Why I Work In Crypto

I am a partner in a start-up hedge fund, which launched earlier this year. This amounts to a risky endeavor in the best of circumstances. After all, over ten percent of hedge funds fail every year — and the average fund life expectancy throughout the industry is about five years.¹

Now consider that this new fund was set up exclusively to trade digital assets (many people use the term ‘cryptocurrency’; we prefer the former term since the full spectrum of ‘crypto’ includes many use-cases beyond what we consider to be currencies, such as utility tokens, securities, or stores of value).

Why, you may rightly ask, is it worth your valuable time to read about my decision to enter a new field that respected media outlets routinely dismiss as a scam, and some of the world’s most successful investors mock as “the biggest bubble in human history”² and/or “rat poison squared”³?

The answer, if I may so humbly suggest, is that my journey of discovery over the past six years might help you to better understand the significance of what is now happening within this emerging asset class. Every day I talk to people who are becoming aware of the asymmetric opportunities within the market for digital assets, and want to learn more. If you have not yet begun your journey “down the rabbit hole” of crypto, then I believe you will find some useful perspective here.

A generally accurate depiction of sensations felt while navigating Crypto Twitter.

First, the bad news…

In the interests of presenting an objective point of view, let’s begin with some harsh facts.

  • Most digital asset funds (like mine) trade cryptoassets exclusively. This is an asset class that is less than a decade old, and in which the vast majority of professional investors have no exposure. In fact, surveys indicate that the percentage of American retail investors who have ever owned these assets is in the low single digits⁴.
  • Liquidity and market stability are problematic, even for the largest digital assets like Bitcoin. Annualized volatility exceeds 50 percent and we are currently arising from the depths of a 70 percent drawdown — which played out over a period of less than six months.
  • Did I mention that this asset class carries a market capitalization of just US$ 230 billion? Compare that to the corporate bond market (US$ 9 trillion) or U.S. equities (US$ 30 trillion). In fact, the 75 largest institutional asset managers EACH control more capital than exists in the entirety of my “tiny” patch.⁵

As long as I’m covering all of the negatives, I should also point out that my partner and I formerly worked in prestigious jobs at two of Wall Street’s biggest banks. Now, instead of writing this from a Canary Wharf or Park Avenue trading floor, we’re set up in a two-room office, just above a restaurant, with barely tolerable air-conditioning.

By now I presume that you’re experiencing a sensation that hovers somewhere between pity and head-shaking “WHAT is he thinking?” disbelief.

But now that we’ve covered the downside risks, let me explain why an otherwise clear-headed guy on the wrong side of forty would choose to make this his life’s work.

The Discovery

Let’s take this story back to the beginning — that’s in late 2012, which is ancient history in crypto parlance.

I don’t exactly remember when I first heard about Bitcoin, or from whom. At the time, I was working for a hedge fund that invested in frontier and emerging markets. I spent a lot of time in countries that had endured multiple financial crises, or whose citizens had been driven to penury through inflation and capital controls. Most of the emerging markets investors that I know have developed a strong libertarian streak over time — a natural reaction to seeing entire nations impoverished by flagrant government corruption and incompetence.

Naturally, when I stumbled across Bitcoin I quickly became intrigued. Here was a financial system that made capital controls largely irrelevant. Anyone could cross a border with their assets, carrying nothing more than a twelve-word passphrase to access their online wallet once they reached a safe destination.

If you’re reading this in Los Angeles or London then that probably doesn’t sound like an important feature. If, on the other hand, you live in Caracas or Nicosia or Shanghai then you know that it’s a truly revolutionary way to protect your family’s assets and possibly their well-being.

Suddenly, the act of sending money to anyone, anywhere, was as easy as sending an email. This new technology was superior to our global banking system — which has run on the antiquated SWIFT network since 1973 — in every conceivable way.

In order to grasp the degree of Bitcoin’s superiority, consider the following:

  • How much easier it is for you to communicate with friends and family via Whatsapp or Facetime — let alone email — than if you were to write a letter, apply a stamp, and drop it into your nearest postbox?
  • Next, review the chart below, which compares US population growth to the volume of first-class mail delivery in the 21st century. Note that, even as the population has expanded over 15 percent, US Postal Service mail volumes have declined by over 43 percent in the same timeframe.
  • Finally, replace ‘mail delivery’ with ‘core banking revenue’ and you will begin to understand the impact that digital assets will have on the world’s mega-banks over the next two decades.
Sources: U.S. Census Bureau (2018); U.S. Postal Service (2018)

Over the next few months I read every relevant article I could find. No one in my professional or personal network had ever heard of Bitcoin, or any other digital assets. My increasingly excited attempts to describe the intricacies of Bitcoin mining were met with glassy-eyed stares and raised eyebrows. When I finally found a business acquaintance who was familiar with Bitcoin, he advised me to stay away from it.

Down the Rabbit Hole

I finally bought my first Bitcoins in June 2013. I paid US$ 85 each. A few weeks later I was introduced to someone who bought 1,000 BTC for $5 each in 2011. I often wonder where he is today.

I wish that I could tell you that I still owned those Bitcoins. However by the end of that year BTC had skyrocketed to US$ 1,000 and the temptation to take profit was too high for anyone with half a brain to resist. I kept enough BTC in the market to cover my cost basis, and sold the rest.

Amidst the ten-fold increase in Bitcoin prices that year, a real mania began to set in around the world. CNBC anchors began talking about crypto. Time Magazine published a cover story about it. Government functionaries appeared on cable news and engaged in finger-wagging lectures about the evils of anonymous currency. (The irony of the almighty dollar’s undisputed role as the ultimate anonymous currency, and preferred payment method for the likes of Pablo Escobar, was clearly lost on them.)

