Volatility vs. Risk
Lets talk for a moment about volatility and the future of crypto investing. In essence, volatility refers to how far the pendulum of an asset price may move in any given period. Historically, volatility of given crypto assets is enormous, with intra year collapses of 95% and intra year booms of 50,000%, not being uncommon. But how does this help us become better investors?
Modern portfolio theory would generally steer us away from more volatile markets and into less volatile ones. But let me tell you now, there is nothing wrong with high volatility, as long as your investment horizon is long enough, and your mental model of investing is capable of supporting the logic behind this sort of specialized investing.
Traditional market investors avoid high beta (volatility) investments under the premise that they are more risky. But let me tell you now that risk and volatility are not necessarily highly correlated, perhaps not even distantly correlated, if measured appropriately. I believe that it was Warren Buffett who said he would rather buy the collapsed and highly volatile stock of a great company, than the permanently high (read: not volatile) stock of an average company. And this makes sense if we are in it for the long term, doesn’t it?
As a crypto investor, I am positively in love with high volatility. Let’s take a step back and dive back into the mental model of crypto investment we have been trying to build over the past 18 months or so. Our investment premise is simple on its face: we believe that if we can identify cryptocurrencies with fundamentals that suggest they will be around at least 5 years from now, it is not really necessary to look at any other indicators. If I can buy into a cryptocurrency founded today, at a seed price, and this crypto is still being worked on and has a user base in 5 years, I am more likely than not to have made an outstanding return (above 50x-100x).
In this example, volatility is the engine that will fuel the rise in price of our carefully selected crypto. Through market booms and busts, crypto volatility keeps the traders trading and the speculators speculating. I am neither of these, but they are necessary actors for our type of investing to work, at least to begin with. As a a long term investor, I am content to ride these cycles out, while these traders flood the market with new money, providing liquidity and paving the way for real adoption.
That’s the key to understanding crypto markets, the enormous inflows and outflows of real dollars being swirled around the cryptosphere. In essence, speculators pay for asset adoption with their own money, by paving the way for other, more stable and longer term players, to enter the market and make it their home. It is this “volatile money” that has led Bitcoins way from essentially a geek club to a sector with many unicorn startups.
But how likely is it that crypto assets will remain highly volatile into the future? Any answer to this question is valid (since we are in essence trying to predict the future) as long as it fits with a logical mental model of the crypto asset marketplace. In the case of our mental model, I would suggest to you a clear distinction between the asset volatility of the space today, and that of new market entrants x years into the future.
I believe that although the crypto market as a whole will become less volatile in time, as the mainstream begins to coalesce around legacy cryptos such as Bitcoin and others, the market for new startup cryptocurrencies will remain highly volatile, because a new coin needs this “volatile money” to get off the ground. Otherwise they will not even register on our radar.
This is the part of our mental construct that leads me to believe, perhaps dream, that my young daughter can follow in my footsteps one day and become a crypto investor. That volatile money is a permanent fixture of the crypto scene and will remain so well into the future, that the market will not coalesce around a couple of ultra large cryptocurrencies (a la Google), but rather be continuously disrupted by upstarts.
Do not misunderstand me, there will be some really big coins out there, and they will wield a large stick, but the financial nature of crypto leads me to believe they will never be able to maintain a monopoly of the kind so common to early innovators in the tech field, and this is fantastic, especially for future investors. Crypto is still a wide open field, and will likely remain so for at least the next decade.