We don’t need no (crypto) institutions
Image Source: https://mubi.com/fr/films/another-brick-in-the-wall-part-2
Just a year ago, at the end of “DeFi summer” and as the craze around “food tokens” (anything from Sushi to Yam to Burgers to Pancakes) was dying down, the world of crypto kept its hopes up with a single dream. The prospect of that dream becoming reality was the fuel behind the enormous rallies in Bitcoin and Ether over Christmas and the New Year.
The dream was that “the institutions are coming”.
After all, for as long as crypto’s history has been recorded, it has been a push for legitimacy. In order to prove that crypto wasn’t just some crazy internet game money, generations of crypto enthusiasts have sought to prove that their digital currency of choice had some worth in the real world, outside their echo chambers: starting by showing that Bitcoin could pay for pizza (and dogecoin could pay for a used Honda), going on to celebrate the creation of Bitcoin and Ether futures on the CME and most recently rejoicing El Salvador’s decision to make Bitcoin legal tender in the country.
The holy grail was the anticipation that once accepted as a legitimate asset class, Bitcoin and the rest of the cryptosphere would then benefit from the much-coveted institutional inflows (read “mutual funds”, mainly) which, in turn, would make all of the early adopters rich. One common trope tossed at institutional managers was to “get off zero”, with the corresponding argument that “if only 1% of institutional capital were allocated to Bitcoin, the price would be <insert impressively huge number here>”.
That dream is still work in progress – and yes, we continue to keep an eye on that, as interest from traditional investment management firms in the space grows, albeit at an incremental pace. The dream is far from over, but we can’t help but question if that dream is even still relevant.
Take a step back and look at the state of crypto right now, and one cannot help but conclude that it has started to chart its own route: one that doesn’t need institutions, but rather builds on the sheer amount of wealth already created within its ecosystem.
With or without institutions, crypto goes on.
The new world, once again
When we think of the “institutions” of our world today, we often forget that the vast majority of them bear the names of the people who started them: J.P. Morgan, Goldman Sachs, Rothschild, Schroders, Salomon Brothers, Lehman Brothers, Smith Barney etc., not to mention the giants outside the financial world like the Rockefellers, the Fords, the Mellons, the Vanderbilts and the Waltons.
Before institutions, there were individuals. The individuals that founded these institutions were the ones who made them into the economic hegemons of their day – many came and went, some continue to survive, even as their internal corporate structures have evolved over the decades and centuries.
Many of these great institutions had humble beginnings, much like any other business, but for one difference: a choice, or a series of choices, made by their founders led them down the path of creating exponential, generational wealth. Often, this involved taking outsized risks, albeit calculated, which fortunately paid off: financing wars, railways, commodities etc. It definitely helped that many of these operated in what was then known as the “new world” – the two centuries of unstoppable growth in the USA.
Interestingly, none of them were the “first” to get there – many came before them who enjoyed much more of a first-mover advantage. But they were certainly early enough.
We believe the same is happening right before our eyes in the world of crypto. The exponential growth of the past couple of years has already created generational wealth for those who got involved early in the space: not necessarily the earliest, but early enough to catch the spurts of development that characterise most growing economies, and shrewd enough to be able to hold on to those gains.
This wealth is already being reinvested into the ecosystem, spawning a new generation of crypto-native “institutions”, backed by the very individuals who contributed to crypto’s meteoric rise. After all, the biggest winners from crypto haven’t been the “investors” per se – yes, they have made unimaginable gains, but the real winners are those who built the very foundations of crypto as we know it, the developers themselves who have seen their projects skyrocket in value as they achieved product-market fit and serve an ever-growing addressable market.
This recycling of wealth by both investors and enterprising developers back into the system is facilitating a virtuous circle of growth, as the value that is being created gets put back into creating even more value, creating not only jobs but laying ever more sophisticated foundations for increasingly complex applications to be built upon the crypto base layer.
What’s perhaps the most outstanding characteristic here is that many of these founder/dev/entrepreneurs have become immensely rich not only by investing and holding their own projects, but also those of their peers. By cross-pollinating capital from the very beginning, they are able to capitalise on the synergies that projects have with each other and with the broader ecosystem in a very tangible way. It is a modus operandi that epitomises the philosophy of open-sourced development at its very finest (imagine Steve Jobs and Bill Gates investing in each other’s businesses? Nah…) – and for some, it has paid off in astronomical proportions. VC DAOs like Metacartel are doing exactly this – a look at their list of partners is basically a who’s who of top crypto developers.
