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Thoughts on Cryptocurrency Investing, Valuations, and Portfolio Construction

“Price is what you pay, and value is what you get”

Warren Buffet

For an asset class that is receiving rapidly increasing levels of investor interest, a majority of crypto investments are purely based on heuristics and not necessarily backed by robust data-driven valuation models. We are very much in the early days with developing frameworks for valuing cryptocurrencies. While the asset class has matured significantly over the last decade and the valuation had soared to almost a trillion at the beginning of this year, we still struggle to arrive at a consensus on the best way to value cryptocurrencies. Efforts have been made to borrow traditional valuation models from other asset classes. The comparison however, is flawed, for multiple reasons. For one, unlike equities, cryptocurrencies are not companies and are not cash-yielding. Secondly, in these early days, we cannot accurately predict the potential scale of disruption that cryptocurrencies and blockchain technology can cause i.e TAM estimates at this point in time could be way off the ball park, as with most early technologies..

Another reason why the current valuation models seem a bit raw is because unlike in traditional finance, folks have not been able to nail down if a coin is a store of value, a medium of exchange, a unit of account; Or indeed if it is purely a utility or a security or something in between. The Austrian economists look at cryptocurrencies as a new form of money that is censorship resistant, while technologists view cryptocurrencies, especially Ethereum and its brethren, as a novel platform for decentralized applications and apply a completely different set of frameworks and mental models to value this asset class. Arguments from both sides of the camp have their own reasonable merits and it is premature to write-off any one of them.

Given the inchoate nature of valuation models, the following are a few rules of thumb with crypto investing that we have picked up using the magic of ‘mosaic theory’ and strongly recommend:

Market over founder – In the traditional VC world, there are folks that will back a founder/team irrespective of the market conditions and then there are those that will back the best available combination in a great market. With crypto, we would prefer to invest in a great market. Of course some basic hygiene factors with the team should check out, but given the odds of any of these ventures really being a home run, you are better off going into a large market with a rising tide with an OK founder rather than into a tough market, early winter, unclear product market fit combination with a rockstar founding team.

Thematic portfolio construction – A core tenet in traditional portfolio construction, this is valid in crypto investing as well. At a basic level, you have the four or five broad themes; smart contracting platforms, infrastructure (foundational as well as protocol), store of value, identity, Web 3 and so on and so forth. The second order to this is around some  ‘sub-themes’ such as distributed computing, file storage, prediction markets etc which are, in our opinion, more medium term hockey sticks than near term. The sub-themes will probably require maturity in the core themes, as well as some more collective churn with UX/UI, so it might be better to invest in what you think are the best teams across these themes that you have access to at entry points you like.

Equity vs tokens – Now that the ICO boom (invest early with favorable terms->exit immediately upon listing -> let retail hold shitcoin can) is firmly behind us at least in its v1.0 avatar, it makes even less sense to get hung up about exclusively investing in tokens. Of course some VCs can only do equity as per their charter, and at this point in the cycle, teams are more than happy to bend over backwards and part with equity as well. The point here is, the smartest, largest, biggest investors in this space are flexible, they do both token and equity.

Invest across the board – Given that crypto is an uncorrelated ( to other asset classes), asymmetric bet it makes sense to invest in not one, but at least two if not three with in each theme. You have the opportunity to hedge across a theme, which is not something that you can do in traditional VC investing. Uber and Lyft, for example, will have very few common investors with sizeable stakes. In crypto however, unless you are one of the big boys yourselves, it is perfectly possible to invest in say, both 0x and airswap, or say Siacoin and Golem. There is a school of thought that might say that it makes sense to take concentrated bets in a few projects, but given the asymmetric information involved and the medium-term liquidity opportunities with tokens, as opposed to traditional VC, we would still prefer spreading bets even within a themes.

As a corollary to this, if you are a VC fund, and if your charter prohibits investing in tokens, definitely invest in a crypto-focused fund. Or two. That way you will automatically get the diversification that your portfolio needs. Do keep in mind however that when a project is offering you favorable liquidity terms, it might be coming at a cost.

Tag along – (as much as possible). Especially if you are starting out, if you get a chance to get into a deal with investors that you respect or admire or simply get along with, or with any one of the crypto big-boys (A16Z/USV/Sequoia and another 10-12 names across the globe), definitely spend the time to take a serious look, even if the terms are slightly less favorable than the best terms offered, but don’t get FOMOed, don’t be afraid to walk away if the terms do not feel right. There is always a better deal available, there is too many fish in the sea. It is only by saying no many times, that you will have an anti-portfolio that you can be proud of. (FYI, our affiliated fund’s anti-portfolio consists of names such as Orchid ( we thought the price was too rich), Filecoin, Rootstock, and most recently, Grin, as well as a couple of distressed operating companies in the space with some interesting narrative upside, but we still couldn’t pull the trigger on!).

Recommended Reading on This Topic:

Cryptoasset Valuations by Chris Burniske

One of the earliest attempts at valuing cryptoassets using the traditional ‘velocity of money’ concept in cryptocurrencies.

Cryptocurrencies are money, not equity by Brendan Bernstein

An interesting post that refutes the conventional wisdom about cryptocurrencies and sheds light on some common biases that investors hold with regards to cryptocurrencies.

An (Institutional) Investor’s Take on Cryptoassets by John Pfeffer

A deep dive research piece on why SoV (Store of Value) coins will accrue most of value and why utility currencies/tokens will capture zero value. Fascinating read if you have the time.

On Value, Velocity and Monetary Theory by Alex Evans

An extension to the above post by Chris with less restrictive assumptions around different parameters in the valuation methodology.

Meanwhile in Crypto Wonderland….

“Coinbase Announces Earn” Yesterday Coinbase announced that it was launching Coinbase Earn, a new system where Coinbase users can earn 0x tokens by completing various educational tasks, including watching videos and taking quizzes. The platform is invite-only at launch, though anyone can sign up to a waiting list. The educational content is freely accessible, regardless of whether a user is part of the Earn platform or not.

“2018: Correction Year” During a Bloomberg interview, Binance’s CZ called 2018 a “correction year” for crypto currencies while expressing optimism for the future of the crypto industry. He noted that while “price is a very strong attraction” for speculators, the industry will grow thanks to builders who make applications and “real use cases” that drive the further adoption of cryptocurrency.

“Widespread Pump and Dump” There are thousands of pump-and-dump groups on popular messaging apps, a study conducted by the Social Science Research Network (SSRN). The newly published data suggests that the pump-and-dump phenomenon is more widespread than earlier reported. The researchers identified 4,818 pump-and-dump attempts between January and July this year, studying data scraped from messaging platforms Telegram and Discord.

“French Parliament Rejects Crypto Amendments”The lower house of the French parliament has rejected the amendments to the 2019 finance bill which would ease crypto-related taxation. The amendments that have been declined by the National Assembly referred to a draft of the government finance bill for 2019. The Parliament rejected four proposals in total, of which one was to introduce a distinction between regular crypto transactions and occasional ones, offering a more relaxed taxation system for the latter.

Crypto Twitter Pick

What We’re Reading
 / Listening To

The Business of Stablecoins by Aleks Larsen

On Aggregation Theory and Thin Protocols featuring Kyle Samani, Joey Krug and Jesse Walden

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