Crypto Watch column | Crypto is as crypto does: Risk profiles differ, invest accordingly

We are pleased to share that we will be publishing a monthly crypto column "Crypto Watch" in Business Times, every second Monday of the month. Our Venture Partner Genping Liu aims to share his perspectives of crypto investing from the "Classic VC" point of view.

First column (13 Dec 2021)

This is first published in the Business Times.

AS those who follow the cryptocurrency market might have noticed, a "flash crash" happened over a recent weekend, on Dec 4. Bitcoin in particular plunged by more than 20 per cent to a low near US$43,000, while ethereum lost more than 16 per cent to hit prices as low as US$3,500. Such volatility is not rare, and investing into crypto means suffering heart attack-triggering events like this often.

There will always be speculation for the reasons behind dives like this. Some guessed that it was due to uncertainty in the stock market, perhaps triggered by Evergrande's imminent default. Or the outbreak of the Omicron virus sparking fear amongst investors in high-risk asset classes.

What's clear is that crypto is not for the faint-hearted. Fear easily drives down prices quickly without any rational reason. Thus, such a phenomenal flash crash is typical.

On the other hand, crypto prices may also rise "too fast" and seemingly without reason. Greed so often plays a major role in generating FOMO, and may even create a "flash to the moon" situation.

I am not a trader, however. And thus, over years of following crypto, I have lost interest in making sense of these short-term events. Instead, as a venture capital investor, I choose to focus on long-term trends and the thesis of crypto instead.

Until recently, crypto wasn't well accepted even by investors who invest in frontier technologies.

I first wrote about cryptocurrency in 2018; the article was titled "Looking at Crypto from a Classic VC's Perspective". At that time, very few traditional VC firms had forayed into crypto, as most investment mandates limited VCs from investing into anything remotely associated with crypto, including Blockchain platforms.

At the same time, crypto-focused VCs anticipated the death of the traditional VC model, in light of the wildly popular, process-light ICO (Initial Coin Offering) model then. Looking back, despite all the frenzy, I'm glad my "Classic VC" training had helped me stay sane and rational.

Today, it seems almost all investors are eager to get their hands dirty in the crypto markets, be they VCs, Wall Street firms, or Main Street banks.

There's a saying among local VC insiders: If your taxi driver starts talking about investing in a particular asset (crypto, in this case), it's time to run far away from it.

With all the activity going on, it does look like the cycle of crypto boom and doom that happened in 2018 may repeat itself. However, from the "classic VC" point of view now, I tend to think crypto and blockchain technologies are just approaching the cusp of a major innovation cycle. Hence, I remain optimistic on crypto and believe it is here to stay for the long term.

Contrary to popular belief, not all crypto tokens or coins are the same. They differ in terms of user adoption, real-world use cases and risk profile etc. Based on my observations of the market, crypto can be broadly segmented into three categories. I recognise that not everyone may not agree with these distinct categories, but I think these distinctions are helpful for readers to get a sense of the respective risk profiles and plan their investments accordingly.

Category 1: Mature and stable crypto-assets

Bitcoin belongs to this category. It seems the crypto industry as a whole has reached a general consensus on recognizing Bitcoin as the "digital gold", proving its efficacy as a store-of-value.

This recognition is further affirmed by numerous factors including listed companies (Telsa, Square etc) adding Bitcoin to their treasuries; the recognition of Bitcoin as legal tender in El Salvador; the listing of the Bitcoin ETF (though it is a futures ETF rather than spot) recently etc.

We don't often hear of technological changes to its base layer, due to it being regarded as a store-of-value, which interestingly results in Bitcoin's minimal exposure to technology risks.

Technologically, Bitcoin might be the most boring asset in the space, but from an asset portfolio construction perspective, it is actually achieving what it has set out to do. I should also point out that the bitcoin community uses a layered approach to build many exciting technological capabilities (Rootstock, Discrete Log Contracts, RGB etc) on top of the base-level Bitcoin blockchain, thus having a call option for value creation in the larger tech space. This is what makes it different from the second category.

Category 2: Fast evolving assets

The smart contract layer is the technological layer that user-facing, decentralized applications are built on top of, and we categorize them as fast evolving assets. They have a relatively medium risk profile in general and Ethereum is currently the most-known asset in the space.

There are a few up-and-coming players like Solana, Cardano, Avalanche and Binance Smart Chain which offer more advantages (such as speed) and thus, are quickly gaining in adoption.

To remain competitive, players must continuously offer better technology and tools to attract and retain developers and users, through community-building efforts.

Community building in crypto works the same way as building traditional marketplaces, except that there is little lock-in effect, due to the open-source nature of blockchain, which makes it easy for users to migrate between chains.

I believe that fierce competition will persist in this category in the future decades, given how early the ecosystem is, how technology is constantly evolving, and how more effective go-to-market strategies are being crafted.

Category 3: Early experimental assets

Decentralised applications including DEFI, NFT, Web 3.0 etc, have gained significant traction and captured the interest of many in recent years. It is certainly mind boggling to follow the trends closely and try to predict what the future may hold.

Due to the high level of experimentation, the assets under this category have a high risk profile: readers probably need to adopt a user-centric, utility-first mindset and actively interact with those projects they are interested in.

After all, active user engagement is what the crypto community has originally set out to achieve. In most cases, it is also very challenging to tell if the price of crypto assets has been appreciating due to the token's utility or due to high speculation activity, or both. Note that even professional investors may find it hard to differentiate a true innovation from a Ponzi-scheme!

Risk on

We live in a time where in fact, any kind of asset, both crypto and non-crypto, might be developing some level of bubble. But at the same time, this is also an exciting moment in history where we witness exponential changes from technological disruption, which have the potential to bring about huge changes in wealth accumulation in the coming decade (well, certain Axie Infinity players are already amassing fortunes).

Allocating some assets towards crypto may benefit your portfolio, but every investor should stay aware of risk exposure, especially categories 2 and 3 of crypto, which may be subjected to federal securities laws. Investors should also keep in mind that, as many sources suggest, crypto as a category may certainly be one of the highest-risk asset classes overall.

Like the article? Read the rest of the Crypto Watch Column here.

**For the latest news on Vertex Ventures SE Asia and India and our portfolio companies, follow us on Linkedin or** subscribe to our monthly newsletter.