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July 23, 2021

The Binge-worthy Basics of Blockchain Investing.

How to invest in bitcoin and cryptocurrencies, told in one amazing story. (Some people binge-listen in one sitting.) Click to hear a free sample.

This week I am indebted to Reddit user Wargizmo, who put together the chart above, one of the most helpful I’ve ever seen. (Full version here.)

I call this an investing superpower.

Many people buy crypto without knowing what their project actually does. This is like buying a stock because your salon stylist told you it was hot. Smart stock investors research the underlying company, and smart block investors do the same.

This chart is similar to the concept of “business sectors” in the traditional stock market. To learn to wield this superpower, let's first explore the concept of sectors.

The Power of Sector Investing

As a traditional stock investor, let’s say that you have two post-Covid predictions:

The demand for IT will be going up (because our lives are increasingly spent online);
The demand for real estate will be going down (because the flight to the suburbs is over, more people are working from home, and there's less demand for commercial buildings).

Using sector investing, you could:

buy stocks of companies in information technology; and
avoid stocks of companies in real estate.

The commonly accepted sector categories is called the Global Industry Classification Standard (GICS), which is not the sexiest name. (“Superpower” is much better.)

The GICS has 11 sectors:

Energy
Materials
Industrials
Consumer Discretionary
Consumer Staples
Health Care
Financials
Information Technology
Telecommunication Services
Utilities
Real Estate

Sectors, in other words, let you group companies by industry. If GICS lists the sectors of the stock market, the chart at the top of this newsletter lists the sectors of the block market.

It’s like a superpower, because it lets you clearly see categories within the blockchain industry – like a kind of X-ray vision. This gives you insights into which “companies” are going to be the winner(s) in each sector of blockchain. Put another way, it lets you predict which tokens will dominate their respective categories.

Compare this with the usual view of blockchain -- by market cap -- and you can see this chart brings structure and order to the industry. It lets you pick a winner in the categories that matter.

As blockchain investors, we must know our sectors. (Which rhymes.) Let’s go through each of the sectors in this chart, in order of investment potential.

Store of Value (excellent)

There’s really only one player here: bitcoin (BTC). While bitcoin has not widely caught on as a currency, it has caught on as a store of value, like “digital gold.” This is why, for example, more companies are storing part of their cash reserves in bitcoin.

This store of value argument is why so many investors believe, “If you’re going to only invest in one digital asset, let it be bitcoin.” They believe that despite short-term volatility, bitcoin is an excellent long-term store of value. (Bitcoin is the foundation of our Blockchain Believers Portfolio.)

Distributed computing (excellent)

I would call this category “Blockchain platforms,” and it's probably the easiest crypto investment decision, behind bitcoin. If you believe blockchain is here to stay, then people will need platforms to develop on it – in the same way they need Windows, Mac, or Android operating systems to develop apps.

The 800-pound gorilla in this category, of course, is Ethereum (ETH). In some ways, Ethereum seems like the most undervalued “company” in the world, with a global community of users, developers, and platforms being built on top of it at a furious pace. It can be seen as the infrastructure of the “Internet of Value.”

That said, Ethereum is not a lock: plenty of technology platforms rise to early dominance, only to lose their lead (Betamax, MySpace, IBM). Other worthy contenders include Binance Smart Chain (BNB), Cardano (ADA), Algorand (ALGO), and others.

We may end up with 1) Ethereum as the clear leader, and a handful of smaller blockchains specializing in niche applications. (Think about a virtual monopoly, like Google vs. all the other search engines.) Or we may end up with 2) two big competing blockchains (an oligopoly, like Windows vs. Mac OS). Right now, Scenario #1 seems more likely.

Financial services (Excellent)

There’s a lot of hype in this industry, but in the case of Decentralized Finance (DeFi), the hype is probably warranted. In our view, DeFi platforms are so important to the future of finance that we’ve written several guides (How to Invest, How to Evaluate, and How to Find Unicorns).

Using DeFi products is still a bit technical and wonky, but once you learn how they work, they are so much better than traditional financial products (such as online banking and online brokerages) that there's really no comparison: it’s like upgrading from travel agents to Google Flights. And they will get even better and easier to use.

DeFi investments are generally riskier than the rest of the block market: it’s the leading edge of the leading edge. But the potential returns are also much greater. If you want to invest in DeFi, consider the projects with the largest market cap – this generally means they have the most users, and are in a good position to become category leaders.

Exchange tokens (OK)

Exchanges are a critical part of the blockchain ecosystem: it’s where you buy, sell, and trade one digital asset for another. Since this is the single largest use case for blockchain today (trading tokens), you’d think digital exchanges would be a perfect investment opportunity.

The challenge is that it’s really hard to run a traditional exchange, given the continual tangle of legal and regulatory challenges. Each country’s laws are constantly changing as they figure this stuff out, but meanwhile blockchain is a global, borderless system that’s happening 24 hours a day.

The history of blockchain is already littered with the bodies of exchanges that have come and gone. Who will be left standing in the end? As Yoda might have said, “Impossible to see the future is.”

Stablecoins (OK)

Stablecoins – or digital assets that hold their value, typically 1:1 with the U.S. dollar – are one of the fastest-growing sectors in blockchain. The two behemoths are Tether (USDT) and USD Coin (USDC), the latter issued by Circle, which will soon go live as a publicly-traded stock (see How to Invest in Circle).

The issue is that it’s hard to make money with stablecoins, since the price doesn’t move. You can, of course, earn “interest” on them (typically called “yield”), using new DeFi protocols (see our page of best DeFi interest rates). This can be a valuable part of an investing strategy, like storing part of your traditional money in a CD or money market fund.

Stablecoins are “safe,” but with low risk comes low reward. (And they’re not completely without risk -- they could still be taxed out of existence by governments). For bigger returns, look elsewhere.

