First Stage Investor: Issue No. 23

How Crypto Will Win

By Adam Sharp, Co-Founder, First Stage Investor

I’ve spent the last few years thinking about how the next few decades will play out for the global financial system.

No matter how I look at it, I always wind up focusing on the inescapable debt problem. The fact is that around the globe, debt levels reach record heights on a daily basis. In the U.S. alone, the national debt stands at $21 trillion and is 106% of GDP – well above even the 60% danger mark the European Union uses.

The path we are on is the definition of unsustainable. You can’t pile up debt forever. Eventually the interest payments will become too much for the economy to bear.

When that happens, the only option will be to “monetize” the debt (pay it off with newly created money). This has already begun with quantitative easing.

In our current system, debt is inherently tied to the fiat monetary systems employed by every government. There is no restriction on how much money governments can print. And since “printing” is the path of least resistance, it is almost certainly the one our “leaders” will choose.

It’s clear to me that the current system will collapse. Yet here we are, approaching disaster with our heads in the sand.

Nobody I’ve spoken to believes our debt will be paid off in a responsible manner. So why aren’t we talking about it? Maybe because it’s unpleasant to think about. Or the problem seems too big to even consider tackling.

One thing is certain: There is no political will to restrain federal spending.

We will continue on this path until it blows up. I see virtually no chance of a responsible resolution to the problem.

I don’t claim to know when this will all play out. It could be in two years… or 20.

But the old system will collapse, and cryptocurrencies will be there to handle monetary duties.

Crypto: From Speculation to Necessity

Today, cryptocurrency is still largely a speculative investment. Most of us don’t “need” it (yet). The old monetary system is still functioning – for the most part.

For now, we are betting that in the future, the world will view private independent currency (crypto) as far more attractive than fiat money. That, one day, we will truly need it.

I believe this will happen over the next 10 to 20 years. As I frequently point out, we are beginning to see fiat money’s vulnerability in places with high inflation.

It’s happening in Argentina, Venezuela, Iran, Egypt, South Sudan, Congo and other countries with more than 20% inflation.

This is where crypto truly shines today. It’s no coincidence that demand for bitcoin and other cryptos is high in these locations.

The citizens of these countries have been through hell over the last few years. I can’t imagine what it’s like to watch your savings erode daily.

Unfortunately, I believe that most of the world will be in a similar boat eventually.

So as the old system breaks down, crypto will shift from a speculative investment to a necessary part of daily life.

It will become the next dominant form of money as the world loses faith in fiat.

The Next (Global) Crisis

All countries have been through currency crises. Typically, governments return to “hard money” backed by gold and silver following the inevitable collapse of fiat money.

It has happened countless times throughout history.

But never before have our monetary systems been so vulnerable on a global scale.

During past crises, there was a diversity of monetary systems. Some governments were on fiat, while others were on gold or silver.

Today every country is on the same fiat-based system. We depend on it for the reliable electronic transfer of value.

Gold and silver are not ideal forms of money in today’s world. Transfer and custody are too cumbersome and expensive.

So while precious metals are a fine way to preserve wealth, I don’t think the next monetary system will be based on them.

Cryptocurrency offers a better solution. A properly designed system, like bitcoin, cannot be counterfeited or cheated. It can be easily transferred from peer to peer – without middlemen.

You know all of this, so I won’t belabor the point.

This is how I believe crypto wins. It won’t be pretty, but as early cryptocurrency adopters, we should at least be less affected by this chain of events than those who don’t hold any.

It’s the clearest example of an “asymmetric” trade that I’ve ever seen.

The upside is nearly unlimited – and the downside is capped at the level of your investment. ■

disappointing buffett

The Most Absurd Things I Heard This Month

By Andy Gordon, Co-Founder, First Stage Investor

Every month I hear some truly absurd things. Things that make so little sense, they just boggle the mind!

I usually say something to the person sitting closest to me – typically my co-founder Adam. (He’s pretty good about listening to my rants.)

But the more I think about it, the more I realize the world should know about this crazy stuff out there that’s masquerading as “facts” and “informed” thought.

So welcome to our new First Stage Investor newsletter feature: The Most Absurd Things I Heard This Month. And this month’s bunch is a doozy.

Berkshire Hathaway CEO Warren Buffett told CNBC that bitcoin is “probably rat poison squared.”

