Options for Investing in Blockchain and Crypto

Blockchain Coinvestors Webinar Transcript

The following is a transcript of the Blockchain Coinvestors webinar ‘Options for Investing in Blockchain and Crypto’. The webinar with the supporting slide show can be watched at:

https://www.blockchaincoinvestors.com/webinars

Summary

Hello. This is Matthew Le Merle and we’d like to welcome all of you who are on the phone to this Blockchain Coinvestors webinar. The focus of this webinar is options for investing in blockchain. The goal of the next half an hour or so is to briefly review some of the various approaches an investor can take to invest in emerging blockchain companies and projects and provide you with a framework within which to place them. Not least because there is so much apparent confusion regarding what are in fact very different investment opportunities.

We need to share a disclaimer at the outset that even though we are ourselves investors and Blockchain Coinvestors manages funds, we are not providing this as direct investment advice and we are not soliciting in the course of this webinar. Each investor listening to this needs to make his or her own investment choices and decisions and should not rely upon any of the content that we are about to present.

Blockchain Coinvestors

Blockchain Coinvestors is the world’s leading venture fund of funds focused on equity investing in Blockchain companies and projects (http://www.blockchaincoinvestors.com). We are very fortunate that through our own investments in a number of the world’s leading blockchain venture investors we are investors in six of the nine blockchain unicorns and we have a wide net of additional investments in the space. Some of the companies we’re invested in include Coinbase, Ripple, Kraken, Block.One, Circle, and Bitfury. I will mention one or two of these companies in the context of investment strategies on this webinar and investors should be aware that we may have vested interests in some of the specific examples used during this webinar — those are of course the examples that we understand best.

In the supporting slide you can see that most of these investments we have accessed through the venture capital firms that we are ourselves investors in.

Early Stage Investment Returns

The launching pad for this call is that early-stage technology investing is one of the highest returning asset categories in the world and yet most people are underexposed to early-stage venture. The supporting slide shows the 25-year returns of different asset classes beginning with fixed income (the Barclays Bond Index) and public equities (the S&P 500 and Nasdaq Composite Indeces) all of which show 25-year time returns of 11% and less.

The US Venture Capital Index shows a net 24% IRR over the same period according to Cambridge Associates. Most importantly, the Early Stage Index is a 32% per year net annual returns. This is why many of us who live in Silicon Valley and work with entrepreneurial companies expose ourselves substantially to the asset class. However, most investors in the world do not.

Blockchain Inevitabilities

In an earlier webinar called ‘Blockchain Inevitabilities’, we spent half an hour talking about some of the most important tailwinds that we think are going to generate enormous wealth and value creation opportunities over the next couple of decades. We won’t repeat all of this since that earlier webinar is also available at the Blockchain Coinvestors website. However, we and many others believe that the exponential innovations that we are living in the midst of — like artificial intelligence, big data, the internet of things, the life science revolution, and so on — are going to continue. They will continue to disrupt and change economic activity globally and they will continue to move us towards a fully digitized, global economy. We believe, therefore, that the highest returns will continue to come from early-stage investing.

What’s slightly different about the next 20 years is that we have to fix the internet we have. There are very substantial challenges in terms of cybersecurity, identity, centralization and, for the thesis of the rest of this webinar, the internet of today does not have native digital monies or digital assets to effect economic commerce and it needs to have them given our progress towards a fully connected world.

The blockchain protocol is a breakthrough that may help solve these challenges and we already see through Bitcoin, as an example, that the blockchain protocol has proven very capable of supporting global, native digital money. We expect that we will see many more of these coming. Large corporate players are already

engaged and will continue to engage. Most of the Fortune 1000 companies have some sort of initiative underway today in the blockchain space. Governments will see that they have no choice but to play. By the time China launches its digital native currency probably sometime in 2020, it will be clear that other governments ranging from the United States and the G7 and EU to countries smaller but innovative nations like Switzerland, Estonia and others will see that this is something they need to do, too.

