Placeholder’s Joel Monegro on the Fat Protocols Thesis

Joel Monegro, partner at crypto VC firm Placeholder Ventures, describes how well his seminal blog post, “Fat Protocols,” is holding up, why he and his partner Chris Burniske opted to found a crypto VC firm as opposed to a hedge fund, and what main factors they think will determine the success of a blockchain. He also describes how crypto and blockchains fit into the evolution of technology, how the business models in the crypto space will be built, and why their first publicly known investment was in Decred. Plus, he reveals why their firm is called Placeholder.

Placeholder: https://www.placeholder.vc

Joel: https://twitter.com/jmonegro

The Placeholder investment thesis: https://ipfs.io/ipfs/QmZL4eT1gxnE168Pmw3KyejW6fUfMNzMgeKMgcWJUfYGRj/Placeholder%20Thesis%20Summary.pdf

The Fat Protocols Thesis:

Decred investment thesis: https://www.placeholder.vc/blog/2018/5/12/decred-investment-thesis

Blog post on information technology cycles: https://monegro.org/work/2018/2/20/information-technology-market-cycles-a-brief-history

Joel’s blog post on the shared data layer of the blockchain application stack:

and on the blockchain application stack: http://joel.mn/post/103546215249/the-blockchain-application-stack

Two episodes featuring his partner, Chris Burniske:

Another episode that I forgot to mention during the show, the interview with Bill Tai, which contains ideas that overlap quite a bit with Joel’s:

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Blockchain Warehouse: https://www.blockchainwarehouse.com

Transcript:

Laura Shin:
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Laura Shin: 00:36
My guest today is Joel Monegro, partner at Placeholder Ventures. Welcome Joel.

Joel Monegro:00:59
Hi Laura. Thank you for having me.

Laura Shin: 01:00
So before we dive into the meatier questions, I just need to know, why the name Placeholder?

Joel Monegro: 01:08
Well, we couldn’t come up with a name, so our lawyers that did all of our legal documents said Placeholder Management in brackets because my partner Chris and I, we couldn’t come up with a name and so there was a point at which we just had to incorporate. So we went with Placeholder.

Laura Shin: 01:25
Okay. I love that. And by the way, for listeners who don’t know, he’s referring to Chris Burniske who has been on the podcast a couple of times and is well known for his models of token valuations I guess. So you fell down the crypto rabbit hole while working for the Dominican government. Tell us what happened?

Joel Monegro: 01:46
That’s right. I started working for the government of the Dominican Republic in early 2013 after shutting down a payments company. And I was hired to start a department called the digital economy department at the Ministry of Industry and Commerce. And one of our mandates was to work on payment system reform policies and infrastructure. And through that work, I did some traveling around Latin America and got to know a little bit about the political environment surrounding payments in different countries in Latin America. And, became really frustrated with the inability of governments to really coordinate their efforts and create a unified financial system in the region. And then I started looking for a technology solution to that problem and that’s how I discovered Bitcoin.

Laura Shin: 02:37
And how did you transition from that to becoming an analyst at Union Square Ventures, which was what your next Gig was?

Joel Monegro: 02:46
So that was an interesting and a little bit random transition. I had a known, not known the USV team directly, but they used to have a website that was a little bit like hacker news, a little bit like a forum that I would frequent. And it was a small community so there weren’t a lot of other people in that community, so it was easy to stand out. And after about a year of working at the government, USV opened up its analyst position, which is a two year position usually. And I applied. And what’s interesting about it is that there isn’t. The application process is basically two videos and something that you write. And the two videos was one around what drives you and the other was around what services out there inspire you. And I was driven by services that help or allow more people to make more money. And then in the service that I picked, I actually picked telegram because they were building a communications protocol and I thought protocols were very important and both of those things resonated with Union Square Ventures, which got me the interview.

Laura Shin: 03:56
And while you were at USV, what did you do?

Joel Monegro: 03:57
So I joined my application project, which was kind of the second stage was I did a study of blockchain APIs. I had already fallen down the Bitcoin rabbit hole. And the reason I want it to work at USV besides it being USV was I’d also gotten tired of working for a small corrupt government, and I wanted to continue working on this idea or this market. And it was great timing because at the time USV had just invested in Coinbase’s Series A, a couple months before I joined. And so USV was already coming into the space or had begun making investments in this space, but no one really knew, not just that USV, but in general, we didn’t really know how this was all going to play out and blockchains felt like a very interesting technology lacking a use case. And so I took it upon myself to figure that out and USV didn’t have a whole lot of structure or guided management and so it was really like a playground for learning and they really gave me the platform to go out and explore this market and get to know entrepreneurs and participate in a couple of early stage investments.

Laura Shin: 05:11
So it sounds like you were part of the process for deciding which crypto projects to invest in. If so, what was that process like? How did USV make its decisions?

Joel Monegro: 05:24
At that time, there wasn’t much of a process. If I were to describe it, it felt a little bit like I was the kid who had found the new thing and they were letting me play with it. And the reason it feels that way is that USV has always, or in general describes itself as a Series A stage from in terms of the stage in which the firm typically makes investments, Series A and on. And the blockchain investments that we’ve made, this was before we called it crypto. The blockchain investments that we made were uncharacteristically seed deals. So the first one that I saw happen shortly after I joined was Albert’s investment in one name, which is now blockstack. And then shortly after that, we got to know the Mine team, which is, which then came to be known as Mediachain and then merged with Spotify. And that was the first investment in blockchain that I worked on. And what would happen is I would find these teams, and get to know them and want to work with them. And, one of the partners would kind of sponsor me and make the investment and then let me run with it.

