I have a conversation scheduled for 4PM today with Real Vision CEO and Co-Founder Raoul Pal. And I wanted to use today's newsletter as a 'prep' for that discussion. Raoul has become quite ensconced in the cryptocurrency world and sees that space as a paradigm-shifting and transformative realm for the global economy.

While I don't have the same level of conviction, I do see tremendous opportunities in the crypto-blockchain space and I want to outline how I am thinking about it as an extension of the revolutionary move of global goods and services from analogue to digital.

I could write a tome. But I will try to condense my thinking enough to give you the broad strokes. Here goes

The analogue world goes digital

When we think of computers, what we are really thinking about is information expressed in ones and zeros. We're talking about taking information that we have historically received in the real world in analogue form and 'digitizing' it into a stream of ones and zeros and stored, read, 'played back' and copied on a machine.

This is an important advance because the copying process of the digital world is perfect. As long as the stored data are not corrupted, they can be copied, transferred to different storage media, and 'replayed' millions of times without error. And that's revolutionary because that's just not how the real world, the analogue world, works.

For example, if I had recorded a radio broadcast to tape in the 1970s when Raoul and I were children, I could only have copied and transferred that broadcast so many times before its sound quality eroded beyond recognition. Every copy of a copy I made would have been different than the previous copy generation, and, thus, less representative of the original recording. No matter how 'high fidelity' my recording equipment was, there would always be an introduction of noise and a degradation of the signal. At some point, those generational copy 'errors' that seemed like noise from one generation to the next would accumulate to overwhelm the signal entirely.

But once we learned how to copy that broadcast digitally, representing it in one and zeros, perfect copies were possible. All we would need to do was find out how to transform the analogue signal into zeros and ones while retaining as much likeness to the original analogue information.

Once we had that down, we had to have the right amount of computing power to do it. And then we had to store it without the data becoming corrupted and we had to have the 'bandwidth' necessary to transfer it physically or 'virtually'. At that point we could copy the data as much as we wanted - a hundred times, a thousand times, a billion times. It didn't matter. All copies were identical.

This is the digitization process revolution that has been happening behind the scenes for every piece of information you can think of that we value. We're talking about text, sound, still pictures, moving pictures, you name it.

The digital world's processing power and storage constraints

In the beginning, the key constraint was the recording process. I remember seeing my mother at work as a scientist in the 1970s, using physical punch cards to record and store data from her experiments. It was easy to transform scientific experiment data as ones and zeros. And it took no real time processing power or digital data storage to make the recording since my mom was using physical punch cards.

But as we began to want to record and store more and more information digitally, processing power and storage capacity became key constraints.. We had to make sure the original digital copy contained as much information inherent in the original as possible and that we had enough computer horsepower to make the recording at all.

Technological advancement in processing power and stable storage capacity meant that ever more complex analogue information data could be stored digitally. For example, by the time Raoul and I entered high school, we could record and transfer physical digital copies of written words (high school term papers) or spoken words (conversation recordings). By the time we left high school, we could even buy audio recordings as compact discs. I bought my first CD player in 1988. By the late 1990s, when we were both living in the UK, I was using my Hi-8 camera to record my daughter's first steps, listening to music on my MiniDisc player as I rollerbladed through Hyde Park, and watching The Net on my computer's DVD Player. The only thing I was missing was a decent digital camera. But that technology would develop quickly in the 2000s as real-time processing power increased and chip size decreased.

By the 1990s, almost all the information I used could be represented digitally and stored and transferred physically.

The Internet introduces virtual transfer

The big (deflationary) shift came with the Internet. It's funny that one of the first DVDs I bought was the Net, which starred Sandra Bullock as a tech nerd whose whole life was lived in front of a computer, because the world that film showed wasn't the real world of the late 1990s. She was getting complex data over the Internet, chatting to friends, ordering food and doing everything on her computer from the comfort of her home and work. That wasn't the world I knew. It was the imagined world that would come. And it did come.

The big transformation that the Internet represented was that it allowed perfect digital copies that used to be transferred physically to be transferred virtually. What used to be something I had to copy to a physical storage medium and walk over somewhere or mail somewhere became a file I could send digitally across wires and cables around the world in seconds. The only constraint was virtual bandwidth.

What that meant is that geographic information silos that had been erected and maintained since time immemorial - barriers from which sellers of that information profited - were immediately rendered useless. I could send music as mp3 files in near real time. I could look up prices of goods and have those goods delivered to me from the lowest cost seller regardless of where they were physically located. I could talk to anyone in the world for free across the Internet instead of paying a phone company to make that call. Basically, we could do anything that involved the transfer of information irrespective of physical location. The only constraint was bandwidth.

