Introduction

Patrick: [00:00:56] My guest this week is Adam Ludwin, the founder and CEO of Chain, a blockchain technology company targeted at large enterprises. Before shifting his career to focus solely on crypto, Adam was a venture capitalist focused on FinTech which is how he came across the Bitcoin white paper earlier than most. I call this episode a sober view on crypto because Adam's take is so balanced. He is certainly long crypto both in his portfolio and career, but he is very skeptical of much of what is happening today in the ecosystem. For example, He offers the best reason that I've heard for not launching an ICO or investing in them. If you haven't read Adam's widely shared open letter to Jamie Diamond, it has become a must-read piece for crypto enthusiasts, read it as soon as you can.

Decentralized Applications and Censorship Resistance

Patrick: [00:00:56] Like the Hash Power documentary, this episode and other Hash Power singles are 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 that already provides a comprehensive set of products and services to individual investors, employers and financial advisory firms. For more information, please visit fidelity.com. One key insight from Adam in our offline discussion was how cryptocurrencies function very much like equities or bonds, just as equity financing enables the activity of joint-stock corporations, cryptocurrencies enable activity in decentralized applications, we pick up our discussion with Adam discussing whether anyone really uses these decentralized applications today.

Adam: [00:02:34] The big question in the market right now is, will anyone ever use these decentralized applications? Will anyone actually buy things with Bitcoin at scale? Will anyone actually do meaningful computation on Ethereum? Will traders begin to enter into high-value contracts and run them on Ethereum? Will people store files in Filecoin instead of in Dropbox? Instead of on S3? If you're a company. And so far, the evidence is that very few people are using these services. The shorthand of this is just to say nobody's using Bitcoin, everyone's investing in it, 100 billion market cap, but if you talk to 10 people who have purchased Bitcoin and ask them, "How many of you have spent Bitcoin to buy something in the last week?" Usually, the answer is zero. If you say in the last year, maybe it's one or two, but that is the stated purpose of Bitcoin. The stated purpose in paragraph one or two in the first pages, this is a means to have commerce on the internet be more seamless.

Patrick: [00:03:43] So there's so much to explore in all of that. The first of which is the features of decentralized applications, when I think of application... a lot of companies are just applications, Facebook's an application, the ways in which that might be better today, or in 10 years versus a centralized version of the same thing. And in your piece, you highlight how, really, if you boil it down today, we can talk about 10 years from now as well, censorship resistance is the one sort of undeniable advantage that a decentralized app has over a centralized one. So can you please explain what censorship resistance is and why that's so important?

Adam: [00:04:20] Yeah, of course. So part of the reason no one's using these services, and again, I want to separate out for your listeners, when I say no one's using them, I don't mean that there's no trading activity. We all know there's tons of investment speculation in the underlying crypto assets, but like I pointed out, those crypto assets serve and enable something new, which is decentralized apps, and very few people are using them. And the reason for that is that decentralized applications are just worse on virtually every dimension by virtue of their design than their centralized counterparts. It's much more efficient to store files in a centralized cloud like AWS than it is to try to parcel them out in a distributed way across a network of computers, and then reassemble them and have a mechanism to order those transactions and maintain global state.

And the same is true for a Bitcoin payment, we all know Bitcoin is sort of limited at roughly seven to 10 transactions per second, Visa on Christmas will do 60,000 transactions a second. So we've got a big gap there and a lot of that gap isn't closable in the sense that well, it's just early and we'll get to a bigger scale, a lot of that gap is the fundamental design of any decentralized system. And so we have sort of these performance and scalability and throughput questions. We also have usability questions, in order for me to, again, retain a decentralized model with Bitcoin, I've got to manage my own private keys. If I stick my private keys or my funds with an online wallet or an exchange, I'm back to PayPal, it's exactly the same, right? So I have re-centralized. Coinbase is an amazing company, but it's helpful to remember they're an app, when you log in to see your balance and claimants, you're not looking at the Bitcoin blockchain, you're looking at the reading from a PostgreSQL table, a database table.

So if you really want to spend Bitcoin and remain in a sort of decentralized mode, you've got to maintain your own private keys, and that's really hard to do. Even if you use a hardware wallet like a Trezor or Ledger, it's a lot more complicated than using, for example, like a password manager, and unlike a password, if you lose your private keys, you don't get to hit reset private key, your money is gone. It's like losing the key to the safe deposit box that's holding your money and there's no recourse. So all of that's to say, decentralized apps are sort of worse on these dimensions. Yes, they'll incrementally get better, but structurally, they have these trade-offs. And those trade-offs are there intentionally and by design in order to get decentralization. And coming back to your question, the real value of decentralization is censorship resistance, which means that nobody can stop me from sending Bitcoin to someone in China.

No one can stop you from taking this podcast and uploading it to Filecoin. Nobody can stop two traders on Wall Street from entering into a contract and having that contract be executed by Ethereum. And that's a very powerful idea that for the first time, we have unstoppable software, there's no company that can kind of intercede. And now for most people, especially in the United States, that doesn't strike them as like, "Oh, finally."

Patrick: [00:07:55] My problem's solved.

Adam: [00:07:56] Yeah, "I was really sick and tired of Venmo censoring my Starbucks transactions. I was really sick and tired of the Amazon cloud, every time I tried to run a computation, they just said, sorry, you're a funny looking guy, I'm not going to process." So for most people, this isn't a selling point, but there are at least two cohorts of people where it is a selling point. And the first cohort are people who are sort of off the grid, right? They don't have access to competently-run centralized services.

Patrick: [00:08:29] Should be like the unbanked or something like that.

Adam: [00:08:31] Yes, the unbanked or people who are living under governments that are, for example, hyperinflating their currencies, or where there aren't competitive market mechanisms that will give them better options, or where they're trying to move money out of a place where there are tight capital controls. So leaving those sort of legal and moral arguments to the side, functionally, that's-

Patrick: [00:08:56] That's a lot of people.

Adam: [00:08:57] It's a lot of people. So people that are off the grid. The other cohort of people are people who want to be off the grid, they're here in New York City and anywhere else where you can access all this sort of traditional software from companies, payment systems, et cetera, but they want to be off the grid. And this is usually when you hear politicians or others talking about Bitcoin, they'll usually just say, "Bitcoin is great for criminals." And they're right, actually-

Patrick: [00:09:25] Monero is even better.

