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How to (Not) be a Shitcoin: What I've Learned About Markets, Psychology, and Value Creation

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This was presented at Dezentral Berlin on Sept. 5, 2018. This talk highlights the nature of human greed and how investor psychology has made the ICO rally of 2018 possible, what drives both the sell side (ICO issuers) and the buy side (ICO purchasers) to continue in irrational and destructive behavior, and what changes may need to take place for the crypto market to stop cannibalizing value.

Published in: Business

How to (Not) be a Shitcoin: What I've Learned About Markets, Psychology, and Value Creation

  1. 1. How to (Not) be a Shitcoin What I’ve Learned About Markets, Psychology, and Value Creation Meltem Demirors
  2. 2. DISCLOSURE 0x | $0X Civic | $CVC Golem | $GNT Ocean Protocol* | $*** Stellar | $XLM Aelf | $ELF DeepBrainChain | $DBC Groestlcoin | $GRS Qtum | $QTUM TenX | $TENX Aeon | $AEON Digibyte | $GBD Litecoin | $LTC Reddcoin | $REDD Tezos | $XTZ Augur | $REP Dragonchain | $DRGN Lunyr | $LUN Request | $REQ Unikoin Gold | $UKG Basic Attention | $BAT Elastic | $XEL Maidsafe | $MAID Ripio Network | $RCN Verge| $XVG Bitcoin | $BTC Enjin | $ENJ MakerDAO | $MKR Ripple | $XRP Vertcoin | $VTC Bitcoin Cash | $BCC Ethereum | $ETH Mainframe | MFT RocketPool | $RPL Waves | $WAVES Cardano | $ADA Ethereum Classic | $ETC Metal | $MTL Salt Lending | $SALT ZCash | $ZEC Caspian | $*** Filecoin | $*** Monero | $XMR Stacks | $*** Handshake |$*** Cindicator | $CND Gas | $GAS Nimiq | $NET Status | $SNT Caspian|$*** I personally hold the below digital currencies and tokens in my portfolio (listed and updated on Medium): I am an investor in the below companies and funds, either via Athena or personally: 3.0 Capital* Chia Network Picks & Shovels Remy* Algorand Blockdaemon* Marble Messari Token Daily Vantage Point Casa Integral aka Summa Paycase / Shyft* TokenSoft Note: * indicates an I hold a compensated advisory role
  3. 3. UNDERSTANDING GREED
  4. 4. BLOCKCHAIN, MAKE ME MONEY! @Melt_Dem 4 Source: CoinMetrics.io BITCOIN $0 $11 $22 Jan-15 Jan-16 Jan-17 Jan-18 Thousands ETHEREUM $0 $600 $1,200 Aug-15 Aug-16 Aug-17 RIPPLE $0 $2 $4 Jan-15 Jan-16 Jan-17 Jan-18 As of 8/2018 Up 874% As of 8/2018 Up 14,408% As of 8/2018 Up 2,854%
  5. 5. THE NEXT BITCOIN, ETHEREUM, RIPPLE @Melt_Dem 5
  6. 6. WHAT INVESTORS AND ENTREPRENEURS WANT 6@Melt_Dem
  7. 7. @Melt_Dem 7 AND THEY’RE DOING IT
  8. 8. THE REALITIES OF THIS MARKET @Melt_Dem 8 t = 4 RAISING MONEY IS AS EASY AS IT’S EVER BEEN § Everyone raises massive amounts of money with no product, no plan, and no market. § Massive amounts of wasted time and effort - 7k total “users” for billions invested BUILDING SHIT IS AS HARD AS IT’S EVER BEEN § Struggling to find actual use cases and product market fit and user adoption § Arguably, there has never been this big of a disconnect between DAUs and $$$ invested THE MARKET WILL CONTINUE TO CANNABILIZE AND CONSUME ALL VALUE § Unless crypto projects start creating and delivering valuable services to users, we’re going to continue to see market value evaporate § Any market rally leads to a wave of capital raising that further dilutes value
  9. 9. THE ANATOMY OF A SHITCOIN
  10. 10. CRYPTO – WHAT’S IT GOOD FOR ANYWAYS? CREATE DISTRIBUTE RETIRE OR REPLACE MANAGE t = 0 t = 1 t = 2 t = 3 Speculation Utilization Specification A BRIEF ANALYSIS OF POPULAR CRYPTOASSETS (ASSET | LIFESPAN) BITCOIN | 9.7 YEARS | $110B ETHEREUM | 3.1 YEARS | $23B LITECOIN | 4.6 YEARS | $3B RIPPLE | 5.1 YEARS | $11B ZCASH | 1.9 YEARS | $600M TRON | 1.0 YEARS | $1.3B EOS | 1.2 YEARS | $4.6B Source: OnChainFX, personal assessment of lifecycle state @Melt_Dem 10
  11. 11. AN INCOMPLETE ASSET LIFECYCLE @Melt_Dem 11 MYOPIC FOCUS ON CREATION AND DISTRIBUTION Projects are focusing on product creation and distribution as the end of a process, when really it is just the beginning of a years, if not decades, long obligation to manage the lifecycle of these assets NASCENT (NON EXISTENT) PROJECT MANAGEMENT PRACTICES Most cryptoassets are traded on pure speculation, and have little or no emergent utility. Many projects have not yet launched their networks. Limited information is available about how projects are developing, even once networks are live and assets freely tradeable. NO PROJECT HAS REACHED “END OF LIFE” YET Given the fundamental uncoupling of assets from the protocols and projects which they’re supposed to be associated with, many tokens with no value keep trading in perpetuity, with no clear plans as to how these assets get wound down or removed from circulation.
