James Wo’s 2019 Blockchain Ecosystem Analysis
Throughout this analysis, I will share three relevant topics that we, at DFG, consider to be the base for our assessment as a Venture Capital firm in the Crypto Industry, along with my personal insight on each point. I’ll begin by describing the conditions of the global investment landscape, followed by our current allocation distribution, and conclude with my predictions as to what we can expect in the future.
Let’s begin with a review of global crypto investments and what other investment firms are doing at the moment.
Global Investment Landscape
First, let’s take a look at the overall size of the funds in the market. An important number here is 150%, which is the growth seen in the number of investment firms when comparing 2017 to 2019. Even though it’s a “super” bear market, we can see that the number of crypto funds is still rising and have reached over 800 firms, a very complicated task under the current bearish circumstances. This is a clear indication that the industry is going in the right direction. Another very significant number is 48%, which indicates the U.S. market domination regarding investment firms. Nearly half of the funds belong to firms in the U.S.A, followed by Hong Kong and China standing second, with about 9%. There’s still is a huge gap between the U.S. and China, however, my prediction is that in the near to medium future there will be more funds established in China and Asia. I think the U.S. lead dominance in investment firms will decrease and, for some promising countries in Asia, there will be more funds established resulting in a better distribution of the investments and fund landscape.
Second, let’s take a look at assets under management (AUM). Overall the total market capitalization of crypto investment funds makes up less than 1% of total traditional asset funds, which is pretty small, and over 60% of these crypto funds have less than $10 million AUM, so a lot of small and middle-sized funds have been established, concluding that the industry continues to grow at a steady pace while still in an early stage. Which brings the question, what kind of projects or companies are attractive to those investors?
It seems, that exchanges and trading related businesses have been obtaining most of the financing during this bear market, on the other hand, wallets, payment solutions or related services have had a decrease in investments. I believe that’s because the majority of funds are trying to gain more certainty when investing in a bear market such as the current one, so right now, the amount of revenue and profit you obtain is of extreme importance. In other words, we can observe that the trend has become investing in businesses with a low degree of uncertainty under these market circumstances, because high-risk businesses in this industry, at the moment, encounter a high level of difficulty when aspiring to raise money. Trading services and exchanges are what we would consider reliable and low risk, where said business models have been confirmed through clear financial data and have verified revenue and profit results.
Now let’s move on to the stages of fundraising. It seems that recently most active crypto funds have focused their investment efforts towards Series A and Series B stages instead of gambling on seed round funding, which is a good sign for the industry’s development process on a long-term perspective since it means a lot of startup companies have moved on to more advanced development stages.
We also have to consider the Venture Capital sector of the industry. What is DFG’s unique vantage point when compared to other well-known firms within the area? Digital Currency Group, Pantera Capital and Blockchain Capital will be our comparison points in this particular case. Digital Finance Group was founded in 2015, slightly later than both Pantera Capital and Blockchain Capital, yet the AUM DFG holds is slightly larger than Pantera Capital and Blockchain Capital but amounts to approximately one-third of Digital Currency Group’s capital, but this is exactly what makes us stand-out among the compared institutions. DFG has only made 20 investments in this industry, combining equity and protocols, which we consider defines us as high-end strategic investors with a high-performance threshold that has to be achieved before we can consider being involved in any given project.
DFG Investment Distribution
Moving on to Digital Finance Group’s allocation and investment details
To date, we’ve established a high number of investment vehicles, mostly in the U.S. and Asia. Specifically, in the U.S., DFG has set up three instruments, a hedge fund, an equity fund, and an incubator focused on investing in early-stage startups being built on top of Ethereum Classic. In Asia, we’ve developed an OTC market, a crypto fund, and a hedge fund.
DFG’s Investment Philosophy
Regarding our investment portfolio, you can clearly observe that our main interest is defined within the following outlines: First, protocol business level. I am convinced that if the public blockchain industry didn’t exist, the whole blockchain industry would disappear, so as a result, we are big supporters of public blockchain projects, as an example, you can see we hold Ethereum Classic, Ethereum, Bitcoin, Polkadot, and Cosmos. Second, for other use cases and applications, we pay special attention to exchange related businesses. We’ve invested in Circle, arguably the largest OTC market in America, we’ve invested in LedgerX, a company that has been granted licenses, on a retail and institutional level from the CFTC. We’ve also invested in the largest exchange in Mexico, Bitso; the largest exchange in India, Unocoin; and the largest OTC exchange market in Latin America called Ripio. These investments will assure us a great deal of certainty and growth.
In addition, the growth of the overall market will increase the trading volume in the secondary market taking into consideration that investing in this sector also contributes to the increase not only of the price but also the trading volume in the exchange. So, in general, we’ve concluded it’s a good bet to invest in exchange-related businesses.
Just as well, when we consider business models that have not yet been verified, we are a bit cautious, but we have certainly invested in extraordinary cases, such as Brave Browser. They have recently passed the 10.4 million daily active users (DAU) mark, which is statistically pretty amazing. I believe they’re the platform within the industry that can generate the most traffic in the upcoming years. Another particular case is Bloq, founded by Jeff Garzik, the board member of the Linux Foundation and former Bitcoin Core team member. Previously, they were doing enterprise blockchain solutions, but now they’ve shifted their focus towards other use cases and business services. Overall, we are very cautious about betting on particular use cases where models have not yet been verified, but I made these specific investments only because of their founders, Brendan is the father of Java Script and Jeff Garzik is renowned for his notable technology background.
