March 21, 2022

It has become too expensive for professional investors to ignore crypto

Yonatan talks about the state of crypto

Yonatan Sela

June 14, 2021

It has become too expensive for professional investors to ignore crypto

Yonatan talks about the state of crypto

Yonatan Sela

Here's where to start

I started looking at crypto investments for Venrock back in 2014 and have been fascinated by the incredible progress in the space ever since. In 2017 I co-founded Props to bring blockchain-powered user ownership into mainstream apps (10M people currently use the token). Still, crypto's unknowns are far greater than the knowns for me - it is fast-growing, complex, and we're still in the early innings. These days, not long after the Coinbase IPO and with crypto markets having recently retreated from all-time high territory, it's clear to most that crypto is here to stay. Though many venture capital investors have been interested (and often personally invested) in crypto, only a small number of 'traditional' venture firms, hedge funds, and family offices went deep early, with a16z and USV being two of the notable exceptions. The void was filled by the emergence of various types of crypto-specific funds that have played an active role in fuelling innovation in the space alongside individual investors.

With crypto now being a code-driven ~$1.5 trillion industry, investors are starting to reconsider their strategy in what I consider to be one of the most transformational and lucrative innovation spaces in tech.

But what are the core concepts and innovations that you need to know to begin tackling this beast? This post is a high-level overview of some of the main buckets of innovation in the space, assuming little prior knowledge. If you’re interested in the space, I encourage you to take a few steps further down the crypto rabbit hole. It's a fascinating land that keeps unfolding in real time.

Where's crypto right now?

An important aside: crypto has had an incredible year. The concept that crypto would decentralize large parts of the digital and financial world no longer feels like a ludicrous fantasy but a long-term outcome of gradually increasing likelihood. Prices reached all-time high across the board this year in a manic bull market. A healthy correction took prices down from the recent highs, but overall Bitcoin (up ~250% over the past 12 months), Ethereum (up ~800% over the past 12 months) and most crypto assets are growing in impact and value. Severe crashes happened several times before in crypto and innovation in the space prevailed, making the next wave ever-higher. So try not to take a short-term view when considering the valuation rise/fall rollercoaster. Putting price noise and excitement aside, what actually happened since the last manic tide of 2017/2018 and where are the opportunities in crypto today?

Bitcoin found product-market fit, positioned itself as digital gold and an institutional-grade asset.

Gold played a significant role in the financial world for centuries, mainly while the gold standard was still in place. The detachment of USD and other currencies from the gold standard in the 20th century was a key driver for the creation of Bitcoin in 2009. The ease with which governments have printed money - and the fears surrounding inflation - has served as a justification for investors to store wealth outside of inflationary fiat currencies (such as USD), and instead keep it in something like gold, or its digital version - Bitcoin. Describing Bitcoin as an equivalent to gold has been controversial in the past but has become widely adopted. The comparison stems from the harsh supply constraints on gold and bitcoin, as they are inherently finite. Both are stores of value that are easily transferable (with bitcoin having an advantage as it is digitally native, requires no truck to transport it and has a clearly defined supply schedule). Some of the largest and most innovative companies (PayPal, Square, Tesla), institutional investors, hedge funds and family offices hold Bitcoin on their balance sheets. Mastercard now supports it. El Salvador became the first country to adopt Bitcoin as a legal tender. ~100 million individuals hold some percentage of their wealth in Bitcoin.

The biggest threats to Bitcoin are regulators in the world's largest markets (China, US) and growing concerns about the environmental impact of Bitcoin. The first risk is mediated to an extent by the global, decentralized nature of Bitcoin and the countries' own economic interests. On the environmental side, things are tricky. A consensus mechanism called Proof of Work is required in order to mine Bitcoin and run the network in a fully decentralized fashion, and this activity consumes more electricity than the country of Norway, and 10x more electricity than Google. Many of the large Bitcoin miners in China use coal to produce the electricity needed for mining, but miners seem to be heading West, a large portion of the global Bitcoin mining activity nowadays is based on renewable energy. While the vast amount of energy that goes into mining Bitcoin is what keeps its network security to a maximum, it also poses a serious threat to the Bitcoin narrative, its most powerful asset. Nevertheless, I believe that no other asset credibly competes with Bitcoin on the digital gold narrative. If you think that Bitcoin will "eat gold" the way software has eaten the world, there's more than 10x to go from Bitcoin's current $600-700M market cap to gold's market cap. Don't forget to buckle up for a very bumpy, non-linear ride.

