shareholders, as shareholders buy the equity and commit capital to an asset. Given that these staking rewards are raw inflation (rather than cashflow earned by a corporation), the dividends become a value transfer between holders that stake and those that do not -- a tax on the unsophisticated user. Also, a dividend by law has to be passed on to the beneficial owner, which is a good thing. But that's not very anarchist of us.
Human nature does not change. We can have arcane towers of financial services and regulatory architecture, but the outcomes are a rhyming echo of our DNA. Let's start with this: Fortnite, a virtual place where 200 million people spent time playing a game in 2018, earned $3 billion for its parent company. The video streamer most popular for playing Fortnite on (essentially) TV earned $10 million for the entertainment he provided to 20 millions followers. One of his videos gathered nearly 700,000 views -- for comparison, Conan O'Brien gets about 1.3 million per night.
Fortnite makes money by selling cosmetic upgrades to players, and since they inhabit this rendered world like any other social network, our dopamine center and social pressures motivate purchases for status. Given the payments infrastructure of this game and its virtual currency (not on the blockchain!) are comparatively weak, criminals have started using in-game value for money laundering. A report from The Independent linked below finds that stolen credit card credentials are being used to purchase game currency and then cashed out at discount on eBay. Additionally, over 50,000 instances of online scams related to the game made their way to social media per month. Welcome to the Internet, everyone! We can't help but remind you that Steve Bannon (yes, that one) and Brock Pierce (EOS, Tether, Puerto Rico, etc.) once ran the largest World of Warcraft virtual money exchange.
So should we bring down the financial regulators on Epic (the maker of Fortnite) as hard as New York state came down on Bitcoin companies with the BitPay regime, freezing innovation? Should KYC/AML be required for all video games? Under the Chinese model, Tencent's "Honor of Kings" mobile game generates $2 billion in revenue per year and is under the same strict government control/license as financial products. Players are checked against a registration database to control for age and name, and (we expect) the play time data flows into a social credit score. But recent studies of KYC/AML policies persuade us otherwise. When looking at the amount of criminal proceeds actually seized by authorities based on those policies, the amount is less than 1%. The cost may not be worth the outcome.
Crypto is dead, long live Crypto. We've tried to update our token offerings and blockchain financing figures to see the state of the market. On a monthly basis in December, there continues to be an almost even split between (1) weird internet crowdfunding at $490 million, and (2) traditional venture funding into blockchain-first companies at $310 million. We think the first figure is inflated despite our attempts at scrubbing it, and reserve the right to revise. Quality of the data keeps going down, and several projects self-reported raises in December that they may have finished earlier in the year. If anything, our intuition is that real (rather than aspirationally self-reported) ICO funding is below the venture number.
As an example, take the largest December self-reported ICO: Jinbi, supposedly raising $47 million for a gold/blockchain token in China. The screenshot is below, but we are pretty sceptical. On the other hand, the $180 million raise from venture into institutional exchange Bakkt is well documented and known. So let that flavor the story for you. Still, when you zoom out on an annual basis, 2018 saw $5.2 billion of venture activity and $19 billion of token offerings -- not bad for a sector in decline. Future activity is indeed trending into Security Token Offerings, with several conferences focused on the space early in the year, as well as players from across industry types competing. Whether you are an equity crowdfunding platform, an ICO developer, or a Wall Street capital markets firm, chances are that tokenizing securities and distributing them globally in a solid regulatory framework is top of mind.
So will this be the saving grace of the sector? Hard to say, but it seems that tokenizing securities is about packaging (1) risky startup equity or (2) a share in some mall in Wyoming and plugging that into the equity crowdfunding theme. That may or may not result in better capital markets infrastructure, democratization and roboadvisor-led asset allocation. Or it may just be left-over junk that nobody else would buy. And second, the crypto economy needs non-financial activity to succeed. People should be building software using the global decentralized computer of Ethereum (or EOS or Dfinity) and paying for it using the global decentralized currency Bitcoin. More crowdfunding ain't that.
We'd love to write about all the interesting decentralized applications that the crypto community has scaled to millions of users. But we can't, because it hasn't. So instead, the news cycle is still stuck on the financialization and securitization of tokens in the far reaches of the Internet. At least it is a re-thinking of capital markets from the bottom up -- and this being a financial technology newsletter, we will oblige with the theme. But what may seem obvious on the surface is really not. Blockchain-based exchanges are not about better systems today (they may be in the future), but about finding cash flow to survive the nuclear winter and later expand into adjacent verticals (e.g., Coinbase, Binance).
The first story is about Japan, where a crypto-friendly regulator has received 190 cryptocurrency exchange license applications. Pause on that. Financial instrument exchanges are not this popular organically, with just 16 stock exchanges accounting for 87% of total stock exchange market cap (see chart below). In Europe, a similar fervor is in place about starting up new banks -- something about the power of the Crown in the palm of your hand. So seeing a wave of small, uncoordinated capital markets infrastructure teams try to bootstrap into a licensed, centralized/monopolized venue for financial exchange across the world isn't a sign of positive progress. It is a sign of a meme echoing across Twitter.
