Last Friday, Yale, the iconic long-term investor that other endowments look to for guidance, made a historic investment in two funds dedicated to crypto, signaling to many that institutional floodgates are officially open.
As the manager of one of the more established cryptofunds, we often get asked, “How big can crypto really get?” The short answer is: much larger than most people recognize.
There are a couple reasons for this. First, crypto is massively market expansionary (e.g., how many thought Uber’s addressable market was the size of the pre-Uber taxi market). And second, Crypto will absorb the monetary premia of many non-money assets that act as an inflationary hedge.
Note: all references to USD are specifically to 2018 USD.
The value of all the gold in the world is about $7 Trillion.
The industrial value of gold (for use in electronics) does not support a $7T valuation. Rational market actors continue to purchase gold at these prices because gold is considered a hedge against fiat inflation. This is true despite the fact that humans continue to mine an amount of gold each year that implies 1.5% inflation, and we don’t have any reason to believe this will slow down in the foreseeable future.
All base-layer (not layer 2) cryptocurrencies are digital gold in that they are not subject to fiat inflation and can serve as a hedge against fiat inflation in a portfolio. Even a cryptoasset such as EOS, which is not generally considered a digital gold like Bitcoin, inflates at only 1%/year compared to gold’s 1.25%.
All cryptocurrencies – including Bitcoin, Ethereum, and many others – share a few key characteristics:
As a store of value, gold is almost entirely inferior to crypto, except that gold has been around longer. Overtime, cryptocurrencies will consume the vast majority of the market value of gold as investors seeking an inflationary hedge sell precious metals for cryptocurrencies.
Expanding The Digital Gold Market
Most people who read this essay will have the good fortune of living in an advanced Western democracy with a reasonably stable fiat currency such as USD or EUR. Many of these people don’t feel a strong need to hedge their balance sheets against the effects of inflation.
However, most of the world doesn’t have this luxury. There isn’t data to substantiate this, but I suspect that somewhere on the order of 75-85% of the world’s population would choose to store their net worth in a currency that’s not their local currency. Consider a simple thought experiment:
If you were forced to store 100% of your net worth in a single fiat currency, would you consider anything other than USD, EUR, CHF, GBP, or JPY? These countries combined account for about 1B of 7B people on the planet.
The very people who want or need to escape their local fiat currency cannot. Argentinians, Venezuelans, Iranians, Turks, etc. overwhelmingly do not have access to securitized gold that trades on regulated exchanges. Even if there was a local gold vault in each of those countries, citizens would be suspicious: In the event of political turmoil, the integrity of the vault could be compromised by insiders or the populace.
Cryptoassets are entirely permissionless. To store crypto, someone only needs a smartphone (which are available for less than $30 now) and an internet connection (a sporadic, slow, unreliable connection is sufficient). With those two things, anyone on the planet can access a state-free wealth storage mechanism. This was never before possible. As these ~6B gain the option to store their wealth in a state-free money, they will increasingly opt to do so, dramatically expanding the size of the digital gold market dramatically from $7T.
It’s difficult to overstate the magnitude of this market expansionary effect. For the first time in modern human history, people will have the choice of storing their wealth in state-free money as opposed to their local fiat currency. Weak governments will collapse, causing mass migrations away from fiat currency.
At least $93T of value is stored in fiat today. It’s impossible to forecast with any reasonable precision the size of this market expansion for digital gold as people choose to trade in their fiat for crypto. On the low end, I suspect this means the size of the digital gold market is $30T, but it could be upwards of 10x, or $70T.
The obvious counter to this is that the 85% of the world’s population that doesn’t currently have access to state-free money doesn’t collectively control that much wealth, and therefore is unlikely to expand the size of the market by 10x. However, this fails to recognize that all liquid assets are priced on the margin. A single dollar invested can increase the nominal market cap of an asset by substantially more than one dollar.
The world’s elite store $20 – 30T of their wealth in offshore bank accounts. These assets are held with the explicit intention of hiding assets from governments such that they cannot be easily seized or taxed. Cryptocurrencies are bearer assets. Absent threats of physical violence, governments cannot seize cryptoassets.
