In an asset class that has been historically perceived as very-high-risk/very-high-reward, altcoins are a step above. We often hear of 1000x returns for some smaller-cap altcoins, others return 100x in a month, it feels like nearly every cryptobro has a story of a 5x return.
And while the volatility can get pretty nasty, the truth is that these assets consistently trend up. To get a broad look at altcoins, I like to check at an index of the top 125 cryptos excluding Bitcoin and Ethereum (you can find it on TradingView as Total3).
From January 1st, 2021 to the local peak on May 12th, the total market cap of these altcoins collectively climbed 634%, a comfortable 7x. But things got ugly in the summer, dropping 64%—meaning if you would’ve invested $1000 proportionally spread across all of these assets, your portfolio would be down to just $350. Ouch.
But if you would’ve put that same $1000 in on January 1st, your roller coaster ride would’ve been even crazier: up to $7000 and then back down to about $3000. So even though the market put in a heavy correction, you’re still up 3x.
This pattern repeats: while alts experience frequent, violent corrections, the overall market cap of alts over time increases, which means an index-style investment trends up despite the volatility (and at a much faster rate than traditional finance indexes).
All of this put together leads to a question: why have small-cap cryptos outperformed pretty much every major investible asset class? Take a look at 2021 (you can see exactly what asset/index each line represents in the upper left corner).
Total3 wins over Total2 (the top 125 crypto assets excluding BTC) by about 40%, while it wins over 3rd place BTC by over 500%. For me, the odds of their sustained success is enough to bet my career on—that’s why I founded Crypto Pragmatist, a publication dedicated to the analysis of altcoins. I think this industry is strong for a few fundamental reasons, all of which represent serious paradigm shifts in markets.
Let’s dive in.
The Internet of Value: Peer to Peer Networks
Peer-to-peer exchange is the origin point of most value transmitted in our world. If we dive into where wealth is created, where ideas are developed, and where the value captured by businesses truly originates, it comes primarily from peer-to-peer transactions.
That’s the layer on which everything else is built. But for much of human history, we’ve had to use intermediaries—third parties that help facilitate transactions due to logistical problems or trust issues between players. And those intermediaries are extractive, making their money by sucking out profit from these peer-to-peer value transfers.
But what if the people actually creating the value owned the means of exchange? Or even better, what if the people creating the value owned the network, and the network itself was distributed, decentralized, and peer-to-peer?
All the value that was once sucked up by intermediaries now becomes distributed thanks to peer-to-peer networks. Bitcoin is the basic unit of value, Ethereum is the base layer for the network, but altcoins? Altcoins and the protocols they represent are now the communally-owned intermediaries that represent the infrastructure of these value transfer networks.
People often think the fundamental value of cryptocurrency is due to its decentralized structure, or the fact that there’s no central bank that plays with supply. I see the fundamental value in altcoins as the removal of intermediaries and the recapture of that value by peer-to-peer networks.
Most people think about leverage in financial terms: the ability to borrow capital and use it to amplify returns (or amplify losses). A 3x ETF would be an example of this; borrowing money to invest is a form of leverage as well.
Crypto protocols access this capital in a multitude of ways. Venture capitalists buy ownership stakes, protocols leverage the value locked inside by lenders, stakers, and owners, lending protocols work as well to amplify capital.
But altcoins don’t just use capital leverage, they also use code and human capital to amplify returns. Think about a DAO (digital autonomous organization) that uses the power of an immutable blockchain to allow actors to vote and direct human capital within: that’s a novel way to manage leverage.
Code, the final form of leverage that sets these protocols apart, represents nearly infinite leverage. Once a protocol is deployed on the blockchain, it is truly costless to reproduce. A cryptocurrency-based protocol has no marginal costs like a factory might; it can coordinate $1 million dollars of economic activity or $100 billion at no additional cost to the protocol creators and owners. This (free) code leverage allows these protocols to expand at exponential rates.
Exposure to International Markets
Cryptocurrency doesn’t just open a door to a new industry, it opens a door to a new group of investors. Many US investors don’t quite understand how difficult it is to purchase US equities abroad, but the barriers are numerous and increase each year.
Foreign investors have to jump through hoops, while foreign exchanges require additional identification requirements, and deal with complex regulations and tax rules just to invest in the simplest of equities, and these rules vary by country.
Crypto has unlocked this previously unused capital sitting in international markets. Twice the capital available to be invested, twice the valuation of an identical US equity, at least in theory.
Exposure to Non-KYC Markets
But international investors aren’t the only players that appreciate crypto—privacy-focused investors are coming in droves as well. Know-your-customer (KYC) laws require traditional finance exchanges to keep detailed records on users, which is undesirable to many market actors for a range of reasons.
Some policymakers view inflation as an implicit tax on money held in cash—for them, a positive externality and a way to negatively affect black market actors who cannot invest their physical cash. But crypto markets, which are largely non-KYC, allow these silent players to invest their money without government interference.
By some estimates, this ‘black market cash’ is worth around two trillion dollars, which is about 3% of the global GDP, or coincidentally, about the same size as the total crypto market cap. For better or for worse, these players now have a place to invest, which leads an influx of investors and capital.
Many see this as problematic, while others concerned about the rise of surveillance states worldwide see it as a universal right. Either way, it contributes to the rising asset valuations in crypto.
Hype and Bubble Effects
Dogecoin, Shiba Inu, Safemoon, even Bitcoin and Ethereum go through periods of boom and bust. It’s a sign of immature markets as well as a sign of markets that don’t have a clear grip on the fundamental value of the assets contained within. Memes become coins and vice-versa, coins become memes.
It’s silly to pretend that something like Dogecoin has real utility or cash value behind it, just as it’s silly to bury your head in the sand as the cryptocurrency revolution takes part around us. Part of any token valuation is the valuation of the community, the hype, and yes, even the meme within the protocol.
Yet another part intrinsic to crypto is the boom and bust market cycles we have become accustomed to. While it’s impossible to truly time these cycles, some try to use tools like the rainbow chart to take a stab. See below:
|I know this graph looks crooked, but I promise it’s an optical illusion.|
No matter what, it’s important to understand that, even though markets trend up, there are undeniable periods of relative under- and overvaluation. Violent bubbles form and pop as the assets trend up in value in the long term.
How Can This Help You?
If you come from a traditional financial background where an S&P 500 ETF allows you to grow your wealth by a relatively consistent 10% per year, it is easy to misunderstand where these ludicrous returns come from, to think crypto is a bubble, or worse, see crypto as a scam. If it sounds good to be true, maybe it is, right?
Once an investor is educated on the subject, however, and understands the paradigm shift and unbounded infinite market that altcoins can address, well, it’s a lot easier to understand why these asymmetrical returns are available. There is volatility and risk everywhere, but crypto, specifically the altcoins representing protocols and crypto infrastructure, remains the largest opportunity we have seen this century.
And how can this make you a better investor? Well, when evaluating a protocol, think about how the mechanics and value proposition of a specific altcoin tap into these categories of value creation. Perhaps it can provide a framework for you to pick your winners and avoid losers. Understanding this framework deeply might even help you discover the next 100x opportunity.