Tim Johnston

Our Thoughts on Libra

Last week we saw the biggest announcement in crypto since the Bitcoin Whitepaper. We are clearly not trying to downplay the enormity of this announcement - it is huge. A consortium of companies, led by Facebook, introduced the world to Libra - a cryptocurrency backed by a reserve of fiat currencies and government bonds.

As your trusted source on everything crypto, we have cut through the noise to distill the possible implications of the Libra announcement. While the project is not without concerns, we think it will be an enormous boost for crypto assets.

Let’s start with some of the positives.

Exposure

Slowly but surely, more and more people are coming into crypto. We regularly monitor metrics like transaction count and unique addresses, where increasing numbers suggest more people are using crypto assets. With Libra, this is set to accelerate, rapidly. The Libra Association includes companies like Uber, Stripe, Booking.com, Visa, Spotify and of course Facebook. The number of users connected to these members has been estimated at over 4 billion. In comparison, the number of blockchain wallets worldwide has been estimated at 35 million. Libra will serve as an on-ramp to crypto assets. Users might start with Libra and as they become familiar with wallets and crypto transactions, migrate to other crypto assets. We are not suggesting that every Facebook user will use Libra or migrate to other crypto assets, but when you compare 4 billion to 35 million, there only needs to be a tiny conversion rate to make a colossal impact.

Ambition

The Libra Association has enormous ambition. In practical terms, the goal is to send money as simply as we send a message - instantly and borderless. This will allow users to easily send, receive and store money - a “simple global currency and financial infrastructure that empowers billions of people.” The Whitepaper cites ambition to help the 1.7 billion people in the world that are still unbanked. Financial exclusion breeds poverty, which breeds civil unrest and in extreme cases, terrorism and war. Libra believes that “global, open, instant, and low-cost movement of money will create immense economic opportunity and more commerce across the world.”

How is Libra better placed to achieve this than existing crypto assets, including Bitcoin?

There are a few reasons why Bitcoin has been slow to be adopted as a Medium of Exchange. First, it is volatile. Second, user adoption has been slow - it is hard to use Bitcoin if your friends and network do not use Bitcoin. Lastly, there is a lack of infrastructure that allows users to pay with and merchants to accept crypto payments. Merchants need additional infrastructure to receive Bitcoin payments and to convert receipts into fiat currency. While there are a number of companies trying to solve this problem, they are all middlemen charging middleman rates, up to 3% either to the customer or the merchant. Why pay with crypto if the fees are higher than existing options like Mastercard or Visa?

The members of the Libra Association can attract the adoption necessary to build the infrastructure. It is a problem of economies of scale. The Libra Association is raising funds to tackle this infrastructure problem and in our view, will be much more likely to succeed than any existing crypto asset or middleman.

Credibility

JP Morgan, Fidelity, Yale, Harvard, New York Stock Exchange, Goldman Sachs and now Facebook, Uber, Mastercard, Visa and Vodafone. These are just some of the names that are now actively involved in crypto assets. The addition of the Libra Association founding members adds more credibility to crypto. This is having a direct effect on investors We are seeing this first hand as we talk to potential investors that take comfort from their involvement.

If you still think crypto is nothing more than magical internet money, it’s time to wake up.

User Experience

The user experience associated with many crypto assets is still poor. Facebook, Uber and eBay all know a thing or two about user experience. They also know that user experience can be the difference in creating and distributing a successful product. Libra will be seamless, beautiful, easy to use. Our grandparents will be able to use, send, store and receive crypto assets as easily as they can receive a text message.

Collaboration with Regulators

The Libra Association is actively talking with regulators. As regulators develop a better understanding of crypto assets, we see this as a step forward in the push for widespread crypto regulation.


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While there are a number of positives about Libra, there are a few concerns.

Privacy

Facebook and privacy. Two words that by themselves evoke mixed responses. When put together, the response is uniformly negative. Facebook has a terrible track record when it comes to privacy. Facebook already has control of vast amounts of our personal data, allowing it to provide a wonderful service to marketers around the world. It is unclear whether it is using Libra to go after our financial data. The cynicists argue that Libra is an attempt to capture our financial data and use this data to Facebook’s advantage. By combining our personal and financial data, Facebook will make even more money from marketers looking to target their advertising. The optimists focus on Facebook’s global inclusionary mission, described above. The Libra Whitepaper is short on detail. It proclaims it will “evaluate new techniques that enhance privacy in the blockchain while considering concerns of practicality, scalability, and regulatory impact.” We retain a healthy skepticism and put the burden of proof on Libra to convince us that transactions and financial data will remain private.

Centralisation

Libra is centralised, not decentralised. Decentralisation is a fundamental property of valuable crypto assets. The most valuable crypto assets are decentralised. While it is an improvement over fiat currency that Libra is not centralised in one actor’s hands, it is not the same as being truly decentralised. Libra will start as a permissioned blockchain and start transferring to a permissionless, decentralised blockchain within five years. We won’t hold our breath.

When there’s someone in charge, an interested party – a policymaker, a banker, a regulator, a shareholder – can lean on them to make changes.

