Morningstar Staff

Left to right: Jim Sinegal, Evan Morris, Kai Wu

Since the first bitcoin transaction in early 2009, the cryptocurrency has moved from the fringe to the futures market. Investors are struggling to value this speculative instrument—part commodity, part currency, with some of the characteristics that we find in businesses with economic moats.

They are also delving into emerging opportunities built on blockchain technology. To explore this uncharted landscape, Jim Sinegal, a senior equity analyst with Morningstar Research Services LLC, spoke with two of Morningstar’s specialists in the field. Evan Morris is an analyst who leads emerging technology coverage at PitchBook. Kai Wu, a project manager with Morningstar Data, leads various blockchain initiatives internally and was recently featured among the “Top 40 Chicago Blockchain Thought Leaders” by FinTank. Our discussion took place on Dec. 5, 2017, and it’s been edited for length and clarity.

Sinegal: Why do you think people are buying bitcoin?

Morris: People are buying bitcoin because they’ve been reading a lot about it in the news. There’s a price feedback loop, where the more it goes up, the more news it gets, the more people get into it, and the more they fear missing out on this revolutionary technology.

Sinegal: How does blockchain as a technology differ from bitcoin?

Morris: Blockchain is essentially a type of decentralized protocol that was pioneered in the white paper written by Satoshi Nakamoto in 2008. Bitcoin is the cryptocurrency that resulted.

Wu: Blockchain is a useful technology even without bitcoin or another cryptocurrency attached to it. Because it’s a distributed database with some features for collaboration among multiple parties, a number of companies have now co-opted it for use on their own private platforms

Sinegal: Beyond payments, what are some of the applications for blockchain technology?

Wu: One is in the financial transaction space, where folks have started to invest quite a bit in these blockchain platforms. One example is the Depository Trust & Clearing Corp. The DTCC is responsible for clearing most of the transactions in the U.S. and settling them. It is planning to move its credit-default-swap settlements onto a blockchain platform in the near future.

Sinegal: We are looking at the disruptive potential of blockchain technology. The most profitable companies we cover are based on monopoly control of information, being a centralized counterparty for transactions. Any of these decentralized applications the blockchain enables threatens those business models.

Morris: To provide some perspective about what inning we’re in, when PitchBook initiated coverage of blockchain in the summer of 2016, I had to convince my colleagues to call it the vertical blockchain rather than bitcoin because there really wasn’t much in the space beyond bitcoin. Ethereum existed at the time, so we knew the potential for it to serve as a platform for distributed applications, but actual development of many of these applications has only really commenced just this year.

Wu: It might be helpful to clarify the terminology. When people talk about blockchain, they could be talking about the specific technology of blockchain, which refers to a distributed database where transactions are collectively confirmed. Or they could be using it as an umbrella term for a stack of technologies layered together to create decentralized applications that might actually compete against some incumbent companies. Ethereum and these tokens are more of the latter. They’re creating decentralized applications that can potentially supplant existing companies, particularly digital service providers like Expedia in travel or Dropbox in cloud storage. Meanwhile, there’s development in existing companies to replace workflows with private blockchain technology. It’s important to make that distinction between public and private blockchain.

Sinegal: A lot of companies are experimenting. Visa, which I cover, has partnered with a company called Chain to do cross-border business-to-business transactions. IBM is doing a lot of work on blockchain. There are the exchanges, the custody banks. But it’s in the very early stages. It’s much like the early days of the internet. Are there lessons from that period that we can apply here?

Wu: In the 1990s, you’d see IPOs where dot-com companies with products without much substance to them ended up with billion-dollar valuations. Something similar is happening now.

Sinegal: So, a lot of the current ICOs are potentially going to end up like the dot-coms from the 1990s?

Wu: That’s fair to say. But now that we have the benefit of 20-plus years of history, we can also say that the internet was a transformative technology. It may have taken longer than expected, but it is disrupting a lot of businesses now. You see bankruptcies like Toys R Us as a result of the emergence of online retailing.

Morris: When comparing the current blockchain revolution with the internet revolution in the 1990s, it’s important to remember that in order to invest in the internet, you needed to invest at the application layer in internet companies. Blockchain is unique in that you can invest at the actual protocol layer, like in bitcoin or in Ethereum. That would be equivalent to investing in TCP/IP, which would have been impossible. You could only invest in, say, AOL or Netscape.

Sinegal: It’s almost like owning a piece of the internet itself.

Morris: Exactly. I saw some analysis that said that the application layer would only capture about 3% of the value of the blockchain space, which gels well with what we’ve seen in ventures. Coinbase recently raised venture capital at over a $1 billion valuation, making it a unicorn.

This blog post is adapted from an article that originally appeared in the February/March 2018 issue of Morningstar magazine. Read the full article.

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