Beware of the Crypto Bull. The blinders can be formidable without a solid handle on present and future macroeconomic conditions. (image source: CoinSpectator)

Getting Real About Crypto Investing

Looking beyond the current hype cycles, it’s time more investors were exposed to real companies building real products that solve real problems in the real world. Our economic future depends on it.

Gunther Sonnenfeld
May 20, 2018 · 20 min read

Many of you reading this title and subheader might be ‘crypto rich’ and thinking: “What the hell is this guy talking about?”

We can all agree that crypto trading and investing in underlying blockchain or DLT structures are related but not nearly the same things from an investment standpoint. If ICOs have taught us anything, it’s that hype and reality are doing a strange dance, perhaps even more bizarre than what we witnessed during the Web 1.0 days or the early days of social media.

In my firm’s case, we talk to a range of high-net worth and high networked investors daily — funds, family offices, large private players, what have you — who have very fundamental questions about the crypto space and seriously question where things are headed from a capitalization, sustained value and asset perspective.

Many of these same individuals and groups are trading cryptos and are making lots of money… and they’re also not believing the hype around the longer term prospects.

Seem market familiar?

Truth is, whether we’re talking about blockchains, distributed ledger technologies or cryptocurrencies, we are still in the very nascent stages of this phenomenon called ‘crypto’. This is a good thing, as we’ll explore in cursory steps here.

Let’s look at all of this through the lens of assets, and the demand around them.

Revisiting the Theory of Asset Demand

There are four main predicates for this demand in financial assets:

  • an increase in wealth
  • an increase in RETe ­
  • a decrease in riskiness
  • an increase in liquidity­

There are two types of financial assets — necessity assets such as cash and checking accounts and luxury assets such as stocks and bonds.

According to the Theory of Asset Demand, the government declares tax exemptions on bond returns. This results in an increase in quantity, an increase in the price of the bond and a decrease in the interest rate of the bonds. As we’ll see in short order, current economic preconditions along with crypto adoption are turning these dynamics on their head. (source: Prateek Agarwal, Intelligent Economist)

As the graphic suggests, price and quantity mechanics are correlated to economic fluctuations, changes in expected inflation, and tax cuts. All of it implies that investment opportunities would increase in a boom or a market upcycle. Depending on where you sit in the market landscape, booms or upcycles are, of course, relative.

What’s interesting about this is the fact that both necessity and luxury asset classes are being significantly disrupted by blockchain and distributed ledger technologies. There’s also quite an analog to this: An institution like Bank of America holds at least 43 known blockchain patents.

BofA is not alone — dozens upon dozens of companies spread across industries such as insurance, healthcare, retail, logistics, and of course banking and finance, have joined the bandwagon. They’ve drastically cut down their costs to capital, while creating significant new operational efficiencies.

What this tells us is that frictionless payment, optimized supply chain and alternative investment systems are becoming standardized. But at what cost to economic growth?

You see, there is a major caveat: Their efficacy and sustained value are predicated on another mitigating factor, which is the availability of vital resources that people need to live and work better. Reality is that nearly half of all U.S. families are struggling just to pay rent and buy food. This does not bode well for economic stability. Or shall we say that economic instability does not bode well for a large swath of the population.

More on that in a moment.

So, it seems that what we’ve come to understand as necessity assets and luxury assets are being replaced or seriously augmented by crypto assets.

Crypto assets can be defined as units of value that work exclusively on the Internet by using a network of computers that lend their processing power to verify and register all the transactions made. In return for their work, computers are rewarded with a payment in the form of tokens. The system that allows for this to happen is known as the blockchain or a distributed ledger technology (they are related but not the same things), and it is the fundamental force behind any crypto asset.

And again, at what cost to economic growth?

The Implications of Asset Demand with Crypto

With expected returns, the Demand for Assets is relative to RETe (real returns expected after taxes) on other assets. A higher RETe results in an increase in demand for assets, and therefore demand for other assets goes down.

