Market Mapping Crypto

Since the publication of Bitcoin’s white paper 10 years ago, an entire ecosystem of entrepreneurs, companies, and capital have mobilized around crypto to create a new asset class. As the emerging asset class enters its teenage years, suites of products and services are vying to become pillars in the high-potential crypto ecosystem.

Crypto’s market map continues to grow in both its complexity and in its structure. This post seeks to present a framework of the burgeoning crypto industry, with select examples in their respective segments. It is not exhaustive.

2019 Crypto Market Map

The framework presented above separates the current crypto ecosystem into two overarching categories: crypto-enablement and crypto-native. As the crypto ecosystem continues to mature and professionalize, I expect both developments from crypto-enablement and crypto-native to begin to overlap and complement each other.

The crypto-enablement category consists of companies that are building atop centralized infrastructure. On the institutional side, companies like Fidelity and Square (at $2.5T AUM and $30B market cap respectively) are positioning themselves to be significant players in the crypto ecosystem in the long run. These large institutions, alongside centralized tech startups like Bakkt and Xapo, are offering a variety of crypto-related services such as digital asset exchanges, brokerage, and custody. In recent years, exchanges have been the early winners, largely driven by retail interest in digital assets.

Retail focused crypto exchanges, such as Coinbase and Binance have been early winners within crypto-enablement, as buying volumes hit unprecedented highs in 2017 and early 2018. Ultimately, companies that are building with the crypto enablement category will act as the funnel in educating and offering access to potentially billions of users. I expect less engrained market segments such as crypto lending (BlockFi) and crypto ETFs (subject to regulatory approval), to ramp attractively in 2019.

The crypto-native category is comprised of the actively forming crypto stack and its ancillary pieces: Layer 1 (L1), Layer 2 (L2), Layer 3 (L3), miners, stakers, and crypto-native accessories.

L1 or base layer protocols cover a wide range within the crypto-native stack, varying by account-based or UTXO, consensus mechanisms, flexibility, amongst other criteria. There are more than 60 smart contracting L1 protocols, as of September; ultimately I believe there will be no more than a dozen L1 protocols, but I’ll save that for another post.

L2 are protocols built atop L1, from privacy-focused, to domain-focused, to scalability-focused; these protocols allow dapps to scale to billions of users.Additionally, L2 may offer increased liquidity amongst dapps, effectively making on-chain activity higher in the stack more secure.

L3 — (d)apps are loosely defined given their interconnectivity to lower layers, especially Layer 2. There are interfaces built on top of an existing protocol (Veil:Augur, Expo:DyDX), and applications leveraging their own unique of smart contracts (DyDx). As L1 infrastructure increases transaction throughput and crypto education increases, I expect to see a wave of decentralized applications. Today, dapps often feel clunky for the average user, nowhere near the mobile app experience we’ve grown accustomed to. CryptoKitties, Radar Relay, Expo and others have made strides in making the user experience better —2019 will be an inflection point for crypto native adoption.

Offerings within the mining/staking segment (responsible for block production and transaction validation) will be fascinating to watch as Ethereum inches towards Proof of Stake, and highly anticipate protocols such as Dfinity, Algorand and Coda launch in the coming months. Bitmain and Bitfury will continue to be dominant in powering PoW protocols, where PoS infrastructure is just forming with Bison Trails and Staked as early contenders.

Crypto-native accessories — these may be features, standalone companies, or extensions of companies across the market map. Ultimately, they complement the crypto-native stack. I’ve accounted for 15 specific segments, although could easily add another dozen.

Crypto-native onramps — wallets, app stores, and crypto ATMs allow the masses to participate directly in the crypto-native stack, without the added step of Coinbase signup, digital asset purchase, delay, and transfer to X dapp.

Conclusion

When I made my first venture investment in crypto in 2015 (Chainalysis), the total market cap was below $5B. As of this writing, that number is roughly $100B with an additional tens of billions in enterprise value from crypto-enablement companies like Coinbase and Binance.

Startups, institutions, large enterprises, and users around the world are driving crypto to form an entirely new asset class. As on-chain transactions increase, crypto-enablement takes on a symbiotic role in delivering crypto to billions of users.

-Ash

I’m an early stage investor at Accomplice, focused on crypto networks and crypto enabled companies. Please don’t hesitate to reach me on Twitter with feedback, comments, or general thoughts.

Special thanks to Jeff Fagnan, Sarah Downey, Ivan Bogatyy, Katherine Wu and James Prestwich for reviewing versions of this post.

Footnotes

**the periphery crypto segment is primarily massive enterprises dabbling in crypto, but remain on the sidelines compared to all-in groups like Fidelity and Square.

**crypto funds/vc funds, structured as hedge funds or long-term venture funds are backing entrepreneurs within crypto-enablement and crypto-native.

**tokenized securities and security tokens as extensions of traditional equity, primarily enabled by Reg-A+ and Reg-D offerings.

**I’m excited to see how crypto will be introduced into existing marketplaces- as payment, escaping expensive fees, or earning crypto for contributing.

Token M&A? ICO Exits Could Get Messy

Today, entrepreneurs are flocking to the green pastures made possible by token sales, a relatively new way to bring capital into an early-stage tech company. In fact, ICOs and token sales have outpaced traditional venture funding, not only for blockchain companies, but for all companies, according to Goldman Sachs.

Given this traction, it's easy to dismiss the cryptocurrency and token markets as a bubble: Peter Schiff and Howard Marks have each voiced their concerns in the space.

However, there is enormous value in issuing tokens, and there are reasons token sales are booming.

These include:

• Entrepreneurs can bring in millions without embarking on the typical months-long fundraising roadshow. (Legendary VC Fred Wilson even believes there is a paradigm shift happening.)