This whole new world was and is extremely deflationary because it reduces geographic silos and opens businesses up to a much wider array of price competition. It increases and facilitates the ease of price discovery too. With enough mobile bandwidth, I could be in a store and comparison shop, allowing me to resist buying an item that I could find cheaper on the Internet. This new world meant greater competition. And that meant lower prices and lower margins for a lot of businesses: music stores, bookstores, movie studios, camera shops, movie rental shops, you name it.

The larger you are as a business in this world, the greater scale you have to deal with competition. That can make it easier to withstand lower margins. And in many cases, there are network effects too where your product is simply better or lower-priced simply because you have more customers, and, therefore, more information to use and offer product and set prices. Think Google. Think Amazon.

So, there was a land grab in the late 1990s with the Internet, a frenzy to get scale as quickly as possible to dominate markets and win in this new lower margin, networked world. And as in all manias, regardless of how good the idea is, the end comes with a crash. Companies get wiped out before they scale or gain profitability and the survivors go on to compete in a “winner takes all’ struggle.

The point is that what seems like irrational at the macro level in terms of seemingly unrealistic revenue projections and ridiculous valuation multiples makes sense at a micro level because individual actors know their window of opportunity to form a business, scale and execute at scale is limited. Once the dominant players are entrenched by operating leverage, economies of scale and network effects, the game is over. Lycos is toast, Ask Jeeves - gone, Excite - buried. Google scaled and defeated them all. And the same is true in a host of verticals from mobile operating systems to social networks to newspapers.

The Internet without constraints

So what does this picture look like without constraints? I talked about the problem of the fidelity of the digitizing process, the processing power, the storage volume, and the virtual bandwidth. There's also the mobility constraint where I can do in-store price comparison shop in real time in DC where I live in 2021 but I couldn't in 1999 when I was in London because the mobile Internet was weak. Increasingly, we don't have that constraint anymore. So I would argue we are nearing a world where there are no constraints. And so we have to ask what that kind of world looks like.

I think that world looks a lot like Crypto. By that I mean that crypto is not about digital money per se, cryptocurrency; it's about harnessing the power of a interconnected digital world with fewer and fewer real world physical constraints. And that's because the key failing of the virtual world is that it's virtual; it's not real. You can't trust the information you get the way you do in the real world when you can use your five senses of sight, taste, touch, smell, and hearing to verify if something is real. The virtual world has a trust problem and crypto is about eliminating that trust problem. That's something that is a heck of a lot easier to do when you have fewer constraints on processing power, storage, bandwidth and mobility.

So, because the Internet, the virtual world, is a distributed network, think of crypto as being about trust as verified by a distributed network. This is something that requires fidelity in the 'original trust copy' and few enough of the other constraints like processing speed, storage, bandwidth and mobility to be executed. And just as we were almost there in 1999 regarding the Internet and what could be done when transferring digital information virtually, we are almost there with transferring trust via distributed networks instead of the centralized exchanges and agents of the physical world - who extract their middleman fee for their verification services to create trust.

Me And Raoul

So this is the headspace I have as I prepare for my conversation with Raoul today. I am thinking of Crypto as digitization wave 4.0 or Internet wave 3.0 or something like that. The corollaries for the economy and markets are vast. Here are a few:

If the Internet's price discovery was deflationary for sellers of information and data (like music companies or movie studios), isn't the crypto world's distributed trust discovery model deflationary for sellers of trust and verification like banks, notary publics, real estate agents, and payment processing companies?
If distributed trust networks are deflationary, what does that mean regarding future industrial organization, legacy business models and employment within those legacy businesses versus employment within the new businesses, that don't require many dedicated employees to 'verify'?
If crypto isn't about digital money per se, but more about distributed networks of trust, what does that mean for cryptocurrencies like Bitcoin and Ethereum which have very different use cases?
If crypto is a land grab just like Internet version 1.0 because of economies of scale and scope and network effects, does it necessarily end as a mania? And does that bubble pop with wide-reaching consequences?
If I can develop trust through a virtual distributed network about the authenticity of something, what will that mean regarding my money payment and store of value preferences?
If I can develop trust through a virtual distributed network about the authenticity of something, what's the likelihood in a post-pandemic world that I would rely on that network to verify authenticity of large purchases like real estate or art rather than real world 'verification' middlemen who charge high fees?

I could go on. But you get the gist. This could be some seriously revolutionary stuff, both in how we live our lives and the systems that we have built up in those lives. Banks, real estate agents, even central banks are all on notice because they have potential competition. In my view, this is a sea change. And we are only just beginning to understand the implications.

Now I am going to watch Raoul's take on this and get ready for our talk. Have a good weekend.

The Credit Writedowns Newsletter

Crypto: a sea change in how we gain trust