Posts from blockchain

Crypto Asset Allocation

Coindesk did me a disservice with this blog post:

It made it seem like I was predicting an imminent crash which I was not.

But just as bad, it has led to a lot of tweets like this one suggesting that I also said that people should have 10-20% of their net worth in crypto:

What I did say is that “true believers” in crypto might want to have 10-20% of their net worth in crypto assets. For many of these true believers that would be down from 80-100%.

So, what do I think is a reasonable asset allocation to crypto for the average investor?

Well to start, as I mentioned in that blog post, The Gotham Gal and I have about 5% of our net worth in crypto assets, across a number of vehicles; direct holdings, USV funds, token funds, etc. We have a fairly diversified crypto portfolio, likely much more diversified than most folks could do on their own.

I think that’s likely at the high end of what the average person should have, but I also think its not a ridiculous number for the average person to have.

Many endowments, pension funds, etc allocate 3-5% of their portfolio to venture capital. They know its a risky asset but it has the potential for outsized returns. The largest allocation I have seen to venture capital from a big endowment or pension fund is 10%. So that gives you a sense of what sophisticated investors do with risky asset classes.

If you had to pin me down on a number, here is where I would end up:

  • young, aggressive risk taker – 10% of net worth in crypto
  • sophisticated investor seeking a high performing portfolio – 5% of net worth in crypto
  • average investor, slightly conservative, but with some appetite for risk – 3% of net worth in crypto
  • retiree seeking to preserve portfolio value and generate income – 0% of net worth in crypto

Hopefully this will set the record straight. It makes me very nervous when I see folks tweeting out “advice” that I did not give.

Diversification (aka How To Survive A Crash)

I was emailing with my friend Harry this past week and we started talking about crypto and the inevitability of a massive crash. I am certain the big crash will happen. I don’t know when it will happen and I think it may be some time before it does. But better safe than sorry. So I’m going to write some thoughts about how to survive it.

I told Harry my personal story of having 90% of our net worth go up in smoke in the dot com bubble and crash.

The only reason it was not 100% was that we owned two significant pieces of real estate that were about 10% of our net worth before the crash and became our entire net worth after the crash.

We were not diversified. We had all of our money in venture capital and internet stocks and had ridden that wave all the way up. Before Flatiron Partners (the venture firm I co-founded at the start of the Internet boom), we had no net worth. So everything we had, we made in the 1996-2000 period. And we essentially lost it all when the bubble burst.

Had we not sold Yahoo! and other stocks to purchase the real estate and pay the taxes on the gains, we would have been wiped out completely.

You might think “you could have sold when things went south” and that is a good point. But when things blow up, your first instinct is that they will come back. They didn’t this time. The selling just continued. A few companies we owned a lot of went bankrupt. These were public stocks that went all the way to zero. So, while it is true that we could have and should gotten out when the bubble burst, we did not, and in some cases could not.

So selling when a market blows up is not the best way to protect yourself from a crash. Selling long before it blows up and diversifying your assets is a much better way. Like we did with real estate, but with a lot more than that.

I like a mix of cash (t-bills, money market funds, etc), blue chips stocks (Amazon, Google, etc), real estate (income producing with little to no leverage), and a risk bucket (venture capital, crypto, etc). I think 25% in each would be a good mix. We have more in the risk bucket but I am in the VC business professionally and have been for 30+ years. 25% in each is where I’d like to get to in time.

I have advocated many times on this blog that people should have some percentage of their net worth in crypto. I have suggested as much as 10% or even 20% for people who are young or who are true believers. I continue to believe that and advocate for that.

But we don’t have that much of our net worth in crypto. We probably have around 5% between direct holdings and indirect holdings through USV and other crypto funds. I think that’s a prudent number for a portfolio like ours.

I know a lot of people who are true believers in crypto and have made fortunes in it. They are “all in” on crypto and have much of their net worth (all in some cases) invested in this sector. I worry about them and this post is aimed at them and others like them. It is fine to be a true believer and being all in on crypto has made them a lot of money. But preservation of capital is about diversification and I think and hope that they will take some money off the table, pay the taxes, and invest it elsewhere.

That is the smart and prudent thing to do. I wish I had done it during the internet boom. I did not, but the next time we made a bunch of money, I did. I learned the hard way. I share my story so that others don’t have to.

Feature Friday: Coinbase Vaults

Vaults are the crypto equivalent of a savings account.

If you have crypto assets that you don’t plan to spend/send frequently, you can put them in vault and get increased security.

Coinbase has had a vault offering for Bitcoin for the past three years and they have now launched the same vault product for ETH and Litecoin.

It appears as an additional account in your Coinbase accounts screen:

With the vault, you get a 48 withdrawal period (so nobody can move funds out of your account for 48 hours) and multiple signers on a withdrawal.

You can have three signers and require all three to sign a withdrawal or you can set up five and require three of five to sign a withdrawal.

I like to keep some crypto assets in my wallet and the rest in a vault. It is more secure.

If you have crypto assets at Coinbase, I encourage you to set up vaults for them.

Fun Friday: Crypto Crystal Ball

Chris Burniske posted this Twitter poll a few days ago:

I voted for option one. I think the crypto markets will be under pressure for at least the remainder of the year. But I am a buyer so that may be wishful thinking on my part.

Where do you think crypto is headed for the remainder of this year?

The China ICO Ban

Regulators in China imposed a blanket ban on ICOs over the long weekend.

A number of people have reached out to me via email and Twitter asking me what I think about this.

I think regulation of ICOs is inevitable and a good thing if done right (ie lightly).

The SEC’s comments on ICOs back in July were well done in my view.

