Want to Invest in Cryptocurrencies?
Here’s What You Need to Know
Cryptocurrency is the buzzword du jour for investors and technology enthusiasts alike. Last month we gave an overview of cryptocurrencies and their foundational platform structure, the blockchain. This month, Andre Huaman, Partner at Three Bell Capital, follows up our cryptocurrency primer with a detailed Q&A with cryptocurrency expert, Brayton Williams.
Brayton Williams is a Co-Founder and Managing Partner at Boost.VC. Boost VC is a venture capital firm headquartered in San Mateo, CA, investing in cryptocurrency, virtual reality, and other emerging technologies.
Brayton and his team have been in the cryptocurrency space for over 5 years and were one of the first venture capital firms to place concentrated bets on the cryptocurrency industry. He is considered an industry expert in the cryptocurrency space.
Boost.VC is currently investing out of their 3rd fund, with $38m of committed capital. Limited Partners in Boost.VC funds include the likes of Tim Draper, Marc Andreessen, and Fidelity Investments.
Andre: Thanks for being with us, Brayton. Cryptocurrency and blockchain are fascinating to us and to many of our clients. We are closely monitoring the activity in the space and more importantly, the potential for investment. Your expertise as an investor in the industry will help us to frame the cryptocurrency space and raise client awareness of potential benefits and drawbacks.
Brayton: Happy to be here. This industry (blockchain/cryptocurrency) is fascinating and being in it for over five years, I have definitely witnessed both the high-net-worth crowd and larger financial institutions start monitoring cryptocurrency and begin to invest in it, as well. It is an exciting time.
Andre: What about this space is most exciting you right now?
Brayton: For the very first time, people are not only asking the question “What is money?”, but they are also exploring solutions to make money and currency better. Of course, that was primarily driven by Bitcoin. As people are now questioning this, they are beginning to also ask: “Can society decentralize money? Can we remove government from money?”
And over the last 2 years, because of Bitcoin, people are questioning what else can be decentralized beyond currencies, and in particular, areas in which the government is involved. People are questioning institutions, their role in processes and business, and exploring if they can be removed from those industries.
Andre: With this momentum, there must be some areas of concern in the blockchain space. What about this industry is making you the most nervous and worried?
Brayton: Overall, my biggest worry is the irrational exuberance. Market caps of many of these cryptocurrency projects are grossly over what the project has actually delivered. Many market caps are in the hundreds of millions and there is no working product.
Left and right, people are becoming self-proclaimed crypto investors and are only making money, not losing money. Most of the new market participants have never seen a downturn. This makes investors, as a whole, think investing in this industry is “easy money”.
However, they are failing to look at what is on the near to mid-term horizon. At some point in the next couple of years, we will see regulation shut down a large amount of these coin projects. We also are likely to see that many of these coins don’t serve an important purpose and like many startup companies, will fail.
Practically, I am worried about regulation. People are not taking the regulatory bodies seriously. They think the decentralized nature of the crypto projects circumvent government authority. This is plain wrong.
I strongly believe that in the next couple of years, laws will be put in place and government regulations and parameters will be implemented in the cryptocurrency space. Because of that, some projects will be negatively affected and may outright fail.
Andre: What areas, in particular, do you think the government will regulate?
Brayton: The U.S. government cares about three main things and this is where we will see them step in:
- Taxes (IRS). Given the decentralized nature of these coins and some of their privacy features, figuring out how to compel coin owners to self-report has been very difficult. The IRS is laser-focused on how to make sure coin owners pay their fair share of taxes.
- Securities Law (SEC). Many of these ICOs have issued coins that should be classified as securities and therefore subject to securities laws. Yet, most of these projects have not followed SEC guidelines on the issuances of these securities. The SEC is beginning to investigate and explore crypto projects that may have committed securities fraud or broken forms of security law. It is yet to be determined as to how they will punish these actors. We do know for a fact that cryptocurrency is a focus of the SEC.
- Anti-Money Laundering/Terrorism (DHS). Given some of the privacy features associated with cryptocurrencies, there is every opportunity for bad actors to utilize the coins as a way to fund terrorism, drug cartels, etc. One of Bitcoin’s first use cases was on Silk Road, the web-based black market that sold items and services ranging from heroin to hitmen, which was later shut down by a combination of the DHS and FBI. The DHS and other U.S. agencies will be focused on how to stop this technology from being used to enhance the funding of illegal activities.
