Over the last few weeks, Bitcoin has converted many of my friends and family to believers. Since I work in tech, have been investing in crypto since 2015, and spent hundreds of hours researching the blockchain ecosystem, I'm getting lots of questions.
The following is an overview written for smart people who are not in tech, and have never purchased cryptocurrency.
Sections:
- Where to buy & security
- Minimizing volatility risk by dollar cost averaging
- The difference between Bitcoin and alt-coins (aka everything else)
- The safest alt-coin bets: dApp infrastructure technologies
- Investment signals: follow developers and users, not financial analysts
- Market size: most of your tech will eventually run on blockchains
- The black swan: China could take over Bitcoin and every blockchain
- A reflection: learning from my past successes and failures
Definitions:
- Blockchain - the novel technology powering cryptocurrency
- Cryptocurrency - Bitcoin and any digital currency
- Mining - the process of a computer powering a blockchain and getting paid in coins
- dApps - software applications powered by a blockchain
- Decentralized - when many smaller computers are used to power software instead of one large one
This content is provided for informational purposes only, and should not be relied upon as legal, business, investment, or tax advice. You should consult your own advisers as to those matters. References to any securities or digital assets are for illustrative purposes only, and do not constitute an investment recommendation or offer to provide investment advisory services.
Where to buy & security
If you’ve never bought crypto currency, and the coin you want to buy is available on Coinbase, you should buy it there. It’s the simplest in terms of getting setup and the interface. It also is the most secure platform from getting hacked. If a coin is not available on Coinbase, it probably is on Binance. [1]
If you’re going to buy “a lot” of coins (whatever that means to you), you may want to buy a hardware wallet like a Trezor. It’s by far the most secure method of storing coins. But be careful, because if you forget your password and lose your recovery passphrase, you’ll lose all your coins.
If you’re not comfortable with a hardware wallet, just put your coins in Coinbase’s Vault. If you’re buying a coin not on Coinbase, and also not comfortable with a hardware wallet, you may just want to not buy that coin.
Minimizing volatility risk by dollar cost averaging
The thing that I always do (or try to do) for is “dollar cost averaging” (DCA). It's where you spread the purchase out over weeks/months to smooth out the volatility. (i.e. instead of investing $10k at once, do $250/wk for 10 months). You can setup Coinbase to do this automatically. If you DCA on Coinbase, I recommend buying it in $150 chunks, which is a sweet spot for getting a lower fee than $149 and below.
With Bitcoin priced currently in the mid $18k’s and Ethereum priced just above $600, it seems like we’re about to be in another crypto rally like 2017. Because of that, you may want decide you to buy it all at once to "beat the crowd”, but of course, that’s a gamble. I'm personally not buying anything right now since there's so much hype but if I did I'd definitely be DCAing and spreading my investment out over at least 1 year.
The difference between Bitcoin and alt-coins (aka everything else)
The first thing to understand is that each coin is built to serve a special function. Coins are similar to gold and stocks. With Bitcoin, it's like cryptocurrency gold in that its pure function is as a store of value. It was intended to be used to purchase day-to-day goods, but now too many people use it. So the transaction rate is too slow.
The plus-side of so many people owning Bitcoin is that it’s now cemented as the reserve digital currency. Now it’s one of the few (or perhaps only) coins you can convert into any other coin in the crypto ecosystem. This is similar to gold in the sense that gold was one of the original currencies, but it’s impractical to be used as one today. So I invest in Bitcoin like it’s gold. My mindset is holding it for decades into old age.
If you're considering investing in other coins other than Bitcoin, these are called “alt-coins”. You can think of them like stocks in that there is a company behind them and they’re not just a store of value. Each coin has a unique blockchain technology behind each of them that functions as part of the blockchain ecosystem. That said, these coins are riskier to invest in since none of them are used by mainstream consumers yet. Any one of them could still fail. So how I've been looking at those is just diversifying into all of the most promising coins across a category and weighting the investment % in it.
