To many observers, today’s crypto-frenzy feels like the California gold rush. During that time, a few made small fortunes but most were left penniless or worse. Still others made a living off the migration — running stores, saloons, laundries and boarding houses, creating towns and cities that still exist today.
In the 170 years since, there have been many more gold rushes. In the last 30 years alone, we’ve seen frenzies for dot-com stocks, bio-tech and baseball cards, all with similar investment trajectories: Irrational speculation, a crash and then the emergence of a few strong, high-quality investments.
Over the past several years, the hottest investment category by far has been cryptocurrencies. While public understanding of the space is poor, many people still fear they could be left behind. We believe it’s important to understand new technologies and combat the fear of missing out with patience, perspective and knowledge.
Bitcoin, launched in 2008, was the first cryptocurrency. The idea behind Bitcoin was to create a utopian cash alternative where finance is decentralized. Cryptocurrency idealists, then and now, envision replacing regular currency to (1) protect people from governmental financial oversight and (2) disintermediate the banking system.
Many people prefer to do their business in private, and cryptocurrency promises this capability. The second goal aims to break banks’ costly and inefficient transaction-processing monopoly. If there were a means to purchase things and settle contracts without these middlemen, the global economy could repurpose trillions of dollars of savings into more efficient, beneficial uses.
However, banks, brokers and governments perform an important and ubiquitous function related to trust and transactions, including combatting fraud. Bitcoin became the first step in creating a technology that promised to verify and enable transactions between companies and people worldwide at much lower cost.
Bitcoin’s innovation was to utilize blockchain technology to verify transactions. Miners would use computers to verify transactions and create digital ledgers that store transaction history forever.
Because Bitcoin was designed (ideally) to be untraceable, it became very popular with criminal enterprises. Yet early on its value was minimal because there was no tangible profit in doing the work of verifying these transactions.
Throughout the 2010s, interest grew as use cases expanded. At the same time, Bitcoin was experiencing major growing pains, including governmental bans, emerging competition and cyberthefts of "digital wallets," which caused major volatility in its price.
When something is volatile and tradeable it becomes investible, regardless of its intrinsic value, and so interest in Bitcoin as a stand-alone investment began. Yet, just like the first automobiles, it was quickly realized that Bitcoin may not actually be very good at what it was designed to do and that there was massive opportunity to improve it. Processing digital transactions through the Bitcoin blockchain is incredibly energy-intensive. If purchased with cryptocurrency, a cup of coffee would take ten times the amount of energy to verify the transaction than it took to make it.
Technologists began to create better, more efficient versions of Bitcoin. "Altcoins" popped up claiming to verify transactions and contracts more efficiently and with lower energy requirements. As the price of Bitcoin rose, the opportunity to create new altcoins was compelling to hopeful entrepreneurs. Today there are hundreds of altcoins.
The best way to think about altcoins is that each one is a tech firm — a technology created to solve a problem related to improving digital transactions. Many of these technologies are themselves de-centralized: designed and managed by a group of coders and hobbyists. This is akin to a company going public but with none of the regulatory oversight or consumer protections.
It’s possible that one of these altcoins will end up representing the winning platform and reward today’s creators/investors. Yet, for one technology to win, many others need to fail … anyone remember AOL, Netscape or Ask Jeeves?
We believe blockchain is an incredibly important technology that has the power to disrupt the entire global payments system. But we have no idea which companies will capture and monetize this opportunity. It’s possible the company that will be the Google of crypto has not even been invented yet.
Investing in crypto is as young and unproven as the technology itself. As we see it, there are currently four cryptocurrency investment approaches: creators, speculators, accumulators, and facilitators.
Creators invest their time developing blockchain technologies in the hope that theirs gets adopted through coin usage.
Speculators are investors hoping to take advantage of market exuberance to make bets on price swings in either direction.
In the late '90s dot-com stocks represented the volatile and emerging technology du jour. High-potential, profitless companies had day traders in a frenzy. For dot-com buy-and-hold accumulators, the story was hardly better. If you invested $10,000 in Nasdaq in 2000, it would have taken you 15 years to get back to $10,000. Investing today in a basket of crypto coins could project similarly.
Finally, there are crypto facilitators. Just like the suppliers who served Old West prospectors, this strategy looks for companies that provide the infrastructure that allows the crypto economy to function, such as chip makers and exchanges. Many of these companies are actually profitable and can be purchased today cheaply and efficiently through targeted index funds.
It’s important to remember that in the halcyon days of the '90s, the dream of the internet was to democratize everything and give the power of information back to the people. Perhaps inevitably, today the internet is run by a handful of incredibly powerful corporations that harvest personal information and governments that use the internet to restrict freedom.
That doesn’t mean we shouldn’t continue to support innovation. During the mid-18th century, China closed its borders to trade with the West. Europe, which had to that point been on par with China militarily, sprinted far ahead of China over the next two centuries. Today China and at least 50 other countries ban cryptocurrencies, either implicitly or explicitly. While we have strong conviction in global diversification, one thing we can be fairly confident about is that the future of digital currency will almost certainly emerge from our own backyard.
Nathan Munits is president of Longwave Financial.
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