Defensive Moats
Let’s talk about moats. If you are flashing back to fourth grade history and picturing a small lake with a castle in the middle, you are on the right track. Moats are a purely defensive combat technology, and they play a key role in our mental model of cryptocurrency investment. Essentially, moats will help us separate average investments from great investments, and investments with great long term potential from those we are not quite sure will be here five years from now.
There are 5 main types of moats: Brand, Switching Cost, Monopoly, Proprietary, and Price. The ones we will be focusing on are Brand, Switching Cost, and Price. Monopoly and proprietary moats don’t really apply as most cryptocurrencies are open source and we are free to clone any cryptocurrency we desire on a whim.
Brand is currently (late 2018) the most important moat. Bitcoin is technologically inferior to pretty much all other major cryptocurrencies out there, it is not turing complete, like Ethereum, and it’s a pretty expensive way to move money, compared to something like Dash. It’s also split a few times consequence of a long raging civil war; yet Bitcoin remains the cryptocurrency of choice with roughly 40% dominance. Why is that? Branding.
When you first heard about crypto money, I bet it was Bitcoin. Nine times out of ten, you read an article or a friend introduced you to this newfangled form of money, and what they talked about was Bitcoin, not, for example, Monero. Bitcoin was the first cryptocurrency and it is the one John Q. Public associates with the word cryptocurrency. It is also the coin that even experienced altcoin investors and cryptocurrency operators often refer to when relating with each other about the mechanics of different blockchains. Branding is the reason a technologically inferior product is still the dominant market force.
Switching costs are another important factor to consider when looking for moats around potential cryptocurrency investments. Switching costs in crypto are generally low, I mean, I can Shapeshift.io pretty much any major coin into any other, so how do switching costs apply here? Well they apply as they relate to your attachment to the ecosystems of value created by cryptocurrencies, beyond the tokens themselves. Let me explain.
There are a limited quantity of high quality tools, such as easy to use wallets or exchanges in the cryptocurrency ecosystem. There is only one Blockchain.info and only one ShapeShift.io, and as users become accustomed to high quality, seamless services, they are unlikely to switch into crypto assets which are not integrated into these services; this is what we mean by switching costs. Have you noticed how a crypto assets price jumps every time Coinbase adds a new coin to its platform?
Price is also a consideration. What are the sunk costs in the development of this ecosystem? Can an ecosystem of value, built around a successful cryptocurrency, be easily cloned into a new asset? The answer is generally no. Each new asset that is created, even if it is a clone of an existing one, has to develop an ecosystem of value around itself, and it will never be the same as the parent asset. Think of Ethereum and Ethereum classic. The trick to overtaking the parent asset is that the ecosystem around the new crypto asset function more cheaply and more efficiently than that of the parent asset. That is why I believe Bitcoin Cash (Roger Ver), will eventually overtake Bitcoin Core.
Moving money in Bitcoin Cash (Ver) is often 100 times cheaper than doing so in Bitcoin Core, it stands to reason the the value chain built on top of it will be lower cost and more efficient. The trick is to identify these qualities early enough in the lifecycle of an asset as to be able to take advantage of this sort of discrepancy. The trick, in fact, is to identify these qualities, and the degree to which they are present, in every single currency we target for acquisition.
There are many types of moats but we are mainly looking for wide economic moats with a deep bottom. Basically this means that the competitive advantages of this crypto asset are both large enough that they set this crypto asset apart from all others, and also hard enough to replicate that they can not merely be cloned or easily conjured.
Let’s look at some examples. ZCash for example, is an anonymity coin, the first ZK SNARK implementation in blockchain. As the first mover with this technology, it carries a large branding advantage. Other entrants have replicated the ZK-SNARK model, but none come close to overtaking ZCash because they can not easily replicate the brand and the ecosystem of value around it. A new entrant would need to be better and more efficient than ZCash as an anonymity coin based on ZK-SNARKS as to be have a shot at overtaking it. This is no easy feat.
ZCash has moderate switching costs, it is integrated into most major tools and exchanges, something not easy to replicate. But there are alternatives in the same field (anonymity coins) such as Monero that perform a similar function and are also integrated across the cryptocurrency space. There is value to the implementation of Zcash’s anonymity solution but it is not the only anonymity solution.
Finally, let’s talk about price. As we alluded to earlier, the cost of replicating ZCashs’ ecosystem of value would be rather high, both in man hours and dollars, due to the need to replicate and overtake its ecosystem of value. It is unlikely this could be done efficiently without a deeper innovation taking place, a mere cut and paste clone would not do the job.
The importance of each of the different qualities of a moat we have discussed, will likely coalesce as the cryptocurrency ecosystem matures. Right now, branding is the most important moat consideration. But as cryptocurrencies become entrenched, again by growing value around themselves, switching costs for users, and the price of replicating these ecosystems of value for upstarts, will create moats around these assets that will be extremely difficult to surpass. Our goal is to identify and invest in these sorts of assets as early as possible.