Adam: [00:09:26] You're right and Monero and privacy coins are better. If you're trying to transact anonymously, if you're trying to buy something you shouldn't be buying, to date, the best way to do that was to show up with a briefcase of US government-issued currency. Now, there's this alternative and by the way, that still might be the best, because there are some open questions about whether you'd really want to use a public blockchain to transact in illicit goods, but in practice, it doesn't take much sleuthing to find very robust dark web marketplaces that essentially denominate everything in Bitcoin.

And so people that want to be off the grid, because they're buying something they shouldn't be buying because they want to evade taxes, because they want to get money to a group that they shouldn't be getting money to. Those are, again, leaving the moral legal arguments aside, functionally relevant for people. And this is what makes I think a lot of folks in the traditional banking world a little uneasy to say politely or just dismissive of this whole asset class, because they will point out these examples and say, "I told you so, this is just stuff for criminals, we have properly run services, why do you need a censorship-resistant network?"

And it's sort of hard to argue with that. At the same time, I pointed in my article to counterexample, which was encrypted messaging, which is the ability to send a message to someone and ensure that there's no third-party snooping in the middle. And encrypting your email was something that even five years ago was sort of the exclusive domain of hackers, spies, paranoids, normal people didn't do that, but if you fast forward, post-Edward Snowden, post-Wikileaks, post even Donald Trump and sort of a new world order that people aren't sure about yet, the number of people in this sort of [inaudible] corridor between New York and Washington and out in the Bay Area, who if you just sort of glance over on a train or a plane and see them on Signal.

Patrick: [00:11:39] Telegram.

Adam: [00:11:41] Telegram, exactly, notice they're using WhatsApp maybe because it's end to end encrypted, is remarkable. And so something I always point out to skeptics around crypto assets is that it's fairly easy to predict how a technology will evolve, we know that public blockchains are structurally going to be difficult to scale, but they'll get a little bit more scalable. We know it's structurally difficult to have privacy at scale, but they'll become more private, we know the user experience is in great, it'll get a little better. But we also know that structurally, these things are largely going to be relevant to folks off the grid, who want to be off the grid, who want censorship resistance, who want more privacy, who want more anonymity, and so on. And so that's sort of easy to predict, what's hard to predict is how society is going to change to either be more accepting or less accepting of a technology.

When you saw the first iPhone, it was sort of easy to predict that you would see people taking photos with it. It had a camera, it had a built-in camera app and it was like, okay, yes, I could see that cameras are going to sort of slowly... that market's under threat now and that these mobile phones might really challenge the traditional camera market, that's sort of easy to predict. What was extremely hard to predict with Snapchat, that's because Snapchat didn't emerge because of technology alone, it emerged because of the way young people engage with technology, their reaction to oversharing, their desire to sort of reclaim their privacy, et cetera, those things are super hard to predict.

So I think the smart money that's investing in crypto-assets and betting on decentralized applications becoming used more and more, essentially, what they're betting on is that there will be emergent phenomenon that is very hard to anticipate right now when you look at the way the world is, that could in ways it's hard to predict and hard to anticipate, embrace these technologies, embrace decentralization, and seek the sort of refuge from the more centralized systems. And in a way, this whole market, this whole arena of decentralized apps and crypto assets and cryptocurrencies is like an internet counterculture. It sort of started as a bank counterculture, financial counterculture, it's still that but it's also an internet counterculture taking aim at not only financial incumbents but also now technology incumbents. And you hear a lot of people that look at this sort of oligopoly, this sort of so-called FANG stocks, Facebook, Apple, and Google and so on, what's the N? Is it Netflix?

Patrick: [00:14:24] It was Netflix but the acronym's changing.

Adam: [00:14:26] Yeah, we can't take Netflix out and still have a workable acronym. But anyway, you look at these incumbents and people go, "Wow, how will we ever have innovation again when they can just buy any company as soon as it's successful?" Well, what's interesting about decentralized applications with respect to something like Facebook and Mark Zuckerberg in particular, is even though there are no killer dApps, you've heard this term killer app, Instagram is like a killer app on mobile, great, Zuckerberg swoops in and he buys Instagram, threat neutralized and also new growth on mobile. Oculus Rift looks like the killer app, next platform is going to be virtual reality, great, let's swoop in and go get the Oculus go buy that. So killer apps are acquirable because they're created by companies that have equity under them and have investors who want to return, the whole model works. Even though there are really no killer dApps, again, through my definition of people using them, if one emerges, Facebook won't be able to buy it because by definition it won't be created by an acquirable company. If Mark Zuckerberg decided he wanted to buy bitcoin today, the question, you smile when you say it because it doesn't make sense, buy the whole project. Or if he said, "Oh, Ethereum, I want to go buy Ethereum." You can buy some Ether, but you can't take over Ethereum. So really, this presents a bit of a paradox to the sort of the software incumbents and the bank incumbents because even though they're not really threatened yet, the genie is out of the bottle, and if something does emerge that is used widely, there's nothing they can really do short of maybe regulatory pressure to compete, and their best hope is that centralized services just continue to be so much better. And again even if decentralized services get better, decentralized apps get better, centralized apps are getting better as well.

Source: Towards Data Science

I mean, look at the new iPhone relative to the first one in 10 years, it's like it's a miraculous improvement. So they're not going to standstill. So the net of all this is just nobody knows where it's all going. And I think if you look at the $200 billion market cap of all crypto assets, you can say, "Where does that valuation come from?" The way I think of it is, first of all, it's probably coming from nowhere. Let's just start with it's Mr. market and mania and all that is true, we should come back to that, but maybe a more academic way to argue it would be to say, the 200 billion represents a small probability of a very large outcome. And the very large outcome is trillions of dollars of sort of economic value across major technology companies and major financial institutions disrupted, but the likelihood of that is still low. So people are sort of waiting for it at one to 10%. That's an academic way of sort of justifying, justifying.

