The growth of cryptocurrencies and the emergence of blockchain over the past decade has unleashed a growing wave of innovation. As 645 has evaluated where we are in the innovation cycle, we’ve found that crypto and blockchain innovation are following the framework described by Geoffery Moore’s Crossing the Chasm framework.(1) In the first phase, technology enables the innovators to access the core innovation. In the case of crypto, this first phase was primarily the creation of bitcoin, followed by currencies such as Ethereum, which catalyzed the building of blockchain applications.
In the second phase, the core innovation moves from the innovators to the early adopters, and new technology is required to accelerate and simplify this adoption. Crypto exchanges and wallet providers such as Coinbase and Binance provide the enabling technology which has allowed cryptocurrencies to be more easily purchased, stored, and managed by a larger percentage of the population. Additional companies have emerged in areas such as token storage, custody, and merchant services, raising significant capital in the process.
We are now moving into the third phase, as adoption moves from the early adopters to the early majority, and crypto and blockchain evolve from primarily speculative and trading use cases to practical adoption in the everyday lives of businesses and individuals. We are seeing this in the rise of blockchain applications, such as NFTs and blockchain gaming, as well as in the growth of DeFi, which holds the promise of transforming our financial system.
In this third phase, providers of infrastructure software will be critical to enable broad adoption. These players reduce the risk of adopting the underlying technology, which may be significant in the early days. As it relates to crypto, one of the key barriers to adoption is financial crime, malicious activity and fraud, which can be rampant. In 2020 alone, financial crime related to cryptocurrency generated $10.5 billion in ill-gotten gains, according to blockchain analytics company Confirm (2). This type of risk can prevent the adoption of a technology by the early majority, which in this case refers to important market participants within financial services.
As a result, we believe companies providing this new layer of infrastructure software for crypto will be critical to reduce adoption risk in the third phase. One company that is providing this much-needed infrastructure for crypto is Solidus Labs, and we’re proud to announce our participation in the company’s Series A funding round.
Solidus has created the first automated, comprehensive and testable market surveillance and risk monitoring hub tailored for digital assets. Their software enables a broad range of crypto market participants, including exchanges, banks, crypto funds, and government regulators, to detect, investigate, manage, and analyze crypto transactions. Solidus was founded by Asaf Meir, Praveen Dosodia, and Chen Arad. While working at Goldman Sachs, the team identified multiple pain points in the adoption of crypto. They realized that traditional software for securities fraud prevention, surveillance and monitoring were insufficient to address the needs of digital assets. This is because cryptocurrencies introduce new market structures, data structures, and trading workflows that are different from traditional securities. These new realities have introduced forms of trading manipulation at volumes that have not been witnessed in traditional securities markets. For example, as recently as two years ago, the crypto firm Bitwise Asset Management estimated that up to 95% of reported crypto trading volume is fake. (3)
As a result, new infrastructure platforms are needed to enable continued growth in institutional demand for digital assets, which has accelerated over the past few years. For example, institutional volume grew as a percentage of Coinbase’s trading volume from 20% in Q1 2018 to over 64% of volume in Q4 2020.(4) Furthermore, over the last few months alone, Goldman Sachs has announced the restarting of its crypto trading desk (5) and NYDIG has partnered with Fidelity to enable banks to offer bitcoin to their customers (6). Institutional investors and large financial firms are experimenting with digital assets and putting in place the financial systems and controls to trade and own these assets, which will ultimately enable crypto to move into the next phase.
Solidus has already signed up an impressive roster of customers, including crypto exchanges, financial services providers, and regulatory agencies, and assembled a top-notch team, with offices in New York and Tel Aviv, and planned expansion in London. We’re proud to be investing alongside lead investor Evolution Equity Partners, as well as Fidelity-backed Avon Ventures and crypto derivatives exchange FTX. We’re also joined by an angel roster that includes former CFTC Chair Christopher Giancarlo, former SEC Commissioner Troy Paredes, and AngelList Founder Naval Ravikant.
Our investment in Solidus reflects our broader aim of investing in software companies that are providing critical infrastructure to address new pain points that arise as crypto adoption continues to accelerate. These pain points include data risks, potential fraud, loss of privacy and identity, reputational harm, and exposure to highly speculative currencies. Just as widespread adoption of the Internet brought with it new risks that businesses and consumers had not considered before, the widespread adoption of digital assets introduces unique risks.
Finally, along with software that reduces new risks, we’re also looking for platforms that support digital asset adoption in areas such as tax, accounting, reporting, and portfolio management. We believe that as digital assets reach the same level of adoption as traditional financial instruments, both business and consumers will require a new set of financial management tools to protect their investments. We’re excited to partner with founders who are living in the future and building the infrastructure to enable us all to capture the benefits of crypto and blockchain technologies.
(1) For an in-depth description of Crossing the Chasm and how the framework applies to startups, check out Geoffrey Moore’s interview with Mike Maples on Starting Greatness: https://greatness.floodgate.com/episodes/why-geoffrey-moores-crossing-the-chasm-is-a-must-read-for-ambitious-startup-founders-P24oXmfg
(3) “95% Of Reported Bitcoin Trading Volume Is Fake, Says Bitwise,” Forbes.com, at https://www.forbes.com/sites/cbovaird/2019/03/22/95-of-reported-bitcoin-trading-volume-is-fake-says-bitwise/?sh=1da841a96717.
(4) “Coinbase Institutional, Retail Trading Volume Grew at Equal Rates in 2020,” Coindesk, at https://www.coindesk.com/coinbase-institutional-retail-trading-volume-ipo.