As investors come to understand the power of crypto, and more specifically privacy coins such as Monero, Zcash, Grin, Tari, and Mobilecoin, they may move substantial portions of this wealth – which are still subject to the whims of some government somewhere – into self-sovereign crypto currencies.
It’s unclear how much of this wealth will flow over, especially given the volatility in crypto, on a long time scale, it’s reasonable to expect material asset flows.
Deflating The Monetary Premia Of Productive Assets
Since President Nixon took the USD off the gold standard, investors have increasingly stored their wealth in all kinds of non-money assets to escape fiat inflation (that essay by Nick Szabo is excellent, by the way).
The assets that have absorbed these flows away from inflationary fiat are real estate, debt, and equities. As central banks have printed exorbitant amounts of money over the last decade since the financial crisis, they’ve primarily purchased debt. This artificially raises the price of debt and lowers yields, which then causes investors to allocate even more capital to other asset classes, primarily real estate and equities. As such, a massive amount of the world’s wealth is being stored in debt, equities, and real estates specifically as a way to avoid fiat inflation.
The global real estate market is worth about $225T, of which $30T is in the US. Global equities are worth about $73T, of which about $30T is US equities. And global debt is $215T, of which about $40T is in the US. These asset classes combined are worth about $513T.
It seems likely that 1- 5%, or $5 – $25T, of that value is not actually productive value, but rather a wealth storage mechanism. Although it’s impossible to measure this, it’s visible in the PE ratio of the S&P 500, as well as the massive number of purchased but unused condos in mega cities in like New York and London.
Cryptocurrencies are a better wealth storage mechanism than debt, equities, real estate, oil futures, fine art, and other assets that have developed monetary premia for all the reasons outlined above. Additionally, cryptocurrencies are bearer assets and cannot be seized, are not subject to real estate taxes, don’t have be turned over frequently like oil futures (beneficial tax treatment), and are fungible and liquid (unlike real estate).
Although it’s come to be accepted that many assets can act as a store of value to hedge fiat inflation, I assert that on a long enough time scale, we’ll look back and think it was crazy that non-money assets ever gained a monetary premia that’s measured in the tens of trillions of dollars. Now that we have objectively better state-free money, capital will slowly flow out of these non-money assets into money-assets, of which cryptocurrencies are by far the best option.
Tokenizing The World’s Assets
Real estate, debt, equities, and electronic fiat currencies comprise the vast majority of the wealth in the world, and none of these are bearer assets.
Record keeping and asset transfer within each of these asset classes is separate. The systems that manage these assets are complex, opaque, slow, and rife with fees.
If we could re-architect all asset ownership systems today without any historical baggage, how would we do it? On a technical basis, the answer is actually quite clear (if you don’t fully understand the next paragraph, that’s ok):
Asset owners (or custodians) generate private keys, sign messages indicating asset transfer, and then broadcast those messages to the public so that the world can verify the scarce asset hasn’t been double spent. Each private key is tied to a public key. Where KYC/AML are necessary, public keys can be mapped to some off-chain identity system (e.g. tax ID).
Or in other words, a blockchain.
All of the world’s assets – which exceed $700T – will be tokenized on blockchains, including fiat currencies. Some of these chains will be permissioned, and others will allow central banks to print money. But all of the world’s wealth will be tokenized.
There’s a real probability that the world’s assets tokenize on a public, permissionless chain. And if this happens, this chain will come to secure hundreds of trillions of dollars of value.
In all blockchains – both proof-of-work and proof-of-stake-based systems – security is primarily a function of the aggregate network value of the base-layer token, and secondarily a function of rate of inflation.
Or in other words, blockchains are only as secure as they are valuable.
This is circular, and the source of a powerful network effect.
As explained in this essay, the chain that secures all of the world’s assets must be valuable. We don’t know if $1T of base layer value can secure $10T or $100T of value on top, but my intuition is that the appropriate ratio is somewhere between 1:10 and 1:100 (security bounds for attacking public chains is a rather technical concept that is beyond the scope of this essay).
