How to invest in cryptocurrency and win — even if there is a bubble.
Aleksandra Buimistere for Forbes Finland (December 2017) and Forbes Latvia (Translation in English)
Market capitalization of Bitcoin is currently higher than the GDP of Hungary- more than $128 billion. Just a year ago the total digital currency was worth less than $5billion.
You probably heard a story about a friend of a friend who invested in Bitcoin when it was worth nothing ($5 in 2012) and now he or she is a millionaire. Moreover, repeating daily headlines “Bitcoin broke a price record” are making the biggest skeptics to consider investing — which, of course, signals “greed stage” of the classic bubble theory. (Usual stages are take-off, media attention, enthusiasm, greed, delusion, “new paradigm,” fear, capitulation). JP Morgan’s CEO Jamie Dimon even compared Bitcoin to tulips — the first ever known bubble from 17th century Holland, which angered many Bitcoin enthusiasts.
However, Vladislav (Slava) Solodkiy, Managing Partner of Life.SREDA fintech Venture Capital, is actually waiting for the bubble to burst. “This will remove all speculators and wrong players from the industry and only the strong ones will stay and prosper, just like Amazon and Google emerged from dotcom bubble,” he explains.
What should private investor know about the cryptocurrency investments and the disruptive blockchain technology?
About Bitcoin and blockchain
Bitcoin exists for 8 years; in the beginning it sounded like non-sense — at least to finance professionals, because it is a purely digital currency and is not regulated by any central authority. However, Bitcoin supporters say that this is exactly why it is so valuable- central bank can’t manipulate it. This year Bitcoin price keeps increasing further and further, trading around $7800 at the moment of writing this article, having increased 680% since the beginning of the year. The second largest cryptocurrency by market capitalization ($31 billion), Ethereum, has risen astonishing 4000% since the beginning of 2017.
The rise of the alternatives
Investments into blockchain startups accounted for only 2%-3% of total fintech startup investment in 2016 (blockchain is original technology behind the Bitcoin, it is revolutionary and secure way to store data). The ICO, or initial coin offering, has allowed companies developing blockchain solutions, which lack venture capitalist attention, to raise funds in order to operate. ICO is a hybrid between IPO and crowdfunding. In order to participate in the future company’s valuation, you can buy a digital coin, which is based on blockchain technology. Some coins shoot-up in value bringing valuations to ridiculously high levels. This attracts speculators. “One of the biggest problems with ICO is that insider trading is not prohibited, like it is in equity markets. Even if some insider trading took place with the equity, it will be known eventually, however the tokens can be bought and sold from anonymous accounts to pump up the price. So, the issuers of the tokens can theoretically buy their own coins to make it look bigger,” says Jeremias Kangas, Founder of Local Bitcoins, a Finnish Bitcoin exchange.
Currently there are more than 1000 cryptocurrencies or altcoins available on the market. This has facilitated a wave of establishment of so-called crypto currency hedge funds and even ETF is that is traded on NYSE (ARKW- investing in tech companies in combination with some crypto assets).
Even if a cryptocurrency bubble bursts soon, removing speculators, that is hardly a worry for venture capital funds that are focusing on the blockchain. Blockchain is the decentralized encryption of information immune to hacking. An easy way explaining what it is to your grandmother: Imagine if, when you make a purchase, you don’t actually give your cash but promise to give it, and network of, say, 100 other people are witnesses. You can’t make the promise to spend more than you have, as these 100 checkers will say you don’t have these resources. This is a very basic and simplistic imagination of blockchain, but it gives you an idea of how it will revolutionize the record-keeping and data management. Blockchain will change the way we store data and it found its way to government. Dubai, for example, will adopt blockchain technology in all government entities by 2020. The proof that governments are interested in the new technology- US Homeland Security awarding $750 million to a blockchain start-up. “Blockchain technologies have the potential to revolutionize the way we manage online identity and access the internet”, said chief of department’s cyber security. Moreover, UK research house Autonomous Next estimates that Blockchain technology companies could experience a revenue pool of $6 billion by 2020 and $20 billion by 2030.
More than 100 funds invest in cryptocurrencies, holding in excess of $3 billion assets under management in total. Their selling points are investor-familiar words like diversification, earnings track record, etc. However, this does not remove the fact that good numbers are often a function of buying at low prices, and diversifications is due to the inclusion of several cryptocurrencies in the portfolio. The researched funds were very secretive, some offer to invest amounts that start at $10,000, others to invest cryptocurrency, but not cash.
