An Investor’s Guide To Cryptocurrencies: Picking The Winners & Avoiding The Losers

Figure 1. Total cryptocurrency market capitalization.

Introduction

I will start by providing some background information on myself and why I take the perspective I do when it comes to cryptocurrency investing.  I started my career in finance as a day-trader at a Miami-based proprietary trading desk but after a few years of trading I began to get burned out by the day-in and day-out stress of high-leverage equities trading.  Following this stint, I moved on to wealth & portfolio management at one of the big 4 US investment firms.  Several years into this position I decided I wanted a more independent role with less bureaucracy, and a something I could call my own, so I left and co-founded a quant-based (algorithmic) investment firm. Since then, things have evolved beyond what I imagined and before I knew it I was trading and managing more than just equities, bonds, and options--I had discovered the new era of "money 2.0"--cryptocurrencies.  Why does any of this matter? It matters because most people from this field aren't watching this movement as closely as they should be, and this present lack of interest gives early cryptocurrency investors a first-mover advantage--one that everyone in this field should try and take advantage of. 

Great Potential

The current and future growth of this technology is easily comparable to that of the internet boom in the 1990s, but I believe it could be even greater.  At the beginning of April, 2016 the total cryptocurrency market cap was approximately $8 billion; today it is just over $12 billion[1], a 50% increase in just 6 months. Borrowing from the recently published ICONOMI whitepaper, the statistics on the growth of 100 cryptocurrencies during Q1-2 of 2016 is nothing short of staggering:

• "Still, when analyzing the price movement of 100 coins in the first half of 2016, average achieved yield is 357% and only 13 coins yielded negative returns. However, returns can be misleading and expertise in the investment field as well as an understanding of crypto coin content is needed to gain optimal exposure into the crypto investment universe."[2]

The technologies behind these cryptocurrency projects encompass more than just transfer of digital currency, some augment or replace everyday processes with all-around better solutions.  Over the coming years we will witness a tremendous amount traditional, archaic methods be succeeded by block-chain-based solutions.  For prudent investors, the key is to try and determine which cryptocurrency projects will address a true need, and are not just a fad of the year (or month).

Looking For Longevity

In the world of investing, there are many general rules to follow but some are more important than others.  The first of several I want to speak about is the rule of longevity.  When choosing your long term investments it's important to select projects that appear to have longevity in mind, not just with the product itself but those producing it.  The common questions to ask are: will this service still be needed or used in several years? Is there a competing service that can easily out-perform this project? And do the developers appear committed?  

If you can answer these questions with enough confidence to determine...

1. A current or growing need for it
2. No imminent competing threats
3. A committed team of developers

...then you're on to something with potentially good risk to reward. 

Seek Platforms Not Features

This is a big one, and I want to stress the importance of considering this rule because a lot of cryptocurrency projects out right now are simply feature-projects, not platform-projects.  This is also another reason you see only 20 to 30 arguably "viable" cryptocurrency projects today, while the other 720+ are useless long-term investments.  With coins like Bitcoin or Ethereum, with enormous momentum and backing, you can't afford to be cryptocurrency or project based simply on a feature--you run a good chance of losing in the long run.  Take Exodus, the multi-cryptocurrency wallet[3], as another example, this is a great platform-based project.  It provides a real life use-case, and is available and easy for the masses to operate.   ICONOMI[4] is a good example of a cryptocurrency-based technology that will exist, upon launch this year, as a platform for cryptocurrency investors to invest in, and on. Many readers are also likely aware of Ethereum[5], this is another great example of a platform--one that people will build applications and smart-contacts upon, and is arguably at little to no risk of something like Bitcoin stealing its thunder--because it's not based on a feature or two.  A smaller, yet fast-growing, and popular project, ShadowCash[6] is another great example of an all-inclusive platform-based cryptocurrency project. The anonymity feature of this coin is just that, a feature, but the all-encompassing privacy platform (encrypted communication, and e-commerce, and eventually other plug-in applications) it incorporates makes it much more than just a coin, and this is the key.  This cryptocurrency is an end-to-end solution to a current and future problem, and that is big. ShadowCash is a good example of the type of cryptocurrency I look for when deciding which ones I plan to hold long term and i'll explain why in the following sections. 