  12. 12. THE PECKING ORDER @Melt_Dem 12 BITCOIN 55% ALTCOIN UNIVERSE Large Cap Small Cap30 – 40% SHITCOINS SECURITY TOKENS AND OTHER WEIRD SHIT I DON’T CARE ABOUT
  13. 13. SHITCOIN: TO BE OR NOT TO BE? @Melt_Dem 13
  14. 14. SOME GENERAL SHITCOIN INDICATORS @Melt_Dem 14 • UTILITY | Does a token need to exist or does it simply add friction? Could an existing digital asset or digital currency like BTC, ETH, etc fulfill the same function? Is it solving some problem that can’t be solved using existing technology? • VALUE CREATION |Does this technology or network or application existing create benefit for individuals or society as a whole? • TECHNICAL INNOVATION | Is it introducing a technical or feature innovation that makes it distinctive in some capacity? • EFFORT INVESTED | Does it have its own network / blockchain that was costly to develop or is it built on another network using a standard like ERC-20, ERC-721, NEP5, etc? How long has the team been grinding on this problem? Has material effort been expended? • STAKEHOLDER INCENTIVES| How are various stakeholders in the network identified, what role do they play, and are they participants in value creation? Has there been time spent on articulating how stakeholder engagement will evolve over time? • COMMUNITY ENGAGEMENT | Does the project have a well-developed community that seems to discuss protocol development, network state, and application creation more than price? Is there a reason for people to give a shit about this project that isn’t tied to greed and self-interest?
  15. 15. DECENTRALIZATION IS AN ESOTERIC GOAL APPLICATION NETWORK PROTOCOL Applications # of independent applications that have VC $ or users 100s 100S ? ? ”Ecosystem” Amount of capital dedicated to ecosystem? $B $B $M $M Network Cost Annual ”mining” reward or cost to maintain network $6B $120M $0 $0 Nodes in Network # public nodes in network 100K+ various types 10K ? 156 Node Concentration # entities with >50% of network power in consensus 4 3 2 1 Distribution of Tokens % supply held by top 100 accounts 19% 34% 81% 62% Development # client codebases that account for >90% of nodes 1 2 1 1 MEASURE METRIC Source: arewedecentralizedyet.com, OnChainFX, BitInfoCharts.com, Blockdaemon research, my back of the envelope math @Melt_Dem 15
  16. 16. THE SHITCOIN SELL SIDE
  17. 17. Liabilities Notes Payable (ST or LT) Accounts Payable Wages Payable Interest Payable Taxes (current +deferred) Company Equity Preferred Stock Common Stock Assets Cash or cash equivalents (BTC, ETH) Inventory (tokens held by project) Accounts receivable Investments Ecosystem fund investments Property Plan & Equipment (PP&E) Goodwill Assets Liabilities + Equity DEBT FINANCING MAKES SENSE @Melt_Dem 17
  18. 18. Liabilities Notes Payable (ST or LT) Accounts Payable Wages Payable Interest Payable Taxes (current +deferred) Company Equity Preferred Stock Common Stock Assets Cash or cash equivalents (BTC, ETH) Inventory (tokens held by project) Accounts receivable Investments Ecosystem fund investments Property Plan & Equipment (PP&E) Goodwill Assets Liabilities + Equity EQUITY FINANCING MAKES SENSE @Melt_Dem 18
  19. 19. Liabilities Notes Payable (ST or LT) Accounts Payable Wages Payable Interest Payable Taxes (current +deferred) Company Equity Preferred Stock Common Stock Assets Cash or cash equivalents (BTC, ETH) Inventory (tokens held by project) Accounts receivable Investments Ecosystem fund investments Property Plan & Equipment (PP&E) Goodwill Assets Liabilities + Equity TOKEN FINANCING – HUH? ??? NOTE: Tokens do not have any rights, uses, purpose, attributes, functionalities or features, express or implied, including, without limitation, any uses, purpose, attributes, functionalities or features on the “decentralized blockchain computing network” platform. @Melt_Dem 19
