The Medium Rules: Long-Term Trends In Media and Technology – Episode 3 – Tom McLaughlin & David Wodka
Podcast Episode 3 Now Live!
Masternodes and the Future of Crypto Mining, with guests Tom McLaughlin & David Wodka.
As blockchain technology evolves, more and more blockchain networks are adopting a “proof of stake” concept with respect to operation and governance as opposed to a “proof of work” concept. But what does this mean, and why is this important? And, further, how should we think about these two modalities in terms of the broader blockchain ecosystem whether it be from a technical perspective or from the perspective of an investor.
In this episode of The Medium Rules, Alan Baldachin sat down with two of the four co-founders of the New York City-based startup Blockstake, Inc. to canvas a variety of topics related to the blockchain in general and proof of stake mining in particular. Blockstake is a crypto mining startup solely focused on blockchain networks based on proof of stake, whereby network participants can earn rewards in the form of more network tokens based on “staking” a certain amount of tokens up front. In exchange for staking, these trusted network participants earn the right to run “masternodes” which perform a variety of functions on the network, including transaction verification as well as governance. Tom McLaughlin is the CEO of Blockstake and David Wodka is the COO, and both Tom and David bring a wealth of enthusiasm and expertise to bear in a lively and wide-ranging discussion covering the basics of blockchain technology (hint: think of a decentralized version of the early aughts Napster network), masternodes and proof of stake mining versus proof of work mining, as well as the origin story of how Blockstake got its start. At the end of the podcast, we try and take a step back and look into the future to identify long-term trends with respect to the blockchain, as well as emerging projects that are of interest to Tom and David.
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Alan BALDACHIN: From the HBA Podcast studio in New York City, welcome to The Medium Rules. I’m Alan Baldachin.
Joining me today in the HBA Podcast studio are two gentlemen on the frontier of the blockchain industry. I’m joined today by Tom McLaughlin and David Wodka, CEO and COO respectively of Blockstake, Inc., a startup “Proof of Stake” crypto mining company which owns and operates a portfolio of masternodes on some of the top distributed networks or blockchains out there today.
Today’s pod is going to be a bit longer than usual, because what I’d like to do is use this as an opportunity to not only learn about Proof of Stake mining and how the Blockstake business fits into the broader crypto ecosystem, as well as the backstory of how the Blockstake founding team came together and landed on stake mining as a project, but also unpack some of the basic concepts I’ve just mentioned, such as blockchain, Proof of Stake, and masternodes.
On the backend of the pod, we’ll also talk about the broader crypto market, the massive pullback we’ve seen in crypto prices since December 2017, and where Tom and David see things going over the next 12 to 24 months in terms of trends.
With that, let’s get started. Tom and David, welcome to The Medium Rules, and thanks to both of you guys for being on here today.
Tom MCLAUGHLIN: Thanks for having us.
BALDACHIN: Tom, let’s start with you, and let’s start at the start. As succinctly as you can possibly get – which will be a challenge – what is a blockchain network?
MCLAUGHLIN: Basically, a blockchain network is a distributed database that keeps a list of records. Those records are kept in what are called blocks. Those are linked using a cryptography process to ensure that the list of transactions that has occurred up until that point cannot be altered.
Now, that’s really important because when you’re a participant in a network, when you can codify this trust process, it takes a lot of the human element out of managing these networks. It provides an environment for networks to be able to transact in a peer-to-peer manner without having to rely on a third party. Basically, the network can maintain itself.
BALDACHIN: What role does mining play, and what role do coins play in the operation of a blockchain network?
MCLAUGHLIN: The miners are incentivized to keep this growing list of transactions. Each miner maintains their own separate list of these transactions. The miner creates these new blocks and, in return for doing that, they receive what are called block rewards or these newly minted coins from the network. So they’re incentivized by a monetary process.
The tokens themselves, you can think about them as the mechanism by which you can transfer value between two network participants. One of the examples we were kicking around before was something like Napster, which was one of the original peer-to-peer networks.
We can think of a blockchain on top of Napster – we could think about that process as adding a way to transact value. Imagine Napster, but people are able to buy and sell these songs with some sort of token that’s native to that network.
One of the things that’s really crucial for is when you’re building a network, it’s just better to have a native currency to that network. Usually when the problems come in is when you’re trying to integrate some sort of fiat currency into this network, where the network participants are all around the world, they use all different currencies, and then you’re trying to funnel them all through this one door of PayPal or the U.S. dollar.
That was not how the internet was designed. The internet was designed in a global manner. These tokens really are just native digital currencies.
BALDACHIN: When you say “fiat currency,” what do you mean?
MCLAUGHLIN: Fiat currency is referring to any government currency, a currency that’s managed by some sort of federal reserve or a central banking system.
David WODKA: Dollar, euro.
BALDACHIN: Okay. When you say fiat currency wasn’t really designed to work on the internet and you need a native coin to transfer value, can you expand upon that? That might not be obvious to people listening to this podcast.
In other words, if I’m participating in Napster and I want to let’s say get paid for making available 300 songs, just to continue that analogy (which I think is useful), presumably dollars would’ve worked? Or not? Why would we in the case of Napster want to have a Napster coin, let’s say?
MCLAUGHLIN: When you’re designing a network like Napster, you want to make it as inclusionary as you can. You want people in Afghanistan, the United States, Canada – basically every crevice of the world, you want it to be accessible to them.
You run into a problem when you’re trying to transact somebody in the United States with somebody in Africa. You have to go through this portal to switch the U.S. dollar into some sort of currency that that other person would want.
You can change that process by injecting a token directly into the network. If I’m on the network and I’m using Napster, and let’s say hypothetically there’s a Napster coin, I can pay that person in Africa for the song that they’ve uploaded. I can pay them in Napster coin and they can decide to hold onto that, or they can change it into their own local currency.
BALDACHIN: Or into Bitcoin.
MCLAUGHLIN: Correct. I think that’s a good segue. Bitcoin really came about with this idea that we transact different online than we do in person, and the internet needed a native digital currency. Now, whether or not that is Bitcoin long-term, we don’t know.