Decentralized storage (OK)

Let’s say you have a massive hard drive – a couple of spare petabytes – and you’re only using a fraction of that storage space. You can “lease” your unused storage for other people to use, then get paid in blockchain tokens. On the other side, users with massive files can “rent” the storage at a cheap rate.

This is the promise of decentralized storage, which is still in its early days, but interesting to watch. Filecoin is the leader, and probably the best investment opportunity (it’s hard to imagine BitTorrent gaining widespread usage, given its history as a piracy platform).

The key “tipping point” is if/when these decentralized storage systems begin to be widely adopted by companies and enterprises. Until then, most investors will probably “wait and watch.”

Gaming (OK)

Blockchain economies are similar to videogame economies: the kind where you buy real money to buy virtual goods, like custom skins and weapons. So there’s some overlap here, but certainly no category leader yet. It will be an interesting space to watch (or better yet, play).

One project to check out is Decentraland (MANA), which lets you use cryptocurrencies to buy virtual assets in this fully-immersive VR world. If you want to invest in real estate, but can’t afford “real” real estate, you can buy plots of land – virtual real estate – in Decentraland. No idea on whether Decentraland will be around in ten years, but virtual real estate is certainly a trend of the future.

Meta Chains (OK)

These are technologies that provide interoperability between blockchains – transferring data between Ethereum and Cardano, for example. As an example, imagine investing in a company that provided interoperability between Windows and Macs. Those companies do exist, but they’re usually a tiny fraction of the overall Windows/Mac market. Probably best for most casual investors to hold off.

Currency (poor)

The great irony is that “cryptocurrencies” aren’t really currencies. Of course, a few weird convenience stores accept Bitcoin, but you can’t really use crypto to buy things in the real world, like traditional money.

So the “Currency” investments on the chart above are probably not great long-term investments. Ripple (XRP) could be the exception, as it is designed for a specialized type of payment -- international money transfers -- but Ripple is currently the subject of an SEC investigation (see our article on SEC vs. XRP).

The bigger issue is that over 80 governments around the world are already working on their own Central Bank Digital Currency, which will offer the convenience of digital money, but backed by the government. Once CBDCs are rolled out at scale, why would people use any other digital currency?

Privacy Coins (poor)

One reason you might use another currency is if you want to stay completely anonymous. Bitcoin and other cryptocurrenies are only partially anonymous – you can still view the complete history of transactions on a blockchain – but privacy coins are a black box.

While privacy coins are used for legitimate reasons -- to protect personal privacy, or to escape tyrannical governments -- they're also used for shady transactions, which makes them unlikely to ever achieve widespread usage. Plus, all the challenges listed in the “Currency” sector above still apply.

Wrapped bitcoin (poor)

This is what is known as a derivative, or a digital asset built on top of another digital asset. The problem with derivatives is they get increasingly complicated and risky for most investors (I always link to the Selena Gomez scene from The Big Short).

Assets-built-on-assets leads to assets-built-on-assets-built-on-assets, and the whole Jenga Tower can quickly come crashing down (I always link to the Ryan Gosling/Steve Carrell scene from The Big Short).

Layer 2 ETH solutions (poor)

This is new technology being built on top of Ethereum. For most investors, ask yourself the simple question: if you believe in Ethereum so much, why not just invest in Ethereum?

Meme coins (poor)

Feel free to invest in Dogecoin, because it's fun. Especially if you think it’s fun to lose all your money.

Specialized coins (mixed bag)

Finally, there's the "everything else" category: all the wonderful and weird experiments being tried on blockchain. These are worth watching, to see which ones are getting traction and potentially seeding new sectors.

The Sector Superpower, Summarized

Investing in blockchain projects using a sector view is like having "laser eyes" in real life.

While everyone else is chasing "price trends," or looking at "social media sentiment," or any of the other hundred flavors of crypto craziness, you can cut through the chaos.

Sectors give you a calm, logical view of blockchain investment opportunities, by category. The process is:

Understand each sector.
Decide which sectors are going to be the most important, long-term.
Then find the 1 or 2 leaders in each sector.
Profit.

Health, wealth, and happiness,

John Hargrave

Publisher

Bitcoin Market Journal

Hey Everyone,

In these market updates, we often give central bankers a lot of flack, but the truth is, politicians are far worse.

One of the things Elon Musk said on the livestream the other day that I really disagree with was that governments are like corporations, and that if you don't like corporations, then you should really hate governments.

Corporate leaders are often driven by greed, and central bankers tend to run into moral hazard, but the incentivization structure of politicians is completely out of whack, since they are elected for the short-term but make decisions that will affect us in the long-term.

When forced to make a decision between what's right and what's popular, a politician will nearly always choose the latter. That's not to say there aren't any good-hearted politicians, it's just how contemporary democracy works.

In a CNN town hall meeting yesterday, President Joe Biden actually made the argument that if enacted, his multi-trillion-dollar spending proposals "will in fact reduce inflation, reduce inflation, reduce inflation."

You can see the video at this link (timestamp: 20:48) in which Biden attempts to support his clearly preposterous economic assertions by citing a recent Moody's report, his good friend Larry Summers, and even "the vast majority of the experts including Wall Street," none of which seem to corroborate the stuff he's saying.

It shouldn't take a world-famous economist to explain why printing more money will lead to persistent inflation, but here's an editorial in the Wall Street Journal written by John Greenwood and Steve H. Hanke, a professor at Johns Hopkins University, who deploy Milton Friedman's famous mathematical formula to show how Biden, Federal Reserve Chair Jerome Powell, and the markets are most likely in for a big surprise.

In summation, politicians lie, inflation is coming, stay humble, and stack sats.

Have a wonderful weekend.

Mati Greenspan