Blog 04: Cantilever Investment Framework: Bitcoin First
Cantilever’s investment work is entirely focused on the digital asset ecosystem—the new frontier of the investable universe. When compared to other major asset classes such as bonds, public equity, private equity, and venture capital—all of which have decades or centuries of track record—the digital asset space that began with Bitcoin’s 2009 launch is in its infancy. Like any frontier investment with a brief track record, this new digital asset class carries high risk/high reward characteristics.
At Cantilever, we consider ourselves to be conservative, value oriented investors. To use a baseball analogy, we are hitting for batting average as opposed to slugging percentage. Our Managing Partner’s investment background consists of credit investing and growth stage venture capital investing—both of which are more conservative investment approaches when compared to traditional early stage venture capital. Applying this experience, Cantilever seeks investment opportunities akin to hitting consistent singles and doubles. Rather than swing for the fences on every plate appearance—surely to yield a high number of strikeouts—we aim to yield runs through a high batting average, augmented with an occasional triple or home run.
At first blush, it might seem contradictory to be both a frontier investor and also embody a value-oriented approach. So how does Cantilever marry these together?
By being “Bitcoin-First.”
Why Bitcoin First?
As we have discussed in prior posts, we view Bitcoin as, by far, the most proven, secure, and decentralized protocol in the digital asset space. Relative to other base layer blockchains (commonly referred to as Layer 1s), Bitcoin is very simply designed. Its primary functions are to (i) enforce Bitcoin’s fully-transparent monetary policy, and (ii) validate blocks of transactions roughly every 10 minutes. In short, Bitcoin’s base layer is deliberately optimizing for security and decentralization at the expense of programmability, speed, and efficiency.
Furthermore, the invention of Bitcoin created the world’s first absolutely scarce asset—there will never be more than 21,000,000 bitcoin. Bitcoin also enjoys the most regulatory clarity of all digital assets. While most assets in this space carry an attendant risk of being deemed securities in major capital market jurisdictions (which is inherently limiting for innovation and broad based adoption), Bitcoin has established itself as the world’s first digital commodity. Even the U.S. Securities and Exchange Commission—historically the world’s leader in regulating novel financial assets—has now expressly recognized this. These key characteristics allow bitcoin to fulfill its key value proposition as a secure, apolitical, and censorship-resistant digital store of value, similar to the role gold has played for thousands of years in an analog-oriented world.
Contrast this with other major Layer 1 protocols—such as Ethereum and Solana—that have accomplished more in terms of technological functionality at their base layers than the Bitcoin protocol, with greater programmability and transactional throughput. Given the superior technological characteristics of such non-Bitcoin base layers, most of the key applications operating at scale in the digital asset space (DeFi, stablecoins, NFTs) exist on these blockchains. However, by optimizing for speed and throughput, Ethereum and Solana are making deliberate tradeoffs around security and decentralization. Through the value investor lens, we view the combination of Bitcoin’s base layer technological simplicity, its maximization for security and decentralization, and its regulatory clarity as key features of the most stable foundation on which to build a next generation digitally native monetary and financial system.
How does Bitcoin eventually expand beyond a digitally native store of value and begin to compete with other digital asset ecosystems from a programmability, speed, and efficiency perspective? In our view, this will take place through a layering process in which other protocols and applications are built on top of the Bitcoin base layer. These “higher level” applications may incorporate features with greater speed and programmability than is possible on the Bitcoin base layer, enabling the creation of products that can compete with both legacy monetary/financial and crypto native networks. At the same time, there would be no compromise in the stability and reliability of the underlying Bitcoin network on which these applications are built.
Before applying this layering framework to Bitcoin, let’s look at the “layers” of the current monetary/financial system and the internet.
Monetary and Financial System. As currently architected, the existing monetary system is constructed on the central banking model. In essence, the Federal Reserve (and to a lesser extent other large central banks) serves as the base layer of the global monetary system. Most day-to-day transactions settle in layers that sit above the Federal Reserve—e.g., credit card networks and interbank payment systems (Layer 2s), and banks and fintech companies (Layer 3s). Periodically, large batches of individual transactions between L2/L3 counterparties are settled with finality on the Federal Reserve ledger.
