Podcast Summary
Cryptocurrencies: A Risky Asset Class: Despite their massive market cap, cryptos lack earnings and are hard to value, making them a risky investment. Some investors, like Block Tower Capital's Ari Paul, have evolved from dismissive to deeply interested due to their resilience and potential as sound money.
Despite the massive market cap of over $136 billion for all cryptocurrencies, with Bitcoin and Ethereum representing 75% of that total, the lack of earnings and the difficulty in valuing tokens make it a highly risky asset class. Ari Paul, CIO of Block Tower Capital, shares his personal journey from being dismissive of cryptocurrencies to becoming deeply interested due to their resilience during market crashes and potential as sound money. The investment ecosystem is shaped by players like Polychain, Metastable, and Block Tower Capital, who collectively manage billions in cryptocurrency investment strategies. However, it's crucial to emphasize that this episode is not investment advice. Instead, it's an introduction to the various stages of cryptocurrency investing and the strategies being employed by the pure play investors. Ultimately, the question remains: Is there real value in cryptocurrencies, and what impact might it have on the banking system and society?
Unique value of cryptocurrencies for those in unstable currencies or oppressive regimes: Cryptocurrencies provide security and borderless access to wealth, making them an attractive alternative to traditional financial systems for many people.
Cryptocurrencies offer unique use cases and value, particularly for those living in countries with unstable currencies or oppressive regimes. The inefficiencies in the cryptocurrency market present opportunities for arbitrage and profit, but operational and regulatory challenges make it difficult for larger financial institutions to take advantage. Another investment approach is in early-stage blockchain projects, where the value captured may disproportionately accrue to those involved in the innovation, similar to the early days of the internet. Ultimately, the value of cryptocurrencies and blockchain technology lies in their ability to provide security and borderless access to wealth, making them an attractive alternative to traditional financial systems for many people around the world.
Understanding the unique nature of cryptocurrencies: Cryptocurrencies require a native perspective due to their unique characteristics, including Ethereum's commodity-like nature and open-source projects' ability to create and capture value.
The value accrual in cryptocurrencies has primarily gone to non-professional, native technologists, rather than traditional investors or financial institutions. This is because cryptocurrencies are a new asset class with unique characteristics that don't fit neatly into traditional valuation methods. For example, Ethereum, which is more like a commodity than a currency, can't be valued based on revenues since it has none. The speaker, who runs a cryptocurrency investment fund, emphasizes the importance of understanding the unique nature of this asset class and approaching it from a native perspective. Open-source projects, which have historically created a lot of value but not captured it, offer a useful analogy. Projects like Tezos, which raised over $200 million through a crowd sale, can both create and capture value in a way that traditional businesses do. Understanding the similarities and differences between tokens (units of a protocol with scarce ownership rights) and equity (traditional ownership in a company) can help investors wrap their minds around this new asset class.
Tokens as Representation of Access to Decentralized Protocols: Tokens represent access to decentralized protocols, with value determined by expected protocol worth. Effective protocols allocate resources, provide fungible & verifiable resources, and don't require their own tokens if paid in other cryptocurrencies.
Tokens represent the right to interact with a specific decentralized protocol, much like how equity represents ownership in a company. The value of a token is determined by the expected value of the protocol it's associated with. Protocols can be thought of as potential future replacements for intermediaries in the form of platform businesses, as they connect consumers and producers. However, for a protocol to function effectively as a replacement for a platform business, it must allocate and aggregate resources through participants, provide a fungible and verifiable resource, and not require its own token if the underlying protocol can be paid for in other cryptocurrencies. The comparison between tokens and traditional equity is not perfect, but understanding the potential use case and scalability of a protocol can help in evaluating the value of its associated token.
The complexities of cryptocurrencies and blockchain require dedication and learning: To navigate the volatile and risky world of cryptocurrencies and blockchain, invest time and resources in understanding the technology, be skeptical of critics lacking knowledge, and embrace the unique decision-making capabilities of markets and blockchains.
Understanding the complexities of cryptocurrencies and blockchain technology requires dedication and a significant investment of time and resources. The speaker emphasizes the importance of being well-informed before making any investment decisions, as the space is volatile, risky, and difficult for the average person to navigate safely. He also highlights the potential benefits of open protocols and the unique decision-making capabilities of markets and blockchains. The speaker expresses skepticism towards critics who lack a deep understanding of the topic and encourages a learning mindset for those who are intellectually curious about the space. In essence, the journey to grasp the potential of cryptocurrencies and blockchain technology is a complex and ongoing learning process.
