The point of no return

Crypto is ready for institutionalization and institutions are ready for crypto

Oct 27, 2021

The transition to Web3 is the most profound technological innovation since the advent of the internet.

Web3 is the next wave of the internet.

We now have smartphones and internet ubiquity. Blockchain technology is the missing piece to the puzzle.

Blockchain technology brings money and finance natively onto the internet (Polychain Capital).

The collision of money and finance with the infrastructure of a new internet inextricably links two very powerful forces - technology and investing. With Web3, the development of the internet and the financialization of the internet cannot be decoupled.

Web3 is both the next consumer internet and the next wave of financial services.

FinTech has evolved from analog to digital, productized to embedded, centralized to decentralized, as articulated in a brilliant post by Matt Harris of Bain Capital Ventures.

The development of FinTech coincides with the consumerization of Web3. With the proliferation of digital financial services, consumers are now ready to live in a world where money is mobile and permissionless.

Building out the financial market structure and consumer tools to on-ramp the next 100 million to 1 billion users to crypto will be critical to the development of the internet.

There are roughly 50 million blockchain wallets as compared to over 4.6 billion internet users. By 2030, Deutsche Bank projects there will be over 200 million blockchain wallets. We are still very much in the early innings of blockchain adoption by the consumer.

The next decade will be defined by the consumerization of crypto.

Investing into Web3 is a natural extension of investing into FinTech because money and finance are embedded into the architecture of the internet in a Web3 world. And Web3 will be the consumer internet, as Jarrod Dicker of TCG Crypto has said.

We’ve reached the point in the development of Web3 where the new internet is here.

And it’s here now.

There are a number of trends that signal we’ve reached the point of no return.

The signals

🚀 Institutionalization is here: Web3 has reached the point where large institutions are engaging with the cryptoeconomy in various ways. Companies like MicroStrategy, Square, and MassMutual hold BTC in their corporate treasury. Large financial institutions like Fidelity (crypto custody and crypto investment products), Franklin Templeton (investing into a crypto fund of funds run by Galaxy Digital), Neuberger Berman (partnering with BlockFi on institutional crypto investment products), and many others now have exposure to crypto or offer crypto investment products to their clients. The first Bitcoin ETF made its stock market debut the other week. Any investor - retail or institutional - can hold Coinbase shares after the watershed Coinbase IPO.

Institutionalization means that crypto as a mainstream asset class is soon on the horizon — and there will be products to usher in this transition. Asset allocation for many investors — including the most sophisticated HNW and institutional investors — into crypto is still woefully low. If just 2% of the $10 trillion of HNW capital in the US private banking and wealth management complex were to roll into crypto, the total market value of crypto would see a roughly 10% increase.

Crypto is ready for institutionalization and institutional investors are ready for crypto. On-ramps to the asset class must continue to be built to make this transition possible.

🤯 DeFi has crossed $200 billion in TVL (total value locked): DeFi, which are decentralized finance protocols like Aave, Uniswap, 1inch, Maker, SushiSwap, dYdX, and many more, that earn rewards, interest, and tokens, has crossed $200 billion in total value locked across protocols. DeFi is still very much in its early innings, but it is quite possible to see it re-architecting many corners of finance. DeFi is able to remove the friction and cost from intermediaries that would otherwise be present in traditional financial services, and as more wealth is made in crypto and deployed into the space, DeFi markets should benefit meaningfully.

✌️ Crypto is culture and culture is investing: Culture has collided with investing. Crypto is very much a movement and has become a global force because its strength lies in the power of its community. Community x Capital is a very real phenomenon and is changing investing as we know it. Every asset has the potential to become a community-driven asset in a world where social media reigns supreme as a form of content creation and distribution. Thanks to concepts like fractionalization and DAOs, crypto has pushed the concepts of crowdfunding and ownership forward to create a much more inclusive financial system where virtually anyone can participate rather than the select few institutions and high-net-worth investors. NFTs have also emerged to transform culture with the potential to change gaming, art, sports, collectibles, music, and many other industries. NFTs and culture are playing a critical role as an on-ramp for consumers to the cryptoeconomy. Games like Axie Infinity, NBA Top Shot, and Sorare are bringing crypto to the consumer in a way that they can understand — whether or not they natively understand crypto. Coinbase’s launch of their NFT wallet has over 2.4 million sign ups on their waitlist — this is a massive on-ramp for consumers to crypto and will prove to be another key development for bringing crypto mainstream.

🧠 Talent moving into Web3: The quality of talent moving into Web3 signals its promise. Across all corners of tech and financial services, some of the most experienced and successful operators and investors have decided to invest meaningful time, resources, and capital in crypto. Legendary traditional investors see the value in crypto — Fidelity CEO Abby Johnson, ARK Invest founder Cathie Wood, hedge fund luminaries Paul Tudor Jones and Stanley Druckenmiller. The list is too long to read out at this point. Many top technologists from Silicon Valley have moved into the crypto space in operating or investing roles. And the young talent out of school or in the early days of their career are going straight into Web3. Go where the builders are — and the builders are in Web3.

Themes and trends

💸 Programmable money: Blockchain technology allows for programmable money. Store of value was the first use case for programmable money. We are now seeing the development of medium of exchange (stablecoins) as the next innovation in programmable money. If we believe that crypto and stablecoins bring down the cost to exchange assets, then both traditional assets and crypto assets will be exchanged leveraging blockchain technology.