In the past, we’ve been using our own capital when investing and at the moment we’re managing approximately 550 million USD, and it’s pretty much equally divided in primary and secondary market assets. The primary market assets account for approximately 250 million USD while the secondary market assets account for roughly 300 million USD. We have also built a hedge fund to actively use our gained trading skills and expertise with the support of high-frequency trading technology. Lastly, we’ve also established a token fund in China as well.
So right now, our strategy is centered on being diversified within the parameters I’ve mentioned before. We’ve invested in equity, tokens, protocols, and a different array of businesses because we are not keen on missing any future investment opportunities, as long as they reach what we consider as minimum requirements.
I believe, in a very short and simple way, investment is just about liquidity and return, and on a personal level, what really gets me excited is public blockchains. Nevertheless, we can see numerous interesting things happening as well. It’s similar to having a large number of applications on the internet. We have Facebook, WeChat, WhatsApp, Instagram, and so on, but you need a solid foundation for them to work on, you still need Windows, you need Linux, you need iOS. Without these, I don’t think any use case or application can be useful or have a future. With this said, we can clearly define what we are currently, we are not only at the building use cases stage but also, trying to lay a solid foundation as a whole. I believe, at the moment, there are still a lot of undeveloped ideas being executed on the public blockchain itself, and that’s why it’s a golden moment for us to invest and assist in building those ideas.
Personally, I believe there are two fundamental steps to successfully run or build a public blockchain. The first is about ecosystem expansion, you definitely need a solid base layer technology and a wide variety of applications. The second and more crucial step is the need for capital to support said ecosystem, we need huge amounts of capital. Because there is no revenue model for running a public blockchain.
Based on that, interestingly, we’ve selected one coin, with which we are almost in an “all-in” state, Ethereum Classic (ETC). It’s a coin which has almost been forgotten by most of the retail investor, but we’re really observing huge demands and opportunities here. Regarding the previously stated ecosystem importance, I find the sheer amount of motivating partnerships and accomplishments that are currently happening within the ETC ecosystem very interesting and inspiring. We have ETC Core, BloqCLOUD, Chainsafe and Whiteblock actively contributing and collaborating in the development of Polkadot, Cosmos and Ethereum 2.0, they were all built on Ethereum Classic, and this is a perfect example of the solid infrastructure in the ecosystem. Furthermore, you can take a look at different applications coming from the Ethereum ecosystem that are willing and effectively supporting ETC, for example, Metamask, Truffle, Gitcoin and Raiden among others.
New Capital Inflows
Now, taking a look at the ETC market capitalization, or focusing on liquidity in the secondary market, we can observe very special statistics. For example, the daily trading volume sets ETC at #9, the turnover rate sets ETC at #8, looking at the amount of exchanges where ETC is listed, it ranks #8, but oddly it ranks #20 in market capitalization. There’s obviously a huge gap, but why is this happening? Well, because a large group of the top 20 or top 30 coins, according to market capitalization, have a large number of their coins held by, in some cases, one entity, which generates situations where you can have high cap valuations without any organic use or growth. If your circulation amount is only $1M but you have a $100M cap valuation of the blockchain, that’s undoubtedly fake. So, this is the reason for an ETC gap where you’ve got all indicators among the top 10 but a valuation at #20.
Regarding regulatory policies, the CFTC Chairman has expressed that “It is my view as chairman of the CFTC that ether is a commodity […] It stands to reason that similar assets should be treated similarly. If the underlying asset, the original digital asset, hasn’t been determined to be a security and is, therefore, a commodity, most likely the forked asset will be the same,” Tarbert said, “unless the fork itself raises some securities law issues under that classic Howey Test.”. This, in turn, creates a wide range of opportunities for ETC in the future, from investment to development. So, now we’ve reached the point where one of the two strongest economies in the world is adopting progressive policies towards blockchain. In overall I think from a regulatory standpoint the environment has become and will continue to be significantly positive.
After everything I’ve said, I must admit that I personally can’t give any assurances or guarantees as to what will happen to ETC, I can only disclose that I have done significant investments in it. Here’s the thing, we are not only invested or investing in ETC, and this takes me to my next point, what are our intentions in the future? We are going to invest in two type of projects, the first is public blockchains that have the potential to rank among top 20 or even top 10 in market capitalization terms, and second, we are going to invest in different kinds of decentralized applications with verified centralized business models, and we firmly believe that these are probably the coins or equity that will assure us considerable returns.
What is Yet to Come
I would like to conclude this analysis with three predictions. First, all public blockchains ranked #20 or above in market capitalization will disappear. If you compare this with the internet infrastructure, we only have 4 o 5 base layer leaders, so we don’t need 200 public blockchains, most of them are nonsense and will eventually begin to disappear, therefore all public blockchains will face very strong competition in the near future. Second, regulated businesses will have better odds to succeed in this highly competitive and systematized industry, this has not been true in the last 2 or 3 years, we’ve seen a lot of immature and unregulated businesses grow a great deal, but right now the policies are changing in China and in the U.S., therefore, you can easily predict that in the future it will be a regulated business dominated market. Finally, and this is a hot topic where people will completely agree or completely disagree with me, and it’s that it’s time to buy Ether, I think when BTC’s price rises in the second half of this upcoming year I fully expect Vitalik to drive Ether to the next step, PoS, and it will most likely be a pretty successful transition and the price of Ether will increase a great deal as a direct consequence, opening the doors for ETC to follow and also increase in coin price and market capitalization.