But as of right now, the idea behind Bitcoin was to have a currency that is directed by code, that creates an environment of trust for everyone. Everyone can see all the transactions. Everybody knows how many new Bitcoin are being created. That’s really a stark contrast to the monetary systems in place, especially in the U.S. We have a central bank that decides the supply of new dollars.
So when you think about Bitcoin, it’s the scarcity and it’s the global appeal that we can now transact across borders.
BALDACHIN: In a trusted – or in some sense the inverse, trustless, because you don’t require trust with a central authority.
BALDACHIN: David, let me segue to you. The way I’m understanding this – and I’m going to continue on the Napster analogy and maybe try to segue into mining – the more popular Napster becomes in our analogy of Napster being a blockchain, the more robust that network becomes and the coins have more value. More people want to join the network, have credits to operate transactions on the network. Is that roughly correct?
WODKA: Yeah. If we take the Napster analogy – it’s a great one – and forget the fact that Napster was a peer-to-peer network, put aside the legal copyright laws with the songs – it was a medium of exchange where people all over the world had a Napster program, a piece of software that ran on their computer.
If I wanted a Red Hot Chili Peppers song, I could find it somewhere and there’d be hundreds and thousands of people that had it. The more people that have that song, the quicker my download was. I could get parts from you, parts from you, parts from somebody else, all over. The more people that were on the network, the more people that had that Red Hot Chili Peppers song I was looking for, the quicker my download was.
But if we think about Napster in a tokenized world where one song costs 1 Napster coin to download, the value of that coin held some monetary value – you could equate it to a Bitcoin value or a dollar value. The more people that come on the Napster network and participate in that, the more demand there will be for Napster coins.
If there’s a fixed supply of them, which is what Bitcoin has taught us, and in contrast to the Federal Reserve and banking system we have now, we have a set schedule and a set inflationary value of Bitcoin supply or Napster coin supply. We know there’s only going to be a total of, in Bitcoin’s example, 21 million coins. We have roughly 17 million today.
We know the supply is increasing at a fixed percentage over time, versus the Federal Reserve can decide to print 10 billion more dollars tomorrow.
BALDACHIN: Which by the way, I want to come back to that when we get into the mining conversation. I don’t know that a lot of people realize that with respect to these networks, the coins that are being minted are finite, and how that process plays out over time.
MCLAUGHLIN: Absolutely, that’s important.
WODKA: If Napster coin in this example is a finite supply, then the more people come on the Napster network and want to download songs or upload songs in exchange for money, the more value 1 Napster token holds. If it starts at a dollar a token, the more participants in the network, the more demand for the fixed supply; therefore, the value or the price will go up as it’s traded on secondary markets.
BALDACHIN: This is a pretty critical point, I think, because that’s what distinguishes successful networks from unsuccessful networks and why some coins will increase in value and others will decrease, because it will be a function of how well-designed, how well-operated, how smart the engineering, how popular the application.
Not all blockchain networks are the same. Some are going to be successful because they’re going to attract a lot of people, whether they’re building on top of or whether they’re a core fat layer. I don’t want to get too technical, but I guess the point I’m making is when you’re thinking about a blockchain network and you’re thinking about picking coins, due diligence with respect to that network is critical.
Who are the engineers behind it? What’s their background? What do you think of the use case? That’s part of distinguishing between scams and networks that have long-term value and will appreciate.
WODKA: Yeah. I think there’s a stigma out there on cryptocurrency in general, that all cryptocurrency is meant to be money or it’s meant to replace dollars. That’s really not the case. There’s thousands and thousands of great applications out there for different – we prefer to talk about “cryptoassets.” It’s called utility tokens.
In the case of Napster, it’s a utility token. You could trade this coin for music. Not everything is meant to be a peer-to-peer payment network, like I pay you for my deli sandwich or pay you to purchase your car.
Not everything is meant to be a unit of money for money purposes, but a medium of exchange for what’s become and what we believe is going to be more and more of a tokenized world. These platforms and these values of exchange will hold more value and be able to transact with each other in their own native currency and will integrate that system and be more effective.
BALDACHIN: Taking that, let’s segue into – one of the things that I think the whole notion of mining solves, among others, is the “problem” of scale with respect to blockchain networks. Talk about how mining solves or is an attempt to solve the problem of scale.
As more and more people are on this network, the amount of transactions just goes up and up and up exponentially, and presumably more and more computing power is needed. Is that a correct way of thinking about the issue of scale with respect to blockchain networks and when mining comes in, at least partially?
WODKA: Sure. Again, kind of what Tom was talking about, it’s based on trust. The way we value the trust and respect the trust is through an effort put into by the miners.
The miners play a very critical role in the recording of that ledger and the formation and the tracking of all those transactions that form the blockchain that create this – immutable ledger is the word, really, that says that you have a certain balance and that you sent Tom 10 tokens, and therefore you had 100 and now you have 90. The record is kept by the miners.
What the miners actually look like could be a number of different ways. It started out as Bitcoin miners, what’s called a Proof of Work mining system. What that physically looks like is machines, hardware machines, miners that are now specially made. There’s very great demand and a limited supply of these machines.
For me to start a Bitcoin mining operation, I need to go purchase some significant hardware, so I need to make a capital investment in an asset. It’s a depreciable asset, but it’s still an asset. They’re made by only a fixed number of suppliers. China is the leading supplier; a company called Bitmain is the leading supplier of what’s called ASIC miners, which is the most efficient, the fastest, the most hash power.
WODKA: Yeah, it’s an application-specific computer, essentially. Not that you couldn’t run it on a laptop, but it’s just much more efficient. They have this specialized technology hardware. So you’ve got to buy a lot of this hardware.
Now you need a space to put it. Typically you see people renting warehouse spaces. You rent a warehouse space, you install this hardware, you’ve got to wire it together, you plug it into a power source. These things give off a lot of heat, so you need a ventilation system in there. It’s a whole physical setup just to start running.
So it’s a big capital investment. It takes some physical space and technical knowhow to plug it in. Then you have a pretty consistent drain on electrical source and electrical cost and physical maintenance cost to maintain these machines.