Challenges Decentralized Applications Face

Patrick: [00:17:21] I think that's the right way to do it. And I like the camera idea and the iPhone. My mom's photographer so I know quite a bit about resolution and camera technology, et cetera. And it's a perfect example of kind of overlaying a linear growth pattern with an exponential. And in the case of the iPhone or digital photos, more generally speaking, you kind of had this long period where it's getting exponentially better, but it started from such a low base that it looks grainy, it's crappy, it's crappy, it's crappy, and then all of a sudden, there's just this vertical line where all of a sudden, digital photos are actually way better and more versatile and everything is better about let's say, the user experience using a digital... my mom shoots only in digital now. She used to have these fancy Hasselblad cameras and maybe still uses that a little bit, but probably 95% of her photos are digital. And that happened instantly.

And I think people always underestimate the exponential growth curve, just because human beings just aren't well suited to understand it. You mentioned something earlier, and I just want to get kind of your specific thinking on it, which is, there's something inherent about decentralized apps or blockchains that mean maybe there's a limit on that exponential, that there won't be that same vertical line, because the counter-arguments of some of what you've said would be, "Yeah, they all stink now and the user interface is terrible and it's hard to manage private keys." But all of those things are going in this kind of open permissionless innovation world going to get exponentially better, and then one year, five years from now, your Bitcoin as a payment network is going to be 10 X better than Chase and then 100 X better than Chase, whatever that might mean. So what do you think about that idea on exponentials versus kind of linear improvement from incumbents? And whether or not there may be reasons why this isn't another example of that.

Adam: [00:19:05] It's a great question. And I'll start by saying it'd be foolish of me to sort of draw a really hard line in the sand and say never because the history of technology is sort of...

Patrick: [00:19:17] Overwhelming ever.

Adam: [00:19:18] Yeah, Exactly. I think the greatest challenge for decentralized applications is that they're decentralized, which is to say that Bitcoin works because it maintains global shared state, meaning every node on the network has a roughly consistent view with every other, updated every 10 minutes with every new block. And that's the only reason it works and maintains its competitive edge over something like PayPal on that dimension of censorship resistance. Most of the proposals that seek to make... let's just stay focused on Bitcoin for a moment, Bitcoin faster, more scalable, and more usable do so by actually re-centralizing elements. So the so-called block size debate were proponents of increasing the block size, meaning the number of transactions per batch that are validated and then distributed. And that argument, the reason that's so contentious is that it boils down to one side saying, "Let's have bigger blocks, even though the file size is bigger and therefore it will tend to benefit those that have better computers, faster internet connections, which will tend to centralize the network around them. It will be worth it because we'll be able to process more transactions on the network," versus the sort of purists that say, "That will defeat the whole purpose of Bitcoin because if it tends towards centralization, it won't be as good as pure centralized services like a PayPal, it'll still be 10 X slower but we'll lose the one thing we have, which is censorship resistance."

And again, if you store your Bitcoin at an exchange, it makes it way more usable, way more user friendly, but you don't have control over your funds anymore, that exchange has control. And we've seen extreme examples of this with Mt. Gox and other exchanges, Bitfinex and others that have been hacked, and people just lost money, you weren't in control of your funds. We may see more subtle examples where exchanges are audited by the IRS and people find out, "Hey, I wasn't as off the grid as I thought I was." So the fundamental challenge is not that we can't get higher performance easier to use blockchains, it's that structurally, the way to do that are all centralized solutions. Now, again, the counter-argument to that is, "Well, Adam, you're not smart enough to see that we're going to be able to have our cake and eat it too. There are going to be technologies that will allow us to maintain censorship resistance, maintain decentralization, have these peer-to-peer networks, not compromise on that and get 10 X or 100 X performance, 10 X or 100 X privacy, 10 X or 100 X usability." So far, it's too early to tell, there are certainly not any compelling examples of where we're seeing that today, but I'm sure this podcast won't age well, and when I listen to it in 10 years, I'll be like, "Wow, I was an idiot, I didn't see it." So it's very possible. I think to sort of sum up, the best argument for that is what you said, which is we just can't see yet the breakthroughs that will enable these networks to really just decimate the others, and that's possible.

The fundamental challenge is not that we can't get higher performance easier to use blockchains, it's that structurally, the way to do that are all centralized solutions.

It's a similar argument, though, to those who say even though no one's using dApps today, it's just because we haven't seen yet the kind of emergent phenomenon. And so the only argument you'll ever hear, that's the sort of the bulls make repeatedly is a version of you just can't see it yet argument on both the technology and the societal use of them. Here's my problem and what I struggle with, and by the way, I kind of agree with those arguments. So let me just tell you what I struggle with though, which is at the beginning of other kinds of paradigm-shifting technologies, like the internet itself, people actually were not making that argument. If you go back and you read magazine articles from 1991, 1992, 1993, where it was just before the web, but people were on BBS systems and connecting the Prodigy and CompuServe and services like that, the question was only how big and what things we couldn't see, but a lot of what people were excited about were things that they were already doing then. So for example, there were already chat rooms and message boards, there were sports scores, there were stock quotes, there was news, there were funny cat pictures, and there was email, there was file sharing. It was kind of junky and weird to use and kind of complicated and nerdy, but for those that were using essentially the early internet and the early web, it was undeniably exciting and real and you could point to those things. And the question was just like, "Are normal people going to want to do these things?" And the answer, of course, was yes. But no one was saying, "Look at all these networks, computers, we have no idea what to do with them, but maybe something will emerge." That wasn't the argument.

Patrick: [00:24:47] The kind of solution in search of a problem.

Adam: [00:24:49] That's right. And the same was true for PCs a decade earlier. There were killer apps from the beginning, word processing, spreadsheets, more advanced computations and calculations, so-called microcomputers later, personal computers had killer apps from the beginning. And so what I struggle with is, I don't see the seeds of that outside of the sort of want to be off the grid cohorts, and that's the part I struggle with. I worry that if we never get there, we'll look back in 10 years and be like, "Oh, I was right because the seeds of those killer apps weren't there in the beginning." But again, I struggle that I'm genuinely torn and the reason I continue to be long crypto assets is you probably want to make a bet because it's so hard to predict and the medium of money and assets hasn't changed that dramatically.

