Disclosures: Multicoin Capital holds positions in some of the assets discussed in this post. Multicoin Capital abides by a “No Trade Policy” for the assets listed in this report for 3 days (“No Trade Period”) following its public release. No officer, director or employee shall purchase or sell any of the aforementioned assets during the No Trade Period.
Open, distributed ledgers and permissionless, censorship-resistant, trust-minimized computation are going to reshape massive sectors of the global economy. This belief led us to found Multicoin Capital in 2017, and after spending two years with entrepreneurs, business leaders, and investors in this space, we’ve developed more conviction in this thesis than ever before.
Over the last few years, the breadth of use cases within the crypto ecosystem has exploded. Given this breadth, it can be difficult to define the underlying macro theses when use cases span non-seizable assets, censorship-resistant prediction markets, peer-to-peer wireless networks, new online advertising systems, and jurisdiction-less enterprises.
The purpose of this essay is to define and articulate the three mega investment theses for crypto. We define mega investment theses as those in which the addressable market is measured in the trillions of 2019 USD.
We expect these theses to play out over a decade or longer and to generate the vast majority of our returns. In the rough order that we expect them to develop:
Open finance. By making units of value—stocks, bonds, real estate, currencies, etc.—interoperable, programmable, and composable on open ledgers, capital markets will become more accessible and efficient. Just as the proliferation of capital markets over the last 100 years enabled staggering levels of wealth creation, open finance will make capital markets more efficient and accessible to everyone on the planet.
Web3. The Web3 vision is about empowering consumers to control their own data, as opposed to the status quo in which tech giants, credit bureaus, advertisers, healthcare providers, etc. hoard consumer data. As this paradigm shifts, incumbents will lose their primary competitive advantage—their data monopolies and associated network effects—creating massive opportunities for new value creation.
Global, state-free money. In simple terms, one can think of this as digital gold. However, we find that the “digital gold” framing is too narrow and substantially understates the opportunity. Global, state-free money is a superset of digital gold in terms of breadth and use cases, and represents a dramatically larger addressable market.
The common theme underlying these theses is reducing trust between transacting parties. The modern economy is built on compounding layers of trust. We trust tech giants, banks, insurance companies, the government, and more every minute of every day.
We trust so many institutions that we take for granted just how many layers of trust the economy is built on. When we’re born and raised with certain trust assumptions, we don’t even recognize them as assumptions anymore. Given global complexity, detecting abuses of trust is more difficult than ever before (e.g. Facebook + Cambridge Analytica, Marriott/Target hacks, Equifax hack, etc.).
For the first time in human history, using open networks bound by cryptography and free-market economics, we can create large-scale institutions that incentivize specific human behaviors without creating new trust assumptions. This is a subtle but profound shift.
This is not to say that trust is intrinsically a bad thing. However, all risk is built on trust. By creating a world with fewer trust assumptions, we can reduce systemic risk, and create ultimately healthier and more productive economies and societies.
Thesis: Open Finance
The Open Finance thesis is sometimes referred to as decentralized finance, or DeFi. However, we prefer the term Open Finance, as the level of (de)centralization is not the basis of the investment thesis. Decentralization is simply a means to open finance.
Trust is the foundation on top of which all financial services are built.
Although large and mature capital markets are generally efficient today, they are still nowhere close to being universally accessible. This is true both in developed markets and in developing economies.
The key innovation enabling open finance is the modularization of financial primitives. By modularizing financial primitives, the open finance stack commoditizes trust such that no application has a unique trust advantage over any other.
Modularizing financial primitives is an abstract concept. What exactly does it mean to modularize financial primitives?
Over the last 24 months, a number of open finance protocols have launched. All of these protocols are modular, and are being used by higher-level applications (and often combined). None of these protocols market to end-customers, provide customer service, or deal with local laws. These protocols are just pieces of code that live on blockchains. This is comparable to how email is built on a suite of open protocols like SMTP, TCP/IP, and HTML/JS to render email in the browser.
For example, let’s consider BlitzPredict (BP). BP is an exchange focused on sports betting built on top of the Augur, 0x, and (in the near future) Maker protocols. BP relies on the Augur protocol as a means to create different kinds of markets, create shares in those outcomes, and ultimately resolve markets. BP relies on the 0x protocol to trade shares between users. And BP will soon rely on the Maker protocol for its collateralized stablecoin, DAI, to denominate trades. Each of these protocols function independently. Because they are modular, a higher-level application like BP can combine the underlying financial primitives to produce a trust-minimized user experience that was never before possible.
Just as the cloud commoditized server deployments, enabling a step-function improvement in the rate of innovation in large-scale web applications, modularizing financial primitives will enable a step-function improvement in the rate of innovation in all financial services.
Because Open Finance is…open, anyone will be able to build local businesses on top of open finance protocols. This is how open finance will enable the un- and under-banked to access financial services. Protocols will not serve consumers. Businesses that navigate local regulations, and provide localized customer service, will serve consumers instead.
A great example of this is the UMA protocol. UMA protocol is a platform that enables two parties to enter into a contract for difference (CFD) that constantly and automatically rebalances as the price of the underlying asset moves in real time. The first product built on the UMA protocol was synthetic exposure to the S&P 500. The UMA team is based in the US, and they are not a registered broker-dealer. The UMA team is not trading using the protocol they built.
Instead, market makers around the world are providing liquidity and hedging out their risk on the traditional capital markets, allowing anyone in the world to get exposure to the S&P 500 without paying any fees (UMA takes no fees), without going through any intermediaries, and without taking on any counterparty risk (the UMA smart contract acts as a trust-minimized escrow agent for the collateral that each party posts). As the 4 - 5B who are un- and under-banked around the world gain access to digital money, they’re naturally going to want to invest in assets that they don’t have access to. The rules that govern the U.S. equity markets make it challenging for this subset of individuals to get the access they want. However, using protocols like UMA, global financial inclusion will become possible for the first time in human history.
We cannot overstate the magnitude of this breakthrough. For the first time, financial markets can be global, permissionless, and for many kinds of derivative contracts, free of counterparty risk. This was impossible until recently.
The world’s financial market infrastructure will move to the Open Finance stack because the Open Finance stack enables millions of businesses—those that are local, national, and international in scale—to offer trust-minimized financial products to the people and businesses who need them most. Unlike legacy financial institutions, the next generation of crypto-native businesses won’t need to be trustworthy, nor will they need to build any new or particularly novel technology. The open finance stack will commoditize the financial primitives on top of which all transactions occur, enabling truly fluid capital flow across asset classes and jurisdictions. As these crypto-native businesses flourish, incumbents will be forced to switch to the Open Finance stack as well.
Open finance is not theoretical. It is happening now, and we expect this mega trend to compound over the next decade. In the last 18 months, the amount of capital locked in open finance smart contracts has grown from $0 to over $400M.
We’ve been evaluating and investing in open finance protocols and companies since the inception of the fund in 2017. Examples include protocols like Augur, Maker, and 0x and companies building on these protocols such as Dharma, BlitzPredict, and Radar Relay(note: these are illustrative examples. Multicoin Capital is not necessarily invested in all of them).