Laura Shin: 06:34
And so was there any type of investment thesis at that time? And, actually just for our listeners, let’s name the timeframe that you were working there.

Joel Monegro: 06:43
So this is now 2014 and I left in early 2017.

Laura Shin: 06:47
Okay. And so was there some sort of investment thesis or was it really kind of one off projects where you were like, “This seems interesting and these founders seem really promising.” Was it more like that or was there… because your writing’s really indicate that you had some kind of overall thesis for how the space would develop at least as early as 2014 from what I can tell.

Joel Monegro: 07:11
Yeah, early on, I think we had an investment instinct more than a thesis and the instinct came from something that is a good skill in venture capital, just pattern recognition. And, what we saw in the blockchain was something that we’ve seen over the history of information technology, which is an open source platform or an open source architecture, that felt like it had the potential to really turn into something great. We didn’t quite know how they were going to work. And so when we made those investments in Mediachain or OpenBazaar and a few others. One of the open questions was, “how are these companies ever going to make money? or how are we ever going to get a return?” Because at the end of the day as interesting as it can be in theory, it is a fund and you have to produce a profit.

Joel Monegro: 08:04
And we went into all of those deals with no answers to those questions and with the idea that the best way to learn was to make the investments and work with the teams. From that first kind of stage in the 2014, 2015 timeframe. What I realized was, “Okay, there’s a new application stack that’s being built here.” And, I kind of put together a model which I called the blockchain application stack, which at the time was very Bitcoin based because it was so early days that there wasn’t really much more than Bitcoin and a few Altcoins. And Etherium had been announced but wasn’t out. And the idea was, “Well, we can use the blockchain as a kind of foundational layer for data and then on top of that we can build, there’s protocol layers and application layers and I was just describing what it, what the blockchain application stack look like, right? And it felt different from the Internet and I was mostly looking at Bitcoin. You have Bitcoin and then you have overlay networks or protocols like lightning and, layer two services and then you have applications like Coinbase and then you have the users. And so I kind of went off that and that gave us a framework that we could use to start studying the space. And then over time, as we made more investments, we got to understand that we opened up a world of understanding in a way in terms of, “Okay, there’s something much deeper going on here.”

Laura Shin: 09:29
Yeah, we’re going to get into all of that in more detail later because it’s incredibly fascinating. But I want to keep moving through your bio. So in 2017 you left to launch placeholder. Why?

Joel Monegro: 09:42
A bunch of reasons, but it starts with… I met Chris in 2016 and we really became fast friends.

Laura Shin: 09:51
I think you and I met him at the same event. Was it at that [inaudible] workshop?

Joel Monegro: 09:51
Yes.

Laura Shin: 09:57
I remember that event. Well obviously partially because I had talked to Chris on the phone, but then I met him in person, but also I remember the panel you spoke on and I remember thinking, “That guy is super smart.”

Joel Monegro: 10:11
So we actually didn’t meet at that event. We met a couple of weeks later. Chris emailed me a paper that he had just finished with Coinbase calling Bitcoin a new asset class and I don’t remember this part. This is how he tells the story. Apparently I took the paper and we met for coffee and I walked into the coffee shop and told him that I had the paper printed in my hand and said, “I haven’t read your paper, but I agreed with it.” But the part that I agreed with and what was so exciting about meeting him was that was right around the time when I started to realize that the value was in, in the assets, in the crypto assets and not in the applications necessarily and the way he was looking at it from a new asset classs perspective, made that a lot more clear. And so we bonded over that. And so, that’s how our friendship started. And then towards the end of 2016 as this thesis around crypto assets and tokens was starting to become more and more clear in the market as a whole was starting to embrace it. We saw the beginning of the sort of crypto hedge fund wave come to market and that’s around the time that Polychain got started. And that was one of the last deals that I worked through at USV and so on. And sometime in October 2016, Chris and I were out somewhere and that’s when we first started talking about what a future might look like in which we worked together. He was working at ARK. I was at USV. We initially didn’t think that we would leave our respective firms so soon, but come 2017, the markets just exploding and we decided to leave and start Placeholder.

Laura Shin: 11:56
What does Placeholder do?

Joel Monegro: 11:58
So Placeholder is a venture capital firm and that was a very conscious decision and it’s related to what I just mentioned around the crypto hedge fund wave because by the time we decided to start a firm, we had the option to go the hedge fund route or the venture capital route and we chose the venture capital route because we saw the volatility in the market and we very much preferred the committed capital structure of the venture capital fund. And so our fund, like most venture capital funds is a ten year fund and it’s committed capital, which means that our investors can’t withdraw their investment from the fund unlike most hedge funds. And so what that means is that our fund is a lot more stable. We don’t have to deal with investor withdrawals. We don’t have to subject the fund to the whims of the market in that way. And that allows us to make a bigger, longer term investments.

Laura Shin: 12:55 And so what is the lockup period for your LPs?

Joel Monegro: 12:55
Ten years.

Laura Shin: 13:00
So if I’m an LP and I have this option of investing in a crypto hedge fund versus one with the ten year lock up, why would I opt for your structure?

