With all the loud and conflicting talk surrounding cryptocurrency, how can someone gauge whether to invest in it, or the idea behind a digital coin?
Last Saturday, Berkshire Hathaway’s Vice Chairman Charlie Munger told attendees at the company’s annual meeting in Omaha that “people who are professional traders that go into trading cryptocurrencies, it’s just disgusting.” According to Nobel prizewinning economist Robert Shiller, “We are over-emphasizing bitcoin.” And JPMorgan Chase & Co. CEO and Chairman Jamie Dimon’s view on cryptocurrencies have arced from disdain to ambivalence.
While Bitcoin (BTC) and Ethereum (ETC) are the cryptocurrencies currently holding the first and second largest market cap respectively (BTC $105.3B, ETC $18.8B), there are more than 2,500 other cryptocurrencies according to this list at Investing.com. The opportunities abound, but just how valid are they?
Crypto Valuation = Philosophy + Technology?
Eric Kovalak, a managing partner for Vellum Capital, a hedge fund management firm specializing in crypto assets, says, “People are trying to translate the value of cryptocurrencies into a traditional model where they’d use something like P/E.”
While there is a calculation called NVT Ratio (i.e., network value to transactions ratio) that mirrors a kind of P/E ratio for Bitcoin, its creator says it’s “not always” a valuation metric for other cryptocurrencies. According to Mr. Kovalak, putting a value on a cryptocurrency means evaluating the asset against a philosophy and technology. He says investors should ask themselves if the cryptocurrency’s fundamental structure provides a transparent, decentralized solution.
Mr. Kovalak says a digital coin should also solve a problem that aligns with the philosophy of a distributed currency solution. For example, digital coin XRP solved the technological problem of allowing Visa- and Mastercard-like volumes of transactions on the network, which has been a challenge for the current structure of Bitcoin. However, XRP is on its own private permission ledger, not a distributed blockchain, and per Mr. Kovalak’s view, not philosophically aligned to the distributed model advocated by many crypto experts.
Going Mainstream: “Using Blockchain Without Knowing It”
One of the greatest levers for widespread adoption of cryptocurrencies is how easily people can acquire, protect and use them. Just ask your grandmother to pay for something with bitcoin. Her reaction will illustrate some of the challenges to broad adoption. Suffice it to say there’s still a great deal of intellectual know-how required to understand, find and sign into an encrypted portal and begin trading.
That said, for believers, the promise of cryptocurrency is its potential to be a first-ever global currency. One cryptocurrency security expert told me, “More than money, crypto is an industry. Imagine you invested in email in 1993 [before browsers provided the platform for mass adoption]; cryptocurrency might be the way to do that today.” It’s a tantalizing thought for investors.
The cryptocurrency industry, say experts, hasn’t arrived at its “browser moment” yet. To go mainstream, they say, you would expect people to use a blockchain without knowing they’re using a blockchain—a kind of backdoor “Intel Inside” strategy. The application built on top of it would be simple to use. For example, Brave Software Inc. is offering a browser that allows users to send money to websites they like. What consumers don’t realize is that the Brave browser is integrated with Basic Attention Token, a decentralized ad platform based on Ethereum. And while Brave Software is making the use of cryptocurrency more seamless, pundits and media outlets have given it mixed reviews.
Formulating A Crypto Investment Strategy
When I asked G. Mark Hardy, an expert on cyber security and president of the National Security Corporation, what criteria he would use to assess the value of cryptocurrencies, his answers included:
- Look at the financial stability and maturity of the cryptocurrency’s core developers and their sponsors.
- Monitor the consumer acceptance rate over time.
- Determine if the company behind the coin is solving a particular business issue. With more than 2,500 cryptocurrencies and growing, many simply emulate what an existing currency is already doing.
I’ll add this: When PE firms evaluate a privately held company, the experience of the target company’s managers shape any decision to invest. Among the first criterion I’d use to assess a cryptocurrency would be looking at the team behind the digital coin. What’s their experience with encryption, economics, software development, auditing and system architecture?
Another criterion is the cryptocurrency’s level of transparency and public statements. For instance, if a company indicates with a news release that it’s struck a valuable partnership with a major company, find out the level of commitment to that partnership. A brand name partnering with a blockchain developer is no guarantee of a successful endeavor.
Last year, news of KODAKCoin broke at the Consumer Electronics Show (CES). Through a licensing agreement with Kodak Co., blockchain developer WENN Digital is apparently building a platform, called KODAKOne, using artificial intelligence to manage digital imagery. KODAKOne is supposed to pay image owners in KODAKCoin. According to recent news accounts, and in spite of the early fanfare and bump in Kodak’s stock, KODAKCoin still isn’t available and critics call the KODAKOne platform no more valuable than Shutterstock. In fact, digital rights management experts question the fundamental business objective of KODAKOne.
Cryptocurrencies are still new and unconventional. But even with digital coins, there’s a conventional, albeit boring, two-part answer to assessing which ones to buy: First, investors should decide if these investments are within their sphere of know-how. If, for example, someone is an expert on manufacturing and misses an opportunity to invest in a healthcare start-up, is it really a miss? Next, learn about the organizations behind these digital coins and decide if they’re solving a legitimate problem. If so, can someone buy the asset for a rational price and articulate a clear rationale for how it is positioned to appreciate over several years?
For those seeking safety in numbers, Mr. Kovalak offers this novel idea for investing in a new and largely untested industry: Pick your top five crypto investments from among the largest cryptocurrencies measured by market capitalization and manage them like your own mini-crypto-fund.