Why Invest in Crypto?
By Jonathan Caras, CTO Lionschain Capital
History of Bitcoin and Blockchain
Created in 2009 by the pseudonymous Satoshi Nakamoto, Bitcoin is an open source, non-state-backed finance network. The launch of Bitcoin debuted the use of blockchain technology. Blockchain technology enabled the creation of digital scarcity. The native currency of the Bitcoin network is the crypto commodity BTC. The Bitcoin network is operated by a public mesh of node operators, which process transactions and monitor the state of the limited supply of 21 million BTC on a global decentralized ledger. The network operators automatically prevent double spending of BTC and reneging transactions; creating a dependable, secure method of digital value transfer.
Historically, money has primarily existed as a unit of account and means of exchange backed by commodities. Over the past 100 years, money has moved away from being commodity-backed (for example by gold) to being state-backed (fiat). This presents a challenge on a global financial scale, where nation-states are able to increase the money supply, essentially taxing the holders of the currency through inflation, and provides little incentives to minimize national debt (as they can always just print more!). Since the movement away from commodity-backed currency, the USD, for example, has lost roughly 95% of it’s purchasing power over the last 80 years.
Bitcoin represents the first successful community backed commodity, which provides a secure settlement layer, enabling the transfer of value between any participants in the world.
Bitcoin and a number of other public blockchain networks are not owned by an individual, but rather are public and decentralized. Anyone can participate in providing the computer resources which power these networks. In exchange for helping to run and secure the network, a percentage of the transaction fees from network usage and low, predictable inflation, known as block rewards, are issued programmatically to network participants on a regular basis. This is referred to as “mining”.
The free market sets the value of the service that the Bitcoin network provides, reflected in the price of BTC.
Over the past 10 years, since its public release, the Bitcoin network has proven to be incredibly resilient to attack, is antifragile, and has steadily increased in value, loosely correlated to the usage of the Bitcoin network.
While this new commodity money network gains adoption by consumers, institutional investors and nation-states, the price of BTC, while generally increasing in value, varies wildly, presenting high volatility risk. The majority of investors owning BTC are investing in the perceived future value of a stateless, antifragile settlement layer — a commodity money.
Ethereum and Smart Contracts
The Ethereum Network with its native token ETH launched in 2014. Ethereum used the technical architecture and economic model of Bitcoin, but in addition to simply enabling the transfer of value and settlement, the Ethereum Network enables the creation of robust open sourced financial assets which are easily configured via a full Turing complete cloud computer. ETH acts as the payment method for access to this network, and is used by developers who want to build open source, uncensorable, composable, financial services . The market of these services has grown significantly in the past 18 months, resulting in the creation of many tools such as exchanges, loans, interest savings accounts, leverage, shorting, predictions markets, etc. Due to the ease of use of compounding open sourced code within the Ethereum ecosystem, the native ETH token, which is required as a payment token for these services, has become the primary store of value for collateral debt within this open finance movement, known as DeFi or Open Finance.
The free market sets the value of ETH which is loosely correlated to the amount of transaction activity on the network, which is a derivative of the amount of demand for services built on Ethereum. The majority of investors owning ETH are investing in the perceived future value of a global, antifragile, robust financial system built on the Ethereum network. Where Bitcoin is often titled “digital gold”, today Ethereum can be thought of as “digital oil” enabling the operation of the most important financial vehicles the modern world has ever seen. In its collateral use case, ETH also serves the store of value use case, and may move further in this direction conceptually with the launch of the Proof of Stake based Ethereum 2.0.
Open Finance aka DeFi (decentralized finance)
Defi offers the creation of borderless banking services to anyone in the world including the unbanked and underbanked, at a fraction of the cost of traditional banking services. As these services have become more mature, we have seen continued positive feedback from global governments as regulation finds a balance between abuse prevention, and enabling innovation.
We anticipate the massive adoption of Open Finance over the next 5–10 years as onboarding and offboarding from traditional services improve, and customer familiarity increases. A total addressable market of western digital native millennials and 2nd and 3rd world citizens will bring 2–3 billion customers to the businesses built on the Open Finance movement.
Because of the volatility between state-backed currency and cryptocurrency, many common use cases for money are difficult to realize in this open financial system. This has presented a challenge to usability for customers leveraging Open Finance tools. Over the past 12 months, the creation of decentralized stable cryptocurrencies, pegged to state back currencies is a game changer in this space.
Since the start of 2018, over $400M has been locked as collateral in decentralized financial applications built on Ethereum.
https://mikemcdonald.github.io/eth-defi/
Stable Cryptocurrencies
Over the past year, over-collateralized debt vehicles built on open-source code, running on public blockchains (Ethereum), have created the ability to generate price stabilized cryptocurrencies backed by crypto commodities. This is similar to a reverse mortgage on a home, where the price of a home may fluctuate, but a bank can provide a collateral backed loan of a fixed USD value, to be paid back with interest. Roughly $100M of USD pegged cryptocurrencies have been issued to consumers, and is now being used in other products where users prefer a stable means of exchange. ETH represents the leading collateralization method for the creation of USD pegged cryptocurrencies.
