Introduction

Patrick: [00:00:00] The documentary you were about to hear started with an email from Matt Goetz, the now CEO of a cryptocurrency investment firm, BlockTower Capital. Matt emailed me and invited me to lunch. He had a great job at Goldman Sachs but was leaving it to start a new hedge fund that dealt in cryptocurrencies, to which I said, "That sounds cool. What the hell is a cryptocurrency?" His partner, Ari Paul, was also leaving his job as a portfolio manager at the University of Chicago's endowment. Ari would be the CIO and Matt would run the business. Over the next several months, with the significant help of Matt and Ari, I had conversations with leading thinkers and creators in the field, big picture philosophers like Naval Ravikant and Fred Harrison. Creators like Juan Benet and Mooney Bali. Investors like Ari Paul and Olaf Carlson-Wee. In the coming episodes, these leaders will be your guide to understanding blockchain technology, cryptocurrency investing, and the future of markets.

Hash Power is meant to be an introduction, but really, it's an invitation to explore this emerging world on your own. As you'll see, nothing that is this early in its development is easy to understand. I hope Hash Power will serve as a litmus test for your own interest in blockchain and cryptocurrencies. Now, crucially, nothing you hear here is investment advice of any kind. Naval Ravikant and several others made a very good suggestion to me. Don't buy any cryptocurrencies unless you spent an enormous amount of time investigating them. It's important to note that as I was having these conversations, I owned virtually no cryptocurrency. I did buy small amounts so that I could watch and experience the blockchain in action. Buying, sending, receiving, converting between currencies. Things like watching transactions settle on the chain without ever being verified by a centralized entity or authority or sending money to Europe and back. You wouldn't opine on Uber by reading stories about it. You'd order a car, ride somewhere and compare your experience to that and the yellow cab.

One thing I think you'll find as I have, everyone is talking about this, but very few have actually tried it. To dismiss these emerging asset classes, I think, foolish. You don't have to buy cryptocurrencies and most probably shouldn't, but you should explore. We will cover the technology, the power of decentralization, Bitcoin, Ethereum, ICO's cryptography, and hashing. We will spend time with the leading active hedge fund managers in the field and with outside investors who are both optimistic and skeptical. In this episode, we focus on blockchain technology itself and its potential impact on the world. In episode two, we will explore investing in cryptocurrencies. And in episode three, we will cover the most exciting projects currently underway and discuss where things will go next. In producing Hash Power, I searched for a presenting sponsor who was thoughtful, forward-thinking, and willing to experiment. I knew I'd found one such company when I learned that the CEO, in this case, Abby Johnson, has a Bitcoin mining rig in her office. This episode is brought to you by Fidelity Investments, a company that is constantly researching and experimenting with emerging technologies like crypto assets and blockchain to improve the lives of their customers. Fidelity provides a comprehensive set of products and services to individual investors, employers, and financial advisory firms. For more information, please visit fidelity.com.

Blockchains and their Potential

Patrick: [00:03:04] If you enjoy what follows, you'll still be very early in understanding this field, most don't. So help me spread this like wildfire, because the more people that understand blockchain, the better its impact might become. Let's dive in. If you were like me, you heard about Bitcoin a few years ago, forgot about it, then saw it come roaring back to prominence in 2017. I remember watching a poorly produced YouTube clip three years ago, that tried to explain Bitcoin and mining. God, do I wish I had paid closer attention back then? Now you hear many people saying that Bitcoin could be a store of value for the digital age. Now, the very concept of digital scarcity requires a new kind of technology, what we call blockchain. And this is where we begin. Bitcoin was the first of these technologies and may turn out to be the most successful, but it's also one of the simplest and may only hint at the broader potential of blockchains. But what literally is a blockchain itself? Every time I ask, I get a slightly different answer. Here's one of the best answers from Jeremiah Lowin, who is a risk, statistics, and machine learning expert, working for a private family office, who has personally explored Bitcoin as a potential investment. We start with his brief description before diving into the far-reaching implications of blockchain with one of our key guides, Naval Ravikant.

Jeremiah: [00:04:30] So blockchain is basically a database. That's the easiest way to think about it. And what's the database? It's like a ledger, like an accounting ledger that you can put entries into. In this case, it's what we call an append-only database. We're not taking anything out of it. So if we want to cancel something, we just put another entry and that reverses it. So this is a database. What's special about it is that it's distributed. It's all across the world. It's hosted by many, many, many different computers. It's in what's called a peer-to-peer framework. So there's no one central server running this and critically, there's no one person who has control of it. So we have this distributed global decentralized database. So what, why is that interesting? What's interesting about that is the original Bitcoin paper produces a way to guarantee or rather to let people trust the contents of that database, even though they don't know who all the other people around the world are, who are writing into it or potentially manipulating it, this is a real problem.

How the Blockchain Works

Source: Intellipaat

How can we have something that's decentralized that I can also trust? The reason the blockchain is so interesting, and I think so transformatively, is it's really an example, the first example that I'm aware of, of a way to actually own a digital asset. What does that mean? A digital asset is a bunch of ones and zeros. So I have a song, I have an MP3, it's a bunch of ones and zeros. And if you write down those ones and zeros in the same order, then you have the song. So how can I claim my own something that can be trivially copied by you? And there's been many attempts through the years to contain that, all kinds of encryption schemes and whatever, but at the end of the day, if I can see the ones and zeros of this asset, that means you can write them down and therefore you can have a copy of the asset. It's that simple. The reason that this distributed database is so interesting is that if in this database, if we treat it as an accounting ledger of who owns what, and we all agree that it shows the true state of the world at any time, then all of a sudden, I can actually own and prove that I own a digital asset. Now, maybe that becomes more interesting than just an MP3 file. Maybe that's the key to my house, is a digital asset on my phone, and sure, anyone can show up with the ones and zeros that represent that key, but only I will be allowed into the house because I'm the person that the blockchain, that this database shows as being the registered owner of that key. That to me is just this incredible, incredible sea change in what we can do. Every attempt to nail down digital assets has basically failed until the blockchain. And that's it. That's what the blockchain is. It's just a way to track the ownership of digital assets.

Patrick: [00:07:13] This concept is what has stuck with me most, we live in a digital age and therefore a variety of digital currencies, means of exchange in different parts of the digital world make a lot of sense. This is not an opinion on the investment prospects of any cryptocurrencies in general, just a simple belief that digital scarcity is a powerful concept. What interests me most about blockchain is their potential to create new networks or ways of coordinating human activity in interesting, fun or productive ways. It is important to explore this concept early on, and I can think of no better guide than Naval Ravikant. Naval is the CEO of AngelList, a partner at cryptocurrency fund MetaStable, and is one of the most concise and insightful thinkers I've ever encountered on a variety of topics. We kick off with his description of blockchains and their potential.

