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Crypto Investing: an Evolution of Venture Capital


Welcome to the Brave New World of Venture Capital Investing

Let's face it. If we are going to trade crypto, we are essentially becoming venture capitalists. 

Imagine trading FB just months after  Zuckerberg unleashed his program onto the Harvard campus in 2004. FB did not IPO until 2012. The people involved in FB were venture capitalists from silicon valley and New York, not your typical investor in that they have much deeper pockets and can pull weight in influencing the success of the FB. 

Take a look at FB's path to IPO. Note that it took in angel and venture capital totalling about $2.36B before going public. 

Facebook’s Path to IPO

From Visually.

Meanwhile, the rest of us have to wait for the IPO. By this time, FB has established a working business model (beyond proof of concept) and has been growing. Public investment makes it possible for FB to expand to the next level.

Less than a handful of cryptos are at IPO maturity level:

In crypto land, the oldest project is Bitcoin which was created in 2009. It has been in development for barely 9 years by the time of this article. I think Bitcoin is almost at the IPO maturity level after early adoption and some initial investment from wall street type firms. 

ICOs vs IPOs

Meanwhile, we have ICOs or "shitcoins" spawning into existence every week. ICOs are NOT like IPOs because they are simply concepts with a supposed team around it and maybe advisory support from some big names. But the thing is, we can invest in these projects the way we invest into FB after the IPO. Are you ready to invest in just concepts and proposals?

We are thrown into an investment arena previously reserved for sophisticated investors so we better up our game. We are now Venture Capitalists

Here are some high-level concepts to ground us before we shoot for the moon. 

RISK of Ruin

risk of ruin.png
  • Most crypto projects will fail. It's just the nature of evolution and crypto land is like the primordial soup for digital protocols, on steroids. (I think I heard this analogy from Trace Meyers).
  • There will be many variations, but only a few will remain. 
  • We SHOULD do due diligence to at least make sure we believe in the project either personally or potentially in others' eyes.
  • As a venture capitalist, we are usually invested for the long haul, instead of getting in and out.
  • But we are not locked in like traditional VCs. We might first think this is an advantage.
  • BUT if all investors in crypto land has this option, it is no advantage. In fact, it burdens us with volatility. 
  • In crypto land, there is a higher risk of ruin, which needs to be compensated by higher gains (comparing to traditional stock markets).
  • So, don't be satisfied with a 20% gain on the year. You risked losing 50%. 
  • Because the risk of ruin is high, we should NOT put all our eggs into crypto.
  • Instead use it for its diversification value. 

Diversification and the Modern Portfolio Theory

Diversification as an Asset Class

  • Diversification is not about just spreading your investment around. 
  • It is not even about minimizing risk itself.
  • It is about maximizing the reward to risk profile of your investment (Sharpe Ratio). 
  • Statistically, if you pool together assets with little, none or negative correlations, the gains will average out, but the variance or standard deviation will actually be much lower than the average. This improves the Sharpe Ratio.
  • Guess what, so far crypto assets has been uncorrelated with the stock market. (Although this could change as the asset class matures). 
  • This is why Wall Street guys like Barry Silbert, Mike Novorogratz, Chris Burniske, Thomas Lee, Trace Mayer etc. all praise the diversification value of crypto assets when added to traditional portfolios, which likely include equities, bonds, and commodities
  • We will be investing like venture capitalists as well as portfolio managers employing Modern Portfolio Theory (MPT).  
  • There should be material crypto allocation in your portfolio for its diversification value. 
  • But what about within this class.
  • There are more than 1300 projects or coins/tokens in existence.
  • Most of these will fail so we have to be discerning. 
  • Should we still diversify? or just pick Bitcoin. 
  • While picking bitcoin might not be a bad idea because it is the most proven project so far, I think we can do marginally better by through diversification into uncorrelated projects. 
  • There are resources, like the website noted above, that provide correlation data. We should use these resources when considering segment and project(coin) allocation. 

HODLing vs. Trading

Funny origin story: HODL was originally a typo (author was probably drunk). The typo stuck especially because it can an acronym for Hold On for Dear Life

  • "Hodlers" are essentially long-term investors and not traders - those who stick with an investment even when price action is painful. 
  • HODLING makes sense because the projects are young and bound to be volatile - meaning we should not be shaken out so easily if we believe in the project. 
  • In the meanwhile, high volatility might make short-term swing trading viable even in a sideways market, or bearish market. 
  • I believe in a hybrid style depending on how confident you are with the project. 
    HODLER: If you are believe in the project and is part of the community, you would hodl.
    TRADER: But if you have only a fain clue what the project does, you might want to just trade a swing, accepting the fact you might miss a big run. But at the same time you want liquidity for projects you are not confident with if we are just trading the chart (looking at price action).
  • Even if we mostly hodl, we might want to re-balance your portfolio periodically. 

Dry Powder

  • Venture capitalists must always have excess cash (dry powder). Because they are "locked into" the investments, there is no liquidity in the portfolio. Having excess cash solves that. 
  • If there is a strong correction in the markets and we are hodling and therefore not rotating into cash, we will miss advantage to buy-on-dips. 
  • There might be times when dry powder runs out. There are 2 ways to resolve this:
    1) Continual deposits: One strategy that seems to work wonderfully in a volatile market is to scale in periodically i.e. after every paycheck. You can start with a more meaningful amount and then add gradually. You might also consider putting a cap on maximum investment. 
    2) Trim at a lower targets: When we trim at a lower targets (instead of the ultimate moon target) we rotate back into cash. We also lock in profit earlier and might miss out if the pump becomes epic. On the other hand, if price dips again, you can pick up more at a lower price. 
  • When investment size is limited, there is the trade-off between being able to buy at lows vs. being able to sell highs. 


USD or BTC Value?

  • Do we trade monitoring asset value in USD or in BTC. 
  • I don't think there is one clear answer for this. We should consider both the USD and BTC value of cryptos when looking at price action and analyzing the charts. 
  • For the most popular cryptos (BTC, LTC, ETH, BCH, XRP, XMR...) the USD value might have more significance.
  • For "lesser" cryptos (ENG, PAY, POWR, LINK, CND...), the BTC and even ETH value might have more importance especially if they can only be bought in BTC, or ETH. 

Segment Investing: Top-Down Approach, Rotation

  1. First we determine whether crypto assets are a viable investment class in the current economic environment.
  2. We do research to support thematic decisions in our segment allocation. 
  3. Then we look at individual projects to make up the segment basket. (Top-Down Approach)
  • For example, if research shows people are increasing demand for privacy coins, we might consider allocating a higher proportion of our portfolio into a basket of these coins by lowering the proportion of something else. (Rotation)
  • Then, we have to consider which coins to invest in and how much of the amount to further distribute for each project i.e. XMR (30%), ZCash (30%), DASH (20%), XVG (10%) ZCL (10%).

Final Thoughts Before we Moon

  • We have touched up on some high-level concepts in crypto investing. 
  • Note that we have not even considered how to assess individual projects. 
  • When we dive deeper into individual projects, it will be critical to understand network technology and  network economics as well as coding languages like python and javascript. 
  • Start by googling those terms and watch some Khan academy or similar video courses.
  • Finally, we will need to build a picture of the crypto ecosystem to help us with the top down approach.
  • This ecosystem will include things like exchanges, cybersecurity services, thought leaders, regulatory bodies, ICO developers, project communities, venture capitalists etc.
  • Seeing this space clearly will will help us spot trends before they mature.

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