Michael J Casey, CoinDesk

Reserve

Libra will be backed by a reserve of fiat currencies and short-term treasury bonds. “The assets behind Libra are the major difference between it and many existing cryptocurrencies that lack such intrinsic value.” While we see it as an improvement that Libra is not backed by one fiat currency, rather a basket, let’s not pretend they have intrinsic value. A major reason for the introduction and development of crypto assets was in retaliation to the devaluing of fiat currencies globally, which still persists today. An appreciation for crypto assets often starts by realising that fiat currencies do not have any intrinsic value. The claim that the Libra has intrinsic value is nothing more than marketing spiel.

Marketing Speak

In addition to the intrinsic value claim mentioned above, there is clearly a degree of marketing freedom within the Libra Whitepaper. Another example is the promise of pseudonymous transactions and anti-money laundering compliance. These are intrinsically opposed. The Libra Association is trying to appease regulators who require AML compliance and crypto purists who value privacy. The presence of marketing speak, like these examples, makes us question the veracity of other claims in the paper.

The Lord of the Coins

Will this be the “One Coin to Rule them All?”

A potential negative is Libra could squash a wide range of other crypto assets. Will Bitcoin lose its appeal as users take a preference to Libra?

We have previously discussed how we divide crypto assets into key verticals - money, privacy, smart contracts, decentralised finance, Web 3.0. It is impossible to optimise crypto, including Libra, across all of these verticals.

Libra poses the greatest threat to the money vertical, specifically as a Medium of Exchange and stablecoins. We do not think Bitcoin will be challenged as “digital gold,” a decentralised, censorship resistant, deflationary, store of value. We do think the Medium of Exchange crypto assets (eg: Litecoin, Bitcoin SV) will be challenged. We think users will prefer Libra over alternatives as it is likely to be accepted more widely and easier to use. Libra will also challenge stablecoins. Tether, USDC, Pax Coin, Gemini, DAI all stand to be tested as Libra enters the market as an alternative stablecoin.

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From a humble whitepaper released to a small mailing list in 2008, to one of the largest technology companies in the world releasing its own version, it is clear crypto assets have come a long way in the last ten years.

We at Apollo Capital are very excited to see the developments over the next ten years.


Volatility, Opportunity & Position Sizing

Our edge at Apollo Capital is our experience in both traditional financial markets and crypto markets. On a daily basis, Henrik and I draw upon our experience from traditional markets to construct a portfolio of crypto assets. Combined with our knowledge of crypto assets, we are the best in the country, if not further afield, at managing a crypto portfolio.

While I don’t pretend to know as much about crypto or financial markets as Henrik, my experience* is different and has undoubtedly shaped the way I approach crypto funds management.  I thought it timely to share a few thoughts on investing in crypto, in particular volatility, opportunity & position sizing.

(*for more information on my background, please feel free to visit my LinkedIn page.)

1. Volatility

A number of traditional financial ratios and models use volatility as a measure of risk. Modern Portfolio Theory (MPT), developed by Harry Markowitz in 1952, is used to optimise portfolios based on their expected returns and observed risk. The standard deviation of an asset’s returns is used as standardised measure of risk. MPT, CAPM, Sharpe Ratio, Sortino Ratios, nearly every ratio I have come across uses volatility as a unit of risk.

The general theory is that the more volatile the asset, the higher the standard deviation of returns, the riskier the asset. The words volatile and risky have almost become interchangeable in financial markets.

If we put crypto through these models, I suspect the models would spontaneously combust. Crypto is extremely volatile. I usually check crypto prices a couple of times a day and it is common to see 24hr price swings of greater than 10%. Imagine if that were the case in equity markets! Throughout the 16 months since inception, the Apollo Capital Fund has already delivered monthly returns ranging from +45% to -34%.

In Berkshire Hathaway's 2007 annual meeting, Warren Buffett said the following about volatility and risk:

“It's nice, it's mathematical, and wrong. Volatility is not risk. Those who have written about risk don't know how to measure risk. Past volatility does not measure risk. When farm prices crashed, [farm price] volatility went up, but a farm priced at $600 per acre that was formerly $2,000 per acre isn't riskier because it's more volatile.”

Instead, Buffett prefers the dictionary definition of risk: “risk is the possibility of loss or injury.”

Why is crypto risky?

It is clear that investing in crypto is risky: there is a possibility of loss (hopefully not injury!) and that possibility exists because crypto is young and the future is uncertain. Any groundbreaking technology is going to be met by opposing camps of skepticism and fervour. Crypto is a complex topic and it’s future is anything but clear. It is easy to forget, but many people thought the same about internet stocks in the mid 90s - they were risky investments.

Why is crypto volatile?

Crypto is volatile for two reasons: it is risky and prices are retail driven.

Crypto prices are predominantly retail driven. Retail investors are more easily caught up in the waves of greed and fear that drive financial markets, especially crypto markets. While the equities that represented the internet hysteria were certainly volatile, they were not as retail driven as crypto markets. Crypto assets are more accessible to the world’s population than equities on listed stock exchanges and equity markets are largely driven by institutional capital.

