I helped Alliance Bernstein analysts Gautam Chhugani and Gaurav Jangale write the note below for their clients.
Last updated 10/29/2017
Twitter is a challenging medium for a manager of an investment firm, since the character limit makes standard disclaimers impossible. A suggestion that I took to heart, was to include a link to such disclaimers and disclosures in my twitter bio. Relevant information will remain on this page, updated as appropriate, however all content is subject to change without notice.
I’m the CIO of BlockTower Capital. We invest in and actively trade many cryptocurrencies. We have the ability to take both long and short positions, and fairly frequently enter and exit positions. Anything that I write about crypotocurrency represents a potential conflict of interest given my role as the manager of a cryptocurrency portfolio. The information included on Twitter or other public mediums is for general information purposes only. Nothing that I write should be construed as, or relied upon as, investment, financial, legal, regulatory, accounting, tax or similar advice. Nothing should be construed as a solicitation to invest in any security, future, or other financial product, and nothing herein should be construed as a recommendation to engage in any investment strategy or transaction. You should consult your own investment, legal, tax and/or similar professionals regarding your specific situation and any specific decisions.
An investment in any strategy involves a high degree of risk. There is the possibility of loss and all investment involves risk including the loss of principal. Any projections, forecasts and estimates are necessarily speculative in nature. Matters they describe are subject to known (and unknown) risks, uncertainties and other unpredictable factors, many of which are beyond my knowledge or control. Any data, calculations, or qualitative statements about the present or past may be erroneous. No representations or warranties are made as to the accuracy, reliability, or completeness of any statements. All information is provided “as is”, without any warranty of any kind. All statements are my personal opinion, unless otherwise specified.
Cryptocurrency investors usually only look at the investable landscape. They ignore those projects that are hard (or impossible) to invest in. This is a big mistake when considering an investment in a competitive industry.
When I talk to cryptocurrency investors, they often defend an investment by saying, “great team, great technology, real use case.” I then ask, “who are their competitors and why do you think that this team will be the winner?” Usually…silence. Sometimes, the person will respond by naming other competitors with an exchange listed cryptocurrency or an upcoming ICO. Never do they respond with competitors that have no cryptocurrency.
Consider Ripple (XRP). XRP has numerous competitors with no tradeable cryptocurrency like R3 and Digital Assets Group. To decide if XRP is a good buy, you have to look at the competitive landscape and decide why you think XRP is likely to beat out the competition.
Civic (CVC) is another example. Great project, great team, but they have at least a dozen serious competitors, some of which may have greater traction. CVC may be a great bet on the blockchain identity use case, but we can only conclude that after comparing Civic to its long list of competitors.
It’s important to remember that most cryptocurrency is open source, and so the value is based primarily on network effects. When looking at new projects that don’t yet have meaningful network effects, we’re mostly betting on the team’s ability to quickly establish a first mover advantage in a particular use case. Making that call requires evaluating the level of traction the competition has achieved.
Back in my college days, I played poker. A lot of poker, at high stakes. I played online, in Atlantic City, in underground Philadelphia poker clubs, and against other UPenn undergrads. I was a very good player, but I had a few college friends who were objectively better. They were better at every aspect of the game…except one: table selection. And because of that one weakness, a couple of them were constantly broke.
These young poker players would make tens of thousands of dollars playing against “fish”, but would then take their winnings and sit down with the very best players in the world. They would challenge the best professionals, like Phil Ivey, to high stakes heads up games. Inevitably, they’d eventually lose to the superior players and often they’d lose everything. Then they’d borrow a few thousand dollars from friends and rebuild, only to lose it all again against the top pros.
I too occasionally tested myself against the best in the world, but I knew I was paying for a lesson, and would only sacrifice a small percentage of my winnings. I spent most of my time playing against weaker players. I realized early on that table selection was a part of poker too, and there was no shame in using that as a critical part of playing profitable poker.
“Table selection” refers to choosing a poker table at which to play. And it, more than anything else, determines whether you’re likely to end up a winner or a loser. Unless you’re the very best or very worst in the world, your expected value depends on your opponents. If you’re the 10th best player in the world but only play against the top 9 professionals, you’ll go broke. If you’re a mediocre player but exclusively play against even worse players, you’ll be profitable.
This concept applies throughout life. Venture capitalists know it’s a bad idea to invest in companies trying to beat Amazon at its own game. And as a trader, there are some tables I want to sit at, and others that I want to avoid.
Trading in many traditional markets is like sitting down at a table of the top professionals. It’s possible to win as a long/short equity trader, but you’ve got to be among the very best in the world. In contrast, cryptocurrency trading is currently like sitting at a table of weak players; there may be the occasional professional, but we’re not competing with the professional. Rather, we’re playing against the price insensitive retail investor – the person who panic sells BTC at $1800 that has never heard of BIP 91, or the person who buys ETH on margin at $400 without a glance at the network capacity or scaling roadmap. We’re not trying to impress with complex trade ideas. We’re not trying to show off by out-thinking other professionals. We’re here to win.
