The Climate of Crypto Investing

The Appeal of Proof of Stake

On March 24, David Siemer of Wave Financial, Parker Waldron of SkyBridge, and Matthew Hoffman, founder of Trusted Advisor, engaged in a wide-ranging discussion of the contemporary climate for crypto investing. In what follows we will expand upon on aspect of that conversation, the appeal of Cardano and Algorand, two platforms that have in common the use of a proof-of-stake protocol as a cryptographic system rather than the proof-of-work protocol that bitcoin begat and that other cryptos have, for the most part, followed. 

Wave Financial, headquartered in Toronto, provides both financial services and financial software for small businesses. Siemer, the recipient of an MBA from the University of Chicago, is its CEO. He is also the founder of a technology oriented investment bank, Siemer & Associates LLC, which he sold six years ago to CEC Capital, and the co-founder of Wavemaker Genesis, an early-stage crypto venture fund that has been investing in blockchain companies and related assets since 2018. 

SkyBridge is an investment firm founded in 2005 by Anthony Scaramucci. It is a registered investment advisor and an alternative investments manager investing in hedge funds, digital assets, private equity, and real estate. 

Parker Waldron has been with SkyBridge and he became a partner in January 2021. 

Last September SkyBridge partnered with NAX specifically in the expectation that together they could provide a range of services that will advance decentralization of the infrastructure of finance. 

Who Was Having a Great Week? 

The SkyBridge/NAX alliance, for example, offers Algorand-based services and a dedicated fund and initiative called UNLOX. Beyond this, the alliance aims to launch at-scale DeFi ventures, and to promote the adoption of Algorand across both North America and the Middle East. 

The March 24 discussion took place at a time when, as Siemer and Waldron observed, Cardano (ADA) was having a great week. (Algorand was having a great week as well, but we will get back to that.) ADA had been trading for just $0.79 on March 12. The value improved slowly, to 0.85 that Friday (March 18). Then there was a zig-zag over the weekend, and value began a serious upward march on Monday. On Thursday, the day of this conversation, ADA was at $1.13, an increase of more than 40% from the low. 

Why was ADA doing so well? The catalyst for the rise was surely the inclusion of ADA in the Grayscale smart-contract platform ex-Ethereum Fund. This fund exists precisely to give investors exposure to leading smart-contract platforms.

One may mention in this context also that the market anticipates the Hydra upgrade, a technical development planned for later this year that will improve scalability allowing up to 1 million transactions per second on the Cardano platform. 

Beyond either of those time-bound points: Cardano is attractive because proof-of-stake is attractive. Its pedigree and academic qualifications have so far made Cardano, and thus its native currency ADA, one of the stand-outs amongst the proof-of-stake group, so although the specifics of timing will have their stochastic side, a broad upward movement is to be expected. 

Back to Basics: Proof of Work 

For a cryptocurrency that uses “proof of work,” including the Matriarch of the group, bitcoin, one party to a transaction, (the prover) must show the other (the verifier) that a certain amount of computational effort has been expended. This is the digital equivalent of letting the seller of a product or service look closely at the dollar bills you plan on using to pay for that product. In each case, the point is to avoid counterfeit. 

But since a proof-of-work system necessarily uses a lot of computational effort, it uses up a lot of electricity. This means, as critics have long charged, that Bitcoin can be bad for the environment. 

Bitcoin and many other cryptos require the expenditure of a lot of energy which requires the burning of more fossil fuels and the release of carbon emissions at the power plants. High net worth individuals who are concerned about associating themselves with sustainable finance might well want to put their money into an alternative approach to making blockchains work, both for cryptocurrencies and for other purposes. 

An Alternative Family of Approaches 

Proof-of-stake is such an alternative approach, or rather a family of approaches. The common idea is that “stake” is a consensus mechanism, in which verifiers validate either others’ stake, in a way that would require potential hackers/counterfeiters to acquire a large fraction of the tokens on the blockchain to mount an attack. 

Cardano, as Siemer said, given proof-of-stake is a likely choice for the investment of high net worth individuals if they want their investment to express concern with climate change and sustainability issues. 

Where does that leave Algorand (ALGO)? It is also proof-of-stake, and it too has experienced a recent price rise. As of March 12, ALGO was worth $0.67.It had risen to $0.91 by the time of the Trusted Advisor conversation Thursday. That is about a 37% increase. ALGO, like ADA, has an outstanding pedigree: it is a product of the mind of Silvio Micali, an MIT professor of computer science and recipient of a Turing Award (2012). 

Indeed, the founder of Cardano, Charles Hoskinson, congratulated Micali on his invention, saying that “we finally have some real competition.”

Into the Weeds on Proof of Stake Protocols 

As mentioned above, “proof of stake” is not a single protocol but a family of them. Cardano and Algorand represent different branches of the family tree. Cardano’s specific protocol is known as “Ouroboros.” It processes transaction blocks by dividing chains into epochs, and epochs into time slots. A slot leader is elected for each slot and becomes responsible for adding a block to the chain. Each new slot leader has to treat the last few blocks of the received chain as transient: a chain is only considered settled once it precedes a prespecified number of transient blocks is considered settled. This is known as the “settlement delay.” 

Although it may look to some like a “bug,” the settlement delay is a feature. The settlement delay is what ensures that the slot leaders have “skin in the game.” It puts the stake in “proof of stake,” without exorbitant use of energy. 

Algorand uses a different system, one it calls the “pure proof of stake” model. The “purity” arises because users are randomly and secretly chosen to propose blocks and vote on block proposals. It is the randomness that gives all users an incentive to increase their stakes, somewhat like buying a lot of lottery tickets. 

It is still quite new, but Algorand is expected to be used going forward as the host of an ecosystem of smart contract-driven Dapps. And this helps explain the SkyBridge deal with NAX last fall. 

That concludes our discussion of the appeal of proof of stake. Next week we will discuss another related take-away from the discussion between Messrs Siemer and Waldron: is the crypto space (or are its interior divisions) winner-take-all jungles? Or could there be lots of winners?