What’s the justification for this range? At the current level of scale of the crypto markets, these ratios could be dangerous. However, as an increasing percentage of the world’s wealth is stored on blockchains, the law of large numbers becomes real, making it harder on an absolute basis to attack the system. The question then becomes, at what ratio does security fail? Even if $500T is stored on public chains, at a 1:1000 ratio that would imply that the base layer chain is worth just $500B, and that it could be attacked for a few percent of that. My intuition is that this is too aggressive of an assumption, but that somewhere on the order of $5-50T of value can secure the network against any attacker.
It’s unclear if and how investors will choose to store their assets in the native state-free money that secures their remaining assets. However, when combined with the argument presented in the next section, this becomes more compelling.
An Honest, Transparent, Market-Driven, Global, Risk-Free Rate
If you define inflation not using CPI, but instead using the amount of money that the government prints, then most government T-bills around the world offer negative real interest rates.
This is insane.
In fixed-supply, proof-of-work (POW) systems like Bitcoin, the liquidity market of the lightning network will set the risk-free rate of the system. In proof-of-stake (POS) systems such as Ethereum 2.0 and EOS, the risk-free rate of the system will be the yield earned by staking one’s assets.
If an investor elects to lock up capital to earn the risk-free rate in a POS system, even in the case of perpetual inflation, she is guaranteed to beat inflation. Given Bitcoin’s hard cap, investors who provide liquidity to the lightning network will beat inflation as well.
In the long run, this will change how asset allocators think about risk-free rates, yields, and risk premia for all other assets. This will ultimately accelerate and expand the capital flows out of other assets and into crypto.
The obvious counter to this idea, specifically with reference to proof of stake systems with long unbonding periods (e.g., Ethereum’s Casper) is that cryptoassets will still be at least somewhat volatile relative to the USD, and that this rate of return is not actually risk-free relative to USD. In practice, investors won’t have to worry about this as they can hedge this risk by selling futures at the time they choose to begin unbonding.
In macroeconomic terms, the only way that humans produce new wealth on a global basis is by increasing the value they add to the production process, which requires specialization, and is ultimately measured through trade.
(Violence and inflation do not grow the pie; rather, they simply change ownership of the existing wealth, and in many cases may actually destroy wealth.)
Prior to the invention of the joint stock corporation, companies could not meaningfully scale beyond the level of one’s immediate family. The invention of the joint stock corporation in the ~1400s changed this, allowing investors to pool risk and share in rewards. This invention – a new way to coordinate human economic activity – facilitated one of the greatest explosions in wealth generation in human history.
Over the last 100-150 years, this has dramatically accelerated as the financial system established the means to scale the concept of equity from private markets into public, liquid markets.
For the first time since the invention of the joint-stock company, smart-contract platforms such as Ethereum, EOS, Dfinity, Algorand, Kadena, Tari, Solana, and others facilitate fundamentally new forms of economic activity that were never before possible. This will ultimately result in not only more trade, but more efficient trade, accelerating the pace of wealth creation by opening up new design spaces that we cannot even imagine today.
As the global economy becomes both more international and local simultaneously (at the expense of intra-national trade), there will be massive opportunities to connect supply and demand in ways that were never before possible using smart contracts. Moreover, as Chris Dixon has written about here and here, modern-day giants stifle innovation.
The aggregate impacts of frictionless and programmable value flow are impossible to forecast at this stage. But if the general hypothesis is correct – that smart contracts unlock new forms of trade and guarantee that incumbents cannot stifle innovation – then the magnitude is likely to be measured in the tens of trillions of dollars.
This is broadly called the Web3 vision or the Internet of Value.
Adding It Up
To understand the magnitude of the opportunity, let’s add it all up:
All together, there’s a clear path to $50T, and a plausible path to $100T.
I need to state this as clearly as possible: everything described above is compatible with the continued dominance of the USD, EUR, and other major fiat currencies.
Crypto doesn’t need to challenge the legitimacy of the USD in order to achieve a $100T market cap. Rather, crypto will challenge the legitimacy of weaker currencies such as the Venezuelan Bolivar, Argentine Peso, etc. and deflate the monetary premia of real estate, debt, and equities.
The only remaining question then is: How do we get there?
I’d like to specially thank Murad Mahmudov for providing the inspiration for this essay, and for providing feedback on it. I’d also like to thank Fred Wilson, Albert Wenger, Matt Huang, Cindy Cheng, Micky Malka and the Multicoin Capital team for their feedback and input.