On Tech, Business, Society.

Category: Finance

What Type of Investors Does Crypto Need?

Let’s beg the question – how relevant are traditional Wall Street fund managers as investors in the crypto sector? 

My viewpoint is that we need fund managers that are long term believers and are committed because they have done their own original research. They should be able to understand crypto to the point where they are able to comprehend what the technology does, where it is going, and are able to form their own defendable (and original) thesis across the many emerging blockchain sectors. But do they? 

For example, of the traditional investors that get it, Ray Dalio is one of them. In a CNBC interview this morning, he said that he sees Bitcoin, cryptocurrencies or digital gold, as part of the “new money” that is a medium of exchange and a store-hold of wealth that you could move between countries. He admitted that Bitcoin had made tremendous achievements over the past 11 years towards those goals.

Sadly, many other so-called crypto investors have a superficial knowledge pertaining to what they got into, and often haven’t even used the technology themselves.  

Fickle investors will flee their investments the minute there is a weakness or bad news, because they need to protect their capital, and will wait for the next momentum cycle. 

Maybe, the crypto industry was too early for the proverbial “Here comes everybody”.

Most current crypto investors have no real relationships with the projects they are investing in, except the relationship they have with the price chart. I doubt some of them even spoke to entrepreneurs directly. 

Investing in crypto is not yet like investing in the stock market where companies are at a known stage of predictability in their business, and where valuation metrics are more easily quantifiable or visible. There is no such thing as a missed quarter that later corrects itself. Instead, the field is full of information asymmetry. 

Traditional Money Managers Don’t Get It, Won’t Get It, Can’t Get it

Reality is that not all traditional fund managers will be able to fully comprehend, let alone believe in the crypto revolution. The grand-daddies of conservatism, Buffett and Munger have already spoken, and their views are the epitome of denial that there is something new here.

In part, the analogy of asking traditional fund managers to get into crypto is like asking a professional basketball player who has never heard of soccer to suddenly play that game. Imagine they would start saying things like: 

  • The net is too wide, that doesn’t make sense!

  • You can’t touch the ball with your hands? That will never work.

  • Why is the field so long and wide? It will be too tiring to go up and down both ends!

  • Why are there 11 players? You can’t easily talk to each other. 

  • Why don’t you stop the clock if there is a whistle? That’s not fair. 

Well, the rules of soccer are very different from those of basketball. And the type of players it attracts is different. Both games have tackling, intercepting, shooting, and blocking in common, but it doesn’t mean that an athletic basketball player that is willing to learn and adapt couldn’t play soccer if they wanted to. However, not all of them will be able to.

Taking the analogy one step further, imagine a sports regulator stepping in and saying: we’ve had the rules of basketball for years, all other sports must adapt to them.

What Matters is Who is Staying, Not Who is Leaving

During the UST/Terra debacle and overall crypto prices correction of mid-May, talking-head after talking-head went on CNBC exposing their ignorance of crypto and predicting the darkest scenarios about an industry they clearly never understood well enough. Most of them would be hard pressed to talk for more than 15 secs about what crypto really does in terms of the variety of use cases and state of practice.

In retrospect, it wouldn’t be such a bad thing if some types of investors flee the crypto markets, as they get replaced by smarter ones who get the longer term view. What matters is who is staying. Developers, entrepreneurs, smart investors and dedicated users are all staying. 

If the narrative shifts too hard towards prices, speculation and superficial involvements, instead of latching on the fundamentals of blockchain technology via a discriminating eye, we have lost the plot about what crypto is about.

It is mind boggling to see most coins (especially the L1 variety) move up and down almost at the same rate. Do these “investors” clearly have any clue about how different the top 10 L1 blockchains really are? For example, for the amount of weight it carries and share of transactions it commands, it is surprising that Ethereum’s market dominance keeps hovering below the 20% level. 

As long as most cryptocurrencies fall and rise in unison, and investors follow each other like sheep, this points to the fact that the market is full of investors that are not very sophisticated nor discriminating. The crypto industry will not be able to break free of its own if it continues to be linked to the vagaries of the traditional markets. 

In the next post, I will debunk the theory of crypto-to-market coupling…or decoupling. 

Bad Actors or Failures Do Not Define The Crypto Industry

There is no point second-guessing the viability of the crypto industry. The industry’s active participants are not going anywhere. The crypto/Blockchain industry is a complex set of technology pieces that are still maturing and growing, so it’s common that it gets mischaracterized along the way. While its boundaries are still being defined, the ambitions of its dreams are not being lowered.

Increasingly More Severe, But Self-Inflicted Injuries

In retrospect, the tough moments that the crypto industry has endured in the past several years were self-inflicted. Mt. Gox, the DAO hack, Quadriga, every DeFi rug pull or vulnerability exploit and the recent UST/Terra situation were the result of bad/incompetent actors or projects from the industry itself.