Bitcoin as a Store of Value

Patrick: [00:25:41] What about the arguments that for one, maybe killer app or killer dApp, which is this kind of digital gold nonseasonal store value idea for Bitcoin specifically where I don't like shoehorning old stuff into this new paradigm but it's an easy way to think about it. So if some chunk of the multi-trillion dollar gold market likes gold because they think it's something that will persist as valuable and they're super skeptical, they hate governments, and they're hardcore libertarians or whatever, those are the motivations, there's a demand for that sort of asset. And then physical gold bullion, which is what the hardcore people will tell you you need to own versus like a GLD ETF is expensive to store, it's incredibly hard to move, it's a pain in the ass. It's centralized in many ways, if you have it in a bank vault someone can seize it from you.

Adam: [00:26:26] Yeah. Even a depository receipt on a gold bar is not good enough, right? Because if that warehouse or that manager goes under, that warehouse receipt just becomes a claim on their debt-

Patrick: [00:26:40] Right, it's an I owe you.

Adam: [00:26:41] Yeah, it's an I owe you. So-

Patrick: [00:26:42] So what do you think about that as a killer app?

Adam: [00:26:44] I like it. I think it's the best argument for why Bitcoin is valuable and interesting, although it's sort of circular. Bitcoin is a store of value because it a store of value and the price goes up, therefore, it's a store of value.

Patrick: [00:26:56] Yeah. Very reflective.

Adam: [00:26:59] Yeah. People make the store value argument, during bull markets when the price of bitcoin is high and you don't hear them very often when the price of bitcoin is low. If budget people listen to your podcasts and buy bitcoin and then in a year from now if there's a correction, or sooner, and it's down 80%, and they're like, "Wait, I thought this was a store of value." So store of value is a fuzzy term, but at the same time, it's the one that I use to sort of explain to kind of friends and family right when I'm beginning to explain Bitcoin to someone what's interesting about it. And even though the original intent of Bitcoin was to be a mechanism for more seamless commerce on the internet, that's a stated goal in the paper, in practice, it's being used mostly, to your point, as a store of value, which is mostly a way to view Bitcoin as digital gold. And like gold, you can always justifications for why it's valuable, but it's largely just everyone believes it's valuable, and therefore it is, and like gold, if I said, "Why is gold worth $1,000 an ounce?" What is the price of gold right now?

Patrick: [00:28:11] I don't even know.

Adam: [00:28:12] I don't even know, let's pretend $1,000 an ounce.

Patrick: [00:28:13] Something that you and I could probably both quote.

Adam: [00:28:16] 100%. No way. Yeah, 100%...say, "Why is gold worth whatever it's worth or price?

Patrick: [00:28:24] It says five, six trillion overall.

Adam: [00:28:26] Yeah. The answer is, there is no answer. The answer is like the first day of economics class, supply and demand.

Patrick: [00:28:32] Some other people think there is.

Adam: [00:28:33] Yeah. So it's all demand-driven. There's sort of arguably, not arguably, there's a scarce supply of gold and so the price is driven entirely by demand. That demand is driven entirely by... I think largely it's a fear index. And it's a lot of these macro arguments around inflation and nation-state sustainability of different things. And so that's why people buy into gold. And I think Bitcoin is very similar. I think a lot of the gold bug mentality, a lot of the anti-state mentality carries over and is prominent within the Bitcoin community. And so I think, yeah, it's certainly a store of value over a short amount of time. If I needed to get $100,000 of value to Venezuela today, Bitcoin would probably be my best way to do that.

It may go up or down 10 or 15%, but I could write that off as a fee, and I might make money or the recipient might make money on the transaction. So as a settlement intermediary, let's say, buying $100,000 of Bitcoin, sending it to Venezuela, they sell it, it's certainly a store of value over that transactional period and certainly a better mechanism to get that money than sending gold bars.

Source: Murad Mahmudov

Adam’s Introduction to Crypto-assets

Patrick: [00:29:52] Yeah. The other thing that I've seen and again, sitting in the US seems like the worst seat for all this stuff because we've got it so good. All right, things are easy for us to do all The kinds of things that I think people want to do with their money. The remittance or sending of money too hard to reach places where the bank system is a complete nightmare, I talked about China recently in an episode where I know a guy that does this all the time, for him, if he was sitting here, he'd say, "No, there is a killer app. I want my dad to get some money in China and he's going to have it in 10 minutes and before that, it was a week and a huge hassle." So there does seem to be some emergent use cases.

But it brings me back to your point around the investing side of all this and you said you're still long crypto assets, probably for some of the reasons that you've talked about, maybe mentioned... I always love the origin stories with everyone with this space, with this asset class, how you first came across it, how you got involved, and how that thinking has evolved kind of through today. As you look at it today, you earn money, there's money, you're a capital allocator like anybody else, you choose what to do with it. How is that thinking about whether or not to include crypto assets as an asset class, let's say in your own portfolio, evolved from your first exposure to it?

Adam: [00:30:59] I had a good friend of mine who ran a security company, not securities but information security company in 2011, sent me the Bitcoin white paper. And he sent it to me because I was a venture capitalist at a firm down the street from here that invested a lot in FinTech. So firm called RRE Ventures-backed companies like Venmo, WisdomTree was ETF guys, Braintree, OnDeck Capital, peer-to-peer. So I was exposed and seeing all these FinTech projects, and my friend said, "Hey, you're working in this FinTech, early-stage investing firm, what do you think of this new kind of FinTech idea, Bitcoin?" And I read the paper and what struck me immediately was it was nothing like any of the FinTech we were investing in. "FinTech" pre-crypto era was really top of the stack of the financial industry. The basic premise of most FinTech was, it's hard to use your bank account, it's hard to use your brokerage account.

Patrick: [00:32:05] Cumbersome, everything's cumbersome.

Adam: [00:32:06] It's cumbersome. We're in the era of the iPhone and the web and social networking, we'll build something that feels as good as your iPhone that's for your financial life. That's Venmo, that's Wealthfront, et cetera. And that's what FinTech has been, it's been this thin layer of UI that is more user friendly and sits at the top of the existing financial stack. But underneath that, is all the same old payment rails, banking, infrastructure and...

Patrick: [00:32:36] Swift network.