The distinction between risk and volatility is important:

“Crypto is not risky because it is volatile. Crypto is volatile because it is risky”

Once we accept this important distinction, the solution to deal with the risk is clear: position sizing.

Position sizing refers to allocation of capital to a particular investment in the context of the overall portfolio. For us as managers of the Fund, we discuss the size of positions such as Bitcoin and Ethereum. Do we invest 10%, 20% or 40% of the portfolio in Bitcoin? For the individual investor, position sizing refers to the amount of capital allocated to crypto relative to the overall portfolio.

Although we do not provide advice to investors in the Fund, we certainly do not advocate investing 50% of a portfolio in crypto, it’s too risky. The possibility of loss is too great and the consequences of any loss too severe. Many of the greatest thinkers in crypto suggest allocating an amount of capital that the investor is prepared to lose. Studies of institutional investors in crypto suggest starting allocations of 0.2% to 0.3%. Crypto is risky and for any investment in crypto there is a possibility of loss of capital.

2. Opportunity

I used to work at a funds management company that managed more than $500m of client funds in Australian equities. My former boss, a veteran investor with more than 30 years experience across a range of markets, taught me a number of lessons about investing. One of the key lessons that stuck with me is “the best returns often come from the ones you feel uneasy about.” I didn’t realise it at the time, but I now understand why.

“Risk creates opportunity”

When a company’s future is uncertain, when the risk feels high, other investors often reach similar conclusions, many choosing to avoid that risk by either selling or not investing. Risk can create opportunities to buy assets that are cheap. It is the job of the investor to discern from risky opportunities that are worth investing in, compared to those that are doomed to fail.

I see similar circumstances to crypto assets. There are numerous reasons why crypto assets may not succeed. Investing in crypto is risky. This creates opportunity. One of the main reasons for this uncertainty is a lack of understanding. The vast majority of people have not or will not spend a little time trying to understand crypto. This is a missed opportunity to learn about a technology with enormous disruptive and innovative potential.

This creates opportunity for those that have a keener understanding of crypto. It is interesting at this point to stop and consider, “how much do I need to understand to make an investment in crypto?” An investor doesn’t need a comprehensive understanding of the intricacies of crypto assets to make an investment. Just as we don’t need to understand the code behind Google’s search algorithms, we don’t need to understand the of code that powers the Bitcoin network. A more relevant understanding is the power of Google’s search algorithms to its users, the power of the Bitcoin network to its users and why both are better than the alternatives.

“Investors need to understand the three forces driving crypto innovation.”

First, it is a groundbreaking technology. We have written at length how crypto removes the need for trusted intermediaries and the resulting waves of disruptive innovation. Second, it has attracted huge amounts of capital. Third, the world’s best computer software engineers are flocking to work on challenging crypto projects. Understanding the power of innovation that is likely to come from these forces is more important than knowing the details of the Ethereum code.

For those that see the potential, for those that read Apollo Capital’s weekly newsletter and understand why crypto shows promise, investing a small amount in crypto is obvious. Investors realise the inherent risks in these investments, but they accept these risks and in doing so, give themselves a chance of capturing the upside.

Again, we come back to position sizing. The future of crypto is uncertain and accordingly, it makes most sense to only invest a small percentage of the portfolio in crypto assets. Despite working in crypto and understanding crypto assets better than most, I only have a small percentage of my net worth in crypto. I have a far, far greater percentage in my house, despite having greater conviction in crypto than the property market in Australia.


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An unfounded fear of volatility and a lack of understanding is causing the majority of investors to miss out on the crypto opportunity. Many are waiting to understand crypto in full, or for there to be greater understanding from their peers and the media. They are missing the point. By the time this happens, the market capitalisation of crypto assets will be in the trillions.

Once crypto becomes mainstream and well understood, the opportunity will be long gone, leaving many investors to regret the omission of a small allocation in their portfolio.

**please note this article does not constitute financial advice. My thoughts are my own.


The Unimportance of Coffee and Cake

When people think of “money”, most think about using it to purchase goods and services. Bitcoin is terrible as a means of payment. It is slow, can be expensive and is not widely accepted. We are often asked, “what you can actually buy with Bitcoin?” The answer is not much.

Crucially though, it doesn’t matter.

Bitcoin offers little improvement for users when it comes to purchasing coffee and cake. It is easy to underestimate the importance of user experience. Often it is the difference between success and failure. The innovation behind a number of successful technology companies is not necessarily the complexity of the technology, but the improvement it offers to the users’ experience. Amazon originally succeeded as a book seller because it allowed customers to browse, purchase and receive books from the comfort of their lounge chair. Uber offers users a superior customer experience as they order a lift from anywhere, track when it is due to arrive and pay with ease. AirBnb offers users a wider range of accommodation options, often for a lower price than hotels.

Bitcoin does not offer customers a better payments experience. In fact, it is far worse and while it might improve with new technology like the Lightning Network, it is unlikely to be a giant leap forward in payments. The bar for payments is currently very high, by design. Existing payments networks are designed to reduce friction for users. Less friction leads to more payments which leads to more profits for payments networks. Visa’s Paywave allows users to buy their coffee and cake with the tap of a card. Paywave is seemingly everywhere. Apple Pay has improved this again by allowing a simple tap of the phone. Any further improvements are likely to be marginal and are unlikely to come from Bitcoin. Bitcoin is slow, difficult to use and does not improve the customer experience.

