Alt Thinking Podcast - Investing in Web3 with Alex Tapscott Part 2

How do we invest in Web3? Alex Tapscott returns to explain why he believes we need to look
beyond the companies building the next generation Internet and include those dipping their
toes in the water, from luxury pursemakers to coffee companies.

Part of Ninepoint’s Alt Thinking Podcast Series. Available at Google, Apple, and Spotify Podcasts.

Michael Hainsworth:
Investing in a new technology is fraught with risk, as anyone who witnessed the .com bubble burst in 2000 can attest. Today we're in the early stages of building the third generation internet, Web3. It's built on a foundation of ownership and value, using technology frequently associated with Bitcoin, the blockchain. The underlying technology and terms like tokens that are all part of it, it's about more than just cryptocurrency. And while the crypto market is experiencing a cold, dreary winter, it's a warm spring day for traditional companies. Such as the one behind Louis Vuitton purses, or video game virtual goods makers, and the makers of your favorite Frappuccino. They're all adopting Web3. Catch the explainer episode with Alex Tapscott, the author of the Blockchain Revolution. And the managing director of the Digital Asset Group at Ninepoint Partners, if you haven't already. In part two, we discuss here examples of this foundational technology. And how, like architectural foundations, Web3 is something that's usually under the surface and ultimately will be hidden from view.

Alex Tapscott:
I agree with the premise that a lot of technology innovation is unseen. When we use the internet, do we think of the TCP/IP protocol, or do we think of hypertext every time we click on a link? No. We find that the experience is really useful and fun, and that's why we do it. So we don't think about the internal combustion engine every time we start a car. The examples are endless. And I think the same thing that will be true for Web3. In the early days as a new technology infrastructure, as you described it, is emerging, the technology is much more visible than it is later on. So you may recall in the 1990s when we logged onto the internet, you had to tie up your phone line.

You had to use a 56 kilobit modem. It made a horrendous sound that was a very noisy reminder that you are using the internet. And then the experience of using Mosaic or Netscape was not particularly intuitive. Now the internet is almost invisible, right? It's integrated into our lives in such a profound way, we sometimes don't even realize that we're using it. With Web3 in the early days, a lot of the really keen innovations, like say tokens or digital assets, were things that were highly visible. The first digital assets were things like Bitcoin. Bitcoin emerged as this alternative store of value, a new way to do business, to transact online and peer to peer. But it's very much took a lot of effort to use Bitcoin in the early days, just like it took a lot of effort to use the internet in the 1990s.

Today tokens, not just Bitcoin, but several other kinds of tokens are becoming more important to many different businesses and industries. And I think that tokens are one of the perfect examples of this kind of unseen infrastructure that is going to become more important over time. People think of tokens as cryptocurrencies, but really a token is simply put, just a container for value in the same way that a website is a container for information. So you can program a website to do anything, right? It can be programmed to be, well, a podcast studio like what we're using it for right now. Or it can be how you access your health records. Or it can be where you get the news. Or it can be a social media site, or whatever. It's an infinitely programmable platform for information. A token is a programmable platform for value.

So token can contain money, but it can also contain stocks and bonds, or titles and deeds. It can contain art or collectibles. It can contain IP or votes. Really anything that requires scarcity to have value. So what that means is I think tokens are going to become this new asset class for the digital age that we are going to use. And we're not necessarily going to know that it's Web3 or blockchain. If you're a customer of Nike and you use Artifact, which is their NFT platform, to support your favorite creator or your favorite athlete, and as part of that you purchase a digital good. Yeah, that's a Web3 application right there.

If you're using Starbucks's new loyalty rewards program, which is based on blockchain and uses tokens, as a way to encourage people to be customers of the coffee shop, you're once again using a Web3 platform. If you're playing a video game and you purchase a digital good, which by the way people have been doing for a very, very long time, now you'll get to actually own that asset, maybe sell it to someone else, peer to peer. Maybe take it to another virtual world, and so forth. So in each of these examples, whether it's in the consumer business or in retail or in interactive entertainment, Web3 tools are going to become increasingly integrated into our lives. And that's just one example, tokens, but there are dozens of others as well.