Adam: [00:32:37] And Swift network and ACH and everything else. Bitcoin was like, "Look, we already have the internet, what's the least we can add to it to get some money in the payment system?" It's like a very thin layer at the bottom of the stack, or really, it's a new stack. It's like a big reset button and says, "Okay, start over." New stack. And that was mind shifting. It was also mind-shifting because I read the Bitcoin paper, I had never heard of it, it wasn't in the news. And so I was sitting there like, "What is this? Is this an entrepreneur somewhere? Who's this Satoshi guy? Am I going to fly to Japan and meet him and try to invest in a Series A?" That's where my head was at. And so I started to ask around in New York who's heard of Bitcoin, is thinking about Bitcoin. There's another VC called Fred Wilson, who's at Union Square Ventures, I had co-invested in another company with him, at a board meeting, asked him, "What do you think of Bitcoin?" He's like, "Oh, I'm really interested in Bitcoin." So we started talking, we hosted an event at his office with the 12 people we could find who had ever heard of Bitcoin. Three of them were in New York, one of them was from some clandestine government agency, who was doing early research, couple guys from Stripe, and we just sat around for four or five hours with Fred and Albert, and a dozen of us talking about cryptocurrencies and trying to figure out with our traditional VC hats on, is this investable? How do we commercialize this? And realizing by the end of it, it's just an entirely new ballgame and new rules, and the way you make money here is not the way you traditionally made money in VC. And so that was sort of my introduction. And I started to think pretty much exclusively about cryptocurrencies while at RRE and meeting all the companies and getting to know for example, like Coinbase, when they were just coming out of YCombinator and trying to wrap my head around what the opportunity set is.

And ultimately decided this was a big enough thing that I should spend all my time on it. I didn't want to just spend part of my time and invest in it, I wanted to spend all my time on it, and that's ultimately what led to change. So fast forward to the present day, in certain ways my thinking hasn't changed that much in that, I still think you ultimately play this market by buying and holding the crypto assets that have differentiation that enables some service that you could see or imagine people using, and I think Bitcoin is still obviously the best example of that, to your point earlier, that yeah, International so-called wire transfers are really difficult and expensive and bitcoin is much better for that, and your friend in China is a great example, store value and index against or hedge against inflation and other things, so that's a good bet. Ethereum I think is a good bet because it enables this emergent behavior more than Bitcoin, Bitcoin is not really a platform, it is what it is. Ethereum is a platform, again, it gives you a lot of optionality on what could emerge. Zcash, another one that I'm an investor in the company and also in the asset there because if you look at what makes Bitcoin appealing, again, it comes back to censorship resistance, a big piece of that is anonymity, and approaching kind of the ability to transact not only trustlessly but invisibly, and you can't do that on Bitcoin, you can with Zcash. And again, it sounds like a spy tool or something but privacy with respect to transactions you might have with counterparties is extremely relevant in virtually every capital markets transaction, dark pools are obviously the latest mainstream example of that. So finding differentiated projects that are real, which is increasingly becoming very hard to do with sort of the ridiculous amount of noise and baloney, basically in the ICO market, with everyone rushing in. So we could talk about that or take another direction.

I still think you ultimately play this market by buying and holding the crypto assets that have differentiation that enables some service that you could see or imagine people using, and I think Bitcoin is still obviously the best example of that

Investing in Initial Coin Offerings (ICOs)

Patrick: [00:36:43] So you had a line, probably my favorite, might have a single sentence in the paper about ICOs, which is I read it and I'm thinking to myself, "Man, is that correct and terrifying," which was nobody, virtually nobody is buying a coin in an ICO because they want to use it to access the dApp, to access the service. It gets back to your point around no one's actually using the majority of this stuff, they're speculating on the value of the coin because maybe it turns into something, but nobody is buying a Filecoin today because they think that next week they're going to spend Filecoin to store something, I shouldn't say nobody, right? I'm not the deep expert here, but certainly, across the majority of these, these are white papers and simple ideas. I'm trained as an investor to always avoid investing in hope because people overprice hope and they overprice potential and they underprice real things that are not exciting. An ICO is maybe the most extreme example that we're going to see of this in our lifetimes. So maybe I'll ask the question having said all that, is there any circumstance in which an ICO would be interesting to you in this kind of hyper frothy clearly 99% speculative market?

Adam: [00:37:56] So Ethereum was an ICO which they only raised $18 million or something along those lines. And that was an example of...

Patrick: [00:38:04] A really good investment.

Adam: [00:38:05] ... a good investment and an example of a project which just look at the pattern there. You had Vitalik and a handful of others who had a vision that was differentiated from Bitcoin, that was informed by their work on other so-called meta protocols, attempts to layer in other assets on top of Bitcoin through the OP_RETURN of Bitcoin and realizing that's not going to cut it, we need a whole different model, solving some really interesting problems, charting a course to get to greater scalability with proof of stake with charting techniques, et cetera. And someone who was creating a model that was internally consistent, what I mean by that is, Vitalik was trying to bootstrap a decentralized application called Ethereum. A lot of ICOs are trying to shoehorn a token into a normal company. So that's the first red flag on any of these. But I think Ethereum is a good example of an ICO worth participating in. But recently, it's become very, very hard to justify investing in ICOs for a couple of reasons, first is the ICO is not usually the initial offering anymore, for projects like Filecoin and Blockstack and others, there are often several rounds that happened before the ICO.

Patrick: [00:39:27] This would be like the SAFT agreement.

Adam: [00:39:29] Right. That's right. And traditional VCs are getting in these sort of discounted rounds or high net worth folks are getting. So you have to sort of start with like, "What's the valuation I'm buying in?" So that's one challenge. The other thing is when you buy into an ICO, oftentimes, you don't even own the token yet. Tezos is a good example of this. People that funded Tezos funded a Swiss foundation, they didn't put in Bitcoin and get back a token. By the way, the same was true of Ethereum, you didn't get Ethereum. And so it's actually not the initial coin offering, it's actually a bit of a misnomer, it's the initial promise to get a coin later offering. And so again, it's very hard to justify the risk of what could go wrong between when I fund and when the coin is actually issued. And also, it's hard to justify when it feels like most of these new tokens are created by teams who are trying to justify the need for one in an effort to just raise capital that is neither equity nor debt, which is very attractive, obviously, as a seller, as an issuer. But coming back to sort of your comment, yeah, the biggest thing I struggle with is that teams are getting a false signal that people want their service. They're telling themselves, "Oh, everyone's buying my token, they must really want my upcoming service." And the harsh reality is nobody cares for the most part about your dApp. And you probably know that too.