The safest alt-coin bets: dApp infrastructure technologies
The alt-coin category that’s the safest bet, I think, is the developer infrastructure technologies. Most notably, the "platforms" that facilitate building “dApps”, which stands for decentralized apps. You can think of dApps as software that’s attached to the coin. If blockchain technology is to exist long-term, the platforms that enable developers to build dApps on them have to succeed.
Ethereum is the most popular dApp platform, with over 4x more developers building on it than any of it’s competitors. Theoretically Ethereum could still get disrupted by a better technology though, since it still has scaling issues to overcome and there aren't any mainstream consumer apps built on it yet.
Most people who use the dApps built on Ethereum and platforms like it are other crypto enthusiasts right now. So with whichever smart contract platform's coin you buy, you're basically betting that future mainstream apps that consumers use get built on it, in however many years it takes to get there.[1]
Also looking promising in the developer infrastructure technologies are "crypto oracles". They basically connect blockchain data to "real world" data for the dApps to run on. These also would need to work long-term since real world data is critical for the blockchain ecosystem working. Chainlink is orders of magnitude further than it's competitors here, in terms of developer usage and team size/quality, so this could be a great one to setup to DCA, although it’s already had it’s “rally” in Q1 and Q2 2020, so the price could drop at some point and stay low for a few years. Coinbase supports Chainlink.
Investment signals: follow developers and users, not financial analysts
The blockchain ecosystem is still infantile. Even though the coins have graphs like stocks and there’s a similar market cap to a stocks, each coin/technology is like a pre-seed or a seed stage startup in the sense of it’s risk profile. Yet all of the crypto blogs drop daily posts with robust financial analyses like the coins are stocks. I’m not a financial expert but it seems like most people are drastically over indexing on historical stock prices for long-term investing. Specifically for coins other than Bitcoin and Ethereum.
The primary things that matters for alt-coins are user traction, team, and total available market, just like if you were investing in a pre-seed or seed stage startup.
So for me, since I’m focusing on investing in blockchain infrastructure technologies like Ethereum and Chainlink, the users are the developers building on those apps. So one of the strongest signals investment signals for me is looking at month-over-month developer growth and retention across each technology.
So at the end of the day, the people who’s opinions matter at this point are almost exclusively developers, because price will eventually follow developer choices of what they use to build their apps.
One of the best places to look at which technologies developers are using, and which apps consumers are using, is State of dApps.
Market size: most of your tech will eventually run on blockchains
Marc Andreessen, the billionaire co-founder of Netscape, believes blockchain technology will be as impactful as personal computers in 1975 and the internet in 1993.[2] The reason being is because it solves for trust. It gives us a solution to fake news, ensuring data privacy, identity theft, domestic currencies hyperinflating, voter fraud, and most other day-to-day scenarios where trust is critical.[3]
These are the reasons “smart people” invest in the space and why the overall market cap is currently $550b despite having many consumer applications. Blockchain technology seems inevitable as a technology society evolves into. It’s just a question of which specific coin/blockchain will be used long-term.
It’s also important to think about what the future makeup of society will look like in 30 years. Eventually, the younger generations who grew up coding and trusting computers will run the world. Programmers will be in government. It’s just a matter of time before every ounce of society is digitized. So any regulatory obstacles or problems with older user adoption, in the case of say, an app to vote on the next President of the United States, will ultimately not be an issue.
In summary, I’m betting most of the tech you use every day will run on blockchains within the next few decades.
The black swan: China taking over blockchains
The most unsettling thing about blockchain technology for me has been the fact that China effectively has control over the whole ecosystem. I’ll break down how that’s become to be the case.
How blockchains work
Ironically, Bitcoins and blockchain technology are designed to be near impossible to be controlled by a single entity. Blockchains are “decentralized”, meaning they don’t run one company’s computer servers, like how Amazon, Facebook, and Google are. Instead, blockchains are designed to run across millions of people’s personal computers.
