Olaf Carlson-Wee is the founder and CEO of Polychain Capital, a blockchain investing hedge fund.

Aaron Harris is a Partner at YC.

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Craig Cannon [00:00] – Hey, this is Craig Cannon and you’re listening to Y Combinator’s podcast. Today’s episode is with Aaron Harris, who’s a partner at YC, and Olaf Carlson-Wee, who’s the founder and CEO of Polychain Capital, a blockchain investing hedge fund. Olaf was also the first employee at Coinbase, and he was part of our First Employee series, which you can check out on the YC blog. Alright, here we go.

Aaron Harris [00:19] – Hi. My name is Aaron Harris. I’m a partner here at Y Combinator, and I spend a lot of time thinking about fintech and how technology is changing the way we use and move money and how that plays into assets, banking systems, insurance systems, which all kind of comes together, for a lot of people, in cryptocurrency, which is obviously this new, not super new, but fairly new in the context of money and financial systems, set of things. And I think there’s a lot of misunderstanding about it, which is why I’m happy we’re doing a bunch of podcasts talking to people who really get this stuff, because I have ton to learn. So Olaf, I’m really super excited to talk to you about this ’cause you get it way better than I do.

Olaf Carlson-Wee [01:02] – Yeah, so thanks for having me. My name is Olaf Carlson-Wee. I’m the founder of Polychain Capital, which is the largest blockchain investing hedge fund in the world. Far before Polychain Capital, I found out about Bitcoin in the summer of 2011 and became extremely infatuated with this concept of digital assets. I decided to pen my undergraduate thesis on Bitcoin that year. I think this was probably one of the first academic works on cryptocurrency. After that, I joined Coinbase as the first employee. Coinbase was actually a Y Combinator company and it is now raising money purportedly at over a one billion dollar valuation. I was at Coinbase for three and a half years, and during that time, I was the head of risk. I was also paid exclusively in Bitcoin.

Craig Cannon [01:54] – From day one?

Olaf Carlson-Wee [01:55] – Day one for the entirety of my time there I was paid exclusively in Bitcoin. There were times when that was a good decision and times when that was a bad decision, but I think net, it was right. And I left last summer to launch the Polychain fund. So we launched with around four million under management and now we have about 200 million under management. We have backing from Union Square Ventures, Andreessen Horowitz, Sequoia, and Founders Fund, among others. A somewhat unusual LP base, and we can get into that a little bit.

Craig Cannon [02:30] – Are those funds functioning as straight LPs or are they investing in the GP?

Olaf Carlson-Wee [02:36] – They’re straight LPs.

Aaron Harris [02:37] – Okay. So I worked for a hedge fund for a while, so I have a conception of how that looks in my head, the kind of things that you look at, but there are a lot of different kinds of hedge funds. There are macro hedge funds. There are long short funds. There are activist funds. What does it mean to be a hedge fund focused on the blockchain?

Olaf Carlson-Wee [02:54] – Yeah. So a lot of those strategies you just stated could all apply to cryptocurrency assets. Some of them are mechanically much more difficult. So for example, short positions in the space are difficult to achieve in a secure way. Also, for example, something as simple as margin trading can be hard to find for the right assets that you’re trying to trade in. For us, we’re sort of what I would call fundamental investors in that we’re long only with a long holding period. And I spend most of my time reading research papers about cryptocurrencies.

Aaron Harris [03:29] – How long of a holding period?

Olaf Carlson-Wee [03:31] – So it really depends on how fast things grow. So we are rebalancing the portfolio roughly every 90 days. So the goal is to hold things that are good positions for years, but we may rebalance or sell down on those positions over time.

Aaron Harris [03:53] – Okay. So in terms of pace of movement, it looks less like a hedge fund and more like I think how people would think about almost a mutual fund kind of thing, but I’m guessing hedge fund because it allows you a lot more flexibility in terms of what you’re allowed to invest in and the strategies you can pursue.

Olaf Carlson-Wee [04:10] – Yeah. So the tricky thing was I knew in my head what I wanted to do as far as investing in these assets, and that it actually looks a little bit like a venture investment in that you find things extremely early when they’re still just a specification. So these protocol specifications or white papers are extremely detailed descriptions of exactly what a protocol will do. It’s often very possible to understand a lot about what this will look like just from that specification. And I often feel comfortable investing if I meet the team and I read the specification and really like what they’re doing. So that looks very much like a venture investment in that you’re investing more in an idea than you are on proven data or numbers. But from there, these investments very quickly graduate into liquid markets. And so because these things are liquidly traded on an order book, unlike a venture firm, you really have to balance those positions. You can’t just wait for the IPO, so to speak. So because of that, I knew we needed to manage liquidity and I knew we needed to have really good risk management around our positions because we have month to month volatility, unlike a private equity or venture fund which can just sit on positions forever. But I wanted to take this long term investing approach that a venture fund would where a lot of your success is defined by very, very big winners and positions that rise substantially in value. So we invest in things at a really early stage. We form really good relationships with entrepreneurs. I’m really proud of a lot of the people we’ve backed, and then hope to hold those positions for years as those things grow.

