Quotes"We have tried to be the bridge between projects that are doing groundbreaking work & the variety of people that believe or want to understand the potential of blockchain." ~Matt Chwierut, Director of Research @smithandcrown Click To Tweet "We're in a market regime now where everything really trades together despite very significant changes in underlying components to these distributed systems." ~Matt Chwierut, co-founder & Director of Research @smithandcrown Click To Tweet "As a set of societies and markets, we are still making sense of what #bitcoin is, what kind of an asset we want Bitcoin to be or think Bitcoin is going to be." ~Matt Chwierut, co-founder & Director of Research @smithandcrown Click To Tweet
Welcome to this conversation with Matt Chwierut, co-founder and Director of Research at Smith + Crown, a blockchain research organization that regularly publishes on cryptoassets and cryptoeconomic systems. This episode is special because it’s one of the few times that Matt has shared his thoughts on cryptoeconomic design in public. Much of the work that Smith + Crown does takes place behind the scenes.
This conversation with Matt is split into 3 chapters:
- Chapter 1: An introduction to cryptoeconomic design
- Chapter 2: How Smith + Crown applies cryptoeconomic design principles
- Chapter 3: A Q&A covering Smith + Crown’s advisory work, the evolving case for Bitcoin & more
Topics Discussed In This Episode
- Smith + Crown’s main focus areas: research, advocacy & advisory
- SCI, Smith + Crown’s intelligence platform
- Cryptoeconomic design & why it’s underappreciated
- Today’s Bitcoin-dominated market
- The four pillars of cryptoeconomic systems
- Why “utility token” is not a very descriptive term
- How a utility token can become valuable
- Using on-chain data to predict price movements
- Cryptoeconomics & stablecoins
- How stablecoins can make money off their collateral
- Spot vs. derivatives volume
- The evolving case for Bitcoin
- Ethereum (ETH) and the Fat Protocol thesis
- Zilliqa (ZIL) and the benefits of Proof-of-Work
- Development taking place during “crypto winter”
Links Relevant To This Episode
- Popular Crypto Weekly Newsletter
- Clay Collins
- Matt Chwierut
- Smith + Crown
- Smith + Crown on Twitter
- SCI (Smith + Crown Intelligence)
- Decentraland (MANA)
- Chris Burniske
- PAX Gold
Clay: Welcome to Flippening, the first and original podcast for full time, professional, and institutional crypto investors. I’m your host, Clay Collins. Each week, we discuss the cryptocurrency economy, new investment strategies for maximizing returns, and stories from the frontlines of financial disruption. Go to flippening.com to join our newsletter for cryptocurrency investors and find out just why this podcast is called Flippening.
Clay Collins is the CEO of Nomics. All opinions expressed by Clay and podcast guests are solely their own opinion [00:00:30] and do not reflect the opinion of Nomics or any other company. This podcast is for informational and entertainment purposes only and should not be relied upon as the basis for investment decisions.
Welcome to this conversation with Matt Chwierut, co-founder and Director of Research at Smith + Crown, a blockchain research organization that regularly publishes on cryptoasset and cryptoeconomic systems.
I should note that this particular episode was recorded in front of a live [00:01:00] audience. If you’d like to attend a live Flippening Podcast recording and directly submit interview questions to guests, then please go to flippening.com, enter your email address, and subscribe. After you’ve subscribed, we’ll be sure to send you email notifications before live recording sessions so you can join us. Space on these live recordings is limited to 100 attendees per recording, so go to flippening.com to subscribe and join us for the next live recording of this podcast.
With that established, let’s talk about Smith + Crown. I got to know [00:01:30] Smith + Crown when they started using the Nomics API to power their Intelligence Product. Smith + Crown engages in advocacy work and provides advisory services to cryptoasset projects on matters such as cryptoeconomic design, which is the subject of our conversation today. Our guest, Matt, will go in-depth on cryptoeconomic design, what it is, and why it’s a useful lens through which to view cryptoasset projects, market behavior, and historical trends.
This episode is special because it’s one of the first times that Matt is sharing this information in public. [00:02:00] A lot of the work that Smith + Crown does, especially the advisory work, takes place behind the scenes.
My conversation with Matt is split into three chapters. In chapter one, Matt introduces the fundamentals of cryptoeconomic design. In chapter two, we discuss how Smith + Crown applies cryptoeconomic design principles to projects. Finally, in chapter three, we do a Q&A, where we cover a range of topics including Smith + Crown’s advisory work, stablecoins, and the evolving case for Bitcoin. During this Q&A, I not only ask personal [00:02:30] questions, but we take questions from the live audience who is present with us at the time of recording.
We’ll get to the episode in just a second, but before we get started I’d to pause for a moment to tell you that this episode is brought to you by the good folks at CryptoTrader.Tax. Here are four things you should know about them: (1) CryptoTrader.Tax automates the entire crypto tax reporting process and has partnered with the TurboTax team to bring cryptocurrency tax reporting to the mainstream. (2) CryptoTrader.Tax offers a complete Tax Loss Harvesting module [00:03:00], to help investors figure out their greatest tax savings opportunities to reduce their taxable income. (3) CryptoTrader.Tax supports all fiat currencies, meaning users from all over the world can use the platform to calculate their gains and losses in their home fiat currency. And finally, (4) CryptoTrader.Tax offers a suite for Tax Professionals to help manage their cryptocurrency clients.
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Okay, back to our regularly scheduled program. Here’s my conversation with Matt from Smith + Crown. Enjoy.
Let’s start with [00:06:30] chapter one, which is about Smith + Crown and cryptoeconomic design. Matt, could you begin by telling us a bit about Smith + Crown, the work that you do there, and also about the work you do around cryptoeconomic design.
Matt: Smith + Crown is a research organization focused on blockchain technology. We’ve been active in this space for over six years now. I’ve seen many, many different waves of change. As a research organization, we spend our time across the primary areas. [00:07:00] First and foremost, we are a research group. We publish free, open, and independent research about crypto assets, cryptoeconomic systems, regulatory developments, market developments, token funding, and we’ve been doing that since our inception.