But once these machines are up and running, once we’ve gotten to that point, the way that they become a trusted participant in the network is by verifying transactions on the blockchain. That’s called Proof of Work.
The work is not only the work you’ve done up to that point to purchase this system and put it into place, configure it and maintain it, and it’s got to have a connection to the internet and run a software program that transacts with the Bitcoin network –
BALDACHIN: And by the way, just for the visual, these are massive warehouses full of thousands of these very expensive machines.
MCLAUGHLIN: It’s server farms.
BALDACHIN: Yeah, basically server farms.
WODKA: There are people that have one or two machines in their basement. I certainly know a couple people that do that. But yes, the for-profit businesses of these are massive farms, massive warehouses. Usually locations where they have low cost of energy.
MCLAUGHLIN: Let me interject. I think this is a later point, but one of the problems that we see with this process is that that group of people that are able to actually mine those networks – it goes from however many billion people in the world, narrowing that down to crypto folks, but now you need to have the warehouse space, you need to have monitors, you need to have electricity, you need to have technical knowledge.
BALDACHIN: And the capital and the wherewithal to raise the capital.
MCLAUGHLIN: Exactly. What we’re seeing in Proof of Work networks, specifically Bitcoin mining, is we’ve gone from anybody who liked Bitcoin back in 2011 could conceivably run a miner out of their apartment and they would do pretty well – that doesn’t happen anymore because it’s all become centralized off economies of scale.
You have people in China that get government-subsidized electricity and access to the best mining equipment, and they’re crushing everyone else. When you’re talking about a decentralized network, when the people mining the transactions go from all of the network participants to 10 people in a room, that’s really scary. I think that’s a legitimate problem with that model moving forward.
BALDACHIN: Let me ask you this, because I think there was one maybe incomplete thought, and then I’d love for you, Tom, to contrast to Proof of Stake mining.
A lot of people have heard about this Bitcoin mining concept solving hard math problems. How does that come into play in Proof of Work mining blockchain? What kind of math problems are they solving, and how does solving math problems relate to verifying transactions?
MCLAUGHLIN: When they’re solving these math problems, they’re basically running computer programs to come up with an exact string of numbers. The first miner that can get that exact string of numbers becomes eligible to create the next block. So they get that block reward.
The more electricity you have behind it, the better chance you have of solving that 25 to 250 string of letters that’s going to unlock the ability to create the next block on the blockchain.
BALDACHIN: Your right to create the next block in the blockchain is also the right to verify transactions and get the rewards?
MCLAUGHLIN: Yes. When you unlock that string, it means that you’re the first person to submit the next block. Every other miner will also have to verify those transactions and submit that same block, but it’s just the first person that is able to unlock that string of numbers that’s able to create that transaction layer that goes into the next block.
Every miner is always simultaneously keeping log of these transactions; it’s just who is the first person to be able to post that to the network.
WODKA: It’s a win or lose game. One particular miner will win that block and everyone else loses, gets nothing. They process about every 10 minutes or so as a Bitcoin block.
BALDACHIN: How do you ever win that? In other words, in Proof of Work mining, wouldn’t it be like I’m playing Federer in tennis? He’d beat me 100 out of 100 times.
WODKA: That’s part of the problem.
BALACHIN: Maybe 99.
WODKA: There are mining pools. People that have a couple of miners in-house aren’t competing with the big guys in China, but they may have thousands of other people that pool their resources together. If one person out of that entire pool gets the block reward, then they all share an equal piece of it relative to the amount of hash power, the amount of work they’re putting into it.
So it’s inherently one of the increasingly difficult problems that’s coming up with the Proof of Work system, and that’s not just Bitcoin, but it’s all Proof of Work systems in that way.
While that’s been a natural evolution from the process that Satoshi Nakamoto created, I’m not sure that’s in the spirit of the whole crypto universe, where it’s money for everybody, supply for everyone, everyone can be an incentivized participant in the network to share relatively equally in those rewards.
If it’s centralized to a handful of players that have proven skill based on their geographical whereabouts, electricity supply, the source –
BALDACHIN: Maybe government intervention.
WODKA: Government intervention. Those people are stacking the deck – and good for them; it’s a very leveraged, smart business decision. But it’s taking a little bit away from the whole ethos of the crypto world on a morality or…
MCLAUGHLIN: Yeah, from a moral standpoint.
BALDACHIN: Yeah, the philosophy of it. Without meaning to get too deep into Proof of Work, because really we’re here to talk about Proof of Stake – Tom, why don’t you segue into what Proof of Stake network is, and also why wouldn’t everyone be Proof of Stake? Why would Bitcoin, for example – because Ethereum is moving to Proof of Stake, is the word.
MCLAUGHLIN: Supposedly, yeah.
BALDACHIN: Let’s talk about Proof of Stake.
MCLAUGHLIN: Sure. The end goal for any of these networks and verifying these transactions is you want consensus. You want every node – a node is a participant. I would think of it like a cellphone tower in a network of cellphone towers. A node is one of those. You want all of the cellphone towers that are keeping the logs of these transactions to be exactly the same. So you’re trying to incentivize as many of those as possible.
The idea behind Proof of Stake is rather than putting all this money into hardware and going through that process to get consensus, the person who’s able to create the next block is directly proportional to the amount of tokens you hold of that network.
In the Bitcoin model, we said it’s kind of random chance. But the more electricity you have, the better a chance you have to make that next reward.
In Proof of Stake networks, they take that competition out of it. To simplify this, if there are 1,000 coins on the network and I own 100 of them, and I’m participating in a Proof of Stake mining pool, I will get 10% of the block rewards. We take all that inefficiency out of all the money and the value leaving the network.
BALDACHIN: what hardware do you need to be a node – or a masternode, which you’ll explain? What does that look like, to be a masternode, to running masternode in a Proof of Stake mining network?
MCLAUGHLIN: Great question. Basically the hardware is eliminated. When you’re Proof of Stake mining, you’re running the same software of that network and you’re verifying the transactions, except –
BALDACHIN: Is it more than a laptop and an internet connection to be a Proof of Stake miner?