Craig Cannon [05:51] – So can you dig into the technical aspect of what you’re actually looking for when you’re reading the white papers?

Olaf Carlson-Wee [05:56] – Yeah. So when we’re reading these protocol specifications or white papers, we’re looking for basically a novel concept or novel idea. So this could be a new application of existing technology. This could be an application of technology that hadn’t been tried in a cryptocurrency framework before. This could be just a kind of new game theoretic model that no one had ever designed before that allows for a novel incentive system or incentive structure, new consensus systems, just anything in this category of enabling new behaviors. So there’s a lot of technologies out there that are forks of existing technologies. So they’ll fork Bitcoin into something very, very similar. That’s usually not very interesting for us. We really like things that are written from the ground up. So Ethereum was not a fork of Bitcoin. Ethereum was written from the ground up. Tezos, whose crowd sale actually ends today, is also written from the ground up. It is not a fork of Ethereum even though it has a Turing complete scripting language like Ethereum.

Craig Cannon [07:04] – When you’re vetting a team, given that there are very few cryptocurrencies with a long track record, are you looking for how many times they’ve committed to evaluate them or what are you looking for?

Olaf Carlson-Wee [07:14] – Yeah, we definitely look at the code base. I think a lot of it, though, just pragmatically speaking, we can’t review every line of code in a new blockchain. We do require all our investments to get security audits from outside third parties. But even that, these are often experimental technologies and they may be broken in unforeseen ways. There are what I would call unknown unknowns here. There are things that you don’t know that you don’t know. That said, I think that I have a long history of, like at Coinbase, I did probably about 500 interviews. I’m very used to talking with technical people and getting a sense of their subject matter expertise. I also really feel comfortable betting on people if they have a great idea. So I think that it’s like seed investing, right? A lot of the time, you meet a really great entrepreneur, they have a really great idea, and that’s basically what you’re investing in.

Aaron Harris [08:17] – So there’s a dividing line or a difference between the technology being interesting and being fundamentally new in some way and there being a use for that technology down the road. And sometimes the uses are completely opaque because we don’t know what the technology is going to do to the world. The things that you invest in that do best actually change the world and create the conditions for which they will be successful. How do you evaluate that set of things or how do you think about that set of things?

Olaf Carlson-Wee [08:48] – Yeah. So the interesting thing here is that most of what we’re investing in today are protocol or infrastructure layer things that really aren’t meant to be end user applications. Most of what we’re investing in are really almost like developer tools to be used for end user applications. So a lot of what we’re thinking about is what’s going to enable developers more than what is going to be interesting for users.

Aaron Harris [09:14] – But in that case, the developers are your users, so I think it comes back to the same question of, do you have a view of what the world looks like in five or 10 years, the things that developers will need to be able to do that guide your thoughts on, “Okay, this is not only an interesting technology, that this is a cool thing, but it will allow this piece of the future that I believe in?”

Olaf Carlson-Wee [09:40] – Yeah. It’s so early in the development of what I would call Web 3, or this kind of user owned, decentralized Web that oftentimes right now to me, it’s pretty clear which things are really needed and which components of this infrastructure layer are obvious value added to developers.

Aaron Harris [10:01] – What are those?

Olaf Carlson-Wee [10:03] – For example, a project like Filecoin, which is launching pretty soon, created by Juan Benet, who actually was also a YC alum. Filecoin is basically decentralized server-client architecture. So Filecoin is an incentive layer for the IPFS server system. So IPFS, instead of being location-based addressing like IP addresses, it’s actually content-based addressing. So when you click a link in the IPFS network, instead of being routed through a specific server, you’re routed to the nearest server that has a specific piece of content. What that means is that you can have a totally decentralized architecture where you have redundant hosting from many nodes across the network, and you pay Filecoin in order to submit requests to those nodes. So it’s like a distributed server architecture. Right now, you see a lot of distributed services, say OpenBazaar. OpenBazaar is a peer-to-peer marketplace, sort of like a peer-to-peer eBay. Well, OpenBazaar, right now as a user, you actually have to download an application, like a DMG, to your computer and run it locally and basically run a node in the network. This is not a great user experience. This means that in Web 3, you’d have to download a new application, sort of like it is on mobile, instead of being able to just go to a URL in the browser. With the IPFS network in place and Filecoin, which basically adds high uptime and fast bandwidth and resiliency to the IPFS network because it has this incentive layer, IPFS is mostly hobbyists right now before that Filecoin incentive layer gets added. Then, when you visit OpenBazaar in the browser, you can have a better user experience and it’s like a more clean experience of this Web 3. So Filecoin to me becomes a clear infrastructural component that’s just a huge missing layer here right now.

