What's Crypto Worth?

Harvard Business School Executive Education delivers a world-class learning experience that energizes aspiring and established changemakers. Prepare for the next elevation for your organization and for yourself. Learn more at hbs.me/breakthrough. That's hbs.me/breakthrough.

The first iteration, Bitcoin introduced people to internet of value. The second generation, you saw ecosystems grow around programmable smart contracts and applications. But those ecosystems did not become an economy until transactions were cheap enough. And that's what's happening now in this third generation.

Welcome to the Barron's Streetwise Podcast. I'm Jackson Cantrell. The voice you just heard is John Woo. He's the president of Ava Labs, the creator of a cryptocurrency called AVAX, which rose more than 2,000% this year to a market value of $13 billion. That's close to the value of United Airlines or Albertsons, the giant grocery chain. But how can a relatively new cryptocurrency with no revenues or earnings or assets or dividends be worth as much as long-established companies that have all of these things? John will make his case. Plus, we'll hear from a seasoned hedge fund manager who'll tell us about an investing strategy that might be well-suited for crypto. And an MIT economist will weigh in on whether crypto belongs in your portfolio. Listening in is our audio producer, Jackson. Hi, Jackson. Oh wait, that's me. That's what our regular host Jack Howe usually says, but he's off this week and he asked me to do an episode on my own. I feel drunk with power already. If I had a time machine, I'd go back to my freshman year dorm room and tell myself to buy some Bitcoin. Sure, a lot of people have had that thought. But on February 1st, 2015, I was actually looking at a checkout page of an early version of the online cryptocurrency trading platform Coinbase and I had 2 Bitcoins loaded in my cart at around $214 each. But the problem was Coinbase needed my bank account info, not just a debit card. So I rifled through my IKEA desk and found my checkbook between a wings menu and a geology syllabus. But then I started to have second thoughts. Sending a full week of my Seattle Parks and Rec lifeguard salary seemed extreme. And it was Super Bowl Sunday. I remember because I had a party to get to. "Pass is intercepted at the goal line by Malcolm Butler! Unreal!" Well, the Seahawks lost in spectacular fashion, and even more tragic, I never finished buying those 2 Bitcoins. They'd be worth $130,000 today. That's a lot of lifeguarding. Bitcoin hit a record high this week, and the first Bitcoin-tracking exchange-traded fund in the US opened for trading. A lot of trading, as it turns out. Futures contracts on the CME will officially debut tomorrow, ticker BITO. We're seeing institutional and professional investors move into the market, and that's moving the prices higher. And Bitcoin is only part of a crypto universe approaching $3 trillion in value. The number 2 crypto coin dates back to shortly after my missed Bitcoin purchase, when a 21-year-old Canadian programmer Vitalik Buterin launched Ethereum. Like Bitcoin, it's a decentralized network that stores and validates information across thousands of computers. Also like Bitcoin, it consists of a ledger of every transaction ever made on the network that anyone can access. What's different is that Ethereum can run programs called smart contracts. This means there's more function you can add on to it, so it's not just for storing and sending money. You might remember an episode of this podcast we did on how investors are paying outrageous prices for digital ownership of unique cartoon rocks. Those are non-fungible tokens, or NFTs, and they're mostly powered by the Ethereum network and its currency called Ether, which has a market value of around $470 billion. But Bitcoin and Ether share a shortcoming. New coins are created through a process called mining, only instead of shovels, it uses computer processing power, which in turn uses electricity. A lot of electricity.

At least in the Bitcoin mining system, you are basically racing, and effectively the more CPU power, the faster you can race in order to to win, to have effectively the right to go and validate and secure a transaction. So a lot of that CPU and that high cost of bigger rigs and bigger machines is not even for the actual validation. It's actually for the right to validate.