These bodies will be focused on this industry, how to best regulate it, and remove some of the bad actors in the space. And trust me when I tell you, there will be many shady characters who will be called out and punished for their fraudulent and manipulative actions in this industry.
Andre: We often hear about the “Bitcoin” or “Crypto” community. What is this community thinking about as it relates to blockchain technology and its use cases?
Brayton: Blockchain by design eliminates the need to trust a third party. Historically, trust needed by a 3rd party cost money. Blockchain enables the removal of third parties since the blockchain itself is truth. And, because it is software, you do not pay for that third party.
Proof of ownership is the key behind the ledger and blockchain. And it is not limited to money. It relates to real estate deeds, proof of ownership of digital goods, contracts, etc… While the rise in cryptocurrency prices has been fascinating and hard to ignore, entrepreneurs who are involved directly in this space are most excited to see blockchain positively impact the entire world and many of the daily activities and critical functions that help society function.
I should mention, in my opinion, I believe that a considerable amount of the cryptocurrencies now in circulation will eventually fail. There are too many cryptocurrencies chasing the same carrot. Some of them likely will end up getting in trouble due to fraud, misleading statements, etc. This will be a much-needed awakening for the crypto market.
Andre: Earlier, you mentioned involvement by U.S. based government agencies. How do other nations’ governments view these currencies? Are there some that are more open to cryptocurrencies and others that are more cautious, versus the U.S.?
Brayton: Some countries, such as Denmark, Sweden, Canada, and others, are positioning themselves as friends of the cryptocurrency space.
I think the countries focused on creating “crypto-friendly” environments are very smart. There is a massive opportunity for any individual or group of countries to be considered the “capital of crypto”. It would be similar to the U.S. being considered the hub of the internet and therefore reaping the benefits of being the home to the top technology companies in the world.
Should a country become the capital of cryptocurrency, it will see tens of thousands of talented engineers and professionals moving in to work on cryptocurrency and the various blockchain applications. The (tax) revenues associated with that, along with increased demand for housing, goods, etc., in those countries, will be massive and can change an entire country’s economy.
Andre: What if, in the worst case scenario, these projects are completely rejected by all governments. If that occurs, can these currencies thrive, or even survive, outside of government acceptance, or could they be absolutely shut down?
Brayton: Yes it could survive and no it can not absolutely be shut down. Shutting down this system, from a government’s perspective, is nearly impossible. If mining became illegal, it would literally take only a handful of computers worldwide to maintain the system.
View this similarly to the gold rush. Did the government grab all the country’s gold? No. Like gold, Bitcoin is too distributed for the government to seize total control.
The only technological way that government could kill Bitcoin is if it placed more resources behind mining than currently exists within the decentralized mining system. If the government finds a way to own 51% or more of hashing power, they could potentially freeze or alter the Bitcoin network. I think this is highly unlikely.
The U.S. government, in particular, has shown interest in wanting to learn more about cryptocurrency, blockchain, and the implications and benefits of these systems. The U.S. government and other governments recognize that these cryptocurrency projects are global and many of the blockchains are primarily maintained and supported (via miners) outside of the United States.
If one country bans a cryptocurrency from being used or mined within its jurisdiction, it does not kill the currency or its potential use cases. If anything, the outright banning of a certain cryptocurrency may, in fact, increase that cryptocurrencies value and utility.
Andre: Moving away from regulatory risk, can you explain how one can buy a Bitcoin? And related, how can an investor be comfortable they will not be defrauded?
Brayton: With cryptocurrency, security as it relates to coin theft or a hacked wallet is generally all about keeping private keys safe. The problem is that for an average investor, being able to securely purchase and store cryptocurrency is both difficult and requires some level of technical prowess.
Crypto security is a growing industry right now. However, the solutions are still extremely difficult for the average investor to manage. Currently, I recommend smaller investors use Coinbase to purchase Bitcoin, as it is the easiest solution in the marketplace today.
With Coinbase and other like crypto exchanges, technically, those exchanges own the currency and the associated private keys on behalf of the purchaser. This is a major risk to all investors who purchase on these sites and something they must realize. The worst case scenario leads to Bitcoins being lost in a hack along with any other Bitcoins stored on any given exchange.
