Citigroup Inc. just released a research report that makes a bullish case for cryptocurrencies — an asset class that hasn’t had much to cheer about in the past two years. The thesis is that blockchain and related technologies will grow to have a billion users and trillions of dollars in value over the next six to eight years. What is missing are the implications for investors, which I will try to outline.
Henry Ford and the Lesson Crypto Enthusiasts Need to Learn
The 162-page report begins with the example of someone in 1900 who predicted the eventual massive economic and cultural change brought about by the automobile. It was not practical to invest directly. Most car startups at the time failed. Ford wasn’t founded until 1903 and didn’t go public until 1956. Shorting buggy-whip companies sounds smart, but it was no more practical than investing in car companies. Additionally, buggy-whip companies had little trouble transitioning to making similar consumer goods.
What would make sense is to realize that cars need gas, highways, and gas stations, and will create demand for motels, drive-ins, suburban housing, rubber, glass, concrete, and many other things. You didn’t have to bet on one car company or technology. Today, there is little reason to believe that massive growth in the cryptotechnology sector will increase the value of most existing cryptoassets. A more promising investment approach is to think about what general technologies will be needed if crypto takes off.
The Citigroup report zeroes in on four key technologies. All of these exist today. Invention is not necessary, but the trick will be to deliver known technologies in the right package that becomes a widespread standard in the crypto ecosystem. (I am an active crypto investor and he has venture capital investment and advisory relationships with crypto companies including the types mentioned below.)
DECENTRALIZED DIGITAL IDENTITY:
Most people have partial digital identities smeared across the Internet in accounts on various websites and perhaps a main identity managed by Google or Microsoft. It is a small problem for hackers and identity thieves to link these together and compile a lot of your personal information. It is also easy for people to fake or steal identities. On the other hand, it’s often difficult to transfer information from one place to another, such as proving to a wine shipping site that you’re over 21 or verifying your identity on your Twitter account.
There are places that give you the ability to create multiple secure digital identities that cannot be linked together. You can use one for work, one for shopping, one for friends, one for financial transactions and one for social media. Each one only discloses the information you want for that purpose, and all information is verified so others can trust it.
If crypto technology expands, there is little doubt that DDIs will be in demand. The problems now are that few individuals bother to use them and therefore few websites accept them and therefore it is difficult to verify most important information. But once the chicken-and-egg problem is overcome by growing user demand, it seems likely that a few large providers will dominate. Some may offer greater protection and be attractive to undocumented immigrants, adulterers and recluses. The big technology companies today may well enter the industry, but probably with lower levels of privacy. Some DDI vendors may specialize in the simplest interfaces, some may offer the most advanced features.
A friend of mine who earned a doctorate in social work and a law degree was struck by how everything she learned in social work classes—gathering as much information as possible about clients to provide the best help—was contradicted in law school: carefully protect and segregate all information. about clients. Certificate of zero knowledge is the solution. They provide the advantage of collecting and provably summarizing information without revealing the components that went into that summary.
An important use of ZKPs at the moment is cryptographic proof of soundness. An age-old problem that has surfaced more than usual in the past 12 months is financial institutions – both traditional and crypto – suddenly revealed to be insolvent. One solution is more disclosure, but this can put the client’s privacy and confidential business information at risk. Moreover, few people have the ability to analyze even a simple financial institution’s books. Regulators and auditors can try to do the job, promising to keep all information confidential, but they are generally too slow and crude to prevent the problems.
The solution is for the institution to run a ZKP algorithm on its own books. The ZKP app sees all the company’s internal information, but it sends out a code that cannot be used by anyone to find out the information. This code can be disclosed to the public and proves that the institution’s cash assets are greater than or equal to its liabilities – or any other required evidence, such as that the market value of assets is at least 110% of liabilities. The institution cannot simply create a code or feed false information to the ZKP app.
Crypto applications require information from the real world: how old a person is, what degrees she has, what an Uber driver’s rating is, who owns a property, etc. Some of this information can come from authoritative sources, but much of it must be encoded in distributed public accounts by private parties. Widespread use of crypto will require building a large number of secure, reliable oracles.
The weakest link in crypto is the bridges that connect different blockchains. Just as embezzlers concentrate on money transfers rather than the underlying accounts themselves, cryptohackers have often stolen money or information during transfer between applications. The problem is not in basic technology; we know how to build safe bridges. The problem is the cost. Proof-of-work networks require a lot of expensive work, such as the electricity needed to secure Bitcoin. Proof-of-stake networks require large stakes. Validator networks need many validators, each of which is expensive to crack.
Today, the resources necessary to maintain safe bridges are lacking. But the need for secure bridges goes up with the square of the number of major crypto applications, so a 100-fold growth in the latter can mean a 10,000-fold growth in the former.
Personally, I’ve accepted the basic bull case Citigroup puts out for years, but I haven’t bought many crypto tokens. I prefer to invest in technologies that will be needed no matter which specific projects win or lose, including the four mentioned above.
More from Bloomberg Opinion:
• Let them eat crypto? France makes a plan: Lionel Laurent
• Crypto fraud and modern capitalism are siblings: David Fickling
• Move over Stablecoin. A new token arrives: Andy Mukherjee
This column does not necessarily reflect the opinion of the editors or Bloomberg LP and its owners.
Aaron Brown is the former managing director and head of financial market research at AQR Capital Management. He is the author of “The Poker Face of Wall Street”. He may have a stake in the areas he writes about.
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