This will make native digital monies ubiquitous. In fact, we can’t have a digital economy and a connected digital world if we don’t have native digital monies. We can’t rely upon an infrastructure that was created for a paper-based world. This in turn means that the companies that create the products and services and the supporting infrastructure to enable this will emerge and will capture much of the value. We also believe that native digital assets will replace paper. Even though we have technology-enabled public equities and fixed income products today, it’s very strange that most of the world’s assets including private equities, most funds and most real estate are still paper-based.

All of this provides an enormous value and wealth creation opportunity for entrepreneurs and investors.

Eight Investment Themes

We have defined eight investment themes that we are focused on at Blockchain Coinvestors. We will also not go into this detail because it is also covered in the earlier webinar.

However, the first four of these all have to do with the financial markets. We expect to see a lot of new peer-to-peer marketplaces and lending platforms. We know that we need wallets and money services to support new digital monies and assets. We know that the exchanges and trading platforms that are used today have to be adjusted and in some cases fundamentally upgraded and improved to support digital monies and assets. That, of course, creates an enormous demand for capital markets and financial services companies and products and services that can support these new to the world ways of doing finance and affecting our economic transactions.

The next four investment themes are other areas that we also believe to be of substantial interest to investors. Enterprise services in areas such as supply chain management made better with immutable distributed ledgers, or registers of assets and information and products where they can’t be corrupted and changed and that users can access to know the provenance of what they are trying to buy are examples. These types of opportunities are being explored by the world’s largest and most sophisticated companies and seem to have a lot of merit.

We also know that the foundational infrastructure of the digital economy needs upgrading. So we expect to see more secure and better browsers and social networks. We expect to see the internet of things and more robust concepts of identity and content management created and enabled by the blockchain protocols. Then the very base layer computing, storage and the security and regulatory management layer will also be affected.

So these are our investment themes and we will return to these a little bit at the end of this webinar.

Lessons of the Internet Boom and Bust

The last time we saw such a substantial transition in human activity was during the rolling out of the internet. There were a lot of takeaways that were of great importance during the internet boom, bust and then boom and we believe many of them are of great relevance to investors considering investing into the blockchain space.

The next slide briefly captures some of the important strategies that turned out to be most important in the last couple of decades. The first we have already talked about. The value was captured early. The entrepreneurs and the investors that backed them captured the vast majority of the value of a set of companies that have now become the most valuable in the world. Whether we’re looking at Apple or Google or Amazon or Facebook, we see consistently that a lot of the value was captured early. When we look at the rankings of the world’s wealthiest people, we see the entrepreneurs — the Jack Ma’s of Alibaba or the Sergey Brin’s and Larry Page’s of Alphabet/Google — are amongst the world’s wealthiest people and, of course, Jeff Bezos of Amazon probably is. So the value is captured early.

The superior returns that are captured in those early rounds shouldn’t be a surprise. We have always known that superior returns only come in disorganized, fast changing, and emerging areas of investment. But the third bullet point here is important, too. We know that follow-on investing reduces the return. In practice, most investors, unless they do some work, will only have access to later-stage opportunities. We have already shown hat embedded in the venture capital return is the reality that the early return is 32%, the average return is 24%, but the late-stage return of the investors who only have access to secondary market investments in pre IPO unicorns is in the low teens.

In the internet time frame, inside deals and circles won big. To see this, we can explore the success of the more than 1,000 venture capital firms in the States that are members of the NVCA. Almost all of them, all but perhaps 50, have never backed a unicorn (a unicorn being a private company with a valuation of more than a billion dollars). In fact, a handful of firms dominated during the internet boom and bust. We can look at Sequoia that has 30 or 40 unicorns, Andreesen, NEA and KPCB have 20 or 30 each but then it drops off quite quickly. We know from past experience that the best way to be an investor is to be either one of those top tier firms or have access to them and co-invest or invest with and through them. Conversely, if you’re not in the inside circle, it’s very hard to consistently catch great investments in your investment strategy and the returns of early stage investors are driven by this most attractive opportunities.

New investors surfaced during the internet boom — let’s use Andreesen as an example. Andreesen was a firm that really came to prominence because of its very active and leading investing activity as the internet was built out and we got many of the household names that we use today. Andreesen was at the center of that and today is one of the largest and most active early-stage tech investment firms. At the time that we were first hearing about the internet, Andreesen was not a household name.

