Opinions and analyses

22 January 2018

Blockchain as an investment opportunity and associated risks

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A commonly held and reasonable view of why blockchain investing makes sense is that the technology is transformational on the scale of what the Internet did for businesses over the past twenty-four years, and possibly a lot more so. But just like the Internet boom of the dot-com-era (late 1990s) we are seeing a lot of hype, euphoria, and speculative buying of securities scarcely anybody understands. By most anecdotal estimates, less than 3% of blockchain tokens are actually being used to buy goods or services or real assets.

Sector thesis

A commonly held and reasonable view of why blockchain investing makes sense is that the technology is transformational on the scale of what the Internet did for businesses over the past twenty-four years, and possibly a lot more so. Back in 1993, with advent of the first web browsers everything from retail to email to information search went online and this has shifted market power greatly towards the providers and users of such technology.

 
The most valuable companies in the world today were built in the post-Internet era (Microsoft and Apple have been around for ~40 years but have transformed to leverage the Internet and Mobile boom)

The Internet era of the past 20 years was built on connectivity: anybody in the world could transact with anybody else, but primarily through large platforms that act as intermediaries and aggregators. Blockchain promises to re-arrange that leaderboard in the next ten to twenty years by introducing a new technology paradigm: trustless decentralization. This removes intermediaries and institutional boundaries like countries, regulators, financial networks, and macro-economic policies as we know them.

Sector Risks

But just like the Internet boom of the dot-com-era (late 1990s) we are seeing a lot of hype, euphoria, and speculative buying of securities scarcely anybody understands. By most anecdotal estimates, less than 3% of blockchain tokens are actually being used to buy goods or services or real assets. Which means although we are all excited about a global network of blockchain nodes relaying ledger updates to each other for performing real world transactions, in reality, what we have today is a global network of nodes at exchanges and wallets that store tokens in the hope that their value increases. That is a classic recipe for volatility and we have already seen a lot of it — and it is not unrealistic to assume that there will be decimation of the market caps of a lot of these tokens/coins at some point soon.

 

Some of the volatility we see is because the nature of crypto token value is not very well understood and sentiment moves wildly in this vacuum of knowledge. Tokens are the fundamental unit of investment in the blockchain today and pricing (today) is not based on “intrinsic value” (a measure of its utility in some context) but on “perceived value” (what a buyer is willing to pay). Although gold is no different in that it has more “historical value” than “intrinsic value” today, its “perceived value” is much better understood than that of crypto tokens.

The lack of confidence in token pricing also stems from insufficiently repudiated claims of fraud and price manipulation in the absence of any kind of regulation. More recently, the SEC has stepped up policing of ICOs, but as a whole, the sector is mostly devoid of regulation.

There is tremendous potential but there are significant risks and to more than a few mainstream retail investors, I have been heard saying:

Your best opportunity for investing in the blockchain is probably going to be defined by: who you are AND your appetite for risk. But the risk vs. return profile of the asset class is currently so asymmetrical that everyone of us should be looking at allocating some portion of a diversified portfolio to this sector. The risks are high enough that it should be at a level where you would not mind losing your capital completely (perhaps the amount you would spend on a completely discretionary/whimsical purchase).

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