WODKA: The beauty of it is it’s just that. It’s an iMac, it’s an open source coded software program you can download on virtually any laptop, and it’s an internet connection. That’s really the limit of the supply you need of the physical hardware investment. You buy a laptop or you have a laptop and an internet connection – which who doesn’t have? – and you’re eligible.
You have to buy – you have to stake some coins. An example of a Proof of Stake network would be NEO. NEO was being hailed as the Chinese Ethereum. It’s a Chinese smart platform.
BALDACHIN: I thought Waves was the Chinese Ethereum. [laughs]
MCLAUGHLIN: There’s a couple.
WODKA: Sure, there’s a lot of them. NEO works very simply as a Proof of Stake network. NEO has its own tokens. You can go to the website and download a Neon Wallet, which is the open source software wallet.
BALDACHIN: Is it buggy, or is it decent?
WODKA: It’s good, it’s decent. There’s updates that come out all the time. So you download that program to your computer and then you open a new wallet account. It gives you an address, a public key, and a private key to keep it secure.
That wallet is also compatible with Nano Ledgers, which makes a cold storage device that keeps those keys offline.
BALDACHIN: I’m going to pause and say maybe explain cold storage?
MCLAUGHLIN: Basically all of these tokens, you can access them through a key.
BALDACHIN: And the key is not a physical key, obviously. It’s a –
MCLAUGHLIN: String of data.
BALDACHIN: If you’ve ever had Microsoft Office, they give you a key. It’s like that. It’s like 20 letters.
WODKA: It could be 25 letters, like capital ‘Q,’ lowercase ‘r,’ 7, 4, ‘i,’ ‘P’ –
BALDACHIN: That’s not your key, right? [laughs]
MCLAUGHLIN: When you have that string of letters, that basically gives you the key to unlock the tokens you have. The idea behind cold storage is you don’t want to leave that string of data online because somebody’s going to hack it.
Theoretically you could write that string of letters on a piece of paper. You could also keep it in your head. But most people need some other medium, so there are actual physical USB devices that store that data. You can keep your Bitcoin or any other cryptocurrency in that wallet.
To hop back, why isn’t everybody doing Proof of Stake? Quite frankly, in the past 2 years most people are. It’s just been kind of a natural shift. I don’t think anybody, when Bitcoin came out, anticipated this problem of five people controlling the mining power in one room at the Consensus Conference. Nobody saw that problem because it’s only happened now that there’s been this scale.
Some of the early Proof of Stake networks – one is called Steemit – you’ve seen that the transactions per second that it can handle is just so much greater. They’re running 3+ million transactions per second, whereas Bitcoin is capped, pre-Lightning Network, at about 15 or 20.
BALDACHIN: Why is the block time, which is the transaction speed – that’s the word for transaction speed on the blockchain network – why is it so much quicker with Proof of Stake?
MCLAUGHLIN: It’s really because you can have a more distributed network of people processing the transactions. It was just rewriting the rules of how we get to that consensus. They’ve done things like you can increase the block size, you can not wait as many what they call “confirmations” for the transaction, because you have these nodes on a network that have a stake.
So if we’re running a node and we’ve also got 10,000 of whatever token it is, basically if we try to screw over the network, we lose that stake. So there’s just a greater level of trust in that everyone is going to do what they’re supposed to do. Because you know that, it allows for a lot quicker transaction and a lot less latency between the different network participants.
BALDACHIN: Let’s jump into your guys’ business. You are a Proof of Stake mining company. What does that mean? Tom, why don’t you take a crack at that? What is the Blockstate business in a nutshell?
MCLAUGHLIN: We own and operate a number of those specialized nodes we were talking about.
BALDACHIN: On Proof of Stake networks only?
MCLAUGHLIN: On Proof of Stake networks. We do own some Proof of Work coins. Bitcoin is the native currency to crypto, so we need to own that to buy other coins. Basically we identify networks that we think are well-positioned, we acquire their currency, and then we stake that. In a lot of cases we put it into a node as well, a specialized node with that collateral that we acquired, the number of tokens.
We run that node with the collateral attached. That helps process the transactions. But the end goal, really, for us is we earn mining fees from these networks. So we put up a chunk of money, we help to spread out the network by another node, so we’re stabilizing the network, and in return for doing that, we earn these new block rewards.
BALDACHIN: Which are more tokens of that network, the native tokens of that network.
BALDACHIN: Which you then do what with, David? Do you reinvest those, do you put them on other networks, diversify?
WODKA: Our business plan, our business model allows us to profit in two ways. Number one is the cash flows from the mining rewards we’re collecting. We don’t own or operate a single Proof of Work miner, but we participate in many Proof of Stake networks and a lot of these special masternodes, which we can go into a little bit more.
That becomes eligible to receive mining rewards and dividends. It’s a volume-based fee we collect from the network for being a good actor on the network. We profit from the mining rewards and we also profit from any price appreciation in the assets we hold.
Again, contrasting to a Proof of Work network, instead of buying hardware machines that, while they’re an asset that you can list on the balance sheet, it’s a depreciable asset because it’ll lose value over time, in the case of NEO we buy 1,000 NEO, let’s say, at a certain price. That NEO never goes away. That NEO earns us dividends and we get paid in more tokens.
BALDACHIN: By staking a masternode.
WODKA: By staking a node on the NEO network, we receive volume-based dividends based on our 1,000 NEO, let’s say. But we also hold the NEO, so if and when the price of NEO fluctuates up or down, we ride that wave.
We’re obviously big believers that the whole crypto market, while we are in the middle of a pullback right now, will continue to expand over the next several years. So we profit from that price appreciation and the mining reward.
Short term, we get these supplies that come to us. Every few minutes we get a small piece of new coin that’s constantly coming. Then you ask, what do we do with them? We’re holding them and reinvesting them, but it also lets us sell some of them off and invest in other projects.
As we get more cash flows in, we can diversify our portfolio. There’s always more projects and more great use cases coming out for blockchain. So it allows us to diversify our portfolio and pursue other opportunities, and it also allows us to sell off some of those rewards to fuel our operating costs of the business as well.
It’s nice that it’s a self-sustaining business model. We use our capital, we purchase these assets, we become eligible to receive cash flow based on these assets. Again, if and when the market goes up, we profit even more from the price appreciation. But short term, we’re always making money regardless of whether the market goes up or down that given day.