If you had been able to be a limited partner in the first Andreesen fund, you would not only have done very well, but you would have been honored and able to continue to invest with them. However, and this is the next point, access diminished over time. It diminished for a couple of reasons. The best firms become magnets for capital from the largest investors around the world, which meant that their minimum investments requirements went up fast. Today, it might cost you 25 million dollars to be a limited partner of a top tier venture capital firm and that is beyond most family offices and certainly most individuals. But even if you were a very big institution — offshore perhaps — it can still be hard to get access and be an LP investor in one of these top firms since they are often oversubscribed and prefer to take capital from investors they know well. Access diminished over time.

The last two points on the slide are more general. As with all forms of investing, diversification is key. This critical need for diversification means that it’s very hard to succeed as a direct investor when you’re investing into an asset class that has a high degree of risk and a high degree of failure associated with it. The way you combat that risk profile is to be highly diversified. But as a direct investor, it’s difficult to find the 30 and 40 and more investments that you need. That’s why fund of funds provided access during the internet boom and we saw the rise of firms like Horsley Bridge and HarbourVest and Greenspring who are dedicated early-stage venture fund of fund vehicles (though none of these has a blockchain venture vehicle). We will talk about this later as well.

Blockchain Investment Strategies

In terms of the blockchain space, we have a somewhat complicated set of investment opportunities and approaches. The next slide allows us to organize all of that confusion.

The reason why blockchain is confusing is that we not only have the traditional technology opportunities represented by the blockchain protocol and the companies building upon it, but the blockchain protocol is also enabling the creation of new crypto monies and crypto assets, which is what the bottom axis represents on this slide. As an investor, you can invest in companies and projects using the blockchain technologies which would be no different than you investing in, for example, internet search companies using new internet search-related technologies or life sciences companies using breakthroughs of personalized medicine or gene editing. So in the left-hand column, we have investing in real companies using the new technologies, but on the right-hand column, you have the alternative approach of instead investing in crypto assets that are being enabled by these new technologies.

Meanwhile, on the left-hand axis, we have traditional funding approaches. Approaches that we know very well such as venture investing, private equity investing, hedge fund investing, ETF’s and index funds and so on. But we also now have new and emerging funding approaches. These new and emerging funding approaches are emerging because the assets themselves are different and the technologies are enabling new ways to invest. So we have direct investing in tokens and token funds and we have the emergence of whole new categories of investment firms and vehicles. Often first time with no track record against their declared investment strategies.

For the rest of this webinar, we will walk around each one of the cells in the resulting 2x2 matrix and explain a little bit more about what is going on in each.

Emerging Funding Approaches for Investing in Crypto Assets

We will begin with the area of direct crypto and hedge fund investments in the top right hand corner of the matrix. This is perhaps the most extreme investment strategy in the sense that you’re investing in new asset categories and you’re investing through new infrastructure and often new firms. The first thing that any investor can do is they can open their own account or wallet at a firm such as Coinbase, Kraken, SFOX and begin by buying some crypto monies: such as Bitcoin or Ethereum or XRP. If these crypto products that you are buying are not considered to be assets, the qualification for the investor is lower. If they are tokenized securities and are viewed as such, then you need to be an accredited investor or whatever the definition is in the jurisdiction within which you invest.

We have Coinbase as an example here because the Coinbase interface is extremely simple for first-time investors, but there are many other choices. To invest in this cell of the matrix requires that you understand and know about the cryptocurrencies you want to invest in and that you have your own point of view about the risks and the returns associated with them. Many institutions require more sophisticated trading platforms and infrastructure that’s provided by, for example, by SFOX and Tagomi. These are digital prime dealers, which means that they integrate underneath each of the major exchanges: Coinbase, Kraken, Gemini, and so on.

The existence of crypto prime dealers enables sophisticated investors to use more complicated investment strategies. Investment strategies which fill orders from a combined order book of the individual exchanges or investment strategies that hide the scale of the trade being made, and so on.

Now to simplify things down, there are also vehicles that have been created to enable direct investing in cryptocurrencies without the need for investors to open their own accounts and actively manage their investments.