The Lindy Effect

I first learned of this theory in the book Antifragile by Nassim Taleb and it got me thinking of all the different things it can be applied to, even from an investment perspective.  Wikipedia defines it as follows:

• "The Lindy effect is a theory of the life expectancy of non-perishable things that posits for a certain class of nonperishables, like a technology or an idea, every additional day may imply a longer (remaining) life expectancy: the mortality rate decreases with time."  -Wikipedia, The Lindy Effect[7]

I bring up this point to again place the focus on project longevity. Now, there will always be cases of a long-withstanding project being made obsolete by a newer and improved competing technology or cryptocurrency, but these events can often be seen coming on the horizon.  Regardless, it is easy to make the argument that platform-based cryptocurrencies will have a higher likelihood of experiencing the Lindy effect than those that are feature-based. Additionally, the longer a development team works at a project, the more likely they are to continue doing so, up to a certain point.  Lots of scam-projects and -coins don't last but a few months, but a few survive longer than this.  A coin that has remained around for over 2 years has a high likelihood of remaining at least another 2 years, and probably much more.  When I look at a cryptocurrency like ShadowCash it is evident the development team, now in their 26th month of consistent development, is committed to this project long term.  

Steady Cash-Flow

This is a straight forward metric to evaluate.  I like to invest in projects and currencies that will provide a steady and easy cash-flow. With ShadowCash, you get all of this.  Because ShadowCash uses the Proof-of-Stake (PoSv3) protocol for securing and verifying transactions, holders of ShadowCash (SDC) can get paid to "stake" their SDC using the ShadowProject Umbra wallet. Other cryptocurrencies such as Bitcoin and Monero (XMR) rely on the Proof-of-Work (PoW) protocol, which instead requires mining--a highly computationally expensive and energy-draining process--to secure the blockchain. With the large PoW-based coins, no average investor can easily mine these coins, and thus they have no easy way to earn a steady cash-flow from the network itself.  With ShadowCash, any holders of the digital currency receive annual returns of approximately 2-4%+, guaranteed, without any special mining hardware or expensive electricity needs.  By staking your coins you also get to "harvest" network (transactional) fees that can add an additional few percent to the 2-4% bottom line return.  

Being "A Pass-Through" Currency

This is a big one. Many cryptocurrencies on the market today will face this problem over the long term, even if they provide real use-cases.  The problem with most cryptocurrencies is, for your average person, there is little to no incentive to hold it.  If you exchange goods or services for Bitcoin, such as a restaurant or service station may do, they will quickly transfer that Bitcoin into fiat, and the Bitcoin will go to the exchange to be sold.  Now without going into more complexities behind this, a cryptocurrency that does just this is merely a pass-through currency.  As a disclaimer, I don't really view Bitcoin as a pass-through currency because of the high demand it has among investors & speculators, and people in developing countries looking to shelter their wealth from local fiat devaluation--like in Venezuela with a 480% inflation rate.  However, there are so many cryptocurrencies out there, especially mere feature-based ones, that suffer from being pass-through currencies and thus may have a difficult time becoming big long term (when you're competing against something like Bitcoin).  The reason I believe ShadowCash is among the few currently that made be more immune to this than others is, 1) people will hold a currency that provides a guaranteed yield, even if it's just 2-4%, it's better than any bank gives today; 2) people will hold a currency if there is a specific platform on which to use it; and 3) people will hold a currency they believe will be higher in value in the future than today.  The first two points are certain, the 3rd is less so because no one knows the future growth of anything, but based on the characteristics of this project, it is fair to assume higher expected value well into the future.

The Big Picture

As the statistics show, right now you can put money in almost any popular cryptocurrency project and make a great return over just a few months. But this strategy is fragile, especially as competition increases, and fragile (feature-only) coins will have a difficult time surviving if they don’t pivot. History has shown that feature-based technologies always get replaced by technologies with platforms that incorporate those features.  When I chose to invest in ShadowCash it was not without days and days of research into other competing projects, especially in the anonymity space.  The same theme I came across over and over again with similar anonymous cryptocurrencies, like Dash (DASH) and Monero (XMR), were coins based purely on features!  All it takes is some innovation in the Bitcoin arena, or on the Ethereum platform (zk-SNARKs via zCash), and anonymous transactions will be added as a feature, which could result in a crushing blow to the standalone anonymity-as-a-feature cryptocurrencies.  As you begin to analyze different projects I encourage you to apply these same rules in the process, and ask yourself the questions listed above.  There is no golden formula, per se, to finding the best projects, but avoiding the ones with potentially dead end paths will help you stay in the game. 

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Disclaimer: Please do not misconstrue this article as an investment directive, and please ensure to perform your own due diligence. All facts and figures have been noted and portrayed for educational purposes only. Investing in cryptocurrencies is highly speculative and can result in loss of capital; only invest what you can afford to lose. Additionally, I am a holder of SDC, XMR, ETH, and an investor in the ICONOMI ICO; I am also a user of the Exodus wallet.  

References:

1. http://coinmarketcap.com/charts/

2. https://www.iconomi.net/CoinFundsWhitepaper.pdf 

3. https://www.exodus.io/ 

4. https://www.iconomi.net/

5. https://www.ethereum.org/

6. https://shadowproject.io/en

7.  https://en.wikipedia.org/wiki/Lindy_effect