145: Nic Carter on the REAL Value of Blockchain

Buck: Welcome back to the show everyone. Today my guest is Nic Carter. Nic is a partner at Castle Island Ventures. Before joining Castle Island, Nic worked for Fidelity as their first crypto asset analyst where he devised research perspectives on public blockchains. He’s also the co-founder of CoinMetrics, a platform devoted to demystifying on-chain data and bring transparency to the inducstry. He’s written extensively about token holder rights, crypto asset governance models and public blockchains as political institutions. Nic welcome to the program.

Nic: Thanks for having me on buck it’s a pleasure to be here.

Buck: So I don’t want to get to sort of pedestrian here but I just did notice that you have a masters in philosophy. So how do you go from masters in philosophy to the digital asset space?

Nic: Well that’s actually kind of a quirk of the Scottish University naming system. That would be equivalent to an undergraduate degree here, it’s just that Scottish universities they call it a masters, which is very confusing. But I studied philosophy undergrad, particularly was interested in epistemology, the sort of the theory of knowledge and political philosophy, I think there’s a lot of crossovers there particularly when you’re designing these kind of novel governance systems, you know you’re trying to determine how property is allocated in society and for the first time we have the disability to conduct kind of experiments especially you’ll notice a lot of the government schemes in crypto many of them rely in some ways on these concepts from social contract theory, political philosophy, so there definitely is a crossover and I wouldn’t say that’s how I got into it. I ended up doing after undergrad I did a sort of much more conventional masters in finance which was really my ticket in along with blogging about this stuff and starting CoinMetrics.

Buck: Yeah. So what was CoinMetrics? Tell us a little bit about CoinMetrics.

Nic: Yes so I started that when I was doing my Masters. The issue at the time, this was late 2016 early 2017, was a lack of good usage data on major public blockchains. So there were some data sources aggregating how many transactions are there a day on Bitcoin and what is the economic value of the flow through those systems, you know what’s like the economics throughput. And they were very scattered and just incomplete in general and I was trying to create sort of regressions against usage to compare that to price to say well can I design a model such that I plug in inputs from the blockchain’s usage data and essentially train it to see whether it’s predictive of price at all, that was kind of the hunch that I had at the time. But the data was basically impossible to acquire. And that’s when I got together with an engineer friend and we started running nodes for Bitcoin, Ethereum, Litecoin, Dash, Manera, etc, etc. And we took the kind of semi structured data and translated it into structured comprehensible simple data so that anybody, and you can do this CoinMetrics.io today, you can download these datasets, we’re not restricting usage or anything, and you can play with on-chain data to determine what is actually going on on these blockchains because the idea was that if people had access to sort of the ground truth of on-chain activity, it would allow them to make better decisions as opposed to just relying on white papers or marketing.

Buck: Yeah so some of the other ones out there I mean I actually I’m sure I should have known about CoinMetrics but you know, what’s the difference between that and say like a Block’tivity? I’ve noticed Block’tivity comes up a couple of times where it seems like that’s more just activity on the blockchain but it’s nonspecific, is that the difference?

Nic: Yeah I think Block’tivity mostly covers transaction count. I haven’t spent too much time on it. I mean the problem really is that the kind of analytical framework is still lacking with regards to really deeply understanding on-chain data so the risk is that we’re just aggregating garbage stats and giving people access to that and so what we’ve always tried to do is be very deliberate in terms of talking about the various nuances involved in analyzing on-chain data and the constraints and the difficulties, so for instance you know there’s this popular notion of transaction volume or transaction value, you know what is the dollar equivalent value of the circulation on a major public blockchain per day and the estimates for those on Bitcoin and Ethereum will vary over several orders of magnitude because it’s just super imprecise. So one approach we’ve taken which maybe distinguishes us from some of the other aggregators is to be very definite about the risks involved in using this data and and the constraints and the drawbacks and so on.

Buck: Sure now CoinMetrics was that before or after you were with Fidelity?

Nic: I started that before. I think that was actually part of how I initially perked up my future boss’s ears, I think he knew about CoinMetrics and then I wasn’t exactly meant to do this but I continued running it on the side while I was there and then ended up spinning it, actually incorporating it as a business once I’d left and once I joined the venture fund that we started.

