When Jason Zweig of The Wall Street Journal takes something seriously in his column, you best pay attention because he doesn't screw around. I've known Jason for more than a decade and first chewed his ear off about Bitcoin back in 2013 as a total aside in the process of discussing Estimize, the fintech startup I had founded in 2011. The genius of Jason is that he is at the same time, one of the preeminent financial historians writing from a personal finance perspective, and completely in the flow of all the modern advancement and disruption of financial markets. Like Tom Friedman of the NYT circa Lexus and the Olive Tree or The World is Flat (before he kind of got bored and went off the rails), Jason has a great skill in boiling down complicated topics without being patronizing.
I caught up with Jason last week as he was writing a piece published on Friday titled "You Can Get Crypto Right and Still Play it Wrong". The basic premise of the piece is Jason doing a bit of a survey on the different ways retail investors can invest in crypto and framing that conversation from the perspective of whether it's smart or even possible to diversify your crypto investments. Jason writes:
There may never have been another type of asset where winners and losers change so fast, says Leigh Drogen, who has invested in cryptocurrency since 2013 and runs Starkiller Capital LP, an Austin, Texas-based investment firm specializing in digital assets. "It's totally possible that none of the existing cryptocurrencies hits a tipping point where it gains so much market share that it washes everything else out," he says. "You could end up with a panoply of technologies that are just constantly usurping each other."
It would be a real shame to get the long term crypto trade right from a macro perspective, but get the asset selection part of it wrong. When we look back at the history of technology there has never been an example where the first investable incarnation of something was the long term big winner, it simply never happens. It would be completely a-historic for Bitcoin, the first iteration of investable blockchain based digital assets, to win out long term. In fact what we see is Bitcoin's percentage of the total crypto market cap fall from 70% to 40% between the beginning of 2021 and today.
What I expressed to Jason in a lot more depth than what he quoted was that crypto is still largely in the experimentation phase. Outside of crypto trading and a few things in DeFi, there really isn't much having a big real world impact, yet. The casino (crypto trading) is the boot program for the liquidity and technological adoption that's necessary for the critical mass needed for bigger real world utility. But all of these things are still early experiments, incredible engineering talent is now flowing heavily into this space, and there may be many many more iterations of the core technologies here until we get to something that is scalable enough to handle transactions on the scale necessary for this to really work. On top of that, both the chains and the protocols written on top of them are completely open to be forked and augmented at will. This coupled with the portability of user data and assets via Web3 wallets produces a situation where neither the chains nor the protocols have any real moat or switching cost. Users and liquidity can move quickly between them as they get better and better. This is a major departure in so many important ways from Web1 and Web2 where data, value and users were locked in to platforms. Because of these variables, it's dangerous to approach investing in this asset class from a DCA and HODL perspective.
So what is an investor to do? Well there are really two answers. Either attempt to do asset selection, which is what we do at Starkiller, or diversify into an index.
Our main approach to asset selection is a focus on cross-sectional momentum. From the most simplistic perspective, we want to own things that are going up the most, because those are the assets most likely to go through huge adoption cycles. While cross-sectional momentum works well in equities, it works even better in crypto, because again, we're dealing with experiments, and we're looking for the experiments that end up working, because when they work they tend to work quickly and at huge scale. Outside of a small handful of coins, and maybe even them too, what we're really dealing with here in crypto are Series A to "growth" venture assets, except unlike startup equity the coins are liquid. So naturally there's going to be massive dispersion in outcomes for these assets, especially given the nature of how one project disrupts another over and over again in the space. Given that dispersion, the goal of an actively managed portfolio should be to give yourself the best chance to ride the right tail of these adoption cycles as many times as possible while mitigating risk of the left tail by continuously rotating into the relative momentum.
But what if you don't want to actively manage your crypto assets, what then? The great part about a market cap weighted index is that it is a natural momentum vehicle. Assets that ascend in value are given higher weightings and those that fall vice versa. This is even more important in crypto than equities. Just look back at the top 10 coins from 2017 which included Bitcoin Cash, Ripple, Litecoin, Cardano, Dash, Monero, IOTA and NEM. Cardano and Ripple are still there (for some strange reason), the rest are long gone way down the list and aren't coming back.
The problem is, a market cap weighted index the average person can invest in doesn't exist. Gary Gensler at the SEC refuses to green light spot crypto ETFs, which is unconscionable given products like GBTC and others are terribly constructed (read Jason's piece for more on this). So anyone unwilling to take a deep dive into DeFi is out of luck there. Even within DeFi, I haven't seen a great product with low fees you can DCA into over time that won't melt your brain trying to actually interact with. Index Co-op which is built on top of the Set Protocol does have a handful of indexes, but until this week when they started to launch some of those on Polygon you had to pay massive ETH gas fees. The construction of these indexes can also be quite arbitrary, which is unfortunately somewhat necessary given the prevalence of shitcoins and legacy assets with large marketcaps.
This gets even more difficult if you want to put together a thematic index where things are changing even faster down the market cap stack and even the smartest crypto investors are somewhat straining to understand what's real from what's vaporware.
Like most things in crypto, we're just still really really early in the evolution of individual investors being able to intelligently invest. The user experience in DeFi is still incredibly poor and a major roadblock to adoption. The first wave of institutional investors are now entering the liquid coin space bringing with them significant capital. But that capital will be dwarfed by the eventual flow from retail investors when they can cheaply index into the asset class through something that probably looks like Crypto Betterment or a NYSE traded spot index ETF (just let it happen Gensler).