Understanding the Early Stages of Cryptocurrency Investing: Cryptocurrency investing involves stages from pre-launch to post-listing, each with unique challenges and opportunities. Polychain Capital excels in the earliest stage, adding value through deep tech understanding.
While there are valid arguments against specific cryptocurrencies and their underlying blockchains, the technology of blockchain with token governance itself is a significant innovation that is here to stay. However, the value of the tokens themselves is uncertain and highly risky due to regulatory risks, potential scams, pump and dumps, and high velocity of money. The cryptocurrency market is still in its early stages, with various stages of token acquisition and value addition. The earliest stage involves investing based on a protocol specification or white paper, which requires a good understanding of the technology. Polychain Capital has been active in this stage, investing based on the promise of a protocol before much code is written. The next stage involves the launch of the token on the blockchain and distribution through crowd sales. Once the tokens are listed on exchanges, they become liquid and can be traded like traditional assets. Polychain's edge lies in its ability to add value in the earliest stages of protocol development. However, this stage is also the most challenging, as it requires a deep understanding of the technology and the potential of the protocol. Overall, the cryptocurrency market presents enormous opportunities for high returns on invested capital, but also significant risks.
Investing in Web 3 technologies: Building the decentralized internet: Firm invests in early-stage tech startups creating decentralized internet solutions, focusing on developer tools and platforms like Ethereum and Tezos, aiming for mass adoption but facing challenges like scalability and infrastructure development.
The investment focus of the firm is on providing capital to entrepreneurs in the soft stage to build prototypes and minimum viable products, specifically in the realm of real breakthrough technologies that will contribute to the Web 3 stack - a decentralized internet with native financial products and a distributed server client architecture. The firm is interested in developer tools and platforms, such as Ethereum and Tezos, which offer potential for high developer activity and application building. However, challenges remain, such as scalability issues in blockchains and the need for infrastructure development, including decentralized server client architectures. The ultimate goal is to create technologies that can be used for everyday functions and reach mass adoption, but it will take time for these building blocks to be developed.
Cryptocurrency Valuations: Debate Continues: Despite disagreements on the value of cryptocurrencies, experts warn investors to exercise caution and diligence due to high risk and potential for project failures.
The value of cryptocurrencies, particularly those based on blockchain technology, is a subject of intense debate. Some see the potential for massive valuations due to their potential as stores of value, while others view the current prices as overinflated and risky. Polychain, an organization involved in underwriting, venture capital, and fundamental analysis, plays a significant role in fostering and funding innovation in this space. However, Jeremiah Loewen, a risk and statistics expert, argues that the value required for cryptocurrencies to incentivize activity on the blockchain is not necessarily large. He is skeptical of the arguments for massive valuations and believes that other use cases are more probable in the short term. Jordan Cooper, a venture capital investor, shares similar concerns about current prices and the high risk associated with many projects in the space. He has seen a high rate of project failures and notes that many are trading at inflated market caps. Both experts emphasize the importance of diligence and caution when investing in this rapidly evolving field.
Identifying foundational technologies and teams in cryptocurrencies: Venture investor Jordan Lyall emphasizes the importance of identifying foundational technologies and strong teams in cryptocurrencies, with Ethereum's utility value and integration with downstream applications as key factors in its potential long-term success.
While some investors may be drawn to the speculative nature of cryptocurrencies and the potential for quick gains, venture investor Jordan Lyall emphasizes the importance of identifying foundational technologies and teams with long-term potential. He believes that the utility value of Ethereum, which functions as a developer-facing platform allowing users to borrow existing blockchain infrastructure, is a significant factor in its value. Lyall suggests analyzing the depth of integration between Ethereum and downstream applications to determine the demand for its native coin. He also acknowledges the role of Ethereum as a store of value, but questions whether its industrial applications add value or detract from it. Ultimately, Lyall values the clarity of a pure play store of value like Bitcoin over the potential complexity of a multi-functional cryptocurrency like Ethereum. As the cryptocurrency market evolves, Lyall anticipates that fundamental analysis will become more granular, potentially leading to revaluations of certain coins.
Naval Ravikant's perspective on cryptocurrencies and blockchain: Naval Ravikant believes in the future of blockchain but evaluating cryptocurrencies as investments is complex. High entry prices require careful consideration of price vs fundamentals, and diversification into high-value use cases like store of value and programmable money is key.
