FOREWORD
2023 saw the building blocks of our firm put into place. We established a structure that allowed for appropriate liquidity to investors and long-term commitments to entrepreneurs. We closed on capital and made lead investments into LongFi Solutions and Ritual Media. We supported those teams through several operating cycles. We learned quite a bit about their decision-making processes as well as their operating environments. We levered those insights into liquid investments which delivered attractive relative performance.
We don’t set much store in quarterly or even annual performance, but I highlight these events to demonstrate that our flywheel is beginning to turn. Deeply researched insights led to convicted investments whose operations refined our insights further and led to outperformance. We have a long way to go, but this is a start.
WHERE OUR IDEAS COME FROM
Our sourcing and research methodology focuses on use cases in which blockchain networks provide significant value by solving immediate need related to financing. Sourcing was a major focus of 2022 and that year’s annual letter offers insights into the ways we assess opportunities. The past year has been heavily skewed toward support of our existing investments, but our sourcing energies have continued, directed at understanding problems related to flood mitigation and long-term climate resilience.
In a recent conversation, someone noted that time spent by a small fund with a solo GP exploring such large problems seemed like a mismatch in resources. My old baseball coach would have said it more directly – “that’s a ten gallon hat on a two gallon head.” This might be said of any problem addressed by venture capital, but it’s particularly true of the wicked, systemic issues that we encounter in the communities across the Rust Belt and the Gulf South. It’s worth a word on why we see these places and these problems as fertile ground for productive investment.
A short answer would be that solvable problems are rare, and we should address them wherever we find them. That’s not a value judgment on the relative burden of any particular issue. It is an observation on the rarity of overlap between awareness of an enduring problem and the energy to solve it. When we find people and places with the awareness and energy to solve a material problem, it’s worth spending time there.
Many investors I admire lift the constraints on solvable problems by slipping the bonds of time. They invest in startups that solve problems which do not exist yet, but will in the future. More often, they invest in solutions to problems which are underappreciated, but will be better understood and more fully resourced in an exacerbated future. They may also invest in solutions to those problems that are fodder for films, pulling the future forward through technology. Lux Capital goes so far as to say they “turn science fiction into science fact.”
Many communities with a deep awareness and energy for financial, infrastructural, and environmental concerns fall below the radar of science fiction storytellers. Our predispositions to gleaming, heroic futurism leads us to miss out on the compelling stories they might tell.
In her delightfully quirky and deceptively deep reflection Time Tells, Masha Tupitsyn observes “from its inception, sci fi has been a genre of both magical thinking and failed mourning…the ‘future’ is really a longed for past…grief produces an alternate reality in which the impossible – time travel – becomes possible. Heartbreak turns into science fiction”.
The Rust Belt, Appalachia, and the Gulf South have known failure and heartbreak in the 20th and 21st centuries, yet they hardly seem like the kinds of places that might give rise to flying cars. I don’t go there to romanticize the tragedy, nor do I go there in hopes that they’ll capture their former glory and acclaim. I spend time with people and their places because in quiet moments, there is a remarkable honesty about what failed in their past, what kept them going in their present, and what might allow them to thrive in the future.
They talk about the big companies and resources that put them on the map and gave them pride. They talk about the intimate bonds of community that sustained them once those large monuments to meaning and opportunity were gone. They talk about heavy handed attempts at renewal. Above all, they talk about a hope that their families and friends could make a life near to their history, near to them.
Entrepreneurs and investors often talk about “the right to exit”, a removal of any constraints and a life of abundance. We often forget that throughout history at least as much innovation has been dedicated to staying put. Once you submit to that constraint, you get pretty interested in finding ways to co-exist. Some wonderful and strange arrangements emerge. Some wonderful technology does too. To put a fine point on it, the operating leverage that emerges from community-led services has kept many places alive for the past fifty years. Those practices, if nurtured by technology, might represent the seeds of future thriving.
We are willing to bet that a great deal of value will be created alongside these communities as they build toward their future. A fellow investor shared that they weren’t spending much time on climate change adaptation and migration, preferring to focus on the market for mitigation because they perceived the market as more established and quality entrepreneurs in greater supply. These problems exist below investor consciousness because many people and places don’t yet viscerally feel these problems. Where these problems are felt, exceptional communities are building solutions which may change investor perceptions.
One thing is certain – if these problems are not addressed, they will scale. By 2050, tens of millions of Americans will be at risk of climate-induced migration. There are small pockets of the country that are living in that future now. The technology we build for these people and these places, allowing them to address massive issues with community perspective and local insight is literally the science fiction of the 21st century.
We think it’s an area rich for collaboration, cooperation, and creativity. We think exceptional founders will find these problems and these places as compelling as we have. We know a number of them. While these issues are existential, we can imagine a future in which small communities and a host of technologists can take action on them. We intend to be there when they do.
WORKING WITH OUR PORTFOLIO COMPANIES
Our attitude towards portfolio construction and investor usefulness is well documented. Our approach is not new, and we borrow here from investors in many assets classes with track records that are longer than my lifetime.