Relative risk simply means that when the risk of an asset goes up, demand for one asset goes down, thus increasing demand for other assets.

Relative liquidity means that capital can move into assets or asset classes that are increasing in value, thus putting limitations on other assets or asset classes seeking capital from similar or related sources. So, if liquidity goes up, then demand goes up for that asset, thus demand falls for the other assets.

What’s interesting here is the idea that liquidity, risk and return are inversely proportional; in reality, they aren’t necessarily.

One of the great monetary mechanisms of cryptocurrencies, particularly altcoins, is that network scarcity holds perceived value somewhat in check.

Sure, there can be mining and consensus issues, as well as hacking across wallets, but the trustless party aspect solves for things like double spend, and fiat phenomena like quantitative easing are removed. To boot, it is often the case that when a crypto like Bitcoin or Ethereum rallies, so do many of the altcoins in the market, as do the altcoins in a particular ecosystem.

This seems to defy the mechanics of relative risk and relative liquidity, and throws a curious wrench in expected real returns. This also defies most scenarios with fiat currency trading in that currency values are inversely proportional. Capping all this off is that currently, stock and bond performance are not inversely proportional, contrary to what we’ve seen historically.

The great challenge for cryptos in this sense is that they are still tethered to fiat — whether pundits want to accept this or not — which means that asset value is still hyperspeculative. (Let’s ignore, for the moment, that fiat is also digital money.)

Relevant Macroeconomics

  1. Fiat is in aggregate decline;
  2. We are experiencing Net Energy Decline;
  3. Bonds have been experiencing inverse yields.

For those of you who are unfamiliar with Net Energy Decline: Net energy can be defined as the energy left over after subtracting the energy used to attain energy — i.e. the energy used during the process of extraction, harvesting and transportation of energy. Net energy is critical because it alone powers the non-energy sectors of the global economy. (source: Jonathan Rutherford, Insurge Intelligence)

What this means, in a nutshell, is that we actually have an oversupply problem — there is enough oil in North America alone to last us 200–300 years. When supply is not commensurate with demand (which it isn’t), then we have price drops and subsequent drops in overall value.

As we all know, oil contracts back fiat, like the USD. These contracts are speculative and essentially rigged via OPEC standards. As of today (March 20, 2018), price-per-barrel for crude oil is hovering around $80 and could spike even higher, but this is temporary given that the physical markets in which oil and gas are sold have a storage problem (oversupply). This means that these same speculative contracts will be unable to sustain the value of crude, thereby affecting the value of the USD and other western fiats.

So, the implications of the above trifecta are enormous.

A declining or struggling dollar implies that the U.S. no longer has global reserve status, and that western economies do not enjoy de facto standards in trade. The massive sell-offs in U.S. treasuries by countries like China are perhaps the strongest signal of this. And given that the U.S. and other western countries have imposed trade embargos with powerhouses like China, means that we must create new, fungible value in the middle markets — the places where productivity is the greatest and where export value is revitalized.

Another factor is labor force participation, a key element in the stabilization and growth of any economy. While government figures tout the lowest unemployment rates since 2000, reality is that more companies in aggregate are laying off workers, in part due to automation. As well, the more important figure of underemployment (a metric which can be referred to in what is coined as the ‘gig economy’) is misrepresented, which is closer to 23% in the U.S., and youth underemployment is as a high as 38% in the U.S., and over 50% in some European countries.

When people aren’t working, they’re not producing. When they’re not producing, tax revenues aren’t being generated.

Remember RETe?

A basic marker for economic health is deficit spending against tax receipts. We have a serious issue or gap in terms of real, after tax expected return, simply because fewer people are working and producing fewer assets which means we have declining tax revenues.

Hence, the reason why Democrats want to tax the rich, Republicans want to shelter tax havens for the rich, many Libertarians want flat taxes, and few seem to realize that tax revenues from durable assets — land, energy, water, precious metals, etc. — are essential to the bigger economic picture.