Aaron Harris [12:03] – So does that mean that, basically, there’s like the use case for IPFS and Filecoin is predicated on OpenBazaar being a thing, or something like OpenBazaar. There will be other things. Is the argument, then, “Okay, an OpenBazaar is fundamentally a better solution to the problem of buying and selling things than today’s centralized systems like eBay?” Do you have to believe that to be true, or is there some other world in which, no, these things actually exist side by side, some people use one, some people use the other, and because the economy is just so damn big and this thing is just, it’s all just going to get bigger, there’s two winners?

Olaf Carlson-Wee [12:42] – Yeah. I think that over the long term, it’s possible a lot of Web 3 services will compete on cost structures with centralized services like, say, eBay. But that’s actually less interesting to me. What’s interesting is what these kind of Web 3 services do that a normal web service could not do. Because the eBay experience is actually pretty solid for buyers and sellers. It’s all smooth. I buy stuff on eBay. I think the fees they charge are reasonable, given they have services, value add services, like dispute arbitration, ’cause all those sorts of things are kind of then independent on something like the OpenBazaar platform. But I do think there are going to be Web 3 apps that really are uniquely enabling behavior, so types of things that we really can’t get out of Web 2.0 or the centralized Web. And this is a hand wavy answer, but I do have this intuitive feeling that we actually don’t really know what a lot of those use cases are. And what we’re talking about is services for things like DAOs, a DAO here being a decentralized autonomous organization that’s basically a pooling of capital on the blockchain. When you think about a DAO pool of capital, I don’t think it can realistically engage in traditional legal arrangements, but it can enter into smart contract or software-based legal arrangements. So I actually think that you’ll see more and more services for DAOs, with DAOs here being just basically global pools of capital that exist only in the blockchain and not in a legal entity. So these are the types of things. They sound a little bit sci-fi right now, but I think in five years, we could see some massive, massive … It’s like in the early internet, I think it was hard to imagine Facebook. And I think there’s this video I’ve seen of Marc Andreessen explaining Netscape in like 1994, and an audience member says, “What are some websites you think are interesting?” He really stumbles. He really struggles to answer the question. And he kind of comes back to, “Well, this is really great technology. I know cool things are going to happen. Today, I don’t really know what to point to.” And I feel like pointing to things that are ostensibly better versions of the centralized Web or efficiency gains on the centralized Web is sort of the easy path. It’s kind of like, “Oh, let’s take something like a library and put it on the internet.” The kind of layer two or native internet application is Wikipedia, which you couldn’t really have in a non-internet environment. So I think we’re going to, at the beginning, be comparing or trying to port, rather, Web 2 things onto this Web 3 or decentralized, user owned Web but that over time we’ll find those Web 3 native applications, and those are the things that I really care about, even though right now they do sound somewhat sci-fi and I think it’s very unclear what they look like.

Aaron Harris [15:54] – Yeah. I think there’s kind of this, the way that I’ve tried to think about it and I’d love to know if this is wrong ’cause it probably is is that the argument being made now is sort of that there is this protean mass of things happening. It’s sort of like the primordial goop from which life originated and the blockchain technologies being built now are the early amino acids. We don’t know what’s going to happen. And it’s entirely possible the whole thing is going to go to zero, that nothing will happen out of this attempt. But if you own a piece of the right amino acids, essentially, those are going to create something. Something is going to happen when you have enough creative energy focused on a small enough surface area that we will see.

Craig Cannon [16:40] – Yeah. But even in addition to some people making money, I think it makes sense now to talk about what we were talking about before we started, which is, what are people not understanding in what’s covered? How’s cryptocurrency portrayed in the media? And then, what are things that people are essentially getting wrong or not covering that are hurting people from understanding the creative power that they might be able to have?

Olaf Carlson-Wee [17:04] – Yeah. This makes me think of something that I saw Naval Ravikant, who’s a backer of mine, tweet, and he’s a great thinker in the cryptocurrency space. And he said something along the lines of, “Bitcoin is the largest fear of kings and those in power across the world dressed up as a get rich quick scheme,” something along those lines. And I really do think this idea that in the mainstream kind of cultural consciousness, cryptocurrencies I think mostly are perceived as a get rich quick scheme. And I actually think it’s an amazing bootstrapping mechanism to get a lot of speculation into the space, liquid markets, incentives for developers, and ultimately people building on these technologies. So I’m actually not necessarily against, per se, a lot of the speculation happening. However, I do think the mainstream media mostly views these as financial markets that are novel rather than novel technologies, if that makes sense.

Craig Cannon [18:09] – What are the key understandings that people don’t get?

