The Right (and Wrong) Way to Invest in Blockchains
What a ride it's been for blockchain investors.
We've almost become numb to get-rich-quick blockchain schemes, as scores have surfaced during the past two years. It seems like everyone and their dog has devised an idea on how to make money off of blockchains.
Let's take a quick walk down bitcoin memory lane.
The genesis of the fast-money ideas began as soon as cryptocurrencies were offered directly to the public. There was no need to be an accredited investor or to work with financial middlemen. Exchanges such as Coinbase and Circle gave individuals with no previous investing experience a way to purchase bitcoin before most people even knew what it was.
Speculation ran rampant. "Bitcoin" became a headline that everyone wanted to read, and its price soared from $1,000 to $20,000 in 2017. Nearly 1,000 other cryptocurrencies became available to the public through Initial Coin Offerings.
The rampant speculation attracted institutions like blood attracts sharks. Investment products such as Grayscale's Bitcoin Investment Trust (NASDAQOTH: GBTC) could be bought or sold through more traditional stock brokers like Fidelity. This gave investors a way to speculate on bitcoin's price without directly owning the cryptocurrency.
Things then just started getting weird. Long Island Iced Tea formally changed its name to Long Blockchain (NASDAQ: LBCC) and its shares immediately tripled in value. Bitconnect came up with a progressive referral program to boost the value of its tokens. No one cared that actions like these weren't actually creating any value.
Suddenly, everyone started rethinking their blind optimism. Long Blockchain's shares fell 95% in six months, and Bitconnect closed its doors after being exposed as a Ponzi scheme.
If "euphoria" described the public's attitude toward blockchains in 2017, then "trepidation" seems to be the word for 2018. This volatility roller coaster has investors hesitant, but still eagerly waiting to see what happens next.
So is there any hope for bitcoin's future?
Image source: Getty Images.
Peering into the blockchain crystal ball
To answer that question, we should recognize that the activities described above refer to the general public's interaction with bitcoin. Things happened quickly, there was massive speculation, and most people had no idea how or where bitcoin could actually be used.
But the enterprise is a completely different animal.
Moving much more deliberately, large corporations actually have an interest in blockchains as a way to improve their operations. And improving operations could translate to increasing profits for shareholders.
I recently spoke with CB Insights' intelligence analyst Arieh Levi at the Future of Fintech event. Levi said that enterprises take a different view of blockchains than the general public:
It's important to separate and understand the difference between two types of blockchain companies. The first is the crop of companies that sprouted up in 2015 and 2016 that are looking to use blockchain technology in the enterprise as corporate infrastructure to help with back-office processes. And those have seen slow growth -- a lot of local funding in those years, but certainly the growth there has slowed.
Then, of course, there's the ICO mania and ICO craze. These are companies trying to build a new, decentralized web. And to a large degree, that thesis has seen lots of money -- they raised $18 billion [cumulative] during the past year, which is more than most other sectors combined, which is insane. At the same time, that sector, that area of blockchain research is softening and moving sideways with the price action. I think we can expect some more of that in the future as some of the worse projects there get flushed out.
There could be a lot of promise in those slow-growth corporate infrastructure blockchain projects. Walmart (NYSE: WMT) is -- perhaps surprisingly -- one of blockchains' earliest adopters, using them in a food safety program for their pork suppliers. Starbucks (NASDAQ: SBUX) also recently piloted a blockchain project for its coffee growers in Costa Rica, Colombia, and Rwanda to improve pricing transparency. Let's not forget that Starbucks' new CEO Kevin Johnson previously worked at IBM, Microsoft, and Juniper Networks, so he knows a thing or two about technology. This won't be the last blockchain project we'll see out of the global coffee giant.
Transaction-heavy businesses can use blockchains to simplify their incredibly complex supply chains. WalMart spends more than $100 billion ever year on overhead expenses, so even a 3% or 5% improvement in efficiency would add up to huge savings.
Levi went on to describe a few use cases where blockchains would absolutely make sense for larger enterprises:
[What] investors should pay attention to is really thinking about where decentralization makes sense -- and where it not only makes sense, but is entirely necessary. In places where decentralization really makes sense and where it's attracting users: That's certainly an area of interest for investment.
A couple of areas that are seeing some traction are 1) decentralized asset exchanges; another is 2) stable coins; another area is 3) non-fungible tokens. But, still, users need to come, and it remains to be [seen] where they'll flock to.
Those three areas are certainly worthy of keeping an eye on. Here is a brief overview of each:
Asset exchanges allow people to buy, sell, and trade things of value with one another, and decentralized asset exchanges could introduce cryptocurrencies to more easily facilitate the transactions. This could eliminate typical sources of friction (such as calculating foreign exchange rates or middlemen charges fees), while also providing additional security against fraud.
Stable coins derive their name from being pegged to other stable assets, such as gold or the US dollar. This could reduce much of the pricing volatility in blockchains, which might encourage them to be used for more actual transactions.
Non-fungible tokens are cryptocurrencies that are each unique and not completely interchangeable. Every US dollar in circulation has the same value, making them "fungible". The same is technically true for limited edition rare coins; but if they are in scarce supply, they might be even more valuable to a collector ("non-fungible"). Cryptocurrencies, too, can be individually marked in a way that may impact their ultimate worth.
The Foolish bottom line
There are no magic bullets in investing. Investment returns follow profits, and profits stem from the creation of value.
Like most other technologies, blockchains will provide progressive companies an opportunity to unlock new pockets of value. The most obvious use cases today are logistical efficiency improvements. But it's likely that we'll see blockchains soon used for commercial transactions or in transactions on asset exchanges.
That might not sound as sexy as reaping a 2,000% gain in a single year. But buying the stocks of large corporations that are taking their time to fully understand and deploy blockchains is a much more prudent, long-term investment strategy.
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Teresa Kersten is an employee of LinkedIn and is a member of The Motley Fool's board of directors. LinkedIn is owned by Microsoft. Simon Erickson owns shares of Bitcoin Investment Trust and Starbucks. The Motley Fool owns shares of and recommends Starbucks. The Motley Fool has a disclosure policy.