Berkshire Hathaway Vice Chairman Charlie Munger told Yahoo that profiting from bitcoin was almost as bad as making money by “trading freshly harvested baby brains.”

“Would you do it?” Munger added.

Buffett will go down as one of the greatest investors of the 20th century.

Lucky for him, his clueless remarks about bitcoin in 2018 will not tarnish that legacy.

And for that I’m grateful.

I’ve held Warren Buffett and his longtime partner and gifted investor, Charlie Munger, in high regard for, well, forever, it seems.

One of my favorite yearly rituals is reading Buffett’s annual letter to shareholders.

His views are so different and yet so sensible.

And he spares no one.

As he has not spared bitcoin.

But this time it feels different – really different.

And not just because “rat poison squared” lacks his usual acerbic wit.

But because it doesn’t come from a place of deep knowledge.

This happens so rarely, I’m shocked by it.

To his credit, Buffett fully understands what bitcoin is not…

It’s NOT something you can touch or feel.

It’s NOT something with a proven track record of growth.

It’s NOT capital efficient. (At seven transactions per second, it’s the opposite.)

Those are serious sins. Perhaps the most serious is bitcoin has no clearly defined function. (Store of value? Payments mechanism? Alternate currency? Data storage?) And except for miners, it hasn’t generated profits.

What a strange beast this must be, in Buffett’s eyes.

He’s unable to reach into his traditional arsenal of metrics to determine if bitcoin is undervalued or overvalued.

I’m not even going to guess at what’s chafing Munger.

Adam says Buffett is protecting his own assets as a major “big bank” owner of Wells Fargo. I’m not sure that’s it.

Buffett has always considered himself the ultimate honest broker who cuts through all the BS and speaks the truth.

I’m taking him at his word.

I think he truly believes bitcoin poses little danger to big banks.

He sees it as a fad that will soon disappear.

Bitcoin even has the wrong personality. Buffett hates hype. He loves boring.

Add it all up and you get the perfect anti-Buffett investment vehicle.

To choose it… even just to take it seriously… is to dismiss Buffett’s most cherished investing principles.

How dare people place their faith in something less than fully proven… something incredibly exciting and very far from boring… something game-changing, even revolutionary.

Perhaps that’s why the words he chose to describe bitcoin are more passionate than clever…

Rat poison squared.

Those are not the words of a seasoned, dispassionate investor. Sadly, Buffett is taking bitcoin’s ascendancy personally.

If you want a different take on why Buffett and Munger hate bitcoin so much, you should read Adam’s column about it on the Early Investing website.

He looks at Berkshire Hathaway’s holdings to divine Buffett’s motive.

But for now, the two most important things to remember are these: One, being rich doesn’t stop you from saying truly stupid things; and two, this summer might just be the best time to invest in bitcoin. ■

Regulation Crowdfunding Turns 2

Portals by the Numbers

By Allison Brickell, Assistant Managing Editor, First Stage Investor

In May 2016, Regulation Crowdfunding launched. Suddenly, startup investing was no longer limited to venture capitalists or accredited investors. These opportunities were available to everyone! Today, two years later, we’ve dug into the numbers of the top crowdfunding portals to see how things have progressed… and we’ve found some encouraging data.

Roundup

This Month in Fintech

By Andy Gordon, Co-Founder, First Stage Investor

The financial sector is finding new and innovative ways to use bitcoin and other digital currencies.

Most banks really don’t know where all of this blockchain innovation is taking them.

But banks are realizing they have to take steps now to keep up with competitors that are already integrating blockchain technology into their operations and products. Otherwise they risk joining Blockbuster Video in the trash bin of history.

The most exciting developments…

ICE: Bitcoin as Commodity Opens Door to Trading

The stodgy New York Stock Exchange and its parent company, Intercontinental Exchange (ICE), are not exactly thought of as hotbeds of innovative tech. Yet the NYSE has found a new way to trade bitcoin… using “swap” contracts.

While more complicated than directly trading dollars for bitcoin, buying a swap contract would enable customers to own bitcoin the following day.

With the Chicago Mercantile Exchange and Chicago Board Options Exchange’s future contracts, investors can play future bitcoin prices long or short but get their returns in dollars.

Swaps allow investors to actually secure the bitcoin itself at a predictable price.

And it’s legal because swaps are done under the Commodity Futures Trading Commission, which treats bitcoin as a commodity.

Clear laws apply here.

