ARK 2023/4 Big Ideas Disruptive Innovation Report

Written by Will Awang

At the beginning of 2024, Cathie Wood, the most shining Wall Street investment manager in technology stocks, led her ARK team to release the "Big Ideas 2024" report. The report aims to cover the field of "disruptive innovation" around the world, has a very high gold content, and is an important reference for global technology entrepreneurs and investors.

This article extracts the content about cryptocurrency and blockchain from two research reports in 2023/4 to sort out and present a way to look at Crypto from the perspective of Wall Street funds.

Among them, we can see the changes that public blockchain can bring to currency, finance, and the Internet, the solutions that smart contracts/DeFi provide for the real world, and the value growth rate brought by the combination of digital wallets with crypto/blockchain payment capabilities.

1. The integration of five major technologies leads the next generation revolution

ARK Research believes that the integration of disruptive innovation technologies will define the development of the next decade, and the current technological integration may trigger more profound macroeconomic changes than the first and second industrial revolutions.

AI, public blockchain, multi-omics sequencing, energy storage and robots, these five major technology platforms are integrating with each other, which will change global economic activities, and the economic growth rate may accelerate from an average of 3% in the past 125 years to 7% in the next 7 years.

The figure below shows the impact of previous technological revolutions such as steam engines, railways and telegraphs, and general technological revolutions such as electricity, telephones and radio on the economy. Today, with the integration of disruptive technologies in five major platforms, AI, public blockchain, multi-omics sequencing, energy storage and robotics, the impact on the economy may exceed that of the past.

As one of the five major technologies, once mass adoption is achieved, all currencies and contracts will be migrated to the public blockchain to support the verification of digital rights and proof of ownership. The financial ecosystem may be reconfigured to adapt to the rise of cryptocurrencies and smart contracts/decentralized finance (DeFi).

These technologies increase transparency, reduce the impact of capital and regulatory controls, and reduce the cost of contract execution. In such a world, as more and more assets are monetized/tokenized, businesses and consumers gradually adapt to the new financial infrastructure. Then digital wallets that carry these assets will become increasingly important. The governance structure of the traditional corporate system will also be challenged.

Second, the changes that public blockchains can bring

The proposal for public blockchains is mainly in the 2023 research report. ARK stated that despite the major earthquake in the crypto industry in 2022, public blockchains continue to drive changes in currency, finance, and the Internet. The long-term opportunities for Bitcoin, DeFi, and Web3 are increasing. In the next decade, the market value of cryptocurrencies and smart contracts may reach 20 trillion US dollars and 5 trillion US dollars respectively.

2.1 The Money Revolution

Public blockchains can coordinate the transfer of value and ownership outside the top-down control of governments and centralized institutions, thereby promoting the transition of the monetary system from centralized to global, decentralized, and non-sovereign.

Existing problems: The centralized monetary system can hardly provide strong guarantees for the global economy:

1) 4 billion people live under authoritarian regimes;

2) More than 2 billion people suffer from double-digit inflation;

3) More than 1 billion people cannot use traditional payment transfer applications;

4) More than 1 billion people rely on remittances.

The power of change mainly comes from cryptocurrencies represented by Bitcoin:

1) Bitcoin can ensure independent property rights, combining encryption technology and self-custody to ensure independent property rights;

2) Bitcoin is inflation-resistant. Its quantity is mathematically measured and predictable. Currently, the supply of Bitcoin is 19 million, with an upper limit of 21 million;

3) Bitcoin is censorship-resistant, and the threshold for transactions is very low. The only requirement is to have a private key;

4) Bitcoin is auditable and transparent.

2.2 The Financial Revolution

Public blockchain can reconstruct a set of decentralized financial technology facilities (DeFi) outside the traditional financial system to meet many needs that the traditional financial system cannot meet, and solve many problems that the traditional financial system is difficult to solve.

Existing problems:

1) More than 2 billion people cannot access basic banking services, including account management and credit;

2) The opacity of the financial system has caused multiple financial crises;

3) The risks of traditional financial institutions as counterparties can easily lead to single point failures in the system, and centralized decision-making leads to rampant rent-seeking.

The power of change mainly comes from the newly constructed decentralized financial infrastructure (DeFi):

1) DeFi eliminates traditional intermediaries, and automatic smart contracts guarantee execution without the need for trusted entities;

2) DeFi is global, and financial services deployed on open protocols enable anyone with an Internet connection to access custody, trading and lending facilities;

3) DeFi is interoperable, and financial services are open source and interoperable, allowing rapid innovation and experimentation;

4) DeFi is auditable and transparent, users manage risks themselves, and collateral and capital flows are stored in the ledger and open to review.

2.3 The Internet Revolution

Public blockchain can help realize personal sovereignty of identity, reputation and data outside of traditional groups and large technology companies, and realize the transition of property rights from corporate sovereignty to personal sovereignty.