Naval: [00:07:56] The reason why I think blockchains are so interesting is that they give us a new way to organize humans. And if you look at what humans do, what sets us apart from other species is that we are the only species that can organize and network across genetic boundaries. So bees and ants, for example, are highly organized creatures with hive minds, but they organize within their own hive and it's within their own genetic code. You get two ants together who don't share a common ancestor and they're going to fight, or at least they're not going to cooperate, but humans are the only creatures out there that self-organize in large groups across genetic boundaries. And they do this by telling each other fanciful stories and creating mental models in their heads and cooperating and aligning and trading and those kinds of things. You can only get horary in sapiens, laid out the interesting example of how human homo-sapiens wiped out Neanderthals because you can only get a couple of hundred Neanderthals in a battlefield because those are the ones that are related by blood, but you can get thousands of humans in a battlefield because they all imagine themselves as Christian or American or whatever. Those are just stories that they've told each other, but this storytelling power that allows us to organize this is really, really powerful at some level. Like the United States is a story that we're all Americans. The Ford motor company's story, capitalism is a story, money is a story.

And even beyond being a story, the best of these stories are actually networks. These are stories where we have rules of operation and cooperation. For example, we know what it means to be a United States citizen. We get certain rights, we have certain obligations. It's a story that's used to stitch together a network and that network is now the most powerful institution in the world. These institutions, these networks that we build, are the basis for the human species and almost everything we've accomplished. Anyone individual by themselves wouldn't make it very far. They would just die or be eaten by wolves or bears or starve to death and what have you. So fundamentally, this networking capability is probably the most important thing that we as humans have developed. Now, the way we organize these networks is really important. How do you organize networks? Historically, we've had to have someone in charge, someone to say, "Oh, people are cheating. How do we punish the cheaters?" We've done that by putting a person in charge. You can put a king or an emperor in charge, that was a plastic solution. A more modern solution was you put an aristocracy or an elite in charge. They're the democratic solution, which says there's a mob in charge. All of these have trade-offs. None of them are perfect. There are many inefficiencies and a lot of power accrues to whoever's in charge. Now the most recent way we've put people in charge is we've created something called a market, and markets civilization in the last few hundred years, but they're a way of being an open network but still being organized based in merit. You have to actually contribute something to the network that's valuable to get your way in. Some markets are a great way of organizing people. And what blockchains really do is they bring a market-based organization into all kinds of networks where it was not available before. I think that's the fundamental institutional breakthrough that has me really excited about blockchain.

Patrick: [00:10:59] In one sentence, blockchains are a simple concept, a tamper-proof database that stores digital assets without any central authority. Bitcoin itself is just that, the first scarce digital asset, which becomes more and more valuable the more people believe the story. This is what George Soros would call reflexivity or what we might call a self-fulfilling prophecy. There is just 21 million Bitcoin that will ever exist. So increasing demand for this scarcely supplied digital asset would cause its price to rise dramatically as we've seen, but Bitcoin has become more or less a simple store of digital value. In another sense, blockchain is more broadly speaking, including examples like Ethereum, Filecoin and others may also represent a leap forward in our ability to coordinate activity globally by creating little markets for specific things with their own tokens, and their own ways of earning and spending these tokens, almost like a fairground. Here's Naval again. And don't worry, we will explain mining and the actual network technology in the next chapter. You wrote somewhere, a really interesting line, which I think is perfect in this context. You said a society gives you money for giving society what it wants. Blockchains give you coins for giving the network what it wants. I think that the notion of the individual, the common term is a protocol, but really these are different kinds of networks for accessing or facilitating human cooperation in interesting new ways. Maybe you could give one of your favorite examples, it could be Bitcoin of, functionally how this has started to work.

Naval: [00:12:23] Yeah. I'll give a couple of examples. Really, what you look for in a well-designed protocol network is that there's a series of people who are providing the network with the scarce resource the network wants, and then the network is in exchange paying them for that. So in Bitcoin, that scarce resource is actually security because Bitcoin is essentially a ledger of all the IOUs that have ever happened in the Bitcoin network so it creates a form of money. It's basically saying, well, Patrick owes Naval this much, then Naval owns Jack that much. And therefore, Patrick owes Jack that much. If you keep a track of everyone's debts, that's really all that money is. The money, the bearer instrument in which holding it basically says, society owes you a certain debt. So Bitcoin is trying to do the same things. The miners in Bitcoin's case provide security. And the way they provide security is they do a lot of cryptographic computational work that is useful for nothing else, other than just locking down the current set of transactions in the system, and then sealing them such that they're incredibly difficult, basically impossible to go back and revoke. That's the scarce resource they provide. There are new coins and networks around safe file storage. There's Filecoin, CACoin, there's a bunch of others.

What you look for in a well-designed protocol network is that there's a series of people who are providing the network with the scarce resource the network wants, and then the network is in exchange paying them for that. So in Bitcoin, that scarce resource is actually security because Bitcoin is essentially a ledger of all the IOUs that have ever happened in the Bitcoin network so it creates a form of money.

And what they're trying to do is they're trying to incense people in the network to provide unused disc space, bandwidth, and serving power to essentially create the next Amazon Web Services or S3 storage layer in a distributed fashion. In that network, the miners get paid for providing storage. They get coins from the network for providing storage. You could take a futuristic example and you can even take it outside of the purely digital domain. You can create a system in which let's say everybody has a solar panel on their rooftop. Well, they're not using all that power all the time. Some people have more capacity than others, and some people have more demand than others. You can imagine a model in which there's a SolarCoin. I put solar panels up on my rooftop and then based on how much energy people near me need and how much excess capacity I have, I get paid in SolarCoin for providing that extra solar power in the network. Same way, if I want to consume solar power, I could pay in SolarCoin to get solar power back out of the network. So you can use the self-organizing property of blockchains to let groups of people organize this for any shared resource. And you might say, "Well, you can do this SolarCoin thing anyway, you can just use Tesla and PGNE, but you need some central authority." The difference is the model I'm talking about is completely permissionless. You don't need anybody's permission. You just take your solar panel, you hook it up to the network and you're maybe getting paid in coin. There is a fundamental difference between permissionless networks and permission networks. Almost all of the innovations that we rely on in the last 50 to 100 years especially in information technology happens because it's permissionless. I don't need anyone's permission to take a computer, write some code, start a website, et cetera, et cetera. So moving to permissionless networks opens up innovation, opens up participation, and opens up ingenuity.

Scarcity of Digital Assets

Patrick: [00:15:15] I think that a good touchpoint is the internet itself which has created obviously an incredible ecosystem, but the foundational plumbing of the internet, the TCP/IP protocol, there's no scarcity tied to that. So maybe talk a little bit about that protocol versus this new type of protocol and why the introduction of scarcity makes those things so different.

Naval: [00:15:37] Yeah. Before we get into TCP/IP of scarcity, just one last point of permissionless innovation is, I remember when the internet was first getting going, there was an argument that AOL, America Online, and CompuServe would have more interesting use cases. They had good walled gardens. They had America Online creating all kinds of content, which had an incentive to create. And people said, well, just the internet is a wild West, but it's not going to have good content. You can create just as good stuff inside America Online. Obviously, today that is laughable. The idea that a closed network will create anywhere near the kinds of resources that an open network will is just insane. So open networks are not only better because they allow slightly more innovation. They are literally the foundation for how everything works. Money, for example, is an open network that can give US dollars to anyone and anyone can give US dollars to me. Now, obviously, the government tries to control that in some ways, but fundamentally, permissionless networks out-innovate permission networks by a factor of a hundred or a thousand. It's not even close. Now it's talking about TCP/IP. TCP/IP, HTTP, SMTP, NMTP, UDP, are fundamental internet protocols. They underlie the internet, they control the routing of web traffic of IP packets of video streaming, all kinds of things. So we rely on these protocols to make the internetwork.

