Crypto Assets and Blockchain Tech: Investing Strategies and Risks

This was shared at "Innovate Finance" during the World Economic Forum on January 25, 201.

Transcript

1. Crypto Assets and Blockchain Tech: Investing Strategies and Risks Meltem Demirors
2. DISCLAIMER All opinions expressed by Meltem Demirors in this presentation are solely her opinions and do not reflect the opinions of CoinShares Co, CoinShares Capital, CoinShares UK, or their parent company CoinShares Holdings Limited or affiliates. You should not treat any opinion expressed by Ms. Demirors as a specific inducement to make a particular investment or follow a particular strategy, but only as an expression of her opinion. Ms. Demirors’ opinions are based upon information she considers reliable, but neither CoinShares Co nor its affiliates and/or subsidiaries warrant its completeness or accuracy, and it should not be relied upon as such. Ms. Demirors, CoinShares Co, its affiliates and/or subsidiaries are not under any obligation to update or correct any information provided in this presentation. Ms. Demirors’ statements and opinions are subject to change without notice. No part of Ms. Demirors’ compensation from CoinShares is related to the specific opinions she expresses. Past performance is not indicative of future results. Neither Ms. Demirors nor CoinShares guarantees any specific outcome or profit. You should be aware of the real risk of loss in following any strategy or investment. Strategies or investments discussed may fluctuate in price or value. Investors may get back less than invested. Investments or strategies mentioned may not be suitable for you. This material does not take into account your particular investment objectives, financial situation or needs and is not intended as recommendations appropriate for you. You must make an independent decision regarding investments or strategies. Before acting on information, you should consider whether it is suitable for your particular circumstances and strongly consider seeking advice from your own financial or investment adviser. See Ms. Demirors’ holdings, investments, and disclosures at www.meltemdemirors.com
3. NOT ANOTHER CRYPTO TALK @Melt_Dem 3
4. BITCOIN HAS BEEN THE WINNING TRADE @Melt_Dem 4 Apr-13 Apr-14 Apr-15 Apr-16 Apr-17 Apr-18 0% 7500% 15000% BTC AMZN
5. MAPPING BITCOIN’S INNOVATION CYCLE @Melt_Dem 5 EMERGENCE FRENZY SYNERGY MATURITY Big bang Crash Institutional Adjustment Next big bang Time Degree of Diffusion of the Technological Revolution INSTALLATION PERIOD DEPLOYMENT PERIOD Intense funding Decoupling of paper value and real value Rampant speculation Focus on production Recoupling of paper value and real value Decreasing growth opportunities Source: Carlota Perez, Technological Revolutions and Financial Capital. Bitcoin price sourced from Coinmetrics.io Apr-13 Apr-15 Apr-17
6. THE 2018 GROWTH STORY @Melt_Dem 6 Source: CoinMetrics.io BITCOIN $0 $11 $22 Jan-15 Jan-16 Jan-17 Jan-18 Thousands ETHEREUM $0 $600 $1,200 Aug-15 Aug-16 Aug-17 RIPPLE $0 $2 $4 Jan-15 Jan-16 Jan-17 Jan-18 As of 8/2018 Up 874% As of 8/2018 Up 14,408% As of 8/2018 Up 2,854%
7. VALUE CREATION ISN’T ALWAYS LINEAR @Melt_Dem 7 BOOKSTORE EVERYTHING STORE COMMERCE ECOSYSTEM $0 $1,000 $2,000 May-97 May-02 May-07 May-12 May-17 Source: Bloomberg Amazon daily ticker data. Logos sourced from Google images.
8. KEY THEMES DRIVING INTEREST @Melt_Dem 8 • Rising populist tendencies and trade wars • Increasing frustration over centralized corporate control • Largest generational wealth transfer under way • Millennials and women invest differently • Crypto assets can drastically reduce friction and barriers • Desire for new investment opportunities MISTRUST GENERATIONAL SHIFT DISRUPTION The preference for crypto is driven by social, political, and economic factors
9. CHANGING BUSINESS DYNAMICS @Melt_Dem 9 • Payments, particularly international/remittances • P2P market places for specific market places • Security tokens • Enterprise grade blockchain • Smart contracts growing in complexity EVOLUTION REVOLUTION Blockchain applications within existing financial systems and market structures Decentralized financial system with new primitives built to abstract out intermediaries (banks) • M1 replaced by decentralized, supranational stores of value • P2P exchange of all assets • Marketplaces without intermediaries or trusted counterparties • Disruption of friction costs The truth is likely somewhere in between these two ends of the spectrum
10. EVOLUTION OR REVOLUTION @Melt_Dem 10
11. A CHANGING INVESTING LANDSCAPE @Melt_Dem 11 Source: Majority of return data from PitchBook 2018 Global PE & VC Fund Performance Report. IPO data from Renaissance Capital research, referencing Fidelity Investments data. ICO data from Benedetti, Kostovetsky, “Digital Tulips? Returns to Investors in Initial Coin Offerings.” STRATEGY RETURN Debt 6% Fund of Funds 11% Hedge Fund 11% Real Assets 11% Secondaries 13% VC 16% PE 18% IPO 21% ICO 179% • Global macro uncertainty and sky-high valuations across asset classes – Q4 2018 correction lasted less than one quarter! • Hedge funds under pressure – “blue-chip” funds 15 – 20% below S&P returns • Venture investors, especially SV, raising more capital than ever but difficult to materialize paper marks • Exits less frequent – IPO valuation premium is low, staying private often better for juicing valuation • For investors who missed BTC and ETH 10,000x returns, the allure of “the next bitcoin” is strong CHANGING INVESTOR SENTIMENT US INVESTMENT RETURNS LAST 5 YRS