Olaf Carlson-Wee [18:12] – Yeah. I think that these technologies are complicated, so I think a lot of people were reeling to understand Bitcoin and just the premise of a blockchain, and right when they thought they maybe understood it, all of a sudden, everyone is talking about Ethereum. And now they’re trying to wrap their head around a Turing complete language which can actually execute arbitrarily complex software in the blockchain, and all of a sudden, this concept of money or currency is a very limited metaphor for what these things are doing. And what we’re going to see is, right when you’re starting to understand Ethereum and ERC20 token, which are digital assets built on top of Ethereum that don’t have their own blockchain but are secured by the Ethereum network, and it all is kind of an order of magnitude more complex than Bitcoin, we’re now going to see just even more complicated things happening. We’re going to see Tezos, which has on chain governance where it’s an inward looking protocol that can actually use protocol rules to change itself. And something like Tezos can actually build pools of capital and incentivize developers to build on the protocol and then sort of dilute every holder of the Tezos tokens in order to reward those developers. And so now you have a protocol that incentivizes development of itself. And this is all on a native protocol layer. A lot of these things, that’s an amazing recursive feedback loop where the protocol actually builds itself in a strange way. But a lot of these things are going to be, again, another order of magnitude harder to wrap your head around, like things like DAOs, which I actually think are going to grow a lot over the next year or two. I think the kind of technology is always going to be basically a step ahead of the cultural understanding of the technology. And I think that’s okay. I don’t expect everyone to spend their days reading these protocol specifications and trying to really wrap their head around it, but I think that if you don’t dive into the technology and how it works, you can just ultimately never really have a deep understanding of this.

Craig Cannon [20:23] – This is related to one of the questions someone sent in for you on Twitter. So this is from John Light (@lightcoin), and he writes, “Most, maybe all app coin tokens are simply used to pay for some resource, like compute, hard drive space, energy, et cetera. Why is a new token needed in these cases, and why can’t we already use existing, highly liquid tokens like Bitcoin to pay for these?”

Olaf Carlson-Wee [20:47] – Yeah. So I think it’s actually a great question from John, who I actually know in real life. So I think that the disagreement that I would have is that a lot of people view tokens from a pure technology perspective. So they think, “We can do this with Bitcoin and the Lightning Network on Bitcoin or something like that which has a high throughput Layer 2 network. So why would we create a new token?” I think there is no strong reason from a technology standpoint. You could use Bitcoin for a lot of these different services, or rather Ether for a lot of these different services. However, when you create a native token, you create a different set of incentives. So for the developers who are building that network, you create a real narrow incentive around that application or around that token so that it’s not just tied to the larger value of Ethereum, which if they contribute this great application on top of Ethereum, Ether might grow in value by five or 10 percent, but that’s not really a great outcome for that founder or developer. In addition, the early backers of that application or token that sort of this app coin as John put it aren’t, if they’re just contributing to this product or service with Ether, they really don’t have this embedded incentive effect for that network to grow. Tokens in this sense are really more of an incentive structuring or like a kind of game theory hack to get really powerful network effects around a specific application. So this is kind of a rough metaphor, but ostensibly, in the United States, we all benefit from the strength of the US dollar, but when I create a new company, I create shares specific to that company, because although even though I might help the US economy and thus help the US dollar, or the underlying network as you might think about that, I want narrow network effects around what I’m building. And so I want my early backers or investors to have upside relative to my specific application, not just to the strength of the US dollar. So it’s a little bit of a rough metaphor. I don’t think it’s perfect, but I do think that tokens provide really narrow network effects and narrow incentive effects, and that’s what’s so important about them. It’s not really a technological reason but rather a game theoretic reason.

Aaron Harris [23:32] – So there are two arguments baked into that that I’m not sure how to think about, one of which is the incentive structure question itself, and a lot of the underlying message here is that money is, at the end of the day, the best incentive that you can give people to develop something. And I think there are very different opinions on this question and I know people who are motivated by money and people who aren’t, and some of those people on either side have achieved great things in life, both for themselves and for the human race. So sort of the first thing, is this the right path to say, “Hey, we’re going to break everything down, all this fundamental technology should be motivated around money?” The second question that I have is around this idea of empowering the collective to develop new things and this massed creativity versus focused creativity. And I don’t know that these are in direct opposition to one another, but one of the things you get with a central authority that does something and says, “Hey, you’re with this much, you’re worth that much,” there’s always going to be problems with the distribution of incentive there, but the thing that you get on the other side is focus of intent, which sometimes is bad when it heads in the wrong direction and sometimes is good when it’s in a positive direction. The Manhattan Project is directed focus on, “Hey, here’s the thing that we all need to do, all you great scientists. Yes, there are subgroups within that, but here’s what we’re going to do.” So I’m curious how you think of both of those things in terms of how they incentivize positive growth, I guess, and if those are the right ways to think about it or if there’s another way that I should look at this.