Second, we point to the $182.5 million funding round just raised by Bakkt, owned by the Intercontinental Exchange (also owner of the NYSE). Microsoft, BCG, Galaxy, Pantera and others chipped in. This is a fat raise, and it reminds us of R3's bank consortium, Digital Asset's trading systems, and a bit of Telegram's $1.7 billion venture capital black hole. Wall Street is building infrastructure for Wall Street, expecting to be the owner of all crypto OTC and institutional flows -- the blue ocean opportunity is now gone. Yet Asian exchanges like Binance continue to be the life-blood of retail crypto finance, built for users trained on video game money. Dressing this stuff up in a suit and trading a lot of it is a meme as well.
The last 5 years have seen fundamental innovation in crowdfunding, regulatory technology, the digitization of financial services, blockchain native organizations, and automated propaganda bots to attract human attention. 2018 brought with it sobriety and a back-to-traditional regulatory treatment of financial assets and their structures. In particular, the crypto asset movement (and its crypto-anarchist community construction) has been put into a well-understood, regulated box by most national regulators. While many interesting lego pieces exist, none of them have yet to fit together. Still, regular people have gotten a taste of both the distribution and manufacturing sides of financial mana.
2019 will re-combine these pieces to instantiate functional autonomous organizations that work in a constrained market environment and perform useful services. Unlike the failed experiments of the DAO or BitShares, these new DAOs will have a clear corporate form, a regulatory anchor, and will focus on delivering products and services to regular people, but scaled through machine strategy. The automation of company formation (Stripe Atlas) will combine with the outsourced human/machine assembly line (Invisible Tech) and distributed governance (Aragon) to create companies that scale frighteningly quickly.
Such creatures need a safe environment in which to operate, with a narrow set of functions and constraints. We see labor platforms like 99Designs or Upwork as useful sandoxes to test whether software-based organizations can compete in a human market. Such experiments will require a re-thinking of the tokenized approach, leveraging the micro-economic discoveries but avoiding the need for a poorly adopted crypto wallet or token. Designers will need to reduce friction, not just lump together coding ideas. But the timing and soil for this could be just right.
Here's what we said would matter in the past year year:
We were strongly correct in thinking that the social media pipes of LinkedIn, Twitter and Facebook will be used for selling financial products; the claim that these tools will be supported by some of the shadier aspects of propaganda bot networks also came true in particular cases. The second largest crypto currency, Ripple, is associated with a large and active bot and sockpuppet network, which has supported the market value of XRP to be $15 billion, only behind Bitcoin, and in competition for second place with the far more functional Ethereum.
Various social influencers – like DJ Khaled (6 million followers on Instagram) – peddled digital assets during the ICO mania and have faced regulatory fines; Youtube similarly was filled with investment advice content from enthusiasts. We were wrong about the pace at which traditional businesses will do this in the short term, but are still convinced this is a longer term change that will happen with the generational shift in both sales and regulatory roles. People are spending 12 hours a day on media, increasingly on LinkedIn, Youtube, and Twitter, and marketers are well aware. And if you have a LinkedIn account, so are you.
Here's what we said would matter in the past year year:
How did we do? Pretty well overall. We predicted massive volatility and we got it. The massive market capitalizations of 2017, rounding up to $1 trillion, have deflated down to $100 billion and change. Many assets melted 80%+, but we will call out Bitcoin Cash specifically, which fell from $40 billion to less than $3 billion after yet another rough fork at the end of the year. On the other extreme, EOS raised $4 billion in ICO funds. New smart contract platforms indeed came to market – from EOS to Hashgraph to Dfinity – but Bitcoin dominance has stayed fairly flat at 40-60%.
The negotiation against incumbent sovereigns and traditional banking moves forward; regulators across the world have placed many 2017 digital assets in a regulated “securities” bucket, with enforcement actions starting to target individuals and exchanges. At the same time, institutions like Fidelity have launched crypto custody divisions, the NYSE is launching crypto exchange Bakkt, and the number of enterprise players in the space has grown like weeds. While no ETF was launched due to SEC concerns around market maturity, an Exchange Traded Product did launch in Switzerland using VanEck index data.
Source: 2018 Keystone Predictions Deck, Coinmarketcap (total capitalization, % BTC dominance), Fidelity, Amun ETP, Bakkt via ICE/NYSE
But wait, there's more! Certainly all top-3 neobank champions by geography are hungrily eyeing international expansion . The US is looking delicious for Revolut and N26, Europe is interesting for Ping An as it invests over EUR 40MM into fintech venture studio Finleap, Fidelity wants to open a roboadvisor in the UK, and so on. Technology does not have borders. This is why we are particularly interested in Good Money, funded to the tune of $30 million by Galaxy EOS VC fund (remember EOS raised $4 billion). Good Money is a "banking platform" whose equity will be owned by users when they take certain actions, like opening an account, installing the app, or referring friends.