Bitcoin might be an improvement for merchants. Using Bitcoin eliminates the risk of fraudulent purchases. Global credit and debit card fraud has been estimated at around US$25bn, a great deal of which is worn by merchants. Bitcoin is a digital bearer asset. Bitcoin can only be spent if the customer is in control of the Bitcoin. There is no room for impersonation. Bitcoin as a means of payment may also result in lower transaction fees to merchants. Credit card issuers charge merchants up to 3% for the privilege of receiving payment. The fees for using the Bitcoin network are typically lower. On the flip side, the Bitcoin network isn’t going to roll itself out to merchants and a middleman is required to build the required infrastructure. Just as Visa and Mastercard charge a healthy commission, it’s safe to assume any middleman will as well. While in theory there might be some improvements to merchants, the customer experience improvements aren’t significant enough to convince customers to absorb the switching costs and start buying their coffee and cake with Bitcoin.

There are two use cases where Bitcoin might flourish as a form of money to make payments. The first is micro transactions. Bitcoin is useful for tiny payments, such as 5c. Credit cards often charge minimum fees per transaction, such as a 30c flagfall, making micro payments impossible. Micro payments could become commonplace for new uses on the web like micro donations or paying for content. Secondly, Bitcoin might flourish for large payments. Transferring $1m to someone else through existing banking infrastructure can be difficult, slow and expensive. Bitcoin happens almost instantly and is relatively cheap. However, the problem of transferring large sums of money is not widespread and Bitcoin’s edge in this regard is unlikely to drive mass adoption.

While Bitcoin struggles as a medium of exchange, many forget that there are other roles of money. There are three roles of money - a store of value, a medium of exchange (buying coffee and cake) and a unit of account.

Bitcoin excels as a store of value - this is where the value of Bitcoin lies.

The following highlights four scenarios in which Bitcoin is appealing as a store of value:

  1. An alternative to gold - Bitcoin is superior to gold. It is easier to divide, transfer, store and secure. Gold has an estimated market cap of $8 trillion and only a tiny fraction is used (in jewellery for example). It is easy to see Bitcoin competing with gold and capturing some of this value.

  2. Offshore banking - it is estimated that $15 trillion is stored in offshore bank accounts such as in Switzerland. There are many different motives for storing funds offshore. It is easy to see Bitcoin competing with offshore bank accounts as an alternative place to store value, outside the purview of others.

  3. Investment hedge - just as many store value in US Dollar or Swiss Francs, many will look to store value in Bitcoin. Storing valuing in Bitcoin is a hedge against macro economic events. Bitcoin is free from association with any country, central bank, political movement or individual. Bitcoin is completely independent and has proven to be uncorrelated to other assets.

  4. In developing economies - for citizens of countries that are ravaged by inflation and political influence, like Venezuela, Bitcoin is an attractive alternative to storing value compared to local currency. For citizens of developed economies, it is easy to underestimate the value of a digital currency that is independent, permissionless and censorship resistant

A common counter argument to Bitcoin as a store of value is volatility. Bitcoin has been highly volatile, which is expected of an asset and technology that is still going through the discovery phase. Bitcoin is only 10 years old. It will take a long time for Bitcoin to be more widely recognised. In the interim, as with any new technology, Bitcoin will be met with both skepticism and enthusiasm. We expect this to continue as the technology and its understanding develops. Gold and fiat currencies have taken a long time to be widely accepted and even today, are at times more volatile than Bitcoin. And volatility works both ways. Just as an investment in Bitcoin may lose value due to volatility, it may increase significantly. Bitcoin clearly has greater potential than gold or fiat currencies.

In most respects, Bitcoin is not a very good form of money. Bitcoin struggles and will continue to struggle as a medium of exchange. People focused on where they can or cannot buy their coffee and cake with Bitcoin miss the point. Bitcoin will continue to break ground as an alternative, superior store of value. Other scenarios to those listed above will likely develop, drawing upon Bitcoin’s groundbreaking properties. There is clearly a large enough market for demand to outweigh supply, as more people learn about and embrace a truly unique form of money.

And if one day it so happens that you can buy a cake with your Bitcoin, well that will be the cherry on top.


Test Driving The Future of Finance

In June 2017, Binance raised $15m in an ICO for Binance Coin (BNB). At the time, it wasn’t exactly clear what the value proposition was for BNB. BNB offered traders a discount on trading fees on Binance’s exchange, but this wasn’t exactly groundbreaking.

Fast forward 2 years and Binance is spearheading some impressive and innovative efforts. The most pressing is the creation of Binance’s Decentralised Exchange (DEX), which will be powered by Binance Coin.

Apollo Capital sees decentralised exchanges as exciting developments and crucial infrastructure in the world of decentralised finance promised by crypto assets. Decentralised exchanges promise minimal counterparty risk, lower costs and censorship resistance. We thought it would be an interesting exercise to sign up for the testnet and take our readers on a test drive through the future of finance.

