Insights From Within The Wild Ride Of Investing In Digital Assets
I’ve kept quiet with my head down over the past couple of years through the ups and downs (mostly downs….for now) of the cryptocurrency market as I purposely didn’t want to engage in the daily shenanigans that often take place in the crypto community. I, instead, focused my time on building a battle-tested digital asset investment fund to match my core convictions in this new market, in the technology and in those entrepreneurs I’ve met in this space who are hands down some of the brightest and most fearless individuals I’ve ever had the good fortune of meeting.
These entrepreneurs have put themselves purposely in harm’s way to build out the infrastructure necessary to foster mass adoption of blockchain technology as well as to bring about institutional and governmental acceptance of digital assets as a new, legitimate asset class. Going against the established order is by no means easy. It’s often fraught with difficulty, never ending head winds, uphill battles, extreme turbulence, at times utter terror and for the most part just a continual daily grind until you hold out long enough to see yourself evolve from a minority to the majority and the consensus get behind your belief system which often times then equates to your business becoming a success.
With a mountain of FUD and disbelief circulating around in the crypto space as Bitcoin’s price pushes down to nearly 50% off its all time highs this year, I thought it useful to dispel some wisdom I’ve picked up over the years having been an active investor in this space since 2014. There were times in 2014 and 2015 similar to now where Bitcoin stuck to the laws of gravity and I saw significant drops in value within a relatively short period of time. It was in those moments that I needed someone to give me a bit of perspective and point out the long game. Those of you who have been in this space through the multiple bear and bull cycles most likely have the proper perspective but those who haven’t might appreciate a bit of a macro view.
These are a few things I’ve learned as an investor in this space to focus on during times of doubt, frustration and disbelief:
1. When in doubt, pull back and look at the big picture. Keep your eyes on the long term macro view.
Many are already familiar with the above chart depicting Bitcoin’s price in relation to the stock-to-flow chart and as you can see, Bitcoin’s price so far has followed the stock-to-flow model quite well, albeit exhibiting extreme fluctuations along the way. This model is typically utilized to price scarce resources and many of us, including myself, look at Bitcoin as a scarce digital commodity. The fact that Bitcoin has followed this chart rather well offers support for this narrative albeit still theoretical at this point.
Unless you are an extremely good day trader and have the clairvoyant ability to read charts you shouldn’t try to time the short term fluctuations of Bitcoin’s price as much as focus on the long term view and capture Bitcoin price appreciation from each of the above reflected halving events. Historically, the reduction in Bitcoin’s rewards has created upward pressure on the price which in the past has led to new bull cycles. The herd mentality takes over and everyone chases up the price of Bitcoin until the price goes parabolic at which point we see a “bubble” pop and the price corrects back down over a period of time (as has happened in 2011, 2014 and 2018).
Based off historical market cycles, it’s my belief that adoption occurs in a series of micro-bubbles that bring new users, mostly driven by greed, into these networks. Rally cycles come about where the price goes up exponentially and ultimately this becomes an unsustainable trend. Then the bubble pops and the market dramatically corrects down over an extended period of time. Most retail investors are negatively impacted by these events, losing interest in the market and then leave the space. But there are always some users who fall in love with the technology, volatility, community or endless opportunity in this space and decide to stay. This is evidenced by eight consecutive years of Bitcoin printing higher lows (2015 was an exception). The number of users in the network continues to grow year, after year, after year.
2. Focus on the infrastructure, not short term price fluctuations.
Especially in months like this one (November), where Bitcoin has dropped materially, it’s important to focus on the fundamentals and not price. Traders who are much more talented than us are having the time of their lives on platforms such as CME, Bitmex and Binance because they can leverage up 100X and short/long this new, relatively small asset class, thus exploiting short term volatility. Pay no attention. You’re in it for the long game. If you play the long game, these short term price fluctuations are meaningless. On October 25th Bitcoin’s price climbed approximately 40% in a single day. Pay no attention. Bitcoin’s price then wiped out all those gains in the following month. Pay no attention. Kick back, eat a bag of popcorn and enjoy the entertainment with your front row seat to the show.
Instead, stay focused on the long term goal of participating in the eventual acceptance of this new asset class and its incorporation into most people’s investment portfolios around the world. Rather than obsessing over current prices, which induce short term anxiety bouts and can make you want to pop xanax like they are pez, focus on the infrastructure which is being built out each day. Price will eventually catch up to the level of infrastructure being built as that infrastructure will bring in new users and those users will ultimately increase the value of these networks.
Unfortunately this new asset class is often times greatly misunderstood. As a result, price tends to be a poor and often times incorrect indicator of value. Given the wild vacillations in price we’ve seen over the past decade, it’s clear that price continues to be a poor indicator of actual value, especially when we’re in a proper bull market — and the same holds true when we are in a bear market. The truth lies somewhere in between and until this asset class matures into adulthood, most people are going to incorrectly value these global networks and unfortunately become emotionally attached to the value of their investments in this space which can be a gut wrenching experience.
The one guarantee you can be assured of is a toddler will eventually grow up to be an adult. The same holds true for Bitcoin and several other key digital currencies. Taking a long term view ensures you won’t improperly try to value these assets until they become full-fledged adults and end up making a significant contribution to society. In this particular instance, these toddlers are going to grow up to change the very fabric of how our society operates and remove borders to where we truly have an interconnected global economy.
