Protocols are a geeky topic. It’s way more interesting to talk about applications. People will go on and on about why they like gmail or some other email application. But not a lot of people get excited about SMTP and IMAP which are the underlying email protocols that allow the gmail application to talk to other email applications.
Open protocols are at the heart of many of the most important systems that we have. The Internet works because of TCP/IP. The web works because of HTTP. Email works because of SMTP. These are open systems that developers can build applications on top of. There are plenty of proprietary protocols out there too. But proprietary protocols tend to lock in users and drive value to the owners of the proprietary protocol, like Microsoft, Apple, Google, etc.
One of the problems we have had in tech is that there aren’t large monetary incentives to create and sustain open protocols. If they are open they cannot be easily monetized by traditional means.
However, that is changing with the emergence of blockchain technology and crypto-tokens. My partner Albert wrote an important post about this last week. Here are a couple paragraphs from that post:
Now, however, we have a new way of providing incentives for the creation of protocols and for governing their evolution. I am talking about cryptographic tokens. You can think of these like the tokens you might buy at a fair to get on a ride: different operators can have their own rides and set their own price in terms of tokens. You only need to buy tokens once (in exchange for fiat currency) and then can use them throughout the fair. With blockchains we now have a way of issuing and redeeming these tokens digitally (the underlying blockchain can be Bitcoin or Ethereum or possibly its own as in the case of Steemit).
A for profit company can now create a new protocol and create value for itself (and its investors) by retaining some of the tokens. If the protocol becomes widely used, the value of the tokens will increase. For instance, think of a decentralized storage service (a la Amazon’s S3). Anyone can implement the storage protocol in whatever language they want to as long as they meet the protocol spec. They can then get paid in the relevant storage tokens. The original creator of the protocol will make money to the extent that it is adopted and to the degree they have retained some of the tokens (so they can sell them at a higher price later on). This is not hypothetical as there are a variety of such protocols out there, including Storj, SIA and Filecoin.
This is super important because the more open protocols we have, the more open systems we will have. If Twitter had been built and monetized this way, things could have played out very differently. In the early days of Twitter, there were third party applications (Summize for Search, Tweetie for iOS client, etc). These were all built on Twitter’s API. If Twitter had imagined itself as a protocol instead of an application, these third party applications would not have had to compete with (or get bought by) Twitter. But at the time, there wasn’t an obvious way for Twitter’s founders and management team to benefit from a protocol-based business model.
In this emerging model, Twitter could have adopted a protocol-based approach and issued a crypto-token, Twokens, that users could earn from things like amassing followers, reporting abuse, etc. Twokens could also be sold by the Twitter founding team to finance their operations. Crypto-exchanges could make a market in Twokens so that anyone who wanted to speculate on the future value of the Twitter protocol could do so.
I am not criticizing Twitter for the approach they took. I was there in the early days and was completely bought into and supportive of that approach. It was the one that made the most financial sense at the time. I am also not saying or predicting that some new Twitter competitor is going to emerge using this new model. What I am saying is that we now have a new model that supports a protocol-based business model and I believe we will start to see innovative new protocols emerge that are based on this new business model. Obviously Albert believes that too and so does the rest of USV. As Albert mentions in his post, we are invested in a number of projects that are taking this approach. It’s a brave new world and we are grappling with what it means for us as investors and how we engage with and invest in this model.
But, as I have said many times here at AVC, I believe that business model innovation is more disruptive that technological innovation. Incumbents can adapt to and adopt new technological changes (web to mobile) way easier than they can adapt to and adopt new business models (selling software to free ad-supported software). So this new protocol-based business model feels like one of these “changes of venue” as my partner Brad likes to call them. And that smells like a big investable macro trend to me.