  20. 20. WHY THE COST OF CAPITAL MATTERS STAGE COST OF CAPITAL EQUITY DEBT ICO DUE DILIGENCE ASSOCIATED RIGHTS Interest rate Cash flows, financial modeling, risk review Principal and interest, liquidation preference Highly variable Ownership dilution, shareholder value Valuation review, business model, product market fit Voting, liquidation preference, 5+ years ? Marketing and legal White paper (concept), conceptual technical design No covenants, no preferences, no rights <1 year TIME TO LIQUIDITY @Melt_Dem 20 If you were capitalizing a company, what path would you choose?
  21. 21. IT’S ALL A GAME @Melt_Dem 21 1. Come up with idea - “we are tokenizing X” 2. Write “whitepaper” 3. Recruit early investors and advisors to social signal and virtue signal 4. Spend millions on marketing, conferences, parties, and cool swag (jackets anyone?) 5. Create FOMO by only selling a small percentage of supply, but make sure the “team” gets 20- 30% of the tokens for the “work” 6. Build an ERC-20 / ERC-721 / NEP5 token by writing some “smart contract” code 7. List that shitcoin on exchanges 8. Announce the partnerships 9. Hope for the pump so you can dump 10. Watch 90%+ of the value of your token erode over the course of a few weeks
  22. 22. @Melt_Dem 22 BUT REALLY MAKE THIS GAME SOMEONE
  23. 23. FEWER AND FATTER: BEING *THE* SHIT(COIN) PAYS @Melt_Dem 23 43 120 222 156 122 72 $0B $5B $10B >$50M $25M>$50M $10M>$25M 5M>10M $1M>$5M <$1M AmountRaisedineachBracket($B) Size of Raise Bracket +845 unreported Number of ICOs Source: CS Research, note data from July 2018 to-be-updated
  24. 24. THE REALITY OF THE SHITCOIN SELL SIDE @Melt_Dem 24 WAY TOO MANY *DUMB* IDEAS FLOATING AROUND § Any and every project that could possibly be tokenized is being tokenized § The siren song of raising non-dilutive capital in unregulated markets is irresistible ENGINEERS TRYING TO BE ECONOMISTS IS JUST SAD § Trying to engineer incentives like input / output functions isn’t working § Few projects understand supply and demand– tokenomics is an immature pseudo-science practiced by self-proclaimer shitcoin gurus and crypto promoters WAY TOO EASY TO PRINT MONEY § Token standards like ERC-20 enable instant asset creation at virtually no cost § Community ethos of permissionless financial innovation means no one can ”police” the money printing process
  25. 25. THE SHITCOIN BUY SIDE
  26. 26. CAPITAL FORMATION IS EVOLVING @Melt_Dem 26 Source: IPO data from SIFMA, VC data from PwC Money Tree Explorer, ICO data from proprietary CoinShares Research. Note 2018 H1 data was multiplied by two to obtain YE 2018 projections, $- $50 $100 2000 2003 2006 2009 2012 2015 2018 BillionsUSDRaised IPOs VC ICOs Linear (IPOs) Linear (VC) 2017 6% 2016 <1% 2018 15%
  27. 27. SHITCOINS PAINT A COMPELLING PICTURE @Melt_Dem 27 STAGE # ROUNDS / CO’S IPO VENTURE ICO* TOTAL RAISED, USD AVERAGE DEAL, USD TIME TO LIQUIDITY INVESTOR POOL DEGREE OF HOMOPHILY 2,713 $45B ~$17M 3 – 5 years 3,000 Medium 107 $32B ~$295M 8+ years 1,000 High 359 $18B ~$29M <1 year 10,000+ Very High Source: PwC Q2 2018 Capital Markets Watch Report, PwC and CB Insights' Q2 2018 Money Tree Report, Proprietary CS Research on Global ICO Trends.