We are very mission-driven about this industry. We believe very strongly in the value and necessity of independent research. We entered the industry at a time when there was just precious little information. A few people trying to make sense of these protocols [00:07:30] and share the sense that they made with a broader audience.
We have entered in the last three years. I think we’re more in an era of misinformation or biased information. We have consistently tried to be that bridge between projects that are doing ground-breaking work and a wide variety of people that believe or want to understand the potential of blockchain technology.
That research work is today the most powerfully instantiated in SCI. There’s an intelligence platform [00:08:00] that we have released in the last couple months. It makes heavy use of Nomics data. It’s one of the reasons that we were able to work together with Clay. This is a platform people can go to browse and see assets.
We have a feed of curated news that we use to make sense of the industry on a daily basis. We have a variety of project-specific research profiles that our summary and our explanation of what projects bring to the space [00:08:30] of distributed systems. We have a platform for publishing and sharing our research across a wide variety of topics, and it has become the outward-facing component of most of our brain. All this is free, open, and we want this to be a resource for the community. That’s what we do in research.
The second component we do is advocacy. We work with heads of institutions, foundations, nonprofits to help explain these technologies, their potential their disruptive impact. We serve as [00:09:00] a Chief Research Advisor for the Chamber of Digital Commerce’s Token Alliance and we serve in the Social […] Foundation and on several trade missions, given testimony in different environments about what these technologies are doing.
Finally, we have an advisory practice. We work with a very small number of projects to develop cryptoeconomic systems. That is a very, very fun component of what we do. We hit a point in the industry where we just wanted to see projects [00:09:30] and to write about protocols that were best in class.
We realized we had unique insights into how a lot of these components worked and that we could play a role in the industry by helping stand up new ideas and helping entrepreneurs really figure out in the trenches what it means to launch a blockchain-based business, array of businesses, system, what have you, and the advisory practices where we have really focused on cryptoeconomic design.
How do we imagine [00:10:00] this and how do we really define this? I actually think that every component of this word is pretty critical to how it’s practiced and how it plays out. First, the crypto. It’s very difficult to practice or develop cryptoeconomic design without a deep understanding of cryptography and the role that cryptography plays in these systems.
One of the things that cryptography brings most specifically is the ability to easily verify [00:10:30] work that was difficult to perform. Without an understanding (even at a high level) of how a Merkle trees work or how cryptography is using these to instantiate state, it’s very difficult to practice effectively and play in this space. It introduces a very unique set of constraints that’s not found in live, off-chain human behavior environments where most of economics is and classical economic spend the time studying.
Crypto is really, really important. [00:11:00] The economic piece of this is of course important. Even in the discussions around what cryptoeconomics is almost takes up too much activity. Certainly, one needs to understand economic theory and there’s many disciplines to draw upon here. Mechanism design being the one the most important, basic game theory, market design of some elements of governance and contract theory. It is often applied without a proper understanding of what the cryptography [00:11:30] both brings to the system and the constraints that it places upon it. It’s very easy to misapply some of this stuff or misapply the insights of economics.
Design is a very important component of this. This is not necessarily just the study of economy secured by cryptographically tradable instruments that are emitted under a wide variety of scenarios. This is the issuance and the creation of a system, a system that is generally intended [00:12:00] to accomplish certain goals.
It’s both more complex than aggregate market behavior in live operating economies and much simpler and more specific. It gets even more targeted from the standpoint of the token issuer. The token issuer is launching a distributed system as something akin to a product, that is intended to accomplish different outcomes. Bringing a designer’s eye and a designer’s mind to this is just important [00:12:30] as having an economic background.
Cryptoeconomics design, that’s how we think about it and it’s how we will hope the rest of the industry thinks about it as well. We really appreciate the importance of each of these components as it plays out in these systems.
Where is cryptoeconomics today? We get very excited about this practice, very excited about this general idea. We also have to be sober about how much this is driving activity, and really understand and respect how not just we see cryptoeconomics [00:13:00], but how the world currently sees cryptoeconomics.
We would argue that this seems to be a period when cryptoeconomics and all of these protocols are very immensely, in some way, shape, or form, form each other in their cryptoeconomics, where Bitcoin is really starting again to dominate the conversation and dominate the understanding of what cryptoeconomics is and can do.
We look at this and we have to appreciate and respect that, at the moment, Bitcoin is still in the driver’s seat for this industry, particularly for broader acceptance of what cryptoeconomics can do. [00:13:30] Prices, broad market behavior and activity, went through a period where there was some acceptance or acknowledgement that these assets are different from each other. If one does well, another one doesn’t or that it has no implications really for another one.
There was even a very strong narrative around the flippening. I’m sure if anyone can ever remember that. A very brief period in 2017 when Ethereum and Bitcoin were inversely correlated. There’s speculation [00:14:00] that people were seeing this as, would Ethereum come to dominate the cryptoasset industry in the way that Bitcoin had been, is if they could replace each other in some way, shape, or form.
We entered a market regime in late 2018 that was substantially different, when almost all the assets really trade with each other, which to some degree is mind-boggling. All of the design components on the use cases, of the target market, the ecosystem size of Bitcoin and Ethereum for anyone who’s in the industry, seem vastly, vastly different [00:14:30].
Bitcoin does not appear to Rootstock has not really gone anywhere, and Bitcoin does not seem poised to support smart contract platforms or active DAPS.
Clay: Hey this is Clay cutting in from the editor’s booth to explain what Rootstock is. For those who aren’t familiar, Rootstock is a sidechain that is being developed to bring Ethereum-style smart contracts to Bitcoin. Like the Lightning Network, Rootstock is a second-layer solution, so it operates on top of the Bitcoin protocol. Back to the show.
Matt: Ethereum conversely is making an attempt [00:15:00] to make a massive change to proof of stake, which Bitcoin will never contemplate.
The idea that these two assets would trade in exactly the same way to someone who is in the industry, is a little bit mind-boggling. That seems to be the case for almost all other assets in the industry, Bitcoin especially with everything. Anyone who’s been following markets vaguely over the past year would mostly observe the degree to which the entire industry moves together and Bitcoin seems to be the leader.