Many investors in venture capital diversify across a number of companies, writing 5-15 new checks per year in the interest of maximizing the potential of an outsize result and minimizing the impact of any one loss. Two perspectives from giants of the industry have been rolling around my head as I’ve built our variant approach:
Don Valentine: “[investors at Sequoia] don’t have a clue what the right answer is [or which particular product will win.] We’re very interested in the process by which the entrepreneur gets to the conclusion that [the entrepreneur] offers”.
Paul Marshall: “At its best, diversification allows you to enhance the risk-adjusted returns of a pool of good assets. The problem is that diversification also looks like it works to improve the risk characteristics of bad assets, in short runs of data. Over the longer term, we tend to discover that bad assets are more correlated than one might have expected, because they share a common factor – they are all bad.”
Investing is an individual art form, so I can only offer what works for me, but I believe just as the correlation of bad assets is one, so too is the correlation of bad or shallow relationships. In venture capital, such relationships are most tested in the decision-making process. Strong relationship doesn’t require agreement; the correlation of decisions I don’t agree with is wonderfully diversified much to the benefit of our partnership. I fear that the correlation of decisions I don’t understand is 1. I cannot underwrite a substantial number of new decision-making processes each year, nor can I build the kind of relationships that would allow me to be an additive participant in decision-making.
If our sourcing process asks a great number of questions about the way a team thinks through problems and makes decisions, then our investment support process helps them allocate capital behind those decisions and improve their decision-making process. We aim to construct a portfolio with significant exposure to quality decision-making processes and a diversified exposure to individual bets.
We operationalize this through a simple, but specific FP&A process. It has done wonders for the partnership’s ability to invest in concentrated fashions. I have also been pleasantly surprised by the extent to which the approach has resonated with CEOs as they allocate team time and resources.
Our practice begins with the work of Ed Thorpe. The author of Beat the Dealer, Thorpe operationalized the Kelly Criterion as an optimal betting strategy in blackjack. As chronicled in A Man for All Markets, he went on to found Princeton Newport Partners, deploying similar philosophies in the more scalable world of convertible arbitrage. Foundational to his strategy was an understanding of the interrelations between probability, bankroll, and bet sizing.
Thorpe argued that in any game, players should bet when they have an advantage and when the expected value of a bet is greater than zero. They should size their bet relative to their bankroll, optimizing for the probability that one of their bets will generate positive return before they run out of money. Most startups engage in this practice through a rough methodology known as runway. Monthly spend over cash balance equals months of runway. It’s useful – with the current team and our current cash balance, how much bankroll do we have?
In practice, I have found it imprecise in unhelpful ways. For one, it masks the investment decisions being made. Using runway, an early stage investment would seem to wager “in 17 months, this team will deliver enough revenue to cover costs or generate sufficient metrics to access someone else’s capital.” The bet appears monolithic. If the bets are not disaggregated, it would seem reasonable that an investor treat them as an individual unit of risk.
Blunt metrics also encourage absolute thinking on the part of operating teams. Discrete bet identification occurs when team time and capex is allocated to an activity which has set duration. At the end of the duration, we can assess, reframe, and bet again using new information and capabilities.
When thinking in the imprecise context of burn and runway, I’ve seen investors advocate for drastic action – “we have to stop this activity now” or “we have to pivot dramatically” when the right course of action might be to say “we should spend money on X only when we see Y metrics” or “we should use a freelance team for these capabilities to make our bet shorter in duration”.
More precise decision-making leads to more learning and more aggressive hypothesis testing. It also pushes decision rights down the organization, as one person should be responsible for the outcome of one bet (appropriately sized to their resources). The whole endeavor becomes more resilient.
Enough theory – in keeping with Thorpe, we identify bets, a rough assessment of probability, and then size them according to bankroll. Our bets are mapped to key business drivers, which requires the creation of a “Drake equation”. Shamelessly stolen from Michael Dearing, the concept refers to an equation calculating the number of sentient extraterrestrials in the world. Definitely wrong, but useful when it comes to searching far galaxies with limited resources. A roughly correct equation for value creation allows teams to focus each bet on a single number.
LongFi’s Drake equation, for example:
If this number is greater than 1, LongFi requires no external capital. That’s a clear measure of success for our bets. We identify a primary driver to bet on as well as a duration of the bet. We allocate opex against it as well as capex, arriving at a bet amount.
LongFi's focus on physical assets means that more than 50% of the current bets are dedicated to capex testing the potential of increased revenue per site, while the remainder are human capital spend improving site acquisition. Ritual’s bets are overwhelmingly opex based – 66% of capital outlay is toward the team, with 34% in content + distribution capex and digital marketing spend.
Our two investments have then become many more. We aspire to work with 5-10 platforms over the course of the coming five years, meaning that we expect more than 100 bets to be placed on behalf of the partnership. Combined with our six holdings in liquid cryptoassets, the portfolio should be sufficiently diversified to protect investors while allowing reasonable successes to drive exceptional returns.