Fundamentally, permissionless networks out-innovate permission networks by a factor of a hundred or a thousand. It's not even close.

The developer of HTTP, for example, was Tim Berners-Lee, who created the worldwide web, or at least commercialized it or popularized it. And he hasn't made any money off of it other than through some consulting gigs. He doesn't make any cash off of it. And that's because the protocol is completely open and free and everyone can use it and plug in. It's an incredible gift to humanity. Now, these open protocols that have no sense of scarcity work really well for the base internet, but they don't quite map to reality for all applications. There are some applications in which resources are scarce. The solar grid that I pointed to, for example, that example, there's scarce solar power. Someone has to pay to provide it. In money, even though it's a purely digital asset, money, code, and speech are actually fundamentally the same thing. There's a scarcity. Two of us can't have the same coin or the same bill or the same bank count at the same time. I can't just fork my bank account and give you a copy and now we have two bank accounts that are both worth just as much. So digital assets, digital protocols have a sense of scarcity. A protocol that routes file storage computing bandwidth has a sense of scarcity. So, how do we model these scarce protocols?

What blockchains allow us to do is allow us to build scarce protocols and keep track of scarcity. Now, when you're keeping track of scarcity, you need a way, you need a token. You need some ledger where you can say, okay, this bandwidth now belongs to that person. This file storage now belongs to that machine. This piece of code has the right to that solar power, whatever it is. You need some way of keeping track. So essentially, any blockchain, because it's essentially allocating scarce resources, needs to have a token to keep track of these scarce resources. That's why almost every use of blockchains involves a token. There are a few marginal cases where you can use a blockchain or it makes sense to use all without a token, but almost always it makes sense to use it with a token. It's almost built into the definitions.

Patrick: [00:18:48] A great line from a book that I know we both love, The Sovereign Individual, is talking about how the world will change in the future. And they say a job will be a task that you do, not a position that you have. I'm curious how you think about how this all integrates into how we think about work, individual sovereignty. You've already touched on centralization versus decentralization of power, but how do you think this affects individual sovereignty and how we think about work in the future?

Naval: [00:19:17] The thesis from The Sovereign Individual is that fundamentally the structure of society is based on the logic of violence, which is an insane concept until you wrap your head around it. But essentially, in human history, there's this predator-prey relationship between makers and takers. If you're making something historically, it's been even harder to protect it than to make it. Go back to hunter-gatherer times, I kill a deer, and then I gave it to someone to skin it or to cook it, and then they run off with it. So we always have to figure out, how do I hold onto what I got, and how do I trust other individuals? What's happened over time is that as humans have learned to create more and more, it's actually become harder, harder to protect those things. For example, in the hunter-gatherer age, I couldn't really have any possessions other than what I just carry on me, but I was carrying them on me. So it was hard to steal them. On the other hand, if you did steal them, they weren't that valuable. So hunter-gatherer tribes were fairly flat in terms of structure. You get to agricultural age, I could spend years creating a farm, farming it, laying the soil and the crops down, and building a good enterprise. And then some bunch of horsemen can show up and burn the whole place down or hold my family hostage. So in that model, the people who get the rewards are the knights and the soldiers and the warriors. When you get to the nation-state in the 18th, 19th century, you basically had done powder and factories. So you need huge institutions to create armies that can protect factories, which are incredibly vulnerable.

But a factory, once it's functioning and fully protected could create assets and weaponry and abundance at a level that a farm just can't even begin to compete with. So the history of the human race has been that we've managed to create more and more, but it gets harder and harder to hold onto. Therefore, we need bigger and bigger overlords to protect it. So it goes from the leader of the tribe being an individual who was not that much wealthier and still very accountable to being a feudal lord, to being a Monarch or a King, to being a massive sprawling nation-state. Blockchains are a part of the opposite trend. Blockchains make it possible for humans to trade, communicate, and hold onto wealth by themselves. They're fundamentally bearer instruments. The private keys, if you know what you're doing, are very protectable. You can even record them completely in your mind, they're essentially an impregnable or near impregnable Swiss bank account for any individual. And that is a very different trend line than what we're used to. So now you have a model where people can create something and they can hold onto it without having to have a sovereign or a lord or someone with a bigger gun or a bigger weapon to help to protect it.

Patrick: [00:21:52] And then they talk about this notion of the information age. I think what you're saying is in the information age if that's what we started in say 2000 or something like that, cryptocurrencies and blockchain will play a central role in more power occurring to the individual. So more individual sovereignty, is that roughly right?

Naval: [00:22:12] I think that's the great trend of the age of computing since the transistor was invented. I like to say the robot armies are already here. Robots have already taken over the world. They're just packed in data centers for eating efficiency reasons. Every human now has trillions of transistors working for them across the world, doing all the kinds of intellectually menial tasks that they would not want to do. So the trend of the internet, the trend of computing has been a democratization of power of intellectual power. Now it's also turning its sights onto wealth. So it's a democratization of creating and holding onto wealth. I could imagine a future in which I do at least all of my digital business and most business these days is quite digital. A lot of its just paper pushing and ideas. I do it in virtual reality. I interact with people all over the world. I interact with their avatars. I don't necessarily even know who they are. I transact with them across boundaries and that I can hold on to that money in any way, shape, or form that I want to. At some deep level, even a corporation, the idea of a corporation, a corporation exists because of finance. It's essentially an infrastructure. It's a set of legal contracts on banking, payments, liability, ownership, all of that is going to be digitized, moving in the blockchains, and what we think of is a corporation may cease to exist.

Patrick: [00:23:29] Here's Fred Ehrsam, expanding on this idea. Fred was a co-founder of Coinbase, one of the largest companies in the entire cryptocurrency ecosystem, an exchange where you can buy and sell certain cryptocurrencies.

Fred: [00:23:40] I think that we are increasingly living in digital worlds. I think that the entire world and the entire universe, as we understand it, can be described through incentive structures. And that's why blockchains are so interesting because they allow you to explicitly program incentive structures into these little self-contained universes. You think about what Bitcoin did, this guy named Satoshi came along, dropped an incentive structure into the world in a white paper. He didn't even write the code, just dropped the incentive structure in. And we saw this incredible emergent behavior where looking back seven or eight years later, we now have the biggest supercomputer network in the world by about four orders of magnitude. And all the guy did was create an incentive structure. So just as with many things in the universe, a very simple set of basic building blocks and incentives can lead its way into this massively complex emergent network and intelligence. One of the reasons humans have taken over the earth I suppose is that we've been able to coordinate ourselves in ways that are in a greater scale than anything else that we're aware of. So the last major breakthrough or a very famous major breakthrough, and this was the creation of the joint-stock corporation, which allowed a bunch of investors to mutually go in on the creation of this thing, this new, amorphous kind of organism, a company, and do really big things.

