Dear readers, the notes are constructed in a Q&A format, similar to how the podcast is structured. I try to abbreviate as much as I can here, but the purpose of the notes is to provide as much useful content including the relevant context in a clear manner, so please excuse the length. Additionally, for 95% of the time, instead of rephrasing, I used the exact same words that was said in the podcast. This is the first post and I am open to critiques and feedback. Thank you all!
Podcast participants — details of the podcast can be found at the bottom of the post
Laura Shin (abbreviated as L): Laura Shin
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Background Story: K sold his company 5 years ago that was originally building software for Google Glass. Ultimately he pivoted the company and sold it because Google pulled Glass. In in Jan 2016, K was unemployed and found out about Ethereum in March 2016. K appreciates the importance of Ethereum because 1) he recognizes platform risk and thinks that won’t happen to Ethereum and 2) he realized that financial institutions are just smart contracts, and then subsequently the future implication of the blockchain. T learned about bitcoin initially in 2013 and realized the importance of Ethereum when K shared the Ethereum whitepaper with him in 2016. T was working on building a marketplace network business in healthcare IT, and he recognized a cryptographically bound network business can potentially replace the traditional business model. He saw that crypto was a new way to organize economic activity. K and T met at NYU and have been best friends since freshmen year.
L: Before companies were vulnerable to platform risk. But now in blockchain, developers can be compensated directly from the protocol. I know that Chris Dixon, Marc Andreessen and David Sacks are individual investors in your fund. Why did you decide to build a crypto hedge fund instead of building an operating company in the space?
K: I have done my gig as an entrepreneur and was doing soul-searching after 2016 Jan. To me, there are 2 white collar jobs- allocator and operators. If I could spend all day thinking and writing, I would. Then I learned about crypto and found my calling to be an allocator.
L: You guys have so many great blog posts theorizing what the wider adoption of blockchain could be. How are you thinking about these different wider paths adoptions and how are you incorporating them into your investments?
T&K: We believe distribution is undervalued, and it’s intrinsically related to the fact that crypto is open-sourced. Essentially there is no IP and no protected technology in crypto. The investments that one team makes in advancing their technology can be borrowed by another team. So, whoever gets the most network effects will end up dominating. It’ll be the team that understands the competitive dynamics of the crypto ecosystem that win. For example, we and as a firm are interested in Stablecoin. However, when we talk to entrepreneurs launching Stablecoin networks, we believe the dominant Stablecoin will always end up adopting the best Stablecoin mechanics from all the Stablecoin experiments and changes. So while we do care about the stability mechanisms, that’s not where we are focusing on. Instead when we look at Stablecoin companies, we are asking- what is their go to market strategy? what is their consumer adoption? how easily can the company adopt the best mechanics from everyone else in the space? This is the beauty of open source, everyone is developing from the latest and greatest.
L: So what do you think are the best distribution strategies? The best way to get broad distribution?
T&K: it depends on the type of application you are building. For example, Funfair has hired a salesforce, who is calling up casinos and casino operators and pitching them on their platform. They have to go through a standardized enterprise sales process and build out an enterprise sales organization. Enterprise sales is largely a science. I ran a sales org at Pristine and enterprise sales is 90% science and 10% art. There is a process and it requires extreme discipline to hiring people who knows how to do that. I find in the crypto space that there are too many tech people and not enough go-to-market people. If you are building tools for developers to build on, you should go hire developer relationship people from Twilio and Mailchimp. I don’t see that kind of strong focus when it comes to thinking about growth. We need to be thinking about 100x growth and how to get there.
Our job as fund managers is to identify asymmetry in risk and reward. In the crypto space, we have a model with something fundamentally different, because everything is open sourced. We see a lot of teams going about competing in the same way as traditional tech companies and that probably won’t work.
Note: A blog post that came out after we recorded in which Kyle expands on his contention that technical features will matter less in the long-term success of a network than people think: https://Multicoin.capital/2018/04/25/good-artists-copy-great-artists-steal/
L: when you are vetting teams, are you looking for teams with business savviness?
T&K: They don’t have to have a sales team yet but they need to have a plan thought out seriously. They need to be willing to hire people who have done it. There are a lot of great companies in crypto and they are hiring their friend who makes marketing brochures. Instead, we tell them, go hire a VP of marketing who have done 3 Series A stage startups. This requires discipline and focus in attempt to systematically get millions of users.
There is this idea of “build it and they will come”, and there was a precedence of bitcoin/Ethereum being built and people went to them without any form of external marketing. But that is not going to play out for anyone else in the space. Crypto companies need to go to market.
L: What else is part of the process where you determine a token merits to be in your portfolio?
T&K: there are a few questions we like to ask. First, how is this project uniquely enabled by blockchain? blockchain has 3 fundamental strength, which are 1) censorship resistant nature, 2) permission-less nature and 3) trust-less nature. If you don’t need one of those 3 attributes, you are better of just using a centralized database. A blockchain is extremely inefficient when you don’t need those attributes. So when we ask that, 99% of the companies that pitches to us fail at that level. Next question is, can we fork this token out of the protocol? Meaning, is this token actually necessary for the functioning of this protocol? If it is not necessary for the protocol, and there are a lot of projects like this, it may have value in the short term, but it is likely that someone will go in and fork out your token. So instead of paying with your token, your open source technology will then allow people to pay with other coins/assets. People have the incentive to do so because they can get financial gains by say shorting your crypto currency. That is inevitable.