WHAT WE LEARNED FROM LONGFI SOLUTIONS
Our thesis on LongFi Solutions
Robust telecommunications infrastructure is critical to thriving in the 21st Century. Decentralized wireless offers the ability to transform the cost of deploying network infrastructure by using open source software and readily deployed hardware. It remains unclear which protocols will succeed and where in the value chain they will create or capture value. Early experience has taught us that regardless of protocol design, installation quality and facilitated early network deployment are critical, a kind of physical market making. We believe that value will accrue to deployers of such infrastructure that can deliver quality installs for new and existing protocols, while managing the risk associated with bandwidth-based commodities.
Agency and the modular stack
In Read, Write, Own, Chris Dixon offers an encapsulation of an optimistic crypto future by noting, “Commoditizing a layer in a tech stack is like squeezing a balloon. The volume of air stays constant but shifts to other areas. The same is true for profits in a tech stack…the overall profits are conserved but shift from layer to layer.” This may not be completely true – certainly not in financial terms. It is directionally true, however, when value is broadly defined and well measured. We find it to be especially true when it comes to the value of agency.
For many years, communities below certain income and density thresholds have existed at the mercy of the federal government and large telcos when it comes to deployment of digital infrastructure. Due to the intensity of the required capex, small cities waited for large capital providers to make decisions about large capital projects. Due to that same capital intensity, when infrastructure was deployed, the value chain was composed of non-modular corporate networks which were structured to meet the specifications of these few outsized participants.
As a dramatic oversimplification for the purposes of discussion, we have illustrated the value chain connecting wireless users to the Internet, as well as evolution in that value chain over time.
In 2011, the wireless value chain was remarkably closed. Much has changed. The emergence of performant permissionless compute in the form of Ethereum and Solana has accelerated the commoditization of the data center layer, but even these protocols have significant exposure to traditional cloud providers making significantly more modular than on-premise servers, but much progress is required before full commoditization is achieved.
Fiber provision is becoming more diverse and open as municipal fiber providers create credibly neutral infrastructure networks. Fiber-to-the-home is expensive to install, but easier to maintain technology than past generations of wired connection, allowing non-traditional providers to emerge. The 2020 Infrastructure Investment & Jobs Act dedicated $41.6B to expanding fiber-to-the home networks. Much of that spend will be captured by existing telcos and it is illegal to use funding on municipal networks in 16 states, but some funding will find its way to more neutral sources, improving consumer access to wholesale fiber pricing.
As our investment in LongFi would indicate, we believe that transformative modularization has come to the wireless stack downstream of fiber and more will follow. In particular, 2023 saw massive leaps forward in mobile core. Mobile core software is the beating heart of wireless networks, responsible for 1) authenticating devices prior to attaching them to the network 2) providing Internet (IP) connectivity 3) ensuring quality of connectivity 4) tracking user mobility also known as tower switching and 5) tracking subscriber usage for billing and charging. (Citation)
While there have been several open source mobile cores in the past (including Magma, and several offerings from the Telecom Infrastructure Project) most existed as open source repositories, waiting to be slightly modified and dropped behind a corporate wall. They failed to be modular in production, introducing substantial friction in onboarding both antennas and SIM users, dramatically changing the economics of interfacing with mobile core or operating a wireless provider.
One of blockchain networks' core functions is the improvement of funding for digital products which are open source by default. Ownership via tokens can incentivize developer investment while avoiding the friction and pricing umbrellas of walled gardens in production. Industry advocates have pointed to proof-of-coverage incentives (in which blockchain carriers pay for tower deployment ahead of data demand) as a critical innovation in infrastructure networks, but we have seen that permissionless access enabled by modular, open source operating systems is far more important to addressing felt need over the short to medium term and does more to reduce costs over the long-term.
Over the course of the past year, LongFi has placed targeted bets related to acquisition of SIM users and by extension, data demand. Our experiences within the XNET and Helium ecosystems have delivered powerful insights around agency and modularity. XNET, built by a team of telco veterans, offers proof of coverage rewards to incentivize deployment of antennas into known dead spots in telco coverage networks. These antennas operate on a carrier-grade, walled garden mobile core. The XNET team markets these deployed clusters to legacy MNOs and MVNOs in exchange for long-term roaming agreements.
While blockchain networks in this context offer the ability for proof-of-coverage rewards and efficient partitioning of cash flows, deployers still exist at the mercy of XNET’s ability to sell their clusters through an enterprise agreement. XNET by comparison exists at the mercy of large wireless carriers to sign roaming agreements. While the product and the pricing is compelling, there are many links in the chain which communities and deployers don’t control. As Jennifer Pahlka would put it, these towers still exist within the waterfall of existing industry structures and incentives.
By contrast, Helium’s more modular stack promises a slower path to data, but one over which value chain participants have more control. Helium’s open source mobile core has been in operation since 2022 and has been actively serving customers since 2023. Its ecosystem may lack the same scale that large MVNO’s can offer; as of this writing, there were approximately 75,000 verified Helium Mobile users in the US versus hundreds of thousands for mid-size MVNOs. For their lack of immediate usage, they offer clear agency for deployers and communities to access coverage without engaging in drawn-out enterprise sales cycles in which they are unlikely to thrive.