Note that investing in cryptocurrency is not the same as investing in blockchain technology, so in reality there are around six firms who do invest in the promising trend.
Life.SREDA is one of these firms. Vladislav Solodkiy left his marketing job in a Russian bank to found Life.SREDA — a venture capital fund focusing solely on fintech startups. He admits he didn’t have any experience in the field, but no one actually did, as it was the new business movement. His advantage though was his marketing skills such as communication ease and feeling the client. The financial skills came along with experience. Five years later the track record is 25 investments (7 successful exits) with IRR 32% and titles like “TOP 35 the most influential fintech investors in the world.”
A Singapore-based venture capital is launching a third fund this year with self-explanatory name: Based on Blockchain (BB Fund). Right now, it is in the pre-sale stage, when institutional investors and selected HNWI are involved and later it will open to general public via an ICO, with the aim of raising a total $200 million. Unlike Hedge Funds, usually run by speculators who look to buy cryptocurrency and dump it before the price goes down, BB Fund will seek long-term capital appreciation. Interestingly, the BB Fund is based on the Blockchain technology itself.
Read more: Traditional Banks Hate Crypto
Investing in Blockchain startups is challenging, admits Slava, as the valuation is hard to establish, due to lack of comparable investments. Moreover the startups themselves are valued extremely high, if you analyze the secondary token market. But as with everything new, it helps to get a new approach. In this case, big technological companies are acquiring startups not for the business they are doing or the technology they are developing, but for the talents working there, so-called equity-hiring. In other words, by investing in blockchain companies you are essentially buying the passionate talents there, even if they account for only 10% of total staff.
If you want to participate in the “hot” ICO market, you have to think about future of the company you are backing up, just like with smart equity investments. Slava says that you need to have a long-term vision as opposed to commonly used short-term speculative approaches. The tokens issued by startups who have long term vision and working in key market trends such as building blockchain infrastructure; big data, deep analytics and regtech startups, decentralized startups with traditional value proposition in banking, payments, lending, wealth management, insurance sectors; accomplished fintech leaders that are moving into blockchain and crypto space. The BB Fund’s investment team has no illusion that the bubble will burst and will erase 90–95% of new comers. But focusing on the mentioned fields, will give the fund power to survive and participate in the new economy that will be created.
Biggest problem with ICO
An ICO sounds like a great way to win big at cryptocurrency roulette table. But as everyone in the industry knows — and few are willing to talk about — you can’t simply cash out and walk away with your newly found wealth. Anecdotally, says Slava, these crypto-millionaires can’t even pay for their own coffee. Even in Japan, which is the most crypto-friendly country with 11-exchanges and more than 260,000 retailers accepting Bitcoin as a mean of payment, Bitcoin enthusiasts are using it in only 10% of their total transactions. What can holders of altcoins outside Japan really buy? Their wealth is sitting in their digital wallets and it is hard to transfer the money to a regular bank account.
Banks globally became tough with cryptocurrency holders three months ago. All transfers above $50,000 get on the radar of bank’s compliance departments and the account gets frozen and, sometimes, even closed. If you try to split your transfer in smaller tranches, it is even worse, because in bank’s eyes you are trying to cheat. Banks do not have a problem with cryptocurrency holders per se, they just don’t want to risk their reputation because of something promising but small, also there is lack of regulation and information. This can be compared to cannabis in the US. Some states legalized commercial sale of weed, but banks are following the federal laws. Hence, even if the business is legal on the ground, the earned profit can’t be held on the bank account.
Slava wants to find a solution for this problem. Life.SREDA is currently looking to buy a US bank, which they will turn around into first crypto-friendly fintech bank that will cater the ICO backed startups. He says, they will be as open as possible with the regulator from beginning to facilitate the understanding of the industry and creation of relevant rules. Sounds like Slava may have his first mover advantage once again.
Blockchain is not a silver bullet, as some make it sound; it still has limited applications. The hype is big, but you can’t plan your wealth following the crowd meaninglessly, as with chasing the price of Bitcoin. You have to always think carefully about which trends have a future without succumbing to the temptation of greed. When you don’t understand the subject completely, don’t believe everyone else does and you are missing out.
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