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Imagine that you had a superpower that let you invest in the next Google, Amazon, or Apple.
I picture this as a kind of "Spidey Sense" that lets you spot the next high-growth, billion-dollar company. Since billion-dollar companies are called “unicorns,” let’s call this superpower “Uni-Sense.”
Today I’ll help you unlock that superpower.
This is a bold claim, but that’s how confident I am in the growth of DeFi, the decentralized finance technology that’s coming to take over the banks. I’m even more confident that the banks have no idea what’s happening: DeFi is eating banks.
If you’re new to the space, DeFi is a new kind of financial services industry, developed partly in response to the confusing legal status of cryptocurrencies. Because governments can’t make up their minds, there’s this furious push to innovate around them in ways that can’t be shut down.
This week the World Economic Forum (WEF) released the Decentralized Finance: (DeFi) Policy-Maker Toolkit to help educate banks and governments on how this new industry works and how they might respond. This report is a must-read for blockchain investors, especially this diagram: |
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Courtesy WEF's Decentralized Finance: (DeFi) Policy-Maker Toolkit
This “Defi stack” is a terrific model for making sense of this new financial system. Once you understand these different layers of the DeFi stack, you can develop your Uni-Sense to help you spot the next unicorn (i.e., the leading company or project) in each of these categories.
Let’s unpack the layers in more detail. From the bottom up, we have:
The Settlement Layer
This is the infrastructure that DeFi is built upon. For the vast majority of DeFi projects, that layer is Ethereum. As I’ve said again and again, the easiest way to invest in DeFi is to just buy and hold ether. It’s the foundation of DeFi, and it’s the foundation of a smart DeFi investment portfolio (including mine).
The Asset Layer
These are the stablecoins that serve as “on ramps” and “off ramps” between traditional and digital financial systems. Most of these stablecoins are pegged to the dollar, so there’s no point “investing” in them, as they won't go up in value—though the companies that issue stablecoins will become extremely valuable as they go public on the traditional stock market. (See my piece on Coinbase stock.)
The Gateway Layer
This is the wallet that holds your crypto. In DeFi, the vast majority of market share is owned by Metamask, which is a product by Consensys. Currently, Consensys is a private company, but I expect that to change. (Coinbase recently launched its own Metamask competitor wallet -- another reason to consider investing in shares of COIN.)
The Application Layer
Here’s where things get interesting. These are like the apps that run on your computer or your phone, and the WEF report has split them into four categories (there will surely be more).
1) Decentralized exchanges: These platforms let you exchange (or swap) one cryptocurrency for another. Think of exchanges like Coinbase or Binance, but decentralized. This is even easier for investors: instead of waiting for them to go public on the stock market, you simply buy and hold their token, whose price is a reflection of what investors think the future value will be worth. The current DEX leader is Uniswap (UNI), which -- true to its name -- is already a unicorn. |
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How DeFi platforms work (courtesy of DeFi: Beyond the Hype)
2) Credit: Instead of borrowing from banks, these DeFi platforms let users borrow from each other. You earn platform-native tokens for lending and borrowing, and these tokens generally go up as the platform attracts more users (see Step 3 in diagram above). The current leader in this space is Compound, which is also a unicorn. To be clear, you can either lend a lot of crypto via Compound to earn COMP tokens -- or, if you believe in the project's long-term potential, you can just buy COMP directly. 3) Derivatives: Here, things get tricky. A derivative is basically a synthetic financial asset that is tied to (or "derived" from) some other asset. There are too many to name: options, futures, prediction markets, and even NFTs are all types of derivatives. The danger with investing in derivatives is that you can quickly build a Jenga tower – i.e., derivatives of derivatives – that can suddenly come crashing down. Tread carefully. 4) Insurance: Trading in DeFi is risky, so one of the biggest opportunities is to simply invest in the companies insuring against all this risk. (Think of Warren Buffett's huge bet on GEICO, one of his most profitable investments ever.) DeFi insurance protects users from smart contract bugs or protocol hacks: the current leader here is Nexus Mutual, whose NXM token has not yet reached unicorn status, making it an interesting investing opportunity. Watch this space with laser eyes.
