Steve J, one of the founders of Crypto Blockchain Research, is a hedge fund industry veteran who brings a wealth of experience and a unique perspective to the Crypto world. He is an expert on fundamental analysis, risk management, and analyzing stocks with exposure to Cryptocurrency. Today, we’ll pick Steve J’s brain to see how he views the Crypto market.
Professor Yang: Steve, in your opinion, how is Crypto investing similar to and different from the stock market?
Steve J: On the surface, the differences between Crypto and equity investing appear to be so numerous that many people have a hard time comparing the two. However, fundamentally, investing is still investing so the same fundamental principles apply. There are many areas we can delve into, but today let’s just focus on the issue of asset classes and investment principles.
It goes without saying that stocks and Crypto are different asset classes. Many professional investors struggle with categorizing where Crypto belongs — is it a currency, a commodity, a derivative, or what? I believe we should think of Crypto as a completely new asset class with characteristics of each of the major asset classes.
Crypto obviously has characteristics of a currency since that was the original purpose of Bitcoin, and Crypto is short for “cryptocurrency”. That was before Bitcoin hit scaling issues which, in its current state, effectively destroyed its ability to function as a currency. There are, however, newer cryptocurrencies that aim at fix the scaling issue so to become an effective currency. After its currency dreams died, Bitcoin is now often viewed as a “store of value” and is being compared to gold, or more broadly compared to commodities. Yet, Bitcoin is not a commodity since it has no application in the analog world, whereas other commodities are consumed or transformed into something useful to society in the physical world.
Unlike gold or silver, Bitcoin is also not a basic element and thus can be infinitely imitated and replicated. It would be like gold if the alchemists got it right and can cheaply turn any other element to gold. Some of the newer Cryptos, for example Neo or Vechain, can also have characteristics of stocks and derivatives since there is a proposed dividend element to it, and its value is derived from the success of the businesses which forms the network.
Without being too technical, stocks are traditionally viewed as a fractional ownership of a business, and are generally viewed as the present value of its discounted cash flows. However, in special situations, certain stocks can also take on the characteristics of currencies, commodities, debt, or derivatives — that is, they become more correlated with other asset classes than with the border equity market. Stocks can also be correlated with Crypto. Recent examples of that would be desperate companies trying to jump on the Crypto bandwagon, in order to avoid delisting or raise money at levels they would not achieve otherwise.
As you can see, both Crypto and stock ecosystems are diverse. We can discuss general characteristics and how they are similar or different, but in my view it is much more profitable to focus on the merit of individual stocks or Cryptos. That’s where investment principles come in, which applies to all kinds of investing.
Investing in anything boils down to knowing what the investment and and knowing yourself. Knowing the investment means knowing its risk-reward profile and its various possible outcomes. Knowing yourself means knowing how much you can risk and how you will react under various scenarios. Of course, there are a lot more to these simple words, but its a good place to start.
Professor Yang: What are common mistakes that you see beginning investors make?
Steve J: The most common mistake I see in beginning investors and veteran investors is the same mistake: it is the delusion of knowledge. That is the mistake of believing that you know something when you really don’t. For example, novice investors tend to believe that the level of details in their models is correlated with the the certainty of their investments, only to learn with experience that excessive details can obscure the truth and give them a false sense of confidence. But I’m talking about novice, professional investors. Most lay people who self identify as an investor are actually just gamblers. They don’t even make models, their analysis begins and stops with the price chart, and their final decision is made by their Chief Emotional Officer. Thinking that you are investing when you are really gambling is an delusion of knowledge.
Unfortunately, this problem is even more rampant in the Crypto world, which appears to be driven by a large number of lay “investors” who are attracted to the prospective of making a quick buck.
The “fix” to this problem is simply to be mindful of your limitations, and be humble. When the ego isn’t roaring for attention, you can better focus on understanding reality. Then, go learn as much as you can and make an informed decision. It’s really as simple as that.
Professor Yang: Is it possible to apply fundamental analysis to cryptocurrencies? If so, how would you go about doing it?
Steve J: It is absolutely possible to apply fundamental analysis to Crypto investing! When I was in college, a famous economics professor told us “if you can draw the supply and demand curve on your final exam, you won’t fail the class”. I thought it was a funny comment at the time, but experience has proven that the statement was spot on. I will tell investors, if you can draw a supply and demand chart for your investments, and understand the drivers behind them, you won’t fail in your investing career. This is what fundamental investing is all about.
For example, when you look at Ethereum, you should ask where the demand will come from. Demand for anything is driven by its real or perceived value proposition. If something adds value to your life, you will demand it. So what value does Ethereum add to individuals and organizations? Continuing with this example, you should also ask how fast the supply of Ethereum is expanding or contacting, and what the barriers are for substitutes. If the barriers for substitutes are low, then supply will keep up with demand, which will keep a lid on the price of Ethereum. If all of this stuff is new to you, I recommend you pick up a Economics 101 textbook — basic understanding of economics has been invaluable to my career and I believe will prove to be valuable to yours as well.
Fundamental investing isn’t some arcane thing. It is simply reading and thinking with a clear head about the fundamental drivers of an investment. Unfortunately, I don’t believe there is a short cut. Anybody who tells you that there is a short cut is probably trying to sell you a book or course.
Professor Yang: What are some companies with exposure to crypto that you are keeping an eye out for?
Steve J:There aren’t many publicly traded companies with any material exposure to cryptocurrencies. In my view, it is much better to directly hold the cryptocurrencies than to buy the stock of a public company that suddenly pivoted to cryptocurrencies. I recommend readers take look at the histories of these companies and if it makes any sense for them to get into the Crypto business. For example, it is fairly obvious that “this won’t end well” when a tiny beverage company started to mine cryptocurrencies. You’ll likely end up with a crappy sub-scaled beverage company with a small and sub-par crypto mining operation — it’s the worst of both worlds!
With that said, there are some companies with legitimate reasons for getting into Crypto. For example, it makes sense for CME Group (ticker: CME) to offer Bitcoin futures, since it is in the exchange business. Why wouldn’t they? Also, NVIDIA (ticker: NVDA) and Advanced Micro Devices (ticker: AMD) dominate the GPU market, so of course they will benefit from the increase in demand from GPU mining. However, even these legitimate companies currently have small exposures to Crypto — we are talking about low to mid single digits. I’m not aware of any Crypto “pure plays” in the public market that doesn’t carry a substantial risk of being a fraud. Crypto investing is difficult enough as it is, why add the extra layer of complexity that comes with owning a business?
Now, when the market turn and people began to turn bearish on Cryptos, the public market may be an excellent place to find hidden Crypto assets since unpopular assets tend to be heavily discounted by the market. Clearly we are not there yet.
Thanks, Steve for the detailed answers. I hope you learned a lot from this Q&A session, I know I did. Make sure to subscribe so you don’t miss out on future content! We have a lot more great content coming out soon, including more Q&As, tutorials, and commentary on news. Stay tuned!