Binance’s Testnet is only available to current Binance customers that have a minimum of 1 BNB. Perhaps this is a savvy marketing ploy, but the first step was creating a Binance account and purchasing 1 BNB (I was interested to observe that the only thing required to create a Binance account was an email address: no ID or anything else is required).

1 BNB Required.png

Next I needed to fund the account where I could receive 200 free testnet BNB sent to my wallet on the DEX.

Funding BNB.png
Funding Secured.png

The exchange looks similar to Binance’s main exchange. There are similar buy and sell ‘panels’ in the bottom right hand corner. There are markets on the left hand side and market depth on the right hand side. The noticeable difference however is there is very little activity. I’m not sure how much feedback Binance is receiving from people using the testnet, but I’d imagine it would be limited until there is a critical mass of users. The lack of activity is understanding, albeit a little frustrating for enthusiastic users like us. I placed an order to buy some BTC for BNB and despite being the lowest ASK, my order remained unfilled for a number of hours. A stark difference to the experience on Binance’s main exchange.

DEX Homescreen.png
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While it is promising to see the launch of the testnet, it appears that the real test will come with the launch of the exchange. As is often the case with crypto projects, given the immutable and censorship resistant nature of blockchains, teams tend to take their time to make sure everything is working perfectly. When considering the irreversible nature of transactions and the value of assets at stake, there is little room in crypto to “move fast and break things”.

Binance’s impressive record over the past 18 months in growing the world’s largest crypto exchange shows that it is highly capable of developing large projects at scale.

Readers might question why Binance would seek to disrupt its hugely profitable exchange, with another exchange that is decentralised. Aside from the immortal words of Steve Jobs, “if you don’t cannibalise yourself, someone else will,” part of the reason is answered by the new business model of crypto.

Traditional business models often revolve around extracting as much revenue as possible out of customers. Crypto assets can offer a new business model whereby the founding team is rewarded with a large allocation of tokens. The team then works on the project, encourages early adopters to look at and invest in the project and seeks to increase the value of the token. All going well, the team is rewarded by an asset that increases in value, as are the early adopters. The key difference of this new business model is alignment - all participants in the network are aligned to increase the value of the token. Binance seems to be a working example where the team have a large and early interest in increasing the value of its BNB holdings, even if this is at the expense of its main exchange. Perhaps it is telling that the team is willing to cannibalise its hugely profitable existing exchange, in place of something which may be even more valuable.

Disclosue: Apollo Capital is an investor in Binance Coin



Blockchain vs Crypto

“I’m big on blockchain, but I’m not so sure about crypto...”

...is a comment we’ve been hearing often.

There is a great deal of hype around blockchain revolutionising the world. Crypto is a scam, blockchain is robust.

Unfortunately, the hype, and this line of thinking, misses the mark.

Private blockchains are little more than glorified databases. They might lead to incremental improvements, but the greater technological leap forward is crypto networks - open, decentralised markets that allow participants to transact with a new basis of trust.

Blockchain and crypto are inseparable, and require a new, unfamiliar way of thinking.

Naval is a vocal critic of the ‘blockchain not crypto’ line of argument

Naval is a vocal critic of the ‘blockchain not crypto’ line of argument

Before I explain, let’s make sure the basics are clear.

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Blockchain is a ledger that keeps track of crypto tokens that are the subject of that ledger.

Let’s dive deeper, using Bitcoin as an example.

The “Blockchain form of accounting” was invented to keep track of bitcoin. When a Bitcoin transaction occurs, the transaction is bundled together with other transactions into a ‘block’. The network needs to validate the transactions, to ensure they are free from fraud and error. Bitcoin miners and market participants prevent double spending by validating the block of transactions using a combination of computational power and mathematical cryptography (the basis for the broader name ‘crypto’). Once the block of transactions is validated, it is added to all previous blocks of Bitcoin transactions. Herein lies the term blockchain - the block is added to a chain of blocks, and we have a blockchain.

Fun Fact: the term “blockchain” was not used in the original Bitcoin White Paper published in 2008.

Crypto (or “Open Blockchains”)

Crypto assets (or ‘cryptocurrencies’, ‘tokens’ or ‘coins’) are traded on a blockchain. In the case of the Bitcoin network, bitcoin is the subject of the transactions. Bitcoin is transacted from one person to another and the Bitcoin blockchain keeps track of the transactions. If we think of Bitcoin as digital money, the system of maintaining the ledger is critically important. A system is needed to introduce scarcity to digital assets, otherwise participants could simply create more money or transact fraudulently, undermining the whole system and inevitably making it worthless. The blockchain solves this problem by preventing double-spending and introducing scarcity to these digital assets.

Crypto networks are a technological breakthrough. Crypto networks redefine trust. For the first time, people can transact peer-to-peer globally, at scale without the need for a trusted third party. Crypto networks are decentralised. Whereas previously a centralised party such as a bank or financial institution was required to process a transaction, now, with blockchain technology, the network processes the transaction. Participants can transact with each other with a new basis of trust. Trust is placed in the open, verifiable system that in turn relies on mathematics and computer code. The removal of centralised third parties removes inefficiencies, costs and has created enormous value.