The Aggregation Layer
Here’s where all these DeFi services can be combined, which is something that’s really unique to this space, and where the banks just can’t compete. Because it’s all based on software, the crypto that you have invested in DeFi can be automatically reallocated, constantly chasing the best return on your money. (Think of it like a robo advisor on steroids.) In this category are:
1) DEX aggregators: Think of Kayak or Google Flights, which are flight aggregation services that save you time finding the best airfares. If you're trying to exchange one token for another, DEX aggregators will automatically scan all the best decentralized exchanges, find the best rate, and route your trade there. The leading service is currently 1inch. (Also see our article on Top Dex Aggregators.) 2) Asset and yield management: Traditional asset managers will invest your money in a well-diversified portfolio. In DeFi, this can all be done in code. One such example is Balancer (BAL), which is like a self-rebalancing index fund. If you want to keep a portfolio of 70% bitcoin and 30% ether, a Balancer pool will keep them automatically balanced for you, making trades behind the scenes as the price of these two digital assets changes. Traditional financial managers will be massively disrupted by these new asset management websites. Business models are evolving quickly, so train your powers of Uni-Sense on this space. |
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The book with the cult following. (From our Read and Grow Rich reading list)
The Secret Book to Develop Your Uni-Sense
There’s a book that has an underground cult following among successful blockchain investors. The book is called Technological Revolutions and Financial Capital by academic researcher Carlota Perez. (The hardcover sells for $125.00 on Amazon, or you can read the the Wikipedia summary.)
Perez argues that technological revolutions come in waves: The Industrial Revolution, the Railway Revolution, the Internet Revolution, and so on. Each of these technological revolutions requires massive amounts of money, because each requires its own infrastructure -- so financial and technological revolutions go hand in hand.
To have an Automobile Revolution, for example, you also need to build out roads, access to cheap fuel, auto dealerships, and so much more. Lots of money pours into these related industries, creating new financial innovations like auto insurance and auto financing. The world begins to change in profound and unpredictable ways: cars mean freedom, so people begin to take more vacations, move to the suburbs, and so on.
Blockchain geeks love this book because we see this current age as the start of a new technology revolution. Bitcoin, cryptocurrencies, and now DeFi are some of the components of this new wave, which will likely be as disruptive and far-reaching as the Industrial Revolution.
But it was this page that I scanned and pinned to my desktop when I first read the book: |
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Courtesy Technological Revolutions and Financial Capital by Carlota Perez
In one page, Perez has neatly summarized the five types of financial innovations that accompany these technological revolutions. I look at this chart regularly to hone my unicorn sensing powers, and I encourage you to spend time absorbing these five categories: they will sharpen your Uni-Sense as well.
The most valuable companies of tomorrow will be the blockchain leaders in each of these categories.
Note that many will not be “companies” in the traditional sense: they will be decentralized projects. Even so, you can invest in them today by simply buying and holding the accompanying token.
Now, let’s combine Perez’s categories with the DeFi categories from the WEF report: |
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This is your framework for the future of finance.
Like the early days of the internet, things are moving fast. These are the current leaders, but new challengers arise each week. Some of these projects may not be around in five years, but the larger trend is here to stay: DeFi is modernizing financial services, and that presents huge opportunities for investors.
TLDR: The simplest way to invest in DeFi is to buy and hold ether. For those with the time and money, consider diversifying into these other stocks and blocks above, as they're likely to be the unicorns of the future (some are already unicorns today). Do your research. Develop your Uni-Sense. Ride into the sunset. |
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| Health, wealth, and happiness, |
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| John Hargrave Publisher Bitcoin Market Journal Full disclosure: I have long-term investments in ETH, COMP, UNI, BAL, and COIN stock. |
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Hi Everyone,
"Borrow more?" I asked my banker with bewilderment circa June 2019, just as I was planning my graceful exit from eToro.
I already had a mountain of debt from being a single earner in a family of five and living paycheck to paycheck for more than a decade. Yet, the amount the bank was offering me at an attractive rate was obscene.
Certainly, I had no actual need for that amount of cash, but with bitcoin pushing $13,000 at the time, and disgusted with the financial system, I decided to take the plunge.
At the time, it seemed like borrowing fake money to buy real money. The ensuing 17-month drawdown was a bit of a killer, but in retrospect, it was probably one of the better financial decisions I've made.
Now obviously, I'm not advising anyone to borrow money in order to invest in any market and the disclaimer never invest more than you can afford to lose should always be adhered to, but this is exactly what Michael Saylor is doing at MicroStrategy, only on a much grander scale. |
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Now, the amount of risk Saylor, who I had the pleasure of meeting in Miami, is taking here is gargantuan, but even if it does go sour, he'll be alright.
Certainly, the example he's setting for the average layman on the street is not healthy. Reference the above disclaimer.
What makes this story super interesting, however, is that the Federal Reserve, which has been engaging in significant money printing of late, seems to have inadvertently purchased some of Saylor's junk bonds.
According to this Bloomberg article, the Fed is holding two separate exchange-traded funds (ETFs) that have a small exposure to