One crypto strategy that might work: A basket of low market cap Proof-of-Stake coins

I've been spending some time trying to think through where the proverbial hockey puck will be going in cryptocurrency, and here's one idea I think might work. 

Right now, if you put $100 in a savings account, you'd be lucky to get even $2 per year. But with this shift in cryptocurrencies to Proof of Stake, the right pick could net you $50 to $80 per year for that initial $100 investment. 

Moving from Proof of Work to Proof of Stake is one big experiment happening now

The dominant cryptocurrencies like Bitcoin and Ethereum operate on proof of work. Miners have to do fairly complicated math problems to figure out what the next step in the blockchain will be. In return, they get a mining reward, which is the primary form of inflation for most currencies. 

Proof of stake is different. Instead of expensive GPU-based or ASIC-based mining rigs, you just run a normal, non-computationally-intensive piece of software on any kind of computer, and attach your "stake" — some amount of the cryptocurrency that you are putting up as proof that you are running the right software and won't try to cheat the system. If you are caught cheating, you lose the amount you put up for stake. This is important in that now normal people who just hold the currency can actually get an interest rate on holding it. 

Generating yield is a big deal

This turns crypto from a negative carry asset (like gold, or putting money in your mattress) into one that actually generates yield.

The world's capital is desperate for yield these days, which is why the stock market is so overheated, why negative or near zero interest rate lending now exists, and why people are so worried about asset price bubbles broadly. People want to grow their capital and it has never been harder to find consistent ways to get it. 

For instance, look at the eye-popping 11% rate of return you would get on CD's back in 1984! 

The days of risk-less return were our parents' generation, and not ours. But cryptocurrencies that use proof of stake for consensus have the promise of a consistent 3% to 8% annual yield, because rather than give that to miners to run the network, they can just share them with holders who are willing to stake. 

One strategy with asymmetric upside: A basket of low market cap Proof-of-Stake coins

Proof of Stake hasn't been proven to work at the kind of scale that Bitcoin or Ethereum have had yet. Crypto experts have pretty divergent opinions on whether it will work at scale over time, which is a risk that is preventing adoption now. 

But as with anything new, it has to start somewhere, and that's where coins like Decred and Navcoin are leading the way in the attempt. Navcoin (at the time of writing) is around $100M market cap, and Decred is around $220M. If either of them can get to top 10 cryptocurrencies, that's a 10X in value from here. Obviously these things are always an absurdly big if, but I like it as a bet with highly asymmetric upside.

Navcoin yields about 5% per year, but Decred yields up to 31% compounded per year. That's pretty amazing. But if the coin itself can 10X in value, you're looking at 50% to 80% annual yield on the initial fiat you might use to buy in. I like a one-time 50% increase in value, but what's even better than that is a a 50% to 310% yield every year into the future. Those yields stack as you increase your holdings in each cryptocurrency as well, which is another nice compounding effect similar to automatically re-investing dividends into a stock. 

The list of PoS coins is actually relatively long, and an exhaustive review of them is left as an exercise to the reader. An incomplete list of more popular ones in addition to the ones above include Peercoin (one of the first to do it), Lisk (largest by market cap), Nxt, and many others. I've also found browsing coin subreddits to be pretty valuable— these coins tend to live or die by developer and community interest, and you can get a great gauge on these things through their forums and subreddits. 

Proof of Stake is not the only way you can get yield from these coins. NEO is another coin (dubbed the Ethereum of China) that gives NEO wallet holders another coin called GAS, which at current time yields about 4.8%

The great thing is if you are an early holder of Ethereum, you'll already get this effect massively, if/when the Casper upgrade to Proof of Stake enters the picture next year. 

Finally, I would recommend small amounts (perhaps with a dollar cost average strategy) that you wouldn't be upset about losing, and as a part of a portfolio such that if one Proof of Stake cryptocurrency doesn't work out (and be prepared for most to stagnate or fail) you have a decent shot at owning the eventual winner. The best thing about asymmetric upside is that you can at most lose 1X, but have the potential for a lot more on the flipside. 

