"We're at the Early Stages of a Truly Novel Structure That can Organize Humans and Money:" Olaf Carlson-Wee

And it's going to be "extremely massive and unstoppable," Polychain Capital's founder told The Defiant.

In today’s episode, I speak with Olaf Carlson-Wee. Olaf joined Coinbase as the exchange’s third employee, right out of college, enamored with the idea of bitcoin and cryptocurrencies. After helping scale the operation to millions of users, he left in 2016 to start Polychain Capital, a venture fund designed to invest in digital assets. He managed to grow Polychain into the largest crypto fund, at one point crossing the $1 billion mark. 

He was already telling Wired magazine about programmatic finance back in 2016, so it’s no surprise Olaf is very excited about the growth and promise of DeFi. He thinks smart contracts are enabling different ways of organizing people and capital, turning traditional corporations into internet sovereign corporations. He says Compound Finance, one of Polychain’s investments, is a great example of a business that was able to so far move from a pen and paper-based to software-based.

He believes that given a compelling underlying product, liquidity mining will be an incredibly effective mechanism for accelerating network effects, which will be applicable to many different types of business models even beyond financial services.

He thinks that the narrative that every blockchain is competitive with every other blockchain and that there could only ever be one winner is dumb. And belives that automated financial services will grow dramatically and that the smart contract execution environment will over time lend itself to the many types of applications that make up the internet today. 

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Olaf Carlson-Wee: I found out about Bitcoin in the summer of 2011 and immediately was enamored by the concept of a totally decentralized monetary system that is sort of governed by the users rather than by a central authority. And so, this idea of moving assets and money natively onto the internet and having it be a distributed system, very similar to the internet itself, where there's no single governing body or person in control, whether it be a government or a corporation, was extremely enticing to me and felt like a massive breakthrough. 

“ … this idea of moving assets and money natively onto the internet and having it be a distributed system, very similar to the internet itself, where there's no single governing body or person in control, whether it be a government or a corporation, was extremely enticing to me and I felt like a massive breakthrough.”  

At first, I was just skeptical that mechanically it would work. I kind of spent that summer diving into how Bitcoin was constructed, all the peer to peer networking, cryptographic signature schemes and mining and everything and became convinced that this was actually a robust, resilient and scalable system that would work to manage basically the world's money and assets. At that point, I was going into my senior year of undergraduate studies and wrote my undergraduate thesis on cryptocurrency.

Camila Russo: What were you studying at the time?

OC: I was majoring in sociology.

CR: Oh, so far from computer science and cryptography.

OC: Yeah. I've always been a pretty hardcore internet user, so I felt comfortable, obviously, navigating a lot of the complexities of the Bitcoin universe. But I really had to convince my professors that this was an appropriate topic, given the area of study. I think there was a lot of skepticism around this topic, but I think I eventually convinced them that it was sort of a valid area and ended up finishing the thesis on cryptocurrency. So that was really exciting. 

Olaf Carlson-Wee. Image source: WSJ

30th user of Coinbase

But also, at the time, cryptocurrency was a very nascent area. It was basically, an open-source software project and a series of forums where people could talk about it. There wasn't what you would call like an industry, the way we think about it today. This was in 2011-2012. Towards the end of 2012, I joined Coinbase as one of the very first users. I was like the 30th user of Coinbase and I thought the product was fantastic. I ended up emailing Coinbase when was fresh out of school and basically said, I'll do any job to work at, just to join Coinbase. 

I joined Coinbase as the third employee, at the time, this was pre-series A, very, very early stage business operating out of a residential apartment in San Francisco. Once I got started at Coinbase, I really got introduced to the entire kind of startup and venture-backed business ecosystem, which I really wasn't familiar with before joining Coinbase. 

At Coinbase, I was there for three and a half years. For the majority of that time, I was the head of risk. We scaled from about 10,000 to 5 million users. We also grew from the three of us up to about 200 employees during the time I was there. So, really went through some pretty aggressive hyper scaling within Coinbase, but also at a more macro level for the crypto industry, the foundation was being laid during that time.

CR: In 2013 crypto had a small “bubble,” Bitcoin had a big run-up in price…

OC: It was a big bubble, I would say. In 2013, Bitcoin went from $10 to about $1,000, roughly speaking. And I think that kind of growth was also reflected in Coinbase’s user base and just the general volumes and activity that we were processing. So that was a wild year. I mean, I was working a lot in 2013. And it was a very big lift, given it was sort of, in a way my first real job, but managed to navigate it all.

And, Coinbase survived despite some serious scaling issues, these are all the best kind of problems to have when you're running a business. But Coinbase made it through that year against all odds, I would say. And a lot of crypto businesses from that time period ended up having various problems, mostly getting hacked, sometimes having issues with banking relationships, we managed to sort of navigate all of that. 

It was a pretty remarkable journey going through all that scaling at Coinbase. And after the three and a half years there is when I left in 2016 to launch Polychain.

CR: Now, what an amazing journey to be right out of school into this rocket ship that was Coinbase and crypto at the time and when the industry was just getting started with the Bitcoin chain, starting in 2009, so just a couple of years you started diving into it.

