What to Look for When Investing in Blockchain Companies
Updated: Oct 9, 2018
Venture needs to move towards Value Investing and leave Hype behind if it is ever going to capture lasting Social Value on the scale that HKETVF is designed to deliver (200X)
Hype: The Greater Fool Theory of Investing
In 2017, the main activity in Blockchain investing (or ICO) seemed to be hitting upon a company that had sufficient understanding of the Gartner Hype Cycle to create a mania of demand for its offering. Then so-called "investors" would figure out a way to get their hands on unlocked tokens and profit from the pent-up demand that mechanisms like a tightly constrained "hard cap" and "white list" creates. This environment attracted the kinds of people who are now under the close scrutiny of regulators, because operating in this fashion violates the spirit, if not the law, of the exercise - which is to incentivize and focus our organizational formation and operation patterns on the goal of generating lasting social value. There is not a lot of evidence that Hype-oriented investing environments result in lasting, widespread social value. There is strong evidence that Hype-oriented investing benefits a small number of people while injuring a large number of people, which comes close to the definition of creating social damage, or even sociopathy.
Venture: The Hyper Growth Theory of Investing
Now that the world of the Gamblers, Speculators, Confidence Artists and Operators has been identified, there are still more types of "investor" in this world. One useful way of individuating them is to use temporal analysis. That approach identifies two more camps: Medium-term and long-term investors. One category of what might be called medium-term investors includes the Private Equity and Venture Capital organizations.
These kinds organizations are very powerful and influential, and their vocabulary has entered the popular parlance. We now have an entire generation of corporate executives who have internalized their language and who are now actively using bizarre phrases like "liquidity event" and "exit strategy" when talking about their own companies. But, strangely, these phrases have little to do with running a company. They have much more to do with buying and selling an interest in a company, which is the basic activity of Venture Capital and Private Equity, who prefer to enter and exit their involvement with a company at specific points on the Technology Adoption Life Cycle. The goal of these organizations is to enter early, when valuation is at its lowest, maintain their relationship while valuation is rising most steeply, and exit when valuation is at or near its peak. This enables them to capture the biggest possible "multiple", which earns them the most money and also covers the cost of carrying the 19 duds they also invested in. But even PE and VC organizations, attuned as they are to getting in cheap and getting out dear as quickly as possible, have come to know that waiting around five to seven years for one of their portfolio companies to come to maturity is about the right amount of time for maximum value capture.
Tellingly, Venture Capital and Private Equity organization might also be fairly characterized as middle-men, or "intermediators" in the Capital Formation process. This is because they get involved with companies when they are small and privately held, and then propel those companies towards "going public" via an Initial Public Offering (IPO) which, by definition, makes the company they are involved with publicly held to some recognizable degree. Despite a strong motivation to move companies in directions that are often at cross-purposes with the proprietors of the companies they choose to enter into and exit out of, what keeps VC and PE in the game is their ability to summon a depth of Capital that until now has been practically impossible for proprietors to otherwise tap. The emergence of Global Capital Formation, powered by Blockchain and Cryptocurrencies, has the potential to permanently change this dynamic.
Value: The Social Theory of Investing
The last group to identify and talk about is long-term investors. These investors often display a characteristic behaviour of wanting to hold their investment positions indefinitely, especially when those investments generate a yield that manifests itself in a predictable stream of cash flows, or dividends. They are also much more hands-off than PE or VC in terms of their desire to influence the operational decisions of the companies they have invested in. Most of the time, they just want the company they invest in to have a script that they can believe in, and then stick to it. This investor group seems to be best aligned with those organizations who aim to generate long-term social value creation, which by the way in no way means turning away from profit maximization. On the contrary, the best of both worlds is a meeting of the minds where long-term investors purchase and hold the stock of companies that are also in it for the long-haul, because time is the ally that reveals socially negative actors and socially positive ideas alike. Everyone with a long-term view, therefore, shares a signal interest in the quality of management of an enterprise, and its ability to execute on a well-formed, feasible strategic plan that targets an open, growing and realistic opportunity that is of lasting value to society over the long run. This is a formula where everyone wins.
It's Good That The Regulators Are Stepping In
Now, in 2018, regulators have started to pay attention to what might rightly be called a historical pattern of "pump and dump" or "bucketeering" in the ICO space. They are taking strong steps to signal to participants that such activity is not only socially undesirable, it might even be criminal. These regulatory moves are forcing ICO investors to abandon short-term investment strategies, potentially skip over medium-term investment strategies and head straight towards long-term investment strategies. Even within the new Global Capital Formation ecosystem, medium-term investment strategies are not available to most participants, because they need to command the resources of "ICO whales" to have enough influence to deviate the organization from it's stated plans. ICO whales, represent a miniscule (and diminishing) proportion of the overall potential ICO participant population, which theoretically includes anyone on Earth with an Internet connection and the ability to read.
So, Where Is This All Headed?
I believe these dramatic changes to the Capital Formation process can only benefit society over the long haul. A happy consequence of 2018-era Regulatory intervention is that Blockchain investors are being accelerated at a breathtaking pace away from the 2017-era "Greater Fool" investment strategy towards something else. My hope is where they will end up is a 2018-era "Seeking Value" strategy that highly abbreviates or perhaps even skips the problematic medium-term VC and PE stage and all of the divergence and baggage that stage can bring with it. The ultimate connection is a direct one, that connects good ideas with resources in a Global Capital Formation process driven by fluidity, transparency, information and voluntary association. The enabling force in all of this is, of course, the Internet in its newest incarnations as Blockchain and Cryptocurrencies. Together, these technologies have created the preconditions for the emergence of something new: A fully globalized Capital Formation ecosystem, something we have never seen before.
The implications of these developments, the active disintermediation of short-termist and medium-termist oriented investment actors, is not yet fully appreciated, or even understood. But I, for one, welcome such developments and hold great hopes for the future in terms of their potential positive social impact.