Patrick: [00:41:02] They want a 10X return in ten weeks.

Adam: [00:41:04] There's this really great phrase that Marc Andreessen invented called product-market fit in the startup world. And product-market fit is just a fancy way of saying that you've got a product that people want, yeah, and YCombinator has this great saying which you walk into their space and it's like everywhere, it just says, "Build something people want." And the reality of these token sales is that they do have a kind of product-market fit. The market are people who want to get rich quick and the product is a way to potentially get rich quick. But they don't have this sort of traditional startup type of product-market fit, which is people actually want to use whether it's Filecoin or Steemit or Ethereum for their stated purpose. So my investment approach to all of this is, first of all, follow Warren Buffett's advice, only invest in things you understand. So if you don't understand what the thing is, avoid it.

My best example of that, by the way, is there is a token called Bancor and there's an FAQ section, and FAQs are frequently asked questions. And this project raised $150 million. And so I was putting a presentation together and I was like, "What the heck is Bancor again? I got to remind myself because they just raised 150 million and someone's going to probably ask me." So I go to their frequently asked questions, the number one question listed is, and I quote, "Why is there a double coincidence of one's problem and asset exchange?" So your face shows me, you don't know what that means, I don't know what it means, we're both kind of like in this world of finance and blockchains and we don't even know what the question means. I guarantee nobody buying the token knows what that question means, and this is the frequently asked questions. So there's almost this perverse thing happening where because nobody understood Bitcoin or Ethereum, and therefore they passed on it and then those turned out to be huge winners, there's almost this thing where people are like, "Well, the more complicated it is, the less I understand it, the more it's likely to be something real." So people are checking their judgment at the door. And again, issuers are playing on this or preying on this and creating projects that are just confusing, or sort of obfuscating, so that you sort of feel dumb and you're like, "Well, I'm probably not smart enough to understand it so I'm just going to put money in." So anyway, build something people want, product-market fit. I don't think a lot of people want the underlying services. And I think there's a lot of shoehorning of projects and sort of these very long-winded justifications for why a token should exist for a web browser or a mobile messaging app or something else where it really is hard to justify.

Patrick: [00:43:45] So there are a couple of sides to this, and I'd love your opinion on the issuer side. So we talked about why maybe it makes no sense to buy ICOs, and there's a moral aspect to this, which we can get into as well, your point about there's no recourse, debt or equity, you don't technically owe anyone anything by raising fiat currency via an ICO to fund the development of some project. But as I study market history, there's a guy named Henry Singleton, for example, who was perhaps other than Buffett, the greatest investor ever that no one knows about. And his brilliance was recognizing the hyper under/overvaluation of his own stock and using that to his advantage. So he would often issue equity, sell new equity, when it was trading at 30 times earnings or something and the market was really hot on his company, he would buy it back when it was trading at eight times earnings. And through this kind of capital allocation, he did extremely well. The question then is if I'm... I actually have a friend who's considering this, who I won't name, but is an incredibly bright guy, incredibly morally sound, I mean, just a fantastic guy, and his thinking is, "Well, why would I go raise venture capital and sell equity when I could digitize this kind of exciting project I'm working on, raise an ICO, maybe raise $10 million instead of two million in seed round, why would I not do that? Why would I take advantage of this? So what do you think about that?"

Adam: [00:45:02] Yeah. So his instinct is what you are seeing play out in the market, people are going, "I would be stupid not to take advantage of this, I would be stupid not to take advantage of the fact that if I have a credible enough team and concept, I could raise 50, 70, $100 million, which by the way-

Patrick: [00:45:27] Give up no equity.

Adam: [00:45:29] ... is not dilutive, it's not debt, I don't have to pay anyone back. They're only buying it because they anticipate it will appreciate and I can get liquid on it, I can hold on to 10% of this and exit before my project starts. Usually, the exit comes at the end, is why it's called exit, with ICO you exit before you start, which is amazing. And so a lot of people and a lot of smart people are looking at that and going, "If there's $100 on the ground and nobody's picking it up, I'm not going to not pick that up." Okay, so here's why you shouldn't pick up the hundred dollar bill, here's why you shouldn't ICO. There's a term in investing, especially in private equity called the winner's curse, and it's usually used to mean that a bunch of bidders for an asset, as a bunch of bidders, whoever wins sort of has the winner's curse, they won because they paid the highest price, that's not what I mean by the winners curse here.

The winners curse means if you are lucky enough to do your ICO during this period of time, raise 50, 70, whatever million dollars, you're going to feel great for a short amount of time, then what's going to happen? Here's the argument that is the self-interested reason not to do it, not even the moral, you're kind of a jerk fully exploiting the greater fools theory. But here's the self-interested reason not to, if you raise a significant amount of money, you're talking probably about somewhere between 10 to 50,000 people who are going to be buying your token, the market's going to correct or crash, it's inevitable.And what do you think is going to happen to you and your project when thousands and thousands of angry Redditors start to email you, start to call you, start to show up at your house, start to write you angry letters in goat blood, which will happen and it's already happening, I have friends that are sitting inside several of these ICOs and we haven't had a correction, the markets just continue to go up. And already there's an active percentage of token investors who are incredibly aggravating to them. And this is where either the token hasn't launched or has launched and it's gone up a little bit. And if you look at Charlie Lee, the inventor of Litecoin, and just the amount of grief he gets just for being like the inventor of something on Twitter, and just ask yourself, "Is it worth it to have 10,000 people and an angry mob following me around for the rest of my life-?"

Patrick: [00:48:17] ...and ICOs too.

Adam: [00:48:18] Yeah, that's right. So I think it's hard to see that right now and we didn't see it in the prior crash, because in the prior crash, we didn't really have ICOs, we had these altcoins and there weren't hundreds of thousands, if not low millions of sort of retail normal people putting money in, but we have that now. I just don't think you want to have that angry mob following you around the rest of your life. And I think some of those angry mobs are going to turn into class-action lawsuits. And some of these projects are going to be made examples of, and I leave that for the end of my point because I don't think the risk is like, oh, the SEC and the IRS and whatever, and you're going to go to jail. I think, for the most part, you can do these in a way where you're insulated from that because you do it aboveboard. At the same time, after every crash, whenever there's pain, there's this inevitable pattern in every other market crash in history where some people get made examples of. And so you always have to keep that in the back of your mind too.