What infrastructure should you focus on? The list of headlines below might be a good place to start:
- CME supporting Bitcoin Futures (launching options in January)
- Intercontinental Exchange (parent company of the New York Stock Exchange) launched a Bitcoin Futures Exchange called Bakkt in September (rolling out Bitcoin options next month)
- Swiss SIX Exchange seems to launch a new Crypto ETP every few months
- The President of China (Xi Jinping) announced the country’s interest in becoming a global leader in blockchain technology and confirmed plans to launch a China Central Bank digital currency
- Fidelity launched Bitcoin custody and trading this year
- eToro, TD Ameritrade, Abra, Robinhood, Square, SoFi and many others offering Bitcoin trading solutions
- Yahoo Finance now tracks cryptocurrencies prices on their website
- Andreessen Horowitz (one of Silicon Valley’s VC Darlings) revamped its entire organization to be able to participate in digital asset investment and recently launched a Crypto startup school that will kick off in February of next year
- Facebook hearings in front of Congress regarding the launch of its digital stable currency token Libra
- Increasing involvement by the US Government and SEC to regulate this space and create new policies around how it operates
- More and more institutions trying to get a Bitcoin ETF approved (one day this will happen)
- Ever-increasing number of digital asset exchanges operating around the world (estimated to be over 400)
- Binance (one of the top retail digital asset exchanges in the world) working towards a goal of creating onramps for the 180 fiat currencies recognized as legal tender by the United Nations
- Samsung integrating digital wallets into their phones
- New York State Department of Financial Services creating a new division to oversee the licensing of cryptocurrencies
- States like Wyoming passing new legislation around digital assets such as a bill to exempt Utility Tokens from securities laws
- The London Stock Exchange conducting its first security token offering on a blockchain
- Gibraltar Stock Exchange allowing the listings of tokenized securities
- Nasdaq, Bloomberg and Reuters enabling crypto indices on their platforms
The list goes on and on and supports the narrative that this little toddler is starting to grow up fast. Market cap and price will eventually follow the same growth trajectory.
3. Take solace in the fact that this technology works, albeit it’s in its early iterations but it will improve and eventually become a category killer within multiple categories (major disruption to banking, domestic and cross border payments, asset management, monetary policy, supply chain management, digital identification, cloud computing, accounting, etc).
Before I launched our digital asset investment Fund, I ran a credit card payments company. I was fortunate in that I saw first hand how inefficient, slow and expensive today’s credit card payments are. Some might not realize that there are many different intermediaries which facilitate credit card transactions and all of which create friction and charge the merchant a fee for every transaction. In the middle of each credit card transaction, you have a card issuing bank, acquiring bank, processor, card brand (Visa, MasterCard, Amex, etc.) and typically an ISO. If it’s an e-commerce transaction you can add to this list of intermediaries, a payment gateway and a shopping cart provider.
All of these organizations create friction in each transaction and charge a fee which can be anywhere from approximately 1.84% to as high as 7%, 8% or even 9% for some high risk merchants. If you utilize your credit card overseas, you’ll also be assessed additional fees (cross border fees, FX fees, etc.). Depending on the merchant’s service agreement with their credit card provider the merchant might not get funds settled into their bank account for days.
Conversely, if you utilize a fast settling cryptocurrency such as Dash or XRP, you remove all of the above mentioned intermediaries and thus, remove their associated transaction fees and reduce settlement times to seconds not days. Game changer. Fundamentally at blockchain’s core, this technology will ultimately be leveraged to begin to remove trusted third party intermediaries which have acted as rent seekers for decades until now.
We’ve estimated that the global value proposition of all the trusted third party intermediaries is approximately $400 Trillion dollars. Thus, if this technology successfully displaced a mere 1% of global trusted third party intermediaries we’d be looking at a market cap in this space of $4 Trillion dollars which would be approximately 20 times higher than it stands today (November 22, 2019). That’s just 1%. Let that sink in for a moment. Fortunately for those committed to this space, we’re going to see global adoption of this technology take place over time which will be significantly more than a mere 1%.
How fast will this displacement take place? The answer is much faster than it took the internet to gain global adoption. In order for the internet economy to fully mature there was a tremendous amount of infrastructure which needed to be built out. We had to lay the fiber optic cables, launch satellites, build home computers and create cell phone technology. There was a tremendous amount of hardware which had to be deployed in order to facilitate the growth of the internet economy. Fortunately, that infrastructure is in place today to where we mostly just need to build the software to power these Blockchains. Therefore, this space should grow at a much more rapid pace than that of the internet.
As early investors in digital assets it’s important to keep some perspective on this space and have an understanding of where we are in the evolution of this new technology and of where we are headed in order to effectively navigate the volatility which comes from investing in a new asset class. I hope sharing some of my views will help assuage some angst during these times of intense volatility and set you up for long term success.
Disclaimer: The views reflected in this article do not reflect investment advice, nor should be construed as investment advice. Certain information contained in this article constitute “forward-looking statements”, which can be identified by the use of forward-looking terminology such as “may”, “will”, “should”, or “believe” or the negatives thereof or other variations thereon or comparable terminology. Due to various risks and uncertainties, actual events may differ materially from those reflected or contemplated in such forward-looking statements and no undue reliance should be placed on these forward-looking statements, nor should the inclusion of these statements be regarded as the Investment Manager’s representation that the Fund will achieve any strategy, objectives or other plans. The information contained in the article is believed to be reliable and has been obtained from sources believed to be reliable, but no representation or warranty is made, expressed, or implied with respect to the fairness, correctness, accuracy, reasonableness, or completeness of such information.