Michael Hainsworth:
Yeah. The whole concept of this being foundational technology is that you ultimately not even care or think about down the road. My favorite version of that comes from Downton Abbey when electricity was a new idea. And you could see the wires, because they hadn't been embedded in the walls. And eventually we don't think about electricity today. We don't think about the tokenization of interactions in transactions, say five years from now, 10 years from now, it's just going to be part of our lives. And you mentioned Nike and Starbucks. Who are some of these other early adopters of Web3 technologies that we're talking about that go beyond the tokenization of information as well?

Alex Tapscott:
Yeah, well, it's a terrific question. So there are lots of different kinds of companies that are integrating Web3 technologies. And in fact, for the new strategy for the Web3 Innovators Fund, we group those together into what we call beneficiaries or end users. So just by way of a primer, the fund strategy basically can be thought of as fitting into three different categories. Category number one is exposure to platforms, and that means the new digital asset class of this new web. So things like Ethereum and Bitcoin, we think that those platforms will accrue lots of value over time as the technology becomes more widely used. Number two is what we call businesses that are pure play businesses. That have staked their fortunes on Web3 technologies, and assuming they weather the current volatility in the market, we think are going to emerge really, really big on the other side.

And there are several examples of companies like that, that are listed in places like Canada and the United States. And then this third category is what we call beneficiaries or end users. So for example, video game studios. There are lots of video game studios including Epic games for example, that have talked about using digital assets as a way to enhance gameplay. Because people are already spending money on virtual goods inside of games. In fact, one estimate has the amount of money at a hundred billion a year that we spend on virtual goods we don't actually own. And so being able to imbue that with ownership, move and store those assets to transact in them, is a hugely important advantage. Another example is in physical infrastructure. So for example, we expect that the demands of AI, of the metaverse and of running new blockchain computing platforms is going to use a lot of energy. And we're going to need as much computing power as we can muster.

And there's some really interesting projects underway, projects like the Render Network, for example, which incentivizes people who own GPUs or graphic processing units. So basically just really powerful chips, to basically pool their assets into a big communal computing pool. And in exchange they get rewarded with a token. And that's attracted a lot of interest from big Hollywood studios, for example. Or other heavy users of rendering technology. You want to make a new Pixar movie, maybe you can get your rendering power cheaper by using one of these decentralized Web3 solutions. We've seen telecommunications companies partnering with projects like the Helium Network, for example. Which is basically creating a decentralized network of internet hotspots using a very similar principle, the idea that people will volunteer their assets if they are going to be rewarded through ownership in this new platform. So this idea of ownership, which I keep coming back to, is not only about data. Though, that's very important as you pointed out. But it's also about being able to actually own the platforms, products, and services of this new web.

And that's a really powerful, an important shift that's occurred between say Web2 and Web3. In Web2, we're internet users. We use social media platforms, we hand over all our data and in exchange we get access to a free service. The companies that provide the service end up taking our data and selling it to advertisers. And that was a bargain we all accepted for a while. But I think a lot of people are starting to view it as a raw deal. In Web3, the model is just a little bit different. As an early user, or as a active participant in an online community, you actually get to earn a share of that platform. And that gives you some upside, but also a say in how it is governed. And so we're seeing that being applied to various different industries from physical infrastructure to computing and graphic processing to even financial services as well.

Michael Hainsworth:
One are the benefits of Web3 is that it's decentralized. What does that mean for governance and regulation? Two critical issues for any investor in anything?

Alex Tapscott:
It's an interesting question for a couple of reasons. So on the governance question, I'll answer it two different ways. One of the new tokens that has been created as a result of Web3, one of these new kinds of inventions, is a thing called a governance token. And basically all it means is that as a holder of a governance token, you have some say in how the platform or service is governed. What kind of decisions it makes. And the more you use that platform, the more of these tokens you own, the more influence you might have. And honestly, that's quite similar to how it works today as a shareholder of a public company. If you're a shareholder of a public company and you own a piece of that common enterprise, then you are entitled to have your say, right? You can vote on certain matters.