One of the key takeaways is that crypto networks are open. The network is open to anyone with an internet connection to both transact and validate transactions. The more independent users that take part in the verification, the more secure and decentralised the networks. This openness is related to the trust equation above. The openness lends itself to this new basis of trust.

“As society gives you money for giving society what it wants, blockchains give you coins for giving the network what it wants”


Open blockchains are not without limitations. Open blockchains are not a good solution to store data and they are currently limited by scaling issues. Both of these limitations relate to the structure of an open, decentralised network. Each piece of information stored in a blockchain, such as details of a transaction, sits in hundreds or more nodes around the world (more than 100,000 in the case of Bitcoin). This is in contrast to the alternative - a centralised repository that stores and controls the data. The structure of storing data in multiple places around the world can make open blockchains costly and slow, although it should be noted that some of the world’s best developers are working on ways to solve these problems.

Private Blockchain

A private blockchain seeks to modify blockchain technology for use by a private consortium. A private blockchain does not use crypto tokens or assets.

We have seen in the press a number of stories about how private blockchains will revolutionise the world, increasing efficiencies, saving companies billions of dollars. IBM has developed the “Hyperledger Fabric,” an emerging de-facto standard for enterprise blockchain platforms. Walmart has announced it is putting its lettuce supply on the blockchain, pushing suppliers to use IBM’s blockchain-based software. Global shipping giant Maersk has announced a collaboration with IBM, sharing information about individual shipment events in an effort to reduce shipping administration costs.

While the hype is impressive, it is exactly that, just hype. A private blockchain is a glorified database. There might be incremental improvements for re-structuring the private database, such as improved error checking and validity, but it’s hardly groundbreaking. If people tracking lettuce want to input incorrect information on the blockchain, they can still do it. If Walmart wants to reverse lettuce transactions, it still has the power to alter the data. IBM have taken new technology that doesn’t need a middleman and have made themselves the middleman.

If a trusted third party could administer the ledger, then a blockchain is a “solution in search of a problem.” CB Insights

In 2016, global mining behemoth BHP Billiton announced a program to apply blockchain technology to its supply chain, to enhance security around real-time mining data, including the movement of rock and fluid samples. The hope was coordinating disparate contractors and moving them onto a standardised blockchain based system. In April 2017, the program was abandoned. BHP cited immature technology that wasn’t ready for enterprise adoption. However, I suspect the real reason is a blockchain simply wasn’t required.

The groundbreaking part of blockchain technology is an open system in which anyone can participate, removing centralised third parties and transacting with a new basis of trust. A private blockchain is, by definition, closed and does not offer these qualities.



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Internet vs Intranet


A similar example to crypto versus closed blockchains is the Internet vs Intranet. In the early days of the internet, people used to talk about the intranet as the really big innovation - and the public internet as being untrustworthy and unregulated - "no one will ever bank or shop on an open internet". The rest, as we say, is history. It will likely be a similar outcome - private blockchains will likely exist but will not be nearly as significant as public blockchains.

Why The Hype?

The most obvious reason for the hype is the PR machine. “Blockchain” is like “Artificial Intelligence” and “Medical Marijuana” - it’s a buzzword du jour. At the start of the year, at the peak of the hype, Kodak announced KodakCoin, an Initial Coin Offering to help track photo rights and royalties for digital photographers. The stock price promptly tripled (although since the announcement, the stock price has unsurprisingly dropped back below pre-January prices). It is inevitable that we will continue to see more blockchain hype in the media.

I have developed my own theory as to why people like blockchain, but not crypto. My theory relates to availability bias - failure of logic due to placing more weight on information that is available to the individual. People are familiar with corporations and controlled entities. The idea of a blockchain being controlled by a government or company is easier to digest than an open blockchain. A private blockchain fits within the framework of familiarity. Crypto assets do not. Crypto networks are a new, difficult concept to understand. It’s a frictionless path to gravitate to the familiar, instead of wrestling with the new. I believe this is the main reason why people make the statement at the beginning of this article: “I’m big on blockchain, but not so sure about crypto.

The idea of a blockchain being controlled by a government or company is easier to digest than an open blockchain. A private blockchain fits within the framework of familiarity. Crypto assets do not.

Apollo Capital’s view is that understanding crypto assets requires a different, new way of thinking. An open-mind is a crucial first step. Public blockchains and transparency around transactions is a new concept, at odds with how society has previously functioned with closed, private transactions. Many of today’s crypto enthusiasts took a long time to understand crypto - myself included. We encourage people to keep an open mind, keep learning, reading, listening and following updates from reputable sources like Apollo Capital (#selfplug).

7 Reasons You Should Definitely Not Invest In Crypto - From a Guy Who Co-Founded A Crypto Fund

“I hate crypto”
“What’s all this bitcom (sic) business about”
“Crypto is a scam”

I have spoken to over a thousand investors since launching  in November 2017. Despite meeting a number of savvy investors, many of whom have invested in the Fund, the overwhelming response to crypto has been one of caution and scepticism. By now, I’ve heard just about every response to why you should not invest in crypto. While some reasons for not investing in crypto are sound, others highlight common failings in investor psychology.

