a16z Podcast | Cryptocurrencies, App Coins, and Investing in Protocols

Polychain Capital's Investment Thesis: The hedge fund invests directly in open-source cryptocurrency protocols (equity ownership of the network) rather than in companies building applications on top of those protocols.

• Analogy: This strategy mirrors investing in domain names during the early internet (1993) rather than betting on specific companies like Amazon or Yahoo.
• Value Accrual: Historical data suggests disproportionate value accrues to the protocol layer; for instance, Ethereum's native token (Ether) has grown over 100x, while venture funding into Ethereum companies has been minimal.

Market Dynamics and Asset Class Definition:

• There are hundreds of cryptocurrencies, with approximately 15 new launches occurring in March alone.
• The fund distinguishes between broad-based currencies (like Bitcoin) and "application-specific tokens" (AppCoins), which act as a monetary layer for specific use cases (e.g., Gollum for renting CPU/GPU cycles).
• This creates a new asset class uncorrelated with oil, gold, traditional equities, and bonds.
• Investment accessibility has shifted from elite venture capital clubs (like Amazon's early investors) to a democratized model where global retail investors can purchase tokens.

Capitalism in Open Source Development:

• Traditional open-source projects (e.g., Linux, SSL) rely on nonprofit foundations or corporate partnerships, often leading to underfunding (e.g., SSL foundation budget ~$500k/year).
• Cryptocurrency tokenization introduces direct economic incentives:
  • The Gollum project raised $9 million in 19 minutes, functioning as a Series A round.
  • Founders can retain 18% equity in the network, aligning developer incentives with protocol growth similar to traditional startups.
• Users become shareholders; they gain wealth as the network grows, fostering "fanaticism" and stronger network effects compared to centralized platforms.

Shift from Centralized to Decentralized Infrastructure:

• Historical Context: While academic/government funding fueled the creation of early protocols (TCP/IP, SMTP), the last 20 years saw a dominance of closed, centralized platforms (Facebook, Twitter, Uber) due to superior funding and business models.
• The New Model: Polychain views blockchain as the first instance of "open services" (e.g., public AWS via mining networks) without central ownership or choke points.
  • Trust Model: Systems operate on "trust no one," using decentralized incentive structures to coordinate behavior without top-down hierarchy.
  • Permanence: Unlike centralized platforms where a CEO (e.g., Vitalik Buterin) can "pull the rug," decentralized protocols are self-sustaining and resistant to unilateral shutdowns.

Specific Protocol Examples and Technical Details:

• Ethereum: Offers a Turing-complete programming language (Solidity), enabling complex applications unlike Bitcoin's limited scripting.
• Tezos: Utilizes a proof-of-stake consensus mechanism where token holders vote directly on protocol upgrades, creating a democratic governance model.
• Maker (MKR): An ambitious project attempting to create a stablecoin pegged to the USD through endogenous smart contract incentives rather than traditional bank reserves.
• Gollum: A peer-to-peer marketplace for computing resources where payments occur via network tokens.

Challenges and Risks:

• Technological Feasibility: Many projects face hard technological challenges; some concepts may be impossible to build.
• Volatility: Assets are highly volatile, with many failing; Polychain advises against retail investment unless the investor possesses deep technical expertise.
• Conflict Resolution: Disagreements occur on public forums and mailing lists, with resolution often determined by mining power (Bitcoin) or voting rights (Tezos) rather than closed board meetings.

Future Outlook:

• Infrastructure Focus: Investment is currently concentrated on the "low-level internet stack" (e.g., IPFS for decentralized storage, ENS for domain mapping) required to support user-facing apps.
• Emergent Behaviors: The combination of swarm intelligence and economic incentives is expected to generate unforeseen applications and behaviors, similar to the internet's evolution beyond a digital library.
• Wealth Distribution: The long-term vision aims to shift value generation from centralized platform owners back to everyday users and early adopters of the protocols.