Consumer, SaaS, or Enterprise?

Early founders often ask whether the classifications of startups (consumer, SaaS, or Enterprise) matter a ton in terms of what kind of startup they should try to start. Is there a such thing as "founder market fit" when it comes to these stages? Unless you're an ex-Oracle sales manager founding a company, probably not. 

It's backwards to rely on the consumer/SaaS/Enterprise distinction early on because that's tactics, only after you've picked a problem to solve. In a nutshell:

  • Consumer — lots of people (tens of millions or more) have the problem, and the problem is medium to severe
  • SaaS — fewer people (hundreds of thousands or more)  have the problem, but the problem is severe
  • Enterprise — a few people (as few as dozens) have the problem, but the problem is extremely severe

Start with what problem to solve, and then choose your tactical approach given what you know about that problem. That'll help you get to where you want to be, and let you optimize for solving a real thing that you actually want to do. 

Finding good startup ideas is hard enough. You don't want to complicate it by setting constraints at the wrong level of a if you can help it.

What to do when you just start making something useful

A founder in China I met asked me what he should do with a business he started that has a few hundred users that are happy. He's not sure what to do next yet.

Here's what I wrote him:

The main thing is to a) figure out how you can make money, and then b) figure out how you can grow. How much you know a and b will determine whether or not you decide to raise money, or do it as a lifestyle business, or don't do it at all. It's important to figure that out as soon as you can, since those are really the only next steps from where you are. If you can grow and make a lot of money (high unit economics / margin) then you should raise money. If you can grow but can make some but not a lot, then you can probably be a good lifestyle business and you should just try to get to profitability. If you can't grow or you can't make money doing what you're doing, then don't do it.

I think the most remarkable thing about this trip to China is while the markets are radically different, the fundamental problems founders face are absolutely the same. 

Babbage's broken dreams: A brilliant design for the world's first mechanical computer, sabotaged by personality

Brilliant inventor Charles Babbage designed the Difference Engine, a pioneering mechanical computer capable of storing and operating upon up to 1,000 numbers with a limit of 50 digits each. Remarkably, it wasn't until the modern era when researchers used 19th-century mechanical fabrication techniques to verify Charles Babbage's designs did work after all. 

A lecture in 2008 at the Computer History Museum by Doron Swade shed light on what went wrong

In fact, no one at that time had warned that these calculating machines could not be built. Many other machines - some of them useless - were in fact built using those same Victorian era mechanical parts and tools. Instead, there were a myriad other factors contributing to the failure to physically realize the Difference Engines. These included: an argument with his lead engineer over worker compensation, run-away costs, muddled financial arrangements, wrangling with a changing British government for funding, and a resulting discontinuity of negotiations over funding and construction.

Perhaps, Babbage's personality had more to do with the failure to complete the Difference Engines then the underlying technology of the time. Known by his first biographer as the "irascible genius" Babbage had lots of pride and hubris. He behaved as though being right entitled him to be rude. His quarrels with the British government and with chief engineer Joseph Clement might have doomed the project.

When Clement resigned in March 1833, the practical construction of Difference Engine No. 1 stopped - 11 years after it was conceived. Negotiations with the British government continued, but funding was finally axed in 1842. Difference Engine No. 2 was conceived and designed between 1846 and 1849 - long after the design of the (never completed) Analytical Engine.

Regrettably, none of these three machines were built in their entirety in Babbage's lifetime. Only years later did we recognize the potential and power of the underlying machine architectures, which were independently "discovered" by later day computer pioneers.

A preventable tragedy. It was lack of interpersonal skills leading to inability to raise funds (and inability to manage execution!) that kept such a vitally important innovation from surfacing. Not the first time, and certainly not the last.

Irascible geniuses everywhere must take heed as they pursue their dreams. Being smart, right, and brilliant is no license to be rude and treat people poorly. So many startups crash and burn, not because the tech didn't work or the founders weren't smart enough, but because the interpersonal neglected. 