LedgerX is the only exchange that currently offers the kinds of swaps that ICE wants to do. ICE, which works with essentially every large financial institution, would put this brand of bitcoin trading on an entirely new level.

Goldman Sachs: Taking Baby Steps

I guess Goldman Sachs CEO Lloyd Blankfein got sick of sitting on the fence. For ages, his party line used to be that bitcoin might or might not be the real thing. And now, with absolutely no sense of irony, Goldman has solemnly declared that bitcoin is NOT a fraud after all.

Thanks for the tip!

As a result, Goldman is starting a trading desk. It will be taking baby steps at first, using its own money instead of customer money. And it will be trading via contracts linked to the price of bitcoin, NOT trading bitcoin itself.

That will come with more regulatory clarity, Goldman says.

But it’s a start. And given Goldman’s stature as a leading light in banking, it sends a signal to every other bank that bitcoin has arrived.

Square: It Didn’t Really Make Millions off of Bitcoin

The devil is in the details. Square did make $34.1 million in revenue from selling bitcoin to users of its Square Cash app. But Square had to buy those bitcoins. They’re not free, you know. They cost Square $33.9 million.

The company still came out ahead… by about $200,000. It must be charging customers a very small markup, which means it’s planning on bitcoin growing into a volume business and doesn’t want fees to become a pain point. We’ll keep an eye on Square. But its growth strategy makes a ton of sense.

China: Unfriendly Regulations Aren’t Stopping Banks From Using Blockchain

A dozen state-owned and private banks (out of 26 publicly listed banks in China) say they use blockchain technology, according to a May 4 report by CEBNet, which tracks the Chinese banking industry. Some examples…

Agricultural Bank of China has developed a decentralized network to offer unsecured loans for agricultural e-commerce merchants. It automates the loan issuance process.

China Construction Bank has launched a blockchain-based platform that provides cross-bank and cross-border loan issuance for small businesses. About $251 million worth of transactions have been processed so far.

Bank of China has completed testing for a distributed IT infrastructure to be deployed across its branches. It will enable further development of a blockchain-based digital wallet.

More than 225 blockchain patents were filed in China in 2017. It’s the most of any country.

Pretty impressive. Just think how much more would have been achieved had China not cracked down on crypto activity last year.

JPMorgan: Rethinking How Global Banks Source and Share Critical Information

Jamie Dimon’s outfit has been actively developing blockchain technology since 2015, when it began working on the Quorum platform in partnership with startup EthLab. Quorum is essentially an enterprise version of Ethereum.

In May, news came out that JPMorgan filed for a patent last October that does a lot of the things that Quorum does. The patent uses distributed ledgers to record payments being sent from one bank to another using a peer-to-peer network. It would make real-time settlements cheaper and quicker.

Why? The patent filing explains, “For a cross-border payment to be made from a payment organization to a payment beneficiary, a number of messages must be sent between the banks and clearing houses involved in processing the transaction. This often results in a slow transaction…” ■

spotlight: korea

When South Korea Sneezes, Cryptos Catch a Cold

By Vin Narayanan, Senior Managing Editor, First Stage Investor

In the cryptocurrency world, there are essentially five markets that drive prices up or down: the United States, the European Union, China, South Korea and Japan. Any dramatic shift in prices – up or down – can usually be traced to news coming from one of these places.

This past month – and for much of this year, if you want to go back further – murky news coming out of South Korea has driven prices of bitcoin and other cryptocurrencies down. In fact, in just 24 hours, bitcoin lost $11 billion in market capitalization because of bad news from South Korea.

So that raises the question: Why is South Korea important? And why is bad news in South Korea driving down the prices of cryptocurrencies?

Let’s start with South Korea’s importance. As a nation, South Korea has embraced cryptocurrencies. South Korea has a population of about 51.25 million. The EU, by comparison, has 508 million people. Yet South Korea is trading cryptocurrencies at levels that about equal the EU in bitcoin and that exceed the EU in Ethereum.

In November 2017, South Korea was one of the dominant players in Ethereum, with the won accounting for anywhere between 20% and 30% of Ethereum trades (by volume). It had between 6% and 13% of bitcoin trades in November as well.

The amount of won used to trade cryptocurrencies has declined since November. As of May 2018, the won accounts for 6% to 8% of bitcoin transactions and 8% to 10% of Ethereum transactions. So what changed?

The regulatory environment grew less certain.

