By the end of this essay, you'll understand how to think about the crypto market.
Blockchain is a breakthrough in computer science and has the potential to disrupt more than just the financial industry. Grasping these ideas today will give anyone an edge 10 years from now.
This essay will break down as follows:
- Blockchain: A Database On Steroids
- Internet Vs. Blockchains
- Talkin' About Tokens
- Incentives For Blockchain
- Incentives For Tokens
- The Case For Cryptocurrencies
Blockchain: A Database On Steroids
Imagine you're a YouTuber creating cute cooking content. You trust Google enough to exchange your information for a YouTube channel. That data safely gets stored in their database. For Google's eyes only.
Current cloud architectures are like this. It relies on a single business providing the service. On the other end, are users paying for that service. Few questions come to mind:
- Can the two entities equally use the same service?
- Can users pull their data and bring it to other applications?
- Can users confidently trust the company to not modify their data?
The answer to these questions is no.
- YouTube does not share its algorithm with its creators. Only YouTube's developers are privy to that information
- YouTubers cannot transfer subscribers into Twitter followers. Google wouldn't want their customers moving to their competitors
- If there's a policy violation, YouTube can intervene by kicking creators off their platform
These are problems that blockchain solves.
Internet Vs. Blockchain
Comparing blockchains to the internet is a helpful way to think about current networks.
Protocols are rules for a system. The Internet is a combination of open protocols with specific actions like TCP/IP (data transfer), HTTP (client-server communication), and SMTP (sending emails).
These open protocols allow people to make money on TikTok and OnlyFans. They're incredibly useful. Otherwise, I wouldn't be able to send this email (SMTP), you wouldn't get it (TCP/IP), and we'd be stuck using the radio for entertainment (HTTP).
A side-effect of internet protocols is that they're too complicated to use. To simplify it for people like you and me, the protocols get processed over application layers (like Netflix, Twitter, Google, or Facebook).
Applications build an easy user interface for people, but they also capture important user data in the process. Businesses like Google compile this data to understand their users better. The results are then used for targeted ads for sponsors. "If it's free, then you're the product". This is true for other applications like Twitter, Facebook, or TikTok.
From the app user's point of view, current cloud systems are based on fully trusting company administrators. They control everything that happens on a server from reading, altering, deleting, or blocking any user data at will. To make things worse, a hack in a system can expose a user's banking information, home address, or identity.
The world of blockchain has changed this:
Ok. I'll bite, what's a blockchain? As the name suggests, it's a public database (chain) made from a sequence of transactions (blocks).
- Blocks = valid transactions
- Chains = bunch of blocks
The Bitcoin blockchain:
Unlike Google, Facebook, or Twitter there's no central server to a blockchain. The data is scattered across multiple computers creating the network instead.
Nick Szabo describes blockchains as a computer in the cloud, shared across many traditional computers and protected by cryptography and consensus technology:
"A block-chain computer, in sharp contrast to a web server, is shared across many such traditional computers controlled by dozens to thousands of people. By its very design each computer checks each other's work, and thus a block chain computer reliably and securely executes our instructions up to the security limits of block chain technology, which is known formally as anonymous and probabilistic"
Blockchains are just like Monopoly. Imagine playing a game with your pals and landing on Community Chest. The words on the card say that "you inherit $100".
Rather than believe you, other players would read the card for themselves before handing over the cash.
Blockchain protocols work just like this. Every event is monitored through proof-of-work and proof-of-stake protocols––creating an unchangeable ledger. It's a new form of authenticating information and committing to it.
The internet is open-source, but databases are kept closed to the public. Blockchains are the next step after open-source because they provide open data as well.
We now have a reliable way to share information, all while allowing millions of people to access, read, and write from the same data source at any given time. It can't be hacked since there's no central server to attack. The data is decentralized.
Best of all, blockchain users are pseudonymous, require no personal data, and don't need third parties. It's a fundamental promise blockchains make. In other words, it's a database on steroids.
Talkin' About Tokens
Ok, so we know what blockchains are. What are cryptocurrencies? "Cryptocurrencies", "crypto protocols", or "smart contracts" will be called "tokens" to avoid confusion.