BALDACHIN: Just so people know, there is a minimum amount of coins you need to hold in stake and in effect put in escrow to be able to operate a masternode.
BALDACHIN: I apologize, David, and I’m going to let you jump in – we’re going to link to websites that are specifically targeted towards masternode investors and people operating the masternode system which tell you how many coins you need to operate a masternode, what the block rewards are, what is Masternodes.online.
MCLAUGHLIN: Or Masternodes.live. I think that’s one of the great parts about this as well. All of that is completely transparent. Each of these separate tokens is really just a piece of software.
Coded into it are different parameters, and one of them in a lot of the cases happens to be this masternode feature. What they’re trying to do is get someone to create a node, keep track of those listed transactions, but also basically prove that you have skin in the game. The more skin in the game, the greater the rewards you get.
BALDACHIN: What’s amazing is the incentive. This is all built by humans, and there are human incentives, rewards that are pulling people in to help sustain and build up the success of these blockchains. You can think about it in those terms.
Just to give an example, Dash is a hybrid Proof of Stake and Proof of Work. That’s one that people know about. One Dash coin is today I think something like $209. You need 1,000 Dash coins to operate a masternode, so today if you wanted to operate a Dash masternode, you’d have to come up with $209,000.
That’s expensive, obviously. There are many Proof of Stake blockchains with masternodes which are much more in reach. I would say part of the special sauce of a Proof of Stake mining company is figuring out how to allocate your assets, which networks you believe in, which team [inaudible 00:35:21] them, so on and so forth. That’s in some sense what you’re bringing to the table.
WODKA: Yeah. We look for opportunities across three different tokenized reward structures. That’s what we’re going after. We want to get paid in these cash flows from tokens.
One of them is a traditional Proof of Stake model, which NEO is a good example of. There is no minimum amount. There is no NEO masternode, so to speak. You could stake 1 NEO, you could stake 10,000 NEO, and you’ll get the same proportion of rewards.
Dash is a good example of a masternode network. If you have 50 Dash, you get nothing. You need 1,000 Dash minimum to come to the table and form a masternode. That is your stake in a masternode for Dash. You have to have, like you said, $209,000 today, which is a good chunk of cash, in order to be eligible.
Then you have to have the technical skills. It’s not a hardware, but it’s a technical skill to have that software program running with your money on that network, secured –
BALDACHIN: Connect your coins to the network.
WODKA: Connect your coins to the network, run the software, and have server space. The masternode records the transactions on the network and you have to have the server space to store it. Do you have your own server, or are you going to cloud server space? There’s a communication there, there’s a software, and there’s a money minimum just to get in the door.
Again, going back to the whole idea of trust, by putting your 1,000 Dash on the table, your $209,000 on the table, that says “hey, I’m going to behave wisely and smartly and I’m going to be a trusted participant, or I’m going to lose my money.”
Then there’s a third aspect to our business, too, that are investments in networks that aren’t necessarily Proof of Stake that still have a function that would pay dividends out to. That is a growing part of the market. It doesn’t exist to the extent that other Proof of Stake networks do.
One of the projects – and this is becoming more common on some of these ICOs – one of the projects we’re very excited about is a project called MEvU, so “me versus you.” It’s a peer-to-peer sports betting platform led by a smart team in Toronto.
BALDACHIN: I like Toronto. Shout out for my hometown.
WODKA: Yeah, fellow Canadians, eh?
So these guys are creating a sports betting platform built on blockchain, which is a great use case of blockchain. I think there can be a lot of blurriness these days in cryptocurrency and what that really means, but an application is super clear this way with sports betting.
It’s peer-to-peer, so Tom and I make a bet with each other about the Yankees versus the Royals game. We have this network of these trusted third parties that verify the transaction, like okay, we wagered 10 tokens against each other.
MEvU was built on the Ethereum network. Again, it’s an ICO in progress that we think holds a lot of value and somebody that we partnered with very early on. We can provide a value to them, and then it’s a strategic investment for us in the long term as well.
BALDACHIN: So you’re going to buy the coins in the ICO, but do you have to stake the coins?
WADKO: Exactly, we stake the coins. MEvU is built on Ethereum. There is no Proof of Stake yet with Ethereum. It’s only Proof of Work right now. There is no Proof of Stake model to staking Ethereum. But what you can do on this new ICO, this new sports betting platform that’s coming out, is you can stake your MEvU tokens and report game scores.
It has this oracle function. Blockstake as a business is not going to be betting on the Yankees beating the Royals (even though Tom and I are big fans). What we are going to be doing is staking our coins and then reporting the game score. So when the Yankees beat the Royals 5-3, we can report that.
How do you verify who wins all these different bets across the network? By reporting that this team beat that team, this horse won the race, Croatia beat Russia in the World Cup, by reporting all these results, we verify other people’s bets. When those bets are settled, a cut, a small transaction fee of those bets, goes to the people that verified the bets.
It’s kind of like a new age of mining. You’re verifying these transactions, but you’re not actually a physical miner on the network. We would have to have a Proof of Work Ethereum mining operation to mine and verify the transactions of the network, yet we’re supporting the platform and being paid a dividend fee based on being a good actor, staking our money to say that we’re a good actor and we’re a trustful actor. By reporting these game scores, we collect a small dividend.
BALDACHIN: That’s interesting.
WODKA: So it’s a new creative concept that we’re very excited about – both this particular project, and there’s other ones along the way that have this oracle function to them.
MCLAUGHLIN: I’m personally very excited about prediction markets, sports betting – any of the industries that are highly regulated where you have an intermediary who seemingly does not provide that much value, but yet charges exorbitant fees. The very basic one is the sportsbook. They charge 10%, 15%, sometimes up to 20% to take one wager.
Now if you can codify that process where I’m going to bet on the Yankees, David’s going to bet on the Mets, why wouldn’t you just put that into some sort of software program that will automatically pay out based on the results of that instead of a 10% fee that each of us pay on the money we paid 2%?
