Thus far, cryptonetworks have used their native asset to entice early investment in their economies via two primary pathways:

Minting to supply-siders that install productive capital

Selling to investors that contribute investment capital

While investment capital can ultimately be converted into productive capital, the two are not synonymous, and value doesn’t always make the leap from investment capital → productive capital. Sometimes investment capital can waste away on balance sheets like unused kindling. The question comes down to who is first prioritized, the supply-side that installs the productive capital or the investors that float the investment capital?

Minting models like Bitcoin represent an initial capital flow that prioritizes building out a robust supply-side first, as value runs from: protocol → supply-siders → investors. The protocol mints the native asset over-time as a subsidy to supply-siders making capital investments in the network. If the only way a supply-sider can earn the asset is by providing the utility that the mechanism design demands, then the network has utility (however small it may be) with the first node that comes online. From there, investors purchase the asset from supply-siders that sell to cover capital and operating expenditures, placing investors second in line [1].

Selling supply to investors first represents an early capital flow that runs from: (promised) protocol → investors → supply-siders. In this case, instead of the protocol directly minting to supply-siders, investors first buy their way into the protocol in what represents a balance-sheet swap between the investor and the network’s treasury. Investors are prioritized and then must trust that the founders of the protocol will allocate that treasury to build out the network’s supply-side (and maybe later lure the demand-side) [2].

While both flows are viable if properly executed, and in my opinion best when combined, it is the last actor in the capital flow chain that is at risk of falling off and thereby dragging down the network.

Minting models fall flat when there’s no investor interest at the tail-end, as then the supply-siders are not able to sell earned assets at high enough prices to cover costs and must abandon the protocol.

Investment-capital-driven networks fall flat when there’s little supply-side support because no clear model was put in place to compensate them for their work, or there’s too little upside left if investors gorged themselves. With no supply-side, the protocol has no utility, and has no chance of making the final leap to enticing a demand-side and completing the economy.

We worry that many teams from 2017 over-prioritized investment capital, and still haven’t put the measures in place to stimulate the conversion of that investment capital into productive capital. We continue to work through these, and other key cryptoeconomic issues, with our portfolio teams.

Thank you to Joel, Brad, Alex and Mario for the many discussions that helped craft the thoughts above.

Notes:

[1] Bitcoin has shown that it’s possible to bootstrap a network purely by minting into productive capital, never selling assets directly from the protocol to investors. It required, however, that the software be donated, whereas most teams raise investment capital so their time is compensated during the software creation phase. In the frenzy of 2017 behavior bled into raising as much investment capital as possible, far more than was necessary to create the software, which may retard networks with capital-intensive supply-sides.

[2] Founders can deploy this investment capital via discretionary or rules-based frameworks. Both can work if responsibly managed, but rules are often less abused and lend themselves more easily to a very important characteristic for productive capital: time-consistency.

Rules allow economic agents to calculate and verify for themselves that any resources expended in supporting the network will be recouped from earnings, and the time-consistency of these rules gives supply-siders time to organize themselves, earn the reward, and then proselytize to taste. Rules also allow for magic internet money to be created over time, continually capitalizing the network, whereas if that’s done in a discretionary manner it tends to cause an uproar.

Most investment-capital-driven networks tend to discretion, while productive-capital-driven networks are by necessity rules-based.