It turns out that those C corps are, well, a pretty big deal today because they've continued to do that on a greater and greater and greater scale. You could view governments as another way of coordinating human behavior for the reasons I described. And those big tech companies have obviously done major things. Google has indexed a ton of the web. Facebook has connected billions of people, more than half the human population at this point, which I'm not sure I can name another organism that has so directly harnessed a network of that many people simultaneously. To me, it seems that blockchain-based protocols are the next logical step in that for the reasons that we were talking about earlier. They allow human coordination at a massive scale because as protocols, they can and will make their way into all the technological foundations of what we use today. They provide the proper incentives for everyone to spread them like viruses, basically. The minute I own a Bitcoin or an Ether, my incentive is now to make sure that that thing is successful in the universe and to spread it. So I think it combines the economic incentive structure that we've seen and the biggest company as of today, that transcend borders like Google and Facebook with the more perceived neutrality of internet protocols that are bigger than any C corp today, like SMTP for email, TCP/IP to just fundamentally move data on the web into what seems to be the most powerful organism today.

Cryptography, Hashing, and Mining

Patrick: [00:26:46] Obviously, there are many open questions around government regulation, development, and coordination, but you can see why people get excited about blockchain. Just as we didn't know where the technology that forms the base layer of the internet would lead, we are still totally unclear as to how far-reaching the implications of blockchain may be. As I learned about this space, I learned to often stop and take stock, which I'll do throughout each episode. Blockchains are ways of creating and storing digital currencies. These currencies are means of exchange within a contained network. Each of which is designed to incentivize some set of participants to create value. Things like security, compute power, solar energy, storage, and so on. And another set to consume that value using blockchains native currency. I think of each like little digital bazaars, specialized markets well-designed to facilitate exchange. So far, we've been a bit high-minded. Lots of concepts in an ideology without a lot of meat on how blockchains actually work. So now we begin chapter two of this story, the technology itself.

Here we get to explore why this documentary is called Hash Power and why we call them cryptocurrencies. The currency part is easy because we're all used to it. The cryptography part is harder to understand, but it's crucial if you're going to really buy into blockchains as the future. We've heard Naval say miners provide digital scarcity and secure the Bitcoin network. A problem in decentralized systems is trust and security. We're used to having banks watch over our money and making sure that people don't cheat the system by say, trying to spend the same money twice. Miners are Bitcoins' answer to this problem. The system was designed so that in order to verify transactions being sent out by all Bitcoin users, a special group of computers that we call miners would be forced to do a lot of time-consuming and costly computational work. The important thing is that we make computers prove to the rest of the network, that they did the work to verify transactions.

Because of this system, the global network agrees or reaches consensus, every 10 minutes or so in Bitcoin's case, on the state of the ledger. Who owns what amounts of Bitcoin as a result of the recent transactions? This method for reaching consensus on the ledger, which is called proof of work, was Bitcoin's way of removing the need for a central authority. I've searched far and wide for the best analogies to describe the work that miners do. One of my favorite analogies is very visual and comes from Reddit user jav_rddt. Imagine that every transaction being sent out is like a puzzle piece. And that there are tons of these pieces. The role of the miner is to find a way to fit all these pieces together into a picture that fits into a certain pre-agreed upon shape. Let's say it's a rectangle.

Doing that work, putting the puzzle together takes time and it's hard for each miner to attempt to complete. But if a miner does figure out how to combine the pieces, it's really easy for everyone else to simply look at the picture and verify that he's done it correctly. He's created the rectangle using the pieces available. The time spent solving the puzzle is the work. The end picture gives us an easy way to verify proof of work. Now, the reason that miners put their computers to work on these problems is because if they are the first to solve the problem, they are paid in Bitcoin. Their services are almost like a small tax paid by Bitcoin users to secure their money. This is no trivial thing. Miners spend hundreds of millions of dollars a year in computing costs for the chance to be rewarded in Bitcoin. It was very important for me to understand, not just analogies, but how this all works. If I'm going to trust a system, I want to see the guts.

I'm not sure this following section will be for everyone, but if you like intense rabbit holes like I do, please listen on. If not, skip ahead to minute mark 46:40. We start by exploring one central concept in cryptography, hashing. Jameson Lopp, who we'll hear from later, told me to think about a hash like a fingerprint. If a fingerprint uniquely identifies a specific human being, a hash uniquely identifies a piece of data. So for example, if you go to Google S-H-A-256 calculator, SHA-256 calculator, which is the hashing method used in the Bitcoin network, and enter in the word blockchain. It will spit out a 64 character long string of letters and numbers. In this case, it starts with EF7797. And you can go verify that. Now, if you add the number 1 at the end of the word blockchain, and run that a hashing algorithm again, the output will be entirely different. Now it'll start with DB0B9. Every collection of data, anything that can be put in ones and zeros, from a Blu-ray movie to a single sense, will produce a different encrypted hash output. To explain all this, we move to my conversation with Charlie Noyes, a brilliant thinker who runs quantitative strategies for Pantera Capital. One of the most prominent cryptocurrency investment firms. Charlie is 18 years old. When I was 18, my peak accomplishment was hitting 10 beer pong shots in a row. Charlie's already been to MIT and is on the cutting edge of running money. We start with the hashing algorithm that powers Bitcoin, SHA-256.

Charlie: [00:31:52] SHA-256 is one of the second iterations of the secure hashing algorithm. SHA-1 was developed in a competition by the NSA. Essentially what SHA-256 is, is a pseudo-random signature generator. What this means is that essentially you can give it any length input, any amount of bits as an input, and always receive a 256-bit pseudo-random output.

Patrick: [00:32:16] So we've got effectively an algorithm, a tool that takes raw data and encrypts it. And it's one direction. You can take any data and every single time you hash it through SHA-256, you'll get the same output?

Charlie: [00:32:28] Exactly.

Patrick: [00:32:29] But you can't take that output and reverse engineer to find the data that wasn't created?

Charlie: [00:32:32] Right. It's one of the examples of things that we think are one way, or at least our one way without more computational power than you could generate using every single atom in the universe as a transistor. This is getting deep into it. But there are certain concerns that maybe these functions aren't actually one way, but for all that we know right now, even with quantum methods, it's really not a huge concern. Well, we'll get into mining after this, but the very basic version of it is that you send a transaction out, everybody else sends transactions out. Within these 10 minute windows, bundles of transactions are put together and included in blocks. And in order to verify the authenticity of these transactions as miners send them between each other, as part of the verification of Bitcoin blocks, you hash all of the transactions together. If any bit in any of them has changed, the output will be entirely different. So if there is any amount of-

Patrick: [00:33:23] The hash output will be entirely different.

Charlie: [00:33:27] The hash output will be entirely different. You put all of their bids together and into this hash algorithm and squish them together, hash them. The nice property of this is that, let's say that there is a thousand transactions in one block, if I change even a single bit out of one of those transactions, any amount of it, literally any, the entire hash as a result of putting them together and applying SHA-256 for them will be entirely different and unrelated to the correct one. For now, you can ignore everything in here except the hash of the previous block and the hash of the transactions included in the current. Basically, you hash those two together and doing this in the same way that changing any bit of any of the transactions when you're hashing them together because you're chaining these hashes through time. Thousands of them literally, literally at this point. I don't remember what the current block height is, but however many, that is chained all the way up all the way from the original one that said, what was it? Banks issue second bailout, was that the genesis?

Patrick: [00:34:25] Yeah.

