The right (and wrong) way to invest in digital assets

The dot-com technology sector boom and bust is an oft-cited analogy. The Nasdaq index plummeted 81 per cent from its March 2000 all-time high to September 2002 lows. Like some crypto projects today, many companies rushed to go public without a sustainable business plan and failed when access to new capital dried up.

Webvan would deliver one item from your local store at any time of the day at the same cost of the store (quite handy if coming home late from the pub when you were in your 20s but how could they possibly make money?); eToys.com and Pets.com were more popular for their Superbowl ads rather than the products they delivered.

Stories of failed companies highlight that the overcapitalisation of bad and terrible business plans can end poorly for investors.

However, Amazon survived the tech boom and bust, even though its stock price fell 94 per cent from its 1999 high to 2002 low, and proved home delivery of everything could dominate retail. It now has the fifth-largest market capitalisation in the world at $US1.4 trillion ($2 trillion).

Later Google, Facebook and Tesla proved business plans with sufficient capital backing that focused on market dominance first and profitability later could thrive no matter what Warren Buffett thought.

When people look at the digital asset space their focus is invariably at the pointy/crappy end of town, as random meme tokens with binary 100 times-or-zero price paths capture the imagination. But in my opinion this is completely the wrong way to engage with the space.

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Most projects in this space will fail. Therefore the “smart” thing to do is to get a diversified beta exposure to the largest tokens, after stripping out all the stablecoins etc you don’t want exposure to.

You should view these larger coins as akin to equities: they have significant market capitalisation and have mostly already proved their use case. Therefore, you are getting exposure to adoption, which is lower-risk than in the smaller coins but still offers an exponential return curve.

This exposure should just sit in the portfolio, untouched and not rebalanced, for the long-term.

The second way to engage is to pick managers who focus on exploiting the many opportunities that arise from a developing market infrastructure. If you already have your beta exposure covered then it’s best here to focus on a fund offering a market-neutral relative value strategy.

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As you move experienced TradFi (traditional finance) traders to a rapidly growing arena, which has a large retail component, the opportunities are large, but so is the need for institutional-grade systems and compliance, so pick your managers well.

My strong belief is that blockchain technology’s potential is profound, and its applications will touch all facets of our lives. But the crypto winter washout has exposed some token projects as self-serving and shoddy in a similar way that the tech bust did in 2001-02.

The failures we have seen of overleveraged hedge funds like Three Arrows Capital have been an issue of poor risk management, very similar to the Archegos collapse of 2021, and not endemic of the digital asset space.

You get very few opportunities to be around for the birth of a major new asset class, as digital assets are. But it’s no get-rich-quick scheme and the best way I can think to get involved in the space is via a small unleveraged diversified exposure.

Vimal Gor is group chief investment officer for Trovio.

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