I’ll read it for you, Vol. III.

Summarizing Meltem Demirors’ “The Truth About the Crypto Crisis ’

Meltem Demirors’ post last week was a nice snapshot of the crypto industry at a moment in time. ‘Nice’ is of course figurative; at this particular moment in time it’s difficult to describe the crypto industry in terms that aren’t apocalyptic. With that in mind, Demirors does a good job of explaining, from the point of view of both investors and operators, how we got to where we are, what’s currently happening, and what the outlook is for the future.

How we got here:

You’ve read the fat protocol thesis. You’ve likely read why fat protocols are not an investment thesis. You follow Meltem, and the Multicoin and Blocktower and Placeholder guys. (Lots of guys, I know. I don’t love that, and would love suggestions of more women who are thinking about this kind of thing to follow on Twitter). So you know that there’s considerable debate about where value is going to accrue within cryptonetworks. There’s a lot of smart people spending a lot of energy to hypothesize and analogize and medium-ize. But what gets obfuscated in these hundreds of thousands of words is the fact that no one currently knows the answer. There’s a general understanding that cryptocurrencies and the blockchains they run will create value somewhere. But nobody knows how to invest in a systematic manner in the places where that value will be captured.

Demirors draws a comparison that’s been bandied about for a while now. In the dot com bubble, traditional business models and distribution networks were being overwritten by the internet, and investors who were used to valuing companies based on long-held assumptions about user acquisition costs and lifetime values were throwing money at businesses they didn’t understand because they didn’t want to be left out. They knew the internet was a good thing for most businesses, but they didn’t know exactly why. And even if they did have a pretty reasonable idea of why, it was impossible to guess at the magnitude of the effects that why would have.

18 years ago, the result was pantsthatzipintoshorts.com or whatever IPOing at a $12 billion valuation and being salvaged shortly thereafter for the copper wire in the warehouse walls and whatever excess zippers were in inventory. Why IPO in the first place? Because they could.

The recent analog to the pantsthatzipintoshorts.com IPO is any ICO. I mean that literally. Any of them. Pick one from this handy list I made:

Crypto News, Pricing, and Research

Projects ran ICOs in 2018 for the same basic reason terrible businesses IPOd in 2001. Because they could. And why not? In an ICO, the cost of capital to the project is essentially zero. It’s non-dilutive. There are no caveats: no ratchets to negotiate, no new board members to accommodate, no IR reports to disseminate. So, a bunch of operators raised a ton of money with no oversight and no rules about how they can spend it. What could go wrong, right?

Where we are:

Briefly, we are at the front edge of capitulation. I’ll shorten this part up a bit because everyone knows how bad it is out there.

Projects have to pay bills (salaries, lawyers, ops, you name it). The only thing of any value on many balance sheets is BTC or ETH raised in an ICO. That being the case, projects hit the bid and sell crypto for fiat, driving down crypto asset prices further. Death spirals abound.

Investors are in similar situations, where they have a book full of smoke and mirrors that they can’t sell. And in many cases it’s not just a case of “we can’t sell this all because it’ll move the market”, it’s a case of “there is literally not enough on the bid to get out of our current position”. Pomp did a good job of painting this picture in a recent newsletter. Meltem suggests that these managers just mark these positions down, sell whatever they can that’s liquid, and hunker down.

Besides chronicling the bloodshed, Demirors makes two interesting points that are worth highlighting:

1. Some mid-cap cryptoassets have fared better through this bear market than the large caps (BTC, XRP, ETH). She postulates that “these are projects have grown up in the shadow of the large caps above; and have less “drama,” more (and better) comms and marketing; a loyal base of stakeholders, some recruited through airdrop or ICO; and a real focus on unique and specific implementations and use cases”. This all smells like better management to me, and indeed Demirors makes the argument that it’s through **centralization** that these projects have survived.
2. I wrote above that the cost of capital to the project for an ICO is zero. That might be technically true, but there is a psychological cost that’s harder to quantify. It doesn’t sit on a balance sheet or change with quarterly income statements. These projects raised money and built communities around a promise. Demirors points out that in large part, no one has shipped product that comes anywhere close to fulfilling that promise (I see you, Augur, stop raising your hand). And in all likelihood, thanks to the death spirals mentioned above, they never will. It remains to be seen what the cost of this technical debt will be. I have to believe that there will be reputational repercussions, and that history will not judge kindly those who raised hundreds of millions of dollars in funding and did materially nothing with it. As the asset class matures, and we get closer to understanding where value accrues, one has to imagine that investor diligence operations will surface these charlatans and they’ll be shunned. I’m setting up a reminder to revisit this in 5 years.

What we’re doing about it:

I use ‘we’ in that subhead rather generously. I personally am learning to write code, writing this medium post, and accumulating as much bitcoin as possible (not financial advice etc etc). Demirors lays out four categories in which investors and operators are doing work to capture value on the next crypto upswing.

1. Institutional investors are looking for exchange traded products and GPs to get exposure to the crypto-native assets themselves. Buying and holding a bitcoin is so far out of the operational expertise of traditional LPs that they’ll continue to pay a premium for “existing strategies that they can understand, report on, and easily manage with their existing infrastructure.”
2. Private companies will be focused on building tools for the speculative use case. She highlights the main players — Bitmex, Binance, Coinbase, Circle — and suggests they will continue building these tools both organically and through acquisitions.
3. Public companies won’t put a stop to ongoing crypto projects because of the downturn in prices. Demirors points out that planning cycles for these companies are necessarily longer and that projects set in motion when bitcoin was mid-parabola are likely still going, whether the purpose was to “(1) create new revenue streams; (2) play “innovation” theater; and (3) build enterprise value.”
4. Crypto funds and asset managers will suffer. However, Demirors posits that the good managers will find a way to profit on short-term price volatility while keeping true to their long term theses. I have a little trouble swallowing this one, as the complete lack of any derivatives market limits the strategies for short-term trading to essentially “buy bitcoin when it’s low and sell it when it’s a little bit higher”. It’s hard to make 2/20 trading spot without getting your eyes ripped out on Bitmex.

Where we’re going:

Demirors finishes on a positive note. She points out that the community is larger and stronger now than it ever has been. Looking at talent flows into crypto, it’s hard to disagree. She also makes the point that a variety of macro factors are pushing traditional wealth creation and retention away from centralized points of failure, and towards decentralized financial systems. That being the case, those systems with battle-hardened governance processes will continue to gain adoption by the masses.