We’re in a market regime now where everything really, really trades together [00:15:30] despite what is arguably very significant changes in underlying components to these distributed systems. Their incentive mechanisms, their target markets, the function of the token. Then, we think about BTC that’s fiat as the first step anyone takes into the cryptoasset industry. Any stable coins and fiat ongoing into Bitcoin is clearly the lion’s share of market activity across reputable and mostly transparent exchanges [00:16:00].
The next step down this rabbit hole is usually Ethereum. Ethereum has brought acceptances, something like Bitcoin’s little brother or some other crypto asset people have heard of. It’s one of the few cryptocurrencies that was called out in Silicon Valley, so it has some kind of cultural cache and that’s the next step down. Even that has been vastly dwarfed by Bitcoin.
Beyond that, you enter a much, much smaller area. [00:16:30] “Alt-to-fiat” and then the other, which would be alt-to-alt. That’s when you’re really in token land, where all these systems that have vastly different cryptoeconomic designs are more traded. We’re just in an era when Bitcoin has the lion’s share of the industry’s attention, of its capital, and of its activity. We see it across markets, across fundraising, wide variety of indicators.
The takeaway for us, where we need to be sober in [00:17:00] how we approach this, is that cryptoeconomics is important, but it’s not yet driving activity. One would expect greater divergence in price bundling, or greater volumes, or projects that have vastly different cryptoeconomic design, is this fundamental component of a lot of these systems was appreciated.
Second, the acid bundling, suggest that the world is still wrapping its head around what a cryptographically secure token even is. [00:17:30] Bitcoin, Ethereum, Litecoin, Monero, all of these seem like the same class or category of thing. Markets probably see them as something that is the same. That’s just an era that we’re in. Differences in the design of these systems may be underappreciated today.
That leads us to the last piece, which is, we may be in an era now where popularly, both to some degree in the industry and even outside the industry, there isn’t really [00:18:00] popular acceptance of the fundamentals in tokenized systems, particularly the fundamental design. But we will always, as an industry, come back to this idea of Bitcoin is the innovation behind blockchain, that there is no open membership distributed system without some component of distributed incentives.
We have gone through an era in the industry today where people are saying, “Let’s get behind Bitcoin as even a thing that should have value,” and then after that, [00:18:30] all of these other distributed systems which have vastly, vastly different designs can start to appreciate the nuance of those just a little bit more.
Clay: Let’s kick off chapter two, which is about cryptoeconomic design practices. Matt, how would you go about diagraming these different distributed systems? Or to put it another way, how does cryptoeconomic design look in practice?
Matt: One of the first things we do in any protocol is draft out what we call the cryptoeconomic design stack. [00:19:00] We’d often start with what are the […] outcomes that a cryptoeconomic system is trying to instantiate? At the end of the day, these are humans that engage in some sort of activity or they program machines to engage in activity on their behalf. So, we’re incentives. What are the ideal […] or outcomes that a system is trying to achieve, has to be defined for any system.
We also take a look at token price. This can be controversial, but it must be acknowledged [00:19:30] that many of these cryptoeconomics systems need price discovery in some way, shape, or form to matter. If you are proof of state system and you want someone to wage your state, there needs to be some understanding of how much value that state has. If that stake you’re going up in value, why and under what circumstances?
Token price has become taboo to talk about for good regulatory reasons, but from a cryptoeconomic [00:20:00] design perspective, token price and its behavior is really important for the incentive to set. It gets layered into this distributed system. It is often heavily or it should, in a market that was paying attention to these, appreciating the nuances, respond to the components that are at lower levels of the stack.
Off-chain digital infrastructure, there’s usually some mediating software that is hosted or is centralized, that allows people to interface [00:20:30] with blockchains. This layer is a lot thicker for application of the tokens or for very, very complex distributed system stacks. These are things that are not distributed. Usually one person owns them or it’s a proprietary codebase. It doesn’t run logic heavily in a decentralized environment, but it would reference it. It can change all the time and is often very, very good at handling changes [00:21:00] when rules are instantiated in here, but it’s not immutable.
You can imagine that the world of off-chain human behavior and the world of off-chain digital infrastructure that is the digital industry today. That is the stack you would need for airline miles points, World of Warcraft gold, or other virtual assets, almost any SaaS solution out there, and what so many people that come into this space [00:21:30] are used to knowing, is that the off-chain digital infrastructure space is totally mutable. You can change anything you want about the software to change behaviors. The full field and the UX is about mediating between the two.
This territory is often, when people come into this space, they understand it very well. In many ways, the technical components of this have become so flexible and so easily implemented, with the decisions that have such little import that it’s taken for granted.
The addition, [00:22:00] the blockchain layer blows a lot of that up and radically changes that. When code gets executed into a distributed environment, then it radically changes what can happen in off-chain digital blockchain layer and ultimately what signals that sends upward, to influence behavior and token price or broader, non-user activity around the token.
This is a piece that is the most immutable. On a core consensus layer, is typically [00:22:30] less changeable than a smart contract in the side chain. Both of them are changed at cost and generally changed with some forewarning and some transparency. This does not have the mutability that higher layers do. Understanding all of these together and how they interact is one of the first steps we take in designing and developing these systems.
Clay: Hey, I wanted to pause for a second to let you know that this episode of the Flippening podcast is brought to you by nexo.io. As someone who personally uses Nexo [00:23:00], I want to point out a few things that I especially like about their crypto-backed loans.
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Okay, back to Matt.
Matt: The other layer that we focus on top of this, since we’ve drafted out where all the rules are—the technological, economic, and legal—there are four pillars we look at with cryptoeconomic systems and all of these really have to make sense together in order for something to run and operate.
We found that if you can describe all four of these, you generally describe an entire distributed system. What you can do is start mapping [00:26:30] those onto a cryptoeconomics […]. The first one is token function. Not all cryptoeconomic systems need a token, but you do usually need some accounting method internally. That can be a token, it can be a credit debit system.
Sometimes, this doesn’t always come into play, but most of the systems have some kind of a token. The function we argued defines the mode of use and the functional rights of the person holding it. We’ve seen a wide variety [00:27:00] throughout the industry’s history and we think going forward there will be much more appreciation into what these things actually enable their holders to do.