L: how much commitment and help are you giving to the protocols that you are invested in? do you sell the tokens after lockup the second they go public?
T&K: In our liquid portion of the portfolio, we have 5–6 assets. In the illiquid portion, we have 7 or 8 more. There are many illiquid assets we don’t own because of 1) current market cycle 2) lack of short term catalysts and 3) there are better alternative coins right now. The fact we don’t own a token now does not mean we don’t believe the token will not accrue value in the long run. One of the major sources of alpha we provide for our investors is being deep in the ecosystem and having the level of understanding that you can’t get from surface level players. The reason we publish so much research is to help teams understand what we are thinking about and ultimately help them think through different kinds of decisions. We may not be investing now but in the future.
We do not go invest in an illiquid stage and then sell it after ICO. For investments we make, we do have commitment to help the team, especially for early stage investments. However, if we buy the token at the public market, we are not subject to lockup.
L: So are you talking with the teams? How much are you treating it like venture investing?
T&K: We help the teams even if we don’t own the tokens. We do this all the time and try to help them. Also, not owning the token does not mean we don’t believe in the project.
L: How have you been weathering the downturn?
T&K: We’ve done quite well during the downturn. We can’t talk about specific numbers. As a hedge fund we have been able to short various assets.
L: Is that with projects you support?
T&K: No, those are general names. We are not going out shorting projects that we support. Shorting has logistical issues too because outside of the top 5 coins, the cost of borrowing is very high as those markets are very illiquid.
L: Assets under managements?
L: How are you meaningful deploying the $50mn?
T&K: Our portfolio is made up of liquid and illiquid portion. ~$45mn in liquid and ~$5mn in illiquid. Our typical check size is $250k to $1mn for early stage deals. You can deploy both the illiquid and liquid assets pretty easily.
L: How are you measuring success?
T&K: Fund is denominated in USD, so we want to show return on USD. Internally we look at comps like bitcoin, ether, and the HOLD 10 index.
L: Trend in your investors base change from a year ago to now?
T&K: Previously our investor base was angel investors and crypto whales. Over the last few months, we have seen inbound interest from venture capital funds, general partners from long/short hedge funds. Now we are seeing a lot of interest in family offices and endowment foundations. These funds are looking to build a strategy around crypto.
L: The big competition is taking shape between smart contract platforms such as Ethereum, EOS, etc., how do you think this race will be decided? Do you think there is room for one or multiple?
T&K: we spend most of my energy and time thinking about smart contracts. We’ve identified some principles and tradeoffs factors in platform design decisions such as decentralization, latency, degrees of privacy and governance. Then we look for platforms under these constraints with local maximum value. We believe there will be multiple local maximum value with some being larger than others. Right now the main one being explored is decentralization on the product at the expense of scalability.
[A More Detailed Explanation of Local Maxima Concept from Later in the Podcast] If you imagine on a 2D plane with decentralization and scalability as the axis and suppose they are direct tradeoffs when architecting a crypto platform. To identify the local maximums, there would be one local maxima and value accretion on the total decentralized end, and then there would be value accretion along the curve. Comparing Ethereum vs EOS is an example. Ethereum is prioritizing decentralization over scalability while EOS is prioritizing scalability over decentralization. Now if we can expand this framework into not only one dimension but N dimensional space, then you can imagine different places in those N dimensional space that could capture value.
Other teams with different views on security and flexibility are exploring other local maximums. We expect there will be multiple winners. What differentiates between these teams ultimately is what is fundamentally cannot be easily changed.
L: EOS only have 21 block producers, correct? If crypto gets big enough, it will pose threat to nation states, and then blockchain may not have much appeal, do you agree?
T&K: Yes, EOS only have 21 block producers. That is the value in diversifying your investments in value accruing local maximums. We look at the world probabilistically. For example, tokenized securities. You do not need censorship resistance for tokenized securities. At end of day, securities depend on the legal system. So tokenized securities with censorship resistance is an oxymoron.
L: Are there particular points in the local maxima that you think can generate value more than others?
T&K: There will be a local maxima where we have decentralized production. The government can’t stop it and there will be real value, and that’s the value proposition from bitcoin and Ethereum. EOS is an example where it tries to be compliant and support laws around the world, and there is tremendous application uses. EOS is architected in such a way where there is a constitution and the constitution is voted in by block producers and the block producers are voted by the people who own the tokens. In the EOS system, to make a transaction valid, you have to take a hash in the constitution and submit that along with your transaction. So if you are in advertising exchange, this is very useful (i.e. Facebook and GDPR, they are complying with laws and delivering applications for real world use cases.) Another EOS example is gaming, teams were originally exploring Ethereum as a backend for games but they encountered throughput issues. They want real systems and real applications so they are gravitating towards EOS. Another example is Kadena. Kadena is a smart contract that is human readable. Maybe in the future, there is a huge world of global commerce people who needs to read smart contracts. If you believe there is probability of the world playing out in such a way, then Kadena can be very interesting.
