The purpose of this overview is to highlight the core economics of DLT and cryptoassets. We also explain how best to exploit the tremendous investment opportunities that have emerged in this space. Distributed Ledger Technology, or DLT, with blockchain as its most common form, has numerous key benefits:
- Distributed architecture, making it more resilient to outside attacks
- Harder to tamper with data
- Increased transparency and easily auditable
- Aligns the incentives of Data Subjects, Owners and Controllers
The real power of DLT is, however, its ability to enable the decentralisation of certain processes which previously could only effectively be centralised. These include money, value creation and value transfer, proof of ownership and creation of networks. This decentralisation can, however, only be achieved by using cryptocurrencies.
DLT and crypto assets go hand in hand. While DLT is the technological innovation, crypto assets are the economic innovation. While cryptocurrencies remain the application for DLT which receives the most publicity, the implications of this innovation go far beyond just a digital currency. The core proposition of cryptocurrencies is not for them to be used as primary means of payments like fiat currencies. They are a different form of money altogether. Cryptocurrencies enable something which was not previously possible, which is effective decentralised governance through clever economic design. In the absence of a centralised authority that can unilaterally enforce “the rules”, a cryptocurrency’s design needs to ensure that it is profitable for participants to add value to a platform, and that it is prohibitively expensive to harm the platform. This is the core role of a cryptocurrency, similar to how traditional money works, incentivising people to undertake economically beneficial activity. Cryptoassets are the next evolution of a more inclusive and democratic capitalism, and the importance of this decentralisation should not be underestimated.
This decentralisation allows the technology to solve three key fundamental economic issues:
- Disintermediation, helping to cut out expensive middlemen who may also gain and exploit excessive market power. It is hard to exaggerate how transformative this will be in the financial sector.
- The solution to the hold-up problem, enabling multiple companies to undertake investments together, with higher levels of confidence in mutually beneficial projects, without fearing that the “rules of the game” could be changed unilaterally by a network owner. Note that granular reorganisation of the innovation and production network around DLT is already happening.
- The disintermediation of network monopolies, providing a potential solution to the competition concerns that regulators and legislators around the world have about the tech giants, who benefit massively from the network effects of their platforms. Note that the shared ownership of the network can also generate a virtuous cycle of growth, using tokens to incentivise participation and contribution to the network.
Industrial Revolution 4.0
Source: PwC, Aaro Capital research
Looking at the bigger picture, DLT and cryptoassets are key to the Fourth Industrial Revolution and its use cases are intertwined with technologies such as the Internet of Things, Big Data (IoT) and Artificial Intelligence (AI). Cryptoassets form a next generation, value-based internet. In the same way that HTTP and HTML are the platform of the World Wide Web, Ethereum and other cryptoasset networks are the platforms of Web 3.0. Web 3.0 is the integration of Industrial Revolution 4.0 technologies and native value management into the internet. So far, financial payment rails have been kept separate from the Web, but in a digital world where data, money and value are so intertwined, this separation makes less and less sense. In the same way that the Web today enables many services, software built on Web 3.0 is already providing a wide range of valuable services to consumers.
Web 3.0 via DLT
Source: Aaro Capital research
Web 3.0 Use Cases
Source: Aaro Capital research
This technology has the potential to disrupt virtually every industry and has applications throughout many different value chains. Key areas for disruption are finance, insurance, healthcare, supply chains and digital identity. Governments, banks and other large corporations are now getting behind both DLT and cryptoassets. Many established companies, ranging from Facebook to Amazon to Paypal, are now involved.
How to gain exposure to DLT and cryptoassets:
- There are many ways for Professional Investors to access the DLT and cryptoasset growth story, but the real challenge is being able to gain exposure in a properly risk-managed and dependable way.
- We are arguably at the same stage of market development as Hedge Funds were in the 1990s. Like then, there is a shortage of widely available information about funds and other investment vehicles in this space. At Aaro Capital, we speak to a large number of managers every month and much of this comes from our vast network. Many of the best managers cannot be found “off the page”.
- We believe that investors who are less familiar with this space should consider a dedicated Fund of Funds, managed by specialists in this area. This not only provides access to the full range of opportunities available, but also avoids some of the operational and other pitfalls in a space that is still in the process of maturing.
- There is a famous quote from Harry Markowitz: “Diversification is the only free lunch in finance”. Whether you believe in this school of thought or not, we believe that, in a space as diffuse and volatile as this one, there are real benefits to portfolio diversification.
- Active DLT and cryptoasset funds have outperformed the cryptoasset market significantly over the last six years, with a third less volatility and half the maximum drawdown. The best strategies based on diversified allocations, have performed even better.
Active Crypto Fund Outperformance
Source: CryptoCompare, MVIS, Aaro Capital research
article written by Peter Habermacher, Chief Executive of Aaro Capital.