In practice, this means that we’re flexible. Back in April I was sitting at the ICO table. I invested in the Cosmos Network’s Atom token at an attractive valuation. Over the following month, the ICO table got much more competitive. Initial valuations skyrocketed as investor capital flooded into the space. And a great many of the professionals entering cryptocurrency are currently focused on ICOs. So…for now at least, I’m not. This isn’t to say that there aren’t attractive ICO opportunities – there are. But I see softer tables at the moment.
Table selection requires that we banish our egos. Avoid the temptation to compete against the best (even if you think you are the best.) Choose your opponents carefully.
Usually in bull markets, the “high beta”, riskier securities outperform. This is what we saw over the last 7 months. Bitcoin rallied impressively, but was dramatically outperformed by the more volatile and more speculative Ethereum, which was itself outperformed by some of the even more speculative and smaller cryptocurrencies. The tail end of such rallies are often “junk rallies”, with the strongest gains accruing to the fundamentally least attractive securities.
But this pattern doesn’t always hold true, and I think we’re about to see the exception. I think we’re likely to see a strong cryptocurrency rally that’s led by a handful of high market cap cryptocurrencies. For a historical analogue, consider the “Nifty Fifty” in the 1960s and 1970s. Institutional investors became enamored with about 50 growth stocks that came to be viewed as “single decision” stocks. People felt they could buy those equities with confidence they were both safe and high performing assets. That belief becomes self-reinforcing for a time – as money flows in and people buy every dip, the securities do indeed look both very stable and very lucrative.
Which securities are the cryptocurrency “Nifty Fifty?” Consider where institutional and retail money can flow most easily. Look at the cryptocurrencies offered by Coinbase, Gemini, and the investment trusts offered by Grayscale, and the equivalent companies in Asia. Look at the most liquid, most stable, and oldest cryptocurrencies, the ones that would be most appetizing to, say, a Family Office that wants to broadly invest in cryptocurrency in as passive a form as possible. What cryptocurrencies can most easily be thought of as “established”?
Over the last two years, the big investor in cryptocurrency was “Silicon Valley.” The high profile investors were mostly tech entrepreneurs and their family offices and venture capital firms.
I just finished a NYC roadshow with mostly that same type of investor (despite being on the opposite coast), but also had some surprising meetings with “Wall Street.” Today I spent an hour at a bulge bracket Wall Street bank and met with their prime brokerage and capital introduction divisions. They’re interested. They get that this is going to be big. Each of the half dozen senior bankers around the table kept saying, “I need to learn more.” Their research divisions are starting to publish detailed sell-side research on cryptocurrency and blockchain tech (including a very impressive 80 page report on blockchain disruption.) They’re holding internal informational seminars for their partners. They’re starting to think about offering prime brokerage, custodial services, capital introduction…the laundry list of services that Wall Street provides for every major asset class. They have a long road to building those platforms, but I suspect that within 9 months, they’ll start providing some of the services necessary to make institutional investors comfortable with cryptocurrency.
I also met with a couple reporters at two leading financial publications on background – and they’re in a similar place. They’ve been reporting on cryptocurrency, but usually as a one-off story. They report on sharp rallies and collapses in the price of bitcoin or ether and occasionally mention the small fund managers in the space, but usually it was presented as a quirky observation of something crazy happening. The reporters have a growing appreciation that this is here to stay but aren’t sure how to approach covering cryptocurrency. Do they treat a crypto fund manager like any other hedge fund manager? Do they report on individual cryptocurrencies like equities or commodities or as new technologies? They know they need to learn more.
Six months ago, I realized we were about to have “the wall street moment.” The pattern of adoption of cryptocurrency has (and I think will be) something like this:
Cypherpunks -> Engineers -> Silicon Valley -> Wall Street -> Institutional Investors -> Main Street
Coinbase added Litecoin for direct purchase today, and litecoin (LTC) is up about 30% as a result. The rumor of this addition may have also contributed to LTC’s 100%+ rally over the last 2 months.
The only other currency Coinbase added (beyond its initial offering of Bitcoin) was Ethereum back on July 21st 2016, just a day after Ethereum’s hard fork. Ethereum’s addition to Coinbase produced an immediate 14% rally, although it’s hard to tease out the real effect given the volatility surrounding the hard fork. Ethereum’s accessibility on Coinbase (and then Gemini) likely contributed to its massive rally over the following 9 months.
Are these rallies rational? Yes. There is a very heavy accessibility premium in cryptocurrency valuations. As a cryptocurrency becomes easier to purchase and easier to store, it’s valuation should rise…and it clearly does.
What does this mean for investors? We enjoy a tailwind if we’re willing to invest in cryptocurrencies that are harder to access. If and when those cryptocurrencies then become more accessible either by being added to Coinbase, offered in trust form, or purchasable via ETF, we can expect the valuations to generally rise substantially.