There’s a circulation model, a set of circular rules that govern how many tokens are in circulation at any one point in time. How that changes and why, where they get distributed, and how much is justified on technological grounds, on economic grounds. Often, there appeals to a moral claim of fairness, so on fairness grounds.
[00:27:30] In addition to that, there are what we may call trustless mechanisms. All of these systems typically involve a set of entities that could be adversaries agreeing upon state. And I use state here in a broad meaning to just be the truth that allows the entire system to keep running. It could be transaction finality, it could be an Oracle answer, it could be the state of the total supply of tokens. There’s gonna be a wide variety [00:28:00] of things that people who don’t know each other must come to an agreement about. The economic gains that are needed in order to instantiate that, particularly at the micro level, is very, very important.
Ethereum’s uncle rewards is an example of something that is a trustless mechanism. The […] market and Ethereum and a wide variety of other smart contract platforms solves problems that have to do with open-ended code. Trustless mechanisms have to be understood and deployed correctly.
And then governance. Rules generally [00:28:30] need to change over time. Anyone who’s issuing or developing a protocol usually just make a conceptual distinction between some entity or set of entities that’s operating on the network, that may want the flexibility and maneuverability of a private company, and a token issuer that owns the rights to the code that is developing, that instantiates this token. You want those to be much less mutable. Again, unless they become just [00:29:00] airline mile points or the World of Warcraft gold.
All four of these have to be defined, in order for a system to really be fully understood, and to get to the point where an executive can understand, “What does a token mean to me and to my business? And how can I build a short-, medium-, and long-term strategy around this?” Where a lawyer, who’s generally involved in all of these designs, can understand all of the risks that are involved. Where a product manager [00:29:30] can understand the impacts, relative value, and product strategy around a tokenized system. Where the technical team can understand where rules get instantiated and where they get enforced.
We talk about token function. Token function is often the key source of value. What kind of an instrument is this? Is it a coupon where I redeem it for a certain value for some kind of good? Does it look a membership where I just get to hold it, I show up somewhere, and I get the [00:30:00] benefits that only members get? Does it look like a claim to some kind of an asset on-chain or off-chain?
Tokens play this in a wide variety of roles. That is broken down into six […] categories. There’s a value transfer mechanism. Holding the token lets me transfer value in some sort of distributed environment. Sub-variants of that would be general-purpose cryptocurrencies, purported or aspiring sources of value, unit of account, and mediums of exchange. [00:30:30] Bitcoin and most flagship cryptocurrencies can have this intention or this function. They aspire to be something that is much greater than transferring value in a small application or in a smaller environment.
There are payments, so tokens can just allow payments of fees or payments within very specific platforms. Golem is an example of this. The Golem token is used to pay for computation resources for rendering files, [00:31:00] but its only purpose is to pay other users in Golem. It doesn’t have this greater aspiration to be a general-purpose cryptocurrency. It is the sole means of payment.
There are discounted payments. Binance, if you can pay for trading fees and you get a discount on trading fees if you pay in the Binance token. Those three sub-variants are all part of how you transfer mechanisms.
The next big category that we look at are contribution tokens. Used elsewhere, have been called the work tokens. [00:31:30] By holding a token allows you to contribute in some way to the network and typically earn fees as a result of doing that. That can be block creation in proof of stake systems or it can be some other labor reporting or oracle functions like we see in SCI.
There are tokens with governance functions. Holding the token lets you participate in governance. You may not get paid for it, it’s not compulsory, but at the same time you get some say [00:32:00] in the future of the protocol.
There’s a membership token that has a membership function. Holding it gives you access to different benefits, or different features, or different privileges on some platforms. On Binance, you can partake in some light level of governance, voting mechanisms, and a set of activities in their research tab, to filling out profiles and things that.
[00:32:30] EOS is another example or Steam is another example, where holding the token gives you access to bandwidth in proportion to the amount of tokens that you’re holding. We call those membership tokens. One can imagine the value that’s stemming from the sum value demand for all the privileges that are conferred.
There’s asset-backed tokens. Tether is a physical asset. Cryptocat is a virtual asset. Decentraland […] is a virtual asset.
Then finally, there are we call dividend tokens. Those used to be a lot more popular [00:33:00] back before the whole industry knew what the Howey Test was, where you hold the tokens and you get some share of revenue or some share of profit associated with an underlying entity or with the network itself. Binance’s buyback and burn mechanism is an example, where there’s an attempt to transfer some, and I mean dividend in a more of a metaphoric sense, that there’s a surplus of value creative that is distributed in some way to token holders. [00:33:30] Binance does that through burning token supply.
All six of these initial variance are very, very different. When we develop things like token valuation methodologies, we would have a very different model for each of these. They all have different properties of value capture. So, would a set of holders rationally expect the price to increase as a result of underlying increased usage in a platform, at what magnitude or what speed, and at what scale?
They have very different [00:34:00] behavioral incentives for holders. Why would the kind of person who would want the contribution token need to be something that is capable of performing the labor or running the software associated with block creation? That’s different than Bitcoin, where you don’t need it in order to do that.
The term “utility token” gets blanket-applied to all of these protocols and all of these instruments. At different points in time, each one of these with tether [00:34:30] accepted has been tethering Bitcoin called the […] token, and they’re all very, very different from each other. When anyone is really looking at a token, or a protocol, or something called the utility token, and the kinds of questions we would encourage someone to ask in understanding token function are what does having this token actually allow me to do?
Clay: Let’s transition to chapter three, which is our Q&A session. We’ll cover topics related to Smith + Crown’s advisory practice [00:35:00], cryptoeconomic design and more. We also take questions from the live audience that was present during the time of the recording.
Smith + Crown appears to exist primarily in the B2B space, especially prior to SCI, and not every organization just right out of the bat is like, “Hey, let’s let’s hire a research firm.” There’s usually a pain point or some initial impetus [00:35:30] for someone coming to you and saying, “Hey, we really want to turn to professionals, to learn more about cryptoeconomic designs and how we should approach a number of problems that they’re likely to tackle.”
