This post did not turn out anything like I thought it would. I want to say I was ruminating, but I was really stewing. The stewing was the result of my continuing frustration with cryptocurrency and in anticipation of writing another in a series of blog posts about what is happening in the crypto fintech world. It was going to be a brutal dissection of the whole situation, but then I had an epiphany. In my world, epiphanies often happen when I give thoughts time to mature. So, maybe the time I spent “ruminating” paid off.
Before I get to that, I want to define some terms. I do this because discussions about crypto lack the rigor imposed by defining what is being discussed. This leads to discussions where the parties are not talking about the same things. I offer these definitions in the context of an environment that seems to lack the rigor that would make discussions fertile. That said, I hope you will provide feedback on my attempt to get some agreement on these definitions.
- Cryptocurrency—Is a store of value that is defined in the context of a cryptographic cypher. The cryptographic element helps to ensure that a unit of crypto currency is legitimate (only one copy of it exists) and secure in terms of ownership of the asset— an electronic equivalent of having physical possession of paper money. In today’s world a cryptocurrency can take on several distinct personas. Cryptocurrency can be:
- The electronic equivalent of traditional paper money. The cryptographic cypher is the equivalent for the security features designed into today’s paper money. In this context the vehicle must be predictable and stable. Fluctuations in value like those seen in most of today’s cryptocurrencies are anathema to this use case. Stablecoins are an attempt to provide a payment vehicle that features the nearly static price point that is so important in a payment system. Finally, in this persona, cryptocurrency can be thought of as a replacement for paper money.
- A medium of exchange—i.e. a payment system. How is this different from what I have described in the previous bullet point? This persona is functionally equivalent to one of today’s electronic payment systems whether it be a credit card or electronic funds transfer (PayPal, SWIFT, Nacha, Venmo, Visa, Mastercard, etc.), they are moving fiat currency from one traditional bank account to another. As in the previous use case (previous bullet), the value of the instrument must be stable and predictable.
- A speculative instrument—in this persona, a cryptocurrency, like Bitcoin, presents itself a lot like gold. It is an “investment”. Supporters of vehicles like Bitcoin see them, in one example, as a potential hedge against inflation or other shocks to the established economic system.
- Blockchain—a blockchain is a ledger that records information and transactions. A blockchain also provides a mechanism to eliminate a trusted 3rd party that would otherwise be necessary as an intermediary between two parties who want to engage in a financial transaction, but don’t trust each other. The best example of such a 3rd party intermediary is a credit card processor. There is a notion that these 3rd party intermediaries are charging excessively high rents for their services, more on that later.
As a ledger, blockchain has four features that make it particularly attractive:
- It eliminates the need for a trusted third party. This was (and still is) particularly satisfying to people who saw the 2007 financial crisis as being caused by greedy intermediaries (banks, brokers, investment bankers, etc.) who were perceived to be charging outrageous rents and were able to manipulate markets which resulted in the 2007 collapse.
- It is perceived to be highly secure. And, within the bounds of the blockchain itself this is certainly the case. One can make the case, and I do, that in the larger context of a real-world processing environment some of its reputation for security is questionable. To wit, passwords providing access to the Bitcoins, can be stolen or lost. In which case your ability to use you blockchain tokens (e.g., Bitcoin) are seriously abridged.
- Anonymity—while it is not a requirement, many blockchain implementations effectively (by not requiring a user’s identity) allow its users to act anonymously.
- Transparency—the ledger and all its transactions are literally an open book. Anyone can examine the ledger and all the transaction recorded therein.
As such, it is this ledger that provides the foundation upon which most of the well know cryptocurrencies are currently built.
- Smart Contracts—a smart contract is a computer program that can evaluate the state of the world (i.e., whether the terms of the agreement, memorialized in a contract, have been met) and if the terms of the contract have been met will automatically execute payment. A smart contract might recognize that a step in a work plan (by analyzing the project management application’s database) has been completed and based on that condition being met make a payment to the subcontractor who had responsibility for completing the work.
- Speculative asset—a speculative asset has much uncertainty regarding its value. This is caused by questions regarding the demand for the asset. Many commodities take on a speculative characteristic depending on how volatile their pricing may be. For instance, a draught can cause wheat, corn, coffee prices to fluctuate wildly. Similarly, if there are or are not questions about inflation, gold (as a hedge against inflation) might exhibit more or less of the character of a speculative asset.
Now that I have put these foundational definitions in place, back to the main storyline which is characterized by a constantly changing story. I was going to write a post addressing if there is any “there” there with crypto based on the ethereal nature of the landscape. But, through my “ruminations”, I have come to a different conclusion.
The real question is: Is it really changing or are the evangelists getting more articulate in describing what they have or is it a bit of both? Satoshi Nakamoto who invented Bitcoin really seeded a petri dish of innovation. He loaded it with several ideas and a live working prototype. What is happening here is the early stages of development of a new financial order in the conceptual equivalent of primordial goo.