Olaf Carlson-Wee [25:21] – I think we’re seeing for the first time capitalism and money incentives being built into open source projects, which I don’t think we’ve ever seen before. I always cringe a little bit inside when I see the Wikipedia banner that’s like, “Please donate two dollars.” And I can’t help but think there’s a world where Wikipedia was incentivized with a token and Jimmy Wales, for his contribution to the world, actually captured a huge amount of value, in that he created a lot of value but he did not capture a lot of value, obviously, having to go out hat in hand for two dollar donations. Whereas I think that what we’re seeing now with open source projects is the creators of something like Ethereum, they’re creating a huge amount of value for the world and they’re also capturing that value. And I think that value capture and that adding this kind of capitalist, for profit mentality to open source will absolutely accelerate development in this ecosystem. I just think that, I don’t have any question in my mind that monetary incentives drive growth and drive people to work on a project. Everyone, or most people in the United States, have a job, and they mostly do that for they money. At the end of the day, that’s a big driver or incentive. No matter how much someone is passionate about something, if you pulled out all the money from it, it would be very hard for them to continue doing that in most cases. So I think adding monetary incentives to this, while it does draw in a different group of people in some ways than you’d find in traditional open source communities like hacking on the Linux kernel or something, I do think that it ultimately will dramatically increase the pace of development here.

Aaron Harris [27:19] – Okay. And then what about this question about focused effort versus distributed effort in terms of creativity and what should get built?

Olaf Carlson-Wee [27:29] – Yeah. I have a kind of open market view on this in that if you build something great then a lot of attention and capital and users will be pushed to what you build. I don’t know if I have a feeling of should or a moral sense about what should exist, but I do think that there’s massive opportunity right now in that when people do have a massive breakthrough the speed at which capital is coordinating to back their efforts is absolutely astounding, and I think it’s something that is unprecedented,

Aaron Harris [28:08] – we’ve never seen before in the world. I think that VCs and early seed investors have always had this somewhat unique access to these early stage projects through their network or something like that. And I think that in Silicon Valley, we take for granted that smart people with a good idea get funded. Now we’re seeing that on a global scale, and we’re seeing these things happen much faster, and we’re seeing huge amounts of capital be coordinated by just pure incentives around projects.

Olaf Carlson-Wee [28:44] – So it’s early days, and it’s hard for me to tell this sort of crowd sale or so called ICO fundraising, how this will play out, but I do think over the long term we’re actually only seeing the very, very beginning of this, even though crowd sales are now raising more money than seed round deals in dollar terms, which is kind of astounding. I mean, this whole concept of a crowd sale is maybe two years old, and really in the mainstream spotlight about six months old, and yet it’s already surpassed seed round financing in dollar terms, and I think we’re in sort of a hypey moment right now, but over the long term, I think this trend is very real and here to stay.

Aaron Harris [29:28] – So I completely agree. The speed with which this has happened and the amounts of money getting diverted to it are mind boggling. Has the distribution of capital into the ICOs matched your model of innovative technology?

Olaf Carlson-Wee [29:44] – No.

Aaron Harris [29:46] – So what’s actually driving? How off is it?

Olaf Carlson-Wee [29:51] – It’s kind of like a dartboard. It’s like a 50 percent. It’s what you’d expect. It’s like a 50 percent hit rate. So for example, Tezos, I’ve talked about Tezos a lot. It’s well known that we were their first backer and largest backer, long before they were known as a public project. They’ve now raised what I think is the largest crowd sale of all time, over $200 million. And so in that sense, I think the market got it right. I think it’s one of the most exciting crowd sales, maybe the most exciting crowd sale that’s happened. And it also got the most money ever. So to me it’s like, “Okay, the market was right, maybe on accident, but the market was right there.” There are other projects, I don’t want to badmouth anyone specifically, but there are lots of other projects that have raised huge amounts of money and have had huge amounts of hype with very little real progress beyond an idea. Tezos, like the white paper was written in 2014. If you go back and read that, it’s amazing how accurately it predicted the future and a lot of problems that would face major blockchain projects like Bitcoin. And a lot of the new projects, it’s like they’re rushing to create a lot of hype very quickly and raise capital, and it ultimately feels like they’re using it more like a fundraising round and a way to amass capital than a means of distributing tokens and building a really powerful user base and network effect, which I think the power of these crowd sales is that. Yes, you can raise money this way, but in a sense, crowd sales were originally a solution to the token distribution problem. If you go back in time before people did crowd sales in mass, there was a project called Counterparty that did a proof of burn. And what this meant was they raised Bitcoin and provably destroyed the Bitcoin. And this was just a means of distributing the token, and they didn’t hold that money, which now feels like almost a little silly. It’s like, “Wow, you should’ve just held that money and used it to fund development,” which is what projects are doing now. But it’s like this was actually first envisioned as a means of distributing tokens, and I think at a latter stage envisioned as a means of fundraising. And so I think that a lot of these projects that are structuring crowd sales also in ways that incentivize a kind of first come, first serve, mass rush for the doors, basically that all the excess value between the cap on the crowd sale and the eventual market price goes to traders, or what I would maybe call ticket scalpers, rather than developers or authentic backers or users.

Craig Cannon [32:46] – So there is a question from Twitter, again, related to this. So @JesseJumpcut asked, “Protocols like Ethereum are exciting for developers and investors, but not seeing much excitement from actual users using the apps.” What do you think?