A protocol is a fancy word for a standard language, which allows people to work on specific problems. Tokens are software protocols (smart contracts) that enforce rules on a decentralized network (blockchain). Tokens are to internet applications what blockchains are to web servers.
First of all, there are thousands of tokens deployed on different blockchains. Uniswap, Dogecoin, MakerDAO, Zcash, Compound, Chainlink, and 1Inch. These are crypto applications that solve specific problems.
Crypto protocols can provide value in two ways. First as a service like any other company or application:
- Uniswap: automated market maker
- Ethereum: general-purpose blockchain
- Compound: borrowing or lending service
Uniswap for example is a crypto exchange (like Coinbase or Binance), but will never IPO because it's not a company. Uniswap's operations are not managed by institutions or employees. It's just a smart contract on the Ethereum network––initially starting with less than 300 lines of code.
Second-way crypto provides value is from the token each protocol is part of (the so-called "cryptocurrencies").
At the time of writing, Uniswap has a market cap of $12 billion. To put that into perspective, one line of Uniswap's source code is worth ~$24 million. Uniswap's token price:
All tokens have a current combined market cap of $1.5 trillion. Some are priceless, others are worthless, while the rest are scams. What do you get when you buy a token? You get a fun afternoon at Chuck E. Cheese!
Just kidding. The element of a token is the cryptography behind it (crypto-currencies). When you buy a token, you're buying a private key.
Cryptography is used to validate the integrity of a message. Private keys unlock the complex algorithms often used to encrypt information.
Of course, there's more to private keys than just decrypting algorithms. In the cryptoworld, private keys are like a virtual fingerprint that is unique to the person who owns them. This is known as a digital signature.
Consider this a crash-course on cryptography relating to tokens. Things will be under-simplified––so be aware that it's over-complicated:
Cryptography boils down to public and private keys––used to encrypt and decrypt data.
A private key is similar to a password. It gives you access to tokens on the blockchain. They also act as an API key to provide the services tokens promise.
Public keys are also paired with your private keys. These act as your pseudonymous identifier. Rather than share personal data, you'd control what to share through your public key.
If someone has your public key, they can send you coins. If someone has your private key, they own your coins. Selling your tokens does not mean you're giving away your public and private keys. You're merely transferring coins from your key to the receiver's key.
My Private And Public Keys:
Public key to my Ethereum wallet: rushil.eth. You can type this into any crypto exchange and send money directly to my crypto wallet. I encourage you to do so :)
Private key to my Bitcoin wallet:
Just kidding. If that really was my key, I wouldn't be able to reset it. Anyone who loses their private key, loses their coins.
Cryptographic keys give access to use token protocols on a blockchain network. Just like passwords giving access to use internet applications on a web server. Rather than providing your data to use a service, you can now control what you share through public and private keys.
That's a fundamental guarantee that crypto makes: decentralized applications that give users control of their data.
Incentives = Future
Ok. So far we've summed up the importance of blockchains, what tokens are, and how it relates to current networks. Here's how to predict the future: study the incentives.
The investor, Charlie Munger once said:
“I think I've been in the top 5 percent of my age cohort all my life in understanding the power of incentives, and all my life I've underestimated it.”
“Show me the incentive and I will show you the outcome.”
Let's see what the outcome for crypto could be:
Incentives For Blockchains
When we can make commitments (finance or otherwise) by cryptography rather than banks, regulators, governments, police, and lawyers; the system is incentivized to go from local and manual to global and automated.
In the words of Coinbase CTO, Balajis:
"Fortunately, technologists spent the decade building crypto protocols and digital assets that replace the need for bank access entirely. They built them not just on Bitcoin, but on newer blockchains like Ethereum. These protocols and assets are now being used together in an internet-native ecosystem known as decentralized finance (defi for short) that is fundamentally fair in a way that Wall Street isn’t. An Indian can use defi protocols without a Bloomberg Terminal. A Nigerian can create defi contracts without paying for American lawyers. And a Filipino can computationally verify that defi code is fair without trusting American politicians and bankers."