Thank you, Y Combinator

Dear friends-

I wanted to let you know I am stepping away from YC. I've been involved at YC since early 2011 and in that time it has been my privilege to work with over 600 startups and over a thousand founders. It would be impossible for me to have predicted the success the team has achieved since then. After nearly five years, I’m ready to take a break and plan for my next adventure.

It's been a great time and I wanted to thank everyone for being awesome. PG, Jessica, Trevor, and RTM have built an enduring organization and I can't wait to see where my friends and partners take it. Led by Sam, the YC partnership has taken the founding vision and put it on track for tremendous success and impact. Between the incubator, YC Research and YC Fellowship, the future is bright indeed. YC is engraved in my heart. To my fellow alums: I will always be there for you.

My wife and I are headed to Southern France and Spain for a few months to relax and enjoy the wonders of parenthood with our 3 month old infant. I don't know what is next yet, but making great software and helping others do the same will always be my life's purpose. See you all back in SF in the new year.

With much love,
-Garry

Deprogramming corporatism

There’s a culture to big corporations that is unnatural and detrimental to founders who have spent too much time in them. Some experienced founders have a really hard time coping with starting a new company, and are very frustrated and surprised when things don’t work even when they're working really hard at it. And even when founders overcome that, often they’ll try to grow the team by hiring experienced directors and managers from corporations that are well known and successful. Many of them fail pretty quickly, and it’s always a surprise to everyone, especially the experienced hire. 

These are well-known startup tropes for a reason. There are specific aspects to that culture that cause problems. If you know what they are, then you can at least recognize it and try to counter them.

Doing things without results

People become corporate do-nothings because it’s easy to become disconnected from the act of creating when you’re at a big company. Even at the best big companies, employees can just do things that look like work that aren’t, and you wouldn’t be able to tell. Getting customers is easier (sometimes trivial) with a large installed base, sales force, or huge brand name. There are large protected revenue streams that cover up failure on the quarterly financials. 

Founders from corporate backgrounds aren't stupid. They're just used to doing things and having something happen— they have the wind at their backs at a big company, and there are a lots of things that you can do at a big co that would never work on your own. It's bewildering to work really freaking hard at something and have no results at all come back. But it happens all the time. 

There’s no air cover for startups. You don’t have backup troops. It’s just you versus the world. So naturally, if your product or service sucks, then you die. You can’t just look like you’re doing stuff. You actually have to make it, and almost totally on your own. 

Cover your ass culture

If doing things that aren’t effective don’t get you fired, then what does? Usually making mistakes that make your boss look bad. Big organizations are just groups of people, and people sure like to talk shit. The one thing you can’t do is look like a bozo. It’s fine to work really hard to no effect (hey, you worked hard!), but if you become a social liability, you’re donezo.

What’s worse than just covering your ass is actually taking credit for what other people do. This seems correlated with people who climb high in organizations. Obviously this works poorly in a small startup environment because there’s nowhere to hide. Someone's got to do the work.

In some sense this dynamic is unavoidable, since we are all social animals after all. Startups can sometimes develop a cover-your-ass culture too, but that’s the job of the founders and CEO to keep people focused on things that actually matter. It helps that startups are just smaller, so this toxic effect of group dynamic is blunted. 

Buzzword thinking and trend-following

How do you avoid looking like a bozo? Well, for one thing, if everyone in the world out there is saying it, then nobody can fault you for it. So getting the right corporate whitepapers, or latching yourself to the right buzzword du-jour (e.g. big data, Internet of Things, NoSQL, etc.) is necessary to blend into the pack. Oh, that big data initiative failed? Everyone else was doing it, so our ass is covered and we won’t get fired. 

Founders get this confused all the time and then wonder why they fail. We said all the right secret words! Why am I failing? It was never about those words to begin with.

Startups can’t survive blindly following buzzwords or whatever trend is hot because you actually have to know what’s coming in the future and be right. That’s all there is. If you chose the wrong market, or you’re wrong about what people want, then you’re toast. I’m not saying all things with buzzword labels will fail. I’m saying that startups for big data, for instance, actually have to make life better for specific customers such that people are willing to pay for it. It has to make sense. It’s not enough to be attached to that name. 

