The Exchanges

Q Okay, so the bubble bursts. Everyone you know is unemployed, hanging out, having fun for a short period of time. Then what?

A Right, it feels like a vacation for about a week, right? And, you know, you play a bunch of video games or whatever, and then after a week you're like, this is kind of boring, like I gotta find something to do. So every morning I wake up, I'd go on Craigslist, I'd look for whatever opportunities that were, apply, then it was eight 15, and say, what am I gonna do today? So I just started walking. So I actually got to see a huge swath of the peninsula just I would say, I'm going to walk west today, or I'm going to walk north. I'll walk miles and miles and miles. Obviously that doesn't pay well. So eventually I said, I've got to start looking outside this little geographic region. So I, I really wanted to stay in the Bay Area. I like the Bay Area a lot. So I just sort of widened my scope. Then I came across a winery up in Napa Valley that was hiring for a cost accountant. And so that was the move I made. So it's about two hours north of Palo Alto.

AI assessment note: “I came across a winery up in Napa Valley that was hiring for a cost accountant.”

Q What are some more examples of use cases of where you'd see bundling or unbundling?

A So I guess another unbundling example would be if just going back to this cash flow and voting right, like say I hold a share of Microsoft, it has these two rights. The voting rights are almost inconsequential to me if I hold a hundred shares, right? But for most atomistic investors, like the voting rights are, are almost meaningless. However, they might not be meaningless to an activist. So to the extent we could unbundle the voting rights from the cash flow rights, you could actually sell off the voting rights Separately, while retaining the cash flow rights. It's kind of like non-voting stock. So, and that's perfectly legal, right? It's like, you can't sell your vote for president. You can sell your vote on a corporate action. And in fact, some of that does happen. Like, there's a famous example with Carly Fiorina on buying votes. Like, when things get close, those votes actually become valuable when there's particularly contentious issues. So, to the idea that you could sell your vote or lease your vote, right? Like, sell it for the next six months or lease it for the next six months. That's something that potentially we could build into these smart securities or programmable securities.

AI assessment note: “another unbundling example would be if just going back to this cash flow and voting”

Q Let's turn to games. You hear a lot about Axie Infinity. What's happening in the world of Web three games?

A There's been an explosion in activity is really the only way to describe it. Axie was the pioneer here. We invested in Axie when they had 15 or 20,000 users probably. One of the problems back then was that they were on the main chain. They were on Ethereum where the transaction fees are very high. Transaction fees could be 10 or 20 or 50 or a hundred dollars if the network is very congested. Which is problematic. This idea of play to earn is one of the big themes in web three gaming. If you're earning 20 dollars a day, but you're spending 30 dollars in a transaction fee to extract that value, the math doesn't work super well. The big thesis on Axie when we invested was that they were building a separate chain called Ronin. It was a side chain to Ethereum. It was already 15 or 20,000 users. If they can port this thing into a no fee environment, or a very low fee, where it's pennies, This thing could explode. And in fact, that's exactly what happened. So they ported it over to Ronin. Users went to 50,400 thousand, and a 1,000,002 million, and so the thing just took off. At that point, it really captured the attention of game producers and game developers. Now, we've seen an explosion of activity. What we haven't seen is most of this stuff landing on Ethereum mainchain. It's landing on Polygon, which is a layer two on Ethereum. It's landing on Avalanche. Which is an EVM compatible…

AI assessment note: “There's been an explosion in activity is really the only way to describe it.”

Q Let's go through each one and start with NFTs. It's certainly a term we hear a lot about collectibles and all that kind of stuff, but why don't you start with a good definition of an NFT?

A We think of an NFT as really just a file format for being able to bring a unique piece of digital content on chain. Let's start with art and collectibles, because you mentioned that, and obviously that's been an early use case. When you think about traditional art, like a Picasso or a Miro or a Dali, What are people paying for when they pay 50 or a hundred, a hundred fifty million dollars for a painting? They're really buying the provenance. Many times collectors will have a replica produced to hang in their house. You may have heard the story about Steve Wynn and Picasso's La Reve, where there was a hole poked in it. So many times they'll put the real one, the original, in storage, keeping it safe, hang the replica. When they went to sell it, the replica wouldn't be worth a hundred and fifty million, even if it looks identical, only the original

AI assessment note: “a file format for being able to bring a unique piece of digital content on chain”

Q How does the DAO go about sourcing the entrepreneur? And then similarly, how does the entrepreneur figure out who is in the DAO that will be helping them after an investment gets made?

