Cryptoassets: the source of value
We all live in a world we believe is out there. And while there is little doubt that cryptoassets constitute a new asset class, people often find it hard to define the newcomer. Some of us, like Warren Buffett, have been living in this world for a very long time. And the more you live by a wisdom, the more you believe in it. It’s believed that the asset should:
- ether have institutional backing (preferably that of a government)
- or have a use value of its own (commodity)
- or represent future cash flows.
The wisdom doesn’t hold, the investment professionals refuse to accept the new reality.
This is only understandable: as an investment class, cryptoassets contradict every word in the book. They don’t have any authority backing them — and don’t need to due to the nature of the blockchain technology. Neither do they have any internal use value or offer (at least for now) any future cash flows. All they promise is future demand from investors and users. In short, they belong to a demand driven asset class.
The irony of the situation is that there is nothing new about it. Gold as an investment asset started out in an exactly the same way. For many years, investment professionals ignored the fact that the price of gold had nothing to do with its production or shortage or intrinsic use value. It is almost solely demand driven. I guess the black swan is not as unheard of as many industry incumbents suggest…
But what if gold is the only exception? What if the black swan does happen once and the rest of the swans are white and white only? Well, if you really want that to be true, your business model probably depends on discarding cryptoassets as some sort of a mirage. You can certainly keep convincing yourself that your perception is correct. For some time. It may even feel like a reality when the cryptomarket goes through its down periods. But when it starts gaining momentum, the doubts again start crippling into the incumbent mind. Because there is no reason why a great number of people believing in and contributing to a certain technology cannot overwrite the rules of the game. Take Wikipedia for a very recent example.
Let’s take Uber for another example. Why is its equity worth anything? The company is losing billions of dollars, has negative unit economics, but its value continues to grow. Could it be because it’s the leader in its field and people believe in the business model? Not quite. Those who invest in the company think that other people believe in the business model. Uber investors are convinced, and perhaps rightly so, that they won’t be the last people investing. Uber’s equity value source is the same as that of gold — it is demand-driven.
People like Buffett come from a different world — a world where everything is supply-driven. The demand is fixed or pre-determined by DCF (discounted cash flow). The balance of abundance and shortage of an asset determines the price. In the world of technology, however, there is a new economic phenomenon called demand-side increasing returns. It is powered by two major forces: unit economics that exponentially increases with time (think Moore’s Law) and the networking effect (think Facebook). Both forces make the demand the major — and oftentimes the sole — factor determining a company’s value. Venture capitalists have known this law for decades. Guys from Wall Street have largely ignored the new economy. Now it’s knocking on their very doors.
What Moore’s Law and networking effect did to many consumer industries — from media to retail — blockchain does to finance. Much like media giants in the late 90s — early 2000s, the leaders of today’s investment industry go through five stages of accepting the new reality.
First stage is denial. It’s instrumental to be ignorant. For some time. Then comes the stage of anger. There was no month last year in which Jamie Dimon, GP Morgan’s CEO and the global leader of investment banking, was not publicly expressing his anger towards Bitcoin. And understandably so — the cryptocurrency is threatening the very world Jamie represents. The third stage is bargaining. Many people are clearly at this stage when they are trying to separate blockchain and cryptocurrency — to find the world where blockchain technology is prospering but cryptocurrencies fail. The fourth stage is depressing. For many investment professionals, this stage will come in the next five years — along with the disruption of their business and investing models. But then comes the fifth and the last stage — acceptance. It will be taking place in the new, very powerful financial system. It’s going to be the world of new technological horizons in the investment industry and ultimate financial freedom for participating businesses.
The described process happens in every industry being disrupted. The whole movement — from initial denial stage to wide acceptance — takes years and results in the classic S-curve they teach in business schools. One thing all global technology-driven innovations have in common: those who go through the five stages quickly enough find themselves in the early parts of the curve and reap the rewards.