Olaf Carlson-Wee [32:59] – Yeah. I think it’s accurate that right now we’re absolutely still in a speculative phase more than anything. I think this is true, by the way, of Bitcoin and Ethereum, as well, not just crowd sales. With that said, I think a lot of these services, speculation actually is very important to drive those eventual network effects. There’s two reasons for this. So one is that a network effect, building a network effect, has traditionally been this chicken and egg problem, that it’s like, if I’m the first user on Instagram, it’s not a very good service. But if I’m the 10 millionth user on Instagram, maybe it’s pretty good, and if I’m the billionth user on Instagram, maybe it’s great. But it really depends on amassing a crowd of people all at once in order to get off the ground. And Instagram had a very big launch day, and I think it’s one of the reasons the service has been successful over time. So by driving in a lot of early people just through speculation, I think you sort of bootstrap that network effect in a little bit more of a raw way where you have this whole speculator base that in the future many of them will become users. And there’s this concept in Bitcoin that I think is sort of new to this asset class, where you see in Bitcoin a lot of people speculating on Bitcoin and also using Bitcoin. And they’re like a holder/user. They’re speculating, yes, and they have an unhealthy percentage of their life savings in cryptocurrency, but they’re also really fascinated by the technology and actually experiment a lot with different things and want to spend Bitcoin whenever they can. I think you bootstrap network effects with speculators, and then over time, the network becomes authentically valuable in the way that traditional networks like Instagram become valuable, and then you move from 95 percent speculation to five percent speculation over, say, 10 years of something becoming useful. The second thing is that a lot of these services depend on a market price and liquidity in order to function. So going back to something like Filecoin, with Filecoin, if I’m hosting a node in the IPFS network and I need to actually host all these various servers for the backend servers for services like OpenBazaar shops, I need to know, what kind of fixed cost can I put into this and how much money can I expect to receive from this? And if Filecoins don’t have a clear price in USD where most of my fixed costs are going to be denominated with a relatively liquid market where I know if I earn my filecoin I can sell it reliably, it’s very hard to know how much to invest into this. And it’s very hard to incentivize nodes to create high uptime, resilient, high bandwidth nodes in these various networks. And this is like Bitcoin mining. It’s very hard to incentivize someone to mine Bitcoin until they know how much Bitcoin is worth, right? And then once you have these liquid open markets, that was a really big part of what pushed Bitcoin to become successful, because before that, miners really couldn’t, they couldn’t liquidate Bitcoin and mining was sort of a hobbyist thing. No one was really going to invest money in mining when there is no clear outcome in terms of what it’s worth in dollars. And because many of these services, as they reach scale, rely on professional operators, like node operators or miners or validators, keepers, whatever you want to call these participants in the network that actually support the network, it’s very, very important that they have a liquid price and liquid markets so they can invest in their businesses, basically.

Aaron Harris [37:05] – For something like Tezos, which has now had over $200 million in funds raised, how much of that, or how much money do you think they actually need or actually makes sense, and I’m just using them as an example, for the development of the company itself underlying the protocol?

Olaf Carlson-Wee [37:26] – Yeah, absolutely. And to be clear, there’s just a nonprofit foundation in Switzerland, similar to the structure of the Ethereum Foundation, for Tezos. So I think in the old model of venture funding and thinking about, “How much cash does a company need to execute on the Tezos vision?” They absolutely don’t need $200 million. They’re a really smart team, and they just don’t need that to execute some level of the vision. Now that said, the market is pricing Tezos at $200 million, basically market capitalization. So a lot of people have called for teams to cap their crowd sales, but the thing is that’s tricky about that model is that when you cap a crowd sale at, say, 20 million, which maybe in venture terms is more like the amount something like Tezos would raise, now the market is going to take the value to 200 million because that just is the market demand for this product. But that means $180 million of excess value basically goes to these traders or ticket scalpers, and it’s the same reason that some Britney Spears concert sells out so quickly on Ticketmaster. It’s not authentic users. It’s people coming in for a trade. They’re going to buy it quickly and then resell it. And this has two negative effects. One is that a huge amount of value, actually more value than is captured by the developer team, is captured by basically traders. And I see no reason why that value shouldn’t be captured by the developer team. I would much rather have Tezos have $200 million than $20 million. I don’t know why that 180 million should go to traders. The second aspect of that is that you actually hurt your authentic users who want to be either like a long term holder and follow the project or like a developer who wants to tinker with the Tezos tokens, you exclude them from the crowd sale because the traders are sitting there, ready to make the click on the first second. They might have co-located nodes around the world to participate on the first block. It’s just hard to compete with as a regular user. While I do think that these, an uncapped sale like Tezos, raise more money than the team strictly needs to execute the short term or midterm vision, I do think that that value is going to go somewhere, and I would rather have it go to the developer team than traders.