Charlie: [00:34:25] Absolutely, that was the genesis string. Anyway, all the way up all the way back from 2008, these hashes are chained all the way to the current block. And if you change any bit in any of this, the whole thing breaks, the entire chain breaks and is completely different. That's the underlying beautiful idea here is that in the same way that if you change any part of these transactions, it doesn't work anymore. That's for the current block. And then you get into, well, how do we establish a canonical chronological system to ensure consistency? And the answer is that you chain these hashes in every block, such that the hash of the current block is fundamentally reliant on the hash of the previous block and the new elements within it. That's the idea.

Patrick: [00:35:12] So you've got some discrete period, call it a block that's a bunch of transactions. That can be a very long list of transactions but converted into a relatively short, fixed-length, hash output, an encrypted output. And then that is combined with the things you mentioned, timestamp, the nonce, which we'll get into in a second, and the previous block in the chain and hashed again, and there's this kind of sequence. So there is this is an incredibly elegant historical chain of transactions that can't be tampered with.

Charlie: [00:35:41] Exactly.

Patrick: [00:35:42] If a blockchain like Bitcoin is just a ledger of who owns what amounts, it's vital that that ledger can't be tampered with by bad actors. Hashing is a great way of protecting that ledger because every new set of transactions is strung together with every transaction that's ever happened. It's effectively impossible to change the ledger without everyone noticing. Cryptography and hashing help provide the security we need in a decentralized system. Now we get to the interesting part, how miners create new blocks through hard work and how they're incentivized to do so with large potential rewards. So that then brings us to mining. So, describe in as much detail as you can, the process of mining, and why it's so important.

Charlie: [00:36:18] Bitcoin provides digital scarcity, the miners are the realization of that scarcity. So mining is extending the chain, creating new blocks, and letting new transactions happen on the network. So when a miner creates a new block, the word mining, I think of it in an analogy to gold, which is that fundamentally, why is gold scarce? Because well, gold is scarce because gold is scarce as a mineral, but it's very expensive to mine gold. It requires luck and time and work. It's fundamentally hard in the same way that the extraction of oil is fundamentally difficult and directly related to its scarcity, relatively. So you might ask yourself, on the internet, how can we have scarcity? How is it possible to have a scarcity of a digital asset when anything else that you can really imagine is not able to be scarce? Meaning if I share a cat GIF or whatever, it's not in any way scarce, even on networks where they have like peppy cash, it's scarce. Not really requires centralization. Again, the question is just how is it possible without any central authority to control the distribution of these Bitcoins? How is it possible to enforce scarcity of them in a decentralized way? And what Bitcoin says is that, in order to do this, you have to make the problem hard. You have to make it difficult. Bitcoin is really in many ways, the first platform to do this correctly. If it takes me one second to calculate one of these difficult proofs, that's okay for me to send an email. But if I want to spam a million people, a million seconds is a pretty long time.

The question is just how is it possible without any central authority to control the distribution of these Bitcoins? How is it possible to enforce scarcity of them in a decentralized way? And what Bitcoin says is that, in order to do this, you have to make the problem hard. You have to make it difficult. Bitcoin is really in many ways, the first platform to do this correctly.

So again, we get into how do you make a problem hard digitally? That's directly related to how do you make digital currency scarce? The difficulty in Bitcoin, imagine that you have four miners sitting around in a circle, and you give each of them a quarter and you tell each of these miners that the first person to get five heads in a row is going to create the next block. That's their problem. That's the difficulty mechanism here, is that they have to flip a quarter enough times to get five heads in a row. And on average, this should take two to five times because you have a 50/50 shot to get heads or tails. So the thing is, is that computers could do a problem like this billion of times. And that's what we see happening here with hash functions. You measure how powerful a Bitcoin miner is in Giga hashes because they're doing this billion of times. But for now, we can just think of it as you got four miners sitting in a circle, they're flipping these quarters. So you say, okay, I want you to create a block every 10 minutes. So the miners sit there and they flip their quarters and it takes them three seconds is to get five heads in a row. And you're like, okay, that was way too fast. So you increase the difficulty, and you say that now, instead of five heads in a row, I'm going to require 15 heads. And you can calculate the optimal number basically to get the interval between the blocks to 10 minutes, which is the target in Bitcoin.

Now you have these miners flipping these quarters for exponentially more time, and it takes them three hours now to mine a block. And you say, okay, that was too long. We're going to readjust the difficulty again. This is actually fundamentally how Bitcoin mining works. You have a bunch of miners distributed over the globe. And instead of flipping quarters, they're using hash functions, which are the equivalent of digital coin flips basically. And what I mean by that is that SHA-256 has 256 bits in its output. You can think of each of those bits like a coin flip, where every time you give it an input, each of them has a 50/50 shot of being one or zero, like being heads or tails. So included in each block, there are transactions and a block header, and you hash the hash of the transactions with the hash of the block header to get the hash of the block. Now, included in this block header, there are a couple of fields, but the most important for our purposes here is what's called the nonce field. So what this allows miners to do is basically, they're all looking for this nonce, this random magic number that when it's included in the block, will result in a hash that has the number of leading zeros required for it to meet a difficulty level. If they're mining blocks too fast, that difficulty level will be lowered? Less leading zeros will be required. And if they're too fast, more leading zeros would be required.

Source: Money Mongers

But fundamentally what these miners are doing is they're flipping billions of quarters per second and trying to get a certain number of heads. You can't guess what the output's going to be given an input, and you can't go backward from the output to the input. We call it a one-way function in that you just have to calculate it to know. So, because this function is deterministic in that any input you give it will always give the same output, the second that a miner finds a nonce, a random number to include in the block that results in it being considered a good block, it shares that block, including that nonce with all the other miners and the nodes in the network too, which are non-miners, but who watch the blockchain. And any miner or node that wants to verify that this block is good, all they have to do is feed it into that same hash function. And because the finding of that nonce, that random magic number is the difficult part, they'll all be able to tell that it was done correctly. So this provides us in really the first large scale way, this provides us digital difficulty and scarceness of an asset.

Patrick: [00:41:52] I know this is intense. I just want to pause here and take a breath. If you feel lightheaded, you're not alone. We now know what a hash is. We know miners have computers that can generate billions of these random strings in hopes that if they get the right one after lots of trying, that number will be used as a key missing piece to a formula whose output will then hit a certain pre-agreed upon target. Think back here to our analogy of the puzzle. This is miners trying to combine pieces that fit into an agreed-upon shape. And while it's incredibly hard to randomly generate that magic number, once the miner has it, he can send it around and it's very easy for everyone else to verify. The difficulty of guessing so many numbers is proof of work. Okay, back to Charlie. Let me play that back to you to make sure that I've got at least a simplified version of it right. So again, thinking of hashing as these constant conversions of different lengths of data into one length, into a single fixed output, you've got previous transactions that have been hashed, each block can be represented in a hash itself. And then there's this block header that has different component parts. But effectively, to add a chain to the block, you need the transactions that have happened in the last 10 minutes. And you need this block header with a bunch of different data points. The role of the miners is effectively to solve for one of those things. That's the knots. And that is computationally harder and harder as there's more and more hash power, and hash power, I just think of as like server power, like CPU power that's dedicated to doing this in this global network.

Charlie: [00:43:21] That's exactly right.

