The appeal of cryptocurrencies and digital tokens is for many the possibility of a home run. But betting on one outcome will make your outcome binary. You are either right or you are wrong. In an investing subject that has such high uncertainty of outcome, as blockchain and cryptocurrencies undoubtedly have, trying to determine who the most likely winner is, might not be the optimal investment strategy.
An investor in the blockchain space, even if that investor would be 100% convinced that distributed ledgers will disrupt the finance industry, will face three major problems:
- We don’t know who the winners will be
- We don’t know what the winner will be
- The last mover advantage
We don’t know who the winners will be
Industries tend to consolidate over time. This has been as true with banking and auto manufacturing as it has been true with breweries and paint manufacturing. Online, the power laws of industry consolidation have been even stronger. In the online world, the winner takes it all. The network effects of digital products such as search engines and social networks are so strong that they tend to create natural monopolies.
There have been thousands of cryptocurrencies and altcoins created so far in the relatively short history of blockchain. If the network effects of cryptocurrencies are anything like in industries that the internet brought us, most of these currencies are destined to die.
We don’t know what the winners will be
One of the biggest allures of blockchain disruption is that distributed ledgers will significantly alter the way humans organize themselves and their endeavours. Some will even go so far as to say that the concept of the company as a way for people to organize their efforts will become obsolete.
Yet, even though the formation of Bitcoin and other cryptos, such as Ravencoin, have been without the ownership and organization structure of a company, most organizations that are developing products and services on blockchain technology are formed through a corporation.
Some are a combination of both. An example of this is the combination of the XRP cryptocurrency by the company Ripple. Ripple does not own or control XRP, but it owns a significant amount of XRP which it received when the company facilitated the creation of the XRP cryptocurrency.
So, where will the value capture be? Will it be on a cryptocurrency level or on a company level? Is it better to have exposure to XRP or Ripple? Currently, this is extremely hard to tell.
Last Mover Advantage
Bear in mind that Google was not the first search engine. Neither Chrome nor Explorer was the first internet browser and Windows was not the first operating system. Facebook was not the first social network.
In the words of Peter Thiel, “you don’t want to be the first mover into a market, you want to be the last mover.” It is possible that none of the cryptocurrencies and none of the biggest blockchain-focused innovators currently out there are the last movers in the space. Maybe we are yet to see the equivalent of Microsoft, Google and Facebook of crypto and blockchain yet.
In an essay called Diversification and the Active Manager, Horizon Kinetics’ Murray Stahl and Steven Bregman bring up a thought exercise whereby an asset manager starts out with a diversified portfolio that includes one overperforming stock and simply holds it over a long period of time.
They take Intel and Microsoft as examples:
“From October 1987 to December 1999, the stock appreciated about 173x. Thus, if a 3% position in 1987 were held in a portfolio and not traded away, it would have become a dominant portfolio position by 1999. In truth, the position would have become so disproportionately large that no active manager would have been permitted to maintain it.
In fact, Intel would be a much better example. Between October 1987 and December 1999, Intel shares appreciated approximately 2,680x. Obviously, a 3% position in 1987 would, as a practical matter, become the entire portfolio by December 1999, irrespective of what performance the other portfolio elements accomplished.
If one contemplates these facts, the implications can be interesting. It should be self-evident that any portfolio manager who simply held Microsoft and Intel shares would have dramatically outperformed the S&P 500. Again, of course, this would not have been permissible. Nevertheless, in hindsight, this would have been the correct action.”
Building a diversified blockchain portfolio
Aside from basically buying a basket of cryptocurrencies, an investor would also like to have exposure to companies that are building blockchain-related products and services or investing in such projects.
Currently, the number of public companies that have that exposure is limited and many often simply seem fraudulent once you look under the hood. There are however a few stocks that are worth considering to gain exposure to blockchain and cryptocurrencies:
- Galaxy Digital Holdings (aim to become a merchant bank in crypto and blockchain)
- Overstock (through its subsidiaries tZero and Medici Ventures)
- Hut 8 (cryptocurrency mining)
- FRMO Corp (shareholder in Digital Currency Group and a number of mining ventures)
More Thoughts on Crypto
- Bitozi Crypto Compendium
- Will there ever be more than 21 million Bitcoin?
- The Economics of Cryptocurrency Mining
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