Currencies have a tendency to build network effects. We anticipate that a dominant collateral backed cryptocurrency will become the default digital currency used over the internet.
This currency and the system powering it, will be programmatic and open source, built on public blockchains backed by a collection of crypto commodities, primarily BTC and ETH.
Stable currency and the software that manages it will most likely run on the Ethereum blockchain, which has the largest developer community and greatest resilience to centralization compared to the competing smart contract solutions currently in the market.
We believe scalable semi-private blockchains or similar Distributed Ledger technology will be used to handle small sum daily consumer spending, inheriting their security through settlement on the antifragile, decentralized baselayers, ie Ethereum and Bitcoin.
Scalability
Due to technical constraints on the Ethereum and Bitcoin blockchains with regard to transactions per second, a number of other private or semi-private blockchains have come to market, focused on high throughput. In order to achieve high throughput and low operating costs, these smart contract platforms are built on a less public, less antifragile, less decentralized architecture.
While these compromises are sufficient for the creation of general consumer products, we do not see the path for management of large volumes of wealth on these semi-private blockchains given the inherent risks associated with centralization.
We anticipate the maturation of cross blockchain asset transfer will lead the antifragile, low throughput blockchains to strengthen their position as secure settlement layers, capturing the largest amount of value, while the semi-private high throughput chains are used by consumers on a day to day basis. This is similar to using a bank for your savings (secure) and your wallet in your pocket (less secure) for daily spending.
Open source software creates monopolies
Open source software historically has resulted in the creation of monopolies. As more developers utilize and expand a particular open sourced project, this project matures at a faster rate than its closed sourced competition, until the use of one open sourced protocol becomes ubiquitous within that protocol’s domain.
Because the monopoly open sourced protocols are ownerless, direct methods of monetization are not compatible with the existing finance system. Open source software cannot own a bank account, cannot charge a fee, and cannot accept payment by customers, until today.
The creation of scarce digital assets powered by blockchain technology enables the creation of self-sustaining open source projects which are publicly owned. These apps run on public or semi-private blockchains and utilize a crypto token to incentivize different types of network participants to create network value. This token is programmatically designed to cover the operation costs of the network, create a fund for continued sustainable development and act as borderless equity ownership by the token holders. These tokens can have an equity-like aspect, enabling decentralized governance, overseeing the development and maturation of the monopoly open source project. These categories of tokens represent “cryptocapital” as opposed to crypto commodities which serve as the native assets of settlement layers such as Ethereum and Bitcoin.
The Decentralized Open Finance movement has leveraged the open source nature of the blockchain space to produce technical advancements over the last 12 months that would have taken 10 years in traditional markets. Developers and entrepreneurs are building off of each other’s tools and services at an increasing rate, bringing new services to market as the Defi movement quickly catches up to the traditional finance technical stack.
The next Internet, Web3
Web3 is the culmination of Stateless Commodity Money, DeFi, and Monetizable Monopolized Open Source protocols. The next generation of the internet will be built on open protocols which will monopolize the future world wide web technology stack.
Customers will own the data they create on the internet and will be able to monetize this data through micropayments.
Entrepreneurs will be able to create new business models through the use of the evolving Open Finance tools, leveraging the ever-growing open source software running on public and semi-private blockchains.
We anticipate the total market cap of this emerging asset class will grow 20–40x over the next 3–5 years, and substantially more over the following decade if this technology reaches its potential. During that time, there will be a number of bull runs where the hype is priced into the market early, followed by crashes and cool offs. As the fundamentals continue to mature, our team is increasingly confident in the industry and we are continuously excited to participate in this market as the thesis plays out.
A hedge on the market
Last, but certainly not least is the hedge an alternative financial industry provides for individuals and family offices. If you look at your portfolio today, you are most likely 100% invested in the current financial system. Even if you sell every stock or bond you own, you are still completely invested in the existing system.
Throughout history, times of uncertainty have resulted in governments seizing assets, freezing banks, and confiscating gold.
Cryptocurrency presents commodity money not tied to the existing financial system, one that cannot be forcibly taken by any power. If you can remember your 12-word “key” you can cross any border with your crypto assets in tow.
Who are we?
Lionschain capital is a thesis-driven long-short hedge fund investing in the crypto assets that are making the above thesis come to life.
Founded in December 2017, Lionschain has managed short term volatility through active risk management and returned a profit of 40% in 2018, while the market corrected at an 85% loss. In 2018 we held exclusively liquid assets and outperformed the market each month except for one.
We continually monitor the evolution of the space, including market sentiment, and take a hands-on approach to identify which early-stage teams are building the infrastructure that will evolve this industry and give birth to the next generation of the internet and world finance.
We meet the teams, read their code, monitor progress and adoption to gain primary source knowledge and combine this knowledge with active risk management to build a portfolio representing the best risk-reward in this market.
What do we do?
We make money for our investors primarily through buying and selling crypto assets.
We use cash as a position to avoid downturns in the market while allocating capital to the most promising projects to catch the upside.
For more information feel free to reach out:
Jonathan Caras
CTO Lionschain Capital