The Importance of Real Utility & Infrastructure

In other words, when we produce things with real utility value — things people actually need — the people managing those resources have jobs.

This also means that those same utilities must be maintained, necessitating the replenishment or revitalization of said resources. Utility infrastructures, such as next generation microgrid systems or regenerative agriculture systems, therefore, offer up the most promise in terms of regenerating investment value and returns.

A macroeconomic case for alternative asset + infrastructural expansion from $8 trillion in current market capitalization, to $25 trillion by 2023. (source: Novena Capital)

The Trump administration has made its case for infrastructural investments, allegedly earmarking billions to do so, but that has mostly centered around roads, bridges and schools. In addition to these necessary elements, we also really need utility development so that we are regenerating value beyond debt financing. Consider that a majority of civic infrastructure builds — those same roads, bridges and schools — have defaulted substantially on their debt over the last 10–15 years. The implosion of retail inventory is also a strong indicator of asset corrosion at the hands of predatory debt structures.

So with asset demand, it is imperative that we realize we can’t just create cryptoassets that aren’t tied to real utilities, simply because if we don’t, nothing tangible backs or represents their value, which means that crypto markets will remain hyperspeculative.

Speculation does not sustain economies, productivity does. And some wealthy investors may not care about productivity, but if we’re not producing new assets, there’s not much more to invest in for the short- or long-term.

Case in point: Thresholds have nearly been reached in almost every traditional asset class — pensions are seeing low or negative returns, dividend conversions are low, and the highest yields are being seen in areas like ETFs, where volatility can be somewhat contained, arbitraged and algorized. (Kinda like how many cryptocurrencies are currently traded.)

To boot, we have already entered auto loan and home loan bubbles in the middle markets (wealthier folks and asset-leveraged people have a relatively easier time getting loans).

Again, this cannot be sustained.

Alternative Assets as New Value Creation

Alternative assets can be defined as assets that are not one of the conventional investment types, such as stocks, bonds and cash. Alternative investments include private equity, hedge funds, managed futures, real estate, commodities (to include renewable energy) and derivatives contracts.

As we invest in hyperspeculative vehicles (like most cryptos), we arguably move further away from sustained value creation. Let’s emphasize the descriptor sustained, which is not to imply that value isn’t or can’t be created through the current factors involving crypto tokenization and crypto trading, rather that it likely can’t be sustained under the (macro)economic conditions identified here.

Monetary diversity and freedom for all… That is, if we can structure the right investment vehicles which can sustain their asset value. (source: Novena Capital)

A great example of this is Ether (ETH).

By industry standards, Ethereum or Ethereum Classic is not considered to be a hyperspeculative vehicle and for good reason — the technology is revolutionary, widely adopted through its network, and brilliantly varied in its applications. However, Ether itself is a unit of measure based on gas, and of course, how gas is priced.

Remember Net Energy Decline?

There are three critical scenarios to consider, all of which lead us to question the notions of stored value and sustained asset value:

  1. The U.S. dollar is halved while oil contracts expand in North America and overseas, which presents us with a classic oversupply problem (Net Energy Decline). In this scenario, Ether, along with the dollar, drops quite a lot in value.
  2. The U.S. dollar is (continues to be) propped up by speculative overseas oil contracts, while interest rates spike and more quantitative easing is established. In this scenario, gas prices spike dramatically, affecting consumption and ongoing value (another outfall of Net Energy Decline). This has extreme pricing effects on Ether, with drastic swings, making it tougher for the average person to invest or exchange its stored value with other people.
  3. The dollar flatlines along with all energy subsidies, inducing price fixes perceived as ‘stabilization’, making it difficult for Ether to rise or fall in value.

These are just three scenarios for the purposes of our exploration. Reality is, we don’t know which of these these scenarios will play out exactly or how, but we do know that Ether (along with other altcoins) is not properly collateralized, which is more or less the same problem fiat faces.

If we follow the price and quantity correlations of asset demand to collateralization, we can factor in network participation, consensus and various in-chain or interchain variations via forking, sharding or verification. However, fungibility remains an open question, and it is not clear as to what perceived crypto-utility actually does to improve conditions for the actors working within a market.

Another way to look at collateralization is by revisiting stores of value. Pundits often talk about intrinsic stores of value with cryptos like Bitcoin since two or more people can transact with one another freely at any time as a medium of exchange. The problem with this is not so much that you don’t need a bank or personal identity to do so, but that:

  • There is very little if any actual market data associated with the transaction or exchange itself (secure or not)
  • Reputational attributes are not factored in, keeping market dynamics highly speculative (yes, this is primarily the intent with a ‘trustless’ system, but also not the point)
  • No real additional or sustained market value is created beyond the transaction or exchange in terms of fungibility

Tokenization largely promises to provide price stabilization and quantity control through ‘direct exchanges of value’, but this still does not account for massive fluctuations in perceived stores of value when a market swings, investors pump-and-dump, or when trading exchanges fail to pay out.

As improvements in all these areas of crypto development are happening at an accelerated clip, very little has been addressed in regard to collateralization, and it is not entirely clear if that is due to lofty monetary or economic philosophy, mathematical hubris, programming bias, or a combination of all three.

To be clear, this is not at all an indictment of Bitcoin or Ether or many other altcoins. Bitcoin and Ether in particular are incredible innovations, and are, without question, revolutionizing business and civic systems.

It can be convenient to overlook the fundamentals or assume they are inherent in crypto programming and mathematical protocols, as it is with any radical set of technological innovations. In this moment, you can just as easily assert that regular money or currency (fiat) has as much if not more value than crypto — stored or exchanged — if you consider it is digitized (ex: PayPal et al), it has data associated with it (any transaction or exchange), and people can create more value as a result of them being seen and held accountable (ex: eBay).

Yet, we all have some idea of the limitations of ‘regular money’ such as the problems we continue to face with security and privacy, not to mention the macroeconomic factors that have been laid out here.

Trent Eady also clearly lays out the velocity challenge Ethereum has as an investment, using Chris Burniske’s and Jack Tatar’s equation of exchange.

As for pricing controls, economists have recently issued a perspective on Bitcoin’s ‘equilibrium price’, but none of it addresses these same economic preconditions, nor does it factor in global debt overload.

Hence why the case is being made here for the creation of viable alternative asset classes.

Alternative Asset Classes are a Huge Market Opportunity

With crypto, the formation of micromarkets is a great representation of how alternative assets are developing on their own.

A new batch of ICOs, DAICOs and STOs are revealing a shift in new asset formation and collateralization through tokenization. Examples of this can be explored through exciting efforts in regenerative crypto mining from the likes of Nasty Mining, Hydrominer and Harvest.

Holo’s recent Initial Community Offering with $HOT is a great example of how new kinds of asset-backed securities can be created through smart hardware and software integrations via next generation blockchains. In this case, the crypto is backed by a socially impactful set of assets that have both commercial and civic utility.

To be really clear, this is not a case being made for ‘crypto versus fiat’.

If anything, we can consider the predominant asset class currently being developed as currency in most blockchain and DLT spaces as ‘cryptofiat’ because, well, that’s pretty much what it is if you factor in what’s been addressed earlier.

More specifically, it’s clear that blockchain and DLT innovations unlock the rapid expansion of alternative asset classes, and accelerate their value.

It’s also really important to note that there are trillions of dollars literally sitting on the sidelines between institutions and private investors that are waiting to be activated for smarter, more durable investments (read: alternative assets).

The biggest investment opportunity the world has ever seen? (source: Novena Capital)

Understanding the Relationship Between Value & Yield

  • There is an increase in expected profitability on capital investment opportunities, especially as costs to capital are cheaper while pricing is extremely elastic (meaning volatile and/or unpredictable).
  • There’s an increase in expected inflation relative to what other people expect; this is driven by monetary policy in combination with wild market overspeculation, signaled both in the crypto and equities markets.
  • There is an increasing willingness in Federal government deficits or state/local government to spend on capital projects.