This raises several important questions:
- What are the ideas that incorporated into Satoshi Nakamoto’s invention?
- Using a shared ledger to record financial transactions.
- Processing these transactions securely in a zero-trust environment.
- Disintermediating third-party processors—trusting the “math” rather than “the man”.
- Creating an electronic store of value whether it be currency or a speculative asset.
- What are the implications of the lack of maturity of this discipline associated with electronic assets?
- Ideas are conflated. Think about the early days of network protocols before the layered OSI model was developed. The network functions were programmed into monolithic solutions that made updating and extending the solutions difficult and expensive. It was not until the concept of a “communications stack” was implemented in the OSI model that innovation really took off– https://en.wikipedia.org/wiki/OSI_model
In a way what is happening in the crypto fintech space is frighteningly similar to early communications network solutions. The functions that support what we think of as “crypto” (currency, payments, database solutions and smart contracts) are bundled into monolithic solutions that do not allow for modular upgrades that will be required as the products supporting each of the functions proliferate and mature. This inhibits the ability of innovators to focus on a piece of the puzzle, build a greatly improved component and plug it in. It bogs down the whole innovation lifecycle.
- Thoughts are not necessarily thought through thoroughly. This refers to both the business issues that are being addressed (e.g., the implementation of electronic currency or more efficient payment systems) and the architecture of the solutions. I understand the “need for speed”, but the pendulum has swung so far, it concerns me that unless one’s time horizon is less than a year, the solutions that are being delivered have no real future. The return on investment resulting from taking the time to: 1) thoroughly understand the business problem you are trying so solve; and 2) look at all of the alternatives before choosing solution is really pretty substantial.
- Things are constantly changing. This is the result of the issue raised in the previous bullet point and lack of investment in developing robust worldviews that provide the framework for understanding the business issue and crafting a robust (reliable, resilient and extensible) solution. We are seeing implementations that are really only partially formed thoughts. I would suggest that this is OK for a social media platform, but not for a system intended to support financial transactions.
- Technology is looking for problems to solve rather than the other way around. It is pretty clear that there are plenty of issues within the financial services arena, but better solutions result if issues are identified, examined and understood before choosing a technical solution.
- What are the opportunities and risks? There are going to be many more losers than winners. What are the risks associated with jumping into the primordial goo?
- Large investments in early implementations that depend on early leaders (e.g. Bitcoin, Ethereum, etc.) are likely to have to be discarded as newer better architected solutions appear.
- There are a lot of very sketchy ideas, some of which will likely be brilliant, are being pitched. The Blues Brothers “Rubber Biscuit” song comes to mind. The hit rate is likely to be very low. There is a chance that the overwhelming number of failed initiatives will weigh down progress and be the excuse the establishment uses to stonewall progress.
- Governments are not likely to cede their authority over currency and how it is used. Think about: 1) why the $100 bill is the largest denomination bill currently in circulation; 2) or whether governments are likely to give up control of monetary policy and let a truly free market control the growth of the money supply or inflation.
If you decide to jump in, what should you be thinking?
- Get a brain trust together. Make sure it is diverse in terms of the backgrounds of your team. Make sure it includes members with business process, finance technical and sales backgrounds. A successful implementation will require a multidimensional solution.
- Future-proof your solution. Make sure that it is not too tightly tied to today’s infrastructure, i.e. that there are layers of abstraction between your business logic and the underlying technology and processing engines that make it run. At the same time understand that compromises (for speed) are going to be necessary.
- Don’t get dogmatic about the technology supporting your solution. For instance, I have to say that I am skeptical that blockchain is the best technology to implement a shared ledger. Keep an open mind and that doesn’t mean closing the door on a solution just because it is “old school”.
- Finally, don’t overengineer the solution. While I have spent quite a bit of time seeming to suggest this, I am just suggesting moderation. Everyone is excited. This is a good thing. That said, I am just saying don’t get carried away…. in either direction.
I kind of feel like I have been through this before. And, I have. I was part of a very small team that developed an electronic payment application that changed the way an industry managed payments. We were lucky that the team was extremely diverse. In the beginning one of us was business focused and the other technically oriented. In those early days we were patient and spent the time to understand the issues and designed a solution that generated tremendous value. That is not to say that we did not cut corners, we did. And, we almost always paid for them. That said, we would not have been around to pay for our mistakes if we did not make them in the first place.
There is a lot of good coming out of the work being done by a lot of teams in numerous areas. My hope is that this analysis will help to provide some focus, get people talking and help to avoid some of the mistakes that I was a party to.
— you can find this (days earlier) and other posts at www.niden.com.
And, if you like this post: 1) please let me know; and 2) pass on your “find” to others.