Existing problems:

1) The development of current Internet technology giants relies on the use, ownership and monetization of user data;

2) Digital identities and reputations between platforms are not interoperable;

3) Centralized decision makers determine the discovery of information and subjectively regulate content and communication.

The power of change mainly comes from the value economic system of Web3:

1) Web3 emphasizes personal sovereignty and introduces the concept of personal digital property rights;

2) Web3 relies on protocols, not platforms. Decentralized protocols support the management and open access to distributed data, limiting the control of central aggregators;

3) Web3 brings a new profit model, which embeds the economic system into the ecosystem, enabling users to monetize and participate in network development;

4) Web3 realizes the integration of consumption and investment. With the digitalization of the economy, consumer behavior is also changing, giving rise to new business models for buying, owning and using.

This public blockchain that combines Bitcoin/cryptocurrency network, DeFi, and Web3 will further redefine traditional assets, capable of achieving a total market value of US$25 trillion by 2030 (including US$20 trillion in crypto asset value and US$5 trillion in smart contracts/DeFi protocol value).

3. Smart Contracts - Driving the Financial and Internet Revolution

After the catastrophic failure of the centralized encryption institutions on 22/23, smart contracts deployed on public blockchains provide a global, automated and auditable decentralized financial infrastructure (DeFi) alternative to the traditional financial system.

Decentralization has proven to be even more important for maintaining the original value proposition of public blockchain infrastructure.

According to ARK's research, as tokenized financial assets gradually gain attention (such as stablecoins, tokenized U.S. bonds, etc.), the volume of assets on the chain has achieved a significant growth. It is expected that the market value related to decentralized applications will grow at an annual rate of 32%, from US$775 billion in 2023 to US$5.2 trillion in 2030.

The following are the main points:

3.1 Smart contracts are the foundation of the value Internet financial system

It is still in its infancy, and smart contracts are powering a new financial system native to the Internet. Driven by Ethereum, the largest smart contract blockchain, multiple networks are supporting on-chain activities and competing for market share.

3.2 Stablecoins highlight the value proposition of smart contracts

Given the rise in hyperinflation in emerging markets and global instability, demand for stablecoins that provide digital access to the U.S. dollar is soaring. Over the past three years, the number of daily active stablecoin addresses worldwide has grown at an annual rate of 93%, from 171,000 to 1.2 million. In 2023, stablecoin transaction volume exceeded Mastercard.

3.3 Traditional financial assets are moving on-chain

Tokenization enables asset management to be implemented on public blockchains, making it easier to verify, track, trade, and utilize funds than in traditional financial markets. In 2023, tokenized Treasury funds grew more than sevenfold to $850 million. Early funds were launched on the Stellar blockchain, but Ethereum became the largest tokenized treasury market in 2023.

3.4 Developers Improved the Protocol During the Bear Market

Faced with the 2022 crisis and its aftermath, core developers proposed a technical roadmap and hardened protocols to support the next bull run. Ethereum successfully achieved Proof of Stake (PoS) consensus, and Solana also set a new record for continuous uptime.

3.5 Layer2 Scales Transactions in the Ethereum Ecosystem

Since the beginning of 2021, more than 20 Layer2 projects have been launched, enabling Ethereum to 4x the average daily transaction size with lower fees. Despite early success, most Layer2s are centrally controlled. The proliferation of Layer2s has created a mixed experience for users and developers.

3.6 Lower costs promote on-chain user stickiness

As transaction costs decrease, on-chain participation (measured by the ratio of daily active addresses DAU to monthly active addresses MAU) has increased.

3.7 Monolithic chains like Solana provide an alternative for vertical expansion

There are trade-offs in the design of smart contract network functions. By prioritizing underlying decentralization, the Ethereum ecosystem has become more complex as it scales. By prioritizing the scalability of a single layer, Solana has maintained a simple architecture for users and application developers and achieved phased success.

3.8 Smart Contracts Can Reduce the Cost of Financial Services

The value of global financial assets has surged from $140 trillion in 2000 to $510 trillion in 2020, a result of global economic growth, increased financialization, and expanded stock multiples. The operating costs of the global financial system have increased with the value of financial assets. The total annual revenue of the financial services industry is $20 trillion, accounting for 3.3% of the value of all financial assets. Smart contracts can significantly reduce this drag on the global economy.

3.9 By 2030, smart contract networks will generate $450 billion in service fees

Smart contracts can facilitate the creation, ownership, and management of on-chain assets at a cost far lower than traditional finance. If tokenized assets migrate to blockchain infrastructure at a speed similar to that of Internet adoption, and the service fee rate associated with DeFi is one-third of that of traditional financial services, then smart contracts could generate more than $450 billion in service fees per year and create more than $5 trillion in market value, growing at a compound annual growth rate of 78% and 32% respectively by 2030.

Fourth, digital wallets - eliminating traditional financial intermediaries

As ARK mentioned in its 2023 research report, public blockchains can transform existing systems at three levels: currency, finance, and the Internet. One of the solutions is smart contracts/DeFi. So who will carry these tokenized assets on the public blockchain? Digital wallets must be mentioned.