If that sounds like tokenized equity intermingled with Binance referral codes, you're right! One thing we've learned from the ICO mania, other than that some people are sharp-elbowed opportunists who will go to jail, is that human beings like being in communities, and that communities grow way faster and cheaper than "customers". By combining crowdfunding with account actions, this play has a chance to build viral loops, and pioneer a model where a corporate structure (equity) and utopian philosophy (communal ownership of money) have mutually-reinforcing benefits. The blockchain software progress of the last two years makes this possible. Whether it will work or not is another fun story.
Last, but not least, is Robinhood and their announcment of banking service to their 6 million mobile-first customers. The products is called "Checking & Savings", will deliver a 3% interest rate (vs. Goldman Marcus at 1.85%) and rebated ATM access with a debit card. It is not a bank account and therefore not subject to FDIC insurance. In fact, the whole thing is old hat -- Schwab does this well now (albeit with lower rates on its money market funds), and every HNW wealth management shop ran such an offering for the last 20 years. But you know, Robinhood actually knows how to sell and position a product for its audience, and are willing to burn venture money to deliver a 3% return. Steve Jobs made a killing announcing previously existing products as inventions of Apple -- and he won, because Apple's re-inventions were better suited for the times. Who will you bet on?
Ugh. Here's the monthly update on the crypto fundraising figures. Let's start with some good examples -- we are fans of Trustology raising $8MM in equity from Two Sigma and ConsenSys, and ErisX raising $28MM from Fidelity and Nasdaq. Those sound a lot like the institutional chassis needed for traditional players. However, from a retail perspective, the crypto markets are not holding their value in an overall downturn, and have been fairly correlated with traditional equities as everything nosedives together. This is in meaningful part, we think, driven by the availability of instruments to take short positions in the market.
We took the ever excellent OnchainFX data from Messari, and looked at the total loss of market capitalization (i.e., "hopium") across their tracked coins from all-time-highs. The answer is that there has been nearly a trillion of burned down value in the last year. Millennials are going to be salty for a long time! But look, it's not all doom and gloom. November saw another $700 million or so in blockchain-first funding, again roughly split 50% between token sales and venture investment. The sustained flow of venture is encouraging to the promise of this sector in the future.
Some conclusions from looking at the tokens in detail: (1) an Arizona offering stood out as an interesting jurisdiction, (2) a few EOS projects are going forward, (3) some projects are using the STO monicker to try and position more positively, and (4) there are still quite a few questionable business models in the mix. Looking at crypto funds, we continue to see new entrants in the space, even as 2018 funds face -80% performance profiles and shed employees. Crypto projects are also starting to downsize, and we projected for Bloomberg a contraction of 25-50% in the number of funded seats at the blockchain table for existing companies today. That doesn't mean there can't be new companies with new opportunities ahead -- it just means their journey will be more rational, and potentially more fruitful.
We moderated a panel on crypto funds (Pantera, Milticoin, Outlier Ventures) at Coindesk's Consensus:Invest conference, as well as appeared on a fun Coindesk Live segment. The general sentiment was that across strategies -- trading, passive, venture -- the funds are very optimistic about a long term horizon, ignoring short term volatility. Of course they have no choice but to tell that story! Second, the event felt very institutional and focused on financialization. That means that there were many security token, custody and exchange solutions, and that many people were garbed in formal dress. While retail peak may have been December 2017, enterprise solutions are coming to market now, and will be catalyzing a very different environment next year. Anecdotally, this New York event was more coherent in its finance vector than the recent European blockchain and token conferences that we have attended.
This institutionalization is also echoing also in larger public companies. See Amazon launching blockchain-as-a-service inside AWS. Or take Overstock -- a discount version of Amazon helmed by outspoken eccentric capitalist Patrick Byrne (not to be confused with Tim Draper, John McAfee or David Byrne) -- which is planning to sell its entire retail business in order to focus on tZero, the blockchain capital markets arm. The company's price is already highly correlated with Bitcoin, and it just feels like Patrick will have a lot more fun running a fintech company.
We dislike this for a few reasons. The first is that Overstock is a commerce destination, and it would be nice if cryptocurrencies, stablecoins or other Frankensteins, were actually used to buy stuff. So that maybe goes away. And second, we remember Overstock launching a roboadvisor, and claiming that the eCommerce footprint was going to be a distribution arm. Well, not if you don't have traffic. There is meaningful money to be made form institutional-grade capital markets on blockchain infrastructure -- but everyone from Nasdaq to Fidelity to JP Morgan is already chasing that dream. Who's going to sell cat food and crypto to the little guy?