Let’s dive in and explore the 7 reasons why you should definitely not invest in crypto.

1. I Don’t Understand It

This is clearly the best reason not to invest in crypto.

Investors need to understand what they’re investing in, whether it be crypto, derivatives or exotic fish. A basic understanding is essential. Warren Buffett has said repeatedly, “don’t invest in something you don’t understand.”

Without an understanding, investors will not have conviction in their investments, will not be prepared for the investment journey and will likely make a poor sell decision.

There are two options for an investor that doesn’t understand an investment opportunity.

The first is to move on. If you don’t understand crypto, if it’s too complex or you simply don’t have the inclination to learn, the wise decision is to move on. Investors cannot be faulted for knowing their limitations.

Many investors don’t realise there is a second option: homework. Read, listen, watch, discuss and learn about the investment opportunity. Warren Buffett avoided investing in many of today’s most successful tech companies because he didn’t understand them. Perhaps he would have been even more successful if he made the effort to understand Internet companies? Applying this lesson to crypto, today’s investors might be more successful if they do the homework to understand crypto. For those interested in learning, our resources pageis a wonderful place to start.

2. Volatility

Crypto is volatile. Apollo Capital recently analysed the average returns of crypto Fundsand the results are fascinating. In a series of returns from June 2013 to April 2018, monthly returns varied from over -30% to over 400%. These returns are not for the faint hearted.

Investors need to know themselves. This sounds like a cliche, but it is true, especially when it comes to investing in crypto. Some investors can stomach volatility, some cannot. If the thought of the value of your crypto portfolio dropping by 20% in a given month makes you weak at the knees, crypto is not for you.

Volatility is relative to position sizing. The volatility of a given investment is relative to how much is invested. If an investor invests their life savings in crypto, the volatility would be extremely difficult to manage. The thought of losing 20% of your life savings in one month is frightening. However, a position of 2%, 5% or 10% of an investor’s portfolio in crypto might mean the volatility is less daunting.

Let’s take an example of investing 2% of a portfolio in crypto. If crypto goes down by 50%, the investor will lose 1% of their portfolio. While not desirable, most sophisticated investors can handle such a loss. Many investors don’t realise the potential upside from a 2% position. In a recent study by Apollo Capital, a 2% allocation to crypto from Jan 2016 to Apr 2018 accounted for 50% of the portfolio’s return.

It is also important for investors to distinguish between the volatility of an investment and the volatility of a portfolio. Including a volatile investment, such as crypto, in a portfolio does not necessarily increase the overall volatility of the portfolio. It all depends how that investment is correlated to the other assets in the portfolio. Crypto assets have shown not to correlate to traditional asset classes. Put simply, even though crypto is volatile, including it in a diversified portfolio doesn’t make the portfolio more volatile. Investors can have the benefit of the return potential of crypto, while keeping the volatility of their overall portfolio constant.

3. Crypto Has No Use

Here, I will go no further than to quote Marc Andreessen’s New York Times’ article “Why Bitcoin Matters”:

Critics of Bitcoin point to limited usage by ordinary consumers and merchants, but that same criticism was leveled against PCs and the Internet at the same stage. Every day, more and more consumers and merchants are buying, using and selling Bitcoin, all around the world. The overall numbers are still small, but they are growing quickly. And ease of use for all participants is rapidly increasing as Bitcoin tools and technologies are improved. Remember, it used to be technically challenging to even get on the Internet. Now it’s not.

Crypto is not perfect. Nothing at this early stage of its development is faultless. We constantly remind investors of two crucial facts. The first is crypto is a technological breakthrough. The second is many of the world’s smartest computer scientists and technologists are working in crypto. And now after the ICO boom, some of the smartest minds in tech are working on delivering on the promise of this technology.

4. Illegal Uses

One of crypto’s first popular use cases was for nefarious purposes. Silk Road was an online marketplace where users could buy and sell illegal goods, including illicit drugs and firearms. Users generally paid for goods with Bitcoin, thinking it was untraceable and anonymous. Many bad actors have moved on from Bitcoin, realising that it is in fact traceable.

The question becomes whether these cryptos are used solely for illegal activities, or whether this is just one use-case. For example, the Internet is used for illegal activities, including piracy, identity theft and terrorists communications. Should we call for a ban of the Internet because it is used for Illegal activities? Yes the Internet is used widely for illegal activities, but this is a tiny percentage of the overall use of the Internet. Applying this to crypto, what percentage of the use case of crypto needs to be for illegal activities before it is worth banning? 10%? 50%? 100%? This is a tough question and different people will have different answers.

It’s impossible to know how widely crypto is used for illegal activities. Top researchers in the space have stated that any reported figures are, at best, an estimate. There needs to be a clear distinction between something that is designed for illegal activities and something that might be used for illegal activities. If something is designed solely or primarily for illegal activities, it should be shut down. Silk Road is a clear example. However, we know there are many use cases for crypto which is not illegal and indeed, is a force for good. It appears naive to avoid investing in something or using it, simply because it can be used for illegal activities.

