A Conversation with Nick Grossman, Partner at Union Square Ventures

The following transcript is taken from episode twenty one of The Scoop, The Block’s first podcast. Listen below and subscribe to The Scoop on Apple, Spotify, Google Play, Stitcher, or wherever you listen to podcasts. Email feedback and revision requests to [email protected]. This transcript has been edited for clarity and length.

Union Square Ventures is one of the most prominent east coast VC firms and is also one of the most notable mainstream investors in the bitcoin market. On this episode of The Scoop USV partner Nick Grossman joined us to discuss the firm's approach to investing in the market -- he was recently promoted to partner to lead blockchain investments after 5 years with the firm. We spoke about Libra association which USV is a member of, we examined USV's portfolio and talked about the future of venture capital and the future of capital formation. I hope you enjoy the episode.

Frank Chaparro Alright ladies and gentlemen thank you so much. I'm very excited for what is an incredibly special episode of The Scoop. I'm joined by my very special co-host Teo Leibowitz and we are here with Union Square Venture partner Nick Grossman. Nick, thank you so much for taking the time. Listeners, you've probably heard of this firm. It's very well known and respected in the cryptocurrency market led by it's very impressive leader Fred Wilson. They have two funds that are making investments in cryptocurrency related projects. The first company you invested in was Coinbase in 2013. So early to the market relative to a number of other players it's not known exactly how much you guys have in the market but it's certainly sizable relative to some of the other things you're investing in. The best place to start Nick, the firm recently made headlines for a comment Fred had about Ethereum. I'm just going to read it for the listeners I'm going to put on my reading voice which is different from my podcast voice and this is what he said: Ethereum as many of you know confounds me. It has shown the way to so many important things, smart contracts, programmable trust free computing, potentially proof of stake and a lot more. But it remains hard to build on, scaling issues abound and many developers are looking elsewhere. It'd be interesting to dive into some of these remarks and have a conversation around Ethereum and whether or not it is a match for bitcoin or other crypto currencies and projects out there and whether or not Fred's view is equivalent to maybe your own.

Nick Grossman Yeah. So first off the best person to talk to you about Fred's view would be Fred. So maybe we can get him on here next and have that conversation. And I know Fred's post the other day kicked off a lot of debate on Twitter and I can't consider myself an expert. It's hard for anybody to consider themselves an expert on any of this because all of it is so new and so everybody is looking for a lens and everybody's looking for a framework. Is Ethereum the AOL of crypto, is bitcoin the IP of the money protocol stack? We're all searching for a way to look at this. I'm not sure exactly which part of Fred's comment is really considered controversial. It has been such an interesting project to watch and be around and the level of creativity that is happening on top of it is ridiculous. I'm in love with the idea of open interoperable protocols where people can take assets and interconnect them with other assets without asking any base permission. So generally the idea of permission-less innovation on top of new protocols is an incredible incredible thing. And you're seeing that on the DeFi space, you're seeing that in NFT's and Ethereum like just opened that all up including ICO's and token's back in 2017. So the part about Ethereum being like this magical sandpit and tool kit is indisputable. So maybe the question is about the scaling and whether that's going to work or not going to work.

Frank Chaparro Which is something that evenVitalik Buterin has come out and admitted publicly saying... I remember this was a year ago or maybe even longer when we were at five hundred billion dollar market cap he said look, listen we're not really there yet. The market in terms of the development of these DAPs and the decentralized protocols being built on top of Ethereum. There's not as many users that would be as meaningful as where we can go or where we can potentially go.

Teo Leibowitz Where Fred and Vitalik probably disagree is that Vitalik sees a path to scale [...] and from Fred's post my interpretation was that Fred doesn't necessarily think that Ethereum can execute on that roadmap and that it could or will probably be usurped by one of these competing small contracts.