At issue here is a question of internet scale and the value of blockchains. At XNET, there is a clear vision that blockchain networks will introduce significant cost savings for scaled entities looking to serve new markets. Helium’s decentralized stakeholders offer many visions for the network, but one among them is the possibility that blockchains allow for the existence of small, functional networks – as small as a single tower – with incredibly sophisticated capabilities.
Toward more local strategy
Given the scale of the installed SIM card base, there’s still immense value in partnering with existing MVNOs. The team at LongFi has been thoughtful and deliberate in ensuring exposure to traditional strategy as it relates to antenna deployment, driven through enterprise processes.
A more transformative infrastructure future would move faster than large enterprises, however, and much of the innovation around the Helium ecosystem is focused on speeding the reach of its modular ecosystem. In the last year, progress has occurred on three main fronts:
- Helium Mobile – by far the most important evolution in decentralized wireless related to Helium’s launch of a hybrid MVNO offering for consumer purchase. The company released a $5 unlimited CBRS and Wifi data plan for limited rollout in Miami. By Q4, a nationwide unlimited plan was announced at a cost of $20. All consumers have to do was scan a QR code. In the background, they would be issued a Solana wallet and an associated NFT that would interface with the mobile core on their behalf. An eSIM card is activated, and phones began roaming to Helium hotspots. Importantly, the company signed a backup roaming agreement with T-Mobile so that coverage would still work in the absence of Helium hotspots.
- Neutral host model – Helium has also found a way to access scaled demand partners by allowing modular access to its towers. At maturity, any provider should be able to begin roaming to Helium hotspots after integrating with the mobile core and staking a set amount of tokens ($1.5M in $MOBILE as of this writing). In current practice, Telefonica is exploring the value of Helium hotspots in neighborhoods it can’t serve profitably. They have identified specific neighborhoods in Mexico for deployment by offering boosted proof-of-coverage rewards (as much as 100x boosts over typical network rewards) as well as data roaming from their budget mobile platform Movistar. In this case, Helium is engaging in enterprise processes, similar to XNET.
- Proof-of-coverage – As a corollary to their activity with Telefonica, Helium has also been offering boosted proof-of-coverage rewards in an effort to increase the deployment of Helium Mobile towers, lower the cost of providing Helium Mobile, and speed payback periods for deployers. Boosts are highest in areas they expect high concentration of Helium Mobile users (largely Miami). Initially, these boosts were disbursed from the Nova Labs’ $MOBILE treasury marking them as a large investment, but not one requiring new issuance. Recent emissions changes have shifted boosts to the proof-of-coverage schedule, and as a result, represent new issuance to incentivize growth.
As discussed in our 2022 letter, proof-of-coverage returns are denominated in a protocol’s native token and are heavily dependent on fluctuations in the value of that token. Data returns on the other hand are denominated in fiat currency, offering lower volatility returns.
Allow me a slight digression. Between June 2014 and January 2015, a collapse in oil prices rocked the natural resources industry. As companies processed the impact of the volatility, assets of all kinds went on sale, bankruptcies were widespread, and a few well capitalized parties closed career-making trades. Special scrutiny came to energy’s midstream sector, particularly those companies structured as master limited partnerships, or MLPs.
The sector had become a favorite of taxable investors for two reasons. Midstream assets in energy provide exceptionally consistent cash flows. Much of their revenue is contracted as take-or-pay, essentially a credit claim on oil and gas producers. Most MLPs paid this out as a dividend due to investor demand and because the structure treated dividends as return of capital as opposed to income. As a result, the listed entities were well loved for their distributions, so much so that they issued equity at the market to fund their growth projects while also paying dividends. Do you see where I’m going with this?
The system worked exceptionally well until some cracks in capital structures emerged due to unexpected price exposure and poor capital allocation. Dividends were cut, which meant cost of equity went up, which broke the model entirely. Companies had to completely restructure their capital structures to atone for decades of equity-funded capital allocation that proved less than accretive. Even those entities that had deployed capital well, such as Magellan Midstream, faced a structurally higher cost of capital for the five year period that followed.
Helium faces an analogous challenge, issuing tokens through proof-of-coverage to fund capital deployment while paying out dividends in the form of its burn and mint mechanism. Helium Mobile could not exist without the arbitrage afforded by token issuance, so it is worth examining the network's growth incentives as they are being stretched to their limits.
This chart approximates the total value required in each epoch to compensate deployers for their capex at a 25% ROIC. An implied reality is that the yellow line shows how much data must eventually run across Helium towers in order to justify the token issuance. The blue line shows data transfer levels expected in each epoch. Projections assume that Helium Mobile grows toward the size of Mint Mobile by 2028. The projections also assume that hotspot rollout occurs on pace with the IOT network. They also assume that boosted hexes cover a large percentage of initial deployed assets and decline in prevalence over time.