Ethereum found product-market fit, established itself as the leading smart contracts platform and the base-layer for most of the innovation in crypto.

Ethereum is the world's second-largest crypto network in terms of market cap (roughly 1/3 of Bitcoin's market cap and growing), but in terms of developer activity, it is the absolute leader.

Ethereum is different to Bitcoin in several aspects. The most significant difference is that Ethereum enables smart contract functionality, which allows developers to build protocols, applications and tokens that run entirely on the Ethereum public infrastructure. These protocols, applications and tokens form the foundation of many products and services, most notably, decentralized financial systems (more on DeFi below). Bitcoin is akin to a simple Excel spreadsheet listing the balance of each network member, Ethereum is like a spreadsheet with fully programmable macros.

In April, Ethereum settled ~$30.5 in value per day. On some measures, Ethereum is much larger than Bitcoin. To put this in perspective, PayPal settles ~$2.5B / day, and has a larger market cap than Ethereum.

While competitors exist, Ethereum has the richest set of tools and distribution, and the Ethereum ecosystem benefits from major network effects (at least in the foreseeable future, as interoperability between blockchains still has a lot of friction). It is the most secure and decentralized platform for building crypto apps. The major threat to Ethereum's leading position is scalability and high transaction costs (“gas prices''). Ethereum currently processes only ~20 transactions per second (TPS), compared with 2,000 TPS for Visa, for instance. There are more people who want to run transactions on Ethereum than capacity, which makes Ethereum slower and much more expensive to use than its traditional competitors, as well as its crypto competitors.

However, Ethereum is in the midst of a major, much-anticipated transition ("ETH 2.0") - moving from Proof of Work as the underlying consensus mechanism (the same one Bitcoin runs on) - to a new consensus mechanism called Proof of Stake (PoS), in an effort that introduces several new benefits to the network's usability. A successful transition to Proof of Stake, along with “layer 2” initiatives that improve Ethereum’s scalability through other measures, would tackle the biggest concern regarding Ethereum's scalability. Their developers anticipate it would make Ethereum 1,000x faster than today. It also introduces more financial benefits to holders of ETH, as they will start earning a yield in the form of a portion of the network fees.

My view is that Ethereum is becoming an institutional-grade asset (a-la Bitcoin). I believe a successful transition to ETH 2.0 could help propel Ethereum to new highs, and in some scenarios even eclipse the value of the very-powerful-yet-somewhat-stagnant Bitcoin network. Either way, together Ethereum and Bitcoin make up 60-70% of the industry's total market cap, and they can successfully co-exist. Long term, I expect their dominance in the crypto space to continue to trend down, as a sign of the growing diversity and expansion of crypto as a whole.

Defi - Decentralized Finance - is getting serious traction as an alternative financial system that runs entirely on open source code, without financial institutions.

A key feature of crypto is the ability to create fully decentralized networks where both "services" and value can be easily consumed and transferred. This means that applications and services that centralized entities, usually companies, have always served - can now be provided by a fully decentralized network of independent actors that don't need to collaborate or trust each other.

Instead, trust and collaboration are achieved through code, cryptography, and built-in, network-specific token incentive mechanisms, which grow as each protocol scales.

For example, let's consider the use case of trading. Instead of relying on Nasdaq and the New York Stock Exchange to provide regulated and safe markets for trade, DeFi services provide exchanges that run entirely off open-source code. And these DeFi exchanges are not small: Uniswap runs approximately $10 billion of transactions per week. Uniswap is also materially different to a crypto-native company like Coinbase, which operates like a traditional company – in the crypto space. On Uniswap, a network of unaffiliated liquidity providers connected only via code and a token are providing the service – there is no company providing it.

Or let's consider lending and borrowing. Instead of borrowing from HSBC, or lending via a fintech company, DeFi allows us to borrow and lend "with the internet" without a company in the middle. Protocols such as Aave and Compound have ~$15B in assets locked to their liquidity pools as I write this. DeFi is an autonomous financial ecosystem that is always on, 24/7, internationally. These protocols are internet native, and their governance is done by their token holders and open to scrutiny by anyone.

The DeFi industry is emerging as an alternative open-source financial system with no institutions

NFTs - "Non-Fungible Tokens" - are specific, unique digital assets that are now the hot 'new' category in crypto.