My question is, what is that place that most projects are at when they come to you? Are they worried that they might be considered a security or the Howey Test? Is it more around designing the economics, to prevent certain types of things that they’ve seen happen with other projects? And if so, what are the horror stories [00:36:00] that most projects are looking to avoid? What’s that initial spark that brings folks to you?
Matt: That’s an excellent question. I’d say that it has varied immensely throughout our history. Most of the work we do these days is word of mouth. We get referrals and we drop in to projects that are pretty wide variety of stages.
Certainly, one of the requirements we have for working with any projects that they’re engaging a lawyer who’s asking questions about the Howey Test pretty seriously or the wide variety of other regulatory concerns. [00:36:30] To be clear. it’s not one that we certainly don’t advise projects on. But it has ranged everywhere from projects and companies. If we do a little bit more work with larger, more established companies, that understand there is a future for blockchain technology, where this is not going away, that they thought it was dead in 2013 and then they thought it was dead in 2017-2018, and they still see people building this technology and they’re starting to get their promise, [00:37:00] and they want to understand how it could be integrated into their business in some way, shape, or form, all the way up to something that is more peer reviews. A project has fully imagined what it […] or its token systems, its distributed incentives, and are looking for a second set of eyes or some validation.
We have engaged projects in the entire gamut of that space. I’d say most of our projects historically [00:37:30] have been building a blockchain strategy. They know they want to use blockchain technology in some way, shape, or form. Some of them are very intrigued about the idea of a token and the types of people they’ve spoken with before they come and speak with us. Other people do economics work and they ask questions about what is the total supply or how much should you give or allocate to different parties.
[00:38:00] Those questions don’t really get at the things that we’re really doing. When we start asking them, “How does this token impact your business? What do you do when the company runs out of tokens? Who makes decisions about the tokens?” If you do that, then it changes the fundamental business model. You can’t sell that service because it’s being acquired through peer-to-peer acquired tokens now.
We start asking projects a series of questions that they just never heard [00:38:30] before. It never really seriously answered and they haven’t answered themselves. A wide variety of projects could come to us before really appreciating the complexity of committing to implementing blockchain technology in some way, shape, or form.
There is one small point there that we typically get asked. Sometimes we ask this question of why does a project need a token? It becomes very popular in the space to say that that’s a question someone should ask at all points. [00:39:00] It seems that there’s a little twist on that question that we typically ask. It’s not why does a project need a token, but what does a project get out of launching a token?
Chuck E. Cheese of course will work with taking dollars and quarters. There are definite advantages that Chuck E. Cheese or […] or anything get out of having their own small mini tokens or their own mini currencies.
It’s what are the trade-offs that having a token that serves a wide variety of roles [00:39:30] and is specific to the system you’re trying to build introducing can you manage that? I’d say that when it’s a question that we get asked a lot people use to poke at projects of like, “Well this doesn’t really need a token,” or, “Why does this need a token?” I encourage people to ask what are the trade-offs involved in building a strategy around this token?
Clay: How do you see value accruing to a utility tokens price? Is it simply based on increased usage? Will side chains put upward or downward pressure on price? Maybe both?
Matt: [00:40:00] It’s an excellent question. It’s one that has bedeviled the industry broadly at least a year-and-a-half going back to even two years when Chris Burniske developed/designed that model. It is (and this may could disappoint the audience) too complex of a topic to boil down very succinctly.
The way that I interpret this question for purposes of a utility token is specifically about tokens that need to be spent. A lot of the [00:40:30] value accrue or discussion in the industry has centered around payment tokens. Payment tokens that are specific to some application. The question is how could people using that token be reflected into the price of the token? We get into debates about NB=PQ and token velocity that ended up very complicated. I will say that there were a series of research reports [00:41:00] that we put out on token valuation methodologies, that go into this a little bit more. I would say at a high level that it’s both a very misunderstood space. and a space that doesn’t lend itself to a lot of empirical work.
Does the extent to which we have a currency that is used to buy and sell goods, that is sufficiently constrained to one small market, [00:41:30] and also has price discovery, where there’s a liquid price and it’s not pegged in some way, is just not a phenomenon we see very often in the world. There’s not a lot of empirical evidence for how this ends up getting […] value accrues back. A lot of the debates today have been theoretical and methodological. We do summarize some of those in a series of reports on SCI.
I would say that it varies immensely. With the value capture in utility tokens [00:42:00] for functions beyond just payment, that would vary pretty significantly and based on what kind of utility the utility token is trying to provide.
Clay: Have there been any reliable on-chain indicators that reliably predict price? I think there’s a lot of exchange data that’s interesting if you look at what’s happening with order books. There’s a variety of high-frequency traders, market makers, and liquidity providers [00:42:30] that reliably make money with order book data and with highly granular trade data.
I haven’t spoken to as many people that are able to make money with on-chain data alone. Maybe I’m just talking to the wrong people. Have you found on-chain data to be predictive of future price movements in any kind of meaningful way for a sustained period of time? Is there something here that doesn’t have almost immediate decay?
Matt: [00:43:00] It’s such an excellent question and it’s obviously become a very, very big one in the industry as understanding on-chain data has become a widely recognized need, and to be a little bit more complex than people perhaps initially thought.
There are a couple of ways to answer that. First, the general state of the literature on what models predict the price based on observed external inputs, so both trailing market data, network fundamentals, [00:43:30] and on-chain activity. Most of the papers that we reviewed have established a long-term relationship between the value of the security involved in the network. Whether it’s a typically a hash rate or a difficulty level and the price of the token, it’s a little bit long-term but have established that one clearly influences the other.
Clay: Hey this is Clay cutting in again, this time to explain what Matt means by hash rate and difficulty level. These concepts [00:44:00] are often confused. Hash rate is a measure of processing power. For example, how many times can a network attempt to perform a computation. Difficulty refers to the effort required to perform each computation. Of course there’s more to the story. This is just a jumping-off point for anyone who’s interested. Back to Matt.
Matt: On-chain […] is still very much in its infancy. People are still figuring out exactly how to operationalize and make use of the kinds of things one can see on-chain [00:44:30]. It also gets very complicated because there are different types of on-chain activities and different types of statistics one can draw. Measurements of token activity in a smart contract, ERC20 token, are quite different from Ethereum.