The chart makes clear how much future productivity risk is introduced by proof-of-coverage. Boosted hexes are highly correlated as a risk factor, given that tokens are allocated via the same algorithms as PoC. For a while, that risk was mitigated to a certain extent by the fact that boosted hexes were not new issuance, but the transfer of $MOBILE tokens held in treasury or purchased in the open market (as in the case of Telefonica). Recent changes to emissions schedules mean that boosted hexes are net new issuance, and the correlation of risk is nearly 1.
If we were to score proof-of-coverage algorithms based on past success, there would garner mixed reviews. In IOT, Helium’s first network, proof-of-coverage incentivized roughly 800,000 hotspot deployments at a total capex of $360M, an incredible feat. As of this writing, however, 393,760 remain active. Many of those units went offline because data demand never materialized. Many of them never intended to provide useful coverage, as the incentives for gaming rewards are rampant in proof-of-coverage ecosystems.
Those same concerns continue in cellular networks. I expect the deployment of cellular networks to be 3-5x as capital intensive as IOT, and its critical the assets be well deployed. Gaming continues. In recent MOBILE DAO debates, it was an accepted baseline that 5-10% of protocol emissions were going to gamers. We have seen gaming setups that stretch the bounds of ingenuity. In one instance, a host put two cell phones next to their hotspot and continuously power-cycled the phones. When they turned off and on, the GPS would “hop” until it could locate itself. This gave the appearance of connecting to many cell phones over a number of locations, and dramatically increased rewards.
Due to the rampant gaming mentioned above, Helium moved from mapping coverage with users’ cell phones to modeling coverage, using obstruction models to offer more consistent estimates of coverage. While deployers can’t hypothecate good coverage through mapping, they can lie about their coverage dynamics, a particularly valuable form of gaming in boosted hexes. A rig that’s online in a basement can attest as live on a roof at a 35 degree azimuth.
Beyond gaming, there are several data points indicating that proof-of-coverage incentivizes short-term decision-making through negative cost of capital which undercuts long-term network value. In recent conversations related to site acquisition in Mexico, LongFi found that certain hosts were receiving inbound calls from the US offering 5-10x above market payouts. These deployers had no path to equipment in Mexico, but assumed they’d be able to deliver hotspots while they could harvest coverage rewards.
Proof-of-coverage, allocated at such a high level allow for substantial value leakage and questionable allocation. The tsunami of rewards on offer masks desired market incentives rather than clarifying them. Given the persistence of these issues over time, Helium’s communal governance, which has been remarkably effective in driving high-quality decisions related to its mobile core, may be too far from the ground to develop effective deployment strategy.
How long markets will extend this mechanism the low cost capital it currently enjoys remains to be seen. Rather than throw the mechanism out, we continue to explore technological solutions which might solve some of these practical hurdles to proof-of-coverage deployment such as AI agents for coverage validation and denylist construction. More practically, it's important to consider who bears the risk of exploration related to PoC. Should it be the protocol? Or other parties. We recognize that it may be preferable to allow parties seeking to incentivize network deployment to fit PoC to their own capabilities, managing coverage validation and compliance in more intimate ways, while the protocol is able to transmit its values through other incentives, such as data credit burns, until protocol-level validation is practical.
For instance, where parties have significant amounts of low cost capital and a desire to improve antenna density, they could offer boosted returns through market purchases of $MOBILE. Such programs could operate similarly to the Telefonica pilot, removing deployment inefficiency by defaulting to coverage modeling or whitelisting deployers, and then verifying through trusted connectivity mapping, removing gaming incentives. Telefonica mappers are not credibly neutral, introducing some risk, but neither were Helium mappers credibly neutral.
This argument becomes a circular one, as Helium Mobile's priorities and capabilities are reflected in $MOBILE's emissions schedule. We would argue, however, that the early experiments in boosted returns with permissionless verification have not returned results that are congruent with quality deployment. There are many other subsidies that could speed the deployment of Helium towers without introducing systemic risk to the protocol (as a result of poor capital allocations). Low cost of capital is earned.
So too are governance rights. Our urge, learned over many years in corporate structures, is to bring governance to the highest possible level, where it might be most scalable and efficient. The history of cooperative endeavors would show, however, that governance should be pushed as far down as possible without compromising shared values. So long as it is member-led, aligned to long-term network value, and non-cash compensated, some areas of governance might be most effective at the edge. We believe deployment strategy may be one such governance area.
Despite our critique, we believe the vast majority of Helium Mobile's activity has worked to push governance and decision-making down rather than up. Thanks to the new MVNO architecture, it’s possible for a demand signals to emerge from underserved communities with relatively little capital. Helium Mobile subscriptions work without the presence of Helium towers. At $20 for an unlimited plan, they also present an attractive consumer offering. Subscriptions act as a beacon for capital deployment. In this case, the absence of boosted hexes and proof-of-coverage rewards would make deployers extremely sensitive to the productivity of their assets in competition for the data rewards. This form of deployment is likely more predictable and near-term actionable than enterprise engagement.
We expect that both such instances would still benefit from many of the cooperative dynamics that bring efficiency to the decentralized wireless model. In the latter method of deployment, there would likely be further cooperative dynamics, as Helium Mobile’s affiliate program would allow local advocates to benefit from efforts to increase the density of SIMs. It seems that subsidies in the form of T-Mobile roaming and affiliate programs are far more effective deployment incentives than issuance for PoC returns.