Joel Monegro: 13:12
Well, number one, it’s much cheaper for you as an LP. A hedge fund. There’s the sort of two and twenty fee model that also applies to VC, but it works differently in a hedge fund than in a venture fund. And that hedge fund, you take two percent a year in management fee from total assets under management. So whatever the value of the portfolio is at that point in time or a year after year. And you also take 20 percent of the profits year after a year typically. And some hedge funds even do take profits quarterly. And so that really prevents money from compounding because you’re constantly taking money off of the portfolio or taking assets from the portfolio or reallocating them. In a venture fund, there’s a two and 20 fee model, but it’s based off of the committed capital, so the total size of the fund and so the management fee is fixed. It doesn’t grow with the size of the fund. And then the other big difference is that we don’t take any carry until after we have returned 100 percent of committed capital back to investors. And so we don’t make any money until we’ve given all the money back. And then, after that we only take carry, when we return capital to investors as opposed to on a continuing basis. So if you’re a longterm investor with a long term mindset and you want to invest in the asset class for the long haul, this fund structure just from that perspective is much more capital efficient and much cheaper for you. From a strategic perspective, it’s this thing that I mentioned earlier around the volatility in the market making it difficult to operate a hedge fund if you are facing withdrawals for example. And so if you have an investor base that is more interested in short term profits and there is a big change in the broader market environment. A hedge fund can really kill itself if a lot of the investors pull out at once and that can be bad for the other investors who want to stay in. So for longer term investors of infrastructure can be a lot more comfortable because it’s more permanent, more stable.

Laura Shin: 15:08
So it sounds like maybe your personal profits might be slightly less, but the longevity of your fund or the potential for the longevity is increased? Something like that?

Joel Monegro: 15:20
Something like that. Though its more than slightly, I would say it’s much less, but it’s a tradeoff between… It becomes a question of what kind of work do you want to do. And this goes back to what Placeholder does. Chris and I were both analysts, at different kinds of financial firms. And our favorite thing to do is not so much invest as it is just analysis and working with the teams and helping entrepreneurs. And with a hedge fund structure, your incentives are set up such that you want to create the maximum portfolio value for the next quarter, for the next year. With a 10 year fund with this structure because our payout is stretched out and pushed over to the later part of the fund and to the longterm, we are more incentivized to do deeper, longer term work. And so we decided that we didn’t want to be on Coinmarketcap everyday checking prices and trying to squeeze profits out of market fluctuations, but rather we want it to have a kind of slower pace of work and really drill in with the teams and help them succeed.

Laura Shin: 16:27
I think that’s a good idea. I think I also would go to crazy town if I had to check coinmarketcap everyday.

Joel Monegro: 16:36
I would be a terrible hedge fund manager.

Laura Shin: 16:38
So what are your assets under management?

Joel Monegro: 16:38
So we raised over $100 million at the end of last year.

Laura Shin: 16:45
And who were some of your LPs?

Joel Monegro: 16:47
So our LPS are mostly institutional. Our first batch of LPs were Union Square Ventures was our first investor and we have investors like Andreessen and Foundry Group. More on the institutional side. We have investors like Aberdeen Standard, Morgan Stanley, Investco. Some fund to funds like True Bridge and we have a couple of foundations and nonprofits like Texas Children’s Hospital and so on.

Laura Shin: 17:16
Okay. I interviewed Eddie Duszlak at a conference. Is that who you know there?

Joel Monegro: 17:27
No our contact is a different person, but we got to know the whole team and we were very impressed with everyone.

Laura Shin: 17:33
You plan to make only 15 to 20 investments over a four year period, which is extremely selective in an environment where new projects are springing up every hour it seems like. What is your process for deciding upon a potential investment?

Joel Monegro: 17:53 So I’m borrowing a lot from USV and I kinda like there being no process in a way it’s a little bit more art than science in some ways, and this is where Chris and I are very complimentary because Chris’s is more pragmatic as an investor than I am. And so we have different styles. From my perspective, the way I work, I treat it as a long conversation with the teams and with the entrepreneurs. And what I really want to get at is, first do I think that this team and these entrepreneurs can build what they are setting out to build. Second, do I think that what they’re building is going to be very valuable. And third, do I want to work on it? And if the answer to all those questions is yes, then I may be inclined to make an investment. But there isn’t a standard process that I follow. And it’s more of a feature of venture capital where it’s the riskiest asset class in many ways or one of the riskiest asset classes. And a lot of the work is more art than science. And different people have different processes for deciding whether they want to make an investment or not.

Laura Shin: 18:59
And for that first question that you asked about whether or not you think the team can accomplish their goals, how do you figure that out?

