Crazy Crypto Times…

Several years ago, chatter started to emerge about Bitcoin and blockchain technologies. Given that one of our core healthcare investment themes at Flare Capital is broadly labelled “Payment Reform,” we have been getting smarter about the implications to the “business of healthcare” as these technologies became more robust, more established. Little did I know what this search would uncover.

Analysts are already now talking about Digital Currency 2.0. How did I miss 1.0? Regularly there are spectacular stories of wild Bitcoin trading activity or some instance of fraud or a “flash crash” as what occurred two weeks ago, when the digital currency, Ether, collapsed from $300 to $0.10 in minutes. Undoubtedly, while these cryptocurrencies are still somewhat under construction, there is something profound emerging that may have far reaching impacts – maybe in healthcare but certainly on my industry, venture capital.

The graphic above from the Digital Currency Group nicely captures the rapid evolution of the cryptocurrency ecosystem in the last half a dozen years, which is not unlike the cycle times of Web 1.0, 2.0 and 3.0. First enabling infrastructure must be built to allow for enterprise products and applications to then develop. Blockchain is often described as digital ledgers managed (validated) by a network of computers (“miners”) to enable transactions and commerce. Specific capabilities around security, governance and payment settlement needed to be developed before wide-spread application usage would occur.

A handful of cryptocurrencies like Bitcoin had relatively broad applicability, while most other cryptocurrencies have been introduced as payment methods for the very specific products and services of a specified network. This has become a very robust method to crowd source development capital for certain companies. These cryptocurrencies for open source networks allow the developers to capture the value of the networks they are building, unlike earlier iterations of other open source networks such as Wikipedia or Linux, where the developers were unable to monetize what became extraordinarily valuable networks. Ironically, new concerns are emerging for Bitcoin as a widely used currency given the data processing framework only allows for seven transactions per second, which is leading to fees of up to $5 per transaction (there are estimated to be 260k daily transactions now).

Some specific examples of the current landscape are quite informative and harken back to the late 1990’s investor frenzy (are you old enough to remember theGlobe.com’s IPO?):

• According to WorldcoinIndex.com, there are 400 cryptocurrencies today that trade on 35 exchanges (coincidentally, there were 486 and 406 IPOs in 1999 and 2000, respectively)
• Ethereum, one of the most popular cryptocurrencies today to support online services and apps, was valued at $10 per token at the beginning of 2017 and now trades at $250, creating an aggregate market value of nearly $24 billion – its token price chart is below
• Bitcoin, the grandfather of cryptocurrencies started in 2008, was trading at $5 per token; now one can buy a Bitcoin for $2,500. There will only be 21 million Bitcoins created – 16.4 million have already been mined
• There are 16 million Bitcoin addresses with less than $60 account balances but only 1,780 with more than $608,000 in value each
• It is estimated that between 0.5% – 0.75% of Americans have ever used Bitcoin, which while sounding like a small number, equates to between 1.2 – 1.9 million people

Arguably with the dramatic price appreciation of tokens, popular investor interest has been stoked. Trading volatility is dramatic with daily double-digit percentage price swings the norm. In an environment of epic low volatility in other financial assets, speculative cryptocurrency trading activity is staggering. A criticism of many central banks around the world has been that much of the stimulus spending went to financial assets and not to real economic activity (thus record high public stock prices with very modest real economic growth). Now as those same banks look to reduce liquidity and tighten monetary policies, expect to see some potential sharp token price corrections. Compounding this is the expectation that many of these start-ups funded by novel cryptocurrencies will undoubtedly fail.

Now through the VC lens, what I was most struck by the last few months is the ability for these novel currencies to upend how capital is raised and invested – particularly by the magnitude. Many VCs were rattled in 2012 when Pebble raised $10.3 million to build a smartwatch in one of the largest Kickstarter crowdsource campaigns ever (notably, the company was shut down four years later). Notwithstanding the hyper-unregulated nature of these platforms and the chronic association with illicit activities, a few recent anecdotes underscore the disruption these platforms may poise, particularly with “Initial Coin Offerings (ICO)” and special purpose investment funds denominated in tokens.

• In mid-June 2017, Block.one raised $185 million in five days which represented only 20% of the 1 billion tokens they will ultimately sell
• This eclipsed the $150 million raised by Bancor a few weeks before that
• And was blown away by Tezos’ “ICO” of $212 million which took three days in early July
• Brave Software raised $36 million in digital coins in 30 seconds
• Blockchain Capital was able to raise $10 million in six hours to launch a dedicate cryptocurrency fund
• Hedge fund, Polychain Capital, was established to invest in tokens pre-product launch and will hold no equity

So, should Wall Street investment bankers be nervous? In some cases, quite clearly yes. Wall Street had been breathlessly waiting for many months for the $300 million Blue Apron IPO in June, which ultimately was quite disappointing. On the other hand, “ICOs” allow companies to create proprietary digital currencies that are to be redeemed later for products and services developed by that company (or that can be sold on crypto-exchanges) very quickly. And this is completely unregulated with meaningfully lower issuance costs. In the past 18 months, there have been 124 “ICOs” which raised $984 million according to CoinSchedule.com, not including Tezos’ “ICO” in early July.

Interestingly, year-to-date 2017, venture capitalists have invested $295 million in cryptocurrency companies which pales to the nearly $1 billion raised via the 78 “ICOs” – in both cases, proceeds were to effectively do the same thing – build the product and scale the company.

Now to come full circle back to where this exploration started – what is the impact of cryptocurrencies on healthcare? Without debate, the handling of medical data today is poorly managed. Blockchain promises to meaningfully improve the security and provenance of data as they will be stored across a distributed architecture (not in one location). Additionally, security is improved given the encryption technologies core to blockchain, which should then further improve the quality and fidelity of the data. Arguably these architectures should also lower the cost of data management through better standardization. Frost & Sullivan anticipates more immediate opportunities to reduce the need for prior authorizations as an initial use case.

But this may not happen in the near to medium term in healthcare. Obsessive concerns around privacy and HIPAA are heightened with each Mt Gox incident (in 2014, $450 million of bitcoins vanished from this exchange, which subsequently went bankrupt) or last week’s hacking of Bithumb, one of the largest cryptocurrency exchanges (32k accounts were compromised), and with any “flash crash.” These technologies need to be more mainstream before more than just pilot activity develops in healthcare.

Notably, the Securities and Exchange Commission has yet to weigh in on whether cryptocurrencies should be regulated securities. And not to be left out, the Internal Revenue Service announced a probe of Coinbase, a popular cryptocurrency exchange with 500k active users, because only 802 people declared Bitcoin capital gains and losses in all of 2015. Recall that Elliot Ness initially brought down Mobster Al Capone over issues of tax evasion. The authorities are slowing trying to get their heads around what this is all about.

But other industries are beginning to explore specific use cases for cryptocurrency and blockchain technologies, particularly in financial services. The NASDAQ is creating an exchange to buy/sell advertising inventory, while many European banks are working with IBM to develop trade finance platforms utilizing these technologies. Last week the leading art and antiques fair (TEFAF) announced that 75% of the 39 top online art sales exchanges are now developing blockchain platforms.

Given venture investors are to invest in technologies that are “over horizon” today, I certainly do not want to wait for Digital Currency 3.0 to realize we missed compelling companies during the 2.0 version. In the meantime, expect to see a new class of “crypto day traders” emerge. Just waiting for the day my Uber driver tells me about the killing he/she made in flipping Siacoin tokens.