The reason for this is to solve for trust and make blockchains near impossible to corrupt. Computers work together to run the blockchain, called “mining”, so if there were a bad actor, the computers are programmed to know and automatically prevent it.
A crude example is someone (or multiple people) powerful enough at Google could easily create fake information to show up on their search engine. If Google were somehow run on a decentralized blockchain, creating fake information would mean simultaneously coordinating with the millions of computer owners, or “miners”, running the blockchain. Creating fake information on a blockchain is implausible… in theory.
How blockchain "mining" businesses emerged
While the utopian vision was for millions of personal computers to mine the blockchain, what’s actually happened in practice is different. Since people are incentivized to mine by getting paid in the coins they’re mining, businesses have formed exclusively to power blockchains and mine coins.
As business grew, the mining companies have acquired one another and consolidated. Since the mining business is so basic (your primary costs are computers, a warehouse, big fans, and electricity), the long-term winners are in locations with the cheapest energy and computer parts, that also have a stable government.
It turns out, China is the trifecta here. So as a result, 65% of Bitcoin’s processing power is consolidated in China across 10 companies, with a similar distribution for other blockchains. With Bitcoin in particular, if you control 51% of the processing power, you can create “fake” information and control it. So it’s fair to say the Chinese government could control the blockchain ecosystem if they wanted to.
Does this mean blockchains won't work?
This was my chief concern with long-term investing in the crypto space until I read this phenomenal breakdown on how Chinese minors could theoretically attack Bitcoin. The gist is that the damage that China, or any state actor could do, would be limited in practice. There are enough independent entities watching each blockchain that we would know of it being compromised within minutes. Then other people supporting the blockchain infrastructure’s hardware and software would take countermeasures, resulting in minimal damage. Then there’s also more incentive to support the blockchains than to compromise them. On top of this, eventually, the mining power distribution is expected to distribute across more countries in the future.
While that blog post is only one man’s opinion, there’s also the opinion of more technical and intelligent investors than I, like Balaji Srinivasan, Marc Andreesen, and Naval Ravikant. While I haven’t heard them speak directly about the risk with China, I’m sure they’ve thought about it and they’re all still heavily invested in the blockchain ecosystem. Since they still believe in it, I do too.
Learning from my past successes and failures
It’s basically been a rule that if I’ve bought a coin because I’m greed-hunting for them, and I catch some news article, blog, or friend who says the coin is hot, the coin ultimately tanked and I’ve regretted it.
When I’ve come across a coin from a user or developer point of view and thought “this makes so much sense, I’d use this technology”, then I bought, I’ve made money. There will usually be a magic moment where I feel like the tech will be big in the same way I feel like a tech startup will be big.
Another time that I’ve made money is when I come across a new piece of information that quells a major concern I had about a coin or the blockchain ecosystem, I see a coin get a lot of user traction, or a large societal problem seems to be worsening that Bitcoin and or blockchain technology is uniquely positioned to solve.
In summary, if you want to buy anything other than Bitcoin, it's good to think about it from a user perspective. Invest in it like it's a startup where there's high risk and you may lose all your money. Spread your investements across the category. If you want to hedge your best for the most guaranteed returns in the cryptocurrency space, dollar cost average into Bitcoin over 12 months or more. I agree with Anthony Pompliano that Bitcoin will surpass gold, which means that it would pass 26x from where it is now. So if you buy Bitcoin and hold it for the next 10+ years, you should have good returns.
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[1] There’s Binance.com and Binance.us. You’ll want to use the .com version.
[2] Practically, many of the platforms will be “successful” but it’s still a question of whether it’s any of those you see today and how successful each one will be.
[3] While the blog post is great, it’s 6 years old and is pretty technical. If you want the 2019 high level verison, this a16z podcast episode is phenomenal. Another great resource to understand the potential of blockchains, along with the legal, financial, and philosophical foundations of the technology, is the Tim Ferriss podcast episode with Nick Szabo.
