The Innovative Investor’s Guide to Bitcoin and Beyond

Chris Burniske and Jack Tatar

Chris Burniske and Jack Tatar’s Cryptoassets: The Innovative Investor’s Guide to Bitcoin and Beyond (2017) is a handbook for people who are curious about investing in digital financial instruments. Cryptoassets include digital currencies, such as Bitcoin, along with a range of other investment vehicles, many of which are not currencies at all…

Cryptoassets Overview

Chris Burniske and Jack Tatar’s Cryptoassets: The Innovative Investor’s Guide to Bitcoin and Beyond (2017) is a handbook for people who are curious about investing in digital financial instruments. Cryptoassets include digital currencies, such as Bitcoin, along with a range of other investment vehicles, many of which are not currencies at all. The book explains what cryptoassets are, why people might want to invest in them, and how to do so.

Cryptoassets have become a hot topic in recent years. While many investors are still unsure about them, they have the potential to be a sound investment. But since cryptoassets are so new, people who use them are not just investors but innovators.

The blockchain is fundamental to all cryptoassets. A blockchain is an encrypted digital ledger for a particular cryptoasset; it records every transaction of that cryptoasset and copies it onto every computer that uses the blockchain. Since the blockchain is copied in exactly the same way every time, and every computer running the blockchain checks its copy against every other copy, manipulating the blockchain is theoretically possible but extraordinarily difficult. This feature makes the blockchain extremely secure.

Cryptoassets are completely decentralized. Unlike fiat currencies, such as the Euro or the US dollar, which are issued by central banks and derive all their value from the blessing of a government, cryptoassets derive their value entirely from the blockchain. Since there are no governments involved, cryptoassets are only very loosely regulated, if they are regulated at all.

Some cryptoassets, particularly Bitcoin, have become extremely valuable in a very short time. If investors purchased $100 in Bitcoin when it launched in 2009, they would have seen that investment increase more than a million times within eight years. The value of cryptoassets — including Bitcoin — is still volatile, but in recent years, Bitcoin has performed well even compared to high-growth technology stocks such as Facebook, Amazon, Netflix, and Google. As more investors embrace them, the value of cryptoassets is stabilizing, and the cryptoasset market is maturing.

For innovative investors seeking to capitalize on the cryptoasset boom, there are several ways to get involved. One way is by creating more cryptoassets. Simply by running the blockchain for a particular cryptoasset, a person can help to encrypt and decrypt transactions for that cryptoasset. This entails a highly complex process called “mining.” When a computer successfully mines a particular cryptoasset, it tells the other computers running the blockchain what it has done. This process is called proof-of-work, or PoW. Once the other computers verify the PoW, the computer’s owner is usually awarded units of that cryptoasset. Mining established cryptoassets with very large blockchains, such as Bitcoin, is now so technically difficult that it requires expensive computers and an enormous amount of energy. Investors lacking those resources can mine cryptoassets by joining a mining pool, a group of people who combine their money and agree to share any cryptoassets they produce.

Innovative investors can use an over-the-counter exchange to trade fiat currency for cryptoassets and store them in a device called a wallet, which is a portfolio of encryption keys that allows investors to access their cryptoassets. Investors must carefully vet which exchanges and wallets they use. Early in the cryptoasset boom, a number of exchanges closed because they were frauds, hackers attacked them, or regulators brought them down. Like exchanges, wallets can be hacked, especially if they store their cryptoassets online. Accordingly, investors need to do their own research when choosing a cryptoasset to invest in, and how to acquire and store it.

Key Insights
Cryptoassets can be a useful way to diversify an investment portfolio.
Before putting money into cryptoassets, innovative investors should research individual cryptoassets, traders, and ways to store their investments.
Blockchain is a foundational technology upon which a variety of applications can be built.
Bitcoin, the original cryptoasset, was created as a decentralized alternative to the centralized financial system through which most of the world’s money circulates.
Governments are uncertain how to classify and regulate cryptoassets.
The value of cryptoassets can fluctuate dramatically, but as they mature, they are becoming less volatile.
Cryptoassets have both a utility value and a speculative value.
Investing in cryptoassets can be expensive and technologically complicated, but in the future, there are likely to be easier ways to invest.

Key Insight 1

Cryptoassets can be a useful way to diversify an investment portfolio.

The cryptoasset boom is only beginning, and these assets have the potential to be enormously lucrative in the coming years. But investing in cryptoassets doesn’t have to mean placing a huge bet on something like Ethereum or Bitcoin. Innovative investors can add some of their money to cryptoassets, using them to diversify their portfolios as a way to shield themselves against a stock market or bond crash.