Investing in cryptocurrencies, particularly Bitcoin, is unlike traditional equity investments due to the potential for massive growth based on network effects and the agreement of the network on its value. Naval Ravikant's idea that blockchain technology is here to stay but evaluating cryptocurrencies as investments is tricky is widely accepted in the crypto community. The fat protocol thesis, which suggests that protocols themselves hold value and most potential returns will accrue to token holders, has proven true thus far. However, the high entry prices mean that investors need to carefully consider the relationship between price and fundamentals, which may still be largely based on psychology and speculative value. Value investors like Josh Siems and his firm Metastable aim to make a bet on blockchain by properly diversifying and focusing on high-value use cases such as store of value and programmable money. Ultimately, the goal is to not miss out on the return potential of blockchain technology by being all-in on one currency.
Impact of Blockchain on Various Industries: Blockchain's potential lies in stable value tokens, credit and debt markets, prediction markets, and base use cases like storage and compute networks. Success depends on both technology and community management.
Blockchain technology is expected to have significant impacts on various industries, particularly in the areas of stable value tokens, credit and debt markets, prediction markets, and base use cases like storage and compute networks. The long-term success of these applications depends on both the technological merits of the underlying protocols and the community management of these open-source projects. While there may be multiple credible candidates in each category, the strength of the technology itself is crucial. The blockchain industry is still in its early stages, and researchers are actively exploring ways to reason about real-world events and bring real-world information onto the blockchain. The potential for blockchain to reason about real-world events is huge and is an area of active research. The fund's approach is a hybrid of top-down and bottom-up analysis, focusing on the long-term potential of each use case and finding credible candidates with a strong technological foundation. Ultimately, the success of these projects will depend on a combination of technological innovation and effective community management.
Understanding Cryptocurrencies goes beyond white papers: Engineers, developers insights valuable, landscape changing, investable cryptocurrencies evolve, stay informed
Investing in cryptocurrencies requires a deeper understanding of the technology beyond just reading white papers. Engineers and developers who can analyze source code and discover bugs have valuable insights that are not easily accessible. The cryptocurrency landscape is rapidly changing, with new categories and coins emerging constantly. Our universe for investing includes anything that is tradable and investable in the cryptocurrency space. Coins represent different versions of digital currencies, some of which are built on existing blockchains like Ethereum, while others create their own. New tokens often piggyback on existing networks to avoid having to build everything from scratch. ICOs, or initial coin offerings, are a common way for new coins to launch, with some projects receiving significant funding and immediate exchange listings. The universe of investable cryptocurrencies is constantly evolving, and it's essential to stay informed about new developments to make informed investment decisions.
Converting Fiat to Cryptocurrency: A Challenge: Banks hesitant to work with cryptocurrencies due to regulatory uncertainty, but some exchanges allow converting fiat to cryptocurrency. Tokens' value comes from belief in underlying protocol's growth and developers' incentive to improve it.
While there are over 100 new cryptocurrencies, or tokens, being issued on the Ethereum network and beyond, converting fiat currency to these tokens is a challenge due to regulatory uncertainty. Banks are hesitant to work with cryptocurrencies until clearer guidelines are established. However, some well-regulated exchanges allow users to convert fiat to cryptocurrency through them. The value of these tokens can be significant, with Bitcoin's market cap reaching $45 billion. Tokens serve various roles, such as representing computing power or storage, and their value can increase as the underlying protocol grows. It's important to note that while we refer to cryptocurrencies as an asset class, they play many different roles. Bitcoin, for instance, functions as both digital gold and a monetary transmission network. The value of tokens comes from the belief that the underlying protocol will grow and the services or capabilities it provides will become more valuable over time. Developers are incentivized to build and improve these protocols because they own the associated tokens.
Cryptocurrencies enable efficient allocation and incentivize production in capitalism: Despite challenges like regulatory hurdles, operational difficulties, and security concerns, active managers can navigate these issues and monetize edges in the cryptocurrency market, applying lessons learned from traditional markets
Cryptocurrencies create marketplaces for scarce resources, enabling efficient allocation and incentivizing production. This is particularly valuable in the context of capitalism. However, while the potential for alpha in the cryptocurrency market may seem enormous due to its perceived inefficiency, it also presents significant challenges. These include regulatory hurdles, operational difficulties, and security concerns that make it difficult for traditional hedge funds to enter and compete. As a result, there are substantial opportunities for active managers who can navigate these challenges and build sustainable structures to monetize the edges in the market. The lessons learned from traditional markets, such as the importance of structural advantages and the need to compete fiercely for small edges, apply to arbitrage in the cryptocurrency space as well. While the potential rewards may be great, the road to success will be long and challenging.