Ultimately, it is pre-mature to see where these local maximums accrue but we would say there is very obvious maximums at maximum decentralization, platform-grade censorship resistance vs sovereign grade censorship resistance.
To be clear, we are providing users a framework to think about these protocols, we are not endorsing these crypto. We are not saying EOS is better than Ethereum, they are addressing different protocols. We are identifying which attributes of a project will help differentiate itself from competitors and which wont, and that will help in our investing decisions.
L: This is the first time K being not so positive about Ethereum. I looked at Github, and it looks like Bitcoin in the last 30 days had more activity with 66 active pull requests as oppose to 16 active pull requests from Ethereum. Why did you say all the developers left Ethereum?
T&K: I am not referring to core level developers, I think more developers are actively developing bitcoin than Ethereum. But I’d caveat that there are multiple Ethereum versions vs one bitcoin version of bitcoin so I think you may be only looking at one of those versions on Github. What I mean is that the people that are building on top of Ethereum is 2–3 orders of magnitude than that of bitcoin. This is collectively from the data points I see, primarily from listening to communities, meetups, Twitter observation. There is not that much change in bitcoin that I see except for recent development Lightening Network, but in the Ethereum layer, I am seeing a massive difference.
L: K, Why are you critical on lightening network?
K: lightening recentralizes bitcoin. If you look at the network topology of Lightening Network, there is no viable game plan to getting Lighting in a decentralized network in a meaningful way. I think Lightening violates that core principle of decentralization, and long term this is corrosive to bitcoin. If you want to solve scalability, giving up layer 1scalability for layer 2 scalability to me is a capitulation of not willing to innovate and solve hard problems at layer 1.
L: You think Bitcoin failed because of debacles in governance. You tweeted governance isn’t important. Why do you think governance shouldn’t be important?
K: Those are different views from different contexts. My view of bitcoin is that it refuses to evolve. If you look at level of technical ambition, they are not in the same ballpark as other teams. Other teams are trying to solve fundamental hard problems like the Scalability Trilemma. Bitcoin core development group is made up of 4–5 people who controls the merges in Github. I believe their view on how to build the future of money is fundamentally incorrect.
L: T, what are your views of bitcoin?
T: I find Lightening to be compelling. I do see real value to complete decentralization for anyone who wants to run a full node. So if we can solve scalability with 2nd layer solution, then you have solved the scalability trilemma. So between level 1 and level 2, you do get decentralized block production, decentralized secured network and scalability. However, there are some technical challenges with Lightening’s global implementation such as how do you route money through the system. But there is a real chance that this is a plausible solution and that Lightening works.
L: How are you managing regulatory risk with illiquid assets?
K: We do not invest in anything that we think has a chance of being an unregistered securities offering. Being compliant is one of our core values.
L: What’s your Stablecoin view?
K: on a long enough time scale, there won’t be a decentralized open Stablecoin. But doesn’t mean we don’t want to invest in them to learn or potential benefits before that timescale. We think its one of the most interesting spaces in crypto right now and as long as we are cognizant of the coin challenges and price the risk accordingly, then we think that is fine. We don’t have Stablecoin investments right now.
L: What is your most controversial position in crypto space?
K: Bitcoin is failing.
T: in Multicoin, I am the least bullish on Stablecoin. I don’t think they are going to work, or become a large scale project. We will see central bank issue fiat on the blockchain, which will eat up Stablecoin market from the bottom up (since its inferior in product than fiat), but will also be eaten top down from bitcoin because those bigger coins will become larger and less volatile.
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Description on this Episode: Kyle Samani and Tushar Jain, cofounders of Multicoin Capital, dive deeply into their sometimes controversial and unpopular opinions on how the crypto revolution will play out. They describe why they don’t think the technology that a team develops early on will play nearly as big a role as some think, why there will be a spectrum of block chains offering different features with different tradeoffs, and why they’re bearish on Stablecoins. They discuss why they disagree on whether or not the Lightning Network is revolutionary (and therefore why they disagree on whether Bitcoin is failing). Samani and Jain also explain how they decide whether or not to invest in a token, their strategies for trading and why they don’t have to be invested in a project to help out.
Kyle’s post on the outlook for coins for store of value, utility tokens and Stablecoins: https://Multicoin.capital/2018/03/15/paths-to-tens-of-trillions/
More Multicoin thinking around Stablecoins: https://Multicoin.capital/2018/01/17/an-overview-of-Stablecoins/
Previous Unchained episode: Why It’s So Hard to Keep Stablecoins Stable: http://unchainedpodcast.co/why-its-so-hard-to-keep-Stablecoins-stable
About Unchained: blockchain technology is about to transform every trust-based interaction of our lives, from financial services to identity, from health care to our Internet of Things devices. In this podcast, host Laura Shin talks with industry pioneers across tech, financial services, health care, government and other sectors about how the blockchain and crypto currency will open up new opportunities for incumbents, startups and everyday people to interact more efficiently, directly and globally.