As an investor’s sophistication grows or their portfolio grows, I would begin looking into cold storage solutions. Cold storage solutions mean that you, the purchaser, truly own your cryptocurrency and the private keys. There are a variety of cold storage methods. In almost all cases, cold storage is a smarter way to store one’s cryptocurrency vs. on a public exchange.
The trade-off between security and convenience is a big one here.
Andre: How secure is the blockchain itself? Can the software that runs these coins and projects, blockchain, be hacked? Is this an investor concern?
Brayton: The Bitcoin and Ethereum blockchains today, as we know them, are secure. I reference these two since they are the largest and longest standing without hacks.
With that said, these are emerging technologies. They are susceptible to attacks, hacking, etc… Yet, they have proven to be virtually bulletproof so far.
Keep in mind that Bitcoin currently holds $100b+ of market value. This provides an awful lot of incentive and temptation to crack. If someone in the world figures out a way to break Bitcoin and its code, even a fraction of it, they may have access to some of that $100b in value. You couldn’t ask for a bigger potential bounty.
Therefore, investors should realize that the blockchain is constantly being explored and prodded for weaknesses and potential errors by hackers. Every day it is not hacked adds to its credibility and security.
Andre: How easy is it to lose Bitcoin, whether it be because of technical incompetence or some other factor? What happens if I sent a Bitcoin to a wrong address or forget my wallet address and private keys?
Brayton: One of the biggest issues with the cryptocurrency space is that, because it is such a young market, most of the tools, services, and products are not user friendly. Therefore, errors on a user’s end are very possible. There are a handful of ways to lose Bitcoin:
- If you store on an exchange or brokerage, and that exchange is hacked, there is no government agency to bail you out for the funds that have gone missing (and most of the exchanges would cease to be in business if that happened to them).
- Your email, phone, and computer can be compromised which allows hackers to sign on to your exchange and brokerage accounts and steal from it.
- The technology interfaces are very young and technical. There is no “undo” button. Sending money to the wrong address means it’s gone forever.
- One of the best methods for storing Bitcoin is a method called: cold storage. In this method, you own and hold the individual keys associated with your Bitcoin, similar to owning the actual certificate of a stock associated with an equity. The Bitcoin is not held on an exchange. However, because you own and control those keys (which are long lines of numbers and letters), the risk remains of losing Bitcoin. If your computer gets hacked and somebody gets access to your keys, you lose the keys, etc., you run the risk of having your Bitcoin stolen.
Bottom line: proceed with caution!
Andre: If one of our clients decides they want to invest in the cryptocurrency space, what would you advise them to consider buying or avoiding?
Brayton: The first thing I tell individuals who want to be involved in cryptocurrency, whether it be via becoming an investor in coins, investing in the companies that are making new tokens and running projects, or investing in a crypto fund, is to actually use the currency.
Take a very small amount of the capital you want to invest and buy Bitcoin (BTC) and Ethereum (ETH). Send fractions of amounts to other wallets, to merchants that accept the currency, and to friends and family. The client must familiarize themselves with the technology, how it works, and how the transference of these coins works, and the power of the blockchain, before becoming an investor in it.
For a novice looking to purchase a small amount of cryptocurrency, I would buy BTC and ETH, as they are the two top market cap coins. They are clearly the leading coins in terms of community, developer network, etc… They have different use cases and different features. From my perspective, both can be wildly successful for entirely different reasons.
For larger investors, there are a handful of investment funds available. Many of them, given the market over the last 12-24 months, are all showing impressive return metrics. My recommendation is to explore investing in funds that have the flexibility to invest both in coins/tokens and in the equity associated with some cryptocurrency companies.
Andre: Will Bitcoin always be the king of crypto? Do other currencies have a shot at occupying the top spot?
Brayton: Right now, BTC has the network effects in its favor, it was first to market, and it is truly decentralized. It would be very hard for another coin to overcome Bitcoin, but, there could be a scenario where something takes over.
The decentralization of the coin is a critical point. All new cryptocurrencies clearly have founding teams and a founder that controls a large portion of the coin’s development and growth. This creates centralization, which is one of the characteristics of traditional currency that cryptocurrency was supposed to eliminate.
Bitcoin is the reserve currency of crypto. All cryptocurrencies peg their value to Bitcoin. It would take a catastrophic event for Bitcoin to be removed as the reserve cryptocurrency.