  28. 28. AND THE INSITITUTIONS ARE EATING IT UP @Melt_Dem 28 2013 20182014 2015 2016 2017 Source: Proprietary analysis using publicly available news sources.
  29. 29. RESULT: THE SHITCOIN WATERFALL @Melt_Dem 29 Early crypto funds and industry insiders 1x 10x 50x Larger, later stage funds, family office, VC, and angels Final FOMO lap on the fundraise trail Exchange listing hype and FOMO, retail buying Early investors start dumping to recoup principal Puke up 75%+ of value in first 30 days Bag holders waiting for the moon that never comes time a race to the bottom
  30. 30. SHITCOIN RETURNS ARE STILL STAGGERING @Melt_Dem 30 Source: Majority of return data from PitchBook 2018 Global PE & VC Fund Performance Report. IPO data from Renaissance Capital research, referencing Fidelity Investments data. ICO data from Benedetti, Kostovetsky, “Digital Tulips? Returns to Investors in Initial Coin Offerings.” STRATEGY RETURN Debt 6% Fund of Funds 11% Hedge Fund 11% Real Assets 11% Secondaries 13% VC 16% PE 18% IPO 21% ICO 179% • Global macro uncertainty and sky-high valuations across asset classes • Venture investors increasingly concerned with valuations, exit environment, and performance • Hedge fund performance has been subpar – in 2017, 43% of funds fell short of performance expectations • Exits less frequent – IPO valuation premium is low, staying private often better for juicing valuation • For investors who missed BTC and ETH 10,000x returns, ICO investing looks very attractive CHANGING INVESTOR SENTIMENTUS INVESTMENT RETURNS LAST 5 YRS
  31. 31. MAGICAL INTERNET MONEY BABY WHERE WILL CAPITAL COME FROM? Legacy Asset Market Size Blockchain Asset Expression Gold $7 trillion Store of Value (SOV) Bitcoin Oil (Commodities) $1.7 trillion Digital Utility Ethereum VC $60 billion New blockchain protocols and early stage ICOs HF / PE growth investing $1.2 trillion Securitizing equity for private companies Security Tokens (STOs) Real Estate $1.4 trillion Fractional ownership and tokenized REITs Securitized Asset Offering (SAOs) @Melt_Dem 31 Source: Global Alternatives Survey, CoinShares estimates. Liquidity, exchangeability, and efficiency are primary features - can crypto capture that premium?
  32. 32. THE REALITY OF THE SHITCOIN BUY SIDE @Melt_Dem 32 WAY TOO MUCH MONEY FLOATING AROUND § Everyone has a crypto fund. Everyone is an investor. Everyone has “access”. § It’s all about the 2%, not the 20%. Gotta allocate to get paid. NO ONE WANTS TO BE THE LAST IN THE SHITCOIN WATERFALL § Retail got burned so badly in the last 6 months that they’re not coming back § Investors are increasingly skeptical – but there is always someone who ends up holding the bag or being the buyer of last resort LIQUIDITY IS EVAPORATING AS CONFIDENCE WAVERS § Maintaining market cap, price, and speculative attention is difficult in this noisy market § Confidence in crypto markets is at an all time low – people are looking for signal but there is little empirical evidence of “value” nor clarity on what constitutes “growth”
  33. 33. ACHIEVING ESCAPE VELOCITY FOR A SHITCOIN
  34. 34. PULLING LEVERS AND USING CAPITAL FINANCIAL SOCIAL HUMAN EXAMPLES RELATIVE SCARCITY NATURE OF NEED § Money (both VC and ICO) § Tokens § Ability to preserve capital § Notable participants / social signal § Reputation & credibility § Press coverage & mentions § Agility & speed § Talent and skill § Execution capability low low medium high medium medium medium high high short term long term long term long term long term short term short term long term long term Focus on increasing the types of capital that are most scarce to compete long term @Melt_Dem 34
  35. 35. COMPETING FOR NETWORK VALUE @Melt_Dem 35 Competing at Every Layer § Accrue value to token holders § Incentivize developers to join project § Incentivize contribution of compute resources § Reduce or subsidize network cost to spread edges § Curate demand for tokens § Incentivize entrepreneurs § Create use case specificity APPLICATION NETWORK PROTOCOL Competitive Strategies Strategies should focus on increasing network value and developing competitive advantage § Investments – High risk venture investing likely a poor strategy to drive demand at the app layer § Mergers – Two or more protocols can combine efforts to consolidate demand § Acquisitions – Protocols and companies can acquire another, either friendly or hostile § Assassination – Kill a protocol through a coordinated attack. We have yet to see a protocol die – what happens to tokens in this case?