Among traditional investment advisers, there is some debate about whether cryptoassets are a worthwhile investment for average people. Despite the excitement that follows any surge in value in a cryptoasset, many personal financial advisers have argued they are still too volatile for most people to invest even a small portion of their portfolios in them. Writing in The Washington Post, Michelle Singletary said that “average investors” with household debts to pay off who were investing to finance their own retirements should avoid Bitcoin unless they could afford to lose everything they put in. [1] In an article for CNN Money, Walter Updegrave cautioned investors to limit their retirement portfolios to stocks and bonds, and to avoid exotic assets like Bitcoin. Adding any new asset beyond stocks and bonds risks making a portfolio both more expensive and more difficult to manage.

Even when compared to some of the more exotic investment vehicles, critics charge, cryptoassets have another disadvantage: their underlying values are hard to calculate, even for investors with sophisticated software and well-trained staffs. As a result, it can be hard for investors to include them in their portfolios without taking the necessary steps to determine what risks they are taking or what returns they stand to gain. According to Updegrave, investors merely planning for retirement should stick with stocks and bonds. [2] Innovative investors must look beyond this debate and recognize that pioneers in any area of investment undertake a greater degree of risk.

Key Insight 2

Before putting money into cryptoassets, innovative investors should research individual cryptoassets, traders, and ways to store their investments.

The cryptoasset market is changing constantly. New cryptoassets appear all the time. Some are viable investments while others are not. As of February 25, 2018, CoinMarketCap.com listed more than 1,500 different cryptoassets with a collective value of more than $431 billion. [3] About half of these assets were not even on the list one year earlier. [4] With so many new assets coming online all the time, it’s hard to know which cryptoassets are viable for investors. In an interview with Ameer Rosic, Jack Tatar said there are too many initial coin offerings today, and that many of the new cryptoassets are simply intended to make their creators rich rather than to provide a legitimate business service. [5] Some new cryptoassets are scams. As a rule of thumb, investors should look for information on any new cryptoasset they intend to buy, such as a white paper from the asset’s creators, as well as other public statements regarding its utility and approach. If there’s a dearth of publicly available information, it’s a sign that cautious investors should stay away from it.

Of course, successful frauds are the ones that initially appear legitimate. One fraudulent cryptoasset that has been widely discussed in the investing community is Confido. Before it was launched, Confido had a slick website, social media accounts, and a white paper describing its new approach. In November 2017, Confido’s creators announced plans for an initial round of investing. Within days, the creators raised $347,000 in Ethereum, which investors traded for Confido units. But then the site and social media pages disappeared, and Confido’s value crashed, leading many people to believe the entire project had been launched to defraud credulous investors. While the Confido team claimed in a Reddit post that they had encountered some legal problems, they offered no details, and a Confido spokesperson said he was unsure what had happened. [6]

Cryptoasset fraud has become so widespread that in January 2018, Facebook banned all advertising related to initial coin offerings and cryptoassets because many of the companies behind them were “not currently operating in good faith.” [7] Facebook said the policy would be deliberately broad until it improved its ability to sort fraudulent offers from legitimate ones.

Key Insight 3

Blockchain is a foundational technology upon which a variety of applications can be built.

Blockchains foster a shared network of accurate information without requiring users to trust a central institution, like a bank. Users don’t even have to trust each other. This is an innovation that can be used for more than just cryptocurrencies. Swarm City, for instance, is a commerce platform based on the Ethereum blockchain.

Alex Tapscott, an investor and founder of Northwest Passage Ventures, says that blockchain technology could be used to reconstruct the foundational institutions of capitalism, including the structure of corporations. Large companies inevitably become more complex as they grow because more people and processes require additional layers of accountability. By sharing accurate information across a company instantly, blockchains could cut these layers within a company and reduce the associated costs. [8]

One industry that has begun using blockchain to reduce bureaucracy is food retail. Walmart, the largest grocery chain in the United States, has worked with IBM, as well as several food producers including Unilever, Nestlé, and Dole, in a series of experiments using blockchain to improve safety in their supply chains. Currently, investigating foodborne disease outbreaks involving large food retailers can take weeks as auditors trace the product in question. Its supply chain may be hundreds or thousands of miles long, and auditors must examine the records of every farmer, processor, and distributor along the way. By adding all the data to a blockchain, however, tracing the origins of a single product could take mere seconds. [9]

Key Insight 4

Bitcoin, the original cryptoasset, was created as a decentralized alternative to the centralized financial system through which most of the world’s money circulates.

While most of the world’s money is a representation of value that’s issued by central banks and comes with the guarantee of governments, Bitcoin and other cryptoassets are valued through blockchains, which are decentralized systems. This detachment from any government is one of the distinctive features of cryptoassets, and one that the creators of these assets have added deliberately.

Writing in Bloomberg, journalist Leonid Bershidsky argues that while cryptoassets offer people a way to store and exchange money free from government regulation, they also come with serious downsides, such as high volatility and a high risk of theft. Independence from government, he writes, may outweigh these downsides, but only for some. In the long term, cryptoassets may only be useful to people who don’t trust government or who want to hide their money. [10]

Key Insight 5

Governments are uncertain how to classify and regulate cryptoassets.

Cryptoassets are unlike anything anyone has ever seen before, so regulators are proposing different and sometimes contradictory ways to approach them. In the United States, the Commodities Futures Trading Commission (CFTC) has attempted to bring them into its jurisdiction by classifying them as commodities, while the Internal Revenue Service (IRS) considers them property. Both these agencies are struggling to regulate cryptoassets because they are trying to apply laws written for tangible assets to a completely new financial instrument.

Regulators have attempted to step up their efforts to rein in cryptoassets. In December 2017, Jay Clayton, chairman of the Securities and Exchange Commission (SEC), released a lengthy statement on cryptoassets, broadly explaining some of their risks to investors and the agency’s jurisdiction. Reiterating an established SEC position, Clayton said that certain cryptoassets are legally classified as securities, even if traders call them “currencies.” Although the form of a transaction may change by being recorded in a decentralized blockchain ledger instead of an institution’s central ledger, Clayton wrote, the transaction’s substance does not change. Accordingly, he added, people trading cryptoassets need to consider their responsibilities when conducting these transactions, just as they must do when transacting with cash. Moreover, traders on some exchanges need to be licensed with the SEC, just as stockbrokers are. Clayton also warned that platforms that trade cryptoassets but are not registered with the SEC may be violating the law. Addressing investors, Clayton acknowledged that cryptoassets posed some regulatory challenges. One issue was that cryptoasset markets could span multiple countries. A fraudulent trader could take an investor’s money out of the country without the investor even realizing it, which would make it difficult for the SEC to go after that trader and recover the money. [11] In response to growing concern that cryptocurrency platforms and traders were violating securities regulations, the SEC launched an investigation on February 28, 2018, by issuing a first round of subpoenas to traders and firms involved in initial coin offerings, known in the industry as ICOs. [12]

Key Insight 6

The value of cryptoassets can fluctuate dramatically, but as they mature, they are becoming less volatile.

Bitcoin is the oldest cryptoasset, as well as the most stable. As Bitcoin has become more popular, it is traded more frequently, so the market can ride out mass buying sprees and sell-offs more easily than it could a few years ago. High volatility is a sign of a riskier asset, but with the increased risk comes the potential for greater returns.

Since the release of Cryptoassets, Bitcoin’s value has undergone huge changes. Between November 12 and December 16, 2017, Bitcoin’s price more than tripled to $19,343. By February 6, 2018, the price had crashed to below $7,000. [13] The cryptoassets Ripple, Ether, and Litecoin all fell over the same period.

Some analysts attributed the drop to a spate of negative news surrounding cryptoassets. One particularly bad piece of news came in January 2018, when hackers stole $500 million from Coincheck, a Tokyo-based cryptoasset exchange, leading Japanese authorities to raid Coincheck’s office. News of looming regulatory pressures from governments in South Korea, the United States, India, and China also forced the price of cryptoassets down. Speaking on Bloomberg Television on February 2, 2018, Nouriel Roubini, a New York University economist who predicted the 2008 real estate bubble, said that cryptoassets were the “mother of all bubbles” and that the bubble was already bursting as governments attempted to introduce new regulations. [14]

In the midst of this period of fluctuation, some respected investors stated that Bitcoin and other cryptoassets were doomed to collapse. In January 2018, Warren Buffett cautioned investors to avoid cryptoassets and stated with certainty that the cryptoasset boom would “end badly.” [15]

Key Insight 7

Cryptoassets have both a utility value and a speculative value.

Because cryptoassets circumvent middlemen, like bankers, people use them to transfer money rapidly around the world. This makes them useful in ways that conventional currencies are not. As a cryptoasset’s utility value rises, it attracts more speculators.

Writing in 2014, venture capitalist Marc Andreessen — who at the time had invested almost $50 million in Bitcoin-related startups through his firm, Andreessen and Horowitz — said Bitcoin would likely be remembered as a technological development equal in its significance to the personal computer in 1975 or the internet in 1993. [16]

Yet while many technologists have called cryptoassets a breakthrough technology, some of the biggest names in finance have argued they have no enduring utility value. In November 2017, Tidjane Thiam, CEO of Credit Suisse Group AG, said Bitcoin had no purpose except to make money, and that the rising interest in Bitcoin was entirely driven by speculation. Since it had no utility value, he declared, Bitcoin was a bubble. [17]

Speaking at the 2018 World Economic Forum in Davos, Switzerland, Axel Weber, the chairman of Swiss banking firm UBS, similarly cut against supporters’ claims that cryptoassets represented a new form of money. He said he would not advise any client to invest in cryptoassets because they were “not a currency.” Echoing some of the skepticism around cryptoassets in the finance world, he also said that cryptoassets were likely to lose value rapidly because their value was based entirely on speculation. [18]

Key Insight 8

Investing in cryptoassets can be expensive and technologically complicated, but in the future, there are likely to be easier ways to invest.

Some of the more developed cryptocurrencies, such as Bitcoin, are already moving away from the margins of the investing world and finding investors on Wall Street. Venture capital groups are investing in cryptoassets. As the market has matured, new firms have emerged which create channels for investment, even for investors who do not mine cryptoassets themselves. One such firm is LedgerX, a New York trading firm which deals exclusively in cryptoassets. In July 2017, as both the popularity and volatility of cryptoasset markets surged, the Commodity Futures Trading Commission granted LedgerX the first license to trade futures contracts for cryptoassets in the United States. Futures contracts are a financial mechanism that allows investors to buy or sell something at a later time, but at a predetermined price. At the time of the launch, Paul Chou, CEO of LedgerX, said being able to buy and sell futures contracts would attract institutional investors, who tend to be more risk-averse, to the cryptoasset space because it would protect them against the market’s volatility. In a sign of its acceptance both on Wall Street and in Silicon Valley, LedgerX was launched with money from the venture capital subsidiary of Alphabet, the parent company of Google. [19]

Aaron Brown, a former manager at AQR Capital, similarly argued that a market for cryptoasset futures would help to reduce volatility. More investors would buy cryptoassets, while investors with large balances would be more inclined to hold them to use as collateral for other investments. As more cryptoassets were taken off the market for this purpose, their value would go up and the market would stabilize further, which would attract more investors. [20]

Important People

Chris Burniske is a co-founder of Placeholder, a New York-based venture fund which invests exclusively in cryptoassets. He is a co-author of Cryptoassets.

Jack Tatar is an investor and adviser to startups in the cryptoasset space. He is a co-author of Cryptoassets.

Satoshi Nakomoto is the pseudonymous creator of Bitcoin. Little else is known about Nakomoto, including whether he or she is one or more people. In 2009, Nakomoto wrote the original software for the Bitcoin blockchain and released a white paper explaining how it could be used to create value for the cryptoasset.

Vitalik Buterin is a co-founder of Ethereum, the second most popular cryptoasset after Bitcoin. He is considered the intellectual force behind Ethereum.

Cameron and Tyler Winklevoss are twin brothers and early Bitcoin investors. In 2013, they attempted to create the first exchange traded fund (ETF) for Bitcoin, but they were denied a license in March 2017.

Authors’ Style

Cryptoassets is designed for people already interested in investing in digital assets, so the authors assume the reader has some knowledge of digital currencies. The text is structured like a handbook, with a section in the back that includes a list of resources to use for more information as readers research new opportunities. But for people who are interested but know little about these assets, much of the book may be difficult to process. Even some parts of the first section, which cover what cryptoassets are, can read like a barrage of technical detail. Readers who are ready to invest and excited about their prospects may find the book useful; those still uncertain about this latest financial technology boom will find little to dislodge them from a position of skepticism.

Authors’ Perspective

Both Chris Burniske and Jack Tatar have written about cryptoassets in the past, and both have invested in cryptoassets for several years. The fact that they’ve staked their own money — and Tatar his retirement — on their assessment of cryptoassets may reassure readers about investing in cryptoassets. Readers who are still uncertain about the longevity of the cryptoasset boom might desire more skepticism from people less committed to them. Instead, the authors’ description of today’s cryptoasset world is mostly handled with the zeal of evangelists.

The supposedly “innovative” aspects of their views on investment raise additional questions. At one point, for instance, the authors allude to the British protectorate of Jersey, home to a cryptoasset fund called GABI, which the authors consider a worthy entrant into the market. They describe Jersey as being “known for its innovative approach to regulation, similar to the Cayman Islands.” [21] What they consider an innovative environment, others have described as a haven of dangerous financial practices that are illegal in most developed countries, with a government beholden to financial high rollers. [22] Why a cryptoasset fund has set up shop there is left to readers to figure out on their own.

References

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