Buck: Yeah and I want to talk about that in a second, but I’m curious about what your experience at Fidelity and obviously they’re now one of the big players that are that are actually gonna get their feet wet in this stuff and get involved. Did that happen, was there a lot of talk of that while you were there? Were you part of that? How did that all come out?

Nic: Yeah great question. Well the short answer is that it didn’t happen overnight, it was a very long and involved process to go from being skeptical or to put a crassly, ignorant about these this asset class, whether it represents an asset class or not, to being one of the the leading institutions in terms of leading the charge right now with custody and then in the future we’ll see whether there’s other products which come out of there. But it was probably about a five year process to go from zero to now they have a custodial offering which I think is is quite a distinguished and differentiated product relative to the other custodial offerings. It got started as part of a wargaming exercise in 2013. It was essentially a scenario planning exercise and trying to guess at things that might happen in the future that might be a threat to Fidelity’s business. One of them was called Frictionless Capital Markets and the worry was, will security settlement end up happening on a peer-to-peer basis? Because that’s a really large part of Fidelity’s business and that ended up not being the case unless we go to this tokenized world, I don’t know if we will very long, but it didn’t end up being the case now at least. However that lead Fidelity to this notion of blockchains and eventually Bitcoin. So they went through a lot of the cycle that large enterprises go through looking at the private blockchains and evaluating those projects and then interestingly they felt that as an asset manager, they might as well focus on the assets themselves, you know the cryptocurrencies, crypto assets. And so there were a few initiatives there but the one that eventually bore fruit was the custody initiative which I think is a really important piece of the puzzle and I know the guys on the team there. I think that they’ll be probably one of the big winners in the custody space. They have an extremely professional view on this, they’ve gone about it in a very deliberate kind of a risk-averse way, and yeah so my little group there was actually distinct from the custody project. We were actually a small balance sheet fund and I was hired to devise research perspectives on these assets. So I’d write long-form research pieces like what does decentralisation mean, what are the dimensions of decentralisation, how is it manifested on these networks, how can we distinguish ripple from Bitcoin for instance, that’s the kind of stuff I was writing about. So my goal there was to develop a sort of a systematic and comprehensive understanding of these assets.

Buck: Yeah it’s really interesting to me because now talking about fidelity getting involved with the custodian side and actually saw today on Twitter, guests that we had on previously with BlockFi, they made an investment in BlockFii which is a crypto collateralized debt which is also interesting, again you know just these small investments again sort of fortifying some exposure to this asset class and then you’ve got you know Yale’s endowment involved it’s pretty interesting. But I want to talk a little bit about now you’re with, I don’t know you you’re the founder or you’re with Castle Island and, it’s a venture fund right that’s right?

Nic: We’re a conventional venture fund yeah. I mean it’s just myself and Matt Walsh. Matt was Fidelity’s director, essentially director of their crypto strategy so I speak of their journey as if I was there which is not the case, you know I was only there from 2017 onwards. He was there from 2013 onwards so he saw and that whole transformation and much of their I don’t know if you know, many crypto believers will believe that what they did was praiseworthy in terms of getting their toes wet in the market, but if you’re a skeptic maybe you think what they’ve done is extremely risky, but a lot of their efforts in cryptocurrency are due to to Matt’s stewardship of that program so he really has a legacy over there. But so yeah Castle Island Ventures is myself and Matt we got started in summer 2018. And we’ve been deploying capital we we are not an ICO fund, we’re not a token fund, we write checks at the seed stage for operating businesses in the cryptocurrency space either building on top of public blockchains that we think are robust and reliable or blockchain agnostic, you know building the sort of associated financial services that we think will need to exist, building exchange tech, custody tech, order management solutions, smart order routing, data, that’s obviously what core metrics does, those kinds of use cases.

Buck: Right. When you’re evaluating these kinds of businesses, they’re not necessarily even blockchain businesses right but they’re sort of part of the infrastructure or some of the use cases potentially of blockchain, is that is that fair?