Joel Monegro: 19:06
Well, there’s many layers to that and it also depends on the stage of the team. If you have a much later stage team that has already been executing and has put stuff out there that works, then that is a much easier question to answer. When you’re dealing with three entrepreneurs and an idea, then it requires a little bit more work. The simple answer is you can vet them, check their background, much like you would a potential employee. You can do reference calls, you can, we don’t go as far as to make full background checks, but you can do that. Um, and so you can diligence the team in that way. But it’s all part of that sort of long conversation. If you’re meeting, for example, the CTO of a team, then if they can… One rule of thumb for me is if they can explain the technology to me in a way that I can understand it and their background checks out, then they’re probably a pretty good engineer or they understand very well what they’re building. So that’s a good signal for me. And then there’s this concept in VC which is this idea of a founder market fit, which is also kind of a [inaudible] and more art than science, but sometimes you get a founder that doesn’t quite match the market and this is imprecise because, you don’t want to miss out in an investment because you misread a founder or you didn’t think that they were the right fit but they were good at executing and so on. But I think, just to bring it down to a more concise answer, it varies. It changes with every team and you kind of have to feel your way through it. And there’s a lot of instinct involved in it

Laura Shin: 20:44
Right now, it seems like a very easy time to raise money for these projects, so how do you compete with other firms that are also trying to get an allocation and how do you negotiate a fair valuation?

Joel Monegro: 20:55
Well, we like to win deals on the basis of our work. We tend to be more opinionated and conservative on the valuation side in part because we understand that we’re in a stage of the market where nobody really knows what these things are worth truly and so we have to proceed with caution and part also because we have such a long timeframe that we don’t care if the token is going to be a 2-3x next year because that’s not our focus. We’re a 10 year fund, so we care more about where it’s going to be in five, six, seven years and so understanding that there’s a lot of volatility in the market and we may be in a very different place next year then we are right now. Just right now, we’re in a very different place than we were a year ago. We tend to be more conservative there, but the argument that we make to entrepreneurs is, and we do this through our work, is you have the ability and you said we were speaking to an entrepreneur, you have the ability to choose who you take your money from and we don’t make claims about other investors work styles, but we know that work that we do and we think it’s valuable and if the entrepreneur is interested in working with us to help them solve the problems that they’re facing, then the price will reflect that. So we don’t engage in bidding wars and have no interest in sort of winning a deal on the basis of outbidding everyone else as much as we are interested in winning a deal on the basis of the relationship.

Laura Shin: 22:27
And since these are open source projects, how do you approach investing differently than you would if these were startups where their code and data were proprietary?

Joel Monegro: 22:43
That’s a huge win for VCs I think. You can actually see for the teams that have open sourced their work and have built their networks out in the open, you can see their progress, you can see them executing, you can poke through Github and you can see the project evolve and you can have the code vetted by other people. Part of the diligence process, can involve diligencing the quality of the code and the quality of the technical implementation in a way that you really couldn’t before because now you do get to look at the code and it’s really important in this market in particular because ultimately as an investor who holds tokens and crypto networks, you are relying on the code more than anything else. So it’s very important that you diligence the code as well.

Laura Shin: 23:24
What structure are you using to invest in these projects? Are you investing directly in the tokens or are you taking equity in these companies? Or how does that work?

Joel Monegro: 23:34
So the structures vary and they vary mostly based on the stage of the team that we’re investing in. Our primary interest in investing in decentralized information networks and crypto networks and holding the tokens directly. When we encounter a team that we want to support but hasn’t released a token yet. Then you can’t hold it took him directly so you can use other instruments like a SAFT or some other kind of futures agreement. But also, or at least my personal preference is to invest in equity in a company that’s going to release the token in the future. And the reason I prefer equity to SAFTs or other structures is that when you have an early stage team that is still in the design and development process for their network, there’s a bunch of open questions around what is the networks monetary policy going to be like? Or is it going to change this at the right one? And, and when you, when you do a SAFT, for example, and you are preselling a fixed amount of tokens, for example, or a fixed amount of a network, you’re kind of locking yourself into a particular economic model for the service. Which, in the future may turn out to be problematic for the entrepreneurs if they later decide or realize that they need to adopt a different mechanism or a different way of releasing the token. With equity, it kind of solves that problem because what we’re saying when we invest in the equity of a company that’s going to release a crypto network is we are in the same boat as you. If the entrepreneurs and the investors are in the same company, in the same cap table, then we’ll figure out the economic model later. We’ll figure out the tokenomics, we’ll work with you on figuring out the issuance models. But for the time being, we have an agreement that we’re partners and we’ll figure out how to release the token later, but we can get involved into the design process using that structure.

Laura Shin: 25:28
My next question for you was going to be about at what kind of support you offer teams once you do make an investment. So did you start to kind of give some examples of what types of help you offer?

Joel Monegro: 25:40
Those are some of the examples. We describe Placeholder or our practice as being focused on cryptoeconomics and governance. I would say that, we’re pretty balanced in our thinking. Chris focuses generally more on the cryptoeconomics and I focus generally more on the governance but we overlap a lot and we work very closely together. And, we’ve found that many teams, especially earlier in their life, crave some support on that end. And it’s not that we claim that we know what we’re doing because these are such new fields. The entire space is 10 years old. All of these are experiments. But, we do spend a lot of time thinking about those two areas and we spend a lot of time looking at different projects and different teams. And so we have a wider perspective in terms of what different kinds of techniques or ideas or approaches there are to solve different kinds of problems in the design of a crypto network.

Joel Monegro: 26:33
So there is that kind of support that we like, that kind of work that we like to do in the early stage. But there’s also all the other things that plague early stage startups. Going back to the founding of placeholder one of the other realizations tied to the fund structure was that behind all these multi hundred million dollar network valuations, you still have early stage, seed stage, series A stage teams that have all the same problems that a typical startup has, except now they’re operating in this open source, public world. But that doesn’t mean that all the challenges that occur in a normal startup don’t occur in this world. And so, we do a lot of work on that front as well. There’s all the kinds of fires that you can put out operationally to even more personal stuff. When you have a founder that’s just burned out and demoralized and sometimes they need a pep talk or some direction, we do a fair amount of that as well.