As an example, we have GBTC, which is the Bitcoin investment trust being provided by Greyscale. This is an over-the-counter vehicle that allows you to be an investor in Bitcoin, though Greyscale also has other products for Ethereum, Zcash and so on. The benefit of these vehicles is you can invest out of more traditional investment platforms including, for example, an IRA custodian or someone else who may allow you to invest directly in GBTC because it is an over-the-counter vehicle. The disadvantages are that typically, there is a premium paid for the fact that Greyscale will be your custodian — will manage the buying and holding of the crypto assets that you are investing in. The major exchanges like SFOX and Coinbase also provide custody, but for some people, GBTC does represent an interesting strategy.

Also in this top right hand cell in the matrix is another investment strategy that is to be an LP in a fund that’s entirely focused on cryptoasset investing. Polychain is an example of a new fund created specifically for this purpose. There are others. We have no association with Polychain, however, it’s a good example of a fund that was put together to invest specifically in cryptocurrencies and cryptoassets. It can be thought of as one of the first, and perhaps the largest, crypto hedge funds.

There have been a large number of new crypto hedge funds creating over the last couple of years. We include them in this emerging funding approaches category because most of them are managed by new fund partnerships and they are often applying new investment strategies to new to the world cryptoassets. There is a lot that is still unknown in this space.

Traditional Funding Approaches for Cryptoassets

In the bottom right-hand corner of our matrix are the more traditional vehicles focused on cryptoassets. In the world of public equities, we’re very familiar with indexes and ETFs and fund of fund vehicles that provide diversified strategies for investing. For example, you can buy an index product that tracks the Dow Jones or Nasdaq or maybe does so for a specific sector or geography or theme. ETFs — exchange-traded funds — were created to do the same with a lower cost basis. Alison’s prior firm BGI (Barclays Global Investors) that is now BlackRock, rose to prominence as the world’s leading ETF company providing low-cost strategies for index products.

Fund of fund vehicles have also been created in the same way. These are vehicles with which we’re very familiar. However, in this bottom right-hand corner they’re being directed at assets that we are not so familiar with: the cryptoassets.

As an example, Bitwise provides a family of indices that track the top cryptoassets and has created funds to allow investors to invest in ways that track the indexes. Once again, Bitwise then manages the custody issues so an investor does not have to hold private and public keys and remember seed words and statements and so on.

A second example is Bitbull Capital that is a fund of crypto hedge funds. Bitbull has taken a traditional approach — a fund of hedge funds — but instead, focuses on the new crypto hedge funds. You end up with a diversified family of crypto hedge funds in a single vehicle. The principal benefit of this is diversification. There are some costs associated with this approach, but for investors who don’t want to have to choose the specific crypto hedge funds to hold this may be worthwhile. In our database, we have upwards of 200 to 300 crypto hedge funds that we’re tracking. Clearly, it’s a lot of work to figure out which ones to focus on and Bitbull does that work for you, as does Protocol and others for are using this investment strategy.

Emerging Funding Approaches to Investing in Blockchain Companies

In the top left-hand corner, we have an investment approach that is to pick off specific assets or companies or projects but invest in them in a new crypto-enabled way. This is really the area of digital assets: security tokens (STO’s) and other forms of asset-backed tokens.

This is a new, emerging field, but conceptually, it’s a continuation of the technology enablement of investing. Just as we took public equities a couple of decades ago and took them from paper and open outcry, and moved them to screen-based trading. Today, almost all of the public equities trading are digitally enabled globally. So the same can be done with other assets that may still be paper based.

So far we have seen a handful of these tokenized asset offerings. One example is a blockchain venture fund called Blockchain Capital which issued a token called BCAP that was secured by a set of investments that Blockchain Capital would make and was enabled by Securitize — the leading STO platform company. Once issued that token then became a tradable token in compliant digital exchanges. So even though it’s a new instrument, it is recognizably a token backed by a set of investments. A second example is the Aspen coin that was used to tokenize partial ownership of the St. Regis Hotel in the Aspen, Colorado. This is a very interesting example because almost all of the world’s real estate is still paper-based and to invest in it, you have to go through a traditional paper-based investment approach. The goal here is to technology-enable the investment of real estate. The Aspen coin is one of the first examples of a technology enabled real estate investment.

