e27 Q&A: Thoughts on Blockchain & Crypto (Part I)

This article was published by e27: https://e27.co/vc-speak-disruption-blockchain-cryptocurrencies-part-1-20170918/

Even as the world is going through a Bitcoin revolution, China’s ban on ICOs and cryptocurrency exchanges sent shockwaves across the world last week. An official order from the Chinese government sent out to Beijing-based exchanges asked to cease trading of Bitcoin and immediately notify users of their closure. The crackdown was aimed at limiting risks, as consumers pile into a highly-speculative market that has grown rapidly this year. 

The crackdown in China, in fact, indicates the growing acceptability of Bitcoin in the country. China is in the forefront of this revolution, as the biggest Bitcoin miners are all located in this Asian giant. While other fast-growing markets are also realising its potential, the ambiguities surrounding this new-age technology still persist.

What is Blockchain and what does the future hold for Bitcoin?

e27 sat with two experts Pankaj Jain and Nitin Sharma, both of whom have earlier worked in the venture capital industry for years before delving into Bitcoin, to cast light on the pros and cons of this technology and its future.

Edited excerpts:  

What is the context in which you are collaborating, and what drew you to the Blockchain and crypto space?

Both of us separately have been venture investors across various stages and funds (500 Startups, Lightbox, and NEA) in multiple geographies for many years. We’ve been watching blockchain for a few years and also dabbled in Bitcoin as far back as 2013.

Over the course of this year, we dove into various ideas to understand what could fundamentally change the way companies worldwide are built, operated and funded in the future. We have met dozens of participants and stakeholders across the US, Europe, India and Southeast Asia and learned that innovation is being decentralized and distributed in a way not seen since the early 90’s.

                                           Source: Coinbase blog

The Internet was built on TCP/IP, SMTP, FTP, HTTP and other protocols which have changed everyone’s life and created trillions of dollars in value. It can be argued that Blockchain and its applications offer the vision of a whole new kind of Internet 2.0.

It has been fun for us to dive deep into the space and (a) identify promising investment opportunities, and (b) think of ways we can help startups (especially in the US, India or Southeast Asia) with our experience and networks.

What is a good way to understand Blockchain and why is it important?

The main idea is that of “decentralization” whereby applications or transactions can run without the necessity for a centralized platform or authority. Examples would be Bitcoin as a currency exchanged without involving a bank, or land records maintained across a network without one central repository, or a new distributed peer-to-peer data storage mechanism not relying on a specific company and its datacenters. Blockchain technologies make this possible.

The way this is accomplished is via the notion of a distributed ledger. This means that the record of all transactions in a particular system is replicated on hundreds or thousands of different nodes (computers) vs. being with one central party. This ledger is not only distributed, but also public and immutable.

Additions to the ledger happen via consensus mechanisms that leverage computational resources of the network, and guarantee that a majority of nodes validate the accuracy and security.

Now, what makes all this possible is the state of connectivity and data infrastructure today, and robust applications of cryptography. There’s a significant amount of cryptographic complexity behind the scenes, but the key is to appreciate that such systems can ensure a high level of trust, transparency and speed without the transaction costs or delays that are normally associated with a central authority.

Obviously, all this is worth paying attention to because it challenges many of our notions: Will companies of the future be essentially run on distributed code and smart digital contracts? Is there a different way companies should be funded? Will all this give more power and value to end users? Will social networks be different?

People often talk about Bitcoin and Ethereum. Which is a better investment?

We don’t want to offer any speculative advice around short-term prices, trading or arbitrage opportunities. What is more important to understand for an average investor who is just beginning to follow this space is that Bitcoin and Ethereum are fundamentally two different things that can’t be compared apples-to-apples.

Bitcoin is arguably the first popular application of Blockchain and plays the role of a cryptocurrency that can be a store of value and/or a medium of exchange.

Ethereum, on the other hand, should be thought of as a platform that makes it easy to develop and deploy various decentralized blockchain applications. Consensus algorithms are much faster, and the programming underlying Ethereum makes it easier for developers to write applications that use “smart contracts” which are executed automatically and digitally.

For example, imagine a supply chain network whereby all steps and transactions can be defined and programmed in smart contracts (actions have to be taken or payments to be transferred once you confirm goods have been delivered..). Hundreds of applications built on Ethereum have also issued “tokens”, which is akin to virtual currencies that work inside a particular ecosystem.

Ether is the fuel or gas required for applications developers to pay for fees and services on the Ethereum blockchain. Because of the benefits of building on the Ethereum blockchain and the popularity of tokens, Ether has also become a hot tradable cryptocurrency as well, rising 30x in 2017 itself.

My understanding is that while there’s a lot of hype around Bitcoin, very few parties are actually using it as a form of payment. So is the price rise just due to speculation?

Indeed, a lot of the price rise is due to speculation and the intriguing long-term potential of Bitcoin. An additional driver of the price rise is the growth of ICOs and tokens, where Ether or Bitcoin is usually required to buy the tokens issued by new projects.

That being said, there is some momentum towards the use of Bitcoin outside the world of crypto, and even in the developing world.

Unocoin, one of the leading crypto exchanges in India, has mentioned recently that 2,500 merchants even in the country are now enabled to accept BTC as a form of payment.