Proof of Work

Source: Intellipaat

Patrick: [00:43:22] And then just to make sure I get that, closing the loop right, the reason why anyone does this, and the reason why there are miners, to begin with, is that if you are the miner that is the first to calculate the nonce, you send it out, you find the missing piece in this new block header that's going to hash and add this block to the chain, you're compensated in Bitcoin. So you're given Bitcoin, which is worth something. That's why you spend real Fiat dollars to go buy a server and stick it on the network and be running CPU.

Charlie: [00:43:51] Exactly. Originally, we had a bunch of people mining using laptops and desktops and the CPUs in them. After that, really, really quickly after the network has started, actually people started using graphics processing units, GPUs to do it. So these are things that would normally be used to render video games, to do 3D rendering now to do deep learning. And their orders of magnitude better at this task than CPUs are because it's very parallelizable. You can do millions of parallel computations at once on them. So that got way faster than CPUs and it became an arms race as to how many GPUs can you put together to mine? After that, we got these things called ASICs, and ASICs are basically tasks-specific hardware. People created these ACEs processing units for Bitcoin, where literally their only function is to calculate as many SHA-256 hashes as possible, given very, very stringent restrictions on the inputs. GPUs, we said were orders of magnitude better at this than normal processors. ASICs are orders of magnitude better than GPU's at it. And it's become like a literal arms race to develop the best and to accumulate the most ASICs. And that's where you start getting into mining farms and people creating them next to electricity plants and stuff like that, where it's just gotten absolutely crazy.

So if you think about it, when there are a million miners it's very, very difficult, your individual odds of finding a block are incredibly low. So someone had a really good idea, which was, "Well, why don't we just basically put all these miners' resources together and then give them pro-rata the amount of money that we make based on their proportion of the hash power used basically?" And so what this would that, let's say that you're 1%, which is a pretty big amount of a mining pool's hash power. You might not find a block on your own for weeks at a time. Whereas with this mining pool, you're going to find it far faster, about 100 times faster. It makes your profit more consistent. It doesn't increase your profit necessarily, but it makes it much more consistent, which is important for the scale of these businesses that they're at. Mining pools originally were these ways of basically doing pro-rata profit sharing with miners, that you would put them all together and say, all right, let's make this more consistent for ourselves.

Ethereum and Other Alternative Coins

Patrick: [00:46:15] To sum up cryptography, specifically hash functions play a huge role in the security of a decentralized blockchain network. One of Satoshi Nakamoto's strokes of genius was making the creation of a new block, very hard and costly in time and Fiat money. But that difficulty is rewarded. At today's Bitcoin prices, there are still about 18 billion US dollars worth of rewards waiting for miners, which will only grow if the network grows. Finally, Charlie and I discuss Ethereum, the other most important blockchain, and perhaps Bitcoin's ideal compliment. Once we understand Bitcoin and Ethereum, we will have the groundwork we need for understanding other cryptocurrencies, and we can move on to the world of investing.

Charlie: [00:46:54] Ethereum is, ... a fundamental difference from Bitcoin is that instead of being purely a network for transacting value, it's a network for contracting value. And what I mean by this is that on the Bitcoin network, on the actual Bitcoin blockchain, transactions are essentially limited to send Bitcoin from me to you, and changing that will require changes to the actual Bitcoin network. That is the most that you can reliably do on the Bitcoin network right now. I can explain how people are trying to extend that in my opinion, it won't work, but for now, Bitcoin is purely a way to store value and a way to send that value somewhat quickly now. But there are a lot of issues, a big one. I like it a lot, but there are a lot of issues that are taking much longer than they should resolve. Ethereum is not Bitcoin version two, but more like the spiritual successor in a sense, I think. So, Ethereum is based on a smart contracting system. What this means is that in Ethereum, you can write anything. The transactions allow you to write them, not just to say, send value between me and Patrick, but to say, Patrick will send me five ether if I sit here for an hour and a half and give him an interview at this location, et cetera. You can think of Ethereum very similarly to Bitcoin. The difference being that these transactions, instead of being transactions are smart contracts and interactions with smart contracts.

Patrick: [00:48:22] Talk a little bit about the way that ether has become the platform on top of which other tokens sit.

Charlie: [00:48:28] Yeah. That's actually super interesting. So on Ethereum, you can actually create basically sub-currencies. Meaning you can write a contract that says, this is a token, there are a billion of these tokens and it'll have the functions send, receive, create things like that. Most basic level like these tokens that we call ERC 20 tokens because that was a specification that was written. I know that I'm getting the actual functions wrong that are included in this, but for the sake of simplicity, and let's just say that it's; send, receive, create destroy, things like that. So you write these operations for these tokens, you create an initial amount of them. And then in an initial coin offering, what it is is people sending ether to the smart contract.

The smart contract has logic in it that says for whatever amount of ether that I receive, calculate the conversion rate to the token. So, let's say that it's one million tokens per ether. So I send the smart contract one ether. Internally, on the blockchain, it calculates and it says, I've received one ether, okay, take a million of these tokens if there are any left and send it to me. So then I receive these tokens and on that contract, it's like a sub-ledger. You can think of it like a triple accounting entry notebook where it says, okay, Charlie.ethe now owns a million of these tokens. And all of the operations are handled within the smart contract itself, which is an incredibly interesting idea, I think because it really is like bootstrapping a blockchain. You don't need a new blockchain to issue these tokens. You can bootstrap it off of the Ethereum. I think it's a wildly fascinating system.

Bitcoin is digital money. Ether is programmable money

Patrick: [00:50:06] So a Bitcoin is digital money. Ether is programmable money. In the world of investing, an interesting example is Numerai, which pays data scientists in their own cryptocurrency called numeraire. They submit useful algorithms for predicting market movements. The possibilities are many. When you hear the term ICO or initial coin offering, these are often tokens being sold to the public where the proceeds from the sale are used to fund the development of a new protocol. Often these tokens don't have their own blockchain but are instead programmed into the Ethereum blockchain. We could have gambling protocols, prediction market protocols, solar energy protocols, and so on. Amazingly, Naval Ravikant was writing about alternative coins or tokens a few years ago. And here again, he is our guide to how different coins supported by different communities or tribes, may proliferate in the future. So going back to TCP/IP again, an enormous amount of value created. It's just that all that value sits on top of TCP/IP didn't accrue to that protocol. It's on Facebook and Google, et cetera. So there wasn't much value captured there. How do you think about how, or could you describe how blockchains could potentially solve that problem?

Naval: [00:51:11] Yeah, so I wrote about this in 2013, 2014, I wrote this post. It's called the Bitcoin Model for Crowdfunding, where I was thinking that there'll be other coins. I call them app coins, they're now called altcoins. Altcoins, a little more pejorative. It was created by the Bitcoin community. It's not like other coins, but let's call them whatever they are. These other coins have their own incentive structures. And what's going on now is that the protocol developers are for the first time getting paid because normally the protocols are free. The apps are the ones that create the choke points and they capture all the value that's created up top. So apps like Google, Uber, Facebook, are apps. Protocols are TCP/IP, HTTP. The HTTP developers don't make any money. Google, Uber, Facebook, the founders get fabulously wealthy. But in the new model, the protocols actually have a lot more power. Why? The protocols have more power because they hold state, they hold identity, they hold scarcity. So they actually track what the scarce asset is. They can actually hold the user data. So if the user switches an application on top, the blockchain itself can have the identity data. It can have the user data, or it can point to the user data and have a hash to it, which is a little more complicated. But in a way, the data is open. So the data's open, the identity's open, and the scarcest track of the protocol layer, the value goes into the protocol.