Viewing crypto as a collection of call options: Investors should diversify their crypto portfolio and identify market regimes to limit risk. The ownership base is small, but there's room for growth and new investors. Barriers to entry are being addressed, making crypto an attractive investment opportunity.
While the potential for significant returns in cryptocurrency is high due to its extreme volatility and asymmetric risk reward, it's important for investors to view their portfolio as a collection of call options rather than individual stocks. This approach can help limit risk through proper diversification and identification of market regimes. Despite the excitement surrounding cryptocurrency, the ownership base is still relatively small, with less than 3% of Americans and under 5% of people in finance owning it. However, as the market cap remains smaller than that of companies like McDonald's, there is significant room for growth and potential new investors, such as family offices and institutions, to enter the space. Barriers to entry, like counterparty risk and custodial concerns, are being addressed, making cryptocurrency an increasingly attractive investment opportunity for those willing to embrace its unique characteristics.
Institutions and Financial Players Increasingly Adopting Cryptocurrencies: Family offices are leading the way in cryptocurrency investments, with Ripple aiming to replace SWIFT for interbank transfers, potentially leading to regulatory arbitrage and innovation. Institutions are cautiously approaching the space due to maturing infrastructure and the need for due diligence.
The adoption of cryptocurrencies by institutions and large financial players is expected to significantly increase in the coming months and years. This is due to the growing ease of buying and storing cryptocurrencies, as well as the development of infrastructure such as insured structured notes, over-the-counter products, and eventually, an ETF. Currently, family offices are leading the way in cryptocurrency investments, with Ripple, the third largest cryptocurrency, aiming to replace the SWIFT network for interbank transfers. Its XRP token needs to have high economic value for this to work, and it's being given away to banks to bootstrap this process. This could potentially lead to regulatory arbitrage and technological innovation in the financial sector. However, endowment investors are still cautiously approaching the space due to the need for mature infrastructure and due diligence. Overall, the cryptocurrency market is still in its early stages, but the potential for disruption and innovation is significant.
Decentralized casinos like FunFair offer transparency and fairness: Decentralized casinos provide transparency and fairness through open-source technology, contrasting traditional casinos with potential regulatory issues and cheating concerns. The crypto market's fragmented information landscape may limit large investor participation, but as barriers ease, competition and innovation may increase.
The decentralized casino platform FunFair, with a market cap of around $60 million, offers transparency and fairness through its open-source and decentralized nature. This contrasts with traditional centralized casinos, where regulatory issues and potential cheating can be concerns. The small community of investors in FunFair, many of whom are passionate believers, highlights the fragmented information landscape in the crypto market. As for hedge funds and large investors, the barriers to entry, such as security concerns and regulatory compliance, may limit their participation. However, as these barriers ease, more players may enter the space, potentially leading to increased competition and innovation.
Competition in the Crypto Market: Only Those with an 'Unfair Advantage' Will Succeed: In the uncertain and rapidly changing crypto market, only firms with deep relationships, market understanding, and the ability to attract top talent will be able to succeed as competition increases and barriers to entry fall.
The crypto market is currently in an early stage with significant barriers to entry, leading to a concentration of power among a few dominant players. However, as these barriers fall, competition will increase, and only those with an "unfair advantage" will be able to succeed. This advantage comes from a combination of deep relationships, market understanding, and the ability to attract top talent. The focus for firms like Block Tower is to build a team and a reputation that makes it difficult for competitors to catch up. The crypto market is uncertain and rapidly changing, with regulatory issues and high valuations being major concerns. Despite these challenges, there is also the potential for significant rewards, as shown by the success of early investors in the space.
Exploring the Future of Crypto with Hash Power: The crypto market's future remains uncertain, but emerging protocols like Filecoin and Blockstack offer potential solutions to industry challenges. Stay informed and adapt to changes as the crypto space continues to evolve.
Key takeaway from Hash Power's discussion is that the future of the crypto market remains uncertain with questions about competitive returns against the cap weighted index of top tokens and the eventual dying down of volatility still up in the air. However, the show offered a glimpse into the future by featuring conversations with creators of protocols like Filecoin and Blockstack. These protocols aim to address issues within the crypto space and could potentially shape the industry's future. As the crypto market continues to evolve, it's crucial for individuals to stay informed and adapt to the changes. Stay tuned for the final episode of Hash Power next week, where we'll delve deeper into the potential future directions of the crypto space and provide insights on what steps you can take next.
