First Stage Investor Issue No. 25

Can Artificial Intelligence Give Retail Investors Hedge Fund Results?

By Andy Gordon, Co-Founder, First Stage Investor

A startup called Heleum has a great idea…

Provide retail crypto investors a path to profits during flat or down periods by using artificial intelligence (AI) to automatically move investments into rising cryptocurrencies.

And, in the event of a crash, use AI to automatically move stakes into fiat money before the crash is fully felt.

Here’s how the company describes it…

Instead of exchanging in regular binary pairs (e.g., U.S. dollar to British pound and back to U.S. dollar), your funds follow paths like: U.S. dollarto bitcoin to euro to litecoin to bitcoin and back to U.S. dollar, with relative gains at each step.

The journey can take a week to three months to complete.

When cumulative gains reach 5% to 10%, your stake automatically reverts to the original currency.

What’s not to like?

It neutralizes a worst-case crash risk. It turns crypto volatility into a moneymaking opportunity. It dynamically diversifies your crypto holdings.

And there are no upfront fees. Investors pay out of their gains.

Just One Catch

It sounds too good to be true.

And upon further exploration, I discovered the technology isn’t quite there – yet.

I’m not surprised.

Foreign exchange (forex) trading is a highly leveraged and sophisticated game. You can make a lot of money on very small price movements. You can also lose a lot of money the same way.

Even the most sophisticated forex traders lose money regularly. And they do this for a living!

If Heleum had “cracked the code,” it would have been a game-changer…

Its algorithms use bid and ask prices in addition to current and historic velocity criteria to pinpoint the best times to enter into a new cryptocurrency trade.

Maybe that’s a starting point (you have to start somewhere!). But it’s far too simplistic for a sophisticated market.

One user reported that in the last six months, Heleum beat bitcoin only twice – in two of the three months that saw bitcoin prices rise.

In general, Heleum’s algorithms allow it to grow faster than bitcoin in a rising market… but drop faster than bitcoin in a falling market. Heleum underperforming bitcoin is not exactly what the company intended.

The chart below shows how your money would have developed if you had invested $1,000 each into Heleum and bitcoin on December 1, 2017.

On the Verge of Something Big

Heleum is now consulting with professional forex traders to improve its algorithms. (I’m more than a little surprised it took this long.)

The point is not to rag on Heleum. These are not the first founders who have bitten off more than they can chew.

But even as their experiment goes through some tough times, there’s one aspect of their idea that excites me…

They’re willing to switch back and forth between crypto and fiat currencies.

It’s at once problematic and advantageous. The problem? Typically, crypto true believers don’t want anything to do with fiat money. And traditional forex traders don’t have the expertise or willingness to trade in crypto.

If you’re a crypto true believer, would you even sanction moving your crypto stakes into fiat? And if you’re a traditional fiat forex trader, would adding crypto holdings even appeal to you?

The big advantage? It gives Heleum’s “floating” strategy more optionality… especially if it can also figure out at what point you transition from crypto to fiat and then back to crypto.

If it were up to me, I’d immediately explore improving the algorithms by adding a good hundred variables tracking each currency… use social media and online search data to identify early signs of shifts in sentiment… and integrate bitcoin futures into their models.

As a practical matter, I’d also give users the choice of a crypto-only option in addition to its current crypto/fiat service.

Disruptions Lead to Turf Wars

Heleum’s big idea remains hugely appealing and potentially disruptive. It’s only a matter of time before a company figures out a way to make this kind of algorithm work. The real question is whether it will be developed by a hedge fund exclusively for institutional users… or by a company targeting retail investors.

Because that’s where this battle is heading. AI isn’t just getting better; it’s taking quantum leaps forward. It’s getting to the point where you could begin using AI to make the same sorts of sophisticated trades hedge funds and institutional traders have had a monopoly on for decades.

That’s game-changing – but hedge funds are not known for backing down from a fight. What will they do to protect their turf?

Will AI really put retail investors on equal footing with these deep-pocketed behemoths? If so, it would mark the beginning of a new era.

And that is what I regret the most about Heleum’s ambitious experiment. It was the first service of its kind intended for retail investors. Perhaps Heleum will prove worthy, but so far it hasn’t been up to the challenge.

I hope (against hope) the next startup will be. A great deal is at stake here… nothing less than the future of investing for everyday investors. ■

most absurd things

Dumb and Dumber
Strike 2 for Chanos

By Andy Gordon, Co-Founder, First Stage Investor

Welcome back to the dumb side of the ledger, Jim. That didn’t take long. We featured this ridiculous statement from you last month:

So this is simply a security speculation game masquerading as a technological breakthrough in monetary policy.

