New Episode on NaluFM: Investing in Crypto currency
vestr’s Head of Business Development, Stefan Wagner speaks to George Cotsikis, CEO of Mentat Innovations, in an interesting discussion about all things blockchain, investing in crypto currency and their risks and opportunities.
How huge is the potential of cryptocurrency now, compared to in the future and should you invest in this opportunity now? What are some tips to get yourself involved in the crypto-trading scene?
Gain insights into the world of crypto and learn about the outlook for crypto and traditional financial markets in the future:
- Definition of Terms used in Crypto
- Understanding How it Works
- Weighing the Risks Involved in Investing in Crypto
- How to be Efficient in the Crypto Business
Read the full interview Stefan hosted with George:
What is blockchain?
George: Great question. So the blockchain is basically a public database. It is a distributed database which has a very specific characteristic: you can only write to it once. Once something is written in that ledger, or database, it cannot be changed. That record or transaction is shared across multiple computers. So, no single node in that network of computers can change the database. This is it. It is pretty simple, actually.
Once a transaction has been recorded, it cannot be changed again. Is it impossible to manipulate the records?
Exactly, this is what immutable property of this database is. It makes them specifically very well suited as a transactional database. Especially when there are financial records found in them. And this is why they form the basis of crypto currencies. They are essentially a way of storing transactional data in a trustless way and globally. People can transact with each other without a central counter party, like a clearing house or a bank.
Ethereum and Bitcoin, are they both using that technology? And if yes, what’s the difference between them?
Fundamentally, yes, they are both using distributed ledger technology.
Bitcoin is the granddaddy. It is the cryptocurrency which is dominating the space, it is seen as digital gold by a number of participants. And it’s the largest capitalisation crypto currency right now.
Ethereum is the number two market population crypto currency with the extra feature over programmability. The Ethereum ecosystem, which has a couple 100,000 developers in its network, is able to essentially not only store transactions, but actually execute contracts and code on this network in a distributed manner. These contracts are called smart contracts. They are a way of programming. “if then else”- statements to make it very simple.
The big difference between Bitcoin and Ethereum is programmability.
There is a very big difference between these two, which is the following: While I consider Bitcoin to be fully autonomous, I would say Ethereum is almost fully autonomous. It has the biggest network effect in terms of developers and spread.
So these two would be the most autonomous. With Bitcoin being the most autonomous and the one which actually is running on a set of economic incentives that requires almost no human interaction.
Now, there are currently 7000 cryptocurrencies. We started with something like a 1000 maybe, a few years ago, we’re up to 7000. And I’m not counting what else could be represented on the ledger like NFTs or tokenized securities and so on. The way to think about all these cryptos is essentially as investments into technology companies. Very early stage liquid-technology investments. They do not have the lockups like a VC fund with a 10 year horizon. Hence, they face this kind of volatility which is clearly visible. Unlike a private equity or VC investment. But at the end of the day, they are technology investments themselves.
You said Ethereum is like a global computer to have to measure some of that cloud setup like Amazon Cloud or Google Cloud. And somewhere there is a place where electricity is cheaper to host that big global computer from Ethereum? How do I better understand that?
No, the computers, the nodes that are participating, these networks are globally distributed. And they are as small as an enthusiast PC running in the basement to huge server farms in low electricity places with renewable energy. So they go from anywhere from individuals to corporates that participate. They earn the rewards by essentially ensuring the security of the network.
What is the security of the network? It’s making sure that the transactions, which are recorded, are correct. They cannot be changed. There are economic incentives for all these players to actually do that.
What would you say, are crypto currencies a good investment? And if yes, how big of a portion would you recommend somebody that their portfolio should be in crypto currencies?
There are two answers to that: one is in isolation, are these investments any good? And there is an answer relative to what is happening in the world in other assets. We also have to think, on a relative basis.
In isolation, Bitcoin has a very interesting characteristic that has a limited supply of coins. 21 million coins. There will never be any more than that. It is one of the very few verifiably disinflationary assets in the world right now. That is why it is called digital gold. Every coin has its own little monetary Central Bank, which could be a large community. This is what matters to a single individual. So, again, you cannot really compare.
But if you were to take a look at cryptocurrencies in context, I think they are a good investment. Not only because of the potential inflationary questions that all of us have. It’s a question of magnitude right now and duration of inflationary shocks. When you have probably disinflationary assets like Bitcoin, I think they really have a value in every investor’s portfolio. And this is what gold does actually.