There are literally scores of these asset-backed tokens in production. For an investor, you can begin to think about investing in asset-backed tokens, but the challenge today is that the STO infrastructure is not yet widespread or easy to use.

This demand for the creation of exchanges and trading platforms for these new tokens attached to underlying assets is leading to the formation of new capital markets infrastructure around the world and we expect that it will become much more accessible to investors in 2020. Because all of these asset-backed tokens are securities they are covered by the traditional security regulations. As a result, the infrastructure also has to meet the legislative, regulatory, and compliancy requirements of traditional investing. So whilst you can go to places like OpenExchange, BankofTheFuture, SharePost and tZERO, which are beginning to roll out this type of technology, the reality is that most exchanges where most investors go to invest in tokens are not yet enabled for new digital assets in a compliant way.

There are, on the other hand, many noncompliant offerings and exchanges. In 2016 and ’17 many ICO’s (Initial coin offerings) were noncompliant. They didn’t stick to the rules of security-based offerings, and they were, in many cases, offered to people that were not qualified to invest. They were not accredited investors. Even today many of those assets continue to trade on noncompliant exchanges.

So this is a world where the investor needs to take great care. As an investor, you want to make sure that not only is the offering compliant, but the exchange is compliant as well. The burden of ensuring this is the investors at this time.

Traditional Funding Approaches for Investing in Blockchain Companies.

At this point, we’ve talked about three of the major strategies. Those that focus on cryptoassets and those that use new vehicles for investment. That leaves the last, which is in the bottom left-hand corner of our matrix. This final strategy is to take a traditional funding approach and apply it to real companies that are building upon the blockchain. This is our focus at Blockchain Coinvestors.

Here, we have three sub-strategies. The first is direct equity investments into companies that you choose. The second is to be a limited partner in venture capital firms such as Blockchain Capital that focus entirely on traditional venture capital investing and taking equity positions in blockchain companies. The third is to seek out fund of funds that focus on this area. We’ll talk about each one of these three sub-strategies in turn. In this corner of our matrix, what an investors is trying to do is to build the largest possible exposure in a diversified way to the most valuable companies in the space. So the issue of diversification that we talked about at the outset is very important here.

a. Direct Equity Investments

It’s very unlikely that anyone can make a small number of investments, three to five let’s say, and hope to get every one of them to be a success. In early-stage technology investing, the failure rate even for the best venture capital firms in the world is in the 50 to 70 percent range. For direct equity investing, you can pick names — we have a handful on the accompanying slide — and try and find ways to network into these companies so that when they’re making offerings, you can participate, assuming that you are an accredited investor and you have the skills to do early-stage technology investing. That’s direct investing and many family offices prefer this strategy in areas of technology that they understand well.

However, very few people understand emerging technologies such as blockchain and the protocols and companies built upon it. So doing due diligence and knowing the best companies in the space is a very complex undertaking for direct investors.

b. LP in Blockchain Venture Funds

The second sub-strategy is to be an LP (a limited partner) in a blockchain venture fund. Just as we mentioned earlier in the webinar that you could have chosen to be an LP in, say, an Andreesen or a Sequoia fund in the 1990s and you would have been very happy to have been one, so there is a new family of blockchain-focused venture capital firms emerging. The supporting slide shows some that we are investors in including 1Confirmation, 1kx, Blockchain Capital, Blockchain.com Ventures, Blufolio, Castle Island, DCG, Fabric, FPV, Ideo CoLab and Pantera but there are obviously many more than this. In the database that we manage, we have about 100 blockchain venture funds identified and our goal is to be in the top 10 or so percent of those funds.

