Cryptocurrencies and NFTs are 100% based on the greater fool theory… expensive digital images of monkeys will improve the world immensely (sarcasm). Bill Gates, Microsoft founder
Introduction
The man who for many years was the world’s richest (and is now only top 5) recently declared all things crypto and NFTs in particular a ruse. It wasn’t a particularly courageous statement to make in June of 2022 as we had just witnessed a significant correction in the entire crypto ecosystem precipitated by the kinds of events that feed a naysayers confirmatory bias. The crash of Terra-Luna in May of 2022 gave observers a window into the excesses that are common in any new industry where economic potential is plentiful. And Bill Gates is not alone. Warren Buffett used his 2022 annual meeting to reiterate the view that bitcoin is “probably rat poison squared”. It turns out Gates and Buffett have more in common than a love for the card game bridge.
Skepticism of the new thing by the incumbents is a rite of passage for high impact innovations. Most game-changing technologies are overhyped in the short run and underappreciated in the long run. In the early days of e-commerce, many of us wondered if we’d ever get comfortable providing our credit card information online, and yet today, online commerce accounts for approximately 20% of all retail sales in America. IMO, the blockchain is not just novel technology but a timely innovation with far-reaching implications for how business will be conducted in the future.
Why the Blockchain Matters
A brief overview of my logic is as follows: Economics is the study of how to make the most of scarce resources. The best way to achieve this objective is for individuals to focus on what they do best, and then find counterparties with whom they can collaborate and trade. Determining the rules for collaboration and trade is called contract theory, and contract theory is one of the foundational fields taught in economics programs and law schools everywhere. Contracts– whether implicit or explicit– form the basis of all economic activity, and one way to think about most business progress is innovations in contracting that result in improvements in economic efficiency. To the extent that we as a society can get the incentives aligned so people work together towards a common end, the production possibility set expands dramatically.
This brings me to why the blockchain is such an interesting technology. While web1 birthed protocols like http and smtp which lowered the costs of computers and individuals communicating with one another, and web2 enabled connections between people for the purpose of aggregating audiences and making it more efficient to sell to them, web3 is principally about smart contracts written into a reliable ledger, aka the blockchain. This ushers in a step function increase in collaboration and value creation as the rules of engagement are written into self-executing software. Since both the terms of collaboration, as well as the consequences of misbehavior (ie, contract enforcement) are clearly defined, individual entities can freely enter into various arrangements without fear of being held up or otherwise duped by the counterparty. This reduces friction and increases trust, and economists have long recognized that trust is an essential element to collaboration, and collaboration leads to improvements in nearly every important statistic regarding economic health.
Examples
For example, consider the process associated with buying a home. One of the first steps for a buyer in getting a mortgage is to demonstrate their creditworthiness through income and asset verification. This typically involves printing out a series of bank statements, brokerage account statements, W2 payroll reports, etc. The addresses on the statements must match the address on the bank’s file, which typically is validated through government issued identification. This cumbersome process could easily be all but automated once information like this is held on the blockchain through a simple series of queries. Furthermore, the title search process can take weeks, and buyers typically have to purchase title insurance to protect them against claims that may arise from events in the distant past. This too is a cost that can drop from weeks to moments, and the cost of the insurance drops from thousands of dollars to all but nothing when titles and deeds are held on a public ledger. In very tangible and identifiable ways, a good amount of friction has just been removed, and all buyers and sellers will agree that this is good thing.
As this simple example illustrates, almost any transaction that requires a trustworthy intermediary can have its costs significantly reduced by using the blockchain and smart contracts. But in addition to making existing transactions and business processes more efficient, the blockchain opens up possibilities for how collective action is organized. In today’s business world, the firm or corporation is the primary way groups of individuals come together to achieve a shared end. The adoption of the blockchain has created a new way for individuals to come together and collaborate, and the form that is receiving a great deal of attention is the DAO (distributed autonomous organization). Giving a full explanation of this idea goes far beyond the scope of this post, but a good way to think about a DAO is if a bunch of people came together and pooled their money to achieve some common purpose. It could be a charitable end, such as how to support organizations that feed the homeless, or it could be a business and entertainment end like buying a sports team (Buy the Denver Broncos DAO). DAOs are flatter organizations with very explicit rules for engagement, unlike firms and corporations that have hierarchies and chains of command to determine what gets done. It’s a concept on the same evolutionary path as the gig economy- a free market system in which temporary positions are common, and organizations hire independent contractors for short-term commitments.
Conclusion
In summary, the blockchain, and the kinds of innovations that are being spawned from it, represent a natural progression that began with the widespread adoption of the initial Web1.0 protocols. Web1.0 was principally about getting computers and the individuals behind them to talk to communicate with one another. The killer apps were web browsing and email. Web2.0 was mostly about getting people more connected to one another for the purposes of making it easier for companies to sell products and services to the end consumer. The killer apps are social media and mobile. At its best, Web 3.0 is about facilitating collaboration and community around shared interests while giving individual participants legal ownership over their joint creation. The killer apps are still to be determined, but the blockchain, decentralization and token based economics form the basis of new forms of community organization and collective action. The potential not only for wealth creation but for a more equitable distribution of those gains is a major part of why I and so many others are excited about this innovation.