Nic: Yeah I would say a lot of them are kind of enabling businesses that would be required for this market to mature. So we’re still at a stage of relative immaturity, you know it’s very difficult for serious institutions to engage with these assets in a meaningful way and you know a lot of the pieces of the puzzle are things like lending which is what BlockFi did and and that’s my old group at Fidelity were the ones writing that check. Casa is a portfolio company of ours, they help people manage their keys in a way that is kind of robust to various different kinds of shocks so if you lose a single key, you can recover from that. So you know those are the kind of use cases that we think are enabling technologies to allow this market to mature a little bit and then we have other approaches which are more at the application layer which will use the assurances involved in public blockchains in some way so we’re seeing a few companies that are relying on the time stamping function that you get from from hashing data into Bitcoin or Ethereum, which is kind of an interesting feature which didn’t exist prior to 2009, a very robust timestamp database.

Buck: Yeah. You know one of the things that I think about sometimes is that there seems to be maybe an overuse and this is probably part of that ICO phenomena of blockchain in general or at least the idea of block chaining everything. What’s your take on that? Like how often do you see businesses that come at that maybe they approach you or you look at them and they’re utilizing blockchain or their own blockchain, but you don’t really need it.

Nic: Yeah it’s it’s definitely a condition that afflicts a large portion of this industry. I’ve been a I’ve definitely been a fairly loud critic of even the word blockchain. It’s an interesting trivia fact that Satoshi himself or herself never used the word blockchain. Satoshi definitely wrote chain of blocks, but not blockchain itself and you know in some ways that’s just a neologism which kind of borrows I think the reputation of bitcoins uptime and reliability guarantees and then tries to apply that to what really look like centralized databases to me and I think it’s been abused to some degree by maybe the IBM’s of the world who are using it for PR purposes. I don’t think their products look anything like a proof-of-work blockchain. In many cases you have consortiums of validators that will come together and take turns signing a database and to me that is fundamentally very different from a public blockchain with permissionless validation like Bitcoin and Ethereum are where anybody can propose a block, provided they submit a valid proof of work so I think there’s a really distinct set of ideas there. I think you know maybe the private blockchains will be useful, that remains to be seen, but I think it’s probably important to distinguish them because in my view they’re essential features are very distinct.

Buck: Yeah and then the other question I guess that comes out of that is in which situations or use cases is it important or useful to be permissionless as opposed to being permission but maybe just more efficient.

Nic: Well very very few use cases. Is it worth undertaking all the additional costs and overhead of permissionlessness. Bitcoin errors would say the money use case alone and then people who don’t like smart contract platforms or computation would say well actually it may be possible to extend this and create versions of Google on Facebook and Twitter that are run on these distributed computation engines with a permissionless element. I definitely see the logic there too, I just think there’s probably a lot more technical challenges to scale before those systems really work. But to me the the main use case we’ve seen is maybe the most boring one if you’re a Silicon Valley investor which is just the money, the sort of alternative monetary system so that’s the only one that I think has really proved its mettle so far. And then I think it sort of remains to be seen whether we can extend these systems into generalized computation engines, but I’m also optimistic about that.

Buck: When you look at the different projects out there, do you consider yourself somebody who’s more on the side of being more of a Bitcoin maximalist or somebody who just sees validity in various projects and who knows, are you kind of agnostic to that from your perspective?

Nic: I would say privately, and maybe there isn’t much privacy left in this world, but privately I’m probably more on the Bitcoin side like my own personal stash would be pretty much exclusively Bitcoin, that’s the only one that I you know believe would last me foreseeably thirty years into the future without too much alteration. However, that said, I’m more agnostic when it comes to diligence encodings on top of these things. What matters I think is that they understand the blockchain they’re building on very well. You’ve had a lot of startups that went astray because they were building for instance on Bitcoin in 2015 and then their business models required that there were always low fees, and then when the fees crept up they sought to change Bitcoin in some way or their business models became obsolete. So I think that’s an interesting case where you have to really build on top of these systems, they’re very uncompromising and you have to understand it very well. So that would be the main thing I’d look for. And then of course you always have protocol risk which is that the protocol itself changes in some sort of unpredictable way and that may be also heard you in the Bitcoin direction because what we have right now is a crop of yet to be launched smart contract platforms where their properties are basically unknown, you know this would be your your DFinities of the world, your Hashgraphs, maybe Telegram if they launch, so well those are just total unknowns we’ll see what happens. And then I guess the risk with Ethereum that I would identify is that they’re good, they’re sort of completely the whole chain from scratch, the consensus is being reelected the virtual machine etc. So it may be the case that if you’re a startup and you build something that’s suitable for Ethereum 1.0 you’re kind of out of luck when something really dramatically changes. So those are probably the main things that I’m worried about.

