Blockchain Asset Selection: Why the Protocol Layer Captures the Most Value
The highest ROI is in technologies that provide value to end users. In the case of blockchain technology, the protocol layer will capture the most substantial user and investor value.
Blockchain technology is developing rapidly. Over the last years, numerous blockchain startups announced the next blockbuster applications – but many of them disappeared almost as quickly as they had arrived. It’s difficult to predict the pace of adoption and the direction of technological progress. That’s a challenge for fund managers: With technology as early-stage as blockchain, identifying the best assets is like finding the needle in a haystack.
Portfolio diversification and active portfolio management are key to success in blockchain markets
Although investments in new technologies can yield excessive returns, they also require significant risk management efforts. Portfolio diversification is the key to success. In the current blockchain market environment, it’s even more important to be diversified, because accurate long-term value predictions are impossible.
Unlike an index fund, INVAO Group’s IVO Blockchain Diversified Bond is backed by an actively managed portfolio. Being benchmark unaware, IVO escapes from the constraining risk-reward relation of an index fund. Instead, the portfolio allocation can shift quickly and across the entire blockchain asset class. When selecting assets for the IVO bond’s underlying Blockchain Asset Pool, INVAO Group’s portfolio managers will screen the blockchain market and pick the 150 most promising digital assets.
We look at the fundamental data of the asset itself such as market capitalization, exchange listing, or asset liquidity. Additionally, we also evaluate the exchanges on which the assets are listed, analyzing security measures, custody solutions, insurance policies, liquidity data, and the reputation of the exchange. We will then cluster the most promising 60 assets into predefined categories with adjusted risk parameters and position sizing.
Investing in early-stage blockchain technology means investing in the protocol layer
During the asset selection process, INVAO focuses on protocol layer projects, as this is where the most value will be generated in the years ahead.
When the internet first appeared on the public radar in the early 1990s, which internet company would have been good investments? Google? Facebook? – Both companies would have generated stellar returns for early investors, but they were not early-stage internet companies.
Google was founded in 1998, Facebook in 2004. Even Google was a relative latecomer. WebCrawler, Lycos, AltaVista; there were many search engines before Google, yet none of them has achieved the same level of success, not even close.
The comparison between the internet and blockchain technology might lead blockchain investors to an investment fallacy: It is still too early in the growth cycle, successful applications will follow later, some might argue. But they miss one key point: At the time the internet was developed, there was no internet. Thus, building applications that add massive value for the end user only became possible at a later stage of the growth cycle.
The blockchain universe is different:
Even though blockchain is early in its growth cycle, the infrastructure needed to build decentralized applications already exists in a centralized form today. That makes it possible for the end user to directly benefit from the value proposition provided by the protocol layer.
During the early days of the internet, end users could barely benefit from the development of the protocol layer. What could an unsophisticated internet user possibly do with HTTP or TCO/IP? Not much. It needed companies like Google or Facebook to build applications on top of it.
On the contrary, in the decentralized blockchain universe, users can directly leverage the protocol layer’s value proposition. We can for example buy and trade Bitcoin. Sure, it needs a digital wallet and access to an exchange, but the wallet or exchange do not provide the most value to the user, Bitcoin does. In comparison, in the case of the internet, HTTP does not provide any real value to the end user, applications like Facebook, Google, or Netflix do provide value.
Value generation for end users provides the highest ROI for investors
From an investor’s point of view, in the long-term, the highest ROI will be in those projects that provide value for the end user. In the case of the internet, HTTP or TCP/IP captured zero value, while companies like Facebook, Amazon, Netflix, Google, which own the end user, made billions.
In the case of blockchain technology, users can directly engage with the protocol layer. Therefore, the protocol layer is where the most value will be generated. Bitcoin for example has aggregated the base layer and the application layer. Bitcoin does not need another protocol to build on, it directly owns the end user. Thus, there are no application protocols that can be built on top of Bitcoin and commoditize it.
Bitcoin-related applications themselves are in fact just user interfaces that add relatively low value to the user. Such applications are for example digital wallets, exchanges, or custody services, provided by companies like Coinbase. As of today, Bitcoin is worth more than $90bn. In comparison, Coinbase, one of the most highly valued Bitcoin companies in the U.S., is valued at $8bn.
All of the above considerations are at the core of INVAO’s investment strategy: As the protocol layer will capture the most substantial value, that’s where we focus our investments.