Smart Contracts & Digital Leverage

For the first several hundred years of business, the only way that you could produce a greater level of output was to hire more people.

The industrial age brought along another resource – capital. The cotton gin, heavy industrial equipment, and the factory all augmented humans in production. Today, we have even more tools at our disposal, most of which deal with computers.

As Steve Jobs said, the computer is like a bicycle for the mind. They have become extensions of our thinking process. Most of us can’t do our jobs, live our social lives, or entertain ourselves without computers in some format.

The computer is the greatest creator of leverage we have today. Hundreds of unicorn startups have been built mostly on the backs of computers. In the mid 20th century, building to a billion dollar valuation took decades at minimum. Today, it takes some tech companies less than 5 years.

Valuation per employee is a metric that can give you a good idea of how valuable the human capital at your company is. Many companies today are commanding huge valuations without needing much human labor. As I said: the computer is a tool of leverage. Code lets you do more with less human input.

Consider the purchase of Instagram in 2012 for $1B when they had just 13 employees. Or the sale of WhatsApp to Facebook in Feb of 2014 for $16B when they had 55 employees. If we compare the valuation per employee of these two companies to the market cap/employee value of some of their analog competitors, the results are mind blowing.

When people talk about automation – typically images of artificial intelligence and advanced robots come to mind. In reality, we’ve already seen incredible automation happen through software. Any time business logic can be written into code, you get dramatic productivity increases.

Smart Contracts Further Automate Business Logic

Computers have already made hand written letters and camera film obsolete. The next iteration of automated business logic will happen with smart contracts. We have hardware and software all around us that can be used to improve our ability to do business with each other. Why not take much of these devices and embed agreements within them?

The term smart contract, like automation, conjures thoughts of intelligent robotic agreements that have some kind of special power. In reality, smart contracts are really just programmable digital agreements. In their ideal form, they’re tamper proof and allow for new forms of economic activity because they significantly reduce counter-party risk. They offer this functionality because they will operate precisely based on the specific parameters set by the creators of the contract. Human interpretation is eliminated once the contract is instantiated (i.e. deployed on a blockchain). Code becomes law, and you don’t need to worry about suing the other party in the event of bad faith activity. The smart contract will serve as the judge, jury, and executioner all on its own.

Smart contracts won’t be used for everything (some things may always be too ‘grey’ for computers and always need intervention from a person). However, these new forms of digital agreement are special in that they allow for programmable financial products and proof of ownership. Most cryptocurrencies are smart contracts, and all NFT’s are smart contracts. We’re seeing an explosion of new assets and protocols that can interact with one another in decentralized finance. We have protocols for the creation of stable value currencies, money markets, and digital art exchanges. These industries used to rely on thousands of people to push around physical goods, oversee disputes, and write up paper based guarantees. Now, you have apps with a few hundred lines of code managing billions of dollars.

The traditional legal & financial system – the thing that has managed records of ownership, financial products, and business law for centuries – is being changed by software in the same way that telecom & photography was 10 years ago. More can be done with less human intervention.

We can see the same effects that happened with communication & media beginning to happen in finance. Coinbase, a cryptocurrency exchange cut from the same cloth as the WhatsApps and Instagrams of the world, rose to fame in the last 10 years to IPO at a market cap in the dozens of billions of dollars. But innovation comes at you fast. There are new financial services applications being built with smart contracts. One example is Uniswap – an automated market maker that essentially does what Coinbase does, but automatically on the Ethereum blockchain. They’ve built a 2 sided marketplace which allows anyone to purchase or provide liquidity for any ERC-20 token. In Jan ’21, they processed over $30B in volume with just 38 employees (note – take some of the employee count estimates for crypto with a grain of salt. I am pulling these from LinkedIn, and crypto people hate LinkedIn).

Let’s take a look at the Coinbase vs Uniswap numbers from 2020:

Coinbase clearly has a higher level of trading volume and market cap. However, they were founded in 2012, while Uniswap launched in late 2018. Uniswap also is regularly processing over $1B per day in volume as of July ’21, putting them on pace for $300B+ in volume in 2021 (Coinbase is growing as well though, processing ~$2B per day).

However, the total values don’t tell the whole story. The point of this article is that smart contracts & crypto are innovating in finance in a way that is more leveraged than anything else we’ve ever seen. And when I say leveraged – I mean it in the way that Archimedes meant it, not the way Wall Street means it. Blockchain devs are securing billions of dollars with less human intervention than even some of the most innovative fintech companies (i.e. Coinbase).

Note: Coinbase had 1,249 employees as of 12/31/20 per their S-1 filing, and Uniswap has 38 employees as of mid 2021 per LinkedIn.

If we look at trading volume per employee, we can see that Uniswap is processing over $1.5B in volume per employee, compared to an already impressive 150M/employee by Coinbase. Coinbase does have other product lines they’re working on, which commands more employees. But the difference is still stark.

We can see the same thing happening between each respective market cap. Less people are creating more wealth. Speculative money is everywhere in crypto, but once again, this is a wide, wide margin.

And it’s not just Uniswap – other areas of decentralized finance are building protocols that manage billions of dollars, with far less human capital than you’d expect (all value locked numbers as of July 1, 2021)

-Aave is a money market protocol with 47 employees and $16B in value locked

-Compound is another money market with 11 employees and $6.5B in value locked

-MakerDAO is a stablecoin protocol w 102 employees and $6.6 in value locked

To put this in perspective, consider that Goldman Sachs has 40,500 employees and $2.1T in assets under management. How does that compare to a protocol like Aave?

All numbers as of July 1, 2021.

We’re in the very early days of smart contract based innovation. The space is seeing remarkable growth – especially in decentralized finance. One of the hallmarks of industries that are rapidly growing is that they still somehow fly under the radar until they are impossible to ignore. While it’s easy to be turned off by Dogecoin memes and speculation in crypto, the technology is real. Blockchain developers have as much leverage as any other class of technologist in history.

Look out for more growth.

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