Crypto: The Floodgates Are About to Open…

Bitcoin and Crypyo in general was without doubt the best investment of the previous decade, and in my opinion it’s likely not only the best shorter term trade right now, but very likely will continue to be by far the best place to invest in this decade.

I’ll explain my thinking by looking at the past. The Winklevoss twins are the archetypical all-American “ideal men”: Wealthy, Athletic, Academic, Entrepreneurial…Both are serial high achievers. But Hollywood did a great job of selling us the narrative that Cameron and Tyler were classic pantomime villains in the film The Social Network. If you’ve never seen the film, purported Facebook founder Mark Zuckerberg is painted as the hero. But, even so, you observe how Facebook, or now Meta, was built by shamelessly copying viral features from its competitors. We know that Mark Zuckerberg settled with the Winklevoss twins, involving cash (estimated to be c.$140 million) and a stock agreement (exact details not publicly disclosed).

Sitting on the beach in Ibiza, a stranger recognised the twins from the famous movie and asked if they’d ever heard of Bitcoin. After the conversation, their curiosity led the pair down a rabbit hole with digital currency. In April 2013, the Winklevoss brothers grabbed everyone’s attention when they announced that they owned $11 million worth of Bitcoin through their company, Winklevoss Capital. Rumour has it that they scooped up some of their Bitcoin for as little as $10 per coin and owned 1% of the entire supply. Bitcoin took a nosedive from $180 to $80 within a week of their announcement, which sums up Cryptocurrency’s wild and unpredictable ride. It dawned on Cameron and Tyler that Bitcoin was Gold 2.0. The network effects, unlike Gold, made it a better version of Gold.

They talk about their aha moment:

“We were used to social networks but realised this was a money network; you could send value on the internet for the first time, like an email. When you realise that money is the greatest social network of all — and Bitcoin is the first internet money, it’s the greatest social network. We tried to kill the idea; we struggled to come up with an explanation as to why this doesn’t work long term.”

Cameron Winklevoss

The Great Accumulation of Bitcoin Has Only Just Begun

BlackRock, as most readers know, is a financial giant, managing a mind-boggling $10 trillion of assets. Their recent application to launch a Bitcoin ETF shows that they are looking to enter the digital asset sector, initially through Bitcoin. Now, let’s look at the size of the available supply of Bitcoin in this context. About 11% of all the Bitcoin in existence — around 2.2 million coins — is being held on exchanges; if we do the maths based on today’s prices, that adds up to roughly $66.7 billion worth of Bitcoin. When you consider BlackRock’s vast financial empire, $66 billion is like a drop in the ocean to them. But here’s the kicker: if BlackRock allocated just 0.74% of its portfolios to Bitcoin, it would be enough to absorb all the available coins on exchanges. What’s more, they are just one out of a cascade of companies filing for Bitcoin ETFs. The reason why so many large financial organisations are filing Bitcoin ETF applications with the SEC is because they make investing in Bitcoin easier by packaging it in traditional investment channels. Buying a Bitcoin ETF won’t really feel any different to buying a stocks and shares ETF for ordinary people. It’s like creating a bridge between Cryptocurrencies and the more familiar investment world.

Cameron Winklevoss and other Bitcoin commentators have come out and said the price of Bitcoin, as a result, could go parabolic.

“It may be your final opportunity to invest at the ground level before the floodgates open.”

Cameron Winklevoss

People who understand the supply/demand implications of the flurry of Bitcoin ETF filings are excited by its potential impact on Crypto prices.

“If Bitcoin were the most obvious and best investment of the previous decade, this would likely be the most obvious and best trade of this decade.”
Cameron Winklevoss

The Winklevoss twins aren’t the only people who see what’s happening as the most obvious investment opportunity of this decade. Michael Saylor wrote one sentence on Twitter:

“The window to front-run institutional demand for #Bitcoin is closing”.
Micheal Saylor, CEO Microstrategy

Former early employee at Facebook and Snapchat, Anthony Pompliano, says retail investors buoyed the price of Bitcoin, but asks what do you think will happen when institutions come in with “Deep Pockets”? Needless to say, Pompliano thinks the BlackRock ETF is a significant development. He compares it to the space race, where countries frantically, over 20 years, tried to be the first in space.

“Now we have a race to accumulate Bitcoin. Institutions and individuals are trying to secure their share of the limited 21 million Bitcoins that will ever exist. Retail investors have accumulated Bitcoin for 15 years; a large portion has not been sold or moved for over a year. BlackRock shows up, and Bitcoin is up 20% for the week. People forget that Bitcoin went from $0 to nearly $1 trillion market cap with almost no institutional participation. If retail investors were good for $1T, what do you think happens when the deep pockets come into play?”
Anthony Pompliano

Will it Actually Happen Though?