Nick Grossman Maybe, you could argue that there's a really really strong network effect in Ethereum in terms of developers and exchanges and assets and projects and that just simply undoing that is not practical or possible. You could also think a lot of it depends on timing and ETH 2.0 and how/when it evolves and honestly I'm not the one to handicap that. A lot of new projects are emerging -- Cosmos and Polkadot and Algorand and thousands of others. It's too early to say exactly what they'll all be good for. Even when Ethereum launched nobody knew really what it was going to be great at and it turns out it was great at creating tokens and creating new kinds of assets. And in particular slow moving assets. It took a while for that to become apparent. It's going to take a while for what other projects are good at to become apparent. For sure there's a world where Ethereum just charges on and it evolves and the improvements that get shipped really make a big difference and it's also possible that as other projects get online certain use cases become super appropriate for those. So in a way that's a non-answer. I know a lot of really smart people who are long Ethereum and believe that it will...

Teo Leibowitz Placeholder being one of them

Nick Grossman Exactly.

Teo Leibowitz [...] published almost a response but it actually came out before Fred's quote pretty much taking the exact opposite view.

Nick Grossman And at the same time there are a lot of projects that have a lot of smart people behind them who are building alternatives. I don't know, I'm not the one to place a binary bet on... My personal... one thing we've learned from watching all these crypto assets is that they don't just go away. It's going to be long and slow and another thing to remember is that we're at the very beginning of all this that I have a hard time making predictions.

Teo Leibowitz We should but I guess as a slightly more direct question -- as an investor you don't necessarily have the privilege of waiting around and seeing how this space develops. So you do have to allocate capital, you do have to place certain bets. So how are you thinking about this space? How are you adapting your investments?

Nick Grossman Yeah for sure. An important thing to realize also about USV is that we're not a crypto only fund. We have traditional venture funds out of which we're investing in education companies and healthcare companies and infrastructure companies and so on. We see the crypto space as an important next piece of all this infrastructure. But unlike some other funds who are out there investing in everything, our strategy is to make a smaller number of bets and investments in what we think are important categories. And I guess to some extent it raises the question of what are the categories that you think are gonna matter? So we backed the Algorand project which just launched which is one of many projects working in the proof of stake space. There's a lot of opportunity to do certain things using that architecture. We were early backers of the Filecoin project which is really coming along. And when that launches, that's a different piece of the stack and a different piece of infrastructure. We just backed a project called Helium which is in the decentralized telecom space. We backed the company Dapper Labs behind CryptoKiddies. We've been trying to map out like store of value, smart contracts, different types of computing infrastructure, gaming, other pieces of adjacent infrastructure like Coinbase like the whole developer tools category. For sure big important project are going to get built in all of those areas. And part of the challenge is understanding the different economics of them and the timing of all of them but I don't see it as a zero sum -- I try not to focus on my time on Ethereum versus something else in just a zero sum head to head kind of way

Frank Chaparro That's a great answer that parlays into what I wanted to talk about next which is looking at USV as a firm in the context of the cryptocurrency community, how it operates maybe differently from others and how the day to day might be different from other firms in the space? But I guess the best place to start would be just what we were talking about before we turned the mics on. When you first started as a VC in this space or started investing in the space you were thinking well what can we do that our LPs can't do or what can we invest in that our LP's might have a difficult time investing in? Describe for the listeners how that transpired and how it has progressed up until this point.

Nick Grossman Yeah sure. We wrote a post sometime within the last year about it, somewhat about part of our strategy investing in crypto and the big takeaway is that investing in this category has caused us to change the way we look at how we operate as an investment fund. USV was founded in 2003, for the first 10 years we operated like a traditional VC doing early stage equity investments in companies and that's how you invested in Internet applications and infrastructure. If you believe that the blockchain crypto space is the next generation of Internet applications and infrastructure as we do we want to invest in that too. And yet the market is entirely different. It's not just companies. It's not just private investments. It's open source projects, it's protocols, it's communities, it's public markets.

Frank Chaparro You're saying that investing in the landscape that's so diverse in terms of the makeup or structure rather of these companies and projects, that's impacted how you invest elsewhere. How so?