A In terms of sourcing, a lot of it is much the way it works in VC. Like, if you have a very strong brand as a venture investor, you're gonna get a lot of inbound. You're gonna get inbound cold, you're gonna get it from founders you've invested in previously, you're gonna get it from co-investors. For example, many times when we lead a deal, we are very active in the NFT space, we'll actively seek to bring Flamingo and Neon and some of these other DAOs in because we know the value that they can provide. The DAO might be brought into a deal through a variety of different mechanisms, but many of them mimic the same way the traditional venture shop would be brought into a deal. Now, in terms of who they'll be working with, usually different people from the DAO will engage. If it's a music platform, you might get some artists engaging, and they'll join a call by the founder. In a venture deal, you might have a call with, say, one partner and maybe an analyst. If you're taking money from a DAO, You'll set up a call with the DAO, and you might get five or 10 or 15 people from the DAO that join that call. Those are typically going to be the ones that are most interested and most engaged as you move forward. Again, there's sort of this administrator called Tribute Labs. They're doing a lot of the signing paperwork and things that the DAO may have to do to actually execute the investment.…

AI assessment note: “In terms of sourcing... Now, in terms of who they'll be working with”

Q In the gaming ecosystem, where have you been most excited about investing?

A Things that look more like platforms than individual games. The interesting thing about Axie is it started out as a singular game, but because people own the characters and because people own the board, you can repurpose these assets into new games. This has really never been possible in gaming before. Let's say I have my little Axies, and I'm playing the Axie game, but somebody else decides, I want to bootstrap my game with the Axie community, so they build a totally different game. So Axies is a battle game, it's sort of like Pokemon. Maybe somebody else builds a racing game. Now, I can take my same character, my same Axie, and I can jump over to their game, and I can play it in there. Even more interestingly, maybe Axies that are really average in the first game Are amazing in the racing game. You could assign different powers or attributes to different features of some of these gaming assets. All of a sudden you get this interoperability for the assets across multiple games, potentially from multiple different game developers. That's one of the fascinating things about building games in these environments. So that's a feature that we often look for. Can whatever's being built morph into something that's bigger than a singular game?

AI assessment note: “Things that look more like platforms than individual games.”

Q When you think about investing in this space, There's the possibility of effectively an infinite number of NFTs and tools around it. So how have you approached investing in NFTs?

A Our fund historically has not taken a lot of direct NFT exposure in terms of the underlying, but we are perhaps the most active investor in the world in NFT related platforms. One of the things we're always looking for is, is this thing capturing attention? If you look at some of the biggest companies in the economy, Facebook, Google, Netflix. These are not financial firms. These are firms that specialize in attention. We're thinking about it much in the same way. When you're analyzing a DeFi protocol, you're thinking about in the context of a financial firm, like how much trading might happen here, how much lending might happen here. When you're analyzing things around NFTs, which are purely a consumer product, people think of crypto as fintech. We really view it as a social technology. We think that actually the biggest use cases in crypto are not going to be purely financial in nature. They're actually going to be things that map the social graph. That's the gap that NFTs have been into. To use a couple examples, we led a seed round for a project called Artblocks. Artblocks is the leading marketplace for generative art. The amazing thing about marketplaces in Web three is not only do they get the revenues from the primary sale, But every time that asset is sold in the secondary market, there is a royalty stream that comes back not only to the artist, but also to the original…

AI assessment note: “we are perhaps the most active investor in the world in NFT related platforms.”

Q I hear a lot about the challenge of interoperability. You have a whole bunch of layer one protocols. You have even more layer two protocols. People are competing to be the most trafficked base layer game. How do you get from that to interoperability and describe what interoperability is?