Buck: Yeah. You know the the question of decentralization in all of this or permissionlessness or all this is really kind of like something I’ve been thinking about a lot because I think there’s clearly a technology that can make things more efficient, faster, cheaper out there, but there seems like there’s this tension between sort of the ideology of, I don’t know if you want to call them blockchain people or or whatever, but of everything being decentralized and permissionless versus something that maybe has some level of central governance, but the technology makes it smoother. I mean is there a balance there that you look at potentially and say maybe it doesn’t have to be perfect in in terms of the ideology behind distributed ledgers, but it works better.

Nic: Yeah that’s a really great point actually. You know I think a great example would be EOS. So they have probably compromised too, I think EOS fans would admit this too that they deliberately compromised in terms of the decentralization of who’s allowed to propose blocks so of course it’s limited to a pool of 21 block producers who were voted on by the owners of EOS. So it’s more of a either democracy or plutocracy, however you want to characterize it. And then there’s obviously there’s the risk that there’s bribery and then it becomes sort of a racket where the larger block producers are essentially buying political support, which we’ve seen some scattered evidence of this happening so that’s the risk right? But in return you only have twenty one sort of economic nodes that matter on the network and so I’m not exactly sure how the consensus works but the conclusion from all that is that they can process ten million transactions a day probably more than that but that’s the most that we’ve seen in the real world, whereas Bitcoin does you know three hundred three hundred, four hundred thousand a day, Ethereum will do up to eight hundred thousand. So you know I think there’s actually a case to be made for sort of very transparently compromising on the decentralized governance side of things to win some scalability gains. I think actually it’s an interesting state of affairs where we have lots of different iterations along with different projects on the continuum and there may be appropriate balance of both acts.

Buck: Yeah the the project that comes to mind when I think about that is actually one that you mentioned which is Hashgraph which I’ve been following and I look at that as an investor and somebody who’s interested in the technology as well and a lot of things that Hedera and Hashgraph have been criticized for by the the cryptocurrency community is ultimately that first of all there’s very clear defined, there’s governance, there’s gonna be these large institutions involved who are gonna make up these super nodes or whatever you want to call them, but then on top of that they’re actually even though it’s going to be open for everyone to use the blockchain, or not the blockchain the consensus network in this case, even though it’s going to be open to everybody, it is patented. So you can’t go fork off and do something else. To me the utility of that in rather than looking at it as ideology just seems like gosh that makes a lot of sense and then you look at guys like you know Mance Harmon and these guys who got a lot of business experience and I feel like yeah maybe they’re onto something there.

Nic: Yeah it is a really fascinating question I mean I’m definitely , you know full disclosure, probably in the more skeptical crowd when it comes to Hashgraph. But you know I think there is definitely a risk that you end up being the Bitcoiners in particular are blinded by their sort of ideological priors and kind of missed the forest for the trees and I think nobody’s laboring under the apprehension that Hashgraph is trying to match Bitcoin for its decentralization. I guess the relevant question is, are they able to strike a balance of centralization and decentralization that is still compatible with their essentially the objectives of the chain. And I will confess I don’t know what the Hashgraph chain is being designed for, what kind of use cases in particular. My view would probably be that if you’re looking to create something which sort of undermines governments which is an alternative monetary system, then you probably have to max out all of the resiliency and decentralization sliders, but if you are looking to create a, let’s say a version of Amazon or version of Facebook which can’t be easily censored by the creator or where D platforming can occur, then it could be the case that you can only set those sliders to 75%. So I it’s gonna be a really fascinating question. I don’t know if the valuation is going to hold up the launch, that’ll also be something interesting to watch.