We believe the BlackRock ETF application is a massive moment for Crypto. We also believe that Cameron Winklevoss is right in his assessment. Now is the time to accumulate Bitcoin at “Pre-IPO prices”, like investing in a company at the ground level before the stampede arrives. But, as ever when it comes to investing, nothing is guaranteed. It could also be a complete nothing-burger. The US Securities and Exchange Commission (SEC) has rejected a series of applications for ETFs concerning Bitcoin in the past. Against that, BlackRock has an extensive list of ETF filings in previous years that resulted in the approval of 99.8% of applications, with only one rejection. But none were for Bitcoin. We should also add in the headwinds from the macro backdrop: high inflation and high interest rates are still sucking liquidity out of the Cryptocurrency ecosystem: this is thought to only be a short-term issue, but there is no certainty of that either. Nevertheless, the balance of probability is firmly that the arrival of large financial institutions into the digital asset sector with familiar brands and traditional tradfi product wrappers will be a massive boost to Crypto demand and prices.

Institutions Will Value Other Crypto Innovations

So far, we have only focused on how institutions are hoping to offer Bitcoin products to their millions of customers. But for people like us working in the digital asset sector, there is so much else in the sector to be excited about given the incredible innovations on the Bitcoin idea to be found in other (often newer) Crypto networks. I am convinced that it won’t be long before institutions recognise these other even faster growing digital asset sector networks, so the prospect for capital growth in the rest of the sector is actually even more attractive.

To illustrate why, let’s look at history again. Today, Rouzbeh Yassini is considered “the father of the cable modem.” But in the early 1980s, critics called him “crazy” because of his radical — yet revolutionary — idea to bring the internet to the masses.

In 1977, Yassini moved from Iran to the United States. After graduating from West Virginia University in 1981 with a degree in electrical engineering, General Electric (GE) recruited him to help build TVs, VCRs, and cameras. While working on electronics, Yassini became intimately familiar with coaxial cables — a copper cable used to support phone calls or television broadcasts. But Yassini knew the internet was the future. So in 1986, he left GE for Proteon, a data networking company that made routers and bridges. These are the hardware needed for internet data transmission. But in the early days of the internet, the technology was unreliable and slow. In the 1990s, downloading an entire feature-length film could take a few days. A simple song took about 30 minutes to download.

At Proteon, Yassini discovered using existing cables was the most efficient solution to increase internet transmission speeds. So he proposed the radical idea to transmit internet data over existing TV cable lines. If internet companies didn’t use the existing cable lines, he argued, they’d need to re-wire every city in America. Every street and every house would need to run another set of cables. That would take decades and hundreds of billions of dollars to achieve. Sceptics said mixing video and data wouldn’t work. Some even called the idea “crazy.” They told Yassini no one cared about data transfers. Customers were only interested in television. Plus, cable companies wouldn’t entertain the idea. They believed transmitting internet data would interrupt their TV business.

But Yassini didn’t give up. He knew solving this problem would bring the internet to the masses and change the world… So he left Proteon in 1990 to start LANcity, where he could pursue his dream to build a device that could transfer high-speed data and video over existing cable infrastructure. This device became known as the cable modem… And it revolutionised the telecommunications industry.

In a 2014 interview with the Syndeo Institute at The Cable Center, Yassini recounted the pushback to his idea of sending data via a cable modem. (He actually hired his former manager from GE to help him develop the idea for the modem):

“So I hired my general manager from GE, who came to be the president and CEO, Fran Scricco.

‘Rouz, do you know how to build high-volume, low-cost products? The data networking industry needs such a thing.’ I said, ‘I know nothing about digital. I’m an analog guy.’ He said, ‘Well, we’ll teach you digital, you teach us high-quality and high-performance boxes.’

So we brought the two together, and the idea was — based on my experience at GE and [after] my experience at Proteon — I asked: Why do we need two separate cables? We really can do all this in one cable.

So that simple question — when I share that with people, people told me I was crazy about thinking that way because we have always done it on two separate cables. That was the spark.”

If you use the internet today, you probably know what a modem is. It’s the device that connects your home to your internet service provider (ISP). The first model created by Yassini was half the size of a refrigerator and cost $18,000. It took a full day to make a single unit.

LANcity’s first customers were military bases, universities, and hospitals, as they were the only customers that could afford such an expensive machine. The company had to give away modems for free to get the market started. And it nearly went bankrupt three times as a result.

Eventually, the entire tech industry realised Yassini’s modem was an amazing data transmission solution. So he sold the company and joined CableLabs in 1996. At CableLabs, he helped develop Data Over Cable Services Interface Specification (DOCSIS). It established the industry standards for cable modems. When Yassini told others his goal was to create a network of 100 million DOCSIS users, everyone laughed at him. Yet today virtually every household and business in America has a modem that operates under DOCSIS. And over 5 billion people use the internet around the world. To achieve that scale of adoption, the price of modems had to drop drastically. And thanks to Yassini’s contributions, that happened.

Here’s what he said in the same 2014 interview cited above:

“Thirty years ago, when we started at LANcity, the cost of a cable modem was about $18,000, and it literally took us a day to make one. Over time, scale became the enabling factor as the barrier of cost went away around the materials. So 15 years later, the wholesale price of a modem was less than $25 per unit. No other consumer electronics device has seen that kind of price drop, that fast, ever.”