A Interoperability is defined as the ability of one computer to use information from another computer, one piece of software to use information from another piece of software. It's something we haven't had with most databases today. Databases we think of as siloed. It's why we need these big systems of intermediation between, say, Bank of America and Wells Fargo. We have to send payments up through the Correspondent Banking System or the Federal Reserve because Wells Fargo has their ledger, and Bank of America has their ledger, and those ledgers don't talk to each other. They're only interoperable through this system of intermediation. But it's not just true of finances. Most data does not play very well with most other data. It's not composable, which is the biggest unlock in web three. The fact that now we have these trust minimized databases and ledgers that can talk to each other. The challenge is that right now they talk to each other within each ecosystem, but not across ecosystems. All the things inside of Ethereum are composable. So I can use this lending protocol, and then I can use my receipt from having done that lending In this trading protocol, and everything just works together because it's all, say, ERC-TV standard. There are these standards that exist in the ecosystem that makes everything interoperable and work together. What's been more difficult to do is to tak…

AI assessment note: “Interoperability is defined as the ability of one computer to use information from another computer”

Q Where did you start your research when you first had time to get exposed to it?

A You know, as soon as I had time, I started reading everything I could, and then, of course, I'm an, I'm an empirical researcher, so I said, I need data, right? Like, I need data, there's not many academics looking at the space, and so I'm gonna just cold email everyone I can think of. So I cold emailed, like, Brian Armstrong, the CEO of Coinbase, and I cold emailed Patrick Byrne of Overstock and a bunch of others, like, anyone who was kind of using Bitcoin in commerce in some way. And what was amazing is back then the industry was still so small that they actually got back to me, right? Like today, it's hard to even get a response from customer service for a lot of these companies. And, and back then it was like high ranking people were getting back to me saying, really, the pivotal one, I guess, was Adam White from Coinbase. He got back and he said, look, so he was like the number two guy there. And he said, we can't give you data like that. We're just not in a position to release data to you. But you should really call this guy Chris Berniske. So Chris Berniske was an analyst in an ETF here in New York called ARK. And Adam said, you know, he's the only guy I know that's thinking about this the way you are in terms of, like, really trying to think through, like, why do these things have value? How does value accrue? How are these networks going to develop? Sort of like a lot o…

AI assessment note: “I started reading everything I could, and then, of course... I need data”

Q What teaching from your parents has most stayed with you?

A Don't quit, right? Which sounds very cliche. Maybe the right term is, um, don't rage quit, right? So with sports or, you know, they always were like, I would have a bad game or whatever, and I'd be like, I want to not play hockey anymore, and they'd say, nope, you're finishing the season, right? Like, you can transition at that point, but, you know, other people relying on you, you're not quitting mid-season, you're not quitting mid-course, you're not quitting, you know, whatever. You're going to see it through To a logical transition point. And that's, that's always stayed with me. Like, if you look at the winery, right, like, I transitioned out of the winery, but I did it in a very, I did it in a very sort of, like, way that was well planned. It wasn't like I just walked in one day and quit and said, I'm going to go join a PhD program. So every transition in my life, I've always tried to approach it that way.

AI assessment note: “Don't quit, right? Which sounds very cliche. Maybe the right term is, don't rage quit”

Q So why does that need to be on blockchain?

A So that's a great question. I think it's one that I thought about for a long time, and I think the idea is that when securities are programmable, you get a lot more features. Now, you don't necessarily need to be on chain to be programmable, but the thing that you get with blockchain is interoperability. So let me tell you what I mean by that. Maybe I'll use an example of realty shares and cadre. So, so in those models, you already can fractionalize ownership, right? So you can take a building and put on one of these platforms, sell 1000 dollar shares or whatever, and raise millions of dollars for a skyscraper. What you can't do is take that asset, first of all, there may not be any secondary market, because what would happen? It would have to be built by that platform, right? Because their business model is Keeping the assets on platform. They get a percentage, right? A management fee for all the assets that are on their platform. They don't want the assets to leave the platform. And so many of them have not built out secondary trading models, but even if they have, you're then locked into whatever liquidity exists within that one pool. So whatever investors are on that platform, what you can't do is take something you bought on realty shares and move it over to CrowdStreet To access a different pool of liquidity, or just if you like their interface better. So in a sense, alth…

AI assessment note: “the thing that you get with blockchain is interoperability”

Q You also talked in the paper about access rights and partnership interests, which I thought fascinating. Why don't you talk some about that particular unbundling potential?

