The New Financial Revolution

Cryptocurrencies such as Bitcoin & Ethereum have ushered in a new era for the world, with Bitcoin hitting highs of nearly $6,000 yesterday. Most of us in the industry have been caught off-guard by how (and why) the market capitalization of crypto currencies & assets has exceeded $150bn so quickly this year. I’ve spent a fair amount of time thinking about this and where we are going to next and so I’m going to try to weave a number of seemingly unrelated observations together in this post to, hopefully, light the way.

Firstly, the big question is “Are we in a bubble?”. The short answer is : “No-one knows!”. I like to point out that the total market value of cryptos are less than Yahoo alone, at the market peak. Also, the behavior of cryptos is remarkably different from stocks and bonds — these are network products, not stocks or bonds. They typically don’t have yields (unless they are a security). Their utility is derived from adoption and network utility. Network effects lead to parabolic/exponential growth and the human mind is famously inadequate at being able to see or predict parabolic value creation.

So what are the driving forces behind the sudden growth in the crypto market? First, we have to take a quick step back and understand how the world has evolved since the last two market collapses (2000 & 2008):

• Governments have been printing money, effectively inflating assets and driving yields down. If you want to create wealth, it’s very hard to find hard assets that aren’t overvalued and that will deliver a yield that makes it worth your while. The risks adjusted prices of stocks and bonds, in my opinion, are incongruent. In almost all cases, you’re chasing single digit returns unless you’re taking on asymmetric risk.
• Crypto-tokens are supercharging network effects by aligning incentives like never seen before. These “DApp” tokens are going to enable the next wave of business models, where micro-incentives and rewards will share the value that a business generates with their users. A business model where early token holders are rewarded for being early adopters, spreading the word, and spending the coin, where companies can change consumer behaviour through incentives. These features are opening business up to customers who were previously excluded, such as the underbanked. Wala is an interesting project that I have invested in, that is makes use of this principle.
• Public utilities are being built using blockchain technology, as I described in a previous post, “Why tokens are eating the world”. These public utilities will fundamentally change the way we design the world that we live in for decades to come. We’re building networks and public utilities which function with their own currency (such as Civic), but instead of rampant and unfettered inflation —we now have cryptographically guaranteed caps on currency issuance, unlike governments who can print new money ad infinitum. It perversely does the opposite of what governments have done to businesses and society over centuries, in that value is preserved and not eroded.
• The stock market has been largely closed to small cap, high opportunity IPO’s. Even when companies do IPO, venture capital & private equity funds have already loaded the companies up with so much capital pre-IPO, that the general public doesn’t really get to participate in the growth of company once it’s public. Companies do this to maintain control for longer, but by the time they go public the risks are mitigated to such an extent that you’re not going to get a mediocre returns, with albeit lower risks. Low risk, low reward.
• Millennials, who saw how the financial system destroyed their parents savings and wealth in 2008, are eschewing it. Banks are unable to cater to this sector adequately and are quickly trying to attract this generation, but with products that are not serving the needs of the market.
• Tech savvy millennials typically have high disposable incomes, and are happy to throw it all into projects that even have a slim chance of creating real wealth for them. It’s the mindset of younger folks who are trying to create asset bases for themselves — they don’t have kids or high overhead lifestyles, and don’t care if they lose their shirts as much as if they were 40+ with families, college savings, etc.
• Global capital formation is changing, rapidly. Companies can do an ICO and raise tens or hundreds of millions of dollars within hours or days, without needing to be backed by a VC fund. So, where is this money coming from? It’s coming, in part, from millions of young, tech savvy kids worldwide who previously did not have any opportunity to participate in the high risk, high reward technology that has upside which could be life changing, like the value creation effects of Ethereum or Bitcoin.
• People, anywhere in the world, are now able to build high upside crypto portfolios with hundreds or maybe thousands of dollars. These portfolios give them the opportunity to make hundreds of thousands or even millions of dollars. They don’t care if they lose the money, they don’t want 5% a year return either. They’re happy to buy hope, and take the risk because 5% won’t change their lives, but this could. The reality is that single digit returns are not going to help those who don’t have much to invest — so the mentality is akin to the notion of buying a lottery ticket when you don’t have enough to buy a single share of a quality company. Yes, it does start to look to more like gambling and not investing, but that’s pretty much what crypto has become, for now.
• With enough high risk crypto assets, you can begin to construct an Efficient Frontier portfolio, that can eliminate much of the risk as a sector and still offer sufficient alpha. How much of your portfolio you choose to allocate to crypto is still your choice, but the point is that we need lots of high risks bets with the hopes that 1/10 or 1/50 pay off at a rate of more than 100–1 to make it all worthwhile. In some ways, this is what VC is supposed to do, but the shape and structure of VC prevents this as partners can only take on so many investments, nor do they have the ability to make smaller bets and spread them out more (although accelerator firms like YCombinator have managed to do something like this).
• The global financial system has meant that stock markets and investment opportunities have been very regionalized for decades. When I was a 20 year old living in South Africa, I could only invest my money on the Johannesburg Stock Exchange and into South African technology companies. I couldn’t open a US account and invest in US stocks or bonds like Yahoo or AOL. The crypto world doesn’t work like that — crypto assets now have global audiences instead of regional ones, which means there is more money chasing these assets — through vehicles that don’t operate like traditional stock exchanges.
• It’s not all going to be roses. There are questions around scams & ponzi schemes, along with corporate governance and giving money to people who are just incapable of running or scaling an organization — but this is why the winners have to pay off at a higher rate — to cover the cost of the losers and generate net positive returns. If you’re smart and diligent (and lucky), you’ll hopefully be able to avoid more mines than ones you stand on!
• Wealth transference from the older generation is happening as the Baby Boomers generation fades gracefully. The younger kids are far more tech savvy and have witnessed so much tech disruption that they are looking for “The Next Big Thing”. This wealth transference is already finding it’s way into Bitcoin and other areas that previously would have been overlooked by less tech savvy, high net worth individuals.
• The other thing that the younger generation has, is time. They have the time to educate themselves on crypto. Open accounts. Monitor trades and chat rooms and be part of the ecosystem and learn about new opportunities before those who are settled and on the road to retirement. By investing the time and energy to absorb themselves in this space, they immediately have an edge and will trade the markets in a far more agile and profitable way.

Lastly, in a world of chaos, let’s not forget about “Hope”. Many of us are hoping for a better world. We’re willing to take risks and bet the farm in the face of all likelihood of failure. We do this because we know that it’s on us to make the world a better place for the next generation. With the same breath, we are finding that there are others out there with the same dream that have never been given the chance to participate in the changing world because of the previous boundaries of the financial system. That world is gone. This is the New Financial Revolution. It’s going to be a rough ride — it may look like it won’t work at some point. Some will give up. Those who persevere will be rewarded. We’re going to have to change everything — starting from regulations to the public utilities to government systems and even democracy. In the end it will be worth it. I “Hope”.