Principles For Managing Risk in Crypto
In the exhilarating realm of investing, particularly when it comes to groundbreaking innovations, the journey is undeniably a game of risk management. Every investor dreams of riding the 'S-curve', transitioning from a mere 0% adoption to a staggering 100% market penetration. Yet, to truly harness the potential of this curve, one must master the art of managing risk.
The gravest misstep an individual can make in the crypto sphere is to succumb to the allure of excessive risk-taking, only to be left behind, watching the monumental surge from the sidelines. Such a failure isn't just about immediate losses; it's about missing out on the transformative shifts that define an era.
Crypto, with its unique dynamics, presents challenges that traditional investment landscapes seldom do. In times of market corrections, cryptoassets tend to converge, correlating almost perfectly. This singularity makes traditional diversification techniques less effective. Interestingly, it's only during the bullish phases, when assets soar, that we witness a broad dispersion.
Having weathered several "once in a lifetime" storms, the Etherbridge Fund stands resilient. Given our experiences and the evolving landscape, we believe it's timely to delve into our guiding principles and strategies for navigating risk in the ever-evolving world of crypto innovation.
Rule 1: AVOID LEVERAGE
Leverage, often dubbed the 'cocaine of the speculator's toolkit', is a double-edged sword. On one hand, when wielded with expertise, it has the potential to magnify an investor's edge, amplifying returns in a manner that can be nothing short of exhilarating. On the other, it's a fickle and treacherous beast, one that can swiftly and ruthlessly increase an investor's chance of financial ruin.
Mature markets, characterized by widely accepted value drivers and a rich tapestry of information, might be more forgiving arenas for the judicious use of leverage. In such environments, the collective understanding of asset prices and the dense flow of information can act as a buffer, somewhat mitigating the inherent risks of leverage.
However, the crypto realm is a different beast altogether. There's a saying that resonates deeply within the crypto community: "A leveraged fool and their bitcoin will soon be separated." This adage underscores the perilous nature of leverage in a market as volatile and nascent as crypto.
If we truly believe in the disruptive potential of blockchain technology, then the allure of leverage becomes redundant. The transformative power of blockchain, if realized to its fullest, offers returns that make the risks of leverage unnecessary. Why gamble with a tool that can lead to ruin when the underlying asset itself holds such promise?
Thus, our first and foremost rule, carved in stone, is clear and unequivocal: NO LEVERAGE
Rule 2: DON'T TRADE EVERYTHING
The crypto landscape is vast and ever-expanding. With over 10,000 tokens available for speculation, the investable universe is nothing short of overwhelming. But let's be candid: Can any investor, regardless of their prowess, truly keep abreast of every project and token out there? The stark reality is, they can't. Attempting to chase every fleeting opportunity not only risks financial peril but also clouds one's vision, making it easy to lose sight of the broader, more impactful trends.
At Etherbridge, we've devised a systematic approach to constructing our investable universe, ensuring clarity, liquidity, and measurability:
Step 1: Liquidity Filter
Before diving into the vast ocean of tokens, we apply a stringent liquidity filter. This step is crucial in weeding out illiquid tokens, ensuring that we're not ensnared in positions that are hard to exit. Our focus remains unwaveringly on liquid coins.
Step 2: Data Classification
We then categorize the filtered tokens into two distinct buckets: Data-rich tokens and Low-data tokens. The beauty of crypto projects is their transparency; they produce financial statements with every block. These statements are treasure troves of metrics that can be employed to assess a project's success and potential. We prioritize tokens that boast at least 3-6 months of data on these metrics.
By adhering to this rule, we guarantee:
Immunity from the chaotic frenzy of chasing every available token.
Investments that are liquid, ensuring flexibility.
A portfolio that is not just traded but is also measurable and manageable.
In the world of crypto, a simple mantra holds true: If you aren't measuring it, you aren't managing it.
Rule 3: Diversify Across Themes of Disruption
Blockchain, as we've reiterated time and again, is a general-purpose technology. But what exactly does that mean?
General Purpose Technologies (GPTs) are:
Technologies that have the potential to drastically alter industries and economies.
Pervasive in nature, affecting a wide range of sectors.
Catalysts for complementary innovations and opportunities.
Capable of improving productivity across varied applications and sectors.
Given the inherent nature of blockchain as a GPT, it's evident that its applications span a multitude of themes, sectors, and industries. This vast potential landscape offers both opportunities and challenges.
Our strategy is clear: maintain diversified exposure across multiple themes of disruption. Why? The reasons are twofold:
Uncertainty of Dominance: In the nascent stages of any disruptive technology, predicting which theme will gain mainstream traction first is akin to gazing into a murky crystal ball. Diversification ensures we're not placing all our bets on a single, uncertain outcome.
Mitigation of Overexposure: While it's tempting to go all-in on a theme that shows early promise, overallocation to a single theme is a risky endeavor. A single regulatory decision, technological hurdle, or market shift could significantly impede a theme's growth trajectory. We aim to shield our portfolio from such systemic risks.
