Morningstar Magazine - February/March 2018 - 58

Investors

Morris: Blockchain is essentially a type of
decentralized protocol that was pioneered in the
white paper written by Satoshi Nakamoto
in 2008.3 Bitcoin is the cryptocurrency that resulted.
Wu: Blockchain is a useful technology even
without bitcoin or another cryptocurrency attached
to it. Because it's a distributed database with
some features for collaboration among multiple
parties, a number of companies have now
co-opted it for use on their own private platforms

blockchain, which refers to a distributed
database where transactions are collectively
confirmed. Or they could be using it as an
umbrella term for a stack of technologies layered
together to create decentralized applications
that might actually compete against some
incumbent companies. Ethereum and these tokens
are more of the latter. They're creating
decentralized applications that can potentially
supplant existing companies, particularly
digital service providers like Expedia EXPE in travel
or Dropbox in cloud storage.

Sinegal: Beyond payments, what are some of the

applications for blockchain technology?

Wu: One is in the financial transaction space,
where folks have started to invest quite a
bit in these blockchain platforms. One example
is the Depository Trust & Clearing Corp. The DTCC
is responsible for clearing most of the transactions
in the U.S. and settling them. It is planning
to move its derivatives processing infrastructure
onto a blockchain platform in the near future.
Sinegal: We are looking at the disruptive potential

of blockchain technology. The most profitable
companies we cover are based on monopoly control
of information, being a centralized counterparty
for transactions. Any of these decentralized applications the blockchain enables threatens those
business models.

Morris: To provide some perspective about what
inning we're in, when PitchBook initiated
coverage of blockchain in the summer of 2016,
I had to convince my colleagues to call it
the vertical blockchain rather than bitcoin because
there really wasn't much in the space beyond
bitcoin. Ethereum existed at the time, so we knew
the potential for it to serve as a platform for
distributed applications, but actual development
of many of these applications has only really
commenced just this year.
Wu: It might be helpful to clarify the terminology.
When people talk about blockchain, they could
be talking about the specific technology of

Meanwhile, there's development in existing
companies to replace workflows with
private blockchain technology. It's important
to make that distinction between public
and private blockchain.
Sinegal: A lot of companies are experimenting.
Visa, which I cover, has partnered with a company
called Chain to do cross-border business-tobusiness transactions. IBM IBM is doing a lot of work
on blockchain. There are the exchanges,
the custody banks. But it's in the very early stages.4
It's much like the early days of the internet.
Are there lessons from that period that we can
apply here?

Wu: In the 1990s, you'd see IPOs where dot-com
companies with products without much
substance to them ended up with billion-dollar
valuations. Something similar is happening now.
Sinegal: So, a lot of the current ICOs are going to end
up like the dot-coms from the 1990s?

Wu: That's fair to say. But now that we have the
benefit of 20-plus years of history, we can
also say that the internet was a transformative
technology. It may have taken longer than
expected, but it is disrupting a lot of businesses
now. You see bankruptcies like Toys R Us
as a result of the emergence of online retailing.
Morris: When comparing the current blockchain
revolution with the internet revolution in the 1990s,

it's important to remember that in order to invest
in the internet, you needed to invest at the
application layer in internet companies. Blockchain
is unique in that you can invest at the actual
protocol layer, like in bitcoin or in Ethereum. That
would be equivalent to investing in TCP/IP,
which would have been impossible. You could only
invest in, say, AOL or Netscape.
Sinegal: It's almost like owning a piece of the

internet itself.

Morris: Exactly. I saw some analysis that said
that the application layer would only capture about
3% of the value of the blockchain space, which
gels well with what we've seen in ventures.
Coinbase5 recently raised venture capital at over
a $1 billion valuation, making it a unicorn.
But if you'd invested in bitcoin at the same time as
early investors in Coinbase, you would have been
better off in bitcoin.

A Massive Experiment
Sinegal: What are the risks with this technology?

Wu: There are two pieces, the technology side and
the governance side. On the technology side,
a lot of these blockchains, specifically the public
ones, have very little throughput. They're
trying to scale up that throughput while maintaining the security and "trustlessness" of
the network. If it doesn't play out, you're stuck
with a system that can only process three
to seven transactions a second. If you're familiar
with databases, that's a pittance: Visa processes
around 150,000 transactions per second.

Governance for these protocols is largely ad
hoc and haphazard. While bitcoin and Ethereum
and a couple other coins are still standing,
it remains to be seen if they have staying power.
Sinegal: Decentralization has some advantages,
but not always. Microsoft MSFT, for example, has some
important advantages over open-source software.

3 Satoshi Nakamoto is the name used by the unknown person or people who wrote "Bitcoin: A Peer-to-Peer Electronic Cash System" in October 2008 and who launched the bitcoin network
in January 2009.
4 Shortly after this conversation, Vanguard announced a partnership with index-provider CRSP and blockchain startup Symbiont that will enable index data to be distributed over a decentralized
database, a platform the firm says will improve benchmark tracking and reduce costs.
5 Coinbase is a platform for buying, selling, transferring, and storing digital currency.

58

Morningstar February/March 2018



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