Joel Monegro at Union Square Ventures or the Union Square Ventures team wrote a great post on this in 2015 called Fat Protocols. And it leads the argument on really well, but the protocols are in fact the value goes into the protocols. Now the specific implementation of how the protocol developers capture value varies. In the case of Bitcoin, the entity known as Satoshi Nakamoto mined some of it early on, but alongside the other users. So it's a very fair system in that sense. In the Ethereum case, Vitalik and Cruz sold a whole bunch of the community, got some money out of it early on, but got it out in the community's hands. There are other schemes where the developers get a piece of every bit that goes on of every coin that gets created in the future. There are other systems where the developers keep all of it. Fundamentally, I view blockchains also as huge experiments in distributed governance. If you look at how governments run, the king's model is that the king has everything. The king is judge, jury, executioner, lawmaker, legislature, executive. But the United States runs a more enlightened form of government with democratic, the downside of the Democrat is a mob, it's not merit-based. It's one person, one book. That's also the upside because it prevents revolutions and revolts. But in the United States system, you have an executive branch that carries out the orders. You have the legislative branch, which writes the orders, and you have the judicial branch, which adjudicates all the disputes. Well, the same thing goes on in blockchains, but here the developers, the coders are actually the ones who create the law. They're the legislative branch. The miners are the ones who execute that through a computing power at it to carry out what the code says that it'll do. The code itself is the law and the adjudicators at the end of the day, if there's a dispute, are the users. And the way the users adjudicate is that they're free to leave. It's open borders, there's no exit or entry. You can go into the next coin, the next coin, the next coin. So you can vote with your feet. You can vote with your money. So what you end up with is the market-based governance system that has a legislature and executive and judiciary where the users are free to come and go. And it creates a model of governance that is far more flexible, permissionless, scalable, and in some weird sense of the word fair than anything else invented to date by the human species.

Source: Fat Protocols

Crypto as a Mass Movement

Patrick: [00:54:34] I'm so fascinated by the nature of mass movements, studying people like Eric Hoffer who have crammed into a formula, what makes for a mass movement? I came across a book or really it's an essay recently called Nostalgia For the Absolute. And it's about really filling the hole or the void left by the move from a very religious society to a more secular society. The fact that we want this,... our identities get so tied up in things, and we kind of crave that. And I'm curious, how much do you see that in the Bitcoin community specifically, or maybe the cryptocurrency community more broadly speaking as a tailwind honestly, and this could be a good thing. There's a little quote from the book, which just, I thought was amazingly relevant to Bitcoin. So it says, "There will be an original group of disciples who are in immediate contact with the master," let's say that's the Satoshi, "with the founder's genius." Soon, some of these disciples will break away into heresy. They will produce rival mythologies and sub mythologies. And now watch something very important. The Orthodox in the great movement will hit such heretics, will pursue them with an enemy more violent than that, which they vent on the unbeliever. It is not the unbeliever they're afraid of, it's the heretic from within their own movement. I read that and I've been so mired in this cryptocurrency movement. I'm curious how you've thought about that at a higher level, this as a movement, more than just a technology.

Naval: [00:55:56] Yeah. Humans are inherently incredibly tribal creatures. As you basically noted, people will fight rebels in the in-group much more than the out-group. A clear example is in the United States, the Hillary supporters, the Trump supporters have more hatred towards each other than they do towards countries that we might be at war with or people who just don't even believe in the American way of life at all. Even though they have a lot more common with each other. It's like where I come from, I was the first generation from India. If you look at Indian Pakistan, they're all at each other's throats, they're fighting proxy, terror wars against each other, conventional wars, threatening nuclear wars. And then when Indians and Pakistanis moved to the United States, they live next to each other out of comfort because their cultures are so similar. They open restaurants together. So it's this really weird thing where you hate the person who's almost like you, but not quite, really because you rely upon your tribe for security. Humans are inherently tribal creatures. We're hive mind creatures. We're more like bees and ants than we are like lions or like individualistic creatures. Any human that wasn't tribal, didn't make it, they died. So we are extremely socially attuned. That's why I think the ultimate superpowers do not care about what anybody else thinks, but nobody has it because if you didn't care about what anybody else thinks, you died, your ancestor didn't make it. So we're fundamentally highly tribal creatures. And when it comes to cryptocurrencies, it's even worse than normal because now all of a sudden you've established a financial incentive system. So Twitter, I hang out on Twitter a lot. Crypto Twitter is probably, it's right up there with Trump Twitter and Hillary Twitter in terms of how much hatred there is flying around, except now you've added monetary incentives, hidden monetary incentives for people to have points of view. It gets extremely tribal, extremely negative. But I'll tell you one beauty of the crypto tribalism relative to others, which is all the other tribal systems that have come before, you're bound by geography, you're bound by people. You're fighting over scarce resources. You can't easily exit the system. For example, in the United States, Hillary, and Trump supporters are fighting or Bernie supporters or whoever is fighting for control over the monolithic entity of the US government. Whereas the crypto solution would be, that's okay. We'll just create a fork. There's a blue fork and there's a red fork. And now you're in red Bitcoin or blue Bitcoin, done.

So right now, for example, Bitcoin is going through a contentious, not quite a fork, but there's another coin that's been critical of Bitcoin cash, which some of the miners wanted to have. So they're on their own coin, which has their own valuation, their own governance, and their own mining and all of that. So because it's code, the code is the law, but you can create a copy of the code and you can fork off. So in a weird way, even though we're talking about digital scarcity, there's still digital abundance in that you can create more and more copies of it. And by the way, people who understand cryptocurrencies poorly, and I don't fault them for that, it's a very complex topic, will then say, well, then what's the value of Bitcoin? I can create infinite copies, but then we'd have to get into a big discussion around network effects. There's still the value of the original that does not go into the copies. But anyway, so I think the tribalism element is alive and well in crypto, but you can fork the tribes very, very easily. So there's less of an incentive for the kings or the priests. There are no kings or priests in crypto to crack down on everybody else. For example, even if you think that I know what I'm talking about in crypto, I can't actually do anything. There is nothing I can do to change how a Bitcoin runs other than somehow amassing hundreds of billions of dollars, and then trying to buy all of it. And even then the price of it, it just doesn't work. There's nothing I can do. The only merit that I have is the force of my ideas combined with voting with dollars or work, in Bitcoin's case, by mining or by writing code. I have to contribute something valuable to the system to have a say, but even then, nobody's going to get the entire state. There is no king, there is no elite, and there's no mob either because mobs form when you have everybody roughly equal to physical power or voice, and there's a tragedy of the comments because they're not necessarily contributing, they're consuming. The governance system around cryptocurrencies, although it's not flawless and it does lead to some tribalism, because of these rights to exit and these rights to fork and because they do not have a consolidation of power under a single leader or a small set of leaders, is still inherently a much better form of governance, I think than has ever been designed.