Internet. The internet also employs a layered approach to enable scaling potential. TCP/IP is a set of base protocols that govern standards as to how data is transmitted across the global network of machines commonly referred to as the internet. Other protocols such as HTTP (webpages), SMTP (email) operate as layers on top of the base protocol to empower specific functions around digital data exchange. The combination of these layers is what ultimately enabled the layer of applications through which consumers now commonly interface with the internet—including services like Google, Amazon, Uber, Facebook, and Twitter.
Bitcoin and Crypto. We see Bitcoin and other crypto networks such as Ethereum scaling in a similar way. Using Bitcoin as an example, the Bitcoin base layer is emerging as a foundational pillar to a digitally native monetary and financial system—i.e., the Layer 1. Layer 2 networks such as Lightning, a value transfer network (the credit card network would be an analogy from the current monetary/financial system), are enabling the creation of Bitcoin-native applications at Layer 3 through which average people can engage with the Bitcoin open monetary network to complete specific tasks. Some examples of Bitcoin Layer 3 companies already operating at scale are Strike for payments (think Venmo), Unchained Capital for asset custody and borrowing/lending (think JP Morgan), and River as an exchange (think Robinhood).
We believe other digital asset networks will scale in a similar fashion. And because other crypto networks like Ethereum and Solana are choosing to optimize for speed, efficiency, and throughput (while making tradeoffs on decentralization and security), we believe that much of the technological experimentation in the digital asset ecosystem as a whole will take place on non-Bitcoin networks. Indeed, the speed and efficiency of the Ethereums and Solanas of the digital asset world is why the initial versions of early crypto applications such as DeFi and stablecoins were built on non-Bitcoin layer 1s.
Take stablecoins. The introduction of stablecoins represents a huge technological step forward relative to legacy cross-border payment rails (international wires, Western Union, etc.) because they enable frictionless, instant, censorship-resistant global payments. Today, stablecoins such as USDC and Tether operate almost entirely on non-Bitcoin layer 1 platforms like Ethereum. However, now that stablecoins have proven product/market fit, we are beginning to see stablecoin innovation happening on Bitcoin (take a look at Taro and Sovryn as examples). While the success or failure of these specific projects is still very much to be determined, what is clear is that developers in the Bitcoin ecosystem continuously evaluate products that achieve scale in the broader digital asset ecosystem and then work to incorporate analogous features/products as layers on Bitcoin.
Zooming out, Cantilever has high conviction of the innovation that is happening within the broader digital asset ecosystem and will continue to make investments beyond the Bitcoin network. Many of these investments will outperform Bitcoin centric investments on a 7-10 year time horizon, albeit with greater volatility and dispersion of investment outcomes. With that said, we do have a view that over the long arc of time (think decades), many of the early applications that get to product/market fit in crypto will find their way into the Bitcoin ecosystem as the Bitcoin network approaches and achieves technological parity with non-Bitcoin ecosystems like Ethereum and Solana.
Why?
As the Bitcoin network begins to achieve technical parity with other crypto networks, the network competition will shift from technological capability to base layer stability. We believe Bitcoin has already won this competition based on its optimization for security and decentralization at its base layer, and the inherent inability of any other digital asset network in existence today to ever achieve these critical features. While the timing of such a consolidation is unknown, we do not see it happening next week, month, year, or potentially even within several years. But Cantilever’s long-term view aligns well with its anticipated fund investments on 7-10 year time horizons.
In sum, Cantilever holds a strong opinion, loosely held, that due to Bitcoin’s base layer stability, regulatory clarity, and absolute scarcity, Bitcoin will continue its emergence as a digital store of value on which a next generation, digitally native monetary and financial system will be built. Given this stability, it is our view that the best risk adjusted opportunities in the digital asset space reside in the Bitcoin ecosystem—specifically, investments in funds, companies, and projects that advance the adoption of Bitcoin and, by extension, increase Bitcoin functionality and accessibility for the mass market via easy to use applications.