To me, that’s the kind of value that blockchain can provide, and that’s something that has legs beyond just the small crypto community. That is game-changing, industry-shaking-up –
BALDACHIN: In other words, you’ve completely upended the sportsbook market.
MCLAUGHLIN: Correct. I mean, yes, we’re seeing legalized sportsbooks now, but a lot of the sports betting that takes place online right now is me depositing money onto an offshore booking account. I don’t know if I’m ever going to get it out. They price gapped people, and there’s no transparency in that process.
BALDACHIN: So MEvU is in effect a sportsbook on blockchain.
MCLAUGHLIN: Correct. You hold onto the funds at all times and there’s no third party risk.
BALDACHIN: And you’re not in this sketchy offshore – now, we know gambling has been legal, anti-gambling laws have been struck down by the Supreme Court. We’ll see how that evolves. But that is a great use case, and that’s something you guys are looking at, obviously.
WODKA: Something we’ve invested in already and are excited to support them.
BALDACHIN: So the ICO is in progress right now. (ICO is initial coin offering.)
WODKA: Yeah. Just to expand the analogy on blockchain as a whole, with your offshore sports betting account, there’s an amount of trust that’s lost along that way. I’m trusting that my money is going to be safe in this offshore account.
BALDACHIN: And that your credit cards aren’t going to get hacked.
WODKA: Yeah, your credit card and bank doesn’t get hacked. I want to have a minimal amount to withdraw from, so if you win a $10 bet, you can’t always get that money. Then if and when you do hit the withdrawal button, how long does it take? How many business days per transaction?
BALDACHIN: There’s also a risk of bankruptcy. You have no idea. If these guys go get rated, boom.
WODKA: To get paid in my Chase bank account, that may take 3-5 business days to withdraw that money, whereas we’re talking about block times of 2-5 minutes in a lot of these networks. So you get verified and paid in your actual wallet almost instantaneously relative to an offshore bank account that you’re not sure is trustworthy and it takes days to get paid, if you get paid at all.
BALDACHIN: Let me ask you guys this. One of the things that’s really interesting, or really fun, so to speak, about blockchain is it’s so new that no one’s coming at this – it’s really open to everyone. You guys, you’re a four founder team. Each of your backgrounds is different.
I’m not necessarily saying to go into the bio of each of you guys and your two other co-founders that aren’t with us today, but how did you come together and decide as Blockstake co-founders that this was where you wanted to land with respect to a startup in the blockchain ecosystem?
MCLAUGHLIN: The founding story of Blockstake, there’s four co-founders. I’d been friends with each of them separately. I personally got into the crypto game a couple years ago. It started with Bitcoin. About 2 years ago, I started full-time trading crypto on a bunch of really weird different exchanges in God knows where.
BALDACHIN: Before that? Were you ever –
MCLAUGHLIN: I was a little bit after that, thankfully. Pretty soon after that. Actually, I started in similar environments of what we’re dealing with now, with the crazy bull market and then bear market.
Back to Blockstake, I knew I wanted to do something in the space. I initially was thinking about doing an ICO in the sports space. I met up with these guys and we all were talking about investing in cryptocurrencies. We had the idea of starting a fund.
As we got down that process more and more, we started noticing this very apparent shift from the traditional Proof of Work networks to the Proof of Stake networks. The more we dug into that, the more it made sense to us that this shouldn’t be a fund. This is an actual business. We’re providing a service, and it’s a much-needed service to the fastest growing area of crypto.
Within the bounds of what we each brought to the table, this made a lot of sense. My background, I started off on Wall Street. I’ve been an entrepreneur in various industries now since I’ve been in college. We have Dave, who’s our COO. He comes from a construction background, but also a very savvy investor. Shawn is our biz dev.
BALDACHIN: Shawn Diamond.
MCLAUGHLIN: Shawn Diamond. He’s a Wall Street guy as well. And then Earl, who’s our wild card, Earl Myers. He’s our Director of Marketing. He has a Wall Street background, but now he’s in the creative area.
WODKA: And he’s deep into coin research.
MCLAUGHLIN: Yes. He’s also one of the other sickos that goes into the really low market cap coins.
BALDACHIN: But you need that. That’s where you’re going to make your skin.
WODKA: That’s where the greatest opportunity is, that’s right.
MCLAUGHLIN: Yeah, we all came together. This idea wasn’t what we initially ran after. The longer we were dealing with these other business models that we were going after, it became more and more apparent to us that this is going to end up being a really crowded space, and we want to be the first movers in that space.
BALDACHIN: Dave, what’s your perspective on this being the business where you guys landed versus doing some other things you could’ve done in crypto?
WODKA: I think this idea of pooling assets together, starting a for-profit business that acts as a stake miner – we call it masternode stake miner, similar wording – on several networks is a pretty smart idea to deploy our capital and diversify our risk.
But also [we] put them in smart places where we’re going to get cash flows and daily returns, as well as, like you said, identify early on projects being early in on the price and experiencing that price movement upward. As the market gains steam, each of these individual projects becomes more and more valued.
The business model – we have a C corp, so we have shares of stock of our company. Then our real future vision is to bring this company to the larger capital market. Our goal is to bring Blockstake to the TSXV, which is the Toronto Stock Venture Exchange in Canada.
BALDACHIN: Which is a very friendly environment for venture style businesses going public.
WODKA: Yes, and there’s already several crypto companies, blockchain companies that are already public on the Toronto Stock Exchange, whether it’s the main exchange or the venture exchange. So it’s a very friendly community there.
The SEC we think is coming along those lines, but right now the SEC is still in subpoena mode for sequestering information from blockchain companies, whereas the Toronto Stock Exchange is posting a webinar series on why you should bring your blockchain business to Canada. So it’s a very friendly environment.
BALDACHIN: With sophisticated investors and sophisticated regulators. Let me just interject and say what’s going on so people are aware.
The SEC is focused on ICOs which haven’t complied with the securities laws, whether it be registered tokens as securities, whether it be have not registered them for resale. Many people listening to this would know that that’s a big area of concern for the U.S. blockchain industry. Not that it’s bad or good; it’s definitely slowed down momentum for blockchain companies looking to sell coins to U.S. investors.