Laura Shin: 27:30
And what are the different ways or moments in time when you might exit from an investment?

Joel Monegro: 27:37
That’s one of the big luxuries of venture capital that have been removed in this market. In traditional VC, the decision of when to sell doesn’t fall on you because you are a minority shareholder in a private company that’s either going to get bought or going to go public and that’s the decision of exiting is made for you by the entrepreneurs or by the company growing to the point where it can go public. Here, we have to decide when to sell and we haven’t made that decision yet and we’re not going to do it for awhile. So we get to kick the can down the road for a little bit. But we do think about that question. Part of the reason where we have the luxury of kicking the can down the road is our fund structure, right? We have a long term time horizon is our first year in business and so we don’t have to confront that for awhile. But, we will have to come up with a framework for thinking around when is the right time to exit an investment. While we don’t have any rules or any specific ideas about how that works, partly because every deal is different or every investment is different and partly because we haven’t encountered that yet. We do have a kind of values or morals in a way in that sense. And for us, it’s something that we borrowed from one of our investors, we exit when the thesis has played out. When the network is successful and has scaled and it has a lot of users and it’s doing what it set out to do and it’s working well. It’s a well oiled machine and it doesn’t need our support anymore. Then we can start releasing, the capital back into the network and get ourselves out from the network and leave it to the community.

Laura Shin: 29:20
We’re going to discuss your fat protocol thesis and Placeholders Investments, and more. But first I’d like to take a quick break to tell you about our fabulous sponsors.

Blockchain Warehouse: 29:31
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Laura Shin: 31:13
I’m speaking with Joel Monegro, partner at Placeholder Ventures. Let’s talk about your blog posts about the fat protocols thesis. I remember when that was published, it made waves and it became, at least in my mind, part of the fuel to the eventual ICO craze that came about in subsequent months. For listeners who haven’t heard of the fat protocol thesis, can you give a brief summary?

Joel Monegro: 31:32
Sure. So the basic thesis is it’s more of an observation than a thesis is that value in crypto network seems to accrue more at the protocol layer, so at the actual network layer, like the Bitcoin protocol or The Ethereum protocol and so on. Then at the application layer, which are the interfaces and services built on top. So that came about after actually looking at our Coinbase investment back when I was at USV and what I did is I looked at every time that we had put money in Coinbase and then went back and looked at the price of Bitcoin at those times and calculated what it would look like if we had instead bought bitcoin and bitcoin turned out to be a better investment. And, that was kind of the genesis observation of that thesis.

Laura Shin: 32:19
How well do you think the fat protocol thesis has held up and how well do you think it will continue to hold up in the future?

Joel Monegro: 32:28
So I think the thesis has held up well, we’ve seen this explosion of growth and value at the protocol layer at the DAO layer of crypto networks. And we’re seeing more and more services being built with tokens that are the ones that accrue value instead of equity in companies. I do wonder to what extent that is a function of the market realizing that we have a new asset class here and so all the new capital is going there and we’re seeing less capital go into applicational layer services. And so I think that it’s too early to tell how it’s gonna play out over the long term. But what I do have conviction in and we based our entire investment thesis on, or the entire fund on this idea is that most of the new value being created in this ecosystem is going to accrue to the tokens. I wouldn’t go as far as to say that the application layer, it doesn’t have any value or is going to accrue very little value. You look at a company like Coinbase, it’s an immensely valuable company riding on top of an immensely valuable protocol. And I think we’re going to continue to see some of those. And I think there’s real investment opportunities at the application layer, but I certainly do think that the protocol layer is a better place to be as an investor.

Laura Shin: 33:43
One thing I’ve always been curious about when it comes to the fat protocol thesis is just how many of the really valuable protocols there will end up being. Do you have any thoughts on how that’s gonna look? As you know, right now there’s this huge race in the smart contract space. So are we going to see five successful smart contract platforms or is there really only going to be one or what are your thoughts on that?

Joel Monegro: 34:09
That is the trillion dollar question. The idealist in me believes that we will see a large number of blockchains doing many different things, but there’s also the investor in me that recognizes that cycle after cycle we get this explosion of innovation and all of these new firms and investment opportunities pop up and as markets mature they tend to consolidate around a smaller and smaller group of players. And so it’s an interesting tension because when you have that kind of market centralization, it ends up being bad for innovation, but it most often is good for consumers. So there’s a lot of things to unpack there. But there’s one thing that keeps me on the more idealist side in terms of believing that we will see a larger number of networks than people expect. And that is that the larger network is the harder is to coordinate it over time and to manage it over time. And I think we’re starting to see some of those or we’ve seen some of those cracks and the way Bitcoin has grown and in some ways how Ethereum has grown. And what we’ve seen is that as developers get frustrated with a particular platform, at least in the space, that there’s something new here, which is you can fork. And I think that as these networks scale and become more and more important in larger and larger, there will be more and more disagreements between different groups of different communities. And that is going to be a driver towards more decentralization over time. That is more of an instinct than anything else. And I did qualify it with the idealist in me because I think it’s a very ideological, way of looking at the world.