Do any other crypto currencies make sense?
Well, they do make sense, if that portfolio has a certain risk appetite or horizon for excess returns. And again, it goes back to; how do you look at your risk? How do you manage your portfolio? It is very difficult to say if a certain coin is a good investment. It depends on what your investment horizon is. What your risk appetiteis.
How do you look at the risk of a cryptocurrency? How do you measure it? Historically, you did volatility sharp ratios. But when you as a retail investor look into any new cryptocurrency, how would you do your due diligence on it?
I started trading crypto quite actively around about 2016. So I’ve been through one big cycle, it was in 17-18 (2017-2018). It was very interesting, very volatile, huge draw downs, huge moves.
And I think what kept me through that that cycle is an understanding of risk as something more as a volatility measure or a drawdown metric. You have to think of risk in multiple dimensions.
- The most important one: What is my horizon? Is my investment basis a three-month basis, a one-month basis, is it like two-days basis, am I a day trader, am I somebody who is thinking of this is going to be a generational opportunity for five years? And I think that changes how you’re looking at it.
- After that, you have to see if this is not a fully autonomous currency like Bitcoin. Where there is a set of incentives, which are clear to everybody. Is the thing that is backing a certain project, a credible team? Are they able to create the network effects that will actually make this coin viable without them? Are they thinking long-term as well? So that’s more of a human capital type of question of risk, which cannot be quantified, but one has to ask.
- Then there is a third, the regulatory dimension. I also care about the predictability of the distribution. If I understand the statistical properties of what I’m trading, and hence, this predictability means that this time series has slightly lower entropy, it means that it’s a better investment for me.
- Probably the last thing, but very, very important: liquidity. I need to make a decision about whether I hold the position, or how I can actually get out.
You just pointed all potential risks out and how you look at it. So, why should people care about crypto?
We have a significant dual revolution. We have both a technological revolution, and the financial/ monetary revolution. So unlike the previous big technological innovation wave, which was around the Internet, and mobile, which allowed e-commerce to flourish, and a few other things, like social networks.
Here, we have also a distributed autonomous monetary system, which I think is the first time in history that this has ever happened, essentially.
And the amount of innovation that is actually happening right now in the crypto space is mind-boggling. So if you feel like I do, that this is the future of capital markets and finance, you cannot afford to sit out on this. We have an asset class, which is two and a half trillion dollars, I think it’s going to be 5 to 10 times bigger in the next two to five years. And the opportunity is now.
You started looking into cryptos when you started actively trading since 2015. But you have more than 20 years experience in the investment business. Why do you do what you do? What drives you, what gets you up in the morning to actually look at another potential investment?
I like the immediate feedback of the markets. At the same time, I am happy to change my mind as the data changes. It allows me to be in an ecosystem where I have this very fast feedback loop. Which leads me to adjust my positions.
In every other endeavor, which is longer term, the cycles are much bigger. As in, you take a decision to build something or do something and the outcome, the feedback will come in months.
For years, in some cases.
For years exactly. You try to trade something. One way or the other, you learn pretty fast how good of a decision that was.
The second one is I do like the multidisciplinary nature of investing a lot. Trying to fuse a lot of data sources and understand, the behavioural, mathematical, statistical aspects.Then compare everything before placing a trade.
Can it sometimes be a very lonely business? How would you have you structured your process or surroundings to actually be efficient in this?
Good question. So in terms of surroundings, I tried to make sure that I always set aside some time where I do not have calls or answer emails. Instead, I try to put my phone away. Actually, I event went through a period where I used an old Nokia with no mechanics..
..which didn’t work, I had to go back to the smartphone. Anyway, having periods of reduced noise is really important. Deep work is extremely important in this business. That coupled with deep collaboration. You need to have people who are going to provide opposing views.
So, these two are very similar, just deep work and deep collaboration.
What they are your up to three favourite finance movies? And also why?
So I have got a couple of movies, which I love:
- The Margin Call, as a movie, cinematically spectacular, the actors were fantastic. And it captured really the mood of what was happening.
- The Big Short is very interesting as well, I don’t think it captures that well, that period, because I think it’s a little bit more spread out in terms of thematics, but it’s really well done.
- Trading Places with Eddie Murphy where he gets recruited by a couple of older dudes to see whether he can be trained to trade.
- Pi, as in the the 3.14 number, which is about a decision mathematician genius, who is going nuts trying to figure out if there is a pattern to the universe, and this universal patterns can translate to indexing the market.
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