But I think for all of those reasons, you should really only do a token if you are trying to create a decentralized application that needs one because most of these projects that are doing ICOs don't need a token, at best they need a virtual currency like Facebook points, or like Starbucks points or at best what they're seeking is just modern payment system, a modern payment rail. They're not actually trying to instantiate a dApp. So I think the same rule of only invest in things you understand from the buy-side applies to the sell side, the issuer side, only create a token if you understand fundamentally why you need one. Don't get trapped by this siren song of all this money because people are going to regret it later for sure. The last thing my co-founder, Devin said to me yesterday that was really interesting, which was he thinks that there will never be an example of a company that ICOs that is later acquired or has an IPO. He doesn't think it's ever going to happen, I think that's probably right. I don't think Facebook wants to acquire your company and inherit those 10,000 angry Redditors. And I don't think an investment bank is going to take any company public that has that kind of hair on the deal. So again, you got to think long and hard, this is your shot, if you want to take it, go for it, get the money, great. Be ready to live with the consequences and ask yourself, "Is it worth it in the end or not?"

So I think the same rule of only invest in things you understand from the buy-side applies to the sell side, the issuer side, only create a token if you understand fundamentally why you need one. Don't get trapped by this siren song of all this money because people are going to regret it later for sure

What Chain is Working On

Patrick: [00:50:57] We've come a long way without actually talking about what you do day-to-day. So it would be great to hear about with all this very early experience, last question or two here, about what Chain is doing and working on and by extension, I guess, that means what are you excited about? You're still spending all your time in this space like you decided to six years ago, what does that look like today?

Adam: [00:51:16] So Chain operates in the half of the market we have spent zero time on, which is fun for me because I spend all my time talking about that half of the market as my day job. So when I do a podcast, I love to talk about other things. So we have products that are essentially modern ledger software, not for accounting purposes, but for tracking and managing financial instruments inside of traditional financial applications. So another way to say that more simply is we're building modern financial databases. We have many different flavors of databases for different use cases in the world today. A ledger is essentially a database for money and the breakthroughs that are coming out of the Bitcoin cryptocurrency, crypto-asset world around how to create secure, append-only, authenticated logs of transactions, those breakthroughs are very applicable to the financial infrastructure that sits within a bank, sits within Visa, sits within NASDAQ, sits under Venmo, sits under Coinbase. All of those services have internal ledger systems that are benefiting from the same cryptography at the RND level that is enabling decentralized applications that cryptography can be employed to just create a more secure and flexible data structure that can manage the transactions across payments across capital markets, insurance, et cetera. and that market is often referred to as sort of the so-called blockchain market, enterprise blockchain, private blockchain, permissioned blockchain. We really don't use those terms anymore, partially because blockchain sort of is very suggestive of decentralization, multiple nodes, different organizations transacting, and a lot of our software is used simply as an internal database, managing within a single org.

Patrick: [00:53:23] So what's the step forward? One of the things that I've gone the deepest on and had the most fun exploring is encryption technology, and obviously, that's a key part of what you're talking about. And what appealed to me about it was how defensive it is, a lot of technologies or weapons technologies are very offensive, allow you to be offensive in what you're trying to do, whereas cryptography is very defensive. So talk about what is the step function, what is what you're working on do to significantly improve, maybe it's via encryption or something, the ledgers of some of these examples like the NASDAQ or something?

Adam: [00:53:54] Yeah, sure. So let's talk about... I like that framing defensive and how does that give you some unique value prop in your financial database. So a lot of our customers are FinTechs that are already using the cloud for basically everything and want to run their ledger in the cloud as well. The challenge, of course, is that the data in the ledger is some of the most sensitive data you will have in an organization. And so we offer a cloud ledger called Sequence, and part of the reason it's getting adopted by FinTechs is for the defensive properties that cryptography gives you. So specifically, what I mean is, Sequence can run the ledger for your mobile wallet or for your fundraising site, or for your ridesharing app. So ridesharing is a fun example, drivers are accumulating balances, riders might have credits or points, all that's got to sit in some ledger, right, database plus a lot of other things that sort of sum up to your ledger infrastructure.

And to date, you've kind of had to build that and keep it in a fortress inside your four walls. So cryptography gives you two things now that allow you to move that to the cloud, which is sort of the value prop of Sequence. The first thing is, even though we're running and managing the ledger for you, the ridesharing service has to sign every transaction with their private keys that sit within their walls. So the amount that they have to manage goes down like 100 X, and it's very thin thing, which is just the private key. And so we cannot add or change the ledger at all because we don't have the transaction signing keys, you do. So we can take the burden of managing the ledger without also taking over the control to transact. And so it's a huge cost savings, a huge efficiency gain.

The second thing we can do with cryptography, you used the word encryption. So the example I just gave is just about digital signatures, which is one piece of cryptography, encryption is the next piece, which is you're running your ledger in the cloud, okay, but what happens if that data gets leaked? What happens if a rogue employee wants to look at the balances of drivers? What happens if we just want to snoop around and see your data? Well, we can now with more advanced techniques, encrypt the data that is in the ledger, not only the data at rest, which is sort of the standard thing you do, but encrypt it such that we can still do computations over that data, but we can't see what the data is when we look at it. And that's an area called confidential computing. And it's the frontier that all the cloud vendors, the Azures, AWSs, Google Cloud, Oracle, they're all working on this, as are we.

So that we can say to financial institutions, you're already using the cloud for CRM, you're already using the cloud for communications technologies, you're already using file storage, now you can move your ledgers, all your balances, all your transaction process into the cloud, because, again, A, we can't transact unless you sign off, and B, we can't even see the data. So even if there was a leak in a worst-case scenario, it's all encrypted. So those are two examples of when you get down to the root kind of RND level, it's the same RND that's enabling technologies like Zcash, like Ethereum, like Bitcoin, digital signatures, zero-knowledge proofs, et cetera. So it's taking the same low-level breakthroughs and the crypto asset half of the market is assembling them to enable a new form of software. Our company is assembling them to enable a new medium for existing assets to transact more securely and much more efficiently in a sort of a digital native way with modern software.