Joel Monegro: 35:56
But specifically on smart contracts themselves, I see smart contract functionality as a bit of a commodity in the sense that any blockchain can really implement a smart contract system if they wanted to. And so I think that what we’ll see is we’ll see a lot of many different chains with smart contracts functionality. But the more important question is what are the developers going to do? Where are the developers going to build decentralized applications? Which blockchains are they going to choose and what are they going to base their decisions on? And I think that the actual functionality is not going to be the issue. I think that we will reach a kind of a feature parody between different chains in terms of what you can do with them as a developer. But I think that the developers in the future are going to base their decision on where to build on the basis of governance and community, and so I look for a good governance mechanisms and strong communities in blockchains.

Laura Shin: 36:55
And obviously, there’s a lot of different experiments right now in governance. What are some of the more promising solutions that you see? And also, some of the bigger problems that you think the space needs to tackle?

Joel Monegro: 37:08
So we’ve announced one investment which is in Decred. And, Decred is it’s own blockchain that started from the basis of, “let’s create a network with good governance.” And then, from that core idea, let’s expand and grow into more and more features. And what’s what’s really brilliant about that is that they basically decided to leave it up to the community, what Decred becomes over time and on Decred’s roadmap is smart contract functionality in its own way and the ability to create decentralized autonomous entities. But Decred started from a much more humble place with a focus on let’s create the tools for the community to build this network and for the community to drive the direction of the network. Which is really at the end of the day, what’s important about governance. We obviously have a lot of conviction in the Decred team, which is why we made that investment, but it is to me, one of the best governed or at least one of the networks that is best set up for long term evolution because of it’s good governance process.

Laura Shin: 38:17
And that governance process is a combination of proof of work, proof of stake plus this percentage of every block reward that gets allocated to the developers. Can you just describe a little bit what that looks like and why you think it’s smart?

Joel Monegro: 38:30
Sure. So it starts at that very first layer that you described. Decred’s consensus algorithm is a hybrid proof of work, proof of stake system that’s different from say Bitcoin’s. In that Bitcoin is only proof of work. And in proof of work, you have basically the machines that run the network and verify transactions are the ones that ultimately have all the governance power. What we learned with Bitcoin is that, that alienates the actual users because if you hold bitcoin but don’t have a machine plugged into the network, then you don’t have that much of a say. A hybrid proof of work, proof of stake system, what it introduces is a system of checks and balances between the users and the machines in some way in that the machines in Decred are producing blocks much in the same way that Bitcoin’s machines are producing blocks, but each block has to be vetted and validated by the proof of stake layer and the proof of stake layer is driven by the asset holders. By the holders of the Decred coin.

Joel Monegro: 39:30
And so every 10 minutes or actually Decred’s block time is shorter, but every time a block is produced, five random users in a way are being picked from the pool of people who are willing to participate in that process to decide on whether that block is valid or not. And then if that block is deemed valid, then it gets added to the chain. And so what that allows the community to do is to control for miners that go rogue or control for miners that act against the interests of the network. And then from that core governance component, they have built more and more user facing governance functions. And so, the latest releases a platform called Politeia, which allows the Decred community to make proposals for funding and to make proposals for upgrading the Decred platform. So that allows the users, the Decred community at large, to govern and direct the evolution of the network over the longterm.

Joel Monegro: 40:28
One example of that is recently Decred announced a proposal to build a decentralized exchange and that proposal is going to be put to a vote to the Decred community using the Politeia system and us as Decred holders can participate in that process and can vote on whether we think it’s a good idea to add a decentralized exchange or not, and so that gives us power as investors to vote on whether the network is going in the right direction or not. And so, as an investor that feels like a very good place to be because you have a lot more influence over the long term evolution of the network. Then you do an network like Bitcoin.

Laura Shin: 41:06
You wrote a very long but interesting blog post about information technology cycles and their business models and it began with describing how the transistor and how IBM came to dominate the market and then how later Microsoft dominated. It ends with how Google, Apple, Facebook, and Amazon are now the the big… the titans. So how do you see crypto fitting into this long view of historical, technological business cycles that you described?

Joel Monegro: 41:40
So what we’ve seen is, ever since the beginning of the information technology industry starting with as you mentioned, the transistor is the cycle of expansion and consolidation and what drives each expansion cycle seems to be the introduction of a new open architecture that changes the information technology paradigm and commoditized the previous cycle. So just running through history, we get the transistor which was an openly available technology that dramatically collapsed the cost of producing information circuits. So that created an explosion of integrated circuits and that allowed for the creation of the modern computer industry starting with a sort of IBM era. So we got the birth of the computer industry as a result of the introduction of the transistor transforming the electronics field. And then we had this big wave of innovation around mainframe computers and so on that later consolidated around IBM as the market mature.

Joel Monegro: 42:44
And then we had another open platform come along, which was the microprocessor, another innovation that collapsed, the cost of building computers by commoditizing what IBM did and making it available in a single component that was widely available. And that allowed for a first that decentralization of the computer industry because then we got an explosion of hardware manufacturers and computers went from being large and taking an entire rooms to now our smartphones, all based on the microprocessor, as the platform. But what happened is that value moved one layer up to the software layer. And so, the microprocessor really took hold in the seventies and also in the seventies we’ve got the software industry boomed on top. And so we got Microsoft and PC software companies that emerged. And then it consolidated of course around Microsoft later in the eighties and into the nineties.

