Thesis: Investing in a Technology Bubble

Note: This investment thesis was originally written in November 2017. 

Cryptocurrency is a digital currency in which encryption techniques are used to regulate the generation of units of currency and to verify the transfer of funds, operating independently of a central bank. The most successful cryptocurrency to date, Bitcoin, is now valued at $150 Billion which places it above the majority of country’s currency in circulation.

Cryptocurrencies have since evolved from simple stores of value to digital tokens that can be used as representations of assets, shares, proof of membership or, most impressively, Turing-complete programmable money. These new tokens and their corresponding cryptonetworks are the foundation for an exciting new decentralized world (Web 3.0).

These cryptonetworks are launched via public and private sales of their tokens called Initial Coin Offerings(ICO).  After the ICO event, the price of the tokens is determined via open exchange on a number of fiat and cryptocurrency exchanges globally.  As a result, the price of a token increases (and decreases) in value together with perceived value or usage.

In 2017, ICO based fundraising surpassed traditional equity-based fundraising by 5x. Yet, only 2 months into 2018, 59% of the Bitcoin backed ICO’s in 2017 have already failed or semi-failed, and this number will only increase.

Accounting for this extreme risk of loss and the fact that simply holding Bitcoin would have yielded a greater return in 2017, it is clear the majority of price increases from most tokens are not from realized value but an increase in speculation around this exciting new class of crypto assets. Many are now justifiably suggesting we are in a crypto-bubble akin to that of the dotcom bubble of the 1990s.

Unlike most, we think bubbles are great! For it is in the fervor of bubbles that new and exciting technologies and infrastructure are built. This cycle of early technological development, followed by overinvestment leading to a bubble, followed by a crash, and then subsequent maturation of the technologies as it reaches adoption, can be seen in the United States’ adoption of Telegrams, Railroads, and most recently in the 90’s Dot-Com Boom and Bust.

It’s objectively difficult to watch that AMZN stock bought at its bubble peak of $100 in 1999 drop to $5. If you held through to today, you’d have realized 72% annual returns($1400), as demand for the new technology gains traction beyond Early Adopters. This maturation of technology adoption happens because of the dynamics of a bubble popping, and the resulting increase in supply after a bubble pops.

At Prime Radiant, it is our core belief that the key to investing in a bubble is as much about avoiding those businesses that will fail, as knowing which ones will not only persist but thrive in downturns.

Opportunity: Where We See Value


How does Prime Radiant pick those that will persist in this new decentralized world? Simply put, we invest in those who are providing real value to real users. There are immense fortunes being made and lost speculating on which cryptocurrency is going to jump orders of magnitude in price in a single day. This to us is gambling.

Instead, our focus is on investing in those with business models that are enabling others to take part in this new ecosystem. As our namesake suggests, we are firm believers in the self-fulfilling prophecy. The best way to predict the future is to build it.

During the San Francisco Gold Rush, the lion’s share of profit was not realized by the gold miners but by those who serviced and supplied them with picks, shovels, and Levi’s. And when the gold rush went bust, these same companies persist because they could pivot their businesses to different customers and products.

We are seeing the same thing in this digital gold rush. While a few early adopters have made great fortunes getting early into a cryptocurrency. Today, the majority of profit is being realized by service companies like Coinbase(exchange/payments) or Bitmain(supply mining hardware). These companies don’t depend on price movement for revenue and can quickly retool to adapt to shifts in technology.

If you just recently found out about or invested in this new market, it might be too late for you to gain exponential returns from the initial rush into cryptocurrencies. But it is still early days for the applications and tools being enabled and built on top of these new networks.

Market Fundamentals


Many funds are struggling with evaluating this new asset class. How do you determine a price multiple of a non-cash flow generating entity? Should cryptocurrencies be valued as currency, equities, commodities, or some sort of hybrid?

While there is a lot of exciting research in the area of cryptonetwork economics, in it’s current infant state, it should not be depended on too strongly for making investment decisions.  Luckily, the majority of our experience is with early stage ventures, where you often only have a few people and an idea.

At their foundation, every network, organization or business is people. And in our experience the strongest indicator of future success of a venture is the team. A large downside of instant price liquidity is falling into the trap of making short term decisions based on equity/token price.  Investing in strong teams, who do not fall prey to chasing short term price gains, is where long term value can be created.

Scoring Metric

The second strongest indicator is the fundamentals of the venture itself. In lieu of quantitative tools, we must use qualitative measurement. In order to go about this objectively, we developed a scoring system (below).

Product:

We invest in teams that love to build. While building a sustaining business often requires significant capital, bringing a prototype live on a test-net only requires determination and a few weekends. Our preference is to identify products in Early-Alpha phase of development, where the value is not often realized in the price.

Team:

We rate teams that have built something together before most highly and anonymous teams the least. We understand that Bitcoin’s creator was anonymous and that in this space there are applications which require anonymity. But in this market, the majority of anonymous teams are scams.

Decentralization:

The value proposition of a decentralized consensus mechanism is to have trust-less applications. We rate tokens with built-in governance most high, but also give points for those with plans to implement in the future, as this is a complicated problem worth taking one’s time to do right. However, If the app or protocol at its core requires users to trust the service provider, it’s no different than traditional web apps or protocols, just with additional cost.

Security:

Crypto is cryptography after all. We most highly value projects which are open source, run bug bounty programs and perform regular audits by experienced security researchers. We do not invest in anyone who rolls their own cryptography. If a cryptocurrency is not provably secure cryptographically, it has no value. This is also why we do not value closed source. If we can’t verify methods used to secure, we assume it’s insecure.

Cryptonomics:

The majority of ICO tokens are not required for the proper functioning of their underlying network. This is difficult to see in a bubble, where price is purely speculative but creates an opportunity for those who can identify crypto-networks with essential tokens. We value most highly those ICO’s which return a software-defined dividend, and whose assets are controlled by the token holders. Utility tokens we value neutrally because they could create value without realizing price increases.

Community:

Regular communication with your community of users and stakeholders is the bare minimum for any publicly funded project. Radio silence or price-focused updates are rated negatively. Beyond simple communication, we strongly value teams that create tools and api’s for external developers to build on. This can be a cost-effective way of multiplying network value. We most highly value teams which are capable of collaborating in value-adding ways with businesses outside the “crypto-world”.

Of the 1541 assets listed on coinmarketcap, we have identified 20 assets with positive scores.

Pricing Tokens

Once we identify an opportunity, the final and most difficult step is to place a quantitative valuation. At Prime Radiant, we minimize the assumptions that a cryptocurrency valuation requires by focusing on specific token asset classes: Tokens which provide equity in a dao, a software defined dividend (or burn), coupon, or are used as a stake in a cryptonetwork. With those class limitations, we can utilize traditional valuation frameworks adjusting for stage of development.

In our experience this method tends to give very conservative valuations, but has not limited our ability to invest. In fact, entering positions at such conservative valuations successful decreases our exposure to bear markets. As the crypto world is no different than the real world, if the project is perfect but the price is too high, you don’t buy.

Coincidentally, all of the 20 positively graded publicly traded assets fall into one of the above asset classes. With 7 of them trading less than their operating balances. We are confident this method will realize great returns at much lower risk than simply holding an index of all crypto assets.