Buck: Well yeah that’s the other question and in their particular case their whole focus is really I mean they don’t they, just talking to Mance Harmon, they don’t really consider themselves competition for Bitcoin, they really see themselves as a faster, more efficient way of providing the infrastructure for quote-unquote centralized tier applications that would be more efficient than Ethereum. But you know I’m curious I guess from your perspective also, what is your take on the growing institutional interest in cryptocurrencies in general in the sense that, what effect do you think that that kind of smart money or big money or whatever you want to call it has on the ecosystem at large? Is it a net positive thing, net negative thing in your opinion?

Nic: Yeah it’s been the source of a lot of strife probably, especially from the Bitcoin crowd. There’s always this worry that large that as with the gold markets where people believe that the the gold paper markets are suppressing the spot value of gold and that the derivatives markets suppress the spot markets, there’s that same worry about Bitcoin for instance with fractional reserves being the chief adversary in Bitcoin land, the question is why would we then reintroduce these central intermediaries that can issue fractional reserves. And on the one hand I definitely see the the validity of the critique, however, I think the the interesting thing with with cryptocurrencies is that you can actually audit them with comparable ease. So it’s not difficult to provide a attestation which is cryptographically sound and auditable which says look, we have a $100,000 worth of deposits and that translates to X many bitcoins in our cold wallets and here’s a proof that we have a sufficient number of bitcoins in our cold wallets. And you can create those proofs such that they may be obscure information that you don’t necessarily want to share with everybody but you know so that people can still verify that you have the appropriate number of bitcoins in your cold storage. So I think the issue with the kind of rehypothecation worries and the fractional-reserve worries with an asset like gold is that it’s very difficult to actually prove that a custodian has the number of gold bars in their vaults, but with any kind of a cryptocurrency, it’s much more easy to prove this. I’m surprised that more exchanges and custodians are not issuing periodic proofs of reserves. And there’s this funny movement happening in Bitcoin land right now, we’re on the 10th anniversary of the chain being founded so upcoming on January the 3rd 2019 a lot of bitcoiners are trying to put together a coordinated run on the bank essentially. So I gotta love the like cultural events that happen in Bitcoin land so they’re all gonna try and withdraw their exchange deposits at the same time and kind of scare the exchanges a little bit and to maybe publishing proofs of reserves.

Buck: The funny thing about that to me is that the people who are so involved with that probably don’t have a lot of bitcoins sitting on the exchanges in the first place.

Nic: Well that’s right I mean not your keys, not your Bitcoin, so they wouldn’t have any on exchanges anyway. So I guess they’re trying to tempt the traders to temporarily withdraw their bitcoins yeah. But yeah I mean to answer your question I think in general it’s positive. If you look at the messaging coming out of fidelity’s digital assets team, they’re very attuned to I think the issues of the space they you know they’re essentially crypto natives so to speak. I know the guys over there, they’re longtime members of the industry so they really understand what people are worried about and concerned about and as more institutional dollars come in that doesn’t necessarily guarantee that you know the price will rise but I think it gives us more liquidity, can it turn some of these liquidity ponds into liquidity pools, prime brokerage and functioning less frictional OTC markets will do that and I think that’s a net win for everybody and generally speaking. More liquidity means you know less market impact of your transactions and and lower fees and just more sort of robust exchanges and maybe we’ll see a transition away from the cowboy exchanges which are kind of ripping off their users towards supervised exchanges which I think is isn’t that positive.

Buck: What do you think, I know you’re not you’re not following, you’re not a trader, I know you’re not a prophet, but we’ve obviously had this massive sell-off and crypto winter and when I look at that as somebody who’s looking at what’s going on with institutional movement into this area, I would think that that would be reflected in market cap, but we haven’t seen that. Is that something you feel like in the next it’s gonna take several years to see that kind of impact or what what’s your take on that?