Aaron Harris [40:06] – But isn’t that true at $200 million as it is true at $20 million that the order of magnitude is different but you could still have traders or financial buyers, speculators, buying $190 million worth of the offering versus $18 million of the 20 million in either scenario? So you could still have the vast majority owned by speculators, which might leave too little there for the developers.

Olaf Carlson-Wee [40:32] – Well, and so I think long term speculators are maybe okay, like a group like Polychain that buys Tezos and intends to hold it for a very long time. That’s a different group than what I’m talking about, which is that they’re very narrowly looking to basically arbitrage between the capped crowd sale limit and the eventual market price.

Aaron Harris [40:53] – But sorry, and I’m just pushing on this ’cause I don’t, I get that the size of the number is different, but there’s nothing, is there something about, let me ask this, is there something about the way the crowd sale was conducted that stopped even short term speculators running it?

Olaf Carlson-Wee [41:09] – Because the Tezos crowd sale was uncapped so there was no limit on the amount it could raise, that’s why it raised $200 million. They put no limit, which means that the crowd sale participants put in their capital, it’s $200 million. Hypothetically, when Tezos goes live and is traded on markets, it should trade at like $200 million. There is no free trade or upside between the crowd sale and between being listed on liquid markets, where when you do a capped crowd sale and the cap is below the eventual market capitalization once it reaches liquid markets, every single person that gets in on the crowd sale is basically getting a free winning trade. And that creates bad incentives for people that have no interest in the project, they don’t know what the technology is, they’re not a long term holder, they’re not a user or anything, to come in and purchase the crowd sale and then just sell it literally days later.

Aaron Harris [42:08] – I see. So when does Tezos go to liquid market state?

Olaf Carlson-Wee [42:13] – Tezos probably will in about three to four months.

Aaron Harris [42:19] – Okay. I agree that eliminates day trading, but three to four months is not a long term positive holder. If you look at this, so you’re Polychain. If there are other hedge funds out there that are looking at these things and they say, “Yeah, you know what? Three to four months hold time, you already have a 90 day hold time, or a 90 day rebalancing time, that is very much within the window of rebalance or speculation.” So I love this idea that saying, “Okay, no, this is going to incentivize the right kind of users to come in,” but it feels as if you really wanted to do that, you’d actually want the liquid point to be something along the lines of a year or two or three or four years out, at which point a couple things happen. One, there’ll be enough development on the protocol to make it really usable, and it’ll start the second order effect of people building things on top of the protocol, and at that point, you go liquid. The financial speculators are washed out of that market ’cause they’re not waiting three years. But the developers, who are really long term minded, are happy to hold for three years. And if it’s 200 million, great. If it’s 20 million, great. If it’s a billion, great. So why not do that? Why not say, “Look, we’re going to turn this into a liquid market in three years?”

Olaf Carlson-Wee [43:30] – Part of the reason is it doesn’t take three years to develop the protocol, so it would be an artificial hold. Also, the space changes so quickly. Keep in mind, Ethereum was launched less than two years ago, did not exist two years ago today, just absolutely did not exist. That artificial hold period I think is maybe too long. The other thing is that I think it can be a little dangerous from an execution perspective, and we’ve seen these problems with Kickstarter, for example, where if you raise a bunch of money without building anything “We’re going to use the money to build something,” sometimes you can’t execute and it results in a really bad outcome. Whereas if they raise money from only sophisticated investors that understand the risk, like a group like Polychain, which Tezos did before the crowd sale, then the crowd sale really acts as a distribution and launch more than it is a fundraising event to build the protocol, if that makes sense. The other things is that these protocols are actively maintained and developed for years and years and years. So the launch moment, while not arbitrary, obviously that’s super important, it’s just the beginning of a very long future of adding features and efficiency improvements and all the rest.

Craig Cannon [45:05] – Okay. So then @JesseJumpcut, asked another question just about protocols in general. Which ones are you excited about?