🛠 Crypto market infrastructure: Much like traditional financial services underwent market structure evolutions across the lifecycle of a trade, crypto market infrastructure needs to be built. Consumers and institutions will need a trading experience — from pre- to post-trade — that is as good or better than in traditional financial markets. Features of blockchain technology and crypto offer the promise that the experience could be even better thanks to innovations with decentralized exchanges, staking, lending, and custody. Opportunities to build out critical market infrastructure also includes NFTs. NFTs will need market infrastructure built out across the lifecycle of a trade as well — from pre-trade market data to allow for efficient price discovery (like Rarity.tools and Curio) to exchanges (like Coinbase, OpenSea, Rarible, Foundation), and safekeeping of the NFT assets in wallets like MetaMask or Rainbow.

🏦 Institutionalization of crypto markets: Institutional investors will need to allocate capital to this emerging asset class. In fact, they will be at a disadvantage if they don’t have exposure to crypto for themselves or their clients. Institutional investors will require products that on-ramp them to the cryptoeconomy in the form of structured products, public and private market fund platforms, and post-trade custody solutions.

👥 Crowdfunding — the next evolution: Crowdfunding has evolved from a donation-based model to an investment-based model (from Kickstarter to Republic). Crypto is in some respects a manifestation of crowdfunding — individuals, accredited, or non-accredited, can often invest into crypto tokens well in advance of when they would have been able to with private companies. The next evolution of crowdfunding is DAOs, where individuals come together in a co-op of sorts to invest into communities and assets where the collective group makes decisions. There are both DAOs and companies like Syndicate providing infrastructure for the creation of DAOs that represent investment opportunities.

🍣 DeFi: DeFi is a re-architecting of finance where the value accrues to the individual by abstracting away much of the cost that intermediaries would otherwise take in traditional financial services. DeFi is bringing traditional Wall Street use cases onto the blockchain (i.e. ABL/repo markets, exchanges, payments, derivatives). With DeFi these processes are written on a trustless, permissionless layer (Layer 1 blockchains like Ethereum), which allow for true p2p transactions to occur. Anyone in the world can lend, borrow, send, or trade blockchain-based assets using easily downloadable wallets without having to use a bank or broker. This lowers the cost of transactions and enables participants to earn significantly higher yields on deposits. DeFi provides the opportunity to invest into the internet’s equivalent of financial markets. DeFi markets are still in their infancy relative to overall crypto market value — DeFi is ~$100 billion of TVL (total value locked up) so once more wealth becomes deployed to generate yield, then DeFi markets will increase significantly in value.

🔑 Tokenization / NFTs: Tokenization represents an opportunity in multiple forms — tokenization of traditional assets, fractionalization of both traditional and cryptoassets, and tokenization of digital collectibles and NFTs. We are undergoing the financialization of everything — and virtually everything can be an asset. That doesn’t mean every asset will have value, but it does mean that the infrastructure around the concept of tokenization will need to be built out. We’ve already seen successful creations of marketplaces around NFTs and tokenization with OpenSea. NFTs also offer promise for new orchestrations of gaming, as we’ve seen with the likes of Axie Infinity and Sorare. The concept of play-to-earn is a powerful feature enabled by NFTs, in large part because it turns participants into owners. No longer do creators or game participants have to rely on platforms to create value for them — tokens enable participants to become engaged owners, allowing for both the creators and participants to monetize in ways they haven’t been able to do before.

Areas of focus

🛠 Financial Infrastructure

Trend: As Web3 undergoes financialization, the necessary market infrastructure from pre- to post-trade of cryptoassets will need to be built. Web3’s financial market structure will have similarities to traditional finance, but will look different and more decentralized.

Impact: Opportunity to build the necessary market infrastructure to enable retail and institutional investors to participate in the crypto markets. There will be some similarities to traditional market structure and some differences. The category-defining companies will balance both.

Representative companies we’ve invested in: Bitso, Republic, CoinList, Shakepay, Rainbow, Etherscan*1, Thesis (Fold App).

🌉 On-ramps

Trend: We have begun the commercialization phase of Web3. Consumers need to be on-ramped from the traditional world to the Web3 / decentralized world with easy-to-use products and UX.

Impact: Opportunity to build better user experiences to on-ramp consumers to Web3 across investing, gaming, NFTs with investment platforms, gaming platforms, and wallets. The best companies will on-ramp the everyday consumer in ways that seem no different than fiat but using crypto rails or assets.

Representative companies we’ve invested in: Bitso, Republic, CoinList, Shakepay, Rainbow, Sorare*, Axie Infinity*, Chingari*, Thesis (Fold App).

🖼 NFTs

Trend: NFTs represent a promising consumer use case for Web3. There is enormous potential for consumers to become stakeholders of games they play and networks they participate in, which changes the dynamics of how games and users monetize assets.

Impact: Games / culture represent a powerful on-ramp for the next 100 million to 1 billion consumers into Web3. NFTs provide more compelling ways for users to participate in and have ownership / earning power in the games that they play. NFTs also represent a way for creators of all types to engage their fans — and turn customers into stakeholders.

Representative companies we’ve invested in: Sorare*, Axie Infinity*, Rainbow, Eternal.

💸 Crypto Funds

Trend: Investing into Web3 requires a different skillset than traditional venture investing. It requires an understanding of technology / protocols, financialization / financial market structure, and community-building. It also helps to have the ability to manage liquid positions in addition to illiquid, equity-like positions. New fund managers will emerge in crypto who possess this multi-faceted skillset as a result.

Opportunity: Those who are living and breathing Web3 every day will be the most successful fund managers. We’ve seen this be the case from those who we’ve worked with since 2016 and 2017. They will be plugged into the right communities and understand where developer energy is at the protocol level. They will also understand the consumerization of crypto. And they will be able to balance both a long-term venture-like investing mindset with a liquid markets trading mentality when necessary. There is opportunity across the protocol layer and the consumerization layer.

Representative funds we’ve invested in: Polychain, Boost VC, Pantera, Thesis.