Cofounder Morpher.com | Previously @ Apple, StartX, Stanford Engineering
Cryptocurrency usually goes hand in hand with speculative trading practices. For the most part it’s devoid of traditional investment practices. From the way cryptocurrency is offered, ICOs and Airdrops, to the exchanges that it’s listed on – cryptocurrency doesn’t easily lend itself to traditional investing principles.
It’s not a big surprise that Warren Buffett; the Oracle of Omaha, the king of value, the sage of traditional investment, has described Bitcoin as “rat poison squared”.
However over time the asset class is starting to mature, with plenty of interest from institutional investors in 2019. And they invest like Warren Buffett – passively, and fundamentally. Here’s what it takes to imitate great value investors and invest in Bitcoin just like Warren Buffett.
Just like stocks, there are thousands of cryptocurrencies in the world, and each one promises to be “the next Bitcoin” (a la “the next Apple”). Before even beginning to tackle some of the issues in asset pricing, and gauging supply and demand, it’s important to start with the basics.
Warren Buffett always aims to have a complete understanding of the business. Likewise, you need to ask yourselves; do you understand this crypto coin?
Every cryptocurrency project has a problem that they are trying to solve. They have a mission and a vision for the coin and the company. Bitcoin was created to satisfy the need of making a transaction between individuals without the banks.
These types of details you will find in the Whitepaper of the coin offering, usually on the developer site. Understanding the problem is the first step in determining whether the cryptocurrency has real potential or is just a pipe dream.
Moreover, it’s important to assess the ability of a market, and the development team, to reach its objectives. The problem may be clearly identifiable, and the solution proposed via crypto may be a good idea, but will the team be able to execute it?
Often the product road-map of a cryptocurrency project falls victim to typical planning mistakes: linear forecasts, the hockey-stick fallacy, and the 20/80 – 80/20 mistake (focusing too much on forecasting growth vs expenses, and vice-versa).
Ultimately, a crypto project may tick all the boxes, and still fail because of regulatory roadblocks. Make sure you are confident that the entire venture is feasible in its current state.
“The key to investing is not assessing how much an industry is going to affect society, or how much it will grow, but rather determining the competitive advantage of any given company, and above all, the durability of that advantage.” - Warren Buffett
The cryptocurrency and blockchain community often resembles a tightly knit troupe, especially among developers. For the most part, everyone is there to lend a helping hand, because so much of the technology remains unexplored, or with little coverage.
However, at the end of the day, the crypto market is extremely competitive.
Notably, a lot of cryptocurrency projects attempt to solve the same problem; simplifying peer-to-peer transactions. While many will produce compelling solutions, odds are that very few will ever get within spitting distance of accomplishing their goals.
The barriers of entry for getting into the crypto world are extremely low. A single developer may launch a project from their bedroom, or an entire corporation can get behind bringing a new idea to market.
Just like Warren Buffett says, when investing, make sure that you pick the companies – or crypto – that has a durable competitive advantage. Some example of cryptocurrency-specific competitive advantages are:
Without a sustainable competitive advantage the potential success of the project may attract competitors with enough resources to seize market share from the original project.
Warren Buffett doesn’t trade, he invests. The difference is a crucially attributable to Buffett’s success as an investor. He believes that you should only have to buy a stock once, and hold on to it forever.
While it is important to have an exit criteria to determine whether you should sell an investment or not (based on availability of new information), it’s best to approach the process of investing with finality.
In the argument of active versus passive investing styles, Warren Buffett is a big proponent of passive investing, and it translates well over to crypto. If you’re looking at a potential investment in a cryptocurrency and your interests are short-term you are most likely assuming a lot of volatility and risk.
By looking at the broader picture, and holding positions for longer periods of time, you allow the price-discovery process of the market to adequately value the coin, as well as monitor the use-case of the project evolve and adapt.
Over the long term you are also able to look back and reflect as to whether the developers or backers of the project are following their own plan, and if not, what has caused them to deviate from the roadmap.
One of the most important aspects will be how the project team faces financial, regulatory, and product challenges.
One of the unique characteristics of cryptocurrency markets is that they’re truly trading 24/7. Unlike stocks, there is no cool-off period and consumers jump in and out of positions on the weekends.
Retail investors see this as an advantage, and there are ways to leverage 24/7 trading in stocks as well. However, with more opportunities to rethink your trade comes higher volatility.
This selling pressure is tough to stomach when holding on to your positions.
Warren Buffett would argue that it is impossible to time the market, so don’t bother worrying about it. You will achieve the highest returns through passive investing, and not fall victim to over-trading.
As long as you believe in the fruitful characteristics of your crypto investment, there should be no reason for you to sell.
Warren Buffett famously invests in companies that are easy to understand, and easy to measure. This is why a lot of his investments are in consumer discretionary, consumer defensive, and cyclical companies.
There are a number of ways to apply this principle to cryptocurrency value investing.
If you are interested in investing in a cryptocurrency, consider what results or metrics would benefit it fundamentally.
For instance, if you believe in Bitcoin due to it’s wide proliferation and use-case as the most popular for peer-to-peer transactions, perhaps you would be interested in which companies accept Bitcoin as a payment.
Or if you’re interested in the extent of using Ethereum in blockchain, you may be interested in what are the most popular ERC20 tokens.
With that in mind, as an extension to the test of feasibility, consider the legal hurdles that may impact the usability of the cryptocurrency, and by effect – the solution that it proposes.