The difference with the governance token is that it doesn't require monthly meetings and proxies and mailings. It all happens instantaneously, because it's all digitally native. So you can have a much more kind of responsive, much more inclusive kind of form of governance where people who are stakeholders in something can be voting all the time. So that's sort of an interesting innovation that is unique to this. And I think that the idea of using governance mechanisms like this will become more popular over time as Web3 becomes more widely distributed. But then there's a separate matter, which is the question of governments.

Michael Hainsworth:
Which is that more regulation component.

Alex Tapscott:
Yeah, exactly. So there's the governance and then the governments, and then how do the governments feel about all this stuff? And the answer is there's no simple answer to that question. I would say that in general, a lot of governments have pretty open mind to this kind of stuff. I'm actually, you can't see right now because we're not on video, but I'm holding this report from the House of Commons in Canada. The blockchain technology report of the Standing Committee on Industry and Technology. This just came out a couple of days ago. It's quite a thoughtful breakdown of what this technology is, what is the opportunities and risks, and what it means for Canada. And I thought that was kind of enlightened. In the US we've seen similar kind of overtures from various groups within government. But in general, it would appear that the tone today is one where they're using the regulatory apparatus of the state.
So the securities regulator for example, to try and increase the regulations around this industry. And by the way, regulations in and of themselves are not bad. In fact, they're often really great. It's good that we have regulations around who can practice in healthcare. It's great that we have regulations around aircrafts. It's great that we have regulations around what goes into our food. Because if we didn't, then a lot of people will get sick and die in plane crashes. So these are good things. And I think with a lot of new industries, you need some regulations in order to give most people confidence and comfort to use it. But at the same time, I think it's possible to misuse and abuse the regulatory tools at our disposal in a way that actually harms innovation in the long run. I think that in general, if there's anything that distinguishes this era of the web from previous eras as it relates to government, I would say that the last era of the web had regulatory tailwinds.

And I'd say that this era of the web has regulatory headwinds. The regulatory tailwinds in the 1990s was that there was a consensus in government that this new technology required some new rules and standards to allow it to grow. And as a result, we got the Telecommunications Act and Section 231. And those rules basically made it easier for internet service providers and platforms to grow without worrying about the kinds of content that was being passed through their pipes, or hosted on their platform. So someone posts a photo of Mickey Mouse on a discussion forum for example. All of a sudden the discussion forum itself doesn't worry about getting sued by Disney. And that had some other broader implications for creators that were actually kind of negative, but overall it allowed the internet to thrive. This time around, I'd say that we don't have that consensus yet, that we need a new set of standards and rules.

And if anything, we're trying to apply the old rules to a new technology. Take for example, the SEC's case in the US. Now, I'm not going to weigh into the morality or merits of this, but I think it's useful just to look at one of the members of the SEC commission have actually said. Her name is Hester Peirse. And she basically said that it's not really the regulator's role to create new laws, new standards for overseeing a new technology or industry. That's Congress' role. These are laws that need to be legislated. And that using enforcement is the only way to regulate an industry, is in her words, "Kind of arbitrary and also not effective." Because they're sort of picking projects at random. And also in the end, it would take decades or hundreds of years to go through the enforcement actions.

So that is the opinion, I'm paraphrasing though, of a member of the commission. And I think it's broadly true. So that's kind of where we're at in the US. I realize this is a long answer to a short question, but if you look overseas, the situation's very different. Like Rishi Sunak, for example, the current Prime Minister of the UK, recently said that he wants to make the UK the Web3 capital of the world. In the Gulf countries, for example, in Dubai in the UAE, they've offered billions in incentives to encourage people to set up shop in this industry. Web3 businesses specifically. In Hong Kong, there's been a big push to attract new capital and new business formation in this industry. Even, as I said in Canada, the tone is a little bit different. So it all depends on where you are in the world.

I'll finish answering this question just with one final thought, which is in the 1990s and early 2000s, some people refer to Silicon Valley as a technical Galapagos for the unique kind of blend of conditions similar to the real Galapagos. The unique blend of capital and talent and technology, and government R&D. And critical mass of people that led to the unique species of tech founders that were not found anywhere else in the world, or the companies that were founded there.