• Introducing tokens often incentivizes token owners (potential users) to contribute to the network, as they now have a vested interest in the network's success. In this sense, tokens are a solution to a network's chicken-and-egg problem.

• Token sales make a company sexy again… Holding an ICO is a sure way to get media attention in 2017. (On the flip side, they may bring the wrong type of investors to the table).

• Companies are now able to raise their seed, A, B and C rounds with pre-revenue traction, and can focus exclusively on building the network and recruiting, rather than fundraising.

As a venture investor at Converge focused on crypto and blockchain businesses, I am curious how tokens will affect an acquirer's decision-making. Blockchain company buy-outs, even those without their own tokens are not yet a norm, although we've seen small acquisitions – Skry, Mediachain, CryptoWatch, Bitnet and CleverCoin.

Before retrofitting an M&A framework and jumping into the logistics of how a corporate might purchase company X with blockchain tokens, it's important to know that many of these tokens are governed via a separate entity: i.e. a foundation, often based overseas (exampled below).

Additionally, tokens offer unique properties: some pass the Howey Test (and are considered securities), many are offered via a foundation (not the company), some have immediate utility, while others may not be distributed for months to years following the token sale.

Wary of cryptocurrency FoMO (fear of missing out), corporates are having conversations on how they might acquire a tokenized blockchain company.

Corporates may want to acquire a company for the team, for the large open-source development community, or simply because the corporation finds the build-your-own token process overly cumbersome.

But, while interest is there, corporate M&A teams do not have a status quo to rely on.

Here are five possible viewpoints:

1. Company has value, tokens are irrelevant

2. Company has value, tokens seem interesting

3. Company does not have value, tokens are important to our go-forward

4. We don’t know which has value, but we want to own it all

5. This is going to be a regulatory, compliance nightmare — let’s sit this one out.

Scenario 1: Company has value, tokens are irrelevant

"We want the company, we don't care about the tokens."

The company owns the patents, the team is superb, but the M&A team does not understand why tokens are necessary for the business or how the tokens merit a high price.

For diligence, the M&A team will try to acquire the company, and ignore the tokens. Just in case, this team will check token sale documents to find out corporate structure of tokens (i.e. was it the C-corp or foundation which issued the tokens?), details on how the team is compensated and token distribution plans. If acquiring tokens is absolutely necessary, the number of tokens issued will likely have a material impact on the exit potential.

If the token market cap is high, and many of these tokens have already been issued, it will be a stretch to see a deal proposed, let alone done.

Scenario 2: Company has value, token has value

The team is great, the technology is great, the protocol makes sense and the team taps into its valuable network of users.

In this instance, there may be an existing relationship between a company and corporation exploring an acquisition. Because most of the activity happening in blockchain is experimental, or the product isn't as far as long as market cap, I think we won't see any corporate pay full equity price plus total outstanding price per token.

The structure of tokens were issued will significantly impact the acquisition price.

Scenario 3: Company does not have value, token does

This company got very lucky in being first to market, but the team is just not up to snuff – maybe there are even signs of fraudulent or malicious activity.

If the market position, developer community and technology are superb, corporates may take an active approach of buying tokens in the wild or even the outstanding tokens.

This is going to be the last strategy an M&A team wants to present to its C-suite.

Scenario 4: We don't know which has value, but we want to own it all

This is the FoMO scenario.

Whatever the reason might be (i.e. a corporation is under pressure from its shareholders and board to develop a blockchain strategy, executives realize they have no one internally who understands blockchain), price sensitivity becomes an afterthought, and the M&A team makes a bid to buy a blockchain token C-corp, alongside outstanding tokens, at current price per token.

Depending on the token acquisition strategy, this scenario could cost billions for the corporation. Biggest question for corporate is what happens to tokens in the wild? And will those token holders remain loyal? Or flock to a competitive blockchain system?

An existing company (say, gambling company Betfair) may shell out $100 million (not $1 billion) for something with regulatory advantages. Companies are clueless about peer-to-peer betting services – let alone blockchain.

Scenario 5: This is going to be a regulatory, compliance nightmare – let's sit this one out

Today's sole corporate strategy for token and C-corp M&A.

The M&A team and C-suite find the landscape difficult to follow, and are worried about losing millions on token volatility, or even how they would go about acquiring token network. Because pricing and acquisitions will be so complex, many corporates will sit on the sidelines and let their competitors dictate price, or may make their own play at the 11th hour.

In this vein, corporates may (Scenario 6) explore potential acquisitions, and ultimately release their own blockchain token, similar to what Kik is doing through Kin Interactive.

Corporates, especially public companies, will drift to Scenario 5 for the next few years, or decide that tokens have immense value and issue their own.

For all of the entrepreneurs thinking of issuing tokens, it's important to understand the downside risk maybe even more so than the benefits of bringing in extra capital. Take the long term view. Ultimately, how would you articulate the value of tokens to your potential buyer?

Other areas corporate M&A teams will analyze, not include above: Who powers the network? Miners?

As entrepreneurs, investors and corporates, we will need to think outside of traditional corporate M&A in the web 3.0 era. If you have thoughts on how tokens affect M&A, come to Boston Crypto's upcoming event, or get in touch (details below).

Ash is a venture capitalist at early-stage investment firm Converge, and led the firm's investment in blockchain startups Chainalysis and Enigma. He also runs Boston’s blockchain group, Boston Crypto – hosting a discussion on tokens September 5th. Please join if you’d like to discuss more.

Follow Ash on Twitter here: @AshAEgan and @CryptoVC. This article was originally published in Coindesk - thank you to Maia Heymann, Ty Danco and Justin Gage for reviewing this article.