In 2015 iTech Capital invested in its first “crypto-asset,” a cryptocurrency mining hardware manufacturer and blockchain software developer — Bitfury. At that time there were not many institutional investors willing to risk a relatively large check in this obscure, intimidating, and yet alluring niche. Two years later, when bitcoin was worth $2,000, I was assured that the cryptocurrency would be worth $50,000 by 2022.
Since then, we have seen an ASIC arms race between miners from around the world, the rise and fall of the ICO market, and the emergence of a large number of new blockchain-based technologies that are reaching deeper into many traditional sectors of the off-line economy.
The increased belief that bitcoin could serve as both an anti-inflationary hedge as well as a speculative instrument with mouth-watering returns inevitably provoked a rise in the price of this asset. Today, the price of a single bitcoin has surpassed $58,000.
Is there a bubble emerging in the crypto market and is there still room for a professional investor to generate returns in a reasonable manner within this space?
Government Regulation, Institutions, and Mining
Obviously, the mass acceptance of cryptocurrencies is still a long ways off. Typical fears of finance traditionalists mostly stem from government regulation or the supposedly pyramidal component of the crypto industry. Many also fear the inability of the system to technically implement the boldest ideas of blockchain innovators. Overall these concerns are still strongly present in the market.
Most surprisingly, neither the narrative nor the statements of the skeptics have changed much in the past three to four years, despite a number of events that have changed the industry dramatically.
A significant flow of institutional money has already made an impact on the sustainability of the system and has provoked a strong rise in the prices of the underlying cryptocurrencies on the exchange market. Bitcoin has reached a capitalization of $1 trillion and is gradually becoming an accessible payment instrument through integrations with Visa, Master, and PayPal. According to the ARK-Invest report, about 80% of bitcoin holders held tokens for less than one year in 2017, as opposed to 2020, when investing in cryptocurrency is considered a long-term investment for more than 60% of all investors. These statistics indicate that the high volatility we are seeing now may diminish over time as the crypto space continues to mature.
The mining sector in particular has attracted a huge amount of investment. Mining farms are growing steadily in places with cheap energy. Riot Blockchain, Bitfury, Hive Blockchain, Marathon Holdings, and others are increasing their computing capacity at a break-neck pace. Marathon, for example, is launching its first mining farm, investing up to $200 million. Bitfury plans to invest up to $425 million in mining farms by 2025, reaching a capacity of 745 MW. Blockcap plans to increase its ASIC miners to 40,000 this year and estimates its investment in the project to be $270 million. Mining company Hut 8 has announced a $30 million purchase of new specialized video processors from Nvidia, which has long had trouble shipping its video cards due to outsized demand from miners. The list is likely to grow as new ambitious mining projects continue to be announced…
M&A activity in the industry is growing, with more than 80 M&A deals involving crypto companies, in aggregate valued at nearly $700 million, taking place in 2020. Central banks around the world have begun discussing digital currency concepts. They are actively developing and implementing national cryptocurrencies in opposition to the dominant ethos of decentralization early crypto-pioneers envisaged. The Italian philosopher Niccolo Machiavelli’s quote, “If you cannot beat the crowd, lead it,” seems to be their playbook.
The presence of institutional investors is already commonplace in the industry. More and more private venture capital funds and private equity funds are allocating assets to both cryptocurrencies and blockchain projects.
Where should an investor go?
We see explosive growth in the DeFi segment (decentralized finance, financial services, and blockchain-based applications). From $700 million in December 2019 to $13 billion by December 31, 2020, and increasing to $40 billion in 2021, the next wave of crypto-innovation is well under way.
For years people discussed the archaic nature of banking technology and the opportunities presented by a decentralized financial system. DeFi’s open-source protocols based on smart contracts allow a range of traditional financial services to be provided in a transparent and reliable way without introducing banks into the mix. Redistributing the “fat” banking margin between borrowers and lenders with high levels of reliability, transparency, and accessibility seems to be a new way. There will be a lot of changes in this sector, dictated by user experience. No doubt there will be pressure from regulators and financial institutions, whose space is being actively taken over by distributed players in the DeFi industry.
It is clear to me, as an investor, that many investment funds will not ignore this segment, so we at iTech are busy keeping up with the market.
The NFT (Non Fungible Tokens) era has bloomed this year, opening up a new market for creating and preserving value in the world of digital assets. NFT tokens implement the long-discussed concept of storing value in the digital world, based on utility, ownership history, future value, and today’s liquidity. The digital content world has long been in need of such a tool, and the excess liquidity in the capital market has served as a strong boost to the development and adaptation of this segment of the crypto market.
Mining As a Service is actively developing as well. Many mining companies offer mining services in the form of a financial product, the profitability of which is tied to the process of mining, with the miners assuming all of the operational risks, and the investors the financial ones. The product is ideal for those who would like to have financial exposure to the sector, but are not willing to bear the operational and regulatory risks traditionally associated with the industry. Furthermore, mining, as opposed to simply investing in the underlying cryptocurrencies, adds another natural layer of hedging.
Is this a bubble? I’d like to believe not. Nevertheless, it’s alarming that many (if not all) of today’s entrepreneurs have long since forgotten the good old fundamental approach to valuation.
Old timers of the investment world and frightening valuations
The pandemic has unhinged the printing presses of every central bank in the world. They are aggressively printing money, which in turn, along with low-interest rates, inevitably gets into the financial markets in general and the crypto market in particular.
Current valuations in the market are scary and frustrating when you look at them through the eyes of a buyer and certainly pleasing when you are on the selling side. If we look at the SPAC (Special Purpose Acquisition Company) market, we see that companies raised about $88 billion in the first quarter of 2021, more than they did in the whole of 2020. As a result, investment companies have accumulated over $1 trillion on their balance sheets to be invested over the next 2 years, leading to a lot of competition for promising companies and therefore inflated valuations.
Reliable investor metrics such as revenues, profits, and margins are slowly and surely fading into the background. The excessive liquidity in the capital market and the growing ecosystem of venture capital investments are certainly changing the landscape that the “old timers” of the investment world are used to.
The crypto industry is still a high-risk investment class, even among venture capitalists. That is why the fundamental approach to valuation is no longer as important to them.
Seed-stage investors are actively working with the expectation that some startups will replicate the success of Coinbase, for example. At the time of the IPO, the company is expected to reach a valuation in excess of $100 billion, with revenues of $1 billion and profits of $320 million, proving investors’ incredible faith in the company’s future growth. This inflation of valuations in the ecosystem will drive down yields for investors over 10–15 years from today.
I have little faith in predictions that bitcoin will be worth more than $500,000 by the end of the decade or reach the $1 million level. However, I remember the summer of 2017, when at around $2000 per bitcoin, my friend Valery Vavilov, the founder of Bitfury, convinced me that one bitcoin will be worth $50,000 by 2022 and even kindly signed his prediction.
While 2017 is ancient history by the standards of the crypto industry, it’s not that long ago for us, mere mortals. I have repeatedly witnessed how the most unrealistic forecasts became reality, and that is why I do not exclude that the $50000-per-bitcoin-bet, which materialized one year before prediction, is just the beginning of another rally.
The industry changes through evolutionary natural selection and that’s what makes it stronger and more stable. It’s no surprise then that the number of cryptoadepts grows every day.