There are three major factors to consider here, as they affect performance in terms of sustained value and yield.

The first is that crypto trading/investing is merging with traditional exchanges such as the NASDAQ, as is the case with the large crypto exchange Gemini. The implications of this are many, not the least of which is the fact that large amounts of institutional liquidity from the likes of Soros, the Rockefellers and the Rothschilds are moving into these ‘hybrid’ crypto exchanges. In other words, these folks are taking massive positions.

Apart from the likelihood that this signals an imminent crash in the equities markets (dividends and buybacks being leading indicators), we can also posit that there will be a ‘tipping of the scales’ so to speak in terms of cash asset ratios and liquidity ratios.

For the ‘whales’, the hyperspeculative activity will most likely be a windfall, regardless of the volatility headwinds or tail risk to various portfolios. However, for middle market investors this could be disastrous. Remember that the middle market is incredibly important for sustained, durable investments.

Family offices and large institutional funds, in particular, would be loathe not to exercise extreme caution around this, especially as they endeavor to build generational wealth.

The second factor is the flooding of the crypto markets with too many ‘currencies’, specifically tokens.

A deeper study of complementary currencies shows us that properly managed asset development and sustained monetary representation go hand-in-hand. Bernard Lietaer — co-architect of the Euro and steward of roughly 196 complementary currency projects around the world — has pointed out in many books and lectures that issuing too many currencies or monetary instruments, particularly without durable assets backing them, commodifies their market value. This makes it difficult not only to invest, but to develop local economies that have very specific socioeconomic and environmental needs.

This research supports Lietaer’s findings, and what my firm has seen with respect to tokens, stating that: “…nearly 90% of all checked tokens, which are traded on exchanges today, lost between 60–70% of their value during the first week (from the ICO price). Then, during the next 6–10 months less than 25% were able to recover.”

In other words, a ‘token economy’ cannot sustain itself without keeping scarcity and pricing measures in check.

Interestingly enough, Vitalik Buterin has recently written this post on a new issuer-backed token model for CDOs (collateralized debt obligations) which claims to avoid ‘black swan risk’.

In the case of ICOs, simple things like failing to deliver on product/project milestones are a major problem, but the bigger truth is that trading and converting tokens on exchanges has proven to be a challenge. Related to DAICOs and issuer-backed tokens, local, national and regional market actors will continue to be challenged with collateral-related issues, as economies cannot flourish unless scarcity and pricing measures reflect the actual market attributes of the people who drive asset and infrastructural development. Tracking their production and consumption behaviors are just one critical metric set.

Also keep in mind that Vitalik’s CDO model proposes that “one of the ‘issuers’ be a contract that holds ETH and has a redemption process that allows holders of a coin to claim an amount of ETH equivalent to 1 USD.”

Again, fungibility, elasticity, intrinsic ETH value and a declining dollar are all at the whim of the market preconditions we’ve explored here.

Related to production and consumption behaviors, the third factor to consider is that Federal and local government spending has also been augmented or replaced outright by various forms of privatization.

As one example, the state of Illinois is bankrupt (it literally declared bankruptcy last year) and is looking at a number of crypto options to subsidize economic development. Another example is in California, where dozens of municipalities have gone bankrupt and are being bought by private parties that are adopting similar measures not only for new asset creation, but for new forms of governance as well. At the national level, at least two dozen governments around the world are already developing their own cryptocurrencies (‘cryptofiat’). Some analysts have asserted that all western governments are technically insolvent, hence the impetus for these efforts.

As such, it is really critical that we bridge the gaps between alternative assets and crypto assets, since they need to work well with one another. In a future ‘best case scenario’ they will be properly interlinked in terms of value creation.

Here’s how both asset groups might be represented, or conjoined, in terms of ‘Alternative Asset Demand Yield’.