  36. 36. THE CHANGING RULES OF THE GAME @Melt_Dem 36 COMPANIES HAVE WAY TOO MUCH FINANCIAL CAPITAL § It’s poorly managed or completely unmanaged in most cases, but it’s waiting for opportunity THE BATTLE IS ON FOR SOCIAL AND HUMAN CAPITAL § There is a fierce competition for attention and talent. Projects who can sustain an inflow of interest and stay relevant will accrue capital more quickly. POWER LAWS DICTATE WINNERS WILL EMERGE § Investors are currently adopting a “spray and pray” strategy when it comes to protocols and tokens. In the future, activist investors will actively collude to make winners. NO STRATEGIES ARE OFF THE TABLE § To date, few novel approaches have been tried. In the coming months and years, no strategy is too crazy to contemplate as networks compete for demand. Get crazier. Be bolder.
  37. 37. WHERE WE GO FROM HERE
  38. 38. EVERYONE WANTS THEIR TURN TO PLAY @Melt_Dem 38 2013 20182014 2015 2016 2017 LEGACY CRYPTO Source:Proprietary analysis using publicly available news sources.
  39. 39. BUT – IT’S STILL SO EARLY CREATE DISTRIBUTE RETIRE OR REPLACE MANAGE t = 0 t = 1 t = 2 t = 3 Speculation Utilization Specification A BRIEF ANALYSIS OF POPULAR CRYPTOASSETS (ASSET | LIFESPAN) BITCOIN | 9.7 YEARS | $110B ETHEREUM | 3.1 YEARS | $23B LITECOIN | 4.6 YEARS | $3B RIPPLE | 5.1 YEARS | $11B ZCASH | 1.9 YEARS | $600M TRON | 1.0 YEARS | $1.3B EOS | 1.2 YEARS | $4.6B Source: OnChainFX, personal assessment of lifecycle state @Melt_Dem 39
  40. 40. AND WE’RE STILL FIGURING IT OUT CREATE DISTRIBUTE RETIRE OR REPLACE MANAGE t = 0 t = 1 t = 2 t = 3 Speculation Utilization Specification The market needs more robust infrastructure to enable assets that create true utility to be functional in a market economy @Melt_Dem 40 Source:Proprietary analysis using publicly available news sources.
  41. 41. BUT WE CAN WE MANAGE BETTER @Melt_Dem 41 INEFFICIENCIES SELL SIDE: Bonding Cost BUY SIDE: Monitoring Cost MARKET: Residual Loss RESULTING IMPACT • Too challenging for investors to track project progress and performance • Information is scattered across channels • Cost for entrepreneurs/ agents to shirk responsibilities is minimal • Founders work on numerous projects • Moral hazard and information asymmetry create loss • Monitoring cost limits investment The industry needs more monitoring tools to lower investing risk and more thoughtful ways to minimize the ability to founders to abandon projects before completion COST • Qualitative and quantitative data • Full time research team • Outside of vesting few limits • Limited social cost • Reputational damage to industry
  42. 42. EVOLUTION IS A PROCESS IPO ICO STO ??? THE EVOLUTION OF CAPITAL FORMATION @Melt_Dem 42 CRYPTO
  43. 43. WHAT I’M THINKING ABOUT @Melt_Dem 43 HOW DO WE CAPITALIZE AMBITIOUS CRYPTO PROJECTS? § What’s the growth story for investing in protocols, networks, or applications? § How does the cost of capital impact fundraising choices and investor rights? HOW DO / SHOULD WE SHAPE THE NARRATIVE AND PUNISH BAD ACTORS? § Little to no social cost for repeatedly engaging in predatory, self-interested behavior § The narrative is quickly spiraling as exit scams become more and more egregious § Should there be more “self policing” or is that inherently antithetical to crypto? HOW DO WE KEEP ICO’S FROM VAPORIZING VALUE? § Permission-less financial innovation means anyone has the right to print money § Continued erosion of any positive value creation makes it difficult to preserve value
  44. 44. Come talk shit to me about shitcoins meltem@athenacap.co

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