Joel Monegro: 43:43
And then in the middle of that consolidated market around Microsoft in the 90’s, we got another open platform which was the internet and Linux. I guess two open platforms that commoditized what Microsoft did. So Microsoft’s business, if you think about it, was built on the basis of proprietary software running on proprietary computers and proprietary distribution because Microsoft had a proprietary distribution network, they could put more CDs in more shelves across the world than any small computer vendor or independent software vendor. And so, when the Internet comes along and when Linux comes along, we have a free operating system combined with a free distribution network. And so, that directly challenges, Microsoft’s leverage and this last cycle around the Internet that we saw is rooted on those two platforms. Once again, value moved up from the software layer to the world we live in today, which is the data layer. And if you think about Google and you think about Facebook, and you think about Amazon, you think about Netflix and all of these large technology companies, at the end of the day, their greatest asset where older leverage lies is in the large amounts of data that they hold and it’s proprietary data and they make it available to select parties and they charge for it. Their entire business model is based on either charging for access to that data or leveraging that data to provide a better service. So for example, in the case of Amazon, Amazon is able to out compete anybody else in the business because they just have so much better data around demand and consumer demand and so on and same for Google and Facebook, etc. Crypto comes along and does to Google, Apple, Facebook, Amazon, what Linux and the internet did to Microsoft, which is directly challeng the business model by commoditizing it. And, in this market, it takes the shape of free data in some way. If you look at blockchains in the way they’re constructed, all that data is open and in some way or it’s available and so data is no longer the proprietary asset and in this world, in the crypto world, the data is open and available for developers to use and interact with. So it becomes pretty difficult to build a business on the basis of proprietary data when everyone else has the data. So you’ve successfully commoditized it, but then value has to accrue somewhere else and then we get into a whole conversation around governance.

Laura Shin: 46:13
So you really think because… I was going to ask you about how this business model is going to change. So you feel like the value will accrue to networks based on their governance model?

Joel Monegro: 46:24
Yes. One more precise way to describe that is I at least personally believe that the tokens that will accrue the most value over the longest period of time are the ones that have a governance function built into them. So a Decred is another good example. Decred is a cryptocurrency. So I can use it as a cryptocurrency, but Decred also gives me power to govern the Decred network as a user, as a holder. And I think ultimately features get commoditized, software gets commoditized and now in this world data gets commoditized because it’s widely available. And so what becomes important once you have large networks that have taken over the world where all the data is free and open, then what becomes important is what are the systems that we’ve put in place to manage those networks and manage that data. And I think that over time, as these networks become more valuable to power, to govern them and the power to change them will grow as well

Laura Shin: 47:23
In that light, what’s your outlook on Bitcoin and Etherium?

Joel Monegro: 47:30
Well, I’ll put on my VC hat and look at it from a pattern recognition perspective and that tells me that the first version of anything is rarely the one that wins. The first social network is not Facebook or the first search engine was not Google. The first computer manufacturer wasn’t IBM. The first operating system wasn’t Windows. The winners tend to emerge later in the cycle as the market begins to understand what matters and what doesn’t. Then newcomers come along with better systems. And so, I don’t want to say that every cycle is different, so I don’t want to say that I don’t see a future on Bitcoin and Ethereum and quite the opposite and at the moment, quite long both, but I also believe that, over time we will see new approaches to both of those kinds of services that will resonate with larger parts of the population. And it’s important to remember that we’re so early in the cycle than most people in the world are not in crypto. Most people in the world are not participants in this ecosystem, but they will be at some point in the future. And they have not yet made a decision about whether Ethereum or something else that’s going to be the dominant smart contract platform. So I think that it’ll take some time for us to really see how these things are going to play out.

Laura Shin: 48:51
In the Placeholder investment thesis, which I urge listeners to read. I’ll put it in the show notes. You and Chris mentioned the importance of crypto economics. What is your current working thesis around what types of systems will work well versus which ones won’t?

Joel Monegro: 49:06
You know, that’s a bit of an abstract question. In what way are you thinking?

Laura Shin: 49:14
We’ve talked about governance a little bit, but I don’t know if you have any particular thoughts on proof of stake, versus proof of work or any other different consensus algorithms or. I know Chris has certain thoughts around the velocity of a token and how that affects the value. So, there’s just any number of factors or variables that you could be playing with and find more promising than other ones?

Joel Monegro: 49:44
So that becomes a design process question and particularly the in cryptoeconomics. It varies network to network. it various service to service. You have to design custom cryptoecomics for every single new network that you are building. But there’s one thing that is constant, which is that you’re probably gonna get it wrong in the beginning and even if you don’t get it wrong, you’re probably going to have to change it in the future. And the reason is because, as networks grow and more stakeholders come to the network, the profile of the network changes. The dynamics of the participants change. And so, cryptoecomics isn’t something that is fixed. It’s something that evolves over time. So for example, there’s a debate now on Ethereum, on whether it should switch to a fixed supply model where they would cap the total number of ether that would ever be created or continuing this perpetual mining model.

