Classic Re-read | a16z Managing Partner: Why Are Crypto Networks Important?

This article was published on the public account Hulian Chain, with the original title: "A16Z Managing Partner's House of Representatives Speech: Why Cryptonetworks Matter" Speaker: Scott Kupor, Translated by: Chinese ZZ

This testimony was delivered by Scott Kupor, a managing partner at a16z and former chairman of the board of the National Venture Capital Association, to the House Agriculture Committee on "Cryptocurrency: Regulation of a New Asset Class in the Digital Age." The date was July 2018. Kupor is also the author of the bestselling book "Secrets of the Dune Road: How to Win the Favor of Venture Capitalists."

The full text of the speech is as follows

Chairman Conaway and esteemed members, thank you very much for the opportunity to engage with the committee on the topic of cryptotechnology and its impact on U.S. technological innovation. I appreciate the committee's careful examination of what we believe to be a foundational area of technological development, which is critical to the health of our capital markets, entrepreneurial spirit, and the U.S. economy.

To start, let me share my background: I am an executive partner at AH Capital Management, and I am also an executive partner at CNK Capital Management, a registered investment advisor managing a $300 million venture capital fund focused on investing in cryptotechnology.

I. Background of Cryptonetworks

Today, I want to focus on the fundamental importance of cryptotechnology and why we believe these technologies present an extraordinary investment opportunity for the venture capital community.

Before diving in, I think it's important to precisely define the meaning space of "cryptotechnology."

Public narratives around cryptographic technologies often center on two areas: (i) Bitcoin itself as a potential store of value and its inherent price volatility; (ii) Initial Coin Offerings (ICOs) offered to unaccredited retail investors, many of whom have rightly been criticized for not complying with U.S. securities laws as determined by the SEC. While these are undoubtedly important aspects of the industry today, the public's focus on these areas almost completely obscures a phenomenon: this exciting and disruptive technological innovation that drives our immense interest in cryptonetworks.

Specifically, we define the term "cryptonetwork" as:

• A new way to build "digital services";
• These services are owned and operated by a "community of network participants" rather than a centralized company;
• The active repositories (i.e., databases) on the network are decentralized and maintained by the community.

What are "digital services"? They are simply internet-based apps, such as many of the apps we enjoy today—ride-sharing, messaging, food delivery, enterprise apps, and so on. We believe developers will leverage the principles of cryptonetworks to create a whole new set of digital services, many of which may exceed our current imagination, but will also yield tremendous consumer utility.

What are the principles of cryptonetworks? They are owned and managed by the community that develops, maintains, and utilizes the network. This is different from the large digital services we use today, which are owned and managed by a centralized company.

At first glance, this may sound a bit crazy—the value of community ownership and asset management may surpass that of centralized corporate control. However, in fact, there are well-known precedents in the history of the tech industry.

First, there is the open-source software movement. This movement began in 1983, led by a researcher at MIT named Richard Stallman, who created the free software movement. Understandably, this was a radical concept at the time—developers could freely release their software, allowing others to modify and integrate it into various open projects. However, over time, this work gradually evolved into mainstream open-source software development, which is now the primary method of developing software.

Examples of widely used open-source software include Linux (an operating system that manages most of today's data center servers and is a core component of nearly all smartphones and tablets) and Git (an open-source software development system used by millions of software engineers worldwide).

Secondly, the development of internet protocols has brought about tremendous employment, economic growth, and consumer utility, all of which we currently enjoy from existing digital services. These protocols—such as SMTP (the email transmission protocol), HTTP (the protocol for exchanging structured text on the internet), and TCP/IP (the end-to-end data communication protocol)—primarily originated from academic or government-funded efforts and, in most cases, were maintained and developed by academic and government developers. They are "open" protocols because they form the foundation upon which many exciting for-profit enterprises (like Amazon, Google, etc.) are built, knowing that the protocols themselves cannot be altered by centralized companies.

II. Why We Need to Pay Attention

Because the history of the internet tells us that well-architected and well-maintained open protocols can serve as the cornerstone for large-scale consumer utility and economic growth.

Why? Because for-profit enterprises are willing to take on all the market risks of establishing a new company, and venture capitalists are also willing to fund such efforts because they know that the premise of taking on this risk is that it will not change due to the whims of a centralized company.

In contrast, the tech sector is filled with startups that have failed due to platform risk, which depends on the game rules defined by centralized, for-profit platforms (as opposed to open protocols). This is not because centralized, for-profit platforms are inherently bad, but because over time, their economic incentives require them to continue to survive as independent enterprises to reap more rewards associated with proprietary platforms, which often leads to platforms altering the previously encouraging relationships with startups that are, in fact, building and improving their platforms.

