In 2010, Steven Johnson wrote a great book called 'Where Good Ideas Come From'.
One chapter in particular explained how innovation is achieved by combining currently available resources to create new use cases. Johnson calls this phenomenon 'The Adjacent Possible'. I want to highlight it because I think it's the perfect representation of how crypto markets have expanded over time, and how they might develop in the future.
Below is the analogy he uses to describe it:
"Think of a house that magically expands with each door you open. You begin in a room with four doors, each leading to a room that you haven't visited yet. Those four rooms are the adjacent possible. But once you open one of those doors and stroll into that room, three new doors appear, each leading to a brand-new room that you couldn't have reached from your original starting point. Keep opening new doors and eventually you'll have built a palace."
The Adjacent Possible
This process of step-by-step discovery is exactly how we've made progress through all of human history. In his book, Johnson provides examples of:
- How the evolution of the semi-lunate carpal bone in dinosaurs enabled new wrist movements and eventually led to dinosaur flight
- How the evolution of opposable thumbs in humans led to the creation of fine tools and weapons
- How the invention of the baby incubator was sparked by a Parisian scientist who saw the effects incubators had on chicken eggs
- How the first signs of life on earth developed over millions of years from new molecular combinations
The big idea here is that innovation happens through a "gradual and relentless probing of the adjacent possible, with each new innovation opening up new paths to explore".
Innovation doesn't come from some genius insight that catapults the world twenty years into the future. As Isaac Newton said, "If I have seen further it is by standing on the shoulders of giants."
The same principle of the adjacent possible holds true in crypto markets:
- Bitcoin was the product of dozens of failed electronic cash experiments that came before it
- Ethereum was heavily influenced by Bitcoin's success and those same early digital cash experiments
- The lightning network relies on both the concept of onion routing (first popularized in the 1990s) and Bitcoin's decentralized monetary system to function
- Decentralized finance relies on Ethereum's ERC-20 token standard and smart contract programming first developed in the 1990s
There is no crypto innovation that just sprung up out of nowhere. The entire $1.5 trillion industry is the product of relentless exploration of the adjacent possible.
Beyond the technological innovations, the adjacent possible is also a great framework for understanding the nature of crypto prices.
For long stretches of time crypto markets can appear boring, and then rip up in a matter of days or weeks as a new door is opened into the adjacent possible. Just look at some of the largest rallies in crypto history:
- The ERC-20 token standard opened the door for anyone to create their own token, leading to the proliferation of altcoins and the 2017 ICO boom.
- Michael Saylor's decision to adopt Bitcoin as a treasury reserve asset opened the door for corporations to put Bitcoin on their balance sheet. This catalyzed Bitcoin's latest rally from $10,000 to over $60,000.
- The ERC-721 token standard opened the door for anyone to mint their own NFTs, leading to the 2021 NFT boom.
This is also how I suspect future rallies will unfold. Someone will open a door into the adjacent possible, and a flood of capital will follow them into the newly discovered room. Below are some of the 'doors' that I think are most likely to be opened in the near future:
- A Bitcoin ETF gets approved in the US, cementing Bitcoin as an institutional-grade asset
- Businesses integrate Bitcoin's lightning network for zero fee international transfers
- Layer 2 solutions on Ethereum dramatically lower gas fees, and allow retail investors to participate in DeFi
- Stablecoins gain significant cross-border payment adoption
- A central bank buys Bitcoin to hold on their balance sheet
- Consumer inflation continues rising in major financial markets, pushing people to move their savings to the Bitcoin network
- DAOs & DeFi projects get regulatory clarity in major financial markets
- A Fortune 500 consumer bank begins to custody digital assets on behalf of their clients
The most exciting thing about innovation in crypto is that entrepreneurs have now explored so many adjacent doors that the industry is no longer dependent on a single one to unlock new capital inflows.
There are dozens of potential 'doors' just waiting to be opened. All it takes is for one innovation to find product-market fit for the crypto industry to roar back to life and suck up the next trillion dollars of capital.
My Writing This Week
This week I examined how stock buybacks differ from the token buyback programs currently offered by projects like Maker, Yearn, Binance, and Ethereum (after EIP-1559 is implemented).
Subscriptions are $5/month for the rest of the day, and will be raised this weekend.