The adoption of blockchain incentivizes social scalability. Don't take my word for it, ask the citizens and activists of Cuba, Nigeria, Belarus, or Venezuela. These are countries already adopting the censorship-resistance of the Bitcoin blockchain and protecting their human rights while doing it.
For example, the pandemic caused devaluations in the Nigerian Naira currency. They were forced to use Bitcoin to pay for international transactions. They no longer needed to buy US dollars with Naira to make trades with China. It also gave Nigeria the leverage to no longer pay large fees to money-transfer firms.
The incentives for blockchains are obvious. It encourages to globally automate, share, and scale. The demand for cryptocurrencies are just now being realized. We're at the crossroads on how it all plays out. Caught between the guarantees that blockchains make today and whether it'll be fulfilled tomorrow.
Incentives For Tokens
Tokens are the birth of a less than a decade-old business model. Decentralized.
There are no longer central authorities controlling a network. This changes how we align incentives between developers, contributors, users, and investors. Consider the concepts below a crash-course on important crypto elements and incentives.
Creators And Network Effects
A network's worth goes up only after more people join it. That's what network effects mean and how current business models work. Twitter only became valuable after people started tweeting on the platform. Early user's didn't get Twitter stock despite increasing Twitter's network value. Crypto changes this.
Unlike internet protocols, tokens offer a direct way to monetize creators. People can now get partial ownership of a network like equity in a start-up. In cryptoland, you're rewarded to join a network early because you'd receive much of the upside. You're encouraged to create and build upon a token's worth, while also increasing your net-worth at the same time.
Composability: Crypto Lego Blocks
TikTok will never share its algorithm with its users. It's too valuable to be open-sourced. On the other hand, tokens are publicly deployed on a blockchain for anyone to audit.
When you create in public, people are incentivized to build on top of it. Anyone has the opportunity to understand a protocol's functionality, find bugs, and fix them. Miners and validators can reach consensus on whether the the fix is logical, and if so it can be added to the token. Open code also allows for a cool concept called composability.
Crypto-land is Minecraft for code. Tokens can plug into each other like lego blocks to build something entirely new. Don't like the UX of a certain protocol? No problem––just build your own using the same code. It's as an open API that anyone can build an app for. Composability can grow networks exponentially. Developers can just plug-and-play code to create countless services. It's a big reason why the entire crypto market has compounded to what it is.
New Business Models
Crypto changes how businesses will work in the future. Most manual work like tracking transactions will be outsourced to smart contracts. The code will manage commitments, while DAOs will manage the code.
A Decentralized Autonomous Organization (DAO) is a community of people who do things that automation cannot: make decisions. Like corporate board members, DAOs look to improve a token's value by financing projects or building more services. DAOs publicly make decisions, whereas corporate board members typically remain private.
I believe DAOs will be the next wave on how humans handle business. This idea will need an essay of its own, but I encourage you to fall DAOn the rabbit hole by subscribing.
The Case For Cryptocurrencies
To go back to our earlier question about current networks:
- Can the two entities equally use the same services?
- Can users pull their data out and bring it into other applications?
- Can users confidently trust the company to not modify their data?
Blockchains and tokens allow this:
- Blockchains have no central control. It's peer-to-peer and anyone can equally contribute to the network
- Users can transfer data interchangeably between tokens through their public and private keys
- Central intervention is a non-problem because there's no company to begin with and data is cryptographically secured
Investors can now find value in a network protocol rather than start-ups, stocks, bonds, index funds, or 401K's. This was an untapped market just a decade ago. Tokens, protocols, defi, smart contracts, blockchains, DAOs, NFTs, and everything else in crypto are extremely early.
You'll hear good and bad takes about cryptocurrencies. Whether the upside outweighs the risks are your decision. I'm here to learn about the nuances of the crypto market and share what I find with you. Right now it involves speculative trading, but investors must realize that crypto isn't useless. Tokens, blockchains, and smart contracts will be what the internet was in the 90s:
Crypto is about convenience. While it's quite complex now, the future will be built around simplicity. You're removing an unneeded step in the system: the middleman. Reducing these constraints will improve efficiency, convenience, and value. Once that happens, mainstream adoption will be quick, then sudden. It's our job to get in before that happens.
Thank you for reading.
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