These reflections make us optimistic about the value of decentralized wireless, but unsure where value will accrue as the “balloon is squeezed”. We are confident that the key functions of the mobile core will accrue value across native tokens and the L1’s on which they operate. It seems less likely however that asset deployment value will translate to value in decentralized protocol layers, either because those layers are not decentralized or because they’re not materially contributing to asset deployment.
WHAT WE LEARNED FROM RITUAL MEDIA
Our Thesis on Ritual Media
Media is infrastructure in the 21st century. An inability to target audiences and deliver validated content at attractive margin has led to a hollowing out of the media ecosystem in which platforms are incredibly large or lacking in sufficient scale to be sustainable. As a wellbeing platform, Ritual works with content partners and royalty agreements to provide validated, hypertargeted media products through owned distribution channels. We believe that such a structure will lead to quality content, sustainable margins, and increasingly targeted distribution relationships, improving relevance and personalized encouragement.
Media in the 21st century
2023 furthered our initial hypothesis that quality media is inaccessible for communities that fall below a certain size or income threshold. According to a Northwestern study, 1 in 4 newspapers that existed in 2005 no longer does. The small market media platforms that remain exist in name only, their ability to deliver quality insights hollowed out by a collapse on two fronts.
- Ad revenue streams have dried up thanks to the take rates of advertising exchanges and agencies. Coherence AI estimates that 50-75% of all dollars spent on digital advertising are consumed by parties upstream of news platforms.
- Subscriptions is under threat as well, as it becomes increasingly difficult to affordably target and convert relevant audiences. An estimated 60% of spend on digital ads never reaches relevant audiences thanks to inflated costs, bots, and non-viewable ads.
What remains are skeleton brands and emerging offerings that often fall prey to pseudoscience or low quality control. Citizen journalism is a critical piece of media in the 21st century, but in many instances, it would have benefitted from editorial input. Wellbeing wisdom is in a similar stage of development, and perhaps more clearly so.
Ostensibly a wellbeing platform, Ritual works with content partners and royalty agreements to provide validated, hypertargeted media products through owned distribution channels. Should the model prove successful, Ritual will show that relationships of trust can be recreated between media and consumers even if that relationship begins with a specific personality. It will also show that relevant media products can be delivered to targeted audiences at low cost and attractive margin.
Early results on this model continue to be promising, though Ritual’s flywheel is just beginning to turn. We expect Q3 and Q4 of 2024 to be critical periods of customer acquisition for the platform, proving out the unit economics of this partnership model. We also expect to gain a clearer picture of the value crypto will play in the Ritual ecosystem, whether as a means of partitioning royalties with content partners, or as a means of empowering content activation and distribution by community members.
While we have always had strong inclinations that crypto would prove immensely valuable in incentivizing media distribution, but the past year has honed our insights into the readiness of blockchain networks to integrate with mature product. Our two major areas of learning with Ritual have to do with the maturity of crypto use cases and the formalization of those use cases in product.
UX in crypto vs. crypto as UX
Members of the crypto community have fried many pixels discussing problems related to user experience in crypto. Contracts are too difficult to use, wallets are hard to deploy and manage. Emissions are difficult to explain. These are valid concerns, but they seem downstream of a more important conversation – what do blockchain networks contribute to user experience as a part of a larger product?
Admittedly, many of the earliest crypto use cases are explicitly financial and the technology met pressing user needs. In the case of MakerDAO, for example, UX is the only thing left to improve because the ability to lend against, manage, and foreclose on collateral algorithmically met substantially all user needs.
When examining products such as media, in which financial infrastructure is only a part of a broader offering, the needs addressed by blockchain networks exist in the context of all needs. The work of Yu-Kai Chou, author of Actionable Gamification, has proven incredibly useful in organizing our experiences with Ritual into a broader framework.
Chou’s Octalysis framework argues that there are eight foundational motivators behind human action in digital applications.
The eight motivations are delineated by their logical or emotional impact (left vs. right) as well as their sustainability (white hat vs. black hat). Chou argues that a mix of behaviors across both lines of delineation generate sustainable engagement. The long feedback loops on white hat behaviors should be paired with some shorter-term black hat behaviors. Balance is critical.
For all the ways that blockchain networks can incentivize and contribute to an ecosystem’s behaviors (social influence, ownership, scarcity), they can also undercut behaviors. Many advocates would argue that speculation is a key benefit of crypto integration, but in a wellbeing app, unpredictability can demotivate participants looking for clear agency. Additionally, when Epic meaning and accomplishment are cornerstone behaviors of wellbeing, crypto integration can muddle intent, confusing users as to the actual values a platform is attempting to foster.
Add to that the fact that many NFT rails are well-developed for ephemeral experiences but struggle to provide consistent infrastructure for longer-term use cases. Any team building in NFTs today can launch projects quickly, but they must make a tradeoff between an expectation that the project rails might change dramatically over time (Polygon) or that those rails might have limited current functionality (ERC-721). When technical issues are considered in the context of securitization concerns tied to royalties, the assessment of blockchain integration can be paralyzing for operators.
