How to reason about what happens next in Cryptocurrency

I recently joined the Gumi Cryptos fund, a $30M crypto and blockchain investment fund based in Japan and San Francisco. There’s a nice interview on HGR here.

I wanted to continue to share some of my perspectives on the macro environment for crypto based on first principles. Please have a look at my scenario planning below and let me know what you think of the reasoning.

All Dogecoins go to Heaven

My “high” scenario for the cryptomarket I call “All Dogecoins go to Heaven”. It’s kind of a funny nonsense scenario.

Description: everything correlates to Bitcoin and Bitcoin continues to pump sky high.

Doge-y Heaven. Apparently we terraformed the moon and there’s grass up there too.

Action Plan: There’s no action plan for this scenario. The only action plan that is relevant to this scenario is: own some cryptos. In fact, for this scenario, the more cryptos you own the better.

All CryptoKitties go to Hell

My “low” scenario is that all altcoins go to essentially zero. What would precipitate such an apocalyptic scenario?

Description: All altcoins go to zero.

Action Plan: There isn’t an action plan for this scenario either. The only optimization you can make to your portfolio is to hold NO cryptocurrencies.

So What do I Do?

To me, it’s nonsensical to pick one of those two scenarios and optimize your portfolio towards it. Namely, you should probably not completely exit crypto, NOR should you completely push into crypto. So really these extreme cases give you almost nothing to do.

There may be a “low-middle” case where the market continues to behave in a bearish way. The harbinger of this case is the inclusion of asset-backed tokens. Asset backed tokens may perform a stabilization role in the cryptoeconomy, because the backing assets will not dramatically change in value (things like equities, real estate, bonds, commodities, precious metals). One optimization for the low-middle case is to diversify into asset backed tokens, which will limit your upside but also limit your downside. There’s a subclass of such assets called “stablecoins” and these coins should do ok in a down market. The danger with stablecoins is that there’s always the temptation to increase leverage on them, and they work perfectly until the day they don’t.

The Middle Case

Logically one should optimize for the middle case.

One thing that is becoming incredibly clear is that there is an oversupply of ICOs. Take a look at this animation and you’ll understand that 14B dollars is a healthy amount of money and this creates lots of experimentation and also lots of potential failures.

In a bit we will start to see a mass extinction of weaker coins.

The thing is, that the stronger coins should get much much stronger.

Platforms

One of the things we should expect to see in this kind of environment, where weak coins die and stronger coins get much stronger is the emergence of strong platforms.

Obviously Ethereum is strong, and EOS with 4B raised and with 1B in Venture Capital being raised on top, they will become a strong platform in due course.

During downturns, these platforms have the opportunity to become consolidators and cheaply roll up hundreds of applications. Obviously some of these ICOs should just rightly die and go away forever. But the ones that are able to acquire users, useage and velocity of money should be able to add value to underlying platforms.

We won’t ever have as many tokens as we have now

One of the classic questions asked of every ICO is, rightly, why do you need your own token? Why cant you just use Ether or Stellar or even Bitcoin? This is a very meaningful question. However, in this experimental stage, the logic of this question operates only at the level of an individual project. If you look at it from the macro of the entire cryptoeconomy, the answer is universal — we need independent tokens for every single project, so we can independently value each project with relative ease. Obviously you can value a project that uses Ether, but this method of tracking is much easier.

Mass Extinction

The world obviously won’t support so many tokens. I say obviously even though there may be a lot of people that will get angry and argue with me. I do think that tokens are more like stocks, so it’s not like having thousands of national currencies, more like thousands of stock tickers — which is a legitimate thing. Perhaps it’s not the absolute count of tokens, which may increase over time — perhaps all I’m saying is that the vast majority of tokens around today wont exist in 18 months at the outside.

Valuable things will have Value

My third scenario I jokingly call “Valuable things will have Value”.

Three types of cryptoassets: Asset-Backed, Service-Backed and Infrastructure

There will be three types of crypto assets.

Asset-Backed tokens will represent an underlying asset. These are commonly referred to as “Security Tokens” but I really deeply dislike that nomenclature because it conflates a regulatory perspective with a functional perspective. To me, the Asset-Backed token is an easy mindset, which is that it is backed by a NOUN — something that is a thing. If you want you should be able to redeem the token for the thing — although in the case of highly fractionalized assets, it’s hard to imagine (such as claiming one/one billionth of a building for example). Service-Backed tokens will represent access to a service. These are commonly referred to as “Utility Tokens” but I just get angry every time someone calls them that. Generally the conversation goes something like this — an entrepreneur says “I have an opinion letter from a lawyer that says my token is a utility token — therefore I can ignore the SEC and sell to whoever I want”. To me the language of Utility Token VS Security Token is completely broken because it conflates regulatory with functional status. The Service-Backed token is backed by a VERB — some action that will be taken if you redeem the token. With Asset-Backed covering all NOUNS and Service-Backed covering all VERBS, you pretty much have yourself fairly well covered. Infrastructure tokens. The final class in my schema is the infrastructure token. These are crypto assets like Bitcoin. Interestingly enough they complete the schema because these tokens are literally “nothing backed”. If they were backed by assets or services, they would not be infrastructure tokens.

So in my schema, there should be 10 Trillion dollars of asset backed tokens entering the crypto asset sphere as soon as we have legal and regulatory frameworks that support such tokens. (If you don’t want to wait for legal frameworks to catch up, I have a “Brooklyn Bridge Coin” that I will sell you for 1M USD). I believe that the world honestly doesn’t need an infinite number of infrastructure tokens — however I am not so naive as to think that there will only be a single infrastructure token (such as Bitcoin). As far as service-backed tokens are concerned, I think there will be thousands, but that 1) most of them will die 2) some of them will be consolidated by platforms and 3) the few that remain will become huge. Think about the FAANG companies that came out of the dotcom world… these will be bigger than unicorns by serveral orders of magnitude.

So What to Do?

What is the action plan?

I would like to enumerate my portfolio action plan:

Maintain healthy exposure to crypto assets (1% to 20% of your investable net worth depending on your financial risk profile) Invest a portion of that into asset-backed tokens (for example Crypto investment funds or the like) to provide downside protection for your portfolio. The world will probably need order 10,000 asset backed tokens in the steady state but this will include many financial derivatives. Invest in service-backed tokens like a Venture Capitalist or Angel Investor. Expect almost all of them to die, but a small number may possibly become deca-corns or larger. If you don’t know what “Invest like an Angel Investor” means, read Jason Calcanis’s book “Angel”. The world will need order of magnitude 1000 service-backed tokens. Invest in Infrastructure tokens like Bitcoin. Interestingly enough Ether and EOS are technically service-backed… but they may be considered Infrastructure tokens also from the investment perspective. Unless you are exceedingly technical, do not speculate wildly in this category. I consider TRON and IOTA to be such speculative assets and I don’t expect either one to survive. The world will need order of magnitude 10 infrastructure tokens, so watch for major extinction level events in infrastructure. Since most chains are open source, the winning chains will cannibalize platforms for good ideas and strip them of their best features.

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