Joel Monegro: 50:40
And those are all open questions that are never gonna go away. And this is why we think that governance and cryptoeconomics are intimately tied with each other. Because if you think of cryptoeconomics as the sort of rules of a blockchain and you think of the governance mechanisms as the mechanisms to change the rules and the power to change the rules, then what you want to achieve is you want to achieve a good balance. You want to come out with a crypto economic model that works. And here works means that it incentivizes all the participants in the network to do what you want them to do, but you also want to make sure that you have the right mechanisms to allow the participants to change the rules in the future as they learn more about the network. As they learn more about themselves. So I look for networks that have both or at least teams that are building both of those values into the design of the protocol. Both sound cryptoeconomics that works for whatever service they are building, but also governance mechanisms that allow the community to change it in the future.

Laura Shin: 51:45
In another blog post you wrote about the blockchain application stack, what does that look like and how does it differ from the tech stack we know today?

Joel Monegro: 51:54
So that is a blog post from 2014, when I thought that everything was going to be built on top of Bitcoin and that turned out not to be the case. But, I think the general structure remains and there’s a graphic in that post, if I recall correctly, where it presents these set of layers were at the bottom most layer. I said, “there would be the Bitcoin blockchain and then on top of that you would have a protocol layer which would be services that would be built on top of that blockchain that would do different things. And then on top of that you would see and an API layer which was kind of unnecessary, but basically to illustrate that there would be an interface between developers and these protocols. And then on top of that layer, there would be an application layer, which is the user interfaces that people actually utilize to interact with the services built on the protocols that live below.” And I think that structure remains today. What has changed is that we’re no longer building everything on top of Bitcoin, but rather there’s a much more diverse ecosystem of blockchains on top of which you can build. That is a little bit different from the current tech stack or the internet stack in that, on the internet you have the protocol layer. These are all the IP protocol stack. So you have a TCP/IP and HTTP and protocols like SMTP and FTP that are simple messaging protocols that were devised a long time ago to help computers talk to each other over a network. And then on top of that you have the entire application layer and all of the data and all of the coordination around what a service is and what it provisions and what it looks like to consumers. That happens at the application layer of the internet. And it lives inside companies like Google and Facebook and so on. So Google and Facebook and Amazon and all of these companies are building on top of the internet protocols. But then they control everything that lives on top of those simple messaging protocols. Here in the blockchain. We’re encoding more functionality into the protocol itself.

Joel Monegro: 54:05
And so a good comparison might be looking at what Paypal looks like versus what Bitcoin looks like. And so using the internet model, you have Paypal built on top of HTTP and a couple of other internet technologies, but all of the payment functionality, all of the ledger functionality, all of the indentity functionality, all of the user interface, all of that has been bundled into the service that Paypal built and provides. If you look at Bitcoin, it’s a lot more or the Bitcoin ecosystem, it’s a lot more layered. You have the internet communication protocols that allow for miners to communicate with each other to facilitate the Bitcoin network. But then, in the Bitcoin protocol itself, we encoded a value transfer service. And so, we encoded the monetary policy, we encoded what it means to transfer a bitcoin from one person to another. How that works and all of those rules were built there. And then Coinbase, one layer up, provides the interface and provides the interaction mechanisms that users can use to transact with each other or to use bitcoin. And that’s a more layered ecosystem. And what’s kind of brilliant about that is that it’s much more resilient in the sense that it makes it such that you don’t have to rely on Coinbase, to use bitcoin. You can use any… there’s a large number of different wallets and services that you can use. Whereas with Paypal, you can only use Paypal for example. And so that is probably the most Important difference. And the way this ecosystem is evolving versus how the web evolved.

Laura Shin: 55:38
Yeah. I just love this description. I think when I read things like what you wrote or think about this description that you just provided, it just blows my mind and it really kind of underscores for me how empowering I think this will be for everyday people if it does end up getting built the way that a lot of people are envisioning, which is an open question. What is something that you and Chris disagree on when it comes to the crypto space?

Joel Monegro: 56:06
That is a tough question.

Laura Shin: 56:09
I mean, if there isn’t anything, maybe there isn’t anything, but…

Joel Monegro: 56:14
We will have debates at times, but we have a very good consensus algorithm. We get to consensus very quickly. It’s kind of scary sometimes how good we are at arriving at consensus. And that’s what’s great about our relationship. It’s very easy. We have very complimentary skills and ways of looking at things. And so, because we’re so complimentary, usually when Chris has a strong opinion around something, it’s good enough for me and when I have a good, strong opinion on something, it’s good enough for Chris.

Laura Shin: 56:53
Interesting. I know you guys are super close and always enjoy talking with you about everything going on in this space because you definitely are some of the brightest minds, in my opinion. We’ll see what the listeners think, but it’s been fantastic having you on the show. Where can people learn more about you or get in touch with you?

Joel Monegro: 57:12
Thank you for having me. The Placeholder website. It’s placeholder.vc That’s where we publish all of our work. That would be the best way to stay on top of what Chris and I are up to.

Laura Shin: 57:28
Great. Well thanks for coming on Unchained. Thanks so much for joining us today. To learn more about Joel, check out the show notes inside your podcast episode. New episodes of Unchained, come out every Tuesday. If you haven’t already, rate review and subscribe on Apple podcasts. If you liked this episode, share with your friends on Facebook, Twitter, or LinkedIn. Unchained is produced by me Laura Shin with help from Elaine Zelby. Fractal Recording, Jennie Josephson, Rahul Singireddy, and Daniel Nuss. Thanks for listening.