So, what prompted you to start your own crypto fund? What was the thesis behind it and how has that change until today?

Programmatic Finance

OC: In 2016, I started to really notice a lot of very, very interesting activity coming out of, at the time, the Ethereum ecosystem. And Ethereum was sort of a new architecture for a blockchain and it tweaked some of the ways that Bitcoin worked. It's still a peer to peer system. There's still this concept of kind of a native cryptocurrency that adds security to the system and also acts as the monetary unit of account in the system. But Ethereum allowed more complicated financial logic to be expressed and embedded in the blockchain and these kind of more complicated bits of financial logic are often referred to as smart contracts. Because instead of relying on a pen and paper legal contract, there are more of a pure software system where the code sort of enforces the state of that contract. 

In 2016, I was starting to see a lot of experimentation with smart contracts and I felt like the larger crypto ecosystem, maybe didn't realize how big a deal this was. And a lot of the investment groups at that time in 2016 were all structured as venture funds, looking for equity investments in startups in the blockchain ecosystem. 

And one thing I noticed though about a lot of those venture firms that were operating here was that while they may be had produced positive returns that accompanied the growth of the cryptocurrency industry, they had massively underperformed. Most of the kind of basement hackers I knew like myself, had actually generated way better returns, basically by buying cryptocurrency itself, which is liquid and freely traded, instead of buying the equity of various startups or software businesses, built on top of cryptocurrencies. 

“ … one thing I noticed though about a lot of those venture firms that were operating here was that while they may be had produced positive returns that accompanied the growth of the cryptocurrency industry, they had massively underperformed.” 

With Polychain, what I set out to do was create more of a structure that was well suited to actually purchase digital assets, so not the equity in businesses, but actually digital assets themselves. I wanted to do a very, very long-term investment strategy focused on these digital bearer assets. A lot of what I was excited about and continue to be excited about is this idea of smart contracts. I think that these are a very, very big deal, an extremely powerful devices that we're still only really learning what they're capable of and the types of ways that they can organize humans and capital.

“ With Polychain, what I set out to do was create more of a structure that was well suited to actually purchase digital assets, so not the equity in businesses, but actually digital assets themselves.” 

I remember I did an interview for Wired magazine in late 2016 when Polychain was getting off the ground. And the area that I talked about being very excited about, I called “Programmatic Finance”. This is sort of combining this idea of money and financial services products with pure software. Anything that you can express in code, you can now embed in a blockchain and have a fully functional financial product that is sort of operated entirely with the code in that smart contract, so you're not reliant on any individual party or government or jurisdiction or corporation to sort of process that financial product. This idea of programmatic finance, now I think has sort of become this larger wave that we now call DeFi or Decentralized Finance. And I think that this continues to be an area that I'm very excited about. 

CR: Your main driver to start the fund seems to have been Ethereum. Is that right? You're excited about this in the possibility of having smart contracts?

Longing for Long Tail Growth

OC: I think that was one of the very big catalysts embedded in the name of the funds. We’re Polychain, not monochain. When I launched Polychain, Bitcoin represented 95% of the market share in cryptocurrency kind of digital assets. And so, a lot of my bet was that there was going to be a lot of very interesting activity that was uniquely enabled by alternative protocols to Bitcoin. It's not that Ethereum was this nice to have thing. It's these types of constructions are uniquely possible using, what's called a Turing complete scripting language that's embedded into Ethereum. And so, that on that remaining 5% long tail growing because of all the unique applications that it would enable, a lot of people to time thought I was crazy.

“It's not that Ethereum was this nice to have thing. It's these types of constructions are uniquely possible using, what's called a Turing complete scripting language that's embedded into Ethereum.” 

Because historically, up to that point, empirically, Bitcoin had really outperformed any alternative project. I continue to be convinced that these alternative systems will kind of uniquely enable new types of business models, new types of products that are only possible because of novel architecture at that lowest level where people can embed code into these blockchains.

CR: Do you think this 5% long tail will grow enough to potentially overtake Bitcoin’s relevance or market share or however you want to measure it, in the crypto industry?

OC: I think Bitcoin is a very powerful system with a lot of very unique properties. So, Bitcoin, I've called it sometimes like the “cockroach” protocol in that it will survive anything. And I think one of the great features of Bitcoin is actually its governance, which is that it doesn't have governance. There is no system to upgrade Bitcoin. And well, that is on one level, kind of a bug in that a lot of new breakthroughs on a technical level have come out since Bitcoin was invented. And frankly speaking, Bitcoin now, if you were to build Bitcoin today, and just make it a bit more efficient, a bit more scalable, you probably wouldn't build it the same way that it was built in 2009, in fact, you definitely wouldn't.

But that said, the fact that if you own Bitcoin today, you know that it will be the very same Bitcoin that you own today in 10 years, I think that is a very powerful feature. And so, I would never bet against Bitcoin.