And we don't think one is better than the other, it's just that's what our company does. And in a way, I'll give one more analogy real quick, your listeners that were kind of paying attention to technology in the '90s will remember there was this meme going around with which was Linux on the desktop, Linux on the desktop was this idea that... Linux had this early success in servers, and at the same time, Microsoft had this monopoly on the desktop with Windows. Microsoft was public enemy number one by the late '90s and the early 2000s, people wanted to take down their operating system monopoly. And so at that time, there was this chorus of opinion that the way it was going to happen was getting Linux to be a desktop operating system for people and that we'll just create a user-friendly version like Red Hat and then that will disrupt Microsoft. Of course, that didn't happen because disruption doesn't work that way, you don't aim for the system or aim for the man and disrupt the man, disruption follows delight, you have to delight people, create something that's better, the sum of all those users changes the world. And so Linux on the desktop just never happen because there are just fewer apps, less user-friendly, et cetera until of course it did and no one noticed. And what I mean is, Steve Jobs got fired from Apple, started NeXT. NeXT was a computing company that had a Unix core, I believe, is a BSD core, that company was acquired by Apple, and NeXT became the foundation of macOS 10. And macOS 10 was Unix. And so if you have a MacBook or any Apple computer, you are now running Unix on the desktop, just not Linux technically, but same idea, Unix on a desktop. If you have an iPhone and you're running iOS, iOS is a Unix-based operating system.

Disruption follows delight. You have to delight people, create something that's better. The sum of all those users changes the world.

If you have an Android, Android was a company acquired by Google that was originally a Linux operating system for cameras, that then they acquired and made the core of their mobile OS. So Android is Linux, Chromebooks are Linux, so virtually every desktop is now Unix and Linux, but it didn't happen in this sort of direct assault, it happened because it was better internals that enabled companies to create better products that delighted users, which ultimately led to these transformations. And so, Chains, sort of the way we think about how these cryptographic breakthroughs are going to transform is more along those lines, that by creating better internals underneath a Venmo, a Lyft, a JPMorgan Chase, that that will enable better products to be created, that more people will use, that will ultimately transform and move us off of a lot of these archaic financial infrastructures that we see out there that is holding us. So a really quick example, Visa is launching a competitor to Swift, I think there's a blog post today on their blog about the latest on that launch, that's built entirely on our platform. And it's only possible for Visa to launch this competitor to Swift because of the internals. And more businesses will transact over Visa's new network in a day than people sending Bitcoin transactions over the last year, is just factually going to happen. So again, not to be one or the other, I think they're both going to transform, but from different directions. But it's certainly in my view inevitable that these sort of cryptographic breakthroughs now being applied to financial services are going to have big changes, and you as an investor, you should try to figure out how to be long this trend, because like other frontier industries, whether it's AI or machine learning or VR drones, it's not exactly clear how it all gets commercialized, but it's pretty inevitable that these are the sort of foundational the seeds of where, sort of the economy and the markets are going.

Investing in Crypto-Assets

Patrick: [01:01:59] I have one last question which will be very quick, but I love that as a way to wrap up on blockchains or crypto assets, which is, if you believe that drones are the future, it's very hard to just generally make a bet on that, you would need to probably get early-stage access to be an equity investor in a drone company or something like that. And then picking the right drone company is extremely hard. And what's always been interesting to me about crypto assets is to a greater extent, maybe this isn't full proof, but you can kind of buy or make a bet on this being, small probability, but this being the thing that fuels the future of this general technology, which is just fascinating.

Adam: [01:02:36] No, that's a great point. And to kind of just build on it real quick. So that's 100% right, super compelling, also risky, you see the sort of the downside of that with people sort of being tricked in all these ICOs. But what's so interesting about crypto assets is that we're seeing a leapfrogging effect, just like you see mobile phones in Africa like leapfrogged landlines, the same is happening in this market, we're leapfrogging all the traditional capital market infrastructure and process in this new asset class. So normally, a new financial product first is created and sold to a small club around Wall Street and eventually ends up in the hands of retail investors, and then the correction happens, right? Here, it's actually going the other direction, crypto assets and Bitcoin has been started at the fringe, now, there are these sort of huge numbers of people that are participating, largely individuals and retail investors joining something like Coinbase. And it's the institutional investors who are now last and looking at it and going, "Ha." And so it would be a very funny reversal if the institutional guys all jump in and then there's the crash, it'd be sort of like sweet karma going back all the way to 2007 and eight, which was the seeds of Bitcoin itself, right? So Bitcoin emerged out of the ashes of the financial crisis. In fact, the very first Bitcoin transaction had metadata linking to an article.

Patrick: [01:04:09] Banks issue, second bailout, it's in the genesis block.

Adam: [01:04:13] Yeah, I think the 10 year anniversary of Bitcoin, which is coming up next year is going to be one of the most interesting years at the interplay of Bitcoin and the sort of broader financial markets. So anyway, yeah, it's fascinating.

Patrick: [01:04:26] Last question I always ask everyone, which is, what is the kindest thing that anyone's ever done for you?

Adam: [01:04:31] Wow. I would say... Wow, that is amazing, I wish I had prepared, but I guess it's better I haven't. My mind immediately went to all the mentors I've had in my life who just helped me at different stages, which they didn't need to do, to teach me something or to help me meet someone that landed me a job or that landed me somewhere. But I actually think I have to go all the way back to my parents and say my parents just telling me, you've got to follow wherever your curiosity takes you and just do your best and we'll be proud of you, and that's all we want from you." I think that freedom but also belief in me sort of served me really well, so I got to go with that.

Patrick: [01:05:17] Well, it's an amazing answer. I honestly have to say I don't say this often, this is one of the best conversations I've had.

Adam: [01:05:23] Thank you. Yeah.

Patrick: [01:05:24] So I really appreciate your time and hope to see you again soon.

Adam: [01:05:27] Yeah, absolutely. I appreciate you having me. This was a lot of fun.

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