Nick Grossman Well it effects the whole structure of how we even do business. The theme we were talking about before was that when we made the Coinbase investment back in 2013 it was clear that we saw crypto currencies as important and not just as curiosities but as assets. And we told our LP's as much regularly but our thinking was well anybody can buy Bitcoin you don't need to have special access like a VC does in private deals to buy bitcoin so they should just go do that on their own. One of the things we've learned over time is that institutions that want exposure to this space do need help doing that. We immediately evolved our strategy... not immediately it took us too long but we evolved our strategy to: we're not just going to own equity we're going to own tokens directly. That seems obvious today but back in 2016 that was pretty non-obvious. At the time we had made a bunch of seed investments in projects like Protocol Labs that at the time it was an equity investment but there wasn't going to be a series a it was going to be tokens and so that step one was OK we're going to have to hold tokens and then step two was well...

Frank Chaparro Which isn't an easy feat to figure out.

Nick Grossman No and again it seems super obvious today but at our LP meeting in 2016 we spent three hours talking about how owning tokens is going to be part of the VC landscape in the coming years. We had to change, we had to think about that. We had to educate our investors on that and then we had to evolve our investing strategy based on that. As you guys have published we've come up with a new and diversified strategy where we're investing in token focused funds, we're investing in companies that are adjacent to this, we're investing in companies that are issuing tokens, we're buying tokens directly on the market. We're doing a variety of things. All things that venture funds didn't do five years ago. Now, separate from that you have a whole generation of crypto focused funds that are doing all these things and more. It's an incredibly interesting time to be an investor because what it means to be an investor is just different and new.

Frank Chaparro How does that translate into the day to day? Are you spending less of your time doing due diligence on potential new projects to invest in, working with those portfolio companies on growing and expanding their business? Are you allocating that time or those resources equally among these different investments?

Nick Grossman It really varies, we are still even with all the changes and new approaches, we are still long term patient capital for projects. We have not immediately flipped over into a day trading operation and that's just not who we are. From a time allocation perspective it's somewhat similar to how it always has been which is a combination of looking for new things and working with our portfolio. It really goes up and down depending on the complexity of the moment as everybody here knows what it means to work with a crypto project is not exactly the same as what it means to work with a company. There are similar issues but it's a more complex public environment. There's governance to be worked out. There's public markets to be navigated. There's untold legal and regulatory issues and so for sure a lot of my time is working with our existing portfolio on all of that stuff and looking at new things.

Teo Leibowitz I love this term patient. A patient fund or patient capital. I feel like there has to be a fund called patient capital, right? It very much speaks to the way that USV does deploy capital, you guys are known for making a small number of bets on a yearly basis. This year USV has made one single investment in the cryptocurrency space which is Helium. Do you expect to make any more investments by the end of this year 2019?

Nick Grossman Yeah and I'll give you...

Frank Chaparro Whats the number?

Nick Grossman How many investments? We make a small number of investments. Period. Out of a given fund which we'll invest over the course of three years, maybe we'll make 20 to 25 investments. So on the order of seven or eight a year. That's a mix across all sectors and we're doing that across two funds. There is no forecasting precisely when the right opportunities come. We're always looking for things but I would say that it's likely that we'd make one or two more investments this year in the space.

Frank Chaparro You've invested in six different funds: BlockTower, Multicoin, Placeholder. Obviously the process for doing due diligence on funds and thinking about investing in a fund is different than a project or a company. How does that process work? And I guess I'm always curious to know what are the things that they can do that you can't do yourselves and why not? Like why not just if it's a more liquid strategy, investing in liquid assets why not open up a desk to do that or something else?

Nick Grossman I would say there's three reasons. Strategy, structure and experience. Just on the structure side we are a venture fund. Without getting too into the weeds venture funds have restrictions over the kinds of assets that they can buy and sell. We're exempted from registering with the SEC as an investment advisor which means that we can only buy and sell a limited number of assets that are not private company stock. To the extent that we wanted to say trade crypto we'd be very limited in how to do that in an active way whereas funds that register like Andreessen just did or funds with a hedge fund model they can trade all day long. That is like right up there like a big constraint on operating and to the extent that where we have exposure to public crypto assets it makes sense to box that in our fund structure that has more flexibility even if it's like a long term balanced type of strategy versus an active trading strategy. As we built a portfolio of funds to make investments and we knew that we wanted to get broader access to this asset class. That was the best way to do it at that time period. We picked a number of different funds that each have different strategies. BlockTower is an active trading strategy. Polychain is slower but still in a hedge fund model. We look to get some diversity, Multicoin has some contrarian points of view compared to some other funds. We like that, we've obviously known the guy's at placeholder for a long time. They're also investing in more of a venture strategy early stage. We wanted to get a balance of perspectives and strategies and then the truth of the matter is, as much exposure and depth as maybe we have in this market, we're still looking at lots of things and the folks who are just chest deep in this all day every day have a level of technical sophistication and thinking that is really really valuable. We've really benefited from having closer relationships with managers in this space who are just super smart and out there every day.

Frank Chaparro It also gives you an interesting perspective on the market in terms of seeing how, and we've seen this over the past two years a blurring of the lines so to speak between these cryptocurrency hedge funds and cryptocurrency venture firms. Many of the hedge funds and the long tail that got wiped out tried to pivot to VC and some were successful, BlockTower's one that makes VC investments, they're one of our investors as an example. How do you see that continuing to play out over next few years in terms of that blurring of the lines? And do you see it impacting, you mentioned Andreessen Horowitz adopting that new model. Do you see that continuing to happen in venture broadly?

Nick Grossman That's a good question and I don't really know all the reasons that Andreessen had for registering and they have ambitions that are broader than just things that they might do in the crypto market. I guess you can ask them why they're doing that. I would say in the crypto space we're definitely seeing a blending of a venture approach and more of a liquid fund approach which just makes sense to me. There are different roles to play to the extent that I'll give you one example, we're seeing a pattern emerge where investors may buy tokens primary from a project and then also buy and sell in the public markets. That's really interesting because you want to be a partner to the project and you also want to be an active participant in the community and that's about being active in the markets, being involved in governance.

Frank Chaparro Not to interrupt can't those interests sometimes be at odds.

Nick Grossman That's possible. It's all new. Everybody is working out the right balance. At the beginning what happened is that many of the funds would keep illiquid investments in a side pocket separated but still inside the same entity, you're seeing more of a venture style fund and more of a liquid style fund. I don't know what the right ultimate structure is but it does make sense to me that an ideal investor can have that patient capital, the long term venture style fund but also the ability to participate in the market. The ultimate/right structure will get figured out over time. It's neither here nor there currently for sure.

Teo Leibowitz Does that give you the necessary diversification that you guys are looking for? As you said a lot of these funds, they were initially structured as hedge funds and have started moving into the venture space. Even something like Helium which I referenced earlier, Multicoin actually led that investment. You co-led it with them so that doesn't necessarily give you that liquid asset exposure that you guys are looking for.

Nick Grossman I'm not sure I totally understand the question. But in that case where...

Teo Leibowitz In the sense that you're double dipping into Helium through your LP.

Nick Grossman I see, we have exposure to it through multiple entities. And that's true in some cases. In the case of Multicoin, we're just one of many investors in Multicoin and it was a great opportunity to work with them closely and hands-on on something, they bring a lot of crypto strategy to the table and we bring a dose of the crypto strategy and a dose of regular platform strategy that has been a good balance on that project. On balance we have the right exposure to that project which is a lot and which is good but it's not necessarily a problem because we did it together with them. I would say more the strategy for us is still we want to have broader access to the market as a whole and doing that through fund investments is great for us because just from an economic exposure and also from a visibility and connectedness we want our LPs to benefit from from all that. Then our strategy basically is to focus on the opportunities where we directly can deliver the most value and engage them so Helium is like a perfect example of that.

Frank Chaparro It might be we've had a few VC's on the podcast over the past few weeks which has been really cool because then we get to see where the thinking is on many different issues. We'll get into regulation and some other topics, maybe Facebook or Libra as well. But before we move on to some other things I'd like to know what the firm's view is on the open finance space or DeFi. There are a lot of different projects, many of which interestingly are really contingent on the growth of the Ethereum ecosystem which we discussed Fred's thinking on that. How do you view DeFi and some of the developments going on there?

Nick Grossman The most straightforward view of DeFi is that this is the proving ground for the building blocks of smart contracts and interoperable crypto assets in a financial space. You've got layering of protocols you've got really interesting projects like Maker that have this governance engine paired with a really useful stable asset. All the different models are getting experimented with. I just think that it's really fascinating as a laboratory and then the real question is does the device base grow to become the Fi space or or not. I don't know the answer. Part of it has to do with the stuff we talked about earlier about scalability and are there real limits to what can be done. Another part of it is about going aside from any technical constraints, going from today's relatively small enthusiast audience to more of a mass market audience. What's the the path that's going to get there? When I look at things like gaming, like CryptoKitties or other stuff like NFTs like the Dapper company has just announced a deal with the NBA to bring in NFTs like really broad consumer, that's amazing because you're going to have interoperable digital assets on a blockchain that are going to touch a lot a lot of people in a new way. It's amazing. But the same concepts are there inside the DeFi space and the question is, what will take today's audience to a bigger one? One thought and this is not fully formed but I was just having a conversation about this over breakfast is that there is a generational shift and there are people younger people in particular who have probably a more significant portion of their net worth in crypto assets and in DeFi. It's an open question of whether the DeFi world like attaches to the regular financial system or just becomes more and more of people's real financial lives. It's probably safe to say that today it's not really the centerpiece of people's financial lives in a mass market way. But you could imagine that happening that way as a generation of people own bitcoin and Ethereum and other digital assets and not stocks and bonds and cash -- if that happens you grow outwards from there.

Teo Leibowitz What's interesting about something like Dapper Labs is that it's fairly obvious as to where value accrues in that system. Which is with Dapper Labs itself as an issuer of these NFT tokens.

Nick Grossman Or with secondary marketplaces and buyers and sellers. One of the interesting things to think about, is there more value captured in primary issuance or in secondary trading? And for assets that are perpetual you could imagine that the secondary market will vastly outperform the primary market in terms of how much value is accumulated

Teo Leibowitz And Supreme is the supreme example here in that the primary issuance market is valued around a billion dollars and the secondary market at two billion dollars. There's actually a lot of activity there and one project that I find particularly interesting as a possible solution there to bridge the two is something like the [...] model where you have this bonding curve and buyers can sell back into the bonding curve and the issuer itself gets to capture that trading value. So Dapper Labs, fairly obvious perhaps not fairly obvious but we'll see. Open finance, where do you think value accrues in that system?

Nick Grossman Probably too early to tell. The lame and obvious answer is that part of it will accrue down to the lower level protocols that secure all of it. In this case today Ethereum, part of it will accrue into important second layer protocols. We don't know yet exactly how much and where. Part of it will accrue to applications on top that participate in some ways whether that's marketplace liquidity fee type of... on the edges -- application on the edges like exchanges and marketplaces or something else. There's going to be a company layer -- there is already a company layer on top and today those companies are relatively thin but they'll probably grow. Another big question back to this question of primary versus secondary is that a lot of projects today, secondary markets are private closed markets. If you look at something like OpenSea for NFTs -- that's a company on top of an open protocol that has it's own marketplace and a lot of the liquidity and exchange protocols are are out there and working but not the center of the action. If you believe that the secondary market is the long term big piece it'll be really interesting to watch those trading protocols and if those can end up being tokenized and really used. I can't claim to be like a full expert on where all of those projects are but it does seem like that's not all the way going yet but that's another really interesting place to look over time.

Teo Leibowitz You used to be invested in Kik which is a social messaging mobile application in 2013.

Nick Grossman Indeed.

Frank Chaparro So even before they decided to launch a token there was an investigation by the SEC that exposed a lot of interesting things, one of which was the fact that there was some, I don't want to misquote their findings but I believe that there was a board member or someone involved in the company who said that this would be a hail mary move to do the ICO in order to prop up or save other aspects of the business, notably the messaging platform. So that's the context for where Kik got involved in being in the crossfire of the SEC

Nick Grossman And I don't want to talk in any specifics about the case because obviously there's ongoing investigation there and the SEC has published it's initial report. Kik has published their response to that. There's a lot of detail there and open arguments about the facts of the case and legal interpretations and so on and so forth. What's interesting about the project is that and what has always excited us about the potential of crypto assets to work inside of social platforms is that they represent the opportunity for a different kind of business model. It's interesting. Advertising is a tough game. It's a problematic business model for obvious reasons. You have to have enormous scale. You're competing against Facebook and Google. What Kik got right was that crypto represented a different way to try and build a business in the social space by putting a digital asset inside of the system. They had a lot of success previously with other virtual goods: stickers and points and stuff like that. The thinking that crypto assets makes sense inside of social platforms for obvious reasons because you can build an economy around them. It has the potential to increase engagement, you can just start to do other things. It makes a ton of sense and that will be proven to be true over time.

Teo Leibowitz Yeah I definitely see why issuing a token would be attractive from the business's perspective. And funnily enough I was having a discussion with my my brother yesterday and we were talking about cryptocurrency and the struggle to actually monetize these open source projects and issuing a token does seem like an obvious solution. From the user's perspective though, using these distinct tokens within distinct applications might not be the friendliest experience. How do you think that is going to play out? If Kik had say replaced KIN with DAI or Ether or a more widely adopted currency a more liquid currency. Do you think that that would engender a better user experience?

Nick Grossman What's interesting is that KIN is vastly more widely adopted today than anything in the open finance space. They've got millions of users.

Teo Leibowitz Do you believe that?

Nick Grossman I know you guys have actually probably run some research on it but like there's millions of users inside of Kik that are interacting and you could argue that it's trivial, like the transactions but there are many of them. We should have a longer session about like, how do consumers think about currencies and how many currencies does it make sense for there to be consumer facing? I already like thinking about purchases in terms of Jet Blue Miles and Amex points and dollars and euros and like to be totally honest there's only so much of that you can keep straight. There's going to be a consolidation on some level particularly for things that are user facing. Another thing to think about is that not all tokens inside of social are going to be transactional. So if you look at the props project which is another one that just did the Reg A that's really a staking token for reputation and it's not transactional but it is yet another signal inside of social that is useful and so it's too early to say exactly what is the right thing where and...

Frank Chaparro What's interesting to me is regardless of whether or not folks are using it, regardless of whether or not the point of the of the token itself is to facilitate something that's integral to the business. The whole point of what we used to call utility tokens is that they have some sort of utility but even if let's say KIN had all those things, people are using, it has utility -- is that fact and could that fact be, it cannot be at odds with it being a security seal, if also the other point of conducting it was to raise money for the business itself can those two things be mutually exclusive? I want to create a utility token that adds value to whatever network I have but at the same time I need a lot of money. If those are the two interests can it then be a security even if you have the utility?

Nick Grossman We could do a whole other episode on interpreting the Howey Test and I'm sure you guys have looked in detail at the SEC guidance that came out. Obviously the ICO boom of 2017 made every token look like a security and made everything look like a fundraise and there was a lot of crap that got raised, the money got raised for then. As I talked to folks about this in Washington and other places, really it comes back to if we're building a network what we're talking about is a new model for building infrastructure networks. What's so beautiful about the crypto asset model is that stakeholders can become owners and that value if you're an early participant in a network whether that's social or infrastructure or some other kind like you can benefit from your effort in making that thing real and that there is this interplay between ownership and utility and the process of getting something off the ground -- I actually think that's beautiful. If all the early users of Facebook had more of an actual quote unquote ownership stake or economic interest or skin in the game or something, that would actually be really good for the world. That's the model that is here and that's great. It's hard to square that and unpack that in the context of securities laws. What's so odd about crypto assets is that the nature of them changes. The Howey test is about, what is an investment contract? An investment contract is a transaction. It's not an asset. For a lot of these tokens it may be that early transactions were of one nature and later transactions maybe of another nature. In the history of stocks and bonds and other securities, we haven't really had that before. This whole idea that that you can have the same asset but multiple different transactions -- all this stuff is new and so I don't want to... a lot of lawyers and a lot of places and a lot of countries and a lot of companies and a lot of government agencies are wrapping their heads around these contexts and we'll get there eventually but we have to come back to the the idea that we're we're sharing the benefit of building new networks and that's a good thing.

Teo Leibowitz Absolutely. So if the courts do rule against Kik, what does that mean for the crypto industry moving forward?

Nick Grossman It has everything to do with the details so hard to say. There's already been one case where a judge contradicted the SECs view on an application of the Howey Test. I'm forgetting the name of the case but it was maybe six months ago. I understand why the SEC takes a rather narrow