A Sure. So access rights could take a lot of different flavors, right? So right now, when I buy a share of Microsoft, I get these two cash flow and voting rights. I don't get the right to I mean, maybe other than the shareholder meeting, like go visit the Microsoft campus, or if I invest in Sequoia's current fund, that does not typically, I mean, may, there may be a sort of an informal arrangement. There's not formally endow my ability to participate in their follow-on fund. But that's actually considered a very valuable, that allocation, like take benchmark, right? So benchmark, you know, I just read an article the other day, like their recent fund has just crushed it, right? Yet, they're not gonna raise a bigger fund. This is what the article was saying, right? It's like, they're actually gonna raise the same size fund they did the last time. Of course, it'll be massively, massively oversubscribed, right? Like, they could raise a substantial additional amount of capital, but they're gonna choose not to, which means that the people that have allocations into that fund, presumably, that's a valuable asset. And to the extent that Benchmark could formally include, like, say they actually tokenized that fund, And it not only gives you a right to invest in this fund, but it also gives you a right to invest in, say, every subsequent fund, or at least the next fund. Well, all of a sudd…

AI assessment note: “what they're also selling are access rights to follow on offerings”

Q When these platforms have the ability to be effectively repeat toll collectors, how do they differentiate from each other? You could imagine lots and lots of people wanting to have one of those platforms.

A Absolutely, and lots of these platforms have sprung up. This is where it comes back to something that way predates web three, which is brand. This concept of trusted brands and brands that have done a really good job of curating and making sure that the quality of things that are produced on their site are of the highest quality and things that people want. OpenSea, of course, is an open marketplace, so there's not curation on OpenSea. Something like 90% or maybe more than 90% of collections on OpenSea have never had a single trade. This relatively small sliver of things that actually have value, this is a point we're always making to people. Taking an item and wrapping it in an NFT does not inherently make it value. There's nothing valuable about the file format inherently, other than you now can prove provenance, but of course it has to be something that people want. Seems obvious, but there seems to be this misconception sometimes that just because it's wrapped as an NFT, this now connotes some value, which is just not true. The vast majority of collections don't trade, and the vast majority of items are probably going to go to zero. You really do have to cut through the noise to find these platforms and these teams that are really driving value back to the users. Once we've started specializing on this intersection of web three and consumer, It became much easier for us to …

AI assessment note: “This is where it comes back to something that way predates web three, which is brand.”

Q So if you're a venture firm investing in a DAO that's then investing in one of these specialties, how is it that DAOs could replace some subset of venture firms?

A When you talk to founders, many times they prefer to take capital from DAOs as opposed to traditional venture firms. Some of that is ethos. DAOs are very community driven. Web three space broadly is very community driven. DAOs aren't going to come in and try to take 90% of the round. And exert a bunch of control provisions and whatnot. The other thing is you're kind of getting 60 people instead of, say, one partner. Our argument is that it kind of goes both ways, because you get 60 people, but maybe there isn't any one person individually that's as incentivized as, say, a partner at a venture fund to create connections, create value. So many of the rounds that we're seeing have both. You've got some traditional venture firms, and then you've got one or more DAOs that are also inserting capital, but what we're seeing is that it's only value add capital that's getting into these deals at this point, so what the founders don't want is just capital. The world is awash in capital right now, web three more so maybe than any other segment. Whether it's a DAO or whether it's a venture investor, they want somebody that's an expert in the specific type of platform that they're trying to bring to market. And with DAOs, you just get a much bigger network. That is the attraction of taking capital from DAOs.

AI assessment note: “many times they prefer to take capital from DAOs as opposed to traditional venture firms”

Q What's the mechanism by which if you own a token in a DAO, you get the proposal sent to you compared to how difficult it is to get people to vote on proxies of equities?

