Investing is separated from gambling in large part by the set of fundamental truths investors can always fall back on:
- Diversification of a portfolio with uncorrelated assets decreases risk.
- Exposure to risk increases the probability of reward.
- Past performance is no guarantee of future results.
There is value to having these universal axioms in our back pocket—on red days and green days, pumps or dumps, we can look at them and apply an untainted perspective to our portfolio.
While the above points are true across investing, each different investment has a set of these principles that are only applicable to that specific asset class.
Today, I’d like to address some universal truths that are a bit narrower in scope: advice, axioms, and principles that are specific and universal to investing in cryptocurrency.
Understand Risk
Most people who have the conviction that Bitcoin will go to $500k may make an error when evaluating risk by not seeing all of the risks.Of course crypto investors understand the most apparent risks when buying Bitcoin:
- Volatility Risk, the risk that the price of an asset may fluctuate wildly
- Market Risk, the risk that all assets face as markets rise and fall (part of this is the risk of Bitcoin going to zero)
But other risks must be understood as well:
- Opportunity Cost, the cost of investing in Bitcoin over investing over another asset. Part of this is related to volatility, the likelihood that there might be a lower entry point where you could make more money.
- Regulatory Risk, the risk that Bitcoin or any other cryptocurrency might be regulated out of existence
- Operational Risk, the risk that cryptocurrency might be attacked, hacked or that the internet might go down and you won’t have access to your money
- Inflation Risk, the risk that good returns will be nullified relative to a specific currency’s purchasing power
There’s another type of risk that’s rarely touched on, but exists:
- A type of Liquidity Risk, the likelihood that you’ll have the conviction to hold onto an investment should it dip or should you have to pay some obligation. Maybe Bitcoin goes to $500k, but you were forced to sell at a loss due to some type of personal liquidation event.
All of this leads to a universal truth: even if you knew Bitcoin was going to $500k, you’d still have to consider these other risks. Cloud you withstand a 99% drop? Should you wait for a drop? Do you have obligations to pay? How long will it take to reach your target price?
In a bullish environment where we focus more on price predictions than risk predictions, it’s vitally important to consider these other factors. A good high-risk investor will have an explanation for how to manage every single one of these risks.
Be Non-Consensus Right
For an investor to participate in high-risk cryptocurrency markets, high returns must be on the table. But what’s the best way to make high returns in this market? By being non-consensus right.
The necessity of being right is pretty obvious: if an asset is not effective, not adopted, has no use cases, it will go to zero.
Non-consensus right is a different story: US treasuries are considered the least-risky asset available. You could be right in assuming that they’re going to pay regular yields, but the opportunity to make money is limited because it’s assumed that the payout is secure.So the opportunity to make high returns is when we go against the agreed-upon norms: if we were to short US treasuries, and then the government went bankrupt, we’d stand to gain tons of money.For cryptocurrency, we must seek these non-consensus opportunities. Look for divides and disagreements in the community, or better yet, universal opinions. Do you believe in a low-market-cap crypto? That presents a great opportunity for high returns.
Do you think that Bitcoin is going to zero? That's another opportunity to go against the consensus (although keep in mind that sometimes the consensus is correct).
Good high-risk investors seek the opportunity to go against the grain.
Seek Out Inefficient Markets
One of the reasons we’ve seen such incredible opportunities to make money with NFTs s the fact that it’s a low-liquidity, information-inefficient market. Those who can find out about new trends and capitalize on them are those who have made a killing.
Markets can also be inefficient in periods of low volume, ultra-bearish activity, ultra-bullish activity, or in early stages of existence.
If the underlying asset is creating wealth, you’re even better off. While the art market is inefficient, it doesn’t create a lot of new wealth as it’s inaccessible. The accessibility of NFT markets and the fact that it allowed many people to unlock the value of their creations means it’s a tremendous opportunity.
Altcoins are also a good space to apply this philosophy. Low liquidity can be a double-edged sword, benefiting you or making it impossible for you to exit a position. Information efficiencies also apply here.
Double Down on Winners
The importance of the ability to double down on a successful investment is illustrated in the popularity of Pro Ratas in venture capital, a contract stipulating that an investor who has already invested also has the first right to future investment opportunities in that copany.Venture capitalists and angels understand that we should bet on winners, not losers. A good asset at a fair price often performs better than a bad asset at a great price. Bubbles should not be wasted.
Unite Concentration, Risk, and Diversification
nvesting is about executing and compounding judgement. Two investors starting with the same amount of capital, with one of them having just 10% better judgment, will have wildly different outcomes over the long term.
I’ve always had a difficult time mentally merging these concepts that tend to be contradictory in practice. Take, for example, the following quotes:
“Diversification is protection against ignorance. It makes little sense if you know what you are doing.”
- Warren Buffett
And:
“If you make 100 investments and just one yields a 1000x return, the other 99 investments could go to zero and you would still see a return of 10x for your portfolio.”
-Naval Ravikant
These two investors are not diametrcally opposed by any means, in fact, I’d argue that they’re much more similar than different: longtime investors, each with many compounding, mid-sized successes.
These two opposing ideas can be unified by something called the Kelly Criterion.
If you were to place an even money bet (a bet of $1 pays out $1) on a coin that landed on heads 60% of the time, with 100 opportunities, and you were given $100, how much would you bet each time?
Well, the odds are in your favor—so perhaps you should bet the entire amount?
No. If you lose that first bet, you’re left with nothing, and thus your advantage is completely nullified. You must bet a small fraction (there’s a mathematical answer to the equation that I won't get into) to maximize your earnings.
How does this apply to crypto? Well, a nearly-sure bet on a high-reward outcome isn’t, by any means, a sure thing. Capital preservation with high-risk investments is the name of the game. Diversify between high-risk bets. Understand that with a lower risk or larger reward, the larger your optimal bet becomes.
Becoming a Sophisticated Investor
To be successful, a cryptocurrency investor must create a system in which they can be disciplined, math-driven, reflective, calm. The higher the risk, the lower the margin for error.The principles will remain the same, the investors, assets, returns, and market conditions will always change. But crypto markets are far from efficient, and periods of outstanding returns are far from over.
Follow your own rules, understand your own risk tolerance. Do it right and there’s plenty of money to be made.
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