12. A CHANGING INVESTOR COHORT @Melt_Dem 12 2013 2018 2014 2015 2016 2017 Source: Proprietary analysis using publicly available news sources.
13. UNTANGLING THE CRYPTO ASSET CLASS @Melt_Dem 13 STORE OF VALUE MEDIUM OF EXCHANGE DISTRIBUTED LEDGER § Digital Gold § Hedge against government instability and seignorage § Potential analogs: - Market cap of gold - Money held in Swiss bank accounts § Global payment network § Remittance & money transfer § Potential analogs: - Some % of global payments volume - Cross border capital flows § Web 3.0 infrastructure § Computational capacity § Potential analogs: - FANG & internet stocks - Some % of the internet application market
14. REMOVING FRICTION FROM ASSETS WHERE WILL CAPITAL COME FROM? Legacy Asset Market Size Blockchain Asset Expression Gold $7 trillion Store of Value (SOV) Bitcoin Oil (Commodities) $1.7 trillion Digital Utility Ethereum VC $60 billion New blockchain protocols and early stage ICOs HF / PE growth investing $1.2 trillion Securitizing equity for private companies Security Tokens (STOs) Real Estate $1.4 trillion Fractional ownership and tokenized REITs Securitized Asset Offering (SAOs) @Melt_Dem 14 Source: Global Alternatives Survey, CoinShares estimates. Strategies are challenging to identify as business models are still being built
15. VALUE CREATION AND VALUE CAPTURE @Melt_Dem 15 BLOCKCHAIN TECH STACK Network Applications Protocols INVESTMENT STRATEGY • Venture investing via equity • Appcoins or “product” tokens • Venture investing via equity • Mining pool or funds • Direct participation in consensus • Venture investing via equity in parent • Protocol tokens Strategies are challenging to identify as business models are still being built
16. “ROLL YOUR OWN” CRYPTO STRATEGY? @Melt_Dem 16 FUNCTION COMPETENCE OVERVIEW COST Banking and Custody Banking Services Strong relationships with transactional banks across multiple regions n/a Storage and Custody Robust crypto custody opsec and infosec 40 – 100 bps Risk Management Trade Execution Relationships with OTC desks and market makers, secondary buyers 15 – 25 bps Portfolio Management Tracking positions across platforms and assets, potentially liquidity 10 – 40 bps Re-balancing Programmatic trading, liquidating illiquid assets or investments 15 – 25 bps Liquidity Management Ensuring positions can be sold over time and managing cash float n/a Governance Network Participation Staking, bonding, delegation, and other types of governance activity – can be performance in-house but more likely outsourced 50 – 100 bps Financial Planning and Reporting Allocation Strategy Quantitative and qualitative analysis of investment opportunities n/a Performance Reporting Robust performance data and tracking 10 – 40 bps Cash Management Accounts payable and receivables n/a Accounting and Tax Valuation and NAV Marking positions, especially in PoS networks or after forks 10 – 40 bps AUM Calculation Need to mark position values for fee calculation, must be defensible n/a Tax and Audit Managing any and all tax and audit liabilities across operating regions 20 – 50 bps Compliance and Legal Legal Review Ensuring full rights and covenants exercised, lawsuits where applicable 50 – 100 bps Filings Regulatory filings and licenses where applicable n/a Expenses ratios range from 2% to 5% for a sizeable fund, and higher for smaller funds
17. Crypto Asset Example Exchange Traded Product Venture Fund “Crypto Fund” Direct Investing IPOs Equities CURRENT EXPOSURE STRATEGIES @Melt_Dem 17 Source: Global Alternatives Survey, CoinShares estimates. Private Equity 10% Hedge Fund 20% Venture 5% Real Estate 30% Equities 20% Bonds, MM 15% INSTITUTIONAL / HNW ALLOCATION HOW THEY’RE PLAYING CRYPTO
18. RISKS OF CRYPTO INVESTING @Melt_Dem 18 IDIOSYNCRATIC RISK “Asset” level risk • Operating strategy • Investment strategy • Financial policies and practices ie “treasury management” • Dependence on “benevolent dictator” founders SYSTEMIC RISK “Market” level risk • Lack of liquidity in most markets • Limited selection of assets (convergence on ! = 1) • Regulatory changes and tax reform risks • Failure of technology creates “bank run” STRATEGY RISK “Manager” level risk • Scalability (AUM growth) • Style drift (chasing every shiny new thing) • Benchmark selection and portfolio valuation practices • Risk management policies and limits on overall position exposure Understanding risk is key to managing it effectively
19. NEW THEMES TO WATCH IN 2019 @Melt_Dem 1 MORE PRODUCTS § Seeing the emergence of leveraged and short structured products (2X levered short) § New options and derivatives contracts, including a volatility index (LXVX) THE ADVENT OF FINANCIAL ENGINEERING § All about the yield baby – more pressure on firms to leverage working capital for low-risk reward like lending and staking § Emergence of new tools to engineer on-protocol assets, especially in Ethereum ecosystem MORE TRADING VENUES AND EXECUTION SUPPORT § Agency brokers moving from commodities into crypto, offering more sophisticated contracts and positions § New regulated platforms launching, offering vertically integrated tools (re: expense ratios)