One can design a distributed application where a user transfers in-application, a token from one person to another, [00:45:00] that doesn’t really make its way back on-chain, or get settled in batches, or where the project takes custody of it for a little while. There’s a lot of off-chain activity that may not get reflected on-chain for ERC20 tokens.
That relationship is a little bit different for consensus layer tokens. Consensus layer tokens also have this issue of side chains enable fundamental activity or the […] network enables fundamental activity, that someone running a node in person, the blockchain doesn’t have great visibility into [00:45:30].
The short answer to your question is that I agree with you. We have not come across anyone that can do it very systematically, other than through models that don’t quite know exactly why there’s not a clear theory driving it, but they can generally see massive transaction movements in a cryptocurrency. We also think that it’s just very, very early days in understanding what on-chain data even means and how it can get properly made use of.
Clay: Another question [00:46:00] that came to mind has to do with stable coins and stable coin projects. It seems to me at first glance, that stable coin projects are just much less interesting. When it comes to from a cryptoeconomic perspective, usually they’re asset-based and in a lot of ways they’re just wrappers around an off-chain asset. Are there cryptoeconomic factors that are at play when it comes to stable coin projects? [00:46:30] And when you do advise these kinds of projects, what are some of the more interesting issues that arise during these kinds of explorations?
Matt: Awesome question. There are a couple components to that. The field of stable coins are divided into three categories. Ones that are backed by physical assets. Tether, Circle, why most of Paxos Gold most operational stable points today. Tokens that are backed by virtual assets. [00:47:00] […] is the one that everyone would recognize. […] token which is backed by some crypto assets. The third would be a class that’s like senior shares. No people remember Basis that had a three token model for introducing a stabilized non-collateralized token. Basis was the most prominent example of that.
Those are the three broad categories and they all have slightly different issues. Senior shares is very [00:47:30] complex. The closest we have to the wild in that is the Sin Dollar, and that is actually quite complex and impressive that it has been able to maintain a rough-ish pain. Certainly nothing like Tether or other protocols. That’s probably the closest in that category. For virtual asset-backed ones, the DYOR is the most prominent example. It does have some complex dynamics involved in it, particularly in managing it.
The physical asset-backed [00:48:00] ones, on-chain there’s actually not a whole lot of complexity. Most people generally get the idea of a physical asset-backed tokens. They’re just wrapped tokens and they’re redeemable or something. They hold value because someone can show up and claim an asset somewhere, so it should rationally track it.
All the interesting, complex cryptoeconomic stuff for physical asset-backed tokens have to do with the business model of the issuer [00:48:30] or the securer. We just put out a piece on Paxos Gold around this that picks apart or takes a look at the underlying business model of Paxos as a Gold holding company. I can illustrate this resurrecting some of those arguments.
Something like Tether; when a project is backing its assets with fiat money, it has this massive reserve of fiat money that it can actually make money off of. It takes this money, it can go invest it somewhere and get a return. [00:49:00] There’s a business model for the underlying issuer. Libra had a somewhat similar idea where the consortium can make money off of returns from everything that was collateralizing its stable coin.
Because that opens the possibility of solvency for the issuer and could create a very neat business model that works, we will see eventually long term things like money market stable coins or high-risk stable coins where what’s being done with the underlying collateral [00:49:30] has much greater attention like this today. To store gold, you actually pay fees; you don’t make money off of holding gold than investing it somewhere. The underlying issuer of the Paxos stable coin is constantly incurring storage fees that have to be accounted for in some way, shape, or form. That pretty radically changes the relationship. It means the stable coin that it’s issuing isn’t the byproduct of being able to invest all of its gold, [00:50:00] it means it has to extract a value somewhere in the system that it has created in issuance, or redemption, or in transfer that’s radically different.
The piece that I’d highlight there in physical asset-backed tokens is the underlying business model of whatever entity is storing the physical asset is immensely important and has to be thought through in a cryptoeconomic design.
Clay: When it comes to market data, do you view volume from spot exchanges or spot markets [00:50:30] and volume from derivatives or leveraged markets as being the same?
On one hand, you could say that spot volumes only take into consideration the direct swapping of assets. If you consider derivatives markets or markets with 10X, 20X, 100X volumes, in a very real sense one might consider that volume to be the same because that value is being exchanged.
What do you think about [00:51:00] spot market volumes versus derivatives volumes?
Matt: It’s such a great question. It’s become such a big question in the space as well with the massive growth of derivatives and the current ratio of derivative volumes to spot volumes, particularly adjusted volumes. The shortest I could say, the perspective that we have is just fairly context-dependent. I think they’re very, very good reasons to treat them as the same. You said that they equally involve [00:51:30] the potential for value transfer within value at equal magnitude. On the other hand, it also represents the activity’s wishes or perceptions of value of a much smaller number of players, actors, and collateral.
It gives a compelling argument that one can look at them differently, not discount on one versus the other. [00:52:00] There are different types of actors that are playing the derivatives market and different types of actors that play in the spot market. One would look at their relationship between the two.
It’s fairly context-dependent. It’s not a big area that we as a firm spend a lot of time focusing on, but we do consume the research work of people that do look at this stuff a little bit more seriously. We generally have enjoyed reading, for example, BitMEX has a research blog and a series of research publications. It’s generally fairly insightful, and just passes some of these issues [00:52:30], and there are a variety of others.
Frankly, it’s one I’d be very curious to hear your thoughts on but I don’t intend to turn it around, but I’m quite curious.
Clay: I think that one way to look at this is you could say the volumes should always be tied to the underlying assets. Regardless of what a derivatives contract might do in terms of amplifying wins and losses [00:53:00] or price movements, at the end of the day the volumes are really based on the underlying assets if you’re going to compare it to spot market volumes.
On the other hand, you could look at the volume that is moving through the contract. It doesn’t matter if that volume is USD or Bitcoin or whatever it happens to be, as long as you can convert that into some quote currency like USD, or BTC, or something that we can all [00:53:30] use to understand the value.
It’s valid volume, and it is fair to compare derivatives or contract volumes to spot market volumes. Certainly, the exchanges are charging a percentage of that volume. If you wanna look at the revenue earned from these exchanges, you absolutely can look at a percentage of the contract volume for derivatives exchanges versus the FX or spot volume of spot exchanges. It is apples to apples [00:54:00].
I don’t know that there is really a clear answer here. As with a lot of things around data, it’s really about are you making logical assumptions? Are you documenting your methodologies? Are people more or less seeing what they expect to see, or are they seeing something that they don’t?
When we first launched Nomics, we were reporting data about all-time highs. We thought we were gonna be really clever and report all-time highs, like the actual all-time high [00:54:30]. Sometimes, the actual all-time high comes from an obscure trading pair on an obscure exchange. But it is an all-time high, but it’s not when people look, it’s five other aggregators. We’re definitely reporting outliers as the all-time high, and it’s not consistent with what other people are showing.
At the end of the day when people are asking for all-time highs, or for all-time high data, what they’re really saying is what is more or less the price of this asset [00:55:00] that I could have realistically bought it at? Not if I had a Korean Won Account and were trading, and had a bunch of this obscure asset that I was willing to trade for Bitcoin on some obscure exchange. Realistically, what could I have gotten?
We moved to calculating all-time highs based on end of day prices for an asset. Is it the most fancy indicator? No. Can we say, “Hey, which trading pair on which exchange [00:55:30] did this all-time high occur on??” No, we can’t because it’s based on aggregated values and their volume-weighted.
People are now seeing figures that they expect to see, we’re no longer getting hate mail on our all-time high prices. I think a lot of this just comes down to documenting assumptions, making reasonable assumptions, and are people seeing more or less what they expect to see.
I’m sure you guys have considered this. There was the ICO boom of the end of 2016 and 2017 [00:56:00], everyone was creating an asset. It does seem like over time, there are fewer ICOs happening. I think we definitely are entering a world where a lot of things get tokenized.
In a world where Bitcoin is king and we aren’t as tokenized as people might think. what questions are people asking in that version of the future world and what is Smith and Crown doing in that scenario [00:56:30]?
Matt: That’s a great question. We are generally of the opinion that if the world can get behind Bitcoin, that there’s room for more than one Bitcoin. Part of that will determine who is a function of what people are really behind Bitcoin for.
The industry has seen so many different narratives of Bitcoin’s value. It’s gonna be the remittance market. Entirety the remittance market was all the rage four years ago. Digital global store of value, hedge against inflation [00:57:00] have been two of the more common ones. Global reserve currency is another one. That speaks in some way to the vast surface area of the idea of Bitcoin, that it is both complex and poorly understood that it allows so many different areas to be projected on top of it, not all of which are quite easily irrefutably disregarded.
That tells us [00:57:30] that we are still really as a set of societies at markets making sense of what Bitcoin, what kind of an asset we want Bitcoin to be, or we think Bitcoin’s going to be. If we project forward five years, I suspect there will be the emergence of other narratives that we haven’t even yet really heard about, about what the value cryptocurrencies and cryptoassets as exemplified by Bitcoin really bring to the industry.
There is a debate [00:58:00] in addition to that which is about whether Web 3 is really a thing. We have Bitcoin as a crypto asset and it performs this function as some facets of a global currency, or cryptocurrency. Some gold medium of exchange unit of account, and it performs to some degree.
The idea that you will have a distributed web stack [00:58:30] or a world computer is a fairly different proposition. Rationally, those two don’t really need to be linked together. Where we were as an industry a while ago where these are two different visions is probably more accurate to where we will end up when we reckon with the Web 3 idea.
That one, we are very open to the possibility that the promise of Web 3, that the difficulty in delivering on Web 3 [00:59:00], a distributed stack comes at two greater costs of performance and user experience that simply can’t be reconciled.
We understand and respect those arguments. We are still very bullish on this idea and think the idea will see many, many different forms. The technology will really continue to improve. We’ve hit a point where more minds [00:59:30] are being drawn to some of the highly complex problems in the space, more people, more creative people, some very, very intelligent people are rolling up their sleeves and have been to work on many of these problems.
The idea that we have even sketched out the whole problem space, much less that all of the available solutions for some of those problems have been unearthed. We frankly think growth is laughable. This debate has a very, very long future. We tend to think there are many examples where applications of a distributed stack [01:00:00] create experiences and possibilities, unlike crypto kitties or provably rare digital assets.
You need a security layer underneath on a global computation resource for that division to be true. There are many components of that that have very real practical applications that are just waiting for killer products to be launched.
Clay: Another question that I’ve long wanted to ask you or your co-founder [01:00:30] is around this idea of a second-order network effects.
Back in the day when I was incredibly bullish on Ethereum, my hypothesis was that Ethereum benefited from what I might call second-order network effects where there are the network effects around Ethereum itself. And then, on top of Ethereum, there are a bunch of network effects around the various ERC20 tokens, and that this could create [01:01:00] a compounding effect where you have network effects stacked on top of network effects and that results in an explosion of value for the cryptoasset, for a cryptoasset like Ethereum, that it represents value in the underlying smart contract platform. Have you found that to be true or do you think that notion is just entirely disproven at this point?
Matt: A lot of really solid insightful questions in there, and some very long-running [01:01:30] debates about is the fact protocol thesis a real thesis, or to what extent do utility tokens or application tokens bring value to their underlying host platforms? A ton of really complex stuff wrapped up in that. It’s a really, really good question.
A couple things on that topic. One is the fact protocols thesis does really need very close interrogation and very close investigation [01:02:00] for two reasons. One is just to properly account for the risk of forking, and that most applications that are built on one protocol can be copied or moved to another one quite easily. If an application launches an ERC20 token, in no way, shape, or form is it bound to Ethereum.
We’ve seen examples and protocols migrating from one to the other. Kik for example, not the best example for a wide variety of reasons, but Kik launched on Ethereum [01:02:30] and then moved part of its supply to Stellar. Applications that are built on top of consensus protocols, they are a lot more mobile than people initially thought.
If we get to the point where that competition is real unhealthy, I don’t think it’s that real or active right now, it does hit protocols against each other. The link between the value that’s taking place at the application layer on top of them and the value that’s taking place and occurred to the consensus layer [01:03:00] underneath them gets broken just a little bit. That thesis does need to be reexamined to properly account for a lot of these things.
It is also certainly the case that the price of Ethereum and the value of Ethereum certainly grew as more and more token sales occurred on top of them. It’s very easy to understand the trustless nature of just sending money to a smart contract to get a token that one could then [01:03:30] sell the next three months, why that would mean to demand for this unique asset that is the only asset you can use to get access to these sales. It does not appear that the price of Ethereum is that responsive to the scale of activity that’s taking place on its application. There’s a stripping out ICO activity, but just smart contracts, applications, and users. I don’t think a very clear link has really been established.
I don’t think we’re really at the point [01:04:00] where any value thesis is totally disproven. We’ve just gone through so many different regimes in the industry, and this shifts from when assets were in many ways appreciated by the market by their diversity are really seen as different behaving members of a class to now all being bundled together.
The industry will go through another phase change. The core value thesis for a wide variety of assets will change in that next phase change. We, as a research firm, [01:04:30] are skeptical of everything but there are very few things you totally ruled out, there’s plenty of laughable nonsense in the industry itself. For a lot of the great debates, we account for them but just know that it still feels in the long arc of this technology like early days.
Clay: I’m wondering if you can share with us just maybe one or more crypto asset or crypto projects that aren’t Ethereum, aren’t Bitcoin, that you feel have really nailed [01:05:00] their cryptoeconomic models, that have done some interesting things, or maybe provided a unique contribution to understanding of what can work.
Matt: There are two that I just as a researcher loved reading about. I thought that they changed the space and will continue to change the space. The first was Steam which was frankly at the time when it was launched, this was the […] before EOS. It was the blogging social media platform launched in 2016 and had [01:05:30] a three token model, was incredibly complex, it embraced that complexity. I think it was the most complex rule set that crypto has seen out there in the wild. It’s gotten to the point where it’s very easy to abuse and it’s very easy to abuse their basic reward system for awarding content. Those two things, showing that a rewards engine could be developed and launched and would enable from scratch an entire medium [01:06:00] website full of content to appear on the internet is amazing.
Then, how quickly though the incentives were manipulated and abused, is another tale for the industry on how the challenges when the implements in doing rewards systems any rewards engines that aren’t based on cryptographically proven blocks, valid blocks, that are based on anything more complex or more discretionary [01:06:30] or based on other factors. How gameable these equations can be if they are complex at all. I thought that brought something really interesting to the industry.
Another one that I always really loved reading about was what Zilliqa did which is proof of work. Over the last two years, I’d say even before this year, the wide variety of concerns around mining and proof of work, both energy consumption and centralization tendencies led to a flurry of interest [01:07:00] in crypto state protocols. There were very few major flagship projects that were launching with intentions to stay proof of work, but there are a lot of things about proof of work. They’re actually quite appealing, and actually quite important, one of the things that we detail in one of our recent research pieces.
Zilliqa is one of the few to have implemented quite a novel mechanism of staged proof of work on proof of stake [01:07:30] where the system would go through small periods of proof of work that would then structure its next epoch of block-creation.
That, I thought, that hybrid model or that bringing together of many pieces they have with non-sustainability and open membership, that proof of work brings with the advantages that proof-of-state brings. We’re gonna see more of that. I think Zilliqa is a good example which [01:08:00] I as the director of research really enjoyed reading about it.
Both of those have their own their own massive problems that aren’t necessarily cryptoeconomic ones. I thought those made contributions to the field that were notable.
Clay: Indeed, and I’m glad I now know how to pronounce Zilliqa.
Matt: I may be wrong in that too.
Clay: You probably know better than I do. I wanna stop right now to just plug the SCI website. If anyone’s interested, I think that [01:08:30] Smith + Crown has just done a remarkable job of implementing Nomics data and combining it with other data sources and including their own.
If you’re interested in checking out another view of what’s happening in the markets with various crypto assets, I’d encourage you to check out sci.smithandcrown.com. It’s a fantastic resource and something that I would just encourage anyone who’s interested in this space to check out.
Maybe we could [01:09:00] close with your thoughts on the future and what might be coming our way. You’ve explored a number of cryptoeconomic models, you’ve advised a number of these projects, you’re knee-deep in this all day long, and I know no one can really predict the future but what do you think we can expect to see as we’re at the tail end of 2019 peering towards 2020. What do you think 2020 and 2021 will bring in terms of cryptoeconomics [01:09:30], or just the space in general?
Matt: What a fantastic question. It’s certainly one that we spend our time thinking about quite a bit just having been in the industry for so long and feeling like it’s almost a new industry every six months.
It’s what it feels like, the pace of change internally inside, who’s involved, what people care about, what are the dominant narratives on change. It’s such a great piece. Some of our observations is that there has been a lot more going on behind the scenes [01:10:00] in this so-called crypto winter over the last year and a half that I think people have respect for.
There are two components to that. The projects that we have met or worked with in some way that have slogged through this period and kept on heads down to deliver products, to deliver protocols, to move forward the projects that they’re doing are some of the best we’ve ever seen.
The concentration of talent and quality in the people, in the entities that are still operating in the space [01:10:30] augers for a breakout where a lot of these things are able to see the light of day once a gust of interest or a gust of wind hits the industry again.
It may still seem wintry from if one just takes a look at markets, but on the ground in terms of what people are building and what teams still have their heads down executing, it’s a really exciting time to be involved in the industry. This can only bear fruit that will be enjoyed in the next [01:11:00] couple of years.
The second is a lot of behind the scenes, large scale projects and initiatives in blockchain technology. We’re more involved in some of them, some of them we aren’t, but a lot of them are very secret and they won’t get launched for another 12 to 24 months.
Major companies are certainly still very interested in the technology, and have very sophisticated strategies built around it. It’s a very exciting time. There’s gonna be a lot of narratives around price, and around having, [01:11:30] and we should take a look at the track very closely and as always keep an eye on Casper. The number of projects that are on the verge of breakout is very, very high, and it’s a very exciting time to be in the space.
Clay: [01:12:00] That concludes my conversation with Matt Chwierut from Smith + Crown. I hope you enjoyed it.
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