…fast forward to today, and people consider Yassini “the father of the cable modem.” His device is one of the pillars of the multi-trillion-dollar internet industry. If he had listened to the naysayers, we wouldn’t have companies like Google, Facebook, or Netflix. They couldn’t operate on dial-up internet. His modem prototype created the infrastructure for companies to offer their products and services to billions of people over broadband internet.

Today, the biggest companies in the world — Amazon, Alphabet (Google), Apple, and Microsoft — rely on broadband internet. They made early investors as much as 267,224%, 6,944%, 267,665%, and 477,503%, respectively, in long-term gains.

Here’s Why I’m Telling You About Modems…

Just like Yassini, there’s a group of developers pioneering scaling solutions for the next generation of the internet: the blockchain.

Using blockchain technology isn’t feasible for many industries today. It’s difficult to use unless you’re an expert… Transaction times can be slow… And transaction fees can be costly when traffic is high.

But developers are working on scaling solutions that will lower costs by up to 90% and increase transaction speeds by up to 100x.

And just like the cable modem of yesteryear carried internet data via existing cable lines, these projects will bring blockchain to the masses.

Layer 2: The Blockchain Version of the Cable Modem

In December 2020, transaction fees on the second largest Crypto network Ethereum reached $16. (NB Ethereum came five years after Bitcoin and incorporated smart contract innovation, making it better suited to transacting than Bitcoin, meaning the Ethereum network has actually grown at a much faster rate in the past five years). That $16 transaction fee is nearly a 250x increase from the start of 2020, when the average transaction fee was just $0.07.

The industry desperately needed a solution. The community couldn’t accept paying $16 per transaction if it wanted to see billions of users adopt the network. That’s when developers came up with a radical new idea: Layer 2 networks.

You see, Ethereum is considered a Layer 1 solution. Layer 1 is the fundamental base network of a blockchain platform. It’s analogous to the pre-existing coaxial cables. Layer 2 networks live above the Layer 1 network. This technology helps the Ethereum network scale by greatly reducing network congestion. Think of it like Yassini’s cable modem.

Just like the cable modem made internet usage more efficient, Layer 2 scaling solutions make Ethereum more efficient by reducing transaction costs and increasing speeds. Layer 2 networks execute transactions off-chain (outside Ethereum). After it executes, the Layer 2 network posts the completed transaction back to Ethereum.

Moving execution off-chain uses significantly less block space on Ethereum — which reduces costs to the user. And to further reduce costs, the Layer 2 rollups bundle hundreds of transactions and post them as a single transaction to the Ethereum network. You can think of this part of the process like paying for drinks at a bar. Rather than paying for each individual drink throughout the night, it’s more efficient to start a tab and pay for them at the end of the night in a single transaction. By streamlining the process and removing congestion from the main network, the networks dramatically reduce transaction fees.

And because the Ethereum network maintains proof of Layer 2 transactions, it doesn’t sacrifice security despite the reduced costs. In fact, if you tally up all the transactions that Layer 2 networks process in any given day, it surpasses the Ethereum mainnet itself. Take a look at the chart below. It shows the amount of Ethereum computing power Layer 2 scaling solutions use.

Source: Dune Analytics

As you can see, Layer 2 scaling solutions are taking up an increasing amount of Ethereum’s block space. That means Layer 2 networks’ usage is increasing. This growth shows no signs of letting up. And why would it? Layer 2 networks offer faster and cheaper transactions than the Ethereum mainnet — in some cases over 90% cheaper and 100 times faster. It’s like going from dial-up to broadband internet.

I have used Layer 2 innovation as a simple example of the exciting innovations happening right now in the digital asset sector. What’s compelling is that there are many such innovations that are making networks cheaper, more user friendly and more secure….thereby opening up many new use cases and more customer segments….

Final Thoughts

If Bitcoin proved to be the top-performing investment of the past decade, choosing to accumulate it now could prove to be the wisest investment decision for the next decade given that institutional money is finally serious about entering the space. And the best news is… you still have time to get in before ‘the crowd’ arrives!

But the opportunity doesn’t stop at Bitcoin. As we discussed at our recent roundtable event, Crypto prices over the medium to long term tend to move in line with a protocol’s success as measured by its network and user growth as well as its transaction fees. There are some exciting and innovative large Crypto protocols that have innovated on the Bitcoin idea and are now growing even faster as a result. We feel it won’t be long before these institutions now entering the sector with their deep pockets and army of seasoned investment professionals realise the attractions of the rest of the Crypto sector too. The simple maths of big money flowing into networks that are smaller and earlier stage than that of Bitcoin is obviously even more attractive to us as investors!

PTLIB is CIO of Dragonfly Asset Management.

DISCLAIMER: This content is for EDUCATIONAL AND ENTERTAINMENT PURPOSES ONLY and nothing contained in this blog should be construed as investment advice. Any reference to an investment’s past or potential performance is not, and should not be construed as, a recommendation or as a guarantee of any specific outcome or profit.