A Primer For Those Who Think Bitcoin Passed Them By.
If you are new and think you missed, read on. You’re in luck.
Like many curious nerds before me, I fell hard for blockchain.
I’m passionate and the passion is justified. This technology will change many things. But real change takes real time. We have learned this again and again with new technologies. Those who remember the lesson will be the ones who profit this time.
So let’s do our very best to objectively evaluate what I will broadly call the “crypto-economy” in terms of its readiness for investment.
First: What are we really dealing with?
A quick primer if you’re new to this.
There are many things going on in the crypto-economy. It all has one thing in common: Using blockchain based software to improve various business processes. Some are doing it on private networks, some on the public Internet. Bitcoin is software designed as a digital currency. It is one application of blockchain.
As you likely know, a blockchain provides embedded security so that any two users can trust one another without a third party. No Visa nor Paypal needed for online payments. A blockchain further can allow machines to conduct commerce with each other. The two machines can agree that if certain conditions are met, value will be exchanged electronically. No human required. A concept called a “smart contract.”
The public Internet side is where the action is. Any blockchain running on the public Internet must have its own unique digital “tokens”. These are encrypted messages that follow specific rules.
Some Tokens are designed for use as currencies in trade (bitcoin being the largest of many.) If you have a valid token, you can pass it to someone else. If you both decide it has value well, then, there you go, I guess you can use it in commerce.
There are also digital tokens designed for use to enable a private network service, like data storage or media sharing. Imagine a network like YouTube but not supported by ads. Instead, you need to submit a special digital token to post or view content. The idea is that, once the service is widely used, it’s token will have value. Only if you possess it’s token can you post your content to “CryptoTube” or whatever you want to call it.
So lots of new companies are creating and selling their digital tokens. The underlying premise being: Get them early, they won’t be cheap when things take off. We’re going to make a really cool application that everyone will want. You’ll need that token or you won’t be able to use our awesome new application (which doesn’t exist yet).
These are Initial Coin Offerings (ICOs). The ICO “projects” (they are usually not calling themselves companies) create and sell little, unique chunks of data which their software recognizes. If you have one, their software will recognize it and allow you to use their service for whatever it is they offer.
This is what a typical token looks like:
Means nothing to us, but software on its home blockchain recognizes it as valid. Could be a bitcoin, could be a ticket to watch a movie on CryptoTube.
OK, Got it. So how do we know what these tokens are worth?
Ah, very good. We don’t. That’s the rub.
It was big news a couple months back when Jamie Dimon (a successful Wall Street Banker and chief of JP Morgan) called bitcoin a fraud. Dimon is not alone. You won’t find much in the way of disciplined investors recommending a position in bitcoin.
Of course, the bitcoin and cryptocurrency faithful hear heresy in such sentiments. That’s the wrong reaction. It’s hard to hear rich establishment types put down revolutionary technology. Nothing gets under the skin of revolutionaries more. But this is no place for emotion.
In matters of money, it’s important to stay rational and objective. Those who can, do well in the long term. Those who cannot constantly ride rollercoasters.
Think of cryptocurrencies as emerging technology (they are) and the crypto-economy as an emerging new way to do business (it is). I doubt Jamie Dimon would disagree with this. The key word is ‘emerging’.
Now, let’s break down the opportunity the same way we would with any emerging tech.
Investors aren’t haters, they are investors. They have their own rules which generally work.
In the early days of something new it’s often easy to see that it will eventually be big. Common wisdom in investing says, “Any fool can predict a trend, it’s timing that’s the trick.”
Seasoned investors know that many forces will play on an immature new technology as it grows. Things get hard and prices go down. Euphoria burns off. Their negative sentiment about bitcoin might sound emotionally dismissive. That’s the wrong way to read it. They’ve just seen the movie before. They don’t have time to explain all the reasons that it’s too early and can’t be valued.
While possible, it’s unlikely global finance figures like Jamie Dimon are having a knee-jerk reaction to bitcoin. These people are smart. They have access to excellent research and insight. They are well briefed on the state of blockchain development, various cryptocurrencies and, of course, bitcoin itself.
They also invest for a living. So they look carefully at emerging trends and buy when they have measures to indicate that an asset is underpriced.