As dumb as that was, your latest statement about fiat currency is actually worse. You’ve really outdone yourself, Jim.

As a crypto holder, I don’t believe – and certainly don’t hope – that fiat currency will bring the world down. And I bet my fellow crypto owners feel the same way. So let’s dive beneath the surface – something I suspect you don’t often do when it comes to crypto.

What many of us do believe is that a serious inflationary period is looming. It’s part of the economic cycle and not a terrible thing in and of itself. Certainly not a catastrophe. The Fed is raising rates to dampen inflationary trends. Again, all perfectly normal. Inflation becomes potentially catastrophic only if it’s accompanied by stagnation and/or huge government debt obligations.

The escalating debt is the big concern here. Government has three ways of dealing with a heavy debt load: Pay it off with inflated fiat money… pay it off with increased taxes…

or do both. In the latter case, the economy stagnates and we’re dealing with not only inflation but also stagflation. I remember our last bout of stagflation from the 1970s and, believe me, that was not fun.

This kind of scenario takes years to play out. As the dollar inflates (and weakens), it will accelerate the adoption rate of cryptocurrency. This isn’t guessing or projecting. It’s happening right now in countries like Venezuela. In a failing economy with a hyperinflated currency, cryptocurrency is a key refuge.

So, you see, fiat won’t bring the world down because of stagflation or hyperinflation because crypto won’t let it get to that point – unless people like you, Jim, succeed in banning it. But that’s easier said than done.

One more thing…

You say you’d rather have food than crypto “in the coming apocalypse.” Good luck buying food with hyperinflated fiat. But, believe me, grocery stores will be more than willing to accept your bitcoin. It will become common practice sooner than you think, Jim. If you want food, you’ll need a crypto account. Pitting one against the other in your shallow fantasy apocalypse scenario is just silly.

As a startup executive, I’d feel exactly the same way. But Dara is not just an exec of any ol’ startup. He’s the CEO of Uber, the company that weaponized capital. It used the prodigious amounts of cash it had on hand to beat down its challengers.

It’s a legitimate pathway to dominance. But it makes me nervous as hell. I’ve seen what piles of money can do. They can eat away at efficiencies and disincentivize hard work.

I’d much rather see companies do more with less – make the hard decisions on whether to spend their precious cash on Project A or Project B…

Low cash reserves lead to capital efficiency. Too much cash leads to capital inefficiency. From Jawbone to Beepi to Theranos, this has been proven again and again. SoftBank’s approach is fraught with risk.

Of course, startups go under all the time because they lack cash. While SoftBank takes that risk off the table, it introduces new problems by drowning startups in a sea of cash. I’m not a fan of SoftBank’s approach.

Russia doesn’t scare me. China does. It’s China that has developed mammoth tech giants like Alibaba and Tencent. It’s China where Uber met its match. It’s China where innovation is – dare I say it – flourishing.

China is three to four years ahead of the U.S. on mobile payments. It dominates drone hardware. It makes the best low-cost but feature-rich smartphones.

And, critically, China’s demographic is younger and more addicted to mobile technology than the U.S. demographic.

Unlike the U.S. government, the Chinese government is very much in the business of championing its home-grown companies and picking winners. It will pour cash into the companies it sees as future global dominators… subsidize their development… protect them against foreign competitors… and unleash them on the big markets in the West and the developing markets it’s cultivating influence in.

Here comes China. ■

Note From Andy: We recommended StartEngine last December. Its raise hasn’t closed yet, so there’s still time to invest. You can put in as little as $500 or anything over that.

internet of things

What’s Next for the Internet of Things

By Andy Gordon, Co-Founder, First Stage Investor

The Internet of Things (IoT) has been in the middle of almost every discussion of “the next big thing” for, oh, I’d say the last four to five years.

And for good reason. For one thing, the market is vast.

Morgan Stanley predicts 75 billion devices will be connected by 2020. That’s 230 times the size of the U.S. population.

Older estimates (as recently as last year) have ranged from 20 billion to 50 billion devices connected by 2020.

So expectations are growing – despite the IoT’s lackluster start.

Why so optimistic? The business opportunities are too big (and exciting) to ignore. IoT investment will amount to $60 trillion over the next 15 years, says GE, itself a big investor and believer in IoT technology.

