Mom’s primer on crypto

1. The technology

1.1 Some history


The basis for a lot of the work in this field comes from Distributed Systems. This is an area of Computer Science that really took off along with networks (and the advent of the Internet). The idea is more or less that as you are able to connect more and more machines on which to spread out work (computational tasks, storing large amounts of data, etc.), you want to make sure that this network is resilient to machine failure. Simply said, if your Macbook dies every 2–3 years on average, a data center with 10,000 machines will experience a dozen or so failures a day. The idea is to make sure the system as a whole can work even if some of its parts fail. Out of this comes the question of how to coordinate work across cooperating machines.


From this work came the idea of coordinating work across machines that don’t belong to a single entity (e.g. Google), but rather to a bunch of different parties with varied interests. This is the rise of peer-to-peer protocols in the 90’s and early 2000’s , used, for instance, to create file-sharing apps. This is a good use case for peer-to-peer sharing because downloading a file can be a bandwidth intensive task, so rather than hitting a single server to ask it to give you the file, you can spread the file across machines and ask a group to each send you a small bit of the file. Plus, by co-opting various machines to do this, you get high availability for your files: a machine will always be on the network to get you your content. Lastly, this is a good application because people started distributing free music and movies through these networks, which is of course illegal, but the decentralized aspect of this made it hard for authorities to crack down on any single culprit (the files are spread across the Internet and the people sharing them connect and disconnect at will from the network).


Throughout this time, and as the Internet grew, people started thinking about how to build a trustless electronic money system. We’ll get to what trustless means, but what is money? A means of exchanging value through a proxy: in order to have value, a currency needs to exist in finite amounts (otherwise people could just create it out of thin air), and needs to be widely recognized as being valuable (otherwise I can’t get someone else to accept it). That first condition is hard to ensure with digital currencies: this is the double spending problem (if you’re familiar with this, just save yourself some time and skip the rest of this section).


This notion of consensus is the key that opens new doors in distributed systems. We can now build an entirely transparent source-of-truth that represents the state of some system in the world. What else can be represented using this technology?

1.2. Some nomenclature

To recap:

  1. The fact that the systems built on blockchains are distributed by their very nature: everybody on the network should have a copy of the blockchain, everybody can mine, etc.
  2. The related fact that there is no central third-party to provide a copy of the truth.

2. The Market

Here is where we move into debatable territory.

2.1. From a product standpoint

Some people (me most of the time) think this stuff is super over-hyped. We’ve built trustless databases… It’s very cool, so what? The world of engineering is that of tradeoffs, and the cost of trustlessness is high. With it comes poor performance, latency, and so many other problems that make a computer system really shitty.

2.2. From an investor standpoint

There are three broad sets of investors involved in this market now, so far as I can tell:

· VCs

These folks are doing a lot of what they’ve always done and investing in technologies they think have a meaningful chance of creating large outcomes. An added layer of complexity has been added to their work though: how do they price these investments since a lot of these technologies are so far away from being useful to end-consumers that they have to invest in the underlying protocols themselves, which, as a kicker, are given monetary value directly by other people in the market. So hypothetically some company may raise funding from traditional VCs and then launch an ICO in which they sell 10% of a token for $100m (valuing the currency at $1.0B). When it comes time for the VCs to distribute capital to their LPs, how do they price that huge capital infusion into the company?

· Hedge Funds

With the plethora of these altcoins launching, there is actually a market of a few hundred tokens that are liquid right now, and so these funds are trading on them based on the underlying technology, perceived value of the protocol, market sentiment, or just dumb luck… A lot of funds are also charging LPs just to hold a couple of assets long, because doing this is still so difficult right now; but perhaps good custodianship is worth this price. Most of their LPs right now are VC funds, high net-worth individuals and now some family offices.

3. Some rational theses

There’s obviously a lot to unpack here and it can get pretty hairy to tell meaningful innovations from fluff in this market. I usually think common sense and first principle questioning of the underlying value of a protocol works well. A fair rule of thumb: if someone can’t explain to you why the protocol should be valuable in plain English, it probably isn’t (though writing this challenges my notions of what is easy to explain).

Network effects

A first clear value of the blockchain is its ability to create self-organizing marketplaces. That is, you can organize liquid markets without a need for a middleman. The prototypical example here is crypto-Uber. Ultimately, Uber’s value proposition is seemingly being able to bring together drivers and passengers under one roof and create a liquid market around ride sharing. Driver availability brings the price down; excess demand brings it up (this is surge pricing).

Fat Protocol (Joel Monegro for USV, now at Placeholder)

The notion here is rather simple, it is simply that value from a blockchain’s use accrues at the protocol level, with the token. The argument is basically that whereby the monetary value for creations enabled by the Internet was concentrated at the application layer (the founders of Google have made a lot more than the inventors of the http protocol), due to the nature of how the blockchain works, useful applications will give value to the underlying tokens: value is amassed at the protocol layer. Specifically, the point Joel Monegro makes in explaining this is that the value of a given protocol will be more than the combined value of all of the applications built on top of it, since there will be speculation as to the future value of the protocol (in much the same way that people trade stocks with varied Price to Earnings ratios).

Usage vs asset tokens (Nick Tomaino for 1Confirmation)

This notion tries to distinguish the types of tokens created by blockchain application, and broadly creates classes for what gives them value. Nick makes a deeper distinction but basically usage tokens are those which are used as part of the consumption of a decentralized service (that you buy into using the token), asset tokens instead are a store of value (much in the same way that Bitcoin could be seen as an alternative to gold). The former provides access to a clear service, the latter operates based on a common agreement that they hold value. Prefer the former, although clearly much of the value in the market has accrued to Bitcoin (and so much has been invested in hardware there that it seems unlikely to go away).

On-chain or off-chain

One should always ask “why should this be decentralized?” There is a more subtle question here as well regarding does this entire product need to be built in a decentralized fashion, or could it be made more efficient or simpler by building part of it off of the blockchain.

4. How this could be a valuable asset class

Such as it is, the market is extremely immature right now: we basically have a technology that we believe can possibly yield value on par with the Internet, but only limited infrastructure for it and tons of missing services (at the protocol level and the app level). But whilst a big portion of Internet investments only became possible after the market matured (and a search engine made it possible for someone to find your product for instance), the nature of the technology here allows us to invest in the protocols themselves…

3. Further Reading

· Fat Protocols



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Henri Stern

Henri Stern

Probably thinking about your data right now. Hopefully it's encrypted...