Builders are funding more builders, and that’s all that is needed. Ultimately, as we’ve written before, code continues to eat the world. Unlike setting up a physical business that requires land, offices, a factory and physical raw materials, software-based applications – especially decentralised ones – just require code and lots of intellectual capital. As a result, notwithstanding the abundance of capital available for the industry, the flipside is that the capital required to take a project from idea to implementation is much lower than ever before.
Abundant funding within the ecosystem, added with much lower minimum investment requirements thanks to the intrinsic nature of code – no surprise that traditional “institutional” money is far from being a “must have” for success.
Too big to handle
For one, we’re pretty sure that last year’s “the institutions are coming” rally didn’t involve any institutions, considering that most of the move happened between Christmas Eve and New Year’s Day, and that we started to receive out of office notifications from the middle of December.
Perhaps the institutions will come one day – after all, the very businesses whose equity they invest in are having their business models disrupted by the developments in crypto (e.g. gaming, banking, payments etc), and increasingly legacy businesses (yes, even a traditional payment system like Visa or Paypal is “legacy” in the face of crypto) are starting to realise the value of co-opting, rather than ignoring, crypto. It’s not going away, so might as well try and make it a friend.
But even when they do come, they might find that the very factors that cement their hegemony in the traditional world hinder their advance in the new, decentralised world. For one, much of crypto was made with the sovereign individual in mind – self-custody of assets, with access only via private key, gives the wallet owner full and absolute control, and responsibility, of its contents. Lose the keys and there’s no customer service to call, hence the stories of would-be bitcoin millionaires trying to unlock wallets whose passwords they’d long forgotten with too few tries left.
This flies in the face of much of what institutional investing is used to: third party custodians, centralised clearinghouses, someone to call if anything goes wrong, insurers to go after when things go really wrong, and hundreds of pages of legal documentation disclaiming risk and responsibility for as many things as possible. No surprise that when looked at from a traditional investment manager’s “risk” framework, crypto screams red flags all over – the responsibility that the manager takes is onerous. Equally, it’s no surprise that many of the crypto “funds” we have interacted with in the past have one common characteristic: > 90% of the capital belongs to the founders, with other “investors” being a tiny minority that are just tagging along for the ride.
Combine this need for taking responsibility with the fact that most crypto projects start with very little requirements for capital, and we get to the problem of position sizing. Again, it is no surprise that many traditional institutions find it not worth their time to get involved: not only are crypto projects essentially, as we’ve described before, early-stage VCs with a listed price, they also land in the awkward spot when deciding how much to invest. On one hand, the position has to be big enough to make a difference in a fund; on the other, it can’t be so big that the fund owns too much of a single project, not to mention the issue of whether there is sufficient liquidity in the tokens for a fund of notable size to trade into the position it desires.
All in all, it’s just another brick in the wall.
Go your own way
And thus, we end up in a perfect storm: the world of crypto goes in its own direction, funded by an abundance of internal capital; and on the outside, the world of traditional finance looks on and wonders how to undo the very constructs that they lobbied to put together which now prevent them from getting a slice of the pie.
Ultimately, in this liquidity-fuelled world which we inhabit, it is easy to forget that not everything is driven by flow. The institutions don’t need to come: as long as the rest of the world comes along for the ride, the institutions will end up being the ones chasing the trends.
Until recently, crypto has been rather cryptic for most people: even supposedly tangible concepts like DeFi remain more suited for a former Wall Street analyst than the average man on the street. Great savings yield, fantastic, but it’s not real for “normal people” aka “normies”.
Then came along NFT art (and by that, we mean REALLY high-end, well-made pieces of art on platforms like SuperRare) and Blockchain Gaming (like Axie Infinity, which we’ve written about extensively) – these developments mark a seminal moment for crypto in our view. They make crypto real to the average person on the street: the idea of owning something in an absolute sense and having full custody of it becomes much more tangible when it’s a unique item. A piece of art, a penguin, an Axie – all the better if you can use it to make a little bit of money or play it in a game with friends, or display it in your favourite virtual world (or on a screen at home) knowing that there is a universally verifiable record of ownership of a specific piece of art.
In the end, it is the individuals that make a market, not the institutions. And the more applicable crypto becomes to individuals, the more value it accrues.
Crypto doesn’t need validation from institutions – in many ways, it has already validated itself. Very much like the US in its earlier years post-independence and post-civil war, it is a market that thrives on open innovation, growing until it was too big to ignore, ultimately taking the top spot from its former colonial rulers.
Crypto will go its own way, with or without the institutions.
Even if they occasionally send reminders of their love.
Image Source: https://villains.fandom.com/wiki/King_George_III_(Hamilton)