Inevitably, as with all market bubbles, crypto prices crashed in January 2014. Bitcoin dropped from its highs above $1,000 and sank to as low as $200, and it would not achieve a new market high for another three years. Most of the market’s late entrants — those who bought Bitcoin in the final, frenetic run-up to $1,000 — lost as much as 80% of their investment and left in disgust. Most media outlets dismissed Bitcoin as a fad, or a scam. “Respectable” financial institutions forbade their employees from owning crypto-assets, citing legal and regulatory risks.

For the next three years, crypto was a relatively quiet place to be. The media largely forgot about Bitcoin, as did the general public. Trading volumes on the largest crypto exchanges evaporated. The world moved on. After all, the S&P was in the midst of an epic rally, Greece was imploding, and Silicon Valley was churning out ‘unicorns’ at a breathtaking rate. Who had time for Bitcoin?

Why Is This Relevant?

Let’s return to the present day.

I have witnessed two full ‘boom-and-bust’ crypto market cycles now — first in 2013–2014, and more recently in 2017–2018. This is one more cycle than most people in this space, though not as many as the true early adopters.

From my perspective, the parallels between these cycles are unmistakable:

  • In each instance the early adopters realized enormous gains and were followed by a tidal wave of speculative money that drove the market to previously unthinkable new heights.
  • The relatively festival-like nature of that 2013 Singapore convention was eclipsed by the scale of mega-events and movements like Puerto Rico’s ‘Crypto Utopia’ in 2017.
  • The mania intensified until prices reached unsustainable levels, and profits evaporated as quickly as they appeared.
  • The frenetic market of December 2017 was followed by the equally momentous collapse of January 2018.
  • Late entrants lost as much as 80% of their initial investment in January 2014 — and in January 2018.
Just another day on Reddit.

At the same time, new projects raised tremendous amounts of capital in each cycle. The success of most projects that launched in 2013 was eclipsed by the frenzy of 2017’s ICO market. Ultimately most of the 2013 projects languished or failed; a few survived and are valued in the billions of dollars today. The ongoing shakeout of today’s ICO projects will be equally painful. A few winners will emerge from the ashes and be catapulted to new heights when the next bull market cycle, inevitably, begins.

It is this cycle of creative destruction that makes the market for digital assets an irresistible place to work. The innovative nature of the best crypto projects is what differentiates this asset class from simple speculative pursuits. I have never encountered anything as fascinating, or as fast-paced, as the innovation taking place in today’s leading crypto projects.

The projects that are being built in this space today are going to change our world forever, in ways that we cannot yet comprehend. Data storage, supply chain management, trade finance, law — these are just an off-the-cuff sampling of the industries that will be disrupted and, in some cases, destroyed by emerging crypto technology. Companies like Hashgraph, Tezos and Zilliqa, among others, are building new technologies and processes that will vastly improve today’s blockchains, or may even render the entire blockchain concept obsolete.

So What’s Next?

At this point, a cynical reader (and I hope that’s you, at least when reading investment newsletters!) might say that this all sounds interesting and promising, but why in the heck would anyone put their money into such an early-stage and speculative technology — let alone build a career around it?

After all, a common critique of crypto-assets is that they are simply speculative vehicles with no real utility. Recently the Economist devoted an entire section to cryptoassets, which was largely a hit piece with a central premise that crypto is ‘a failed nine-year old technology’ that ‘is in search of a problem to solve’.⁶

I categorically disagree.

Bitcoin, the leading crypto-asset, has the ultimate use-case.

As a store of value and means of exchange, it is superior to any currency or monetary unit that mankind has ever created.

Bitcoin has not yet reached its tenth birthday, and its security, transferability, and resistance to political manipulation are already better than any product currently on offer within our existing global financial system. To paraphrase one of my favorite lines from the vastly under-rated film War Dogs, “anyone who disagrees with this statement is either in on the racket, or stupid.”

At the same time, companies and projects are being built right now that are technologically superior even to Bitcoin. The use-cases coming on line right now are staggering.

Final Thought

In the early days of my journey into crypto, I would go to Bitcoin meet-ups at dodgy pubs in London’s East End, where the smartest people I have ever met were on stage and in the crowd. These weren’t fraudsters, or dreamers. They are brilliant people who remember what it was like, ten years ago this month, to be on the brink of global financial disaster and decided that there had to be a better way for our financial system to operate.

And then they began to build it.

These people are now building the future of our financial markets. And I’m excited to be along for the ride.

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I work at Kosmos Capital Management, which actively trades the emergent class of digital assets. Follow me on Twitter @kvirgil

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DISCLAIMER: Nothing in this column is intended as investment advice and you definitely should not interpret it as such. Don’t rely on my advice, or for that matter anyone else’s advice, when making investment decisions. Doing your own research is the key to success in any market.

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Endnotes

1 New Yorker, August 2014. John Lanchester, “Money Talks”.

2 This gem courtesy of Nouriel Roubini in May 2018, who as Dan Morehead of Pantera Capital points out has foreseen twelve of the past two financial crises. He also helpfully referred to Bitcoin as “bullsh-t” and its investors as “suckers”.

3 Courtesy of Charlie Munger, who offered this candid observation — also in May 2018. In his opinion, buying Bitcoin is akin to “trading turds”. No insight was offered into how crypto’s success might ultimately impact his massive investments in American Express, Bank of America and Wells Fargo — over US$ 56 billion as of Berkshire Hathaway’s latest 13-F filing.

4 Blockchain Capital Survey, November 2017. survey.blockchain.capital

5 Willis Towers Watson survey, October 2017. “The World’s 500 Largest Asset Managers”

6 The Economist, Technology Quarterly August 30, 2018. “What To Make of Cryptocurrencies and Blockchains.”

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