The new blockchain asset class: should I invest?
In part 2 of this series we covered some of the ideas behind “blockchain tokens” as representations of the value generated from this technology. We left off with the natural question that comes from starting to grasp this new asset class: “should I invest?”
For us to answer the question of whether one should invest in this space, we must first understand the nature of the space and how value flows through it. Blockchain investing is akin to extremely early stage, risky, seed capital investing.
“Trading in blockchain is like trading in early-stage R&D.” — Fred Wilson, Venture Capitalist
Each blockchain project is like a new startup with untested assumptions and experimental governance structures. Some are mere pet projects like Dogecoin, while others are serious ventures like Ethereum or Waves. As with any startup, if successful the upside potential is significant, but there are a plethora of factors that can lead to failure as well. In the Venture Capital (VC) industry the failure rate can be anywhere between 75% and 90%. It is even higher in the blockchain space.
Wild, wild, west
Given the unregulated nature of the space, there often aren’t the usual consumer protection mechanisms in place and participants must shoulder a significant amount of the due diligence for each project they would like to participate in.
This is necessarily so in the early stages of any new technology.
To properly evaluate the potential/risks, someone would require competencies that range from a technical understanding of the specific project, to knowledge about blockchain technology in general, to an understanding of the risks associated with nascent financial markets. Just on the financial side, blockchain asset markets are by their nature subject to volatility and price manipulation because of their relatively small market caps.
Even with well vetted and seemingly sound projects things may not always go as planned, as was the case with ‘the DAO compromise’. This was an instance where a much anticipated investment fund smart contract had managed to accumulate ~US$150M in funds and was then subsequently drained of a substantial portion of those funds because of an inconspicuous bug in the contract code.
Contentious issues may also arise from underdeveloped best practices in an industry that is just now finding its footing. This was the case with the hack of the popular Bitfinex exchange where a particular method of securing customer funds was found to be less than ideal. This lead to an ~US$80M compromise that was discovered and swiftly corrected, but not before some damage was done.
Incidents like these are unfortunate, but they also contribute valuable lessons back to the space as a whole and they help to push both the resilience and the evolution of the technology. They are par for the course, and participants must be well aware of these risks.
Maturity is your friend
In a space like this, one of the most valuable allies of any project is time. Blockchain projects are constantly under attack. They are projects run in the full view of the public with all their code and inner workings exposed. A potential compromise carries with it the promise of significant financial reward for any successful attacker. Given this, the longer a project survives and the more actively/publicly it is used, the stronger the case is for its reliability and security.
The most time-tested blockchain so far in the space is Bitcoin with its roughly 8 years of continuous runtime. While Bitcoin has seen its fair share of ups and downs in that time, it’s relative price stability has greatly improved and much investment has poured in to develop the digital and physical infrastructure needed for it to be secure and to grow.
For perspective the second project by market cap, Ethereum, has only been running in the public domain for just over one year now.
Should I invest?
Given all these factors, blockchain tokens as an investment or speculation vehicle really should not be touched unless one has a firm grasp of the technical workings and the community’s outlook, and a healthy appetite for the high risk involved.
Investments undertaken if at all in this space should only be done in proportion to a person’s understanding of the specific project and of the risks involved.
If someone really does want to get involved in this space, Bitcoin is by far the most stable project in relative terms given its long track record and developed community. It serves as a decent introduction to the world of blockchains and cryptocurrencies, but even then one should take the time to learn about how it works, how to properly store and send its tokens, and what the overall value proposition of the project is.
Where should I start?
If you’ve gotten this far and are convinced that you would like to move ahead, analyses like the following, published by Forbes recently, are a great place to start.
Persons can also reach out to their local Bitcoin communities for help with learning more about the space in general.
As with many things in life, getting your hands dirty and meeting people who are already knowledgeable are usually some of the best ways to learn about anything new.
This is a multi-part series exploring the question of what a “blockchain asset” actually is. In this third piece, we looked at understanding some of the context around this new asset class with a view to answering the question, “should I invest?”. In the next piece we will look at the how to spot poor projects, and fraudulent offerings masquerading as blockchain assets.
*Title image courtesy Shutterstock
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Other pieces in this series:
