Cryptocurrencies and initial coin offerings are stirring up a lot of interest among investors and family offices. The asset class has undergone a staggering rise since the beginning of the year, with Bitcoin now worth more than $10,000 from just $740 a year ago. Whether a family office wants to buy cryptocurrencies and/or participate in Initial Coin Offerings is up to their own risk profile and decision-making criteria.
But here are some thoughts - in a question and answer format - about cryptocurrencies from Thomas Krenik, founder of Nextvest, a direct investment community for family offices and high net worth individuals.
Family Capital: Most investors have heard of bitcoin and cryptocurrencies and more now hearing about initial coin offerings. Nevertheless, few really understand what they’re are all about. Can you give us a very quick overview of what a blockchain is, what a bitcoin is, and what an ICO is?
Thomas: A very, very simple explanation of a blockchain is a list of records which are linked and secured by cryptography. To put it in transaction terms, imagine that I want to give you $10,000. Traditionally, I would send you the money and the bank would verify the transaction and store a record. In a blockchain, the transaction record is stored on many computers at once, creating a decentralized verification and record of events. These transactions are stored in a “block”, which is a group of records that includes the answer to a difficult mathematical problem.
Now, a “miner” of a block is somebody who first discovered the answer to the mathematical problem. The “miner” is paid for their central processing unit (CPU) effort in discovering the block and in processing transactions with “coins”. So a blockchain is a system which uses mass collaboration, cryptography, and collective self-interest to achieve secure decentralized transactions.
This is what led to Bitcoin, which is the first “currency” to be transacted on a Blockchain. An ICO is a separate matter – it is a fundraising mechanism in which new projects sell their underlying crypto tokens. There are very interesting implications for the securities markets should ICOs continue their growth, but that is a separate discussion.
Family Capital: Do you think the cryptocurrency investment trend is a big bubble waiting to burst?
Thomas: I do think we’re witnessing a remarkable secular movement towards cryptocurrencies – the amount of interest is truly staggering, and leads me to believe there will be some level of staying power. ICO volumes are now said to be 5% of the venture market. That’s a pretty staggering number given that no one outside the hobbyist community was really paying attention to cryptos 5-6 years ago. In fact, back when the bitcoin phenomenon started, investors in them were widely considered, at best, lacking foresight, and at worst, crazy.
My view is that anything that is capable of capturing the popular imagination the way cryptos have indicates that something fundamental is occurring. How big that fundamental trend is truly remains anyone’s guess.
Family Capital: How do you make sense of all the different cryptocurrencies and ICOs?
Thomas: Honestly, I don’t spend a lot of time trying to have a perfect holistic picture of this market. Things are changing fast enough that any prescriptive viewpoint is almost certainly wrong within a matter of weeks, if not days. I would like to emphasize that trading in bitcoin/ether and participating in ICOs are different forms of investing at the moment.
Family Capital: What’s driving investor interest in cryptos? How do you see investors playing cryptos?
Thomas: Investors seeking to buy these assets would appear to be driven by one of three fundamental mindsets:
- You’re a momentum investor who is trying to ride the rapid recent run in these assets;
- You’re a long-term investor who believes they offer fundamental value;
- You’re using the volatility to play the technicals.
In terms of what is driving interest, I think it is obvious that a highly-volatile, massively bullish market would be of a lot of interest to investors. Volatility in the public markets is at all-time lows (as measured by the CBOE Volatility Index), and investors will always be interested in the opportunity for returns. Exponential growth in a market, for whatever cause, is a rare thing, and we are seeing it here.
At a deeper level, one way to view cryptos is that they represent easily-accessible, sometimes un-taxable, sometimes un-traceable access to a somewhat-liquid pool of risk. There is an awful lot of liquidity in the world right now, and it is often very difficult for that liquidity to easily enter discretionary pools of "risk-on" assets where there is a frequent mark-to-market. Venture capital investing is super illiquid, geographically constrained, and difficult to do well. As cryptos have yet to have a true cycle, we are writing the rules as the game unfolds, and that creates a tremendous opportunity to make/lose money. Those factors are amplified by the liquidity - it is much easier to "test the waters" if you believe you can sell the asset.
In many ways, that is what makes this market so amazing. It has emerged so quickly that the regulator is being forced to react suddenly at a global level, but the train has already left the station.
Family Capital: Is there any one style of crypto investing you would recommend, or exclude?
Thomas: Like with many things in the markets, it is certainly possible to make money on cryptos in a variety of ways, and with a variety of viewpoints. The biggest thing that worries me is that quite a few people are starting to invest without any understanding of what cryptos are. We are in a phase where a lot of the trading strategies being talked about are clear examples of “the blind leading the blind”.
The commodities markets have shown us repeatedly that there are a lot of ways one can get in trouble as the trading behaviour becomes too far decoupled from the fundamentals of the commodity at play. I also feel that investors don’t give enough thought to the liquidity concerns of the various crypto assets at play. Should trends reverse, liquidity can dry up stunningly quickly in markets like this.
Family Capital: What is your view on family offices investing in crypto?
Thomas: My fundamental view is that, if you do your homework, there are opportunities here. However, a lot of investors develop an approach which basically goes, “I am only betting a small amount of money, so no big deal if I lose it”. That isn’t investing, that is speculation. And it is very easy when we make money to convince ourselves that speculative behaviours are really investing behaviours. There is a very good reason that, in every downturn, we look at certain common behaviours during the good times and wonder, “why would anybody think that?”.
Family Capital: Is there anything else that worries you about crypto investing?
Thomas: Many things. But my biggest concern is simply that I see this market as being heavily driven today by enthusiasm. And who knows what the trigger for that enthusiasm to reverse might be? The one thing that history does tell us is that whenever an asset goes on an amazing upwards run, eventually a correction does occur, and typically only when nobody expects it anymore.
NB: None of this article should be interpreted as investment advice
Thomas Krenik can be reached on firstname.lastname@example.org