This was a tough lesson for me to learn personally. At 23, I turned down the shot to be first engineer at Palantir (now rumored to be worth $20 billion!) even though Peter Thiel personally took me out to dinner to recruit me. I thought the buzzwords were signal, and absolutely zero of the mainstream press or tech blogs were abuzz about the latest hot government enterprise software startup in 2004. It turns out you have to work on things that a) you know are right, and b) most people don’t know yet. This is why Peter likes to ask: What super valuable company is nobody building yet?

Deprogramming

Experienced founders who have grown up in these environments are not doomed to failure. Quite the contrary, those who succeed have avoided, overcome, or escaped the problems described above. 

The recurring theme seems to be simply results. We spend a lot of time trying to get founders to focus on action and results — build product, talk to customers, that’s it. Think in terms of concrete numbers, whether it is user growth, savings to customer, or revenue. There are lots of places in the world where you can survive without results of your own, but startups are not one of them. 

Just as corporate culture is a culture that is learned, not innate— founder culture is learned as well. I think one of the reason why YC works for founders is that it takes a village. It takes a bunch of people who all believe a thing, and practice it daily. It takes fundamentally changing your surroundings and the people you’re around. It takes avoiding the coworking space [0], and working harder than you ever have in your own space. 

This is also a big reason why they say YC is a concentrated form of Silicon Valley. For decades, Silicon Valley has been the place where people can escape their corporate cultures and create something new. Now you can do it with a lot more like-minded people by your side. 

[0] http://www.quora.com/Why-doesnt-YCombinator-have-a-physical-space-for-its-startups-to-work-out-of

InboxSDK launches — The Biggest, Most Unexploited API Frontier in 2015 is now open

The Facebook API. iOS. I remember when their API docs hit the scene, and what a greenfield opportunity it was. Today, the opportunity for Gmail apps is much bigger than when those greenfield APIs were released. There are over 1 billion daily active uniques on Gmail now, and it’s a fundamental pillar of how people communicate today. But until today, it was cumbersome and nearly impossible to consistently write an app that had a good user experience that worked as well as being a part of Gmail itself. 

InboxSDK, released today by YC-backed startup Streak CRM, is that solution. It provides the missing things that would be extremely cumbersome to do with Gmail’s backend APIs alone. Lots of companies like Dropbox, Stripe, Screenleap, and Streak CRM themselves actually use InboxSDK right now in production. 

An incredible amount of work was put in to make InboxSDK possible. A Gmail API is a monumental task — just look at all the possible interactions, with multiple inboxes, chat, preview panes, conversations, different Gmail Labs features, and many kinds of email compose windows. 

As with any brand new opportunity, we don't know all the amazing things people will build yet. But this is a rare opportunity for hackers and founders to think about ways to make awesome stuff that works on top of email. A billion users are going to be in for a treat this year.  

Share buybacks: Big cos say "We don't know what to do with the cash anyway!" and why it's good for startups.

Stock buybacks are the biggest force influencing equities since 2009 — over $2 trillion have been done.

Some are probably good, but many aren't. In 2011, Warren Buffet wrote about how you can tell: (via Seeking Alpha blogger Chuck Carnevale)

Charlie and I favor repurchases when two conditions are met: first, a company has ample funds to take care of the operational and liquidity needs of its business; second, its stock is selling at a material discount to the company's intrinsic business value, conservatively calculated.

Clearly a lot of buybacks fail the 2nd criteria — but there are so many boards and management teams that are compensated by EPS that the share buybacks keep happening even when the price is not a discount. A natural result when incentive structures meet personal self-interest. One blogger points out, it's actually a form of managers looting their companies. 
By using large stock buybacks to manage the short-term objectives that trigger higher compensation for themselves. By using those stock buybacks to manipulate the share price, which allows them to use inside information to time their own stock sales. By using buybacks to funnel most of the company’s profits back to shareholders (including themselves).  They use the stock market to loot their companies.
It's a claim echoed by the Atlantic in February of this year in an article called "Stock Buybacks Are Killing the American Economy." Rather than new jobs, new factories, new products, it's straight back into the financial system.

