Polychain Capital, a new hedge fund investing in bitcoin, ether and other digital assets, has garnered $10 million in investment from two marquee venture capital firms, Andreessen Horowitz and Union Square Ventures.
Launched in September with $5 million from 30 investors, the San Francisco-based firm is headed up by Olaf Carlson-Wee, the first employee of one of the most well-funded and popular cryptocurrency startups, Coinbase. He is also known for living most of his financial life in bitcoin and other cryptocurrencies. USV led Coinbase’s Series A fundraising round, and Andreessen led its Series B.
The investment signals the belief among some venture capitalists and other players in the cryptocurrency and blockchain industry that the future will consist of multiple digital assets beyond the first one, bitcoin, and that one of the best ways to participate in the blockchain revolution is through investing in the tokens rather than in digital asset companies themselves.
“There will be many types of assets codified into the blockchain, and they are all not just going to be on the bitcoin blockchain — it’s going to be a number of different assets here. And the best way to invest in that is a diversified portfolio,” says Carlson-Wee.
Noting that Carlson-Wee was the first employee at Coinbase, Brad Burnham, partner at Union Square Ventures says, “He has a longitudinal perspective on the emergence of tokens as a store of value that very few people have and he also understands how to look at and evaluate tokens and determine which tokens are most likely to appreciate in value.”
While previous hedge funds, such as Global Advisors, have invested solely in bitcoin, a couple new hedge funds investing in blockchain-based assets, aside from Polychain, are in the works.
However, these digital assets are not conventional investments such as stocks or bonds. Carlson-Wee says that they are shaping up to be part investment and part token used for participating in a network. In a blog post this summer, USV partner Albert Wenger likened these digital assets to tokens needed to go on rides at a fair — but in this case, the token also has a value and so you can also simply trade it as you would a stock or other investment.
“As a modern internet user, you’re part of endless networks — Twitter, Facebook, LinkedIn, Etsy, Ebay, Tumblr,” says Carlson-Wee. “But the value of those networks is extracted by a profit-seeking central entity, even though the value is generated by the users themselves. On Twitter you see other people’s tweets, you don’t see things that Twitter the company wrote. So in this new model, where people actually own the network, that value goes back to the people who own the network, and all the value generated by Twitter goes back to the users of Twitter relative to their contribution. So if you’re a very early user of Facebook, it’s almost like you get 1,000 shares and if you’re a later user you get 100 shares as the network grows.”
Since there is no middleman in these peer-to-peer networks, Carlson-Wee says the the only way to invest is to purchase the tokens. “There is no company to invest in, there is no venture capital seed round or Series A to participate in,” he says. “The hope here is to own small portion of networks that become the future infrastructure of the internet and potentially compete or disrupt many of the centralized web services that dominate the internet today.”
These digital tokens (one subset of which is called app-coins, which are specific to certain applications such as file storage, described in my Forbes magazine story) also revolutionize the way that developers can make money. Previously, the creators of internet protocols like http for the web or smtp for email did not profit in the same way that, for instance, companies built on top of those protocols like Google, Facebook or Amazon did.
“For the first time, open source, peer-to-peer protocol developers can monetize their project on a protocol level,” says Carlson-Wee, adding that if they release a million tokens but keep 10% and the network becomes popular, “the demand for the tokens increases because you need the tokens to participate in the network. And as that demand increases, because the supply of tokens is scarce and fixed, the price goes up. So it acts sort of like equity in a startup to incentivize the founder and employees, but it’s really monetizing an open source peer-to-peer protocol, not a company.”
The trend of crowdfunding by issuing your own token could also disrupt traditional venture capital, which Burnham welcomes. “It means the creators, innovators and entrepreneurs are participating in that value creation, and not the financiers. We look forward to that change,” he says.
Carlson-Wee is discriminating about when a token is or isn’t a good idea.“It doesn’t always make sense to have a token on the blockchain that is both useful and represents ownership — it has to be something where there’s a network effect,” he says. “That’s why I cite Facebook as an example of what could be disrupted more so than, say, Amazon — which is bit more centralized and is not exactly a network of users in the same way. I don’t only go on Amazon because it has other users. The core content isn’t provided by other users. So it’s not every company, but I think huge swathes of the GDP could be stored in blockchain-based tokens.”
Carlson-Wee projects that someday, the market cap of all blockchain-based tokens could be “in the trillions of dollars,” though currently, all the cryptocurrencies combined are at around $13 billion, with almost all of that value residing in bitcoin.
Some examples of other cryptocurrencies and blockchain-based assets include ether, used to operate on the Ethereum network, which is known for the ability to create and run so-called smart contracts, or self-executing computer programs that carry out the terms of an agreement; REP tokens, for betting on outcomes in the prediction market Augur; Golem Network Tokens (GNT), used to pay for heavy computation, like, say, graphics rendering from a distributed supercomputer, among others.
While a number of crowdsales in new digital currencies have flourished this year, with the most notorious one called the DAO raking in $150 million in ether to create a decentralized venture fund (which someone then stole $50 million from), discerning which ones are legitimate investments and which are scams isn’t easy.
Burnham noted that the evaluation requires several layers of analysis, starting with determining which tokens are most likely to appreciate — which problem is being solved, will the network grow? Then come questions around the network’s economic system — how many tokens are being released vs. kept by the creators, how are they being released, etc. — as well as the security of the protocol in terms of how easily it could be hacked.
And USV also must vet how the fund manages security — since cryptocurrencies have a reputation for being lost or hacked, the manager must have a theft- and loss-proof process for handling the keys to these tokens. Given that one of Carlson-Wee’s roles at Coinbase was head of risk, Burnham says, “Since Olaf was central to the creation of that security at Coinbase and has been thoughtful about this for a long time, I think he has the best model for that right now.”
First appeared at Forbes