And I think that if you look at the history of the internet, the US kind of dominated most of the business formation. This time I think is different. And I think that technology tools are more distributed, governments have a different views around the world. And that's going to lead to some really interesting and unexpected outcomes, including this technology not being based anywhere really, but being something that happens everywhere all at once.

Michael Hainsworth:
It's a long answer to a short question, but a critical question that needs to be asked. Because to your point about the previous generations of the web, it was amazing to watch lawmakers in the United States grill Mark Zuckerberg about the nature of Facebook, when they clearly had no clue how it worked. They had no idea how they were going to regulate it. And it was frightening to me that these people who had no concept about what they were dealing with, were going to be the ones who were making decisions about how that technology would evolve over time. Do you have confidence that the powers that be today, the lawmakers... You mentioned Canada, the document you're holding up now, had some very cogent thoughtful approaches to the issue of Web3. Do you believe that we're going to get it right this time?

Alex Tapscott:
Well, I'm an optimist by nature, Michael, so I'm hopeful for sure. I think there's a lot more that needs to be done. Look, I mean think there's a role for government in society, and in setting the conditions for enterprise and industry to succeed to some degree obviously. I'm a free market capitalist, but I understand that we have a multi-stakeholder world that we live in. And when it comes to government, like a new technology emerges, and they're definitely not going to be expert in it. In the early 1990s when the internet was first invented, I think up until like '95, there was one internet connection in the entire Congress building. And it was in the congressional whatever it's called there, the Capitol building. And it was Ted Kennedy's. For some reason, Ted Kennedy had an internet connection. There was this other guy, I can't remember his name, but the senator had learned that the internet was used by pornographers and criminals. And so he had his aids print out a bunch of porno from the internet.

Michael Hainsworth:
Geez.

Alex Tapscott:
Carry around pieces of paper with internet porn. And he used to wave it around peoples faces whenever they had a chance to see it. And also in the 1990s, there was at one point an idea floated that, well, if you're going to launch a website, you're a broadcaster. And if you're a broadcaster, you have to apply for a radio license. And there are only so many radio licenses in the world. And if you think about websites and how they work, there are millions or billions of different unique URLs out in the world. Making it so that everybody had to get a CB radio license to launch a website would've been extremely limiting to the growth of the internet.

So all of those things were being floated. Just as today there are all sorts of ideas, maybe good and maybe some not so good, that are being floated on how to address this technology. And we just have to keep pushing forward. You've got to keep educating people. I think it's really important that people in government talk to people in the private sector. Whether they're founders, or business people, or venture capitalists, what have you. Those stakeholders have agendas of their own. So it's not like you're going to buy into everything they say, but you got to talk to them to become educated. And I think we had that for a while, and I think we've lost it a little bit recently.

Michael Hainsworth:
So you point out that the Web3 Innovators fund breaks things down into three main investible areas. Exposure to platforms, business pure play, and then the beneficiaries or end users.

Alex Tapscott:
Yup.

Michael Hainsworth:
First mover advantage doesn't always prove to be an advantage. Are there companies within those three categories that do stand out to you as doing it right?

Alex Tapscott:
There certainly are. And what you've described is a central problem for a lot of incumbent companies. So remember, between crypto asset platforms and the companies that are really deeply into this space, that's already two thirds of what we're looking at. So, we're only talking about a third of the portfolio here in this last category. There's a famous book by Clay Christensen called The Innovator's Dilemma, that basically describes some of the pitfalls and problems of being a leader in your field. So there are a lot of times where companies have been leaders in their field, and actually the logical thing to do is to ignore new technology because you want to focus on your existing customers and your existing business. And because you've been highly tuning that business, that's actually super profitable and those clients are super profitable as well. And it's often with new technologies that at least initially, there isn't as much money to be made.