Olaf Carlson-Wee [45:15] – I’m very excited about 0x. 0x is a decentralized exchange and order book that lives in an Ethereum smart contract. So the idea is, like my former employer, Coinbase, runs a cryptocurrency exchange. But you have to go to the centralized exchange, sign up, create an account. There are some restrictions on where you’re based in the world, all sorts of other things like that, and there’s just high friction. And then you have to deposit money and trade on a traditional centralized exchange. And then there’s also historically big counter party risk here, like Mt. Gox, which was hacked. A lot of other exchanges, I won’t name names, have been hacked. And so it’s actually sort of dangerous to hold your funds on a centralized exchange, in some cases. I think Coinbase is the best in the world at security. But when I look at 0x, it lives in a smart contract, so it allows you to basically instantaneously trade between Ethereum and tokens or tokens for other tokens natively in this Ethereum smart contract. And because this Ethereum smart contract is just like a piece of software, the 0x exchange capability can be built into any application built on Ethereum. So if you’re using some casino game that takes specific types of tokens in Ethereum and you run out of those tokens, you could natively, within the app, use the 0x protocol to exchange Ether for tokens. It should take one block, which in Ethereum is 17 seconds. You now have your new set of tokens and you can trade more or play on this casino game or something. So this idea of 0x and their exchange protocol being actually baked into every DApp, or decentralized app, that’s built on the Ethereum protocol is really amazing to me. So it just will facilitate this extremely fluid exchange of token for token and the ability to go from Ether to other token and token to another token is going to become very, very fluid. It’s going to be baked into the user experience, and it’s going to take like 17 seconds without needing to sign up for a centralized service or take on any of the counter party risk that you take on holding your funds on a centralized exchange. So 0x I’m very excited about. I’m also really excited about Maker. Maker is pretty complicated if this already wasn’t all too complicated. So Maker is trying to create a stablecoin. So this coin is pegged to the IMF currency basket, which is itself is trying to be like a steady basket of stable fiat currencies. Maker is creating a token, ERC20 Ethereum token, called the DAI. The DAI is pegged to this currency basket. And there’s market mechanisms that make the DAI either harder or easier to create based on how its market price is pegged to this currency basket. So basically, if it goes off the peg, it becomes harder or easier to issue DAI in order to keep it to that peg. And what you do when you issue DAI is you actually collateralize other Ethereum-compatible assets, so Ether or Ethereum tokens, in a smart contract in a value that exceeds the DAI you’re creating. If you want to create one dollar worth of DAI, you collateralize like a $1.50 worth of Ether. And so it’s like the DAI is basically backed by collateral that’s held in smart contracts as Ethereum-compatible assets. What this is getting at, this is all, I know that’s a lot at once, what this is getting at is a decentralized stablecoin, so a coin that is volatility free but isn’t backed by a centralized bank account which is a huge weakness from a compliance, hacking perspective, from so many different perspectives. And so now, if Maker works, basically DAI issuance has an interest rate, and that interest rate gets paid to Maker holders. Maker holders also determine, through a DAO structure, so a decentralized voting structure, what the interest rate and collateral requirements are to create DAI. So the Maker DAO, which is the decentralized organization that decides those things, is like a crypto central bank for this decentralized stablecoin. And I just find that concept totally fascinating. Now, this project is very experimental. Amazing team behind this. But this is the type of thing that I think we will see emerge over the next few years is volatility free crypto coins, and I think that’s huge, because if you’re going to see a lot of other applications work like Augur’s prediction markets or OpenBazaar, just e-commerce markets, you need a stable stored value. You could bet in an Augur prediction market and be right but then actually lose money because of volatility, and that’s a horrible experience, or bad user experience. It’s going to really limit the ability for those markets to gain adoption, and even for something like OpenBazaar where your money might be held in escrow for a couple days, you might end up paying a lot more or less than you thought or earning a lot more or less than you thought from an e-commerce transaction, which has very narrow margins. You’re talking about three, four percent margins in e-commerce. So to me, something like stablecoin and the Maker project is really exciting, as well. So yeah, those are a couple.

Craig Cannon [51:09] – Yeah. Are there other concerns you advise people to think about whether they’re going to put money in? I’m thinking chiefly on the regulatory side right now, but both people developing tokens and putting money into tokens.

Olaf Carlson-Wee [51:24] – I would urge anyone who wants to invest in tokens to know what they’re investing in and really do their research and understand that this is a basically experimental and highly volatile market. Don’t do anything unless you know what you’re doing, basically. For people that are creating these things, this is a much longer conversation around, do you create a sort of parent entity, like a nonprofit foundation? Where is that foundation located globally? The main places that are turning out to be friendly either from a regulatory and or tax perspective here are Switzerland, the Cayman Islands, Hong Kong, Singapore, to an extent, Gibraltar. And then there’s a handful of teams experimenting with other locales, as well. And I think we have yet to see how that plays out. I think that that is, yeah, it’s a longer conversation, definitely.

Craig Cannon [52:29] – Okay. If someone wants to dig deeper, are there blogs you read or what do you recommend?

Olaf Carlson-Wee [52:34] – Yeah. The problem is that just not that many people have even gone through that process, and not that many people have gone through it in a really legitimate way. I think that the IPFS team is a really great resource here, so in so far as Juan or Jesse from that team has written blog posts, or like the CoinList project, which is a partnership between IPFS and AngelList, I think they’re maybe thinking about this the most carefully, from a US-centric perspective, as well.

Aaron Harris [53:09] – Thank you so much, Olaf. This was super fascinating.

Olaf Carlson-Wee [53:11] – Yeah, thanks, guys. I can’t believe that the hour is already up.

Craig Cannon [53:14] – Yeah. Thanks, man.

Aaron Harris [53:16] – Yeah, thanks for chatting.

Craig Cannon [53:18] – Okay, thanks for listening. So as always, you can read the transcript or watch the video at blog.ycombinator.com And don’t forget to rate the show and subscribe. Alright. See you next time.