A Typically, these things are executed online, so it's less of a push and more of a pull. There's usually some mechanism through which communications happen. I would say for most DAOs, that actually happens to be Discord. In Discord, there would be a variety of channels. Which is where you reach what we call soft consensus. Let's say somebody sees a protocol. They say, this is exciting. We should invest in this. They'll open up a channel and people will start talking about it, like debating it. Like, here's what I like about it. Here's what I don't like about it. Let's set up a call with the team. Anybody from the DAO is welcome to join that call. A very typical process that a VC fund would go through. There's a vetting process. Once you've reached soft consensus inside of the messaging channel, inside of discord, It then moves to what's called hard consensus. It looks like there's support for this thing. Let's put a formal proposal on chain, and this is where you have to go in with your wallet and vote. Usually there's rules around what constitutes a quorum. 30% or 50% of all the members must vote, and a majority or a supermajority of them must vote in favor, depending on the type of proposal. Wallet to wallet messaging is still one of the big unsolved things in crypto. The reason it's hard is because as soon as you open up wallet to wallet messaging, you get massive amounts of …

AI assessment note: “Typically, these things are executed online, so it's less of a push and more of a pull.”

Q How do you think about the accretion of value if there's no scarcity?

A Just like I think about accretion of value of a website. Have you built something that is compelling and that people want to go to and spend time in? It could take many forms. I think a lot of these will be games. We think of a metaverse as a base layer, so it's a layer upon which many other things will be built. You can go into the metaverse and you can play a game. You'll probably be able to go into the metaverse and trade stocks. You'll probably be able to go into the metaverse and watch a concert. All these different things you might be able to do inside of this base layer digital environment. Those are the things that will actually create value. People to want to go into the environment and participate in whatever the creator has created in that particular space.

AI assessment note: “Just like I think about accretion of value of a website.”

Q How did that take hold? So what were you researching, and what were you trying to produce?

A Yeah, so initially we were really interested in how price volatility impacted consumers. How does the volatility of Bitcoin impact its use in commercial transactions? So we're really interested in sort of on-chain volume, and it turned out that's actually pretty difficult to parse out, like, which transactions are commercial and which are sort of exchange in nature. I mean, you can separate off exchange volume, but when you look at the on-chain volume, you've kind of got a mishmash of a lot of different stuff. So then we moved on and really started looking at ICOs. So of course, I've been studying, you know, securities my whole career, have thought a lot about IPOs and equity issuance, and so we said, oh, so the ICOs are sort of this equivalent for the crypto industry, and so really just started going through IPOs and thinking about all the different attributes, right? So like, is there a vesting period? What's the background of the founders? Like, what sorts of things kind of contribute to, to success?

AI assessment note: “initially we were really interested in how price volatility impacted consumers.”

Q Well, Steven, I can't let you go without asking a few updated closing questions. So what is your favorite hobby or activity outside of work and family? And I suppose that also means outside of crypto.

A That was an important qualifier at the end. My favorite thing to do when I'm not vetting deals or doing stuff specific to the fund is play with this stuff. Like, if you talk to most crypto fund managers, it's why they got into it initially. Most of us didn't anticipate becoming fund managers. We got into it because we love tinkering. We love playing with the newest DeFi protocol or minting an NFT and seeing what access rights it gives us in the metaverse is how we spend our spare time is playing around. But if I have to choose something outside of crypto, I live on a small family farm, so I've got a tractor and all the toys you can attach to it. That's where I spend time when I'm not messing around with the newest DeFi protocol.

AI assessment note: “I live on a small family farm, so I've got a tractor”

Q I was going to ask you if someone wanted to start to dive in and learn more, where would they go? But maybe a better question is what's on your syllabus?

A So this is my last year at the university. I don't have time to do it in addition to the fund anymore. So I actually met with the dean office a couple of weeks ago and I said, I would like to continue providing this content to the students because after I leave, I'm not sure if there's anyone else that's going to teach crypto. And they said, why don't we produce a series of really professional videos? And so we're going to do that over the summer. Maybe we can make it available to more than just our students and actually make it publicly available, because there does seem to be a thirst for learning the basics, like what is a blockchain? What is Bitcoin? What's the history? What is DeFi? What is an NFT? Those are the things on my syllabus. I start from the assumption of no knowledge. We start with, what is a blockchain? And I don't dive really deeply into the technical aspects. I dive more deeply into, what are the applications? What is it? But also why is it important? Why is it going to touch all these different segments of society from finance to music to art to human organization? We talk about what are the challenges around web three, whether it be regulatory energy consumption, all the various things that people might point to as challenges. We cover the regulatory and legal environment. Like are these things securities? What are securities? What might not be securities? …

AI assessment note: “Those are the things on my syllabus. I start from the assumption of no knowledge.”