The amount of data the IoT will generate is unimaginable. Consider that just one jet engine creates a terabyte of data in just five hours, according to GE. One terabyte, by the way, is the equivalent of 350 episodes of The Simpsons.

The “big” part of “the next big thing” is indisputable. It’s the “next” part that has failed to live up to expectations.

Instead of taking the world by storm, the IoT has resembled a slight and steady drizzle. No awe-inspiring thunder and lightning here.

The IoT was supposed to be transformational. It was going to usher in a new age of convenience, speed and automation… a world where billions of devices were at the beck and call of humanity.

And talking not only to their human owners but also amongst themselves. Let’s listen in on a machine-to-machine conversation taking place somewhere in the world today…

How Connected Devices Work

Of course, these smart devices don’t really talk like they’re characters in Smokey and the Bandit. They’re designed to respond to preset conditions that trigger a simple action, like turning off the lights.

“Conversations” like the one to the left are what a smart home can do at its most basic level right now. It has neater tricks up its sleeve.

How about your alarm clock waking you up at different times, depending on that morning’s traffic?

That’s the kind of future many thought would have arrived by now.

Unfortunately, it’s been delayed by a jumble of competing and incompatible standards, formats and platforms. The industry is operating with one hand (maybe two) tied behind its back.

It shows.

IoT projects are failing left and right despite the piles of money being thrown at them.

About 60% of IoT projects don’t get past the proof of concept stage. Only 26% of companies have had an IoT project that they consider a success, according to research from Cisco.

This is not how industry executives drew this up.

Both companies and investors have paid the price in unrealized gains.

Timing (as I’ve said more than once) is everything. Both parties were early.

Security, cost and data integration issues had not been fully resolved, preventing the IoT from scaling and reaching mass adoption.

But we’re starting to see meaningful headway being made on all three fronts. We’re at an inflection point. The time is now or never for IoT to show what it can do. And signs are pointing to now…

Security: We’ve seen smart cars hacked and hospitals grind to a halt from cyberattacks. Nearly every make and model of voting machine is “vulnerable to hacking,” reports The New York Times. Around 70% of IoT devices are vulnerable to attack, says HP.

Securing high-value devices such as cars presents one kind of challenge.

A very different challenge is securing the billions of simple devices now being used.

Both ends of the spectrum have been inadequately equipped to ward off attacks. But that’s changing.

Low-power hardware products can now embed security features directly into IoT devices. Machine learning can spot behavioral anomalies and potentially compromised devices. And security tools designed for IoT networks are becoming increasingly available.

Cost: Low-power, wide-area networks can provide connectivity at a low cost, and they’re now being widely adopted. This is driving adoption of IoT applications for smart cities, smart utilities and smart agriculture projects.

Data integration: Data helps the IoT get smarter, serve users better and drive mass adoption. But at what point does data accumulation from billions of activities become counterproductive?

Some argue for less data. That’s especially true with sensors operating “on the edge” or “at the end points” – physically close to what is being monitored. Keeping devices dumb is cheap. The more complex the data, the more expensive the cost.

Others argue that billions of IoT devices capturing so much data requires analysis to sort through it all. Dumb devices just take up bandwidth with useless data, which is a big waste.

The solution? To do the analytics physically close to where the data is generated. That reduces the delays (latency) associated with transmitting data between the sensors that generate it and the cloud-based applications that analyze it.

AI is helping with this problem. It’s increasingly being used to analyze IoT-generated data and automate operational decision making. Nearly every major IoT platform now has AI capabilities, says Deloitte.

The Big Boys vs. the New Boys

The IoT’s huge potential has the big boys excited. Amazon, Microsoft, Google, Apple, IBM and others are all in.

But as the IoT ecosystem grows bigger and bigger, it will be virtually impossible for these big companies to wrap their arms around it. At some point, the centralized model will become more of a problem than a solution, with its servers becoming both a bottleneck and a big fat target for hackers.

Blockchain technology will have to replace a model where devices rely on a central server to identify and authenticate individual devices.

That’s a scenario I see unfolding in the early to mid 2020s. But today is the perfect time to start looking for companies developing blockchain technology for the massive IoT market of tomorrow. ■

this month in fintech

The Race Is Heating Up to Tokenize… EVERYTHING

By Andy Gordon, Co-Founder, First Stage Investor

The World’s First Decentralized, Tokenized Bank

Our fintech news tour begins in Malta, which has become a hotbed of crypto-related activity. Malta is essentially to Europe what Puerto Rico has become to the U.S. – a haven where crypto initiatives are welcomed and nourished.

