Early stage valuations fall to earth

I initially wrote the following as an internal memo to our team this morning, but thought it might be interesting to the broader crypto world.

We’re seeing something play out in real time (but slow motion) that we’ve long expected.  The crazy valuations of early stage projects are falling to earth.

6 months ago, a decent team with an idea on a napkin were raising at $100m+ valuations, sometimes $250m+.  This happened because investors mistakenly extrapolated the amazing returns of 2017 ICO investing forward.

The average return on a pre-ICO or even ICO investment prior to around April 2017 was outrageously high.  The projects from before this period were generally valued at <$10m pre-ICO and <$40m at ICO time.  They were generally high quality projects, since it wasn’t easy to raise $20m in an ICO prior to 2017.  The ‘get rich quick’ entrepreneurs mostly weren’t on the scene yet, so the ratio of good projects to bad was relatively high, and the valuation entry points were relatively low.  It’s far easier to earn a 5x on a $10m valuation than on a $100m valuation.

Combined with the general market run-up in the second half of 2017, every one at every stage had a chance to profit.  The earliest pre-ICO investor got a mark up to the later stage pre-ICO investor, who got a mark up to the ICO investor, and all were able to exit on exchange listing to an exchange buyer, who often also profited.  In the last 6 months, the exchange buyer has consistently been losing badly, so they’ve mostly stopped buying.  This means that the late stage pre-ICO investor also started often losing.  Until now, the early stage pre-ICO investor was still winning, but it’s like dominos, and we’re nearing that last domino falling as well.

As a result, many investors have been more public about their aversion to investing at ‘crazy’ valuations, even when offered deep discounts to those crazy valuations, since those deep discounts still look overpriced and there’s likely to be no one to sell to in the near future.  For example, a 75% discount to a $200m valuation is still $50m, which is still aggressive for an early stage project with limited usage, network effects, and switching costs.  Sometimes I find myself looking at a project thinking, “I’d never invest at in this at $50m, but maybe it’s interesting at $50m if that’s a 75% discount to the $200m valuation others are or will pay?  That line of thinking isn’t inherently irrational, but it is dangerous.  It’s a trader’s mentality, not an investor’s mentality, and it relies on market timing, not investment underwriting.

These things play out in slow motion, because both investors and projects are reluctant to realize mark-downs, and the lack of a liquid exchange price means they can fool themselves.  One way this plays out is what we’re seeing – much smaller raises at the high valuations.  For example, consider a project that had an initial angel round raising $2m at $10m, and now raising $10m at $200m.  If they find the $10m of investment at the higher, those early investors think they have $40m worth of tokens.  But while the $200m valuation is ‘fair’ from an accounting perspective, it’s not real from an economic perspective – there’s only $10m worth of liquidity at that price, so holders of the $40m worth of tokens can’t exit at that level.  If even half of them tried, it would likely crash the valuation 50%+, maybe much more.

As a result, there’s been a long lag in pre-ICO valuations coming down to earth to match the public markets and changing investor sentiment.

This may produce some attractive investments in the near future if investors ‘panic’ and look for OTC liquidity to exit their pre-ICO investments, but since many of these valuations have so far to fall, and investors are very reluctant to realize 80%+ losses, this will likely both take some time to play out, and willing sellers at attractive levels may be scarce.

This market dynamic is not a surprise to most of the investors in the space – many understood that they were playing musical chairs, and just hoping to be able to find a chair before the music stopped.  Timing the music is far harder than identifying the game.

The very best projects will survive their valuation write-downs and ultimately thrive.  And hopefully we’ll see new projects come to market at reasonable levels, 1/5 the valuations of the recent batch soon that will provide attractive investment opportunities.

Timing these cycles is challenging, and the illiquid nature of the assets means that to successfully time them, you have to anticipate the cycle by 3+ months (maybe 6+ months now given longer lock-ups.)  Doing this at the margin makes sense (e.g. deploy more capital in bear markets, less in bull markets), but I think it’s generally best to do so as shifts to an underlying consistent investment strategy.  In other words, rather than deploying nothing for 9 months, and then racing to deploy, I think it makes sense to have an underlying “slow and steady” approach to allocating capital to top decile projects each quarter, and to maybe cut that pace in half when valuations seem high, and to double it when valuations seem cheap.  To the extent an investor wants to further time the general market, this can be done by increasing or decreasing liquid cryptocurrency exposure.

That’s the end of the internal memo.  I’m getting asked by a lot of projects what this market dynamic means for them.  There’s no “one size fits all” advice I can give – it depends on your project, the current size of your treasury relative to your roadmap, and your ambitions.  But there are a few specific suggestions I can give. 

First – be realistic.  A down round (aka raising at a lower valuation than your last raise) is optically bad and you may reasonably choose to avoid it by simply not raising at all if your treasury is sufficient.  But…if your project needs that influx of capital to thrive, swallow your pride.  Whether you exchange $5m for 10% or 30% of your project’s tokens is trivial relative to maximizing the odds of your project surviving and succeeding.  30% of 0 is still 0.  And 10% of $1 billion is still $100m.  Momentum and optics matter, but they ultimately matter far less than actually building a product/service/network that offers value to users.

Second – think about what you really need.  Sure, it might’ve been nice to build a $50m warchest, but what do you really need to execute on your vision?  Think critically about your roadmap and what you need financially to execute on it.  

Third – love your investors.  A great many investment agreements in our industry are on questionable legal and regulatory footing.  Some are explicitly ‘donations’, others are utility token agreements with lengthy contracts that exist in a regulatory gray area.  Many ‘good actor’ projects likely violated legal and regulatory fine print.   JP Morgan and Credit Suisse routinely violate contracts with one another over delivery of treasury bonds for example.  This *could* result in a lawsuit, but almost never does – rather they resolve things amicably instead of racking up huge legal bills, incurring negative publicity, and damaging relationships.  When the market is up – no one looks too closely at contracts or thinks about lawsuits.  When markets are down, this becomes an issue.  Recognizing that early stage investing is largely based on trust and that this industry is largely one based on relationships, projects should be careful to treat investors as valued partners in all regards.  One example – many projects are currently re-writing their investment agreements to better comply with current SEC guidance.  Such re-writes can be viewed as exploitative by investors or as necessary for the project’s success.  Pivots, contract re-writes, and corporate restructurings may be important for a project’s success which every investor desires for their portfolio holdings.  Project leaders must communicate both the substance and intent of such changes.  This is important to ensure that investors view such changes as for their own benefit as well as the welfare of the project.  





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Education – University of Chicago Alumni Event

BT Educationpdf

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Forbes Article: It’s 1994 in Cryptocurrency

Comparing Cryptocurrency in 2017 to Tech in 1994:



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Cryptocurrency And The History of Money

I helped Alliance Bernstein analysts Gautam Chhugani and Gaurav Jangale write the note below for their clients.

AB_CryptoFinance Insights_Is Bitcoin money

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Disclaimers and disclosures

Last updated 03/07/2018

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.

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Don’t ignore the competition

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.

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Table Selection

++ 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.

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