Right now, crypto is in transition, and this is the perfect time to be reflecting on what the next big thing might be.
And as traders and players in the space, thinking about what’s ahead is the key to identifying that next big thing.
Which reminded me of Andy Kessler. He was an old Wall Street maven and fund manager. In one of his books, he had a story about meeting a Swiss investor on a plane. That discussion over a five-hour flight led to a series of deep dives into innovation history.
So I grabbed Kessler’s Wall Street Meat off the shelf to refresh my memory.
Whoops. Wrong book.
It’s great, but the one I want is Kessler’s Running Money.
In Running Money, Kessler shows us how he developed an investment thesis while managing a hedge fund. And he tells us in great detail how he figures out what the next big thing might be.
He does this by exploring the evolution of other innovation periods and the key insights he gets from them.
And as a bonus, he’s doing this during Web1, so the entire book is like hopping in and out of a time machine.
Running Money gives you insight into what it’s like to be a hedge fund manager in the beginning and through the dot.com boom. Published in 2004, this is a great reference to the evolution of the thinking at the time.
Prior to running money, Andy had been on Frank Quattrone’s team. Quattrone was a legendary Wall Street investment banker that started numerous tech teams around the street. His team brought key companies public, including Netscape, Cisco, and Amazon. Kessler’s book Wall Street Meat was about his days as an analyst.
Kessler left this team and went on to start his own fund. Running Money is about his days as a fund manager. If you’ve read Soro’s legendary Alchemy of Finance, this is a similar journal style, only more fun to read.
In the book, Kessler has a chance meeting with a Swiss investor. They start talking about how Silicon Valley does what it does.
What makes the Valley what it is.
So Kessler embarks on a journey through the evolution of the industrial revolution. Then explores how this applies to technology.
These sections are connected with entertaining interludes about what he was doing as a hedge fund manager.
Scale through efficiency and innovation
Andy takes us on a journey through the Industrial Revolution. The industrial revolution is a story about a series of accidents driven by necessity.
There is the development of the steam engine using insights from another technology at the time. Then it was improved, lowering the cost of power and increased efficiency. This idea of increasing power for the same unit of energy is a common theme in the industrial revolution.
More power and efficiency drove other potential opportunities in other unexpected areas. Like replacing horses that were used to control flooding in mines. Which led to more coal mining for cheap reliable fuel for foundries.
The foundries were there in part because of demand for cannons (the things that fire large steel projectiles for those of you that just imagined an expensive camera) created a need for heat to forge metal. And that required fuel, which at the time were the trees around the foundry.
As the trees disappeared and the fuel supply got further away, costs increased, lowering margins. Eventually, the foundries moved closer to areas rich in coal to drive the bellows for more efficiency. These are the same mines that increased reliability through the use of the updated steam engine.
More power and cheaper energy contributed to other innovations in cotton processing and textile development. The raw materials for textile manufacturing were imported from around the world. The finished products were exported, creating vast networks of supply chains.
The further lowering of energy costs and increasing efficiencies occur throughout. Every increase in power and improvement in efficiency leads to more scaling. It was this ebb and flow of innovation, efficiency, and scaling over time that made Britain the industrial powerhouse of its age.
Then Andy looks at the industrial model to see if it applies to technology.
The Silicon Valley model
His exploration of the history of technology sections alone is worth the price of the book. You get to meet some of the people that created these technologies through Andy’s conversations with them. This is an inside look at the origins and development of Web1.
He explores the birth of ARPA to DARPA and the evolution of the internet. Then there is the development of packets and switching. He tells you about how the silicon of Silicon Valley started and how it evolved. How chips were started and how they were evolved by Fairchild, Intel, and TSMC in Taiwan.
Lots of this story is about finding ways of creating more powerful outcomes that do so with greater efficiency.
Now, remember, this whole story is the lead-up to what became the dot.com era. So you will see the story of Netscape and how the Silicon Valley model was developed. This is an important background when thinking about crypto. This is Web1, where the advocates of Web3 believe crypto should go back and do better.
OK, back to Andy. What Andy discovers is that the Valley’s model is about what has become globalization. This model is about creating IP that can be emailed to a factory across the world at no cost. The innovation is built with low-cost labor and exported back to the US as finished goods and paid for with dollars.
The profit margin to the American companies is the fattest part of the margin on every finished product. The IP part is the majority of the value. Everyone else in the chain gets the scraps. The Silicon Valley way is a business model.
This business model innovation is an important part of the puzzle to think about as you reflect on crypto.
Crypto and the search for efficiency and scale
If you’ve been through enough crypto white papers, you will see this old theme of power and efficiency repeatedly. Energy efficiency at a point becomes a part of the scaling outcome. Every protocol is working on solutions to this issue.
But that isn’t the whole story here either.
There are technology constraints built into the software that represent the mechanics of security. These are key when software is validating transactions and securing the network.