Another key innovation brought about by blockchain technology is the ability to create digital scarcity: there can only be 21 million Bitcoins, and if you send your Bitcoin you cannot keep a copy of it (unlike an email or a file). Most cryptocurrencies are scarce but fungible - if you hold two Bitcoin, there is no difference between them. However, non-fungible tokens (NFTs) are unique - each of them represents a unique asset, and whoever holds the key to the underlying 'smart contract' owns the asset.

Take, for instance, a unique piece of digital art - turning it into a unique NFT means that wherever it travels on the internet, it has an owner and the potential to generate income for both the piece's original creator and current owner. Think of it as the digital, publicly-traded version of baseball cards, without the need for physical authentication. This can become lucrative - NBA Top Shot, which runs on the Flow blockchain, made $53.9M in sales in one week in February 2021.

Most of the world consists of unique, non-fungible assets: your house, your family photos, anything you collect. As more aspects of our lives move from the offline world to its digital version, the potential for NFTs is tremendous.

Prime candidates for NFTization are digitally-nascent items in video games (some of the early use cases), music and other media items that translate real-world copyright to digital scarcity (the way that the NBA and Players Association assign copyrights to NBA Top Shot), sneakers, fine art and later even real estate and other unique objects that are not digital-first.

Now that we can definitively identify a digital asset's owner wherever an asset appears on the internet, these assets can be used in other, more creative ways, such as collateral for a loan. It is still early, and there are a number of challenges for NFTs, for example, the tension between owning the NFT of an asset and owning its IP and getting royalties. However, as the crypto ecosystem grows, I think there will only be more opportunities to use and transact with NFTs in unique and exciting ways.

"Decentralized Infrastructure" is now live and increasingly used

Just as Ethereum provides a decentralized computing platform, there are meaningful attempts to create a decentralized alternative to other key building blocks of the digital world. For instance, Filecoin, a decentralized storage network, is live and used by many developers as an alternative to AWS or Google Cloud. Helium is a decentralized wireless coverage network for Internet of Things (IoT) devices with >30,000 hot spots globally, that is independent from existing telecom networks. Livepeer is a decentralized video streaming network, where "video miners" run video transcoding nodes in return for token rewards.

I see a world in which the next globally dominant infrastructure services will be decentralized.

"Ethereum Alternatives" are starting to find an audience

While Etherum is the dominant smart-contract platform, alternatives with significant developer activity are gaining traction. Smart contract networks such as Polkadot, Solana, Algorand, Tezos, Near and several others, which offer specific advantages over Ethereum, are seeing an uptick in usage. These alternative networks usually offer hefty financial subsidies for developers building on them, in order to incentivize the development and usefulness of the network. Broadly speaking, Ethereum's competitors strike a different balance than Ethereum, opting for improved performance (e.g. transactions per second) and lower transaction costs, at the price of less decentralization (read: security). Some of them have better consensus mechanisms (already running on Proof of Stake, a mechanism that Ethereum still hasn't upgraded to) or governance features (e.g. Tezos), but the open-source nature of all crypto networks means successful features are often replicated on other networks. As Ethereum transaction costs ("gas prices") increase to unprecedented levels, we're starting to see growing usage for its younger competitors for some use cases. The disruptor is becoming the disrupted. Will Ethereum be "the MySpace of smart contract platforms"? My prediction is that in either case, Ethereum is here to stay and will remain an important part of web 3.0 for many years to come, especially for critical financial functions. However, it's unclear whether its dominance will grow or diminish over time as other networks continue to grow and serve specific functions, especially for high throughput use cases such as social networking, gaming or micro-payments, which have lower security requirements than some DeFi use cases.

Crypto-enabling companies are becoming large businesses

Unlike the above, this sub-section refers to companies - not protocols with tokens - that support crypto's intersection with the incumbent financial system (and other systems) of the non-crypto world. Coinbase is a prominent example, but there are many others, for example Chainalysis (crypto data analysis and fraud detection), BlockFi (wealth management for crypto owners), Anchorage (crypto custody and trading and associated services for institutions) etc. We are also seeing major companies such as Paypal and Square, building in functionality to enable interaction with crypto ecosystems.

The beginning

Crypto has grown to become a large, complex industry – and this post outlines the absolute tip of the iceberg. I'm excited for the future of crypto; it represents an entirely new way to interact with digital-native assets, and opens up a new canvas for innovation. There is more developer talent than ever working in the crypto space, and many outstanding entrepreneurs choose to build there.

If you're an investor who wants to discuss this further, or a builder working on any of the above themes - I'd love to talk with you. Feel free to email me at