And he points to several just unbelievable examples. Everything from the motorcycle industry in the 1960s and 70s all the way through to the internet itself. And the same thing could be true here. At least today a lot of companies are, for example, like say Nike and Starbucks, since we talked about them earlier. LVMH, one of the biggest luxury brand makers in the world. The contribution to their bottom line from Web3 is still not huge, but we think over time will grow. And because we think they're doing it the right way. They're investing in the new technology, they're becoming educated, they're experimenting, they're learning to fail quickly, they're bringing on great talent. But they're not like betting the farm on this until the time is right. And I think timing is really important with any kind of new technology, but our view is that Web3 is going to become a foundational technology for business just as the first eras of the web were.

And that the companies that start early, not necessarily by being first mover, but just by being first thinker and first adopter, I think is going to be really, really important. In the 1990s, Michael, there were several companies that Wall Street analysts were sure were safe bets, great investments. Companies that were dominant in their industry or the leaders in their industry that had loyal customers and great products, right? Companies like Kodak. Companies like Polaroid. Companies like Blockbuster, or Borders, or Barnes and Noble. Or Macy's or Sears Roebuck. I mean, you get the idea. Every single one of those companies may have been good investments in a different paradigm, but in this new paradigm, they were about to be disrupted by the Internet of information, by the first era of the web. And a lot of those companies failed to adapt. Even companies like America Online, which we think of as an internet business, actually had a very different vision than what we now have today, which is an open web.

They wanted to own the internet basically. The thing that you would per subscribe to AOL from every month to get access to. So all of those old legacy models got disrupted. So we have to look at the world today and say, "What are some of these businesses that exist today that seem entrenched and seem defensible and seem to be dominant, but may actually have a fatal weakness?" And the fatal weakness is that despite them not knowing it, they're actually standing on a burning platform. And when you're standing on a burning platform, the risk of jumping into the unknown is actually less than the risk of staying put and finding yourself disintermediated. And so we think about a lot of industries like that. Industries like big tech or financial services, companies that have kind of dominated the economic arteries of the first era of the web.

We wonder whether or not we'll see new avenues open up, new arteries open up that end up sucking some of the lifeblood out of those legacy businesses. And so that's something that keeps me up at night. I mean, at least it's the thing that we think about constantly. We're very diligent in examining the market and trying to identify [inaudible 00:24:45] opportunities might lie.

Michael Hainsworth:
So what's your best advice to someone interested in investing in Web3?

Alex Tapscott:
I would certainly encourage them to look at the Web3 Innovators Fund by Ninepoint. The ticker is TKN on the TSX. It is an ETF. In our view it provides investors with exposure to a broad range of innovation, not only in businesses, but also in crypto assets and vice versa. It's in a very convenient and easy to understand structure. As an ETF that trades on a major global market, anybody can purchase it. We think, given what we're bringing to the table, the fee structure is quite competitive at 70 basis points. It's a lot less than people are charging for other actively managed strategies in this area. And we think that we've got the domain expertise, and the experience in this field to bring real value to the table. And to help investors, not only sort of survive, but thrive in this next era of digital disruption.

Michael Hainsworth:
Ninepoint recommends that investors work with their advisor to ensure the Web3 Innovators Fund is suitable for their investing goals and risk tolerance.

The opinions, estimates and projections contained within this recording are solely those of Ninepoint Partners and are subject to change without notice. Ninepoint makes every effort to ensure that the information has been derived from sources believed to be reliable and accurate. However, Ninepoint assumes no responsibility for any losses or damages,  whether direct or indirect, which arise out of the use of this information. These views are not to be considered investment advice nor should they be considered a recommendation to buy or sell. Investment funds are not guaranteed, their values change frequently and past performance may not be repeated. Important information about the Ninepoint Partners Funds, including investment objectives and strategies, purchase options, and applicable management fees, and other charges and expenses, is contained in their respective prospectus, or offering memorandum. Please read these documents carefully before investing. We strongly recommend that you consult your investment advisor for a comprehensive review of your personal financial situation before undertaking any investment strategy. For more information visit ninepoint.com/legal. This report may not be reproduced, distributed, or published without the written consent of Ninepoint Partners LP.

Part of Ninepoint’s Alt Thinking Podcast Series. Available at Google, Apple, and Spotify Podcasts.