Crypto 3.0 – More Than Meets the Eye

At the time of writing, we find ourselves in the throes of another bull market for the crypto sector. The market capitalisation of Bitcoin has recently passed the USD 1 Trillion mark for the first time. The digital currency born just over a decade ago has created many zealous followers; and staunch critics and has left many investors just scratching their heads as to how this invented digital currency can experience such a meteoric rise. While it is easy to dismiss Bitcoin as the new tulip of 2021, there is more to the story than the spectre of bitcoin, tulip or not.

The term “cryptocurrency” gets thrown about a lot, but that can be quite unhelpful when many of the assets being talked about often have little to do with “currency”. The term “Crypto” literally refers to the use of cryptographic functions[1] (the math) that help make these types of computing applications work. It is better to think of this as a very specialised sub sector within information technology more generally.

At Stewart Partners we are not fond of making predictions, but there is little doubt that the underlying technology, widely known as DLT (distributed ledger technology) is transformative. While blockchain is now a household term, there are other types of decentralised networks[2] that make trusted transactions possible without the need for counterparties and intermediaries. That might not sound like much to write home about, but it carries the potential to create enormous efficiencies across arguably every industry, not just financial services.

Many are hopeful the speed and scale of these new decentralised networks will create such efficiencies and innovation that we will move into a new era of the internet, commonly dubbed Web 3.0[3]. And you would be wrong to think this is just a niche idea for the crypto enthusiasts. A Bank of International Settlements report [4]states that over 80% of central banks are already researching Central Bank Digital Currencies (CBDCs). Again, the potential for efficiencies and transparency holds great promise for consumers, on the assumption they are carefully designed and properly implemented[5].

Now let’s get to why you’re reading this article... After all, the differences between a Proof of Work, a Proof of Stake, and the Hashgraph consensus algorithm (common jargon for how the different blockchains work) is all a bit too much detail when $100 of bitcoin in 2010 is worth ~$80M today. While it is natural to want to participate in large gains making headlines, it’s somewhat odd to us that people regret not buying bitcoin, but do not regret failing to place $100 on the winning trifecta in the 2009 Melbourne Cup. That said, we can write about how our own hardware (the human brain) does a staggeringly poor job of rationally processing information another time…

Despite what some YouTubers will tell you, the task of finding future value in digital assets is no mean feat. Many of the largest networks such as Ethereum, Cardano and Polkadot, are creating entirely new economic models of their own. Like most new models that create new possibilities, they have unintended consequences. For example, Bitcoin, born in fierce opposition to the centralisation of our financial system, is now remarkably centralised given the incredible specialised computing power needed for mining. (“Mining” is a process whereby computes solve complex cryptographic equations to validate new transactions which add data blocks to crypto currencies).   Bitcoin also absorbs incredible amounts of energy to operate - the same energy requirements as Sri Lanka[6] - which seemingly creates an interesting dilemma for people like Elon Musk to invest in both Bitcoin and Tesla.

Costs are also increasing.  Ethereum fees, which used to be compellingly cheap to run applications, are now expensive due to the fees being denominated in its native cryptocurrency ETH (which has appreciated dramatically) and network congestion.

Part of the appeal of crypto is the potential for disruption across such a huge span of economic activity, but this brings with it an inherent requirement to understand the huge span of forces that will drive and repel the adoption needed to make them successful. These forces mesh across several domains, including economic, technological, legal, and political domains.

Assessing new crypto economic models (tokenomics) needs to be coupled with a deep understanding of the relative technological prowess, forecasts of future application participation, and assessment of governance models at the very least. But if you really want to make money overnight, you just need to know which coin Elon Musk will tweet about next.

If this is the beginning of a new era for the internet, it’s worth looking at the beginning of the last one. There is a striking resemblance between the late 90s and much of the crypto bull market today. If history is a guide, perhaps in 10-20 years from now we’ll look back and see that many, if not most, of the innovators didn’t survive. But in amongst the fever, there very well may be the next Apple - or more accurately, a new network serving as the ‘Apple Store’ for the world’s apps.

Will Bitcoin become the new global store of value? We do not know. Will a new type of asset class emerge? Possibly. Is this a good investment for those who do not have the technical expertise? Probably not. Will decentralised networks change the world? They have already started to.

Author: Brendon Vade

[1] https://youtu.be/bBC-nXj3Ng4

[2] https://www.datadriveninvestor.com/2019/02/14/what-are-the-different-types-of-dlts-how-they-work/#

[3] https://www.forbes.com/sites/forbestechcouncil/2020/01/06/what-is-web-3-0/?sh=79a7f4c458df

[4] https://www.bis.org/publ/bppdf/bispap107.htm

[5] https://www.Blockchain-DLT-Consortia-White-Paper.pdf (fujitsu.com)

[6] https://www.cell.com/joule/fulltext/S2542-4351(19)30255-7