Since the companies themselves have no specific better ideas about how to use the capital to grow in real terms (e.g. real new products that drive real new revenue) all their professional managers can do is buy shares back regardless of price. In this world, buybacks are directly related to Thiel's ideas around indeterminate optimism of the markets, where companies are encouraged to be as profitable as possible.

Who cares if you're buying back at a ridiculous price? We don't know what to do with the cash anyway. 

This is interesting because a traditional criticism of whether we're in a bubble is whether P/E ratios are high or low. The E part is Earnings Per Share, and so if managers manipulate the denominator for both P/E and EPS, they can make it seem like things are fine (and get their quarterly bonus to boot!) when functionally there's little happening. 

On the bright side, the lack of innovation in traditional incumbent businesses means that startups have a chance in more arenas than ever. If big companies have management that won't take the risk of failure, and aren't hiring teams to attack new markets, then it's wide open for new players to get capital, hire people, and make these things happen. 

If buybacks are killing the economy, then startups will save it. Pretty sweet if you ask me. 

Chart via Factset
More reading here: ValueWalk 

Defending A16z: Noam Scheiber mistakes a VC portfolio for his 401K

Labor and workforce reporter for the NY Times Noam Scheiber takes on Andreessen Horowitz in this recent piece:

Rather than profiting like Mr. Ovitz and his fellow agents, the venture capitalists may be more like the Hollywood studios — chronically overpaying for projects whose costs they can rarely recoup. Mr. Andreessen and his partners have invested so much in so many start-ups that it would take a remarkable string of successes to make the approach pay off. For all their skill — the firm bought into the likes of Airbnb, Instagram and Pinterest relatively early — their track record suggests it’s unlikely. Already, they’ve suffered a few impressive flameouts, including Fab, on which they are likely to lose tens of millions of dollars.

Even when they pick well, they often bid so much for stars that the return is relatively modest. It’s easier to triple or quadruple your money when you’ve invested $10 million in a $100 million company than when you’ve invested nearly $100 million in a $1 billion company, as they did with the daily deal site Zulily. There are only so many companies that are acquired for billions of dollars or reach that kind of price through an initial public offering. Fewer retain such valuations — Zulily’s stock price has fallen sharply since last year.

Noam doesn't make a data-based argument. He uses an anecdote. Because data would ruin a really good story in this case. He compares Silicon Valley juggernaut Andreessen Horowitz to the excesses of Hollywood and CAA.

There's a big difference here. Let's take Avatar, for instance. It's a film that was made in 2009 for $237 million. It grossed over $2.7 billion worldwide — a roughly 11X return on capital. That's the highest grossing film ever made, and a good proxy for how profitable Hollywood can be at best. 

Let's take another example from Silicon Valley— Facebook. Peter Thiel invested $500,000 in the fledgling company in its first seed round in 2006, and from public records held 22.4 million shares of the stock at IPO. Those shares, if he hadn't sold them, would be worth $1.9B today (at about $74 per share). That's a 3,800X return on capital. 1 

Multi-billion dollar companies happen when non-obvious ideas and huge market needs meet perfect execution. We've seen it before our eyes — Uber, Airbnb, Dropbox, Stripe, Instacart — and when you have the potential for 100X to 4000X returns, it's not about avoiding loss or minimizing downside. A proper venture portfolio is not like your 401K. The only way startup investors truly lose is if they miss the Uber. 

And that, in a nutshell, is why using anecdotes (e.g. Zulily in Sheiber's piece above) as evidence against Andreessen Horowitz makes no sense at all. An individual investment may fail but it's just one in a portfolio. The returns that are possible in early stage technology investing far outweigh anything Hollywood has ever seen or ever will see. Software is eating the world, and the numbers bear it out. 