The South Korean government isn’t anti-crypto or anti-blockchain. In fact, it’s well aware that the country hosts two of the world’s most active crypto exchanges and a thriving blockchain startup scene.

What South Korea is, though, is anti-fraud. That’s why South Korean officials began investigating Upbit in early May. The probe, which sent cryptocurrency prices tumbling, is looking at allegations that Upbit deceived its investors with “fake” balance sheets.

Upbit, which is owned by the highly profitable Korean messaging giant Kakao, says an internal audit clears it. South Korean authorities are still investigating the exchange.

Bitcoin’s market cap plunged from $153 billion to $142 billion when news of the probe leaked.

The May investigation is the latest in a string of market-changing news from South Korea. In September 2017, South Korea banned initial coin offerings. In late December 2017, it announced it would end anonymous cryptocurrency accounts, forcing investors to comply with strict know-your-customer rules. Those rules went into effect on January 30, 2018.

And on January 11, 2018, South Korea floated the idea of making cryptocurrencies illegal, which once again sent cryptocurrency prices tumbling. The government walked back those comments four days later.

So why did the government back off? Politics. Young white-collar South Koreans love cryptos. A survey by South Korean job portal Saramin shows 31% of salaried workers have invested in them.

Then there’s Kakao. In South Korea, Kakao is more than just a messaging giant that happens to operate Upbit. It also has ride-sharing, games and payments companies. Tencent was an early investor in Kakao. This past January, it raised $1 billion through global depositary receipts in Singapore.

More importantly, Kakao announced in March that it was launching a blockchain company in Japan. The rivalry between South Korea and Japan is real. South Korea doesn’t want its nascent blockchain industry uprooting and moving to Japan.

The government didn’t get its act together in time to prevent Kakao from going to Japan. But it does seem to be moving toward a regulation-friendly approach for cryptocurrencies and blockchain technology. It’s still going to crack down on things like fraud and tax evasion. But it doesn’t look like it’s going to go any further than that. And while that’s of little comfort for investors who saw the value of their portfolios drop, it’s good news for the future of cryptocurrencies. ■

SECURITY GUIDE

Don’t Get Hacked

The First Stage Investor Guide to Securing Your Cryptocurrency

By Adam Sharp, Co-Founder, First Stage Investor

The beauty of cryptocurrency lies in its peer-to-peer nature. Crypto doesn’t require a bank or middleman to transfer value.

The trade-off is that we are responsible for our own security. There are no armed guards protecting a safe full of money. And that can be scary in a world where thieves and hackers are developing increasingly sophisticated ways to steal cryptocurrencies.

The good news is that, if you follow the recommendations in this guide, you should be fine. You’ll be able to sleep soundly and not worry about the safety of your crypto holdings.

And even if you don’t have a large amount of crypto today, it’s worth taking the time to secure your coins. A modest amount today could be worth a lot in the future.

Securing Your Email

Using a secure email account is critically important. If a scammer has access to your email, they can often reset the passwords of any accounts attached to that address.

1. Choose a trusted email provider. I recommend Google’s Gmail or another provider with an excellent security track record.

2. Use secure, unique passwords. Each of your accounts (cryptocurrency exchange, email, bank, etc.) should have a password that’s unique, long and random. Don’t use anything that hackers could guess, such as your birthday, dog’s name, anniversary, etc.

I recommend a password that is at least 15 characters long with multiple numbers, capital letters and symbols. Here’s an example of what a very secure password looks like: sUgU699a&$!*qXnoP%x.

If you use words in your password to make it more memorable, it needs to be even longer. (30 characters is a good length, and the words should be as random as possible. Add in some numbers, capital letters and symbols for good measure.)

3. Beware of “phishing” attacks. These are attacks where hackers impersonate a legitimate service and attempt to steal your login and password. A common phishing attack involves sending an email that pretends to be from a legitimate crypto exchange or service.

No matter how real they look, don’t click on links that appear to be from exchanges or other crypto services. Instead, go directly to the exchange; and make sure you’re on the correct site and that the connection is secure (https:// will appear in the web address bar in your browser). Then you can complete whatever transaction you need to on the site.

4. Use a separate email address for crypto. For ultimate security, I recommend setting up a separate email account for your crypto dealings (primarily exchange accounts).

Securing Your Computer

Using a secure computer is also vitally important for safely owning crypto. Here are some tips to make sure your machine is safe.