III. What Does This Have to Do with Cryptonetworks?

As I mentioned earlier, cryptonetworks provide innovators with a new way to create new digital services without having to build on centralized platforms. In many ways, cryptonetworks draw from nearly 50 years of history in the tech industry that facilitated the initial development of internet protocols and the open-source movement; that is to say, developer communities can openly share their work and appropriately manage networks without centralization.

As my partner Chris Dixon (editor's note: A16Z Crypto General Partner) has written, cryptonetworks fundamentally replace the trust requirements that rely on centralized companies, only requiring you to trust the software itself to perform the functions it was built for (the underlying code is open-source for you to verify).

However, at the same time, cryptonetworks introduce a powerful economic incentive mechanism that did not exist when developing previous technologies—the existence of tokens creates direct economic incentives for community members, enabling them to appropriately develop and manage the network. Tokens in the world of cryptonetworks serve a series of functions: (i) they are a means of value exchange between network participants, i.e., consumers "pay" for services using tokens, and sellers "receive" tokens in exchange for services; (ii) they provide economic incentives to reward developers and other maintainers of the network—meaning people can receive tokens to ensure the authenticity of transactions completed on the network.

IV. The Importance of Regulating Cryptonetworks

Thus, tokens play a very important role in the operation of cryptonetworks; they are the glue that connects various participants and provide appropriate economic incentives for all market participants. Moreover, recall that since all software in these networks is open-source, this means that anyone wanting to create a competing network can simply use all existing software and build a competitive network, with competitive incentives for market participants aimed at fairness and responsiveness to user communities.

However, the tokens themselves and the distributed nature of such networks present a series of new challenges for regulators.

First, I want to clarify that we believe appropriate regulation of cryptonetworks is very important, and we welcome the opportunity to work with you, as well as members of both houses and various agencies, who are interested in establishing a regulatory framework that encourages innovation while protecting consumers and ensuring well-functioning capital markets. We believe that operating under regulation is important, and we also believe this is one of the reasons why the U.S. has emerged as a playground for the development of so many groundbreaking technologies in the business world.

In fact, the work done by CFTC Chairman Giancarlo in establishing LabCFTC is a great example of how regulators are striving to find a balance between encouraging technological innovation and protecting consumers. This kind of collaborative engagement between regulators and innovators is precisely what fast-changing markets need, including activities related to cryptonetworks. Thank you for your support and sponsorship of these initiatives as a committee.

Similar to the recent statement from the SEC's Director of Corporate Finance, we believe that the regulatory nature of cryptonetworks changes with the development stage of specific projects. In short, if a centralized sponsor seeks to raise funds from investors before the functionality of the network itself is realized, then the contract between the sponsor and the investors is likely to be an "investment contract," and therefore should be subject to appropriate regulation under U.S. securities laws as determined by the SEC. However, the nature of the tokens to be delivered under that contract may not be securities; they need to be evaluated using the same Howey test applied to all potential securities.

As the Commodity Futures Trading Commission (CFTC) has stated, some tokens are not securities. Once the network is operational, particularly in a decentralized context, we believe that the nature of tokens appears more like commodities than securities. This is because there is no effort from a centralized sponsor, and the value of the tokens largely does not depend on them. Instead, tokens will have value representing the utility of services to their participants; this value will not derive from the coordinated activities of a centralized sponsor.

Clearly, these determinations are not easy and require the efforts of this committee, other agencies, and various regulators. However, we believe this framework is consistent with the earlier statements from the SEC and CFTC.

Regardless of jurisdiction, we believe that investor protection, well-functioning capital markets, and support for innovation should be hallmarks of regulatory focus.

V. Conclusion

In conclusion, I would like to present the following points to the committee:

• For a long time, the U.S. has been a leader in technology, largely due to a favorable regulatory and financial environment that encourages risk-taking and innovation.
• While we have already felt the innovative benefits of economic development, job growth, and consumer utility from many great tech companies of our era, we believe that cryptonetworks provide an exciting new opportunity for us to continue along this path.
• This is why you see venture capitalists and other financial professionals increasingly concentrating their investments in this area. Like other fields of technological development, our job is to provide venture capital to what we believe can support long-term, self-sustaining business innovation. We believe that cryptonetworks are such a field.
• However, to ensure that the U.S. continues to be a playground for such technological innovations, we need to establish a regulatory framework that encourages risk-taking and venture capital, provides clarity and certainty for market participants, and protects the integrity of individual investors and the market.

I appreciate your time in discussing these issues, and I look forward to the opportunity to collaborate with the committee on this important topic.