Whereas tax exemptions on bond returns are the former expectation, we can now consider that expected asset returns are the basis for overall demand. With real utility driving value at the center of price and quantity movement, value reflected in stabilization, realization and regeneration points to dynamics that are far more realistic in terms of their socioeconomic and socio-ecological impact. More on this will be explored in future posts and thesis material.

Now that we’ve established what alternative classes can actually represent, we can further clarify how the investment landscape is being transformed.

Why (re)Investment via Crypto is so Important

This bares repeating: Real assets are a major hedge against inflationary risk.

An even stronger position can be taken regarding renewable or regenerative assets hedging against inflationary risk.

The net-net is this: Real (physical) assets generate real value, more investment, more jobs and longer term growth. In the best of scenarios — such as the case with certain types of renewables — they regenerate value, investment, jobs and growth.

If we can accept this axiomatically, then we can apply stores of value and mediums of exchange to real, durable asset creation in far more dynamic ways.

The simple truth is that much more refined tech development is required in crypto circles to address asset transfer value (ex: ERC-721), identity value (ex: ERC-725) and (non)fungibility options (ex: ERC-20 & ERC-223) such that investments reflect the multimodal value presented earlier.

The even bigger truth is that crypto development suffers from ‘protocol dissonance’ in the sense that interchain solutions are still few and far between. ‘Proof of’ debates seem insidious, considering this vital need, especially since socio-ecological variance requires different approaches to consensus mechanisms given different contexts for applying them in the real world.

With that said, crypto is without question the determining factor in creating new alternative assets for economic revitalization.

Creating Real Impact through Crypto Investment

  • socio-ecological utility (deep social and/or environmental impact)
  • regenerative value (ways to generate repeated investment + returns)
  • ecosystemic relevance (how ventures/projects integrate seamlessly to create maximum market impact)

It is important to point out that this approach is not the same as ‘impact investing’, which basically utilizes the same capital structures under the auspices of ‘diversified investment’. Judgments aside, the fact remains that less than 3% of all impact funds worldwide are actually being allocated towards viable, active investments, which should tell you something about the size of this middle market opportunity and what isn’t being done to capitalize on it.

The rationale behind impact investing carries with it a host of conflicting assumptions about what’s good for markets, for society and for the planet, none of which we need to deconstruct here. What is important, however, is that crypto-based approaches via the blockchain, distributed ledgers and/or tokenization can help create, and are creating, a different set of market conditions based on greater transparency, expanded stakeholder investment, better data and stronger utility.

And in the best of scenarios, all of that value — in a variety of forms — can be regenerated.

A More Viable Way Forward

To emphasize, we all must come to a far better understanding of economic realities to then unlock true, polycultural economic + investment opportunities. More diverse opportunities.

These are incredibly exciting times, especially for institutional investors, private players and independent developers willing to stretch the limits of their asset offerings and their portfolios.

Thank you for reading and considering these possibilities.

This is a good discussion with Vala Afshar (Chief Digital Evangelist at Salesforce) and Ray Wang (CEO, Constellation Research) on how the blockchain enables sidelined funds in our financial markets to be reinvested into durable assets and the real economy.


Gunther Sonnenfeld is a seasoned technologist, global strategist and respected cryptoeconomist. He has had a direct hand in the development of over 50 ventures, including the world’s first Bitcoin POS platform, and is the recipient of a Forrester Groundswell Award for groundbreaking social analytics work (graph analysis) with Adobe. Gunther is slated to speak next month at the Blockchain Economic Forum on the macro- and microeconomic impacts of crypto technologies per Novena’s unique socio-ecological methodologies.

Novena Capital combines nearly three decades of capital markets + investment banking experience with sophisticated emerging technology and venture development capabilities to help companies realize the enormous potential of blockchain + DLT integrations.

You can read Novena’s three foundational theses on The Next Economy, Smart Ecologies and Beyond Crypto & The ICO here.

Gunther Sonnenfeld

Written by

Co-Founder, Novena Capital + Next Block Group ::: Executive Director, Exosphere ::: cryptoeconomist, ecologist, technologist, builder of good things