1 David Hammer suggested a better comparison would be Accel, their Series A partner. Their 10% stake at IPO is now worth $14.8B, so their $12M investment yielded roughly 1100X return.

Spotify as a simple case study in making something people want

A passage in the New Yorker long form piece this week on Spotify really illuminates the key parts of what we spend a lot of time trying to help founders create: Something people want. 

Problem: Piracy was how people did it at the time. 

“It came back to me constantly that Napster was such an amazing consumer experience, and I wanted to see if it could be a viable business,” Ek went on. “We said, ‘The problem with the music industry is piracy. Great consumer product, not a great business model. But you can’t beat technology. Technology always wins. But what if you can make a better product than piracy?’ ” Ek continued, “Piracy was kind of hard. It took a few minutes to download a song, it was kind of cumbersome, you had to worry about viruses. It’s not like people want to be pirates. They just want a great experience. So we started sketching what that would look like.”

They started with a simple problem statement. All of the great era-defining startups seem to start that way. What was broken? They knew exactly what was broken. 

Solution: 200 milliseconds

Their “product vision,” in tech parlance, was that the service had to give the impression that the music was already on your hard drive. “What would it feellike?” Ek asked. “That was the emotion we were trying to invoke.” The key was to build something that worked instantly. Streaming, whether audio or video, tends to have built-in delays while you wait for the file, which is stored on a server in the cloud. But if the music starts in two hundred milliseconds or less—about half the time it takes, on average, to blink—people don’t seem to perceive a delay. That became Ek’s design standard. He told his lead engineer, Ludvig Strigeus, a brilliant programmer he had worked with before, “I don’t accept anything that isn’t below two hundred milliseconds.”

What would solve that very direct problem? Well, a great streaming service that was superior in a specific way. They knew how to measure success. Clearly if you could make a streaming service act as if it were on your local hard drive, you could win. 

Hard-to-build proprietary technology — the first time it was done, just enough of an advantage

Strigeus responded, “It can’t be done. The Internet isn’t built like that.”

“You have to figure it out,” Ek insisted.

The solution involved designing a streaming protocol that worked faster than the standard one, as well as building their own peer-to-peer network, a decentralized architecture in which all the computers on it can communicate with one another. In four months, they had a working prototype.

“And I knew when we had it that it was going to be very special,” Ek said.

This is a signature piece of why Spotify was special early on. There are two parts to this. The first is could it be done? Until these early prototypes, it hadn't. The second part is can it be cloned? As with almost anything software related — yes. Novel tech is not an infinite defense, but it was enough of one for Spotify to get off the ground. You don't need a technological advantage that lasts forever (though of course that'd be preferable) — just one that will last enough such that your competitors can only copy your innovation from 6 months ago. It can take that long to fast follow, which is enough to keep your unoriginal would-be competitors at bay while you blaze ahead. 

The Schlep = The Moat

Ek’s original idea was to launch Spotify in the U.S. at the same time that he launched the service in Europe. Ken Parks, Spotify’s chief content officer, said, “Daniel thought he could just go down to the corner store in Stockholm and pick up a global license.” He didn’t realize that he would have to negotiate directly with all the different copyright holders, a herculean task. Not surprisingly, the labels weren’t interested. Ek was an outsider—a techie, and a Swedish one at that. Parks, an attorney who’d worked at E.M.I., recalled, “We needed to overcome the music-is-free mentality that Spotify represented.” Of the labels’ attitude, he went on, “If you have something you’ve invested a ton of money in, and you’ve been selling it for a lot, and you feel raped by piracy—to say to that person, ‘The only way to beat this is to co-opt the people who are stealing from you,’ that was a challenge.” Ek said, “If anyone had told me going into this that it would be three years of crashing my head against the wall, I wouldn’t have done it.”

This is a common refrain. If founders knew how much work these things would be, often they wouldn't do it. But they do, and that's protectable long term enterprise value. 

This analysis is of course with 20/20 hindsight. In the moment, Ek and the Spotify cofounders and investors had no idea they'd be right. But they figured they might be, so they built it.