How did we get here?
In August of 2008 the domain bitcoin.org was registered. Soon there after a white paper titled Bitcoin: A Peer-to-Peer Electronic Cash System was made available to the world authored by Satoshi Nakamoto.
Early on Bitcoin was slow to be adopted and value was often negotiated directly between early supporters and adopters. One commonly noted early transaction between two of these users was for 10,000 Bitcoin for the delivery of two Papa John’s pizzas. At the current price that is over $50,000,000 per pizza!
By the middle of 2013, there were approximately 14 digital assets, most with network values under $1,000,000. The total network value sat at around $1,500,000,000. Bitcoin was trading around $125.
Over the next two years, the pace of growth and value steadily increased, but nothing compared to what was about to come. The launch of the Ethereum network and associated smart contract capabilities in summer of 2015 ushered in a new era of digital assets. At the time, there were approximately 500 digital assets and the total network value was just shy of $4,500,000,000. Bitcoin was trading around $260.
The first six years of crypto bear virtually no resemblance to the last two and a half years since the birth of Ether. The meteoric rise in both the prices and prevalence of digital assets has attracted an unprecedented amount of attention from the media and general population. During this time, some of the world’s brightest and most opportunistic entrepreneurs have focused their attention to the blossoming world of block chain.
As I write, there are over 1,600 digital assets with a combined network value of just under $600,000,000,000 while Bitcoin is trading around $11,000.
A space that not too long ago closely resembled a hobby has become an emerging asset class that bulls and bears alike can’t help but talk about on a daily basis.
The Choice of an Investor
Given where we sit, each investor is now faced with two important questions governing their participation decision in the emerging asset class of crypto currencies.
Where do I want exposure? How will I get this exposure?
The point of this post is not to argue or advocate for exposure to the asset class or exposure through the CAOF. Many of you reading have already made those choices. Below I will discuss the disciplined approach I take in constructing a portfolio of digital assets in order to achieve the desired exposure.
Sifting Through the Noise
I believe that there are several compelling arguments for an investor to have exposure to crypto currencies as an asset class. I also believe that many investors approach this exposure in an untargeted manner. Can anyone really claim to be able to sift through heavily fragmented, very immature data on 1,600 and counting digital assets and pick winners on a one-off basis in a bottom up fashion?
Over time, this approach has proven exceptionally difficult in more mature markets with much more complete information. So, why should it be reasonable here?
In the stock market there are defined sectors. Also, it is typically more difficult to pick winning stocks then to pick winning sectors.
As far as I am concerned, crypto currencies can be viewed through the same lens. By identifying the appropriate market sectors and then creating a basket of digital assets that represent my views allows me to create a diversified portfolio that enhances the CAOF’s ability to capture long term success. Below I will discuss a few of these sectors and why the CAOF allocates to them.
The Gold Standard
Recently the transaction fees on the bitcoin network have been declining rapidly, fee chart. Previously, due to the high fees and long transaction times many have viewed Bitcoin as more of a store of value than a transactional currency. As a result, a comparison to digital gold emerged, and for sake of the construction of the Fund’s portfolio, I agree. Bitcoin is the most referenced, largest market in the asset class. I believe if institutional investors enter the crypto currency markets on a larger scale Bitcoin will likely benefit and deserves an allocation in any portfolio of digital assets.
Value and Utility Creation
The ability of smart contracts to build decentralized and trustless applications or protocols that will disrupt traditional businesses created a sector which radically changed the crypto currency markets. Digital assets whose blockchains support this functionality such as Ethereum, Neo and Stellar are the lifeblood of a robust and developing blockchain eco system and therefore also warrant attention in a well-constructed portfolio of digital assets.
Despite the previously mentioned recent reduction in Bitcoin transaction fees, transaction cost and times have limited adoption as a payment system. People are drawn to Bitcoin’s value but its usefulness for transactions has left a need for blockchains that confirm transactions differently. In the CAOF’s portfolio, I think of this as the transactional sector. As the borderless, trustless digital eco-system grows and evolves the need for prompt, secure and inexpensive payments only become more pronounced. Currently digital assets such as Ripple, Litecoin, Bitcoin Cash and Dash fill this void.
It was once thought that the public blockchains offered a high degree of anonymity to users. Your public address was the only information on chain that others could see and your identity and sensitive information were secure. While privacy is certainly enhanced by the public blockchains, it has become increasingly evident that sophisticated blockchain users can decipher more personal information than originally thought. As a result, many users require solutions further protecting their identities. Privacy coins such as Monero, Z-Cash and Verge use processes that further obscure transaction details in order to protect the user identities.
The four above sectors are just a few of the many valuable sectors in the crypto currency markets. I would be happy to discuss these or others with anyone out there reading.
Regardless of whether the approach of sector creation and targeted allocation resonates with you, it is clear a successful, long-term investment strategy in the immature and volatile crypto market requires a high degree of discipline. These concepts help guide my investments and I feel provide the discipline required to successfully navigate the market.