Some of these are serial fund managers. That means that you can see the evidence of their early funds and the performance of those funds. Blockchain Capital, for example, has completed the deployment of most of its fourth fund. Pantera is well in the investment process on its third fund. 1confirmation, Fabric and Future Perfect are each deploying their second funds. But there aren’t that many serial fund managers in a new space such as blockchain. So you inevitably find yourself looking at first-time funds as well. Some of the others we’re invested in like 1kx out of London and Berlin, Blockchain.com Ventures out of London and San Francisco, Castle Islands in Boston and New York, and IDEO CoLab Ventures in San Francisco are all first-time funds. In most cases these funds have general partners who are very experienced and professional venture capital investors. But nonetheless, institutionally, these are first-time fund managers.

c. Blockchain Venture Fund of Funds

For some investors access is an issue. They don’t know the fund general partners and don’t know how to reach them. It takes time and effort to make those connections and few large institutional investors can do this across all of the asset classes in which they need to have exposure. In addition, the minimum investment requirements of these firms can be an issue. While some of them will take commitments of $250,000 or even less, many of the best now require multimillion-dollar commitments to be an investor. Some investors find that these issues of lack access, the size of the investment required, and the work required to make a portfolio of LP positions in early-stage venture capital firms focused entirely on blockchain are too much to take on. This then sets up the third sub-strategy that is to be investor in a blockchain venture fund of funds.

This is our preferred strategy at Blockchain Coinvestors.

The way we go about this is that we begin with three databases that we use to make sure we are fully informed and can make targeted investment choices:

1. First we have a blockchain and crypto fund database. We have about 400 funds we track and three-quarters of them are crypto hedge funds. We are primarily a blockchain equity investor so we focus more on the 100 or so blockchain venture capital firms.

2. Once we have made fund investments, we then need to track the combined portfolio of those fund managers — what are all of the companies that they’ve backed and how are they doing? This gives us a good sense of the overall combined portfolio and the coverage that it represents.

3. Thirdly, we utilize third party emerging unicorn databases where we’re constantly keeping track of the upward valuations of blockchain companies.

Our goal is to combine these three databases to figure out if our fund managers are giving us a broad enough combined portfolio so that we are covering off as many as possible of the emerging unicorns. We also have targeted allocations by geography, stage and investment theme that these databases allow us to monitor.

Benefits of Fund of Funds

There are benefits for an investor to derive from a fund of funds. These are:

· One-stop-shop. A venture capital fund-to-fund is a very focused place, even more so if it’s a blockchain venture fund of funds.

· Less expensive. It can be less expensive than building a direct and diversified portfolio of in-house resources.

· Skilled and experienced staff. You need to constantly analyze and monitor the different firms and make decisions about who to re-up with and conversely, who to disengage from. If you’re one of the world’s largest pension funds or endowments or sovereign investors then you have the resources to do the in-house analysis. But even most family offices don’t have that level of in-house resource.

· Risk management. A fund of funds has a sophisticated allocation strategy that creates an overlay of exposures by geography and asset class and investment theme. This allows you to manage risk in a more sophisticated way.

· Enhanced returns. Relative to being a direct investor and having to find your own deals and do your own due diligence and make your own investments, fund of funds can provide an advantage by investing in the most sophisticated investors in the space.

We hope that this was a good introduction into the options for investing in blockchain and crypto. We have tried to indicate some of the opportunities and options and we’ve talked about some of the pros and cons. We certainly hope you will think this is a worthwhile space to invest in. For our own part, as we said at the outset, we believe that we are now entering a new phase of enormous wealth and value creation enabled by new technologies. At the core, we need to fix the internet that we have and the blockchain protocol and the projects and companies building upon it will be important in that endeavor. Becoming an investor in the most attractive companies building upon blockchain technologies should be high on the minds of most professional investors if your goal is return optimization rather than simply managing the capital that you have today in ways that you hope will avoid capital loss.

We hope you found this of interest. For those of you who want to learn more about blockchain, please take a look at ‘Blockchain Competitive Advantage’, our bestselling book that is available on Amazon, Apple, Smashwords, Goodreads, and every good online bookstore in ebook, paperback, hardback and audible.

For those of you who want to learn more about Blockchain Coinvestors please visit www.blockchaincoinvestors.com or just reach out to myself or any other member of the team. We’re always happy to talk to people about our investing strategies.

With that, I will bring this call to a close.

Thank you.