1. Install computer updates regularly. Always install updates to your computer and operating system. Major vulnerabilities have recently been discovered, and more pop up all the time. Most machines come with built-in assistants that suggest updates to install, but contact your computer manufacturer if you’re not sure where to start.

2. Use anti-virus software. I like Malwarebytes, but most anti-virus programs will protect against common threats.

3. Use secure Wi-Fi. Don’t log in to your exchange or email accounts over public Wi-Fi. That data could be intercepted. And be sure to use a secure password for your own Wi-Fi network at home.

4. Don’t install suspicious or unnecessary software. Hackers often try to get users to install “malware” on their computers or phones. This could be a piece of crypto trading software, gain calculators or any number of other things. Research any software you install on your computer thoroughly.

5. Consider using a separate machine for crypto. If you have large crypto holdings, or your computer has been infected in the past, consider getting a separate computer to use for all your crypto dealings. Only do crypto on this machine (no games, movies, downloads, browsing, etc.), and turn it off when you’re not using it.

Securing Your Exchange Accounts

If you choose to keep crypto in an exchange, here are a few easy ways you can add extra layers of protection to your account.

1. Always use two-factor authentication (2FA). This is critical to keeping your exchange holdings safe. 2FA requires you to enter regular login information and a unique code for every login. I recommend using Google Authenticator (an app that runs on your smartphone) for this purpose.

When you add 2FA to your accounts, you’ll get a chance to store a backup key in case you lose your phone. Write this backup key down and store it somewhere safe. If you lose both your phone and backup key, you’ll still be able to access your account, but it may take a while for the exchange to process your request.

I don’t recommend using text message-based 2FA because it’s less secure than Google Authenticator. For more information on 2FA, visit your exchange’s support section and search for “Authenticator” or “two factor authentication.”

2. Only store significant amounts in a trusted, secure exchange (such as Coinbase). I believe Coinbase is the most secure exchange. It stores 98% of customer coins offline (in cold storage) and has insurance in case of theft/loss. (Note: This does not cover cases where your individual account is compromised by stolen login credentials.)

Coinbase is more expensive than most competitors, but there’s a reason for that: It’s really secure. It has a huge security team filled with extremely talented people.

3. Use Coinbase’s “vault” feature. Once you’re logged in to Coinbase, you can add a “vault” under the “accounts” tab. After your vault is created, you can transfer cryptocurrencies from your primary wallet into the vault. Accessing coins in a vault requires a 48-hour waiting period. So even if your account is compromised, you will be notified that a vault withdrawal has been initiated – and be able to stop it.

4. Beware of “fake support.” Be sure you only access support information directly on the exchange’s website (check the address to be sure). Scammers often set up fake support phone numbers, websites or email addresses to trick users into giving them their login credentials.

Never give anyone your password or offer them your 2FA information. And don’t allow them to remotely control your computer. Legitimate exchange representatives will never ask for this information or access.

Consider Using a Hardware Wallet

The most secure way to store cryptocurrency is offline in a “hardware wallet.” This is a small physical device that connects to your computer via USB.

Because these handy devices can be disconnected from the internet, it’s impossible for web hackers to access them. (Technically, what you are storing on a hardware wallet are private keys. Think of these like passwords that provide access to coins on a blockchain.)

Hardware wallets are not for everyone. They can be tricky to get used to, and you’ll want to update the software whenever a manufacturer releases a security update. You’ll need a safe place to store your device and a separate location to store your backup info.

However, if you’re technologically inclined (or willing to put in the time to learn), hardware wallets are an excellent way to store your cryptocurrency. Here are some tips.

1. Get either a Trezor or Ledger hardware wallet. These are the two market leaders, and they offer the most secure and user-friendly devices.

2. Don’t skip any setup steps. Both these wallets have interactive guides that will walk you through the setup process. Pay close attention and complete all the steps.

3. Seek help online if you need to. If you’re having trouble with setup, go to YouTube and search for your hardware wallet name. You’ll find a wealth of guides and tips.

4. Buy directly from the manufacturers, if possible. And make sure you’re on the official website (trezor.io or ledgerwallet.com). If you buy through Amazon, I recommend buying directly from Amazon and not a third-party seller.

It’s unlikely (but possible) that scammers could tamper with the device before shipping it. So buy directly from the manufacturer or through a trusted reseller like Amazon. ■

June PORTFOLIO