Andre: In the 1849 gold rush, companies that provided services to the miners made large amounts of money selling pans, picks, jeans, etc.. Most of the miners themselves went bankrupt. Investing in Levis would have been a better investment than gold at the time.
How would you contrast investments in the tokens and coins of cryptocurrencies vs. companies that are utilizing blockchain technology to create services and products? Are there parallels we should be drawing here?
Brayton: Like with any investment strategy, especially in a new and emerging market, it is totally undefined who the winner is (the coins or the projects using blockchain).
My fund, Boost.VC, has direct exposure to cryptocurrencies themselves (Bitcoin, Ethereum, Aragon, etc.) and also exposure to and investments in the equity of companies building in the crypto space (exchanges and hardware companies like Coinbase, Ledger, etc…).
I obviously think this is a superior way to invest in the space. It is a dual approach in ownership via owning part of the actual tokens and companies. It is unclear which side will be the ultimate winner in the space – so, for the time being, we prefer to own both.
Not all tokens and coins are created equal. Some token projects accrue value on the token layer while others accrue value on the project layer. Therefore, realize that some of the tokens may never appreciate or may not need to have a value, yet, their projects may be highly successful.
In other words, there are other tokens that do not require value or appreciation in their coins for the projects to work. Some of the coins may not rise in value at all, while the actual companies could be hugely successful. In that scenario, it is better to own the equity in the company/project instead of the coin or token of that company.
Andre: Sometimes when looking at these projects, we hear founders of crypto projects discuss how their coins or projects are built on top of Bitcoin, Ethereum, etc. Can you please explain what that means? Do those projects cease to exist without their underlying coin? Are they dependent on whichever major coin they choose?
Brayton: One of the hardest things about starting a new crypto project is the integrity and security of the blockchain. A coin I am very excited about, Aragon, is building out a project using blockchain that will eventually allow for decentralized government and organization models. Some call it digital jurisdiction. In order to jumpstart their project and have security and integrity associated with their coin and project, Aragon decided to build their coin on top of Ethereum and leverage the security of that ETH blockchain.
Building “on top of” reputable projects like BTC and ETH only enhance the security of those projects. Because of this phenomenon of building on top of BTC and ETH, BTC and ETH inherently become more critical in the cryptocurrency ecosystem given their association with so many other coins.
These coins can build and exist within their own blockchains, however, if their community is not large enough and the support isn’t at the level required, their blockchains will fail. Therefore, building on top of BTC and ETH is, as of now, a common decision made by new crypto projects.
Andre: Whether it be a coin or equity ownership in a cryptocurrency project, it seems like the market is inflated. Are we in a bubble? Does Bitcoin going from under $100 in 2013 to over $15,000 in December of 2017 worry you?
Brayton: Ok, Andre – short answer for you is: short-term we are in a bubble, yes. But long term, no. Cryptocurrencies will have a market cap, eventually, much larger than today.
Prices of projects today are greatly inflated compared to the status of what the projects have delivered. Some of these projects have yet to deliver a product, yet, they are receiving $100m+ valuations. That said, there are some projects today, that if they work as the developers believe, can absolutely rise much higher than they are today as they will have major positive effects on the world’s population.
While the analogy is used often, I view an investment in Bitcoin and other cryptocurrencies as similar to investing in Amazon, Ebay, Google, at the inception of these companies and when the internet was still young and the power of it unknown. I view Bitcoin as undervalued and I would absolutely be an investor today at the current prices.
Andre: As we wrap up, any final thoughts or words you would like to share with our clients?
Brayton: Crypto is one big R&D project. Nobody knows what is going to work but we all have a shared vision for the future. We are all running experiments and hoping we find the “next big thing”. So, view this as an absolutely risky allocation/investment, especially in many of the newer projects. 2017 brought a new asset class – cryptocurrencies. They were used for little more than speculation – eventually, these currencies must have utility or something from which to derive value or else they will rapidly drop to zero.
I think that in 2018 we will start to see the use cases emerge outside of speculation. It will be a year where crypto teams need to deliver on some of their promises related to their companies and projects. Keep an eye on those projects that start getting real traction because they will certainly stand out.
Andre: Thanks for the time and thoughts, Brayton. We look forward to the next conversation and wish you the best of luck on your new fund!