By diversifying across various themes of potential disruption, we not only hedge against unforeseen challenges but also position ourselves to capitalize on multiple avenues of growth.
Rule 4: Diversify Across Technological Approach
At its core, a technological approach refers to the design choices made by developers to realize a specific vision for their project. It's the blueprint, the strategy, the method by which a concept transforms into a tangible, functioning entity.
Reflecting on my journey as a portfolio manager, grappling with technological approaches has been my most challenging lesson. The very first piece of advice I received upon entering financial markets was crystal clear: "Do not fall in love with your positions." Yet, the crypto landscape, with its intricate blend of technology, culture, and ideology, often blurs these lines, making it all too easy to become emotionally invested.
Crypto isn't just about technology; it's a movement. Concepts like decentralization are deeply intertwined with cultural and ideological beliefs. However, our primary objective remains unwavering: to generate returns for our clients. We are not here to champion political movements or ideologies. It's imperative to keep these objectives distinct, lest we risk our portfolio's integrity and our clients' trust.
Before delving deeper into Rule 4, pause and ponder: "What will the blockchain technology stack resemble a decade or two from now?" Having immersed myself in this market for over six years, I can vouch for the unpredictability of such a projection.
Acknowledging the inherent uncertainty of predicting the future landscape of blockchain technology, a pressing question emerges: Why would I, or any investor, concentrate exposure to this evolving technology within a singular technological approach?
Diving Deeper: The Case of Smart Contract Platforms
When we zoom into the market segment of smart contract platforms, the diversity in technological approaches becomes even more evident. Let's break down the three primary design architectures:
Single Validator Set, Single Chain: A streamlined approach where a single set of validators oversees a singular chain. This offers simplicity and often faster consensus but may face scalability issues as the network grows.
Single Validator Set, Multi Chain: Here, while the validator set remains singular, the platform operates multiple chains. This design can address scalability concerns to an extent, offering a balance between efficiency and expansion.
Multi Validator Set, Multi Chain: Arguably the most decentralized approach, it involves multiple sets of validators overseeing multiple chains. While it offers robust security and scalability, it can also introduce complexities in achieving consensus.
Each of these architectures presents its own set of advantages and challenges. Our stance isn't about picking a definitive winner but understanding the nuances of each approach. It's worth noting that projects are not static in their design choices. As they evolve, they might pivot from one approach to another based on the challenges they face or the advantages they seek. A prime example is Ethereum, which transitioned from a single validator, single chain, proof-of-work model to a single validator, multi-chain, proof-of-stake model.
By acknowledging the diversity in technological approaches, we can delve deeper. Our analysis then shifts to identifying the market leader within the smart contract segment as a whole and subsequently pinpointing the frontrunners within each specific technological approach. This layered analysis offers a comprehensive view, allowing us to discern which players are truly excelling, optimizing their chosen approach, and maximizing measures of success. In essence, it's about appreciating the broader landscape while also understanding the intricacies of each path within it.
Diversifying across various technological approaches isn't just a strategy; it's a necessity. It ensures we're not tethered to one vision of the future but are poised to benefit from the myriad possibilities this dynamic field promises.
Bringing it all together:
At Etherbridge we have carefully studied innovation and its diffusion through society. We use these insights to create holistic rules that we believe can be applied to any general purpose technology or technological revolution.
Something we have identified in almost every technological revolution is the heightened degree or chance of financial ruin. The most important thing about investing this far up the risk curve in long duration assets is staying in the game by engineering a portfolio that objectively balances the risks associated with the new paradigm.
The S curve of innovation diffusion is like riding a raging bull (volatility), you know that the bull will eventually succumb to domestication (stabilization/maturity), your only job in this regard is to stay on the bull. To do this you need to remain objective, humble and open, anything less and you will find yourself in the graveyard of thousands of investors that fell off the longer term trend.
We believe that these basic principles if applied consistently will allow the investor to invest throughout the technological diffusion and position them well to capture the bulk of investment returns afforded by the new paradigm.
While it’s easier to look away, seeking to understand is the only path to a more enlightened and empowered world. Bitcoin, Ethereum and distributed ledger technology are complex systems that require due diligence to comprehend and operate in. Etherbridge lowers the barriers to understanding this fast-growing digital economy.
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This is not financial advice. All opinions expressed here are our own. We encourage investors to do their own research before making any investments. Collective Investment Schemes (CIS) are generally medium to long term investments. The value of participatory interests may go down as well as up. Past performance, forecasts or commentary is not necessarily a guide to future performance. As neither Lima Capital LLC nor its representatives did a full needs analysis in respect of a particular investor, the investor understands that there may be limitations on the appropriateness of any information in this document with regard to the investor’s unique objectives, financial situation and particular needs. The information and content of this document are intended to be for information purposes only and should not be construed as advice.