What just happened with UST/Terra was not a symptom of a systemic matter. It was just one project. But since everything is interconnected, there is cause for concern because this last disaster and extent of the damages became bigger in scope.

Mt. Gox’s losses were into the hundreds of millions, the DAO hack was $60 million, Quadriga was $200M, DeFi rug pulls or smart contract vulnerability exploits are typically in the $50-350M range. But the UST/Terra debacle was a $60B blow, accompanied by another $500B in overall market cap decrease.

That is an order of magnitude jump and it is not to be underestimated, but let’s not allow bad actors or failures to define the crypto industry. There are so many other good parts about crypto and the Blockchain industry that are still in the works:

Web3 is unraveling with its many pieces and use cases: the creator economy, smart contracts, GameFi, DeFi, DAOs, NFTs, token-based models, cryptocurrencies, self-custody wallets, the metaverse and much more. These are the artifacts and mashups of the blockchain economy from which web3 will emerge.

Extreme Enthusiasm or Excessive Hope?

There is no doubt the UST/Terra situation will be analyzed for months and years to come, just like the DAO hack and Mt. Gox fiascos were. Whether it was extreme enthusiasm or excessive hope in an unproven experiment, both of these factors were certainly responsible for compounding the gravity of the situation.

Longer term, we need to wonder if this incident was caused by a rare reckless driver or whether there are other projects or people with potential failures on the horizon.

There is a difference between experiments and fully proven and tested projects. The UST stablecoin relied on a protocol of algorithmic adjustment of supply (arbitrage) to stabilize its price. That type of algorithm is really at the experimental stage, and it did not pass the ultimate stress test that eventually killed it. The utopian thought of an algorithmic central bank is just that, for now.

Cryptocurrencies have given us innovative possibilities in the programmability of money, and it’s very exciting. This led to the field of smart contracts that codify business or technical logic into programs and commit them to auto-run on the blockchain. However, money protocols (e.g. UST) are at another level. They combine smart contracts and algorithms together in a compounded manner. If they work well, it’s great. But if they don’t, the failures can be spectacular.

The backers of Terra (or any other crypto project) shouldn’t be confused with an assurance of success. Backing a project simply means that you are willing to go down the risky path with them. It is an endorsement of the journey, not a guarantee for success. VCs are portfolio managers, and their true north is to diversify risk by investing in multiple projects so that the winner end-up offsetting the failures. It’s one thing if Terra/UST represented 5% of a given fund’s portfolio, but it’s another thing if it was 50% of someone’s investments or savings.

While experiments are necessary, we cannot just rely on the hope they succeed without knowing well what the impacts of failures might be. In retrospect, UST/Terra became too big too quickly due to excessive marketing and misleading analysts (that’s another subject I will cover in a subsequent post).

Stablecoins are essential and important for the future of cryptocurrency. Perhaps we should confine their constitution to the simple backing of verifiable assets, and refrain from exotic algorithms that are broadly at the experimental and risky trials stage.

“It takes a lifetime to build a good reputation, but you could lose it in a minute”. Such were the famous words of Will Rogers.

The crypto industry has been working hard to build a good reputation for the last 10 years, despite it being perceived to live in a closet as a fringe sector and not getting the respect it deserves.

We are still testing the boundaries of what’s possible or not. Back in the early Web/Internet days there were many stupid ideas and failed ones. And there were spectacular failures as well (Pets.com, Enron, Webvan and others).

We should not let failures or over zealous / reckless entrepreneurs define the crypto industry. Let us extract the lessons, and spring forward without that baggage.

How Will DeFi Enter the Mainstream?

I’ve been thinking a lot about DeFi, the latest significant emerging blockchain technology segment.

Despite the excitement and positivity surrounding it, DeFi is not on a good trajectory. DeFi users (just like its creators) are geeky. They are mostly crypto nerds or early adopters.

The innovation around DeFi merits that it grows beyond its early adopters beachhead, but it is facing headwinds because its growth will be limited if it doesn’t break out and start attracting more mainstream users.

For DeFi to thrive, it must enter the mainstream and attract those users who do not tolerate nor understand DeFi’s geekiness.

I’ve written a post on CoinDesk explaining why and how DeFi could grow further: For DeFi to Grow, CeFi Must Embrace it.

I do believe that the central exchanges have an opportunity to incorporate DeFi products into their offerings, but both sides have some work to accomplish, in terms of technical integration and market education.

Here’s the link to the article: For DeFi to Grow, CeFi Must Embrace it.

Powered by WordPress & Theme by Anders Norén