Institutional Investors in Crypto

Patrick: [01:00:12] So as Naval explains, we can now create different cryptocurrencies, which granted will be worthless without a community to support them, a network effect to create value. This becomes key. If we think about cryptocurrencies as an asset class, within which there are a number of currencies that we can buy and sell. Much more on that in episode two. It's important to emphasize that this world of cryptocurrencies isn't all just brilliant coders in their dorm rooms or scammy or outright fraudulent ICOs. Huge institutions are entering the fray, including the sponsor of Hash Power, Fidelity Investments. This is a snippet of my conversation with Peter Jubber, who helps oversee corporate strategy at Fidelity, including, in particular, their investigation of and investments in blockchain. I asked him how a huge incumbent company like his thinks about new technologies as both a threat and a potential opportunity.

Peter: [01:00:59] It all started for us in 2015, when we completed a fairly detailed look into the future. And for this round, we identified the emergence of blockchain technology, as well as obviously the sensational headlines around Bitcoin, Silk Road, and the like. But looked a little deeper at the blockchain technology that's part of the scenario and saw pretty quickly that the involvement of intermediaries could quickly be eliminated were you to believe that something like this could come to scale. Scenario planning is, it's a well-worn path that has been used well over 50 years by government institutions, companies as well. So you can look at the methodology, which is fairly straightforward, which is you look at the trends that you're observing in the marketplace and as well as what we call uncertainties. So things that could go either way, or we're just not sure how they're going to play out. Then you pick a time horizon and we picked 10 plus years out to look at and said, well, let's look at what happens if you believe these trends to play out over that timeframe. So you use a collection and interaction of trends and uncertainties to describe these future worlds. And if you do that enough times, you're able to alight on a few of these future worlds that we think are more relevant for us than others might be.

So I just want to make a one really important point. It's not at all about prediction. It's about understanding and provoking. So we don't have to be right. When we started the journey to understand where there might be opportunities in the capital market space, we started with the obvious pain points, which is T plus three, or now at T plus two, to have a securities trade settled, or even the pain of multiple days on an ACH transaction in getting money moved around. That basic stuff around money movements and transactions and payments were where we started and blockchain is at this first blush the instant solution for that. That's what caught our interest initially. And then we delve pretty deep and began to understand in greater detail Bitcoin as a currency, Bitcoin as a protocol, the underlying notion of a blockchain. And unpack that at some detailed level, from the most senior person in this company to the rest of the working team, understanding what hashing is, the basics of cryptography. We got fairly detailed into it, even resulting in our little mining operation.

Patrick: [01:03:48] One of the defining features of open source projects or protocols is cooperation. I think that when you investigate blockchain, you see it everywhere. So I'm curious to hear your take about the cooperation with the core community.

Peter: [01:04:01] In our journey, we have recognized the need to work closely with these tiny companies and partners as you one, learn and understand, and two, then figure out what they can contribute and what we can contribute to the equation. I think large incumbent players, and that would include us by the way, should feel fairly threatened by what this could represent in the future. So for the financial system that's in place, that's an issue. So every incumbent should be spending time and money on this topic to understand it, at least to understand the threat. But I think there's just a massive opportunity.

Patrick: [01:04:39] We've seen some huge names denounce Bitcoin specifically in recent weeks. Corporate and investment leaders who are both smart and accomplished. But as Peter points out, this probably isn't binary. Understanding the threats and opportunities is important. In that spirit, we close episode one with a quick thought from Olaf Carlson-Wee. Olaf has become a poster figure for all things blockchain because his experience has spanned the ecosystem. He was the first employee at Coinbase, the huge cryptocurrency exchange, and the founder of Polychain, one of the first crypto investment firms. As I was on my way to meet him, I saw him on the cover of Forbes. Olaf has thought long and hard about where this all might be headed. We will hear much more from him in episodes two and three, but for now, he puts what we've learned in perspective.

Olaf: [01:05:22] That idea that the money lives on the internet, is the breakthrough. So now you have the same open-source, open-access architecture you saw on the internet for communication, now we have it for finance. This means that you can build banking products, loan products, derivatives, all sorts of crazy financial systems, all using smart contracts, which again is this code that lives inside a blockchain. I think we're at the early innings of this playing out. Just like the early internet looked like a joke or a toy, I think cryptocurrency to the average person, looks like a joke or a toy right now. It's like, "Man, this is just crazy and speculative and it's pretty unproven. Why would I use any of this? Why is it useful for me?" I think people were struggling to find the internet useful until maybe '94, '95, but then five years later, the internet was like an integral part of everyday life. This happens very slowly until it doesn't. Then it's very sudden, and by the time you see it coming, it's too late. So I do think we're in the experimentation phase, the deployment phase, and it is some parts of this are immature, and it does look like a toy. But that over time, people will realize, wait, actually, this was as important as,... this is maybe the most important creation since the internet, as far as just a game-changer for the world. And by the time the average person realizes that it will be inevitable. Like the genie will be out of the bottle and there's no way to put it back.

Patrick: [01:06:55] Here, I'll take the final stock of what we've covered. The core idea around blockchains is that they are the next leap forward in open source internet protocols. The first set of internet protocols enable the global permissionless exchange of information or data, which has totally changed the world. This new set of protocols allows the global permissionless exchange of assets or value. Bitcoin was the first network to solve a huge problem. How do you trust a system with no central authority? Miners provide that security and secure digital scarcity in a way that banks or financial institutions do for us now. The ability to exchange value on the internet could be a game-changer. We could see vastly improved capital coordination, new kinds of markets or even things like decentralized autonomous organizations, crazy as that sounds. I think Olaf said it correctly. We were in the early stages of all this, which means there's a lot of speculating.

We don't really know where this is heading. I hope to bring on legal and other experts in the future to throw a bit of cold water on blockchains because I think a balanced approach is a key to any analysis. If you have any favorite skeptics, send them my way. This experiment has led to many relationships within the field, which is growing fast, including relationships with people who are hiring. If you're a full-stack generalist engineer, looking to work for well-funded companies, developing decentralized apps, email me at hashpowerdocumentary@gmail.com. Please write "Developer" in the subject line and include a link to your GitHub account. Please also include a short summary of your skills. You do not need previous experience with blockchains, but a couple of pluses are experienced with React, Redux, Swift, and Objective-C, commits to an open-source project or open project on GitHub with 25 plus stars.

Remote work is fine. Now, I've been behind the curtain quite a lot in the last few months. I'd like to close by telling you just how much momentum this all has. Momentum is a powerful force. And this instance of it is fueled by some of the smartest people I've met in my career. It is financed and supported by the biggest names in venture capital. It is being led by very young people with very grand visions of the future. We know how powerful open source protocols can be. They've changed the fabric of the world in the past, and we might be watching it happen again. Could it all be bunk? Sure. But I would not bet against this technology, not by a long shot.

Now, investing in cryptocurrencies is an entirely different conversation. Stay tuned for episode two, where we meet the leading investors in how they buy and sell different cryptocurrencies. Hash Power continues next week. And we will also be releasing full conversations with the guests over the coming weeks, which are available at investorfieldguide.com/hashpower. If you thought episode one was interesting, wait until you hear from Ari Paul, Olaf Carlson-Wee, Josh Seams, Naval, and Jordan Cooper.

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