However, that said, as an early-stage investor with a lot of knowledge about how these low-level technical breakthroughs will manifest, new types of business models, new types of ways to organize humans and capital, I think that there is outlier opportunity as an early-stage investor in many of these alternative systems. And I continue to believe that the market share represented by Bitcoin will continue to drop. Now that said, it does not mean the price of bitcoin will drop. It's more than its market share, relative to the macro growth of this entire area will reduce.

“I think that there is outlier opportunity as an early stage investor in many of these alternative systems. And I continue to believe that the market share represented by Bitcoin will continue to drop. ” 

CR: Because the industry itself will just be bigger. You also mentioned this particular or specific feature of your fund that was different to most funds back then, which is that you wanted to invest specifically in digital assets and not equity. And I just wanted to dig a little bit deeper into how you invest in crypto protocols and projects.

Do you only invest in the token and not the equity and when you do, is it a long term hold? Or are you actively trading tokens and participating in these protocols, for example, in all the DeFi protocols, providing liquidity or taking an active role in governance. What kind of investor are you? 

No Short Positions, No Algorithmic Trading

OC: We continue to operate that digital asset fund today. It's a long term buy and hold. None of the alpha generation here is trading strategies, algorithmic trading or anything like that. We don't enter into short positions. We don't use synthetic or derivative style instruments. It's a very vanilla early-stage acquisition and then buy and hold approach to the digital asset kind of landscape. 

Now, in addition to that, we've since launched venture funds that do equity investing in startups building in the blockchain landscape. And part of the reason that we did that is that between 2016 and 2018, the entire size of the cryptocurrency landscape grew by something like 100 times. It just went through another dramatic period of growth, very similar to the time period between 2012 and 2014.

After that period of growth, I started to feel that the opportunity at seed stage in equity was there for the first time. I didn't feel that it was a compelling opportunity in the 2016 landscape, in part because there simply wasn't a big enough outcome. When I launched Polychain, Coinbase was the most valuable cryptocurrency business in the world, and it was valued at $400 million. That may sound like a lot of value, but in the scheme of a venture fund, that's not a very big outcome in order to balance inevitably the seed stage investments that fail or are more middling outcomes. 

And so, in order to justify seed-stage equity investments, you need to feel that there's a very enormous market for those seed-stage companies to grow into. By the time 2018 came around, I felt like that market was there and that's why we launched our venture funds that do seed-stage equity investment. 

CR: Can you name some of the biggest investments you've made in both equity and tokens?

Next-Generation Systems

OC: Absolutely. I think some of the systems that are on the kind of cryptocurrency protocol level that we're excited about include Filecoin, Polkadot, Dfinity and Tezos. These are some of the kind of more emergent, newer architectures that I think have very, very interesting properties. That's not an exhaustive list of the types of things we're investing in. But these are some of the kind of next generation systems that are in the midst of launching. 

Another very recent launch we saw was, for example, Cielo, which is sort of an entire blockchain protocol dedicated to the issuance of synthetic assets that are pegged to more traditional asset classes. The first product there is like this Cielo dollar, which is pegged to the US dollar value. I think those are some of the things that we're excited about happy to dive into what any of those are.

Then on the equity side, one of the things we're really excited about are businesses built around this concept of smart contracts. I do think that very, very unique business models are emerging out of this concept of smart contracts are totally programmatic financial services. And one of the trends we're seeing that I think is really, really interesting. We've seen it sort of evolve over the last several years is this idea of corporations and when I use that word, I mean, basically a way to pool capital and organize humans to grow the size of that capital, right, where, where the very corporate structure itself is defined by smart contract code logic.

[ … ]

Paid subscribers have access to the full transcript, including sections on:

  • Internet-sovereign businesses

    “This is a very powerful construction in my mind for allowing any two people in the world to enter into basically an arbitrarily complex business arrangement, in this case, it's narrowly lending, but I think over time, these things will become much more sophisticated.”

  • Hacking network effects

    This network mining system where you actually distribute ownership in that internet sovereign corporation (…) it doesn't make for a good product by default (…) However,it is gasoline for network effects. It just absolutely accelerates the solution to that chicken and egg problem.”

  • Participating in governance

    We are going to make whatever proposals and vote on proposals that others put forward in order to maximize the value of our holdings.”

  • Ethereum killers

    “I really don't like the sort of false narrative that every blockchain is competitive with every other blockchain and that there could only ever be one winner. That is one of the big reasons why my firm is called Polychain.” 

  • Internet sovereignty

    “ We're at the very early stages of a truly novel structure that can organize humans and money. I just find that very exciting. And I think, as a kind of mega trend, it's going to be extremely massive and sort of unstoppable.”

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The Defiant is a daily newsletter focusing on decentralized finance, a new financial system that’s being built on top of open blockchains. The space is evolving at breakneck speed and revolutionizing tech and money.

About the editor: Camila Russo, is the author of The Infinite Machine, the first book on the history of Ethereum. She was previously at Bloomberg News in New York, Madrid and Buenos Aires covering markets. She has extensively covered crypto and finance, and is now diving into DeFi, the intersection of the two.