5. Another Bitcoin


A common response I have heard from wary investors is will Bitcoin be the Myspace to another crypto’s Facebook? It’s a good question and there are two key responses.

The first is network effect. Network effects have been called the business model of the Internet. Bitcoin has the largest network and the most number of users. At the time of writing, Bitcoin’s market cap and daily traded volume is roughly three times that of Ethereum, the second largest crypto. This is not to say that Bitcoin will be dominant for eternity. Network effects can be competed away. Myspace and Facebook is a well-known example. However, currently, Bitcoin is the dominant crypto and it will be extremely difficult for another “money-like crypto” to compete.

The second response is a portfolio approach. Investing in crypto is best done in a diversified portfolio. There is no reason why an investor cannot invest in both “Myspace” and “Facebook.” We don’t need to be exactly sure of which one will win, we don’t need to put all our eggs in one basket. With a technology this young, the best approach is to invest in a range of crypto projects which show enormous potential.

6. Crypto Has No Intrinsic Value

Another reason not to invest in crypto is because it has no intrinsic value. Crypto does not pay dividends, is not tied to cash flows, has no right to other assets.

This line of thinking requires a broader perspective. Let’s consider fiat currency. A $5 note has no intrinsic value, it’s simply a fancy piece of paper. The piece of paper is worth $5 because we all believe it’s worth $5. Some will argue that it’s backed by the government which issues the currency, but this doesn’t point to any intrinsic value. There have been plenty of cases where this backing has become worthless, like the current crisis in Venezuela.

Another example is gold. Gold has been the worldwide store of value for thousands of years, yet where is its intrinsic value? Gold is valuable because we all believe its valuable. In both cases of fiat currency and gold, neither has any intrinsic value. Yet they are valued because we are told to value them and we collectively believe in their value. We all believe they have value until we stop believing.

We could argue that this applies to any asset class — there is no such thing as intrinsic value. The value of all assets comes from the perception that other investors, often called the market, would be willing to pay for that asset. In some asset classes like equities and real estate, the models used to value the asset are well established and well known by market participants. The value of other assets, like commodities, currencies and crypto, are determined by the forces of supply and demand. Investors point to discounted cash flow models and net present values, but the only model that truly works to value an asset is working out what someone else is willing to pay for it. That’s where value comes from. In crypto, the asset class is young, scarce, not well understood, is a technological breakthrough and we believe the demand for these assets will increase in the future.

7. Wait and See

At the start of the article, I mentioned that some of the reasons for not investing in crypto are examples of failures in investor psychology. The “Wait and See” approach is the most serious of these failings. In most cases, it will only lead to worse investor outcomes.

Let’s analyse the scenarios for the Wait and See investor after crypto prices go up, go down or go sideways

  1. Crypto Prices Go Up — prices have gone up, therefore crypto is great and I’m now comfortable to invest, albeit at a higher entry point
  2. Crypto Prices Go Down — the investor gets scared, there must be something wrong with crypto, and decides not to invest
  3. Crypto Prices Go Sideways — crypto isn’t that impressive, what’s all the fuss about?

One of the biggest lessons from co-founding Apollo Capital is how I have observed countless investors, including sophisticated and professional investors, using price as a proxy for quality. At Apollo Capital, the interest we have received in investing in crypto has been directly correlated to the price of crypto. Prices goes up, everyone wants to invest. Prices go down, no one wants to. We all like to believe we are capable of going against the heard, being the contrarian investor who reaps the uncommon gains, but most of this is self-delusion. I haven’t heard one investor say “I’d like to invest, but I’d like to see prices drop to buy in cheaper.”

The approach we advise is the same as analysing any other asset class: it comes down to fundamentals. While crypto assets don’t have fundamental earnings, business plan or asset backing, the fundamentals in crypto is the technology. Investors need to understand or at least appreciate that crypto is a technological breakthrough, it is early, and that there could be huge demand for these assets in the future. Price action should have no impact on investors’ decision making.

Conclusion

Crypto is not for everyone. In the basket of alternative assets, it is an alternative asset. There are a number of sound reasons why investors should not invest in crypto. Yet, through my own personal journey in crypto, I learnt an important lesson. When I first heard of Bitcoin, I dismissed it almost instantly. It might have been fear of the unknown or because crypto is difficult to understand. It was easier for me to dismiss crypto and move on, than to keep an open mind and learn about it. Now, with the benefit of perfect hindsight, I realise I should have set aside a few hours and learnt about this fascinating new technology. It would not have cost much to invest a small percentage of my portfolio. At worst I would have lost my investment, shrugged it off and moved on. Instead, I was later than I would have liked to what is shaping up to be the biggest investment opportunity of my lifetime. I wonder whether the same applies to investors today who are yet to invest in crypto.

Tim Johnston is the Managing Director of Apollo Capital — Australia’s Premier Crypto Fund. The Apollo Capital Fund is a professionally managed portfolio of crypto assets, offering investors exposure to the fast growing crypto market. For more information, please head to apollocap.io