Q Three hundred million people out of five billion. So call it six percent of the population is engaged in this. How will web three in the near term affect the general public?

A If you think about like, why did most people open their Coinbase account or open their FTX account or open their Binance account? It's really about trading. People wanted to make money. The same reason they opened their Schwab account or E-Trade account. But this was especially prevalent in that 2017, 18 era. People were opening Coinbase accounts because they thought, I want exposure to these assets, I want to trade these assets, I want to get rich. There was very much a trading mentality around crypto, and there sort of always has been for many years. The big difference over the last 12 to 18 months, NFTs are the ones that caused this paradigm shift. The mentality went from trading to using. That's a really important shift that probably most people who are outside the industry haven't fully grasped. The reason you're owning these NFTs is because you want entry into a Discord, you want entry into a DAO, join a community, access some sort of video content. I had to buy an NFT yesterday for VCon. VCon is a big conference that's happening in Minneapolis in a few weeks. The tickets are NFTs. That's why I bought the NFT, not because I'm going to trade it, because I got to show this thing at the door to get in. This mentality around, let's use these assets, Is really, really important. It takes it out of purely speculative trading. I think the number is going to go up type of mentali…

AI assessment note: “using these things to join a community and to perform certain actions and to get access”

Q So every time there's a new evolution in this, there's probably almost an equal number of people trying to figure out how to game it and steal from it. What are some of the mechanisms that you've seen of people trying to figure out how do you manipulate a DAO?

A There's not a lot of examples of that. If the smart contracts are not written well, and a hacker gets in and exploits it, they could conceivably take the capital that's inside there. There are a few examples of that. In fact, the very first DAO, which was called the DAO several years ago, it suffered from this. There was an exploit shortly after it was launched. If the smart contracts are battle tested and they're sort of unexploitable, if anything, there's the opposite problem, which is because it requires consensus, it's actually hard to get the money out of these smart contracts because you've got to get everybody to agree That it's a good idea to spend money on this thing or to invest in this project or whatever the proposal is. So we've definitely seen with some of the big DAOs that have many thousands of members, there's a little bit of gridlock going on where in fact the treasury is massive and it's just not getting spent because there's not enough consensus around the things that are being proposed. So if anything, I would say the biggest challenges around DAOs today are not that People are absconding with the money, but in fact that the money is not being spent quickly enough. The Lao and Flamingo are smaller DAOs. They're, as I said, about 60 members. They've been very good and very efficient at deploying capital. We need to take some of the things we've learned in th…

AI assessment note: “If the smart contracts are not written well, and a hacker gets in and exploits it”

Q So what were some of those differences and what didn't make sense and then what, maybe what you learned that either corrected it or?

A The thing that was interesting is that the common path to PhD is to go straight out of undergrad or maybe a very brief experience. So in that sense, it was a really non-traditional path to have worked and risen up to sort of a C-level position and then gone back. And so what I did is I took those experiences and they actually formed the basis of Of most of my early research. So my first paper that I wrote with my advisor, David Dennis, was basically, let's look at companies that take on large debt issuances, right? Because I've been thinking about large debt issuances through the wine industry. And then the second paper was, what happens when a CEO is sort of innately risk taking, right? Or innately not as risk averse. Because the, the wine industry attracts a lot of characters. And One of the things I noticed was that when we came across a, our winery was sort of an incubator. There was about 30 different brands that were started out of our facility because it was just a large production facility. We did services for other wineries. One of the things I noticed was that the personality of the CEO really imprinted on the company. So when I got to school, I thought, well, was that just sort of like a weird phenomenon in the wine industry that's happening because these are relatively small companies, or is this sort of a, a larger effect? And so we went out and we said, well, we w…

AI assessment note: “I took those experiences and they actually formed the basis of most of my early research.”