All of this is to say that blockchain networks can dramatically improve the unit economics of media platforms, but only after those media platforms have established the kinds of ecosystems users want to invest and transact in. As Ritual develops relationships that would clearly benefit from enhanced ownership and empowerment, we see opportunities to integrate blockchain capabilities without compromising keystone behaviors.
The phases of crypto use case development
Our experience with Ritual has confirmed an initial hypothesis that blockchain networks formalize informal economies, and therefore, it’s critical we assess the maturity of those economies (and their existing economics). We have to be able to tell where crypto will add value, and at what stage of a use case it’s appropriate to incorporate. Importantly, we believe that communal behaviors have to come first, and the tooling comes later. Much of the crypto investment sphere advocates that if you put people in a Discord, they will magically act out of a sense mutual obligation and not rabid self-interest. In almost every instance (except for a few critical ones), this has not been the case.
We currently think in three phases of crypto use case development:
1. Migration of analog behaviors to the digital sphere. Before any economy can formalize in the digital sphere it must conduct its activity in the digital sphere. Typically, this means it has a method of digitally verifying presence, identity, and activity. Digitally native assets coupled with binary behaviors can be digitized quite simply; Helium, for example, developed a protocol for the proof of physical work as a part of deploying its cryptoasset, HNT. Other times, however, digitization is a significant endeavor in its own right, and should be a sole focus ahead of crypto deployment.
More complex behaviors are more difficult to digitize. We have come to expect a certain flatness in our interactions with our phones. Cultivation of the digital world as a place for spiritual growth and mental wellbeing takes time. Building practice architecture and social behaviors that support such an environment constitute the vast majority of Ritual’s content and product bets. We can see clear lines of sight to situations in which more intimate distribution networks will be required for the company’s content, but the current structure offers attractive ROI.
These types of investments, in which digitization is a discrete step, will be relatively rare, as we expect most of the community behaviors we find compelling to have some significant digital footprint. This step also represents one of our biggest sticking points with many crypto schemes for “real world impact”; without reliable methods of introducing “real world” assets and behaviors to the digital world, digital jurisdictions will be of little use.
2. Organization of digital behaviors into a functional cryptoeconomy. In this phase, digital behaviors exist, but transactions are slow and convoluted or remain implicit. While structured economies bring the clear benefit of lower transaction cost and increased frequency, the challenge is to simplify transactions without washing away the layers of meaning that made the underlying activities worthwhile in the first place. Often times, this step is the most nuanced.
In many cases, this phase of maturity will require as much social structuring and product simplification as it will technological innovation. At Ritual, we see emerging economic behaviors that could benefit from formalization. For example, there is great value in personalized encouragement and practice contextualization. As individuals help each other to continue rhythms of practice, such value should be recognized. We already see users remixing content in the form of voice notes or gifting each other subscriptions in times of known need. One could also imagine a small group of users finding deep meaning in a diversity of practices and standing up their own organization to act on their convictions in a specific context.
It might seem strange to call such relationships economies, and perceptions of creating formal structures at small scale range from “playing house” to over optimizing a local maxima. When placed in the greater context of the internet and the global economy, such formal structures become both necessary and immensely useful.
3. Rationalization of cryptoeconomies with traditional economies. Oftentimes, cryptoadvocates take on an “either/or” mentality, forcing a purity test on centralization. We recognize, however, that centralization has some benefits. Perhaps the best we can hope for is that the centralized and the decentralized economy are legible to each other, allowing resources and information to flow between them seamlessly and support each economy’s competitive advantage.
When a cryptoeconomy is organized, it tends to be limited to the resources immediately under the control of its participants. It also tends to be limited to the areas of life over which participants can re-write rules and norms (sometimes called laws). This can cover important parts of life, but it is necessarily limited. At maturity, cryptoeconomies can satisfy certain conditions of traditional structures while maintaining their independence and unique values – in a future state this might look something like trade agreements between the centralized and decentralized economies.
This phase tends to a consideration of “upside outcomes” for the communities we serve as well as the investments we make. Explorations try to uncover the best version of economic arrangement (or what old folks might call a business) for each community context. Sometimes the answer is migration from the existing system of actors, but often the answer is found somewhere in the inter-agent space.
For example, consider the value that accrues to communities when large telcos are able to integrate with blockchain-powered infrastructure to provide cell coverage to existing plan holders. One could also imagine value accruing to digital wellbeing communities if their behaviors are rewarded by insurance companies, or funded by non-profit institutions. The funding available to such groups to promote wellbeing would increase dramatically. Consider also the benefit of integrating wellbeing content into larger player ecosystems such as YouTube and Spotify. Monetization would improve, while content would reach users in the ecosystem most conducive to their needs.
Rationalization will take years, and will restrike economic arrangements, and may even require legal changes. It is a long-term interaction we believe necessary and exciting.