Nic: Well I think a lot of the I call it a bubble that occurred in 2017 was due to the expectation of massive inflows from kind of institutional investors, larger investors, endowments, hedge funds, conventional hedge funds, right? And I anecdotally and hearing from my friends at non crypto hedge funds, so these would be you know equity funds or commodity funds, so now we’re looking at a we’re thinking about a Bitcoin position or we’re analyzing Ethereum, so interestingly now that the downturn has come they’re interested again right? Because nobody wants to buy on the top your . But yeah I think that the bubble really was a function of people’s miscalibrated expectations and it really is a slow process, keep in mind that it took Fidelity for five years to go from thinking about this seriously to actually having a product out there, that’s the kind of pace that these things operate on and you know I’ve talked to some of the endowments that are operating in the space and they’re not taking a direct cryptocurrency position because that’s typically not how endowments operate they like to go through managers so they might back a cryptocurrency venture fund or a cryptocurrency hedge fund so in many ways it’s still sort of indirect exposure.

Buck: Yeah I think I remember somebody talking about that with for example Andreessen Horowitz has been involved with cryptocurrency projects and then there’s endowments that you know have been involved with Andreessen Horowitz for years, they’re getting exposure but they’re getting exposure indirectly.

Nic: Yeah I would say the a16z crypto fund, you know 300 million dollar fund, is an interesting case where they will take a stake in a liquid live crypto asset directly, they did it with with Maker famously. So you see it flows through eventually and then of course a lot of those endowments-backed paradigm that large new crypto hedge fund so I mean it’s simply happening and I would say the the serious wealth managers I talked to are definitely aware of the asset class, but in many cases the questions are like, well how do we analyze this stuff? How do we value it? No one’s ever come out with a good DCF methodology for Bitcoin or Ethereum, so I think those funds would either seek to develop those methodology to wait till there’s more agreement or consensus on how that would be done and there’s people that attempt ratio analysis, I’ve certainly tried myself, but there’s not a lot to backstop necessarily the value of these things and for better for worse so I would say if you do value Bitcoin it’d still be based on your expectations of its future market penetration and what you think the velocity might be in the future and to many serious alligators that’s not a sufficient answer to the question and that would keep them from moving in.

Buck: Yeah and it’s funny because you know I’m on following people on crypto Twitter and I hear some tweets from some well-known people and like this community, it says you know you know stick to the fundamentals, and I’m like well what are the fundamentals?

Nic: We’ve never defined the fundamentals.

Buck: Right and we have not been able to value those so it is a it’s a little tricky. I mean I see value in it, Bitcoin in particulars as the use case being a storage of value, but I don’t think fundamentally you can there’s a way to you know to quantify exactly how much it would be worth at this point.

Nic: Yeah it’s something that I struggle with. I think about a lot. Ultimately maybe it shouldn’t be the case that it’s hedge funds buying opportunistically, maybe it should only be purchased by users that can really benefit from the actual attributes that it has. And people of course are going to try and guess at what with that population, that interested population might be, but I think a more authentic value might just emerge as a function of people learning about the chain and finding out what they can do with it that they can’t do with with the legacy financial system but of course it’s extremely hard to model adoption process.

Buck: Right. So Castle Island. How big a fund is this? Who are your investors? Are you institutional nature?

Nic: Our LPS actually Fidelity came in as our largest investor so kind of a harmonious decoupling there and the remainder of our LPS are mostly mostly high net worth individuals in Boston. We raised thirty million.

Buck: Cool, very good. And how do we learn more about your work? You’re pretty active on Medium.

Nic: Yeah so I like to I spend my weekends thinking about cryptocurrencies and blogging about it on Medium that’s probably the main place to follow me. I do the occasional podcast here and there but really I like to do some more sort of data-driven work on Medium so I did one where I compared the the TPS, the transactions per second of a whole bunch of blockchains and then actually legacy financial systems like Swift and Fedwire and ACH, and then I also compared it to the typical transaction size, so like what would be the average physical cash transaction? apparently it’s around $20. And what’s the size of your average Ethereum transaction and what’s the size of your average debit card transaction. So I compiled that all into a single chart, I was trying to compare all those different payment and settlement systems so that’s the kind of stuff that I’ll do.

Buck: Who won?

Nic: That depends. You’ve got the ones with really small transactions but there’s tons of them and you’ve got the really big transactions but there’s not that money.

Buck: Right yeah. Well listen it’s been really fun talking to you Nick and I want to thank you again for being on the program.

Nic: Thank you so much it’s been a pleasure.

Buck: We’ll be right back.