Interestingly, the digital wallets in the ARK research report are not equivalent to the crypto wallets based on the public blockchain, although some of the growth points after the improvements in the digital wallets mentioned below can be fully achieved through the Crypto/Blockchain Payment method.

From the perspective of ARK, digital wallets use the Blockchain method to transform the traditional payment system (whether internal or external), thereby achieving cost reduction and efficiency improvement (closed-loop payment ecology), and combined with the huge consumer/merchant dividends that digital wallets have accumulated before, so that the value is reflected on the main company of the digital wallet.

4.1 Overview of the Current Status of Digital Wallets

Digital wallets have attracted billions of consumers and millions of merchants, and currently have 3.2 billion users, covering 40% of the world's population. As consumers and merchants gradually adopt digital wallets, the usage rate of traditional checking accounts, credit cards, debit cards and direct merchant accounts will decline.

Digital wallets can fundamentally change the nature of traditional payment transactions - eliminating financial intermediaries.

Digital wallets can provide a closed loop for more than 50% of payment transactions, which will save the market nearly $50 billion in costs. By 2030, the value of digital wallet companies could increase by an additional $450 billion from the current $1 trillion. ARK research shows that the number of digital wallet users will grow at an average annual rate of 8%, covering 65% of the world's population by 2030.

Vertical software applications are a set of solutions tailored to the needs of specific industries, such as Block, Shopify and Toast. The current leading vertical software applications are rapidly expanding to financial services on both the consumer and merchant ends. Through a two-way network, this software can facilitate closed-loop transactions from consumers to merchants, merchants to employees, and employees to merchants.

ARK believes that digital wallets on these applications will achieve a completely closed payment ecosystem. According to ARK's research, over the next seven years, revenues from closed-loop consumer payments, commercial banking, and employee wages/payments will grow at an annual rate of 22%-33%, from $7 billion in 2023 to $27-50 billion in 2030.

Here are the main points:

4.2 Consolidate commercial financial services and expand user consumption services

Block, Shopify, and Toast are all very attractive platforms that are likely to use digital wallets as the core of the ecosystem connecting consumers, merchants, and employees. In addition to supporting core business operations, they use digital wallets as the core, work with partner banks and fintech companies, or activate their own banking licenses, thereby eliminating the inefficient traditional financial institution services in interacting with countless merchants.

At the same time, vertical software applications can not only realize a huge back-end business network, but also build a front-end consumer network through digital wallets. By expanding both the merchant and consumer networks, vertical software applications are closing the loop and becoming the operating system for these two-sided networks.

4.3 Closed-loopPaymentEcosystems

Closed-loop payment ecosystems combine the transfer of funds within the network in three ways: from consumers to merchants, from merchants to employees, and from employees and consumers to merchants. To build these payment ecosystems, platforms must have: 1) a large and active two-sided network; 2) end-to-end visibility into merchant operations and finances; and 3) vertical industry expertise.

Transactions using digital wallet balances bypass banks and bank card networks, saving transaction fees for payment service providers, merchants, and consumers. In ARK's view, vertical software platforms with scaled consumer and merchant ecosystems can better use digital wallets to facilitate closed-loop transactions and achieve maximum benefits.

In 2022, Block paid about 60% of customer transaction fees to third parties for exchange, evaluation, processing, and bank settlement fees. If Block's front-end consumer application Cash App enables users to use their balances to trade with Block merchants, Block's net fee rate could more than double.

Closed-loop payment ecosystems are commonplace in mainland China, eliminating the intermediary role of third parties and saving nearly $50 billion in costs for digital wallet platforms, consumers and/or merchants outside mainland China. By 2030, the total enterprise value of digital wallet platforms may increase by $450 billion.

In addition, in the 2024 report, ARK specifically added financial services for merchants and salary/payment of merchant employees to the closed-loop payment ecosystem.

According to ARK's research, the core revenues of Block Square, Shopify and Toast will grow at an annual rate of 22% over the next seven years, from $7 billion in 2023 to $27 billion in 2030. By 2030, closed-loop payment businesses such as consumer payments, merchant financial services and employee wages/payments will generate an additional $23 billion in revenue, increasing the annual revenue growth rate from 22% to 33%.

Five, in conclusion

Although the public blockchain industry will not have an "iPhone" moment like AI, its impact on transforming traditional architectures (especially traditional financial architectures) will be profound, although this is a long-term path of change.

This path will start with financial payments, and the most direct, or most capable of value capture, is payment companies.

From the perspective of Wall Street funds, digital wallet companies that currently have huge consumers/merchants on both ends, after combining the capabilities of crypto/blockchain payment, can bring huge value growth to the company, whether through stablecoins or internal settlement networks to transform the traditional payment system, which will be reflected in the company's stock price.

This is the most direct way for Wall Street funds to capture value, and it is also the path for crypto to achieve mass adoption with the help of the off-chain world. This can be seen from Paypal's strategy of launching on Solana after launching stablecoins.