CONCLUSION
We look to the year ahead as one full of information. A Bitcoin ETF has already been approved and an Ethereum ETF could follow. We are agnostic on the flow dynamics of such developments and find more compelling the fact that critical blockchain infrastructure has moved under the purview of the CFTC as a result of the ETF processes. As we head into a cycle of market optimism, our liquid portfolio remains concentrated, reflecting a belief that relatively few projects have achieved collective governance as well as the stability to serve as infrastructure for long-term focused founders. For the most part, our holdings are Layer 1 tokens with the notable exception of MakerDAO.
I’m grateful for our partnership. The firm is still early in its maturity, a prototype of sorts. We have strong points of view on where to invest capital and how to access outsize returns, but it takes vision to see how that evolves into a fully realized strategy and it takes trust that I can execute over the coming years. I can’t thank you enough for both.
As always, I am happy to discuss our investments in greater depth. Please don’t hesitate to reach out.
In partnership,
John Garry
Garry Elevator
Disclosure: Unless otherwise indicated, the views expressed in this post are solely those of the author(s) in their individual capacity and are not the views of Garry Elevator, LLC or its affiliates (together with its affiliates, “Garry Elevator”). Certain information contained herein may have been obtained from third-party sources, including from portfolio companies of funds managed by Garry Elevator. Garry Elevator believes that the information provided is reliable but has not independently verified the non-material information and makes no representations about the enduring accuracy of the information or its appropriateness for a given situation. This post may contain links to third-party websites (“External Websites”). The existence of any such link does not constitute an endorsement of such websites, the content of the websites, or the operators of the websites. These links are provided solely as a convenience to you and not as an endorsement by us of the content on such External Websites. The content of such External Websites is developed and provided by others and Garry Elevator takes no responsibility for any content therein. Charts and graphs provided within are for informational purposes solely and should not be relied upon when making any investment decision. Any projections, estimates, forecasts, targets, prospects, and/or opinions expressed in this blog are subject to change without notice and may differ or be contrary to opinions expressed by others.
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Performance Disclosure – The extracted performance results shown include the extracted performance of the liquid portfolio of the Fund, which have not been compiled, reviewed or audited by an independent accountant and may reflect estimated results. The hypothetical scenarios described herein are for illustrative purposes only and the asset allocation used in connection with such hypothetical scenarios is not the actual asset allocation of the Fund, of which the liquid portfolio is only one part. Results are based on the Fund’s internal books and records as maintained by HC Global Fund Services and are subject to adjustment. These returns are shown only to demonstrate Garry Elevator’s experience in managing an investment portfolio and returns generated by the liquid portion of the portfolio held by the Fund may vary substantially from the results of a separate pooled investment vehicle’s liquid-only portfolio. The Fund’s overall performance is available on request.
The extracted performance results shown herein are based on the returns that might have been obtained had all of the assets of the Fund been allocated to the liquid-only portion of the Fund’s investment activities and do not reflect the performance of the assets of the Fund that were actually allocated to that portion of the Fund’s portfolio. As a result, the returns shown may differ from those that would have been obtained had all of the Fund’s assets actually been allocated to the liquid-only portion of the Fund’s investment activities.
The results calculated herein are similar to results generated through the use of a model and back-testing, is for illustrative purposes only, and is not necessarily indicative of performance that would have been actually achieved if a pooled investment vehicle utilized the liquid-only portion of the Fund’s strategy during the relevant periods. Further, back-testing results are not necessarily indicative of a strategy’s future performance. The inherent limitations of a model and back-testing include, but are not limited to, (i) potential errors in the model tested and the processes used for back-testing, (ii) model results do not represent the impact that material economic and market factors might have on an investment adviser’s decision-making process and (iii) there are numerous factors related to financial markets generally, many of which cannot be fully accounted for in the preparation of back-tested results and all of which may adversely affect actual investment results.
Performance is calculated based on the capital account of a hypothetical limited partner that invested in the Fund’s liquid positions from the date of the fund's first investment and made no additional contributions or withdrawals after such initial investment. A two percent (2%) management fee and has been imputed to such performance as if such fee was payable monthly and a twenty percent (20%) performance allocation has been imputed to the portion of such performance in excess of an annualized return of six percent (6%), compounded annually, as if such allocation was made at the end of the 2023 calendar year, in each case, in accordance with the terms of the Offering Documents. An estimated expense ratio of [0.25%] per annum was imputed on such performance as an estimate for fund operating expenses and trading fees, but expenses for an actual investment in a fund making liquid-only investments could be higher or lower depending on a variety of factors, and may vary substantially from the estimate used herein. Performance also reflects the reinvestment of dividends, earnings, staking rewards, and any similar types of income. Returns experienced by individual investors would have varied based on their dates of investment and will differ based upon actual operating expenses. Hypothetical performance results are for illustrative purposes only and are not necessarily indicative of performance that would actually have been achieved if an investment utilized the strategy during the relevant periods. Please contact Garry Elevator for further information regarding these assumptions and calculations. Hypothetical performance results are for illustrative purposes only. There are frequently sharp differences between hypothetical and actual performance results.