The rapid growth taking place in the cryptoasset world means the space is complex and constantly evolving – and it’s just getting started. We recently sat down with Chief Investment Officer Suzanne Brenner and Deputy Chief Investment Officer Justin Reed to hear the Brown Brothers Harriman (BBH) Investment Research Group’s latest thinking on blockchain and the cryptoasset ecosystem.
People often use Bitcoin and crypto – or cryptoassets – interchangeably, but there’s far more to the space. Tell us about the importance of looking at cryptocurrency as more than another form of currency.
Suzanne Brenner: That is such a key point. It’s important to understand that Bitcoin does not equal crypto. Bitcoin is just one of thousands of use cases of crypto. It’s supposed use case is as a supply-constrained currency – if you believe it’s a currency at all. Readers have heard this before, but it’s worth repeating: We do not believe that trading Bitcoin represents an attractive investment strategy. In general, currency trading doesn’t align with our focus on fundamental research and investing in high-quality companies with great management teams that have a long-term orientation.
Justin Reed: If you are focused just on Bitcoin when thinking about crypto, you are missing the forest for the trees. Many remember the 1990s and the dawn of the consumer internet. There were skeptics who pointed to evidence of Pets.com and Webvan as support for the view that the internet didn’t make sense. Importantly, those companies were just two internet use cases, and many of the internet companies we know and love today were not yet even contemplated. Similarly, we think crypto, broadly speaking, has internet-like game-changing potential, and pointing to a single use case like Bitcoin, or even cryptocurrencies, as evidence of crypto’s eventual demise is a myopic perspective. There are countless other crypto use cases that have simply not been created yet.
Stepping back for a second, what is blockchain, and why should we be focused on this technology?
SB: One of our newest managers, venture capital firm Andreessen Horowitz, or a16z, thinks that the best way to think of a blockchain is as a new computer – more specifically, a virtual computer that runs on top of a network of physical computers that provides strong, auditable guarantees that the code it runs will continue to operate as designed.
We like to also think about it as a distributed database that maintains a continuously growing list of records, resistant to tamper and revision. Blockchain technologies provide a way of achieving consensus on the state and history of a database, without requiring trust between parties.
JR: Blockchain is a real game changer, and many companies in BBH’s portfolios are astutely incorporating this technology into their businesses. We also think that the companies being built upon the blockchain, and their related tokens, are important. In fact, we think that investors who are not monitoring the development of blockchain and cryptoassets as a disruptive force to existing business models over the long term are doing so at their own risk.
As the space is evolving rapidly, there’s still no standardized taxonomy, and there are many terms to keep up with. Can you provide a broad overview of the cryptoasset ecosystem?
SB: The crypto and blockchain ecosystem is about 14 years old, but we are still in the early stages of its buildout, so you’re right, there is no standardized taxonomy. This is partially why “crypto” can be so hard to understand. Our team has been monitoring the space over the past couple of years, and we have created a shared language around crypto that we have found useful. These definitions are not fixed, though, and as the crypto ecosystem continues to develop over time, we expect to also refine these definitions.
First, there is blockchain, which we have already addressed. Second, there are cryptocurrencies, which provide the network upon which decentralized applications are built – platform protocols like Ethereum or Solana – or the payment method that allows participants to transact in the ecosystem – payment protocols like Bitcoin.
Next is the infrastructure. We think of infrastructure as the “picks and shovels” that allow the cryptoasset ecosystem to function as intended. Infrastructure often connects the cryptoasset ecosystem with non-cryptoassets – such as exchanges and custody solutions.
Then, we have decentralized applications. Think of these as the programs developed by companies to operate on top of platform protocols – many refer to these programs as Web 3.0. We include decentralized finance, or DeFi, programs, in this category as well.
Finally, we have tokens. There are several different types, but the tokens we find most interesting are what we refer to as utility tokens, which represent digital units of value. It can be helpful to think of them as rewards points that are offered to early users of a program as an incentive mechanism. Importantly, these tokens increase in value the more an application is used. Many investors are thinking of these as somewhat analogous to equity. Another form of token that many people have heard about are NFTs, or non-fungible tokens, which are collectible digital assets that exist on and are authenticated via a blockchain.
What’s an example of how this all comes together?
JR: These terms can be esoteric, so it’s great that you ask for an example.
Helium is a decentralized Web 3.0 company that provides a decentralized wireless network for the internet of things, or IoT. There are millions of IoT devices, such as electric scooters, that sometimes end up in areas without an internet connection. The founders of Helium recognized this issue and set out to build a long-range, peer-to-peer wireless network by persuading people and businesses to set up internet hot spots. Interestingly, Helium was initially founded as a traditional company and struggled to get enough participants until 2019, when it pivoted to becoming a Web 3.0 company that would incentivize people to set up hot spots in exchange for a utility token. The more IoT devices utilize an owner’s hot spot, the more utility tokens the owner receives. That token, like other utility tokens, increases in value as the value of that network increases and can be held or sold on an exchange. Helium’s new business model has proven to be incredibly successful thus far. Instead of having to build the network itself, Helium made itself fully decentralized and let users build it themselves by buying and connecting their own hot spots. We think this example provides a nice case study for how crypto allows for a slightly different business model from the ones that have existed in the past.
This isn’t a recommendation for Helium, nor are we convinced that the company will be a “winner.” Rather, it’s a case study that illuminates how crypto can be used to innovate on existing business models. And as we mentioned earlier, many of the eventual “winners” in crypto have not yet even been created. We’re still in the early stages here!
What’s the path from here with regards to crypto?