There are, as yet, no functioning commercial uses with any scale in the crypto-economy. Bitcoin doesn’t work as a currency (yet) because it’s too volatile. You may have heard the one about the kid who asks his dad for $100 worth of bitcoin: $100! replies dad. I don’t have $112 dollars! What do you need $95 dollars for?
There is — so far — no objective measure of value in the entire crypto-economy. The only thing setting the value on cryptocurrencies is excitement about future potential. Experienced investors know that excitement over-values assets 100% of the time.
Excitement always underestimates timing.
I recently attended a rather nerdy Wall Street blockchain seminar. This was a mix of folks working on private and public blockchain projects. It wasn’t about cryptocurrencies per se but included one panel of some early hedge funds investing in them.
The hedge fund guys all freely admitted that they have no way to value these assets. They are going up because they are going up. And no one disagreed that they will also crash. Of course, everyone thinks that they will be the ones to get out before they do.
Other things that give me pause: The computer code that makes smart contracts work isn’t ready. The transaction speed of bitcoin is far too slow. Most (if not all) of the business models for the crypto-economy are theories on paper. This stuff is just not done yet.
Be excited, yes. But don’t buy in to a made up valuation for a technology that doesn’t really do anything yet.
Lastly, the really big missing piece for valuation is what government will have to say. Governments around the world have so far been silent about setting policy for the crypto-economy. They will make rules and will almost certainly create both winners and losers.
This all adds up to a pretty clear fact: Cryptocurrencies are not ready to be valued professionally.
The amateurs are setting the value for now by guessing. It’s nigh on impossible they’ve guessed right.
But don’t write it off and look away — there is something real here.
Make no mistake, blockchain networks are here to stay. They will change the way we do many things. But don’t let anyone tell you that they are “out of reach of government.” And certainly don’t give in to the idea that the train has left the station. No, the train isn’t even finished being built.
Humans have a natural love for the bandwagon. We love to jump on, we love to jump off. And man, do we love a good, “I told ya so.”
All such nonsense has nothing to offer the disciplined investor.
What we have in the crypto-economy is a set of game changing technology. It is currently being valued by euphoria over it’s newness. There is not yet any visibility into when the various potential applications will roll out nor what market forces will act on them when they do. There is not yet any visibility into how much and how they will be regulated by governments.
When these things begin to be more clear, prices will begin to reset. Some values will go to zero. All will drop significantly.
When that happens, there may be a train to catch.
When bubbles burst there is great backlash and acrimony. Often, the darlings of the bubble become pariahs. The early money sulks out. It lost all its big gains at best, it lost risk capital it could ill afford to lose at worst. No one wants to talk blockchain or cryptocurrency at parties anymore. It’s embarrassing. People were too smug for too long as prices rose. They’d rather talk about anything else.
That’s when there just might be a train sitting in the station that’s going somewhere. Crashes weed out weak stories. When the excitement is gone, all that’s left is sound business.
Many, many people walked completely away from Internet and tech stocks when that bubble burst in early 2000. Walked away from the Internet shaking their heads, “Well, I guess that’s not going anywhere after all.” Seriously. For a little while even saying “dotcom” drew a sneer even in polite company.
Meanwhile, the smart money was buying Internet companies.
Let’s not call it a bubble bursting or a crash. It’s really a reset of valuation. Factors appear that begin to cast light on the real value, it’s way lower than the market thought, so we experience a bubble burst, a crash. Those sound like such bad things.
But the valuation reset is a good thing. A great thing. It marks a key opportunity. It means instead of being artificially inflated, values are now artificially deflated. That’s when real investors show up. And you can be certain they will.
Over the next months and years it will become clear where the promise really lies in the crypto-economy. Which tokens, which applications, perhaps even which currencies have a chance to endure.
Carefully watching these will reward patient investors. Opportunities will arise to buy the good ones cheap. They almost always appear when everyone else is home nursing a headache.
Happy New Year.
Here’s to finding opportunity where it once appeared lost.
The opinions expressed here are just that — mere opinions. I am an individual and I neither give, nor seek, nor profit from, investment advice. This opinion column is to encourage thought and debate. Nothing more. Any decision you make to buy, sell, not buy, not sell, or do otherwise are yours and yours alone. You alone are responsible for the consequences of your actions. As always.