WODKA: Exactly. We get asked all the time, “Are you guys doing an ICO?” No, we’re not doing an ICO. We’re not creating Blockstake coin.
BALDACHIN: You don’t have a network.
WODKA: No, nor do we intend to create one. We want to be a participant and a trusted actor and to provide this infrastructure and this service in exchange for the cash flows and rewards that come from it across several networks.
Our goal is to bring this product – so yes, we have a registered security with the SEC; we have a stock of a traditional company that’s registered. When we bring that stock to the public markets – the Toronto Stock Venture Exchange is our goal – we want to be able to bring this opportunity to everyday retail investors.
So both institutional and retail investors could someday hopefully soon participate in and own a piece of the crypto market, a piece of our company, a piece of crypto stake mining through an Etrade account, through a traditional investment mechanism that a lot of people are much more comfortable with relative to opening up a coin-based account and purchasing some Bitcoin or Ethereum or Litecoin.
We think this has advantages for all, both to open up the doors of the crypto community to more and more investors that are comfortable with trading, buying, and selling stocks.
BALDACHIN: You want exposure to crypto.
WODKA: Yeah, you have a bigger liquidity pool on the entire market and you have a more simplified tax situation too. I know if I buy at $10 and sell at $20 in this amount of time, I know my capital gains and I know how to evaluate that very simply versus having to go through tax implications on the crypto market.
BALDACHIN: Let me correct one thing that you said. You said you have registered shares. You’re a private company?
WODKA: We are a private company.
BALDACHIN: Okay, let’s just be clear with that. [laughs] Let’s make sure we’re compliant here on the podcast. We’re a fully compliant podcast.
MCLAUGHLIN: Get that disclaimer in now.
BALDACHIN: Right. Last question, Tom, let me ask you this. It does feel like there are characteristics of a fund in Blockstake. Primarily, from what I understand, a small percentage, 5% of your overall capital is in effect for operating expenses and the balance is actually directly invested in tokens.
BALDACHIN: You didn’t set it up as a fund. Why a corporate structure?
MCLAUGHLIN: It’s a fantastic question, and it was a very difficult one. The idea behind this business was to get the masses involved outside of crypto. Really, the best way to do that is to run and operate a business that generates revenue that looks like other businesses in the world.
We decided not to go with a fund structure because it’s an oversaturated area to begin with, and quite frankly, we wanted this to open the doors between crypto and the rest of the world. We didn’t want to make a number of very high net worth investors a lot more money, because quite frankly, that’s not really what the ethos of this whole movement is about anyway.
BALDACHIN: And the reason for that is you can’t publicly list a fund.
MCLAUGHLIN: Correct. I think we get tripped up here a little bit. Basically our business is identifying projects and providing them with the capital and the infrastructure that they need to grow into bigger networks. I think there are a lot of other businesses that do exactly that, probably yourself included, but they’re just not necessarily dealing with owning a liquid token.
With owning that liquid token, I think we automatically get characterized into being some sort of investment fund. But in reality, holding that token is no different than having some sort of incentive or long-term benefit for having a business relationship with someone. The token is just a new form of –
BALDACHIN: Collateral, really.
BALDACHIN: Let me shift gears a little bit just in the last few minutes of time we have. Maybe step back into the broader blockchain ecosystem. As I alluded to at the top of the pod, there has been a significant pullback.
Just to take Bitcoin, we saw Bitcoin prices hit 16,000, maybe even 17,000 back in December. They’re down to the low 6,000s. Dash, we mentioned that coin, that’s gone from –
WODKA: 1,300 to 200.
BALDACHIN: To 210 and dropping. Ethereum has dropped. All the coins have dropped. EOS was as high as 15, it’s now 7. What do you guys think is going on? Was it simply height? Are we seeing now leveling? What’s your take, and how do you think this bodes for the future?
MCLAUGHLIN: It’s a combination of factors. Namely, it has to do with the hype cycle. I think when you look at any of these markets, basically what we saw was nobody knew what Bitcoin was 18 months ago.
We saw it on every CNBC episode for about 2 or 3 months at the end of summer, and at that time you had all of these venture capital firms that missed out on blockchain 1.0. They’re all pouring in. So naturally you have this hype bubble that comes.
Really, it’s just been a lack of liquidity since. I think all the people that wanted to buy it did buy. It got completely ballooned up. Those marginal buyers that came in at $18k, they weren’t in it for the right reasons. They had no sufficient – they were weak hands. I think we’re seeing a progression of that.
I actually think that this pullback has been quite healthy. A lot of the behavior I saw specifically in the ICO market in the past years just didn’t make sense to me. Again, I think that’s one of the reasons why I really was drawn to the Proof of Stake and masternode area of this ecosystem. You’re dealing with a lot of projects that aren’t going out and raising $100 million to build a project in 24 months from now.
What we’re looking at more are projects that already exist, they’re working, and they raise money by increasing the value of their token.
BALDACHIN: They’re post-launch. Are you in only post-launch networks? In other words, do you have tokens of networks that have not yet had their launch?
MCLAUGHLIN: Yeah, we do own some. But I would say as an investor, that’s the biggest risk hurdle. Why would I throw $200 million at a network that doesn’t exist when I can invest in a lot of these great masternode networks which have a network that’s working and they have thousands of nodes, close to 100,000 transactions per day on their network?
One, it’s a lot easier to value. Two, the market capital of those coins compared to some of these bigger coins like Dash, it’s pennies on the dollar.
So I think we’re going to continue to see what you’re talking about. I think all of the Proof of Work coins outside of say Bitcoin are just going to continue to bleed because there’s just no new marginal buyer. They got so overvalued, to an extent that they just can’t keep the momentum going.
At a time like now, maximum pessimism, at least for us, is the time of maximum opportunity.
BALDACHIN: Sure. Dave, what are you keeping your eye on in terms of the some of the networks that you’re looking at? Without meaning to ask you to give away your special sauce. [laughs] Anything you can talk about, like characteristics of things that you guys like, that you’re monitoring, that you’re thinking about?