That's John Wu. He's the president of Ava Labs. It created a crypto network called Avalanche, which runs on its own token called AVAX. Avalanche is one of a newer class of cryptos that are designed to use much less energy than Bitcoin or Ethereum. Investors have been pouring money into just those types of coins. There's another problem with Bitcoin and Ethereum. For something that's supposed to be the future of money, they're slow. Bitcoin's network can process about 3 to 7 transactions per second, and Ethereum's network, maybe twice that. But Visa, the credit card giant, processes 1,700 transactions per second, making it more than 100 times faster than Ethereum. Right now, a Bitcoin transaction takes an average of about 7 minutes to go through, and the average fee is about $4. But there's a lot of variation around those averages. There have been stretches where confirmation times have crept up to around 20 minutes, and fees to $30 or more. That's not great if you're trying to use Bitcoin to buy a cup of coffee for $3. And by coffee, I mean a 2-pump half-caf venti caramel apple spice. And by $3, I mean $7.50. Maybe the slow transactions and high fees help explain why so few merchants accept Bitcoin. Although this past weekend was the first time I've ever had a Bitcoin transaction come in handy. I was in Montreal with my friends and we went to a famous bagel shop and the sign said cash only. Only I didn't have any loonies. That's what Canadians call their dollars, loonies, because the Canadian $1 coin has a loon on it. There's also a $2 coin called a toonie. All right, I'm getting off track. I was about to give up on my bagel purchase when I saw that the laundromat across the street had, of all things, a Bitcoin ATM. So I opened up my Coinbase app, sent $100 Canadian to the ATM, which then printed out a receipt with a redemption code. And when I entered that code into the ATM, I was prompted to wait, but after an awkward 5 minutes, voilà! The machine gave me 100 loonies. It was my first Bitcoin to loonies to bagels conversion, and it was a moderate success. My bagel laundromat arbitrage would have been even smoother if I had used a speedier cryptocurrency. And that brings us back to John and his Avalanche network. Avalanche is among a group of new crypto projects that enthusiasts sometimes call Ethereum killers. Others include Binance, Polkadot, Solana, and Cardano. All of these Ethereum killers use a transaction verification system called proof-of-stake. Proof-of-stake is quicker than the energy-intensive process that Bitcoin and Ethereum use to verify transactions. That one's called proof-of-work. Ethereum may change over to that quicker proof-of-stake system at some point. Its founders call the switch Ethereum 2.0, but the change is complicated and will require approval from a majority of computers on the network. Still, as it stands now, Ethereum can process 13 transactions per second, while John's Avalanche network can theoretically process 4,500. John never used the words Ethereum killer, but he thinks a faster network like Avalanche could unlock more real-world uses than Ethereum or Bitcoin today. John also talked about DeFi. That's not a crypto fraternity, it's actually short for decentralized finance. He argues that if you can build a protocol that enables trust between two parties, you don't need the middleman. This could mean lending and borrowing without a bank, or even executing more complicated derivatives trades without a broker.

You're not just simply a guy who buys stock on your Schwab account, You actually can be Schwab or New York Stock Exchange in some sense in the creator economy.

Okay, I can be Schwab, but do I want to be Schwab? My brokerage account has low fees and lots of services. I asked John, what else can DeFi do for me? And he gave me some examples.

The way Ticketmaster right now works is all QR codes. That's actually not very safe. There's been plenty of times where we've seen where 5 people show up with the same QR code for 1 seat. And what's worse off for the entertainer is that they don't have the revenue associated with the secondary sales when people resell it on Ticketmaster. And in this case, they can get a cut of every secondary sale.

That's more like it. Too much of the money paid for tickets goes to ticket sellers and scalpers. If DeFi can create a direct transaction between fans and artists, that's a good deal for both me and Carrot Top. Don't judge. That future, though, is not here yet. I checked out a few decentralized apps on websites that interact with the Avalanche network. It was a bit of a wild west. I didn't get scammed, but I wasn't confident I'd be able to spot a scam if I came across one. John agrees that the user experience has some room to evolve.

The user experience and the user interfaces right now are not very friendly. And frankly, a lot of the technology in the blockchain crypto world are built for pure functionality because people are trying to break barriers and innovate and try new things and create new things.

I asked John about AVAX's gigantic market value. What makes it worth as much as United Airlines? He says it's not an apples-to-apples comparison. He compared cryptocurrencies with startups.

Some of the same principles that I used at other startups are still applicable, but the big difference is this is a space that is growing even faster than the fastest social media companies or the best internet-type companies back in the '90s and early 2000s. It is what I call hypergrowth. And to describe it, you know, a hypergrowth environment is trying to build a plane while the plane is in the air with passengers, as opposed to in a growth environment, you have no passengers, the plane's on the ground, and you have to build the plane until it's ready to go, then you can fly off.

The comparison between Avalanche's AVAX token and a share of a publicly traded company is an unusual one. For example, each quarter Albertsons, the grocer, is required to publish its revenue, expenses, assets, cash flow, and a lot of other details. Shareholders have voting power and can elect the board members who direct the company. Albertsons also has nearly 300,000 employees. You can walk into an Albertsons store. With crypto, there's no revenue, No quarterly updates, no profits, no dividends, no employees, and no free samples. All you really have to go on is the price. According to fund manager Jonathan Honig, though, price is all you need. In fact, he recently published a book on the topic, and it's called Price Is Primary.

You know, price is like the weather. You can't argue with it. You can't, you know, go out in a swimsuit in the middle of a storm and say, no, no, no, this Storm is wrong, it's really supposed to be warm. Price is primary, price is all we have, so it has to be respected when it comes to our investments.

Jonathan has been managing a hedge fund called Capitalist Pig since 2000, but he got his start in finance as a Chicago pit trader in the late '90s.

I was fascinated that so many of the best soybean traders, for example, they didn't know anything about crop reports. You know, they weren't following the rain necessarily or agriculture, but they were following price, they were following trend, and they were following sound money management.

In his book, Jonathan argues something that value investors might find controversial. He says that looking for cheap stocks and trying to buy low and sell high can lead investors to making mistakes. And they're better off using technical indicators, namely price.

Adding to the losers fundamentally is a bad strategy. And like one can only think back to, I mean, I don't know, Cisco is an example, a great example that comes to mind. You know, Cisco looked like a great idea in 2000. It was, I think, $80 a share back then. This is 21 years later, it's still not back.

