Cryptocurrency’s “Nifty Fifty”

++ 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”?

Posted in Cryptocurrency | 11 Comments

The Wall Street Moment

++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

Posted in Cryptocurrency | 5 Comments

The Coinbase Effect

++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.

Posted in Cryptocurrency | Tagged , | 2 Comments

How To Think About Investing In Cryptocurrency Part 2 of 4: What *needs* to exist.

++Part 2 of the 4-part series “How to Think About Investing In Cryptocurrency” starts exploring the economic forces that will drive market segmentation to help us identify the future industry leaders.  It’s best to start by asking, what needs to exist?  What services does the world need that can best be provided by a public blockchain?

++First, let me try to convince you that cryptoccurency isn’t “winner take all”, although some specific niches within the crypto world probably are.  Imagine if Uber tried to offer term life insurance?  Imagine if Lloyd’s of London tried to sell virtual reality headsets?  Imagine if McDonald’s tried to offer a 12-course $400 dinner with wine pairing?  Imagine if Nordstrom tried to compete with Walmart with rock bottom pricing?

++Some business models are natural fits for particular products.  People want to buy their insurance from stable, long-lived, boring companies.  And the companies best suited to compete on cutting edge technology offerings are generally smaller, leaner, and have an ethos of “move fast and break things.”  IBM is a good example of a huge stable company that appears superficially to be a tech business, but really is a consulting firm that just happens to consult on tech.  Similarly, Apple used to be a nimble tech innovator, but is now a consumer brand company, more comparable to something like Coca-Cola.  The winning cryptocurrency in a niche will usually not be decided predominantly based on marginal technological differences relative to competitors.  Launching a new cryptocurrency that aims to copy a market leader with a slight improvement is kind of like saying I’m going to create a product to compete with the Iphone with a better camera, or that I’m going to launch a competitor to Coca-Cola that tastes the same but with 10% fewer calories.  I’m unlikely to get very far because the specs and price are just one small part of their success.

++Turning back to cryptocurrency, there’s a critical idea that’s often overlooked: the role of community.   In cryptocurrencies, governance is driven by that cryptocurrency’s community (developers, miners/stakers, users, service providers, etc).  There’s often a positive feedback loop that makes the community more homogenous over time.  Consider Ethereum’s hard fork after the DAO bug was exploited.  Many of the community members (holders of ether, miners, developers) who strongly opposed the fork abandoned the ETH chain.  Alternatively, people who liked the philosophy that led to the hard fork were attracted to the ETH chain.  The result was that the community post-fork was substantially more homogenous than the community pre-fork.  The community is often a key feature of a cryptocurrency because it contributes to governance via game theory.  While the community can certainly change over time, it needs to be thought of as a core part of how a cryptocurrency functions, almost on par with the scripting language.  To put it simply – the community makeup of a cryptocurrency directly influences how that cryptocurrency behaves.  Cryptocurrencies are differentiated not only by their code, but also by their communities.

++Bitcoin has a community that is mostly committed to stability.  To the majority of Bitcoin users and developers, Bitcoin is IBM, it’s Lloyd’s of London.  This makes technical innovation at the protocol layer very difficult in Bitcoin, but also lends it a great deal of stability.  By “stability”, I don’t mean price stability, but rather protocol stability.  If I buy 1 bitcoin today, I can be fairly confident that in 5 years I’ll own pretty much the same thing.  In contrast, the Ethereum community has adopted a “move fast and break things” mentality.  Ethereum is Uber, it’s Facebook 10 years ago.  This community facilitates breakneck technological progress, but increases the risk of bugs, and makes it impossible to know what ownership of 1 ether will mean in 5 years.

++We see a similar dichotomy in the protocols themselves.  Bitcoin has a very simple scripting language which makes it difficult to build new features, but also relatively easy to avoid devastating bugs.  In contrast, Ethereum has a complex Turing complete language which lets it do pretty much anything, but greatly increases the chance of serious error.

++I don’t view one of these communities or scripting languages as superior to the other.  Rather, each is optimized to fulfill a particular need.

What does the world need?

++The world needs “digital gold” – an unseizable store of value, with great liquidity, a high market capitalization, stable protocol, and great security.  While it would be nice if the cryptocurrency that filled this niche also had a quick confirmation and low fee, those things are not core to the value proposition, and those factors are unlikely to determine which cryptocurrency dominates this niche.  I think this niche is likely “winner take all.”

++The world also needs cheap, fast, and private, monetary transmission.  Much of the infighting in the Bitcoin community today stems from the growing realization that it might not be possible to optimize a single cryptocurrency for both the “digital gold” and “monetary transmission” niche.  For Bitcoin to do both well will probably require a secondary layer like the Lightning Network.  Alternatively, the “monetary transmission” niche may be best served by an entirely separate cryptocurrency that may eventually be made interoperable with Bitcoin via parachains.  Cryptocurrencies like Monero, Litecoin, Dash, and Zcash are primarily competing for the “monetary transmission” niche.  For this niche, protocol stability and extreme defense against doublespends, is less important than speed, cost, and/or privacy.  I don’t need $1 billion worth of security if I’m only paying an $80 restaurant bill.  Because there are different levels of security demanded for different transactions, this may not be a “winner take all” niche.  I can imagine a scenario where there are 3+ cryptocurrencies providing varying combinations of speed-security-cost-anonymity for monetary transmission.  For example, Zcash may offer the best anonymity, but relatively slow execution if you’re on a smartphone since the algorithm is so intensive – this might be a welcome tradeoff for some uses, but highly inefficient for others. We may soon have a world were crypto A is used for maximum speed and lowest cost, crypto B is used for perfect privacy, and crypto C is used when users want a hybrid compromise.

++The world needs a platform for decentralized applications (dApps).  The cryptocurrency to provide that platform has to have a complex and evolving scripting language, and a community that embraces constant innovation (at least for the next few years until the technology is more mature). This is such a new area that I find it impossible to predict if the equilibrium is one dominant platform or multiple competing platforms with different network architectures and communities.

++So far I’ve only explained why Bitcoin and Ethereum are the two biggest cryptocurrencies by market capitalization by far.  I can’t say if Bitcoin and Ethereum will remain the dominant players in their respective niches forever, but if they get replaced, it will probably be by something that looks very similar to the incumbent in terms of both the code and the community.

What *else* does the world need?  That will be the topic for Part 3.

Posted in Cryptocurrency | Tagged , , , , , , , , , | 27 Comments