SB: We think that a helpful, if imperfect, analogy is the development of the internet. The internet, which was initially conceived as a way to enable communications between computers, has since developed from that single use case into the technological platform supporting millions of use cases, including search engines, streaming websites, social media websites and instant messengers. Value has largely accrued to the owners of companies formed to capitalize on these use cases – for example, Google and Facebook. In much the same way, we would not be surprised to see blockchain and related cryptoassets serve as the foundation for many use cases one day and entities set up to capitalize on them.
JR: In addition, it often takes a “killer app” for mass adopters to recognize the potential of new technologies. Many consumers didn’t see the value in personal computers until the word processor and Excel were created as killer apps. “Why would I ever need a mainframe computer in my house?” was the question. Smartphones in the 2000s were the same way. Mass adoption did not occur until apps like Uber and Instagram capitalized on the integration of GPS, high-resolution cameras and portable computing power. As more applications are built to capitalize on the unique strengths of crypto, we would not be surprised to see accelerated adoption.
a16z has talked about how, historically, new models of computing have tended to emerge every 10 to 15 years: mainframes in the 1960s, PCs in the late 1970s, the internet in the early 1990s and smartphones in the late 2000s. If this cycle holds true, it does seem time for a new model of computing to arise. Maybe, just maybe, the next wave is crypto.
What is BBH’s view of the investment landscape in this space?
SB: We are closely monitoring the development of blockchain and cryptoassets as a disruptive force to existing business models over the long term and an opportunity for companies to incorporate innovative technology, and we are watching the space as a potentially interesting investment opportunity. We caveat again, though, that it is the blockchain technology that is interesting from an investment perspective, not trading in cryptocurrency.
As we alluded to with the previous examples, Web 3.0 is particularly interesting because of the new business models it facilitates, as it allows various stakeholders to be compensated for their contributions in a way that is not currently possible in a Web 2.0 world. For example, think of Uber vs. Lyft if the early drivers – who used both services – got Uber tokens or Lyft tokens in return for driving passengers. Those tokens would rise in value with the underlying value of Uber or Lyft. Do you think that would change the behavior of those early drivers? We would surmise that it would. Incentives are incredibly important. Or think, for example, of the data privacy issues affecting many of the FAANG1 stocks today. Imagine another business model where the consumer owns his or her data and only makes it available in exchange for Google tokens, which accrue value the more that person uses Google.
We recently came across a helpful framework for thinking about the development of Web 3.0. Think of Web 1.0 as “read-only” in that internet users predominately went to the internet to obtain information. An example of a Web 1.0 company is AOL. Web 2.0 is “read-write,” which involves internet users both obtaining content and creating content. Facebook or LinkedIn are great examples of Web 2.0 companies. That brings us to the dawn of Web 3.0 – or Web3, as many people refer to it – which is “read-write-own.” It’s the idea that users will not only obtain and create content, but they will also benefit from “ownership” of the underlying business. That is potentially game-changing and makes it worth monitoring from an investment perspective.
Will crypto have a role in the BBH portfolio?
JR: Crypto does have a role in our portfolio, but only through bottom-up investment decisions, not currency speculation.
In our public equity portfolio, our clients are predominately exposed indirectly through companies like Block (formerly known as Square), Visa and Mastercard.2 Block actually has invested in Bitcoin on its balance sheet and allows customers to buy and sell it. Visa and Mastercard are each in the top 25 corporations with the most blockchain-related patents worldwide.
More recently, we added additional exposure through our investment partnership with a16z, which has a dedicated crypto/Web 3.0 team focused on making investments in Web 3.0 companies.
Having said all that, there are risks that we must continue to monitor, including the regulatory environment and the fact that crypto is still in its infancy. There will most certainly be winners and losers. Partially as a result, we believe it’s important to size crypto-related exposure appropriately and partner with the best to mitigate some of these concerns.
Given your last answer, are you concerned at all about the recent drawdown in cryptocurrencies?
SB: This gets back to cryptocurrencies vs. the broader crypto ecosystem. Much of the news revolved around Bitcoin price declines and the loss of confidence in a popular “stablecoin” called TerraUSD, following a break in its peg to the dollar. We would categorize both as cryptocurrencies. We happen to not see value in the trading of cryptocurrencies, and we will never make bets on short-term price movements. However, we do see potential value in blockchain and related platform protocols, as well as in the companies being built on top of these protocols. Simplistically, we are focused on doing something we’ve always done in a part of our portfolio – which is investing in talented, highly technical founders building innovative software and technology companies. Interestingly, the related tokens for some of these Web 3.0 companies declined during this recent sell-off, but when you remember that they are software and technology companies, it makes sense that the decline was correlated with a broader sell-off in technology stocks in the public equity markets.
JR: To answer your question directly, we are always concerned when there are drawdowns, and when they occur, we research them carefully to understand the reasons – if they are fundamentally driven or a result of technical factors that do not change the underlying value of an investment. There will surely be many drawdowns and failures in the crypto ecosystem over the coming decade. Similar to many other investment opportunities, volatility actually creates opportunity that can be turned into strong long-term returns by the best active managers. We encourage investors to focus on the potential of the ecosystem and the companies that are showing signs of adoption and success.
Suzanne and Justin, thanks for this informative conversation.
References to specific companies or digital assets are for illustrative purposes only and are not intended to be and should not be interpreted as recommendations.
1 FAANG: Meta (formerly known as Facebook), Amazon, Apple, Netflix and Alphabet (formerly known as Google).
2 Within the Qualified Taxable Balanced Growth portfolio, Block is a 1.3% exposure, Visa is a 1.0% exposure, and Mastercard is a 2.4% exposure as of June 30, 2022.
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