The Maltese parliament recently approved three distributed ledger technology (DLT) and crypto-related bills, ensuring no regulatory surprises for companies creating blockchain products.

And now Binance is backing plans to create a blockchain-based bank there. It would be the world’s first decentralized, community-owned bank. The owners of the future “Founders Bank” will be issued “legally binding equity tokens” in return for their investment via the blockchain-based equity fundraising platform Neufund.

All this started earlier this year when the Maltese government convinced Binance – one of the world’s largest cryptocurrency exchanges – to move its headquarters from Hong Kong (where it was no longer wanted) to Malta.

Next stop… Switzerland.

Crypto-Friendly Switzerland to Offer Tokenized Stock Exchange

Malta found a way to tokenize bank ownership. But there’s more than one way to tokenize equity. Switzerland’s main stock exchange – the SIX Swiss Exchange – is building a digital version of itself on a distributed ledger. To be clear, it will NOT be for trading cryptocurrencies. Rather, it will be where investors can trade tokenized securities of the stocks they own or want to buy. Initial plans call for the new DLT platform to debut next year.

OK, ready to pay China a visit?

So What Is “Not So Friendly” China Doing?

Something big, if its 41 patent filings are any indication. “Crypto allergic” China is putting together the technology to build its own central bank digital currency (CBDC).

It comes with its own digital wallet, which would actually store the encrypted digital currency itself along with multisignature security protocol. That’s a significant upgrade over much more traditional cryptocurrency wallets, which merely store the private keys to a certain asset.

As you’d expect, China’s goal isn’t so much to replace its fiat currency but to “upscale the existing circulation of fiat currency.”

As such, I seriously doubt its CBDC will be truly decentralized. More likely, the government wants a plan in place in the event that digital currencies and digitized assets become prevalent.

A government-created/managed CBDC that transacts with other digital assets would leave China’s main economic levers under Beijing’s firm control.

Next up… the U.S. and Germany.

Too Big to Fail: Two Powerful Banks Try to Capture Massive Shares of $9 Trillion Market

Citibank and Commerzbank have both developed blockchain technologies that go significantly beyond what their peers are doing in trade finance.

Citibank is combining blockchain technology with artificial intelligence (AI) and the Internet of Things (IoT). Its goal? Creating a “real time” payments system. Nothing like this has ever been tried.

The AI would help identify conditions that have to be met before a payment is made. IoT sensors could be used to do verifications, like when shipments arrive and go through Customs. AI and IoT sensors would then combine to pay the supplier (and ideally Customs duties).

As for Germany’s Commerzbank, it’s going the extra mile too, but in a very different direction. It’s refusing to build its blockchain platform on just one protocol. Instead, it’s building it on five!

(Geek Note: The five protocols are MultiChain, BigchainDB, Hyperledger, R3 and the Enterprise Ethereum Alliance.)

The reason? Commerzbank believes there will be many blockchain solutions – not just one. What’s more, they will need to talk to each other.

The key then becomes interconnectivity.

So how would Commerzbank choose which protocols to use for each use case? It’ll depend on a number of factors, including permission restrictions, consensus mechanism, scalability, whether or not it can develop smart contracts, and the other players involved in the specific use case.

“There is not one silver bullet blockchain that is good for all future use cases,” the bank says.

By the way, the Chinese government would be interested to hear that Commerzbank believes that central bank money on a blockchain is a crucial missing ingredient. “We need to find a solution that includes money transfer in the ledger, backed and controlled by central banks,” says Commerzbank.

Bitcoin is also attacking a “crucial missing ingredient.” Let’s visit the Lightning Network for our tour’s last stop.

How Well Will the Lightning Network Work “in the Wild”?

Lightning-enabled transactions are supposed to be a fast and cheap way to make digital payments – much faster and cheaper than credit cards. But that future is still far down the road.

Layered on top of the bitcoin blockchain, the Lightning Network is supposed to reduce friction for recurring payments, but the tech is still in its infancy.

So what CoinGate is doing should really help accelerate Lightning Network’s learning curve. It’s opening up a pilot program to 100 merchants who will test a Lightning-backed version of its service “out in the wild.”

Right now, few shoppers have the resources to send cryptocurrency from a Lightning wallet. It’s too complicated, and extra coding is needed. So this pilot will showcase both Lightning’s capabilities and weaknesses in terms of speed, security and convenience.

“It will help not just us, but the whole community, because the bugs we find might help the whole protocol,” says CoinGate. ■

portfolio update

Positions as of 7/31/18