For example, there is near-constant criticism of bitcoin’s proof-of-work protocol and the energy demands. Ethereum’s change from PoW to PoS is in part to address this limitation. The idea is designed to create potential additional efficiencies in order to scale.
Looking across blockchain projects, you’re seeing this theme repeatedly. Every chain wants to be more efficient and scalable. They want more throughput compared to the other guys. But this comes with the cost of some security. And they all appear to be competing to scale individually in a winner takes all approach.
The scalability part in crypto is more complex than a traditional industry. Scale encompasses nodes and throughputs, but it also includes the user component. Scale is unlimited in terms of potential reach with open-source distributed technology. But the ability to attract and retain those users is more complex in a competitive environment with numerous options for substitution. This is where crypto governance and incentives come in.
But unlike the valley sending their IP via email to be done somewhere else, the contributors and audience, and product are always accessible regardless of location. The finished goods are digital. The IP is more individually based than corporate.
This is where the community has become a key piece of the crypto evolution.
Crypto: industrial + tech
Now, we’ve previously explored the idea of a thesis. In it, the idea is that crypto will represent a vast open playground for value exploration and discovery. Part of the thesis is that international competition will keep a large part of the regulation at bay.
This competition risk was acknowledged in the crypto bill presented to Congress in 2022.
We have tens of thousands of different projects in the works covering various tokens, altcoins, and blockchain platforms. The projects span the entire crypto stack, which is all the layers from the blockchain up.
So we are seeing massive innovation that is flush with funding and a lot of incentives.
And when we look at Andy’s exploration, what we see is what looks like a combination of the industrial model and the tech model together.
The industrial model of crypto is the automated tokenization of energy and computer power. The software is an open-source virtual factory attached to physical and human energy driven by an incentive system.
This virtual factory can be adapted and configured in numerous ways to explore value creation and discovery. It can create unique, portable, programmable, infinitely transferable storage options.
It does so through borderless distributed relationships. People from all over the world can work together without a common building, culture, or outlook.
In the Valley model, the IP is created in the US and sent at no cost to be built elsewhere. In the crypto/Web3 model, we get something different.
The IP, rather than often constrained to one large entity, is instead distributed to numerous owners. They are incentivized through their contribution to the virtual factory. Participants can exchange their participation in many instances for other assets.
Or they can store that incentive in alternative storage like NFTs or software wallets.
IP flows freely, and building is focused around a belief system. That belief system can be a protocol or a platform created to gather others that believe in the vision. This is where a platform like a DAO can represent a unique focal point of modern individualized IP development.
Cross-chain integration is the new fabric
Ok. So, where does this model go next, and how does it scale?
Well, it could be argued that scale is already happening in one way. There are more than nineteen thousand token, altcoin, and cryptocurrency projects on Coinmarketcap. This proliferation of projects is one form of scale.
And this is possible because of the open-source foundation of the space. But these projects are mostly unique to themselves. It’s possible to move assets from one chain to another, like wrapping Bitcoin in an ERC-20 token to use on Ethereum. But these are still relatively uncommon for other assets. Even stablecoin USDC, while available on multiple chains, is still chain-specific based on where you get it.
The industrial revolution had fabric textiles, while crypto and Web3 have an organic evolving digital mesh.
Crypto and Web3 are in the process of figuring out how to fully develop this fabric layer to bring it together into a more seamless whole. And I think challenging market conditions will generate some incredible insights and evolutions.
From blockchain to the future
The old mantra of crypto was that blockchain was going to do everything. That was so 2018. It was almost evangelistic at the time, and after a while, it was hard to take the idea seriously.
The problem with the assertion was looking at it through an old model. The idea that, somehow, the existing business models could be adapted to suit the innovation. You just bolt it on, and it will work.
But that’s not what we see happening. New business models and structures are being developed to explore the unique capability provided by many aspects of crypto, including the blockchain.
We see the potential for nationally agnostic businesses built around DAOs. We can see stablecoins like USDC being adopted, exploiting the efficiencies of moving value across a distributed network in real-time.
And the way people interact is changing.
While efficiency is improving, scaling through substitution has dominated. But scaling through efficiencies and connection is coming.
Where the big change is going to have to come from is the business models.
In the book Loonshots, Safi Bahcall talks about two kinds of loonshots. One is pure innovation. This is the world of a young Steve Jobs, Pan American Airlines, and Edward Lamb’s Polaroid. The other is business model innovation.
The secret, says Bahcall, is to occupy the place between the two, which he calls phase transition. The reference is the transition zone between water and solid ice. Most businesses can’t occupy this place. Typically they can be great at one or the other.
And for crypto to scale beyond where it is today will require occupying the place between pure innovation and business innovation. And that means the next frontier for crypto is a growing focus beyond pure innovation to business model innovation.
This is where the next big opportunities will be.
But we are going to have to embrace the challenges and uncertainties on the way there.
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