Protocol Labs

Protocol Labs made a series of announcements earlier today including that Union Square Ventures made an equity investment in the company late last year. We are thrilled to be working with Juan Benet and his team and excited to be able to share some of our thinking here. 

As most of you know all of us at Union Square Ventures believe in the decentralized, emergent, permissionless innovation that was so central to the vitality of the early Internet. Prior to the Internet, the media industry was dominated by a small number of companies that controlled access to in their respective mediums, print, television, radio, cable etc. It was the broad adoption of a set of open protocols, like TCP/IP, SMTP and HTTP, that allowed any creator on the planet to get to any consumer and unleashed the wave of innovation that led to the consumer Internet we know today. That vital innovation is threatened today by consolidation at the applications layer of the Internet. Publishers find themselves becoming commodity content suppliers in a sea of undifferentiated content in the Facebook news feed. Web sites see their fortunes upended by small changes in Google’s search algorithms. And manufacturers watch helplessly as sales dwindle when Amazon decides to source products directly in China and re-direct demand to their own products. 

The source of this market power is control over the data we all contribute as we interact with these services online. The key to mitigating the market power of the web giants is open protocols further up the stack. If an open public communications network (the Internet) unlocked the distribution bottlenecks that characterized the media industry, an open public data layer is the key to and unleashing another wave of innovation. It is the mission of Protocol Labs to coordinate the efforts of a large and passionate community of open source contributors to create these protocols. 

It is an audacious mission. As you move higher in the stack the complexity of the protocols is exponentially greater. Luckily, they are not starting from scratch. Juan Benet, the founder of Protocol Labs, is the creator of IPFS (the Interplanetary File System) an increasingly popular protocol that allows content on the web to be addressed directly instead of by reference to a file located on a specific server. This subtle but profound change means that a provably unique piece of content is no longer tied to a specific server but can exist anywhere there is a little surplus storage capacity on the web. Protocol Labs and everyone else working on open protocols today has another advantage that was not available to the creators of the original Internet protocols. They have blockchains. 

Blockchain based crypto tokens have been have been described as the native business model of open source software. They have the promise of being able to fund the critical shared infrastructure of the information economy in a way that equity can not. Protocols are more valuable when they are open and shared broadly. But equity is most valuable if a company can extract monopoly profits from a resource they exclusively control. When a protocol incorporates an incentive in the form of a crypto token it can resolve this inherent contradiction. 

In the next few weeks, Protocol Labs will be introducing Filecoin, a crypto-token to support the development of a next generation protocol that enables a decentralized data storage layer on top of IPFS. By funding this effort through the sale of a token rather than the sale of additional equity, they ensure that the creators and consumers of value in the storage network (the people who buy storage with tokens and the people who earn tokens by storing files for others) will benefit directly from the success of the network and the protocol that defines it. This happens because the protocol sets limits on the number of tokens that can ever be issued. Because the tokens are the currency in this marketplace for storage, as the protocol becomes more broadly adopted and the marketplace for storage grows, demand for the token increases, and the currency appreciates. So the tokens that investors purchase in a pre-sale to fund the engineering effort to build the protocol, the tokens people hold in their wallets in anticipation of buying storage and the tokens people earn by providing storage capacity all grow in value over time. 

The bitcoin protocol demonstrated that it was possible to finance an enormous computing infrastructure - reportedly one with a hashing power greater than all the super-computers in the world - with an crypto-token. But it does so at a great cost. Securing the bitcoin blockchain could by 2020 consume as much electricity every year as all of Denmark. With Filecoin, Protocol labs, hopes to secure the network with useful work - work that has to get done anyway - storing files for people. Over the next few years, Protocol Labs plans to develop a series of protocols that could become the infrastructure of a more decentralized economy. By funding these efforts through sales of crypto tokens, they ensure that the economic value of the protocols is shared broadly. By designing systems that secure the network by doing useful work, they respect the limits of our natural resources. 

But they have also made one more investment to further the development of this shared infrastructure, they have invested heavily in the legal design of the Filecoin token and the pre-sale process in the hopes of demonstrating that these offerings can be done responsibly in respected jurisdictions. We have already made the point that the pre-sale of a crypto-token is different than equity. It is also not a commodity, a currency or a futures contract. It is something new. As such, it does not fit neatly into any existing regulatory or legal framework. Many of the recent offerings of crypto-tokens have avoided the difficult task of fitting the round peg of crypto-tokens into the square hole of existing regulatory frameworks by raising money in a foundation based in Switzerland, and offering the token for sale in a jurisdiction like Malta or Singapore. This is a reasonable approach. The reality is that these offerings are inherently global. Pretty much anyone anywhere can participate, and the recent returns in the sector have caught the eye of investors around the world. In the near term, it benefits the existing holders of the token to have access to global demand in an unregulated offering, but not all of these offerings will end well. Protocol Labs is playing the long game. They believe that a pre-sale of a crypto-token is an important new funding mechanism that will support the creation of a rich ecosystem of protocols that decentralize the web, democratize access to services and spread the wealth created by networks beyond a narrow cohort of equity owners. To further that goal, they are working with an army of lawyers to create a mechanism that is defensible under U.S. law and regulation - one that can hopefully be a template for others who want to build infrastructure that lasts. 

Protocol Labs is creating new infrastructure in an new way. We think their commitment to the re-decentralization of the web will lead to protocols that are powerful, broadly embraced and generative. Their approach to financing their work will spread the value that is created more broadly. Their commitment to investing in a legal approach that respects the current regulatory environment while not compromising on the promise of the new technology will be a foundation others can build on. We are thrilled to be along for the ride.

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