Instead of doubling down on investments that fall, Jonathan says to pay close attention to the prices of your holdings and have a systematic strategy to hold on to your winners and get rid of your losers. He mentions staggered stop-loss orders, which can automatically sell off shares if prices fall below a set point.

One of the techniques we talk about in the book, for example, is this idea of staggered stops, because no one sells the top, no one buys the bottom, but this idea that, for example, If it's at 50, let's say you're long from 30, maybe you put a stop at 45, you put a stop at 40, you put a stop at 35. So that in effect, if the market does move against you, and they always do, you get stopped out of some of your position, maybe even half of your position. But when it turns around, you're still in the game and can even get backed in ultimately if it retakes some all-time highs.

So how does Jonathan's strategy apply to cryptocurrency? It's the same strategy. Look for cryptos with prices trending up. Start with an intentional starting position size and adopt a consistent and emotionless exit plan. A technical investing strategy can be time-consuming. It requires a lot of looking at charts. Jonathan cautions against falling in love with any asset class, including crypto. He mentions crypto evangelists who see Bitcoin dominance as inevitable and tend to hold no matter what.

Bull markets are built on doubt and bear markets are built on hope. You've heard that one as well. So my expectation is that when Bitcoin does break, and it's going to break, no market goes up uninterrupted, you're going to see all these Bitcoin evangelicals. They're the ones that are going to be buying the dip, buying the dip, buying the dip, and go broke doing it.

So that's what a technical investor has to say. But what if you're more of a buy-and-hold type? An index fund holder-onner like me, whose only experience with staggered stops comes from getting off an escalator too quickly. Lisa Shallet, a chief investment officer at Morgan Stanley Wealth Management and guest on this podcast, already looked into that question. She authored a special report titled The Case for Cryptocurrency as an Investable Asset Class in a Diversified Portfolio. The report, which came out in March of this year, calls Bitcoin highly speculative. It says digital assets could decline rapidly and investors could lose their entire investment. It highlights that since 2011, Bitcoin has experienced crashes of more than 80% 4 times and crashes of more than 30% 16 times. During that time period, the S&P 500 index dropped more than 30% just once. But the report did have some positive things to say about cryptos. It looked at the effect of a 2.5% allocation of Bitcoin on a 60/40 stock-bond portfolio. It found that between January of 2014 and September of 2020, a 2.5% position rebalanced monthly would have improved annualized returns by 1.64%, quote, without significantly increasing volatility. To find out if a small allocation of crypto might deserve a closer look, I turned to MIT economist Andrew Lo. Andrew teamed up with finance professor Stephen Forrester to co-author a book called In Pursuit of the Perfect Portfolio.

Our view is that constructing a portfolio is a never-ending task, and part of the reason is because your target changes over time. You know, when you're 20-something, you've got one set of goals and set of financial constraints, but when you're in your 40s, that's different. And when you're in your 60s, it's different yet again. And so we have to be constantly in pursuit of that portfolio.

In the book, Andrew and Steven interview 10 famous figures in finance about which assets would make up their perfect portfolios. The group includes Nobel laureates like Harry Markowitz and Robert Shiller and pioneers like Jack Bogle, who shaped the diversification techniques and index funds used by many investment advisors and retirement savers today. I asked Andrew what the 10 luminaries had to say about cryptocurrencies.

There was actually general skepticism and concern about crypto. It's not clear that they are really an asset class. And the volatility of crypto makes them very poor stores of wealth. And so at this point, I think that most of the luminaries we spoke to were skeptical, but they also remained open because they realized that new asset classes, you know, come and old ones go over time. However, I would say that there are also some significant concerns that they need to be aware of, including the volatility, including the fact that we don't know whether or not this will continue to be an asset class and people will continue to hold value. And there are all sorts of legal and regulatory issues that have not yet been addressed. So I think the jury is out as to whether or not this will be an asset class that will withstand the kind of scrutiny that other asset classes have enjoyed over time.

So if crypto doesn't belong in an investment portfolio yet, what needs to change for it to get there? One common selling point for Bitcoin is that there's no central entity that controls its supply, like governments do for regular currencies. However, Andrew says that in the end, it might be central governments that take crypto mainstream.

So I'm thinking Fedcoin. If the United States decides that they want to launch its own cryptocurrency backed by the faith and credit of the US government, I think that cryptos will take off like a rocket and everybody will start using crypto cash in place of regular cash. Until we have that type of regulatory infrastructure, until we have cryptocurrencies being legal tender by a major government, it's still going to be an experiment. We'll have to wait and see how it evolves.

Thank you for listening. I'm Jackson Cantrell in for Jack Howe, who will be back next week. Our executive producer is Melissa Haggerty. Additional thanks to Katie Ferguson. You can subscribe to the podcast on Apple Podcasts, Spotify, or wherever you listen. See you next week.

Model portfolios have evolved from a one-size-fits-all solution. In a recent roundtable conversation, Jeffrey Safe of BlackRock and Alessio DeLongis of Invesco break down what's driving the next model moment, discussing how a deeper level of customization is producing a better alignment with investor goals and creating a practice differentiator for financial advisors.