There are all sorts of bad things going on in the ICO market right now, from outright scams to projects raising tens of millions of dollars on a white paper written in a day to celebrities getting in on the action.

We needed a cooling off period and if China’s actions are that cooling off period, then I welcome them.

However, a blanket ban on ICOs seems like bad policy to me.

The SEC is heading in the right direction by making a distinction between tokens with real utility vs tokens as a substitute for securities. The former is where the innovation lies. The latter is just a fast and loose way around the rules.

If you look back at the Ethereum token offering several years ago, it is hard to see how that was a bad thing. It provided needed funding to the Ethereum project and the result has been a wave of innovation on top of Ethereum, including the whole concept of ICOs.

If I am reading the Chinese regulators correctly, they are saying that an offering like the one that Ethereum did is not going to be allowed. That’s bad.

Many have speculated that this Chinese ban is temporary to give the Chinese authorities time to come up with sensible regulations. I suspect that is right.

However, I would not like to see the SEC and other regulators follow suit. I think a better move would be to work to rid the market of the scams and other bad actors and actions while allowing for real innovation to continue. That seems to be where the SEC is headed and I encourage them to keep going in that direction and not follow the Chinese.

The US has always been a home to innovation and innovators. We have been able to do that while applying sensible regulations (for the most part) on innovative new technologies. If we continue to take that approach we can compete and even beat China to market in areas like blockchain where they are arguably ahead of us. Naval said it well in this tweet yesterday:

Multi-Sig Wallets

A lot of financial processes require multiple signatories, like a wire transfer for example. That adds a level of security and comfort to a process that moves a lot of funds quite quickly.

So it makes sense that blockchain technology would find a way to mimic that in software.

It is called a “mult-sig wallet” and if you use one, you need multiple “signatories” to move funds out of the wallet. I put signatories in quotations because what you actually need is multiple private keys to move funds out of the wallet.

CoinCenter wrote a nice explanation of multi-sig technology back in early 2015 that I frequently share with people who ask me about multi-sig. Give that a read if you want to learn a bit more about how this technology works and why it is so useful.

Our portfolio company Coinbase uses multi-sig technology in its vault product which is currently available for Bitcoin wallets and will eventually come to its other wallet offerings.

If you use a hardware wallet like Ledger, you can use the BitGo software to get multi-sig on it. Here’s a blog post about that.

With the big increase in crypto prices this year, many people are now holding significant amounts of crypto assets. It is worth taking security more seriously and putting your assets, or at least most of them, into a multi-sig wallet is a good step toward that.

Store Of Value vs Payment System

One of the debates that has raged inside and outside of the Bitcoin community since I got involved back in 2012 is whether Bitcoin was a store of value vs a means of payment.

When I first started buying and owning Bitcoin, I would use it as a means of payment all the time.

I would whip out my phone and send Bitcoin to people instead of paying cash.

This was a Bitcoin t-shirt I bought in the summer of 2013:

At today’s prices, that t-shirt cost me $830. I love that t-shirt.

 

This was a payment I made that same summer for a golf caddie:

 

And this was a gift I made to the Bitcoin foundation in the spring of 2013:

That gift is almost $700k at today’s prices.

 

I share these three transactions with all of you to make a point.

And that point is that you can’t keep spending something that goes up as much as Bitcoin has.

So I don’t spend Bitcoin anymore.

I hold it.

It’s a store of value now.

That much is clear.

How To Value Crypto Assets

Given the explosive increase in the prices of crypto assets this year, there is a growing discussion on how to value them.

This is a very good thing.

Andy Kessler weighs in on the topic in this WSJ piece which was published over the weekend.

You should go read the piece as it does a good job of dissecting the economics of the transaction processing system that underlies Bitcoin (aka the Bitcoin Mining Network).

Andy finishes his post with the following statement:

at some point the market will wake up and apply rational valuation techniques. That price—$4,361—implies a lot of belief in Bitcoin as a long-term store of value well beyond the economic value of the transaction platform. 

Like Andy, I hope and expect that the market will apply rational valuation techniques to crypto assets. There are a number of people trying to do that. I think the work of Chris Burniske is very solid.

My issue with Andy’s analysis is that he’s conflating the market value of the Bitcoin Mining Network with the value of Bitcoin, the crypto token.

My partner Albert says it well in this tweet:

Blockchain technology upends many of our traditional notions of what networked applications look like.

Our former colleague Joel captured this “upending” well in his seminal post on Fat Protocols, in which he says:

What’s significant about this dynamic is the effect it has on how value is distributed along the stack: the market cap of the protocol always grows faster than the combined value of the applications built on top, since the success of the application layer drives further speculation at the protocol layer. And again, increasing value at the protocol layer attracts and incentivises competition at the application layer. Together with a shared data layer, which dramatically lowers the barriers to entry, the end result is a vibrant and competitive ecosystem of applications and the bulk value distributed to a widespread pool of shareholders. This is how tokenized protocols become “fat” and its applications “thin

Networked applications that run on top of the shared data layer of blockchains will be forced into commodity pricing and rent seeking will be nearly impossible. Those who build the Visas and Mastercard networks on top of Bitcoin will never achieve the economics of Visa and Mastercard. But that is the point. The Bitcoin protocol will capture those economics and the only way you can participate in that is by earning or buying and owning the crypto token (ie Bitcoin).

And so that is what we must model, analyze, and understand. We cannot use EBITDA multiples to do this work. We need to turn to other tools and that is what Chris and others are doing.

I applaud Andy for putting this critical issue on the table and hope that he and other serious market analysts and observers will take the time to understand what is really going on here and help us all figure out how to properly value it.

Speculation is rampant right now and without the proper valuation tools, we lack the ability to arbitrage and profit from that speculation. We need that.