It is worth noting, however, that there’s not much of an incentive for holders of BTC to use it for small payments, let’s say for a cup of coffee. One, because the transaction fees are still relatively high, and secondly, because most people currently want to hold BTC (like gold) with anticipation of manifold price increase in the future.

We do think that widespread use in transactions is still a few years away, and may happen via different coins (e.g. LiteCoin) with different computational requirements that lower the transaction fees. In any case, if an average investor believes in the fundamental changes that Blockchain could enable in the long-term, it’s worth paying attention to cryptocurrencies from a portfolio diversification perspective.

Aren’t you worried about regulatory risk with respect to cryptocurrencies?

This is also a complex topic where it’s too early to draw conclusions. What we have noted, however, is that there is surprisingly a lot of positive momentum for Blockchain from the public and private sectors in various countries.

Many governments (Japan, Australia, Germany, other EU countries, etc.) have created regulatory frameworks allowing use of BTC as legal tender. Deloitte has reported that 90-plus central banks are engaged in Blockchain discussions and 80 per cent of the banks will initiate distributed ledger technology (DLT) projects by the end of 2017. Even the IMF has said encouraging things about the potential of blockchain and cryptocurrencies.

Separately, Blockchain applications are popping up in various places ranging from land registries in Sweden or Honduras, to cleaning up the polluted Niger delta to smart contracts for gold ownership in the 1,000-year-old British Royal Mint vault. We believe these experiments and applications will see exponential growth.

What are some applications of Blockchain that are relevant to India or Southeast Asia? Isn’t it too early in terms of adoption?

The World Economic Forum said last year that it expects Blockchain to become the beating heart of the financial system, and identified nine use cases ranging from international payments, wire transfers, compliance reporting by banks, insurance claims processing, faster letters of credit, loan syndication, repackaging of mortgages, etc. If you think about it, almost all of these are ripe for disruption in India or Southeast Asia because there are no or few strong incumbent standards to begin with.

                                   Source: Deloitte, ASSOCHAM

Outside of financial services, many other systems can be thought of being more efficient in a decentralized world. Many supply chains (retail, manufacturing, healthcare, oil and gas, etc.) can increase transparency and reduce legal and other operating costs on the back of automated smart contracts.

Similarly, everything around identity management or authentication, or government recordkeeping, or the complex web of procedures around import and export, can potentially be transformed with distributed ledgers.

 It isn’t too early. In India, for example, states like Andhra Pradesh/Telangana have already initiated recording of land registries on Blockchain. Twenty-four banks have come together to create a community called Bankchain to implement Blockchain in areas like KYC (Know Your Customer), loan syndication and international payments. Corporations like Mahindras, ICICI, Yes Bank, Axis, Bajaj and the NSE have all initiated blockchain projects towards proofs of concept.

Similarly, in Southeast Asia, we see OCBC and other central banks are experimenting with applications around remittances and cross-border payments. Singapore in particular is expected to be a hub for a lot of crypto activity and company creation, given the perceived ease of doing business.

There are also interesting emerging companies like Otonomos or Omise, the latter being the first company from the region to do what’s called an initial coin offering (ICO), essentially the issuance of tokens that will be used in their payments ecosystem.

What kind of promising startups are you coming across? What are the main gaps they have?

On the currency side, new exchanges (to buy and sell cryptocurrencies) are still coming up even though there are some funded players already. Liquidity on the exchanges in Asia is a challenge, but given the meteoric rise in BTC and ETH, there’s an optimism that hundreds of thousands of new retail investors might want to gain exposure.

Other startups are trying to position themselves are asset managers or crypto hedge funds to deploy trading strategies on behalf of clients; it’s still very early and regulation is undefined.

On the blockchain or smart contracts side of things, most of the activity so far is in startups that are partnering with banks to help them implement distributed ledger technology for processes around KYC, identity verification and digital signatures. Outside of financial services, we’d like to think that logistics and supply chain management offer some of the more intriguing possibilities.

There are definitely a number of challenges or gaps, most important of which is simply the insufficient understanding of blockchain among the business customers or the general population. It is hard for most people to imagine how things would work without centralized platforms or authorities.

This isn’t a new programming language or a new business model, but a different framework for building software, systems and platforms. Some appreciation of the computer science behind it is necessary but a bit esoteric for most people.

Until simpler and friendlier interfaces are developed, widespread adoption and scalability will remain a challenge. There is a craze around ICOs and issuing tokens which may not be relevant or necessary. In our opinion, this is not sustainable in the long-term.

Obviously, there is a corresponding limitation on the talent side, for example, developers who can write smart contracts in Solidity (a programming language for Ethereum). A large part of the developer community is concentrated in Eastern Europe and the US, but the numbers in India and SEA are going to grow.

—-

Part II of this interview, which will cover altcoins, tokens and ICO, and how all this is changing the funding landscape, will be published next week.

Jain is a veteran investor who has seen both the hedge fund and venture worlds. He started his career at Long Term Capital Management (LTCM) and until recently, built and headed 500 Startups India where he invested in over 60 startups across the US, India, Bangladesh, Jordan and Europe. He tweets @pjain

Sharma is an ex-founding member and Principal at Lightbox (a US$200 million VC fund focused on India), and was also previously a VC in the US at NEA besides being an early employee and head of business development at EverFi, one of the largest edtech platforms in the US. He tweets @nitinsharma1

Image Credit: backyardproduction / 123RF Stock Photo