WODKA: Part of our research process when we do look at potential investment opportunities, specifically within the masternode community, is we look at what their code is. It’s not necessarily a technical aspect of reading a code line by line, but it’s what is the block and reward structure. Everything has a fixed inflationary schedule.
While it’s attractive, some of these networks boast they have 1000% ROI every year from their mining rewards – that’s a great number, but what’s that going to do to the value of each token? It’s just going to plummet the value of the token. So we look for a combination of a healthy inflationary schedule that’s not too drastic, but that’s still going to give us good rewards and provide a useful service.
Sports betting is a good example. Another project we’re very excited about is GIN. What GIN provides is a platform for hosting other masternodes, which is really quite creative because they’re taking what’s technically a difficult process – to set up the masternode on your own, both in running the code and having the server space.
GIN provides server space and a platform to host your masternodes on. You spoke about Dash before. Dash, PIVX, there’s a lot of them. Apollon.
MCLAUGHLIN: Stipend, SmartCash. There’s many of them.
WODKA: Yeah, there’s a lot of these both legacy and new and developing masternode projects that are being hosted on GIN’s platform. What GIN allows you to do is you still own your money, so you still own your 1,000 Dash in your wallet. But you connect your wallet – again, that’s held securely by you.
They don’t have access to your funds, but they provide you with the server space. They provide the software program that runs in the background that verifies the transaction, that enables you to be a node of the network, to process the transaction and maintain the ledger. They provide that service, and they call it a 1-click setup.
BALDACHIN: It’s almost like a browser.
WODKA: Almost like that, yeah. It’s a platform. If you want to use the Napster analogy, it’s like the platform program you download for that. They provide that service in exchange for a fee.
They’re entitled to receive a fee in exchange for their services, so they collect their fee in their own native token, GINcoin – which we think is a pretty creative, smart idea. Like Tom was speaking about earlier, it just makes more sense to integrate a native token into that process versus bringing in dollars or even Bitcoin or Ethereum into that process. It runs seamlessly.
We both host GIN nodes of our own that support the GIN network –
MCLAUGHLIN: Yeah, we’re one of the biggest masternode holders on the GIN network. Just to humble brag a little bit, we found this network before it was listed on most of the pricing indexes, close to $3. In the time that we’ve gotten in it, it’s been listed on all of the major listing sites. The number of new nodes has exploded. It’s gone up 250%, 300%.
BALDACHIN: Fantastic. So to crystallize the GIN conversation and maybe to extrapolate it, the bet with GIN is that masternode mining is going to increase in popularity.
WODKA: And there’s a value of real life service. There’s many great projects that will someday say they’re going to provide this service or do this function, but they’re doing it right now. We’re looking for projects that are built, that are actually functioning and not just a promise of “something smart may happen in the future.”
MCLAUGHLIN: And betting on GIN is basically betting on the masternode ecosystem, which is exactly what we’re about.
BALDACHIN: Let me wrap up by asking you guys each if you can identify any long-term trends – not necessarily specific networks, but with respect to blockchain over the next 12 to 24 months. What are you looking out for? Little bit of a big question.
WODKA: Yeah. Like Tom was saying, we’re both frankly pretty excited about the pullback right now. We’re long-term believers, so I’m okay with Bitcoin hovering around the 6,000 mark relative to it almost hit 20,000 last year. It’s an opportunity. We see it as a short-term opportunity for ourselves.
We see a widespread adoption of cryptocurrency or cryptoassets, the tokenization of different platforms happening. Then we also expect – you see in the news headlines and some of the financial blogs and websites that there’s going to be more and more of these publicly traded financial instruments.
There’s future markets for Bitcoin already; that came out over the winter. They’re supposedly going to process several different crypto ETFs that are going to become traded on the various exchanges. I think NASDAQ is talking about having one. So there’s all these publicly traded tools that supposedly are coming out, and certainly Blockstake wants to be one of them, as we spoke about earlier.
We think these are going to open the doors to more and more investors, more people that are comfortable buying an ETF or buying a stock on an exchange and being another way to onboard capital.
BALDACHIN: And bring institutional money into it.
WODKA: Bring institutional money, bring private money, become included in some even broader ETFs. It’s a great way for people to diversify their personal portfolios of risk and opportunity that way.
We really see a growth in the capital market side of the crypto world being a giant portal. It’s open already, but we see it becoming bigger and bigger and wider and wider in the not-too-distant future, and we’re quite excited about that. We want to be a participant and supporter of that too.
I think Tom had talked a little bit more on some of the other projects and use cases that are out there that we think blockchain as a technology is continuing to solve more and more problems and to be a more efficient solution to something like sports betting that’s easily relatable.
BALDACHIN: Tom, I’ll give you the last word.
MCLAUGHLIN: I think this whole idea of blockchain, the way I like to think of it is if we are building upon the internet, blockchain enables the transfer of value or the ability to transfer money through the internet. By creating this trust, blockchain is really like the best Lego block to build on top of. It was a Lego block that we’ve been missing since the start of the internet.
Where do I see this going in the next 12 to 14 months? I think that hype bubble has taken away a lot of the attention that there is so much development work going on, and there is so much capital that was put into this market a year ago.
In the next 12 to 14 months, the crucial things are, can we clarify the custody solutions? How can investment banks, pension funds, etc. get into this market? Because right now it’s very specialized to hedge funds like angel investors, etc. That’s one challenge.
But I do think that in the future, this blockchain technology is going to be basically the underpinning of most applications that people use – things like Uber, Facebook. These are all models that can be reimagined, that can be owned by a network instead of the management team of a company.
BALDACHIN: Yeah, and the investors certainly taking over profits.
MCLAUGHLIN: So I’m very bullish. It’s just a matter of the timeline.
BALDACHIN: We shall see. With that, I really want to thank you guys. This has been hopefully entertaining and enlightening for people. We would love to have you guys back at some point to update on how Blockstake is doing. Thanks very much for coming in.
BALDACHIN: Great. Thanks, Tom.
BALDACHIN: That’s a wrap.
That’s a wrap on this episode of The Medium Rules with Alan Baldachin. For more information, go to our website at www.hballp.com. You can also follow us on Instagram, Twitter, and Facebook, and don’t forget to rate us on Apple Podcasts.