I recently had a conversation with an old friend that I grew up with. He’s also an investor, but he’s focused exclusively on crypto and has been investing in the space since 2017. Candidly, our conversation was amazing. It was exploratory, intellectualy stimulating, and open to the, “I don’t know’s” of life. We are at two totally different depths of the adoption curve of crypto/web3, but our conversation left me wondering. Where are we headed with Web3? What does it all mean? And how can Web3 consistently create value for real people and real businesses?
As an investor, I think about competition and comparative advantages a lot. What is the scalable/repeatable distribution strategy? Does a competitor have a cost sturcture that offers better pricing? How does this product’s wedge compare to existing solutions in market? As Web3 continues to take root in the cultural zeitgeist, and gain more attention, investment, and talent - I wanted to explore my own perspective on what the comparative advantages of Web3 actually are. Plainly I think there’s a few things:
Peer to Peer (And Trustless) Digital Exchange
Immutable Data Storage
As we’re want to do in VC, because we loooooove to pontificate on ideas, I’d like to share my thoughts on each of these comparative advantages with all of you. My perspective is open to feedback and criticism is encouraged. Generally, I believe that iron sharpens iron and if you disagree with my thinking (or agree) I’d love to hear.
If you’re new to Web3 and none of the above makes sense to you, that’s okay. I made a living, breathing list of helpful resources to get started, here. It’s a compiltation of resources I’ve used to get more up to speed myself as well as others that have been recommended to me. I’ll continue to add/refine this list over time.
Okay cool. Let’s dive right in. Also as I dove more into this first perspective, I realized I don’t want to overload you all with information in one article. I’ll continue to explore my other opinions on these comparative advantages later on, but for today we’re just going to focus on one idea -
Comparative Advantage #1 - Peer to Peer (And Trustless) Digital Exchange
Before getting into how a blockchain enables peer to peer digital exchange, let’s first take a moment to discuss how money moves today. When we think about money moving, for many of us - it’s intuititve. It falls something along the lines like this:
I hand someone cash, they hand me change
I swipe my debit card, money is pulled from my checking/savings account
I swipe my credit card, the charge is recorded and I pay that charge off sometime in the future
I hand someone a check, they deposit the check, the exact amount is pulled from my account
In the case of handing someone a cash or check, 100% of the money you spend is recieved by the person you pay. You’d think that the same thing happens with a debit or credit card right? Nope. When you spend money with a debit or credit card, it’s something closer to 97% of the amount you spend is recieved by the person you pay. In order to facilitate the consumer convenience of no longer needing to lug bags of cash around (which carries inherent risk), and to be able to happily swipe away our finances with little plastic cards - the card networks (i.e Visa, Mastercard, American Express, Discover) developed over time to create a system where they operate as the middlemen that connects the bank that store YOUR money (i.e Bank of America, Citi, your local credit union, etc.) to the banks that store BUSINESSES’ money.
That 3% that businesses lose is the cost they pay to faciliate a positive customer experience. It is the cost they pay to have the confidence that 99.99% of the time when a customer is ready to pay for something at their store, they can accept whatever form of payment that customer chooses to whip out.
Where Web3 comes in, and throws down the gauntlet is by saying “Hey Visa, Hey Mastercard - you guys don’t need to exist. We’ve got this cool new tech called a blockchain that is a decentralized database/storage system that removes the need for intermediaries in financial transactions. As long as you have access to the internet, you’ve got access to a blockchain, and a blockchain can in theory make you guys go bye bye.”
Okaaaaaay so, Dez - what is a blockchain? Glad you asked. Here’s a technical definition of a blockchain from the OGs of computing, IBM -
A blockchain is a shared, immutable ledger that facilitates the process of recording transactions and tracking assets in a business network. An asset can be tangible (a house, car, cash, land) or intangible (intellectual property, patents, copyrights, branding). Virtually anything of value can be tracked and traded on a blockchain network, reducing risk and cutting costs for all involved.
Here’s another definition from everyone’s favorite website that got them through their first finance course - Investopedia!
A blockchain is a distributed database that is shared among the nodes of a computer network. As a database, a blockchain stores information electronically in digital format. Blockchains are best known for their crucial role in cryptocurrency systems, such as Bitcoin, for maintaining a secure and decentralized record of transactions. The innovation with a blockchain is that it guarantees the fidelity and security of a record of data and generates trust without the need for a trusted third party.
And finally for my fellow visually or auditory oriented learners in the room, here’s a great video from Wired that explains blockchain at 5 levels of difficulty from child to expert
You don’t need to watch this from end to end (but it is a useful video), but when Bettina Warburg, the expert, is having the conversation with the Teenager, Ian. She broaches the conversation with Ian by comparing a blockchain to Ebay, which at the time of the interview, happened to be where Ian was selling his computer. When asked about why he decided to sell his computer on Ebay, Ian said this
"Well I’ve heard of it, and I trust it a lot because they have all of their guarantees. I know that I’m going to get money, and I know that the person is going to get what they want.”
As Bettina continues her analogy between blockchain and Ebay, Ian asks an insightful question, “So how does it work?” This is Bettina’s response:
“It’s basically a network of computers that all have the same history of transactions, so instead of being one company with one database that holds all the information, the same sort of list is held by all of these different people, like you could have it on your computer, and that gets validated by everyone and basically that turns into the next part of the list.”
So, in the spirit of learning in public, how I interpret all of this information is that a blockchain is a shared database that in theory removes the need for trusted intermediaries, and in theory cannot be retraoactively changed because it is shared across a massive group of people.
I know that was a lot of context to provide, but here’s where I’ll start to make my point on the comparative advantage that I see with a blockchain. In the Bitcoin whitepaper, which is basically like crypto’s version of a consitution (because it was the first successful blockchain), Satoshi Nakamato (a pseudonymous person or persons who developed bitcoin, kinda like a Santa Claus for adults) presents this vision for Bitcoin,
Bitcoin is “a purely peer-to-peer version of electronic cash [that] would allow online payments to be sent directly from one party to another whithout going through a financial institution.”
Because Bitcoin was the first successful blockchain and because Bitcoin directly sought out to create this “peer to peer version of electronic cash” all of the iterative improvements of blockchain technology are built on top of this initial vision, and all of these iterative improvements (in varying degrees) are focused on reducing the existing need for intermediaries on the internet to facilitate digital transactions whether they be financial in nature or otherwise.
That 97% of a transaction that goes to a business in today’s world when you or I pay with a debit or credit card? In theory - it goes to 100%, when it’s facilitated by a blockchain instead of our exisiting payment systems. That 3% may not sound like a lot but when you realize that ~54% of the time consumers pay for things with a debit or credit card, and in 2020 based off of personal consumption expenditures reported by the Bureau of Economic Analysis, consumer spent nearly ~$14T on goods and services; the numbers start to add up. The quick math on that is that roughly ~$200B dollars is being diverted away from the producers of the goods and services, and into the hands of centralized intermediaries that use their market power, economies of scale, and effective duoploies to impose this tax on American business writ large.
Source - 2020 Findings from the Diary of Consumer Payment Choice (Federal Reserve)
Now, I said that in theory, with blockchains - 100% of a transaction can be executed peer to peer. There are two important points we need to consider:
Blockchains have not successfully scaled in a way that the card networks have
Blockchains are not free utilities, they require some form of payment or work to function
To illustrate my point, in 2021 Bitcoin processed nearly 98 million transactions. Wow! That’s a lot! Yes, until you compare that to the 800 pound gorilla that is Visa. In the twelve month rolling period ending June 30th 2021, Visa processed 206 BILLION transactions. Holy Shit! That is literally 2000x more than Bitcoin, and it simultaneously illustrates the opportunity for blockchains (and more broadly, one part of Web 3’s potential value) And on my second point, blockchains are not free. When you go to submit your data to the distributed database/ledger that is a blockchain, you have to PAY for that storage space, and you are paying that distributed network of computers/software to store your data. The cost structure shifts from being placed on businesses to on the individual, the cost structure doesn’t just dissapear in it’s entirety.
I bring these two points up because I want to illustrate that one of the comparative advantages I’m arguing that Web3 has, Peer to Peer (And Trustless) Digital Exchange, is in it’s very early stages and it is not perfect. Effectively, Web3/Crypto/Blockchains all offer the opportunity for this comparative advantage to be realized, but not the guarantee. This is a key distinction for me, because if the people building in Web3/Crypto cannot figure this out, the value proposition of what they are building is diminished, people stop believing in the opportunity at hand, growth stalls and capital, talent, and attention exit stage left.
One final closing thought for all of you. In a lot of ways, with technology - we are effectively Ian, the teenager from the Wired video. We can understand things conceptually, but not technically. I don’t know how the radio in my old my high school 2010 Toyota Camry works. I have a moderate understanding of how the TV in my living room works. I have enough of an understanding of how the internet and the computers I depend on for my livelihood, work. BUT I don’t feel a need to dive deeper into understanding what happens under the hood, for any of these technologies, because the guarantees each of these technologies provides me consistently occurs. I place implicit trust in the fact that when I turn on the radio - I will hear music. When I turn on the TV - I can watch Game of Thrones (and STILL be pissed about Season 8.. BRAN???). When I turn on the internet, I can rewind time and relive this vintage piece of culture that has 4.2B views and is almost a decade old.
My point is we place trust in both technologies, companies, and institutions that provide us what we want when we want it. At an individual level, we value this and when that trust is scaled to millions or billions of people, you can make boatloads of money. As Web3 continues to emerge as a technological paradigm shift, a sociocultural phenomena, and an alternative industry/opportunity path for the masses - the technical infrastructure that is being built needs to work, and needs to work at scale for anyone, anywhere. I think the most salient point my mind comes to is the fact that the comparative advantages of Web3 need to align with the wants of individuals. Ostensibly we are seeing a shift where people WANT to own the data they transmit on the internet, because over the past 20 years we’ve realized just how incredibly powerful the data is. In one sense, we are bringing power back to the people and it is a fascinating thing to watch in real time.
I’ll continue to explore the mechanics of Web3, and share my perspective on the industry, opportunity, etc. as I learn more. If you are a founder, an operator, or fellow investor and you just want to jam on these ideas. I’m happy to chat. Feel free to reach out to me directly at firstname.lastname@example.org or follow me on Twitter
Note - If you want to explore Wired convo more (it’s a helpful intro) the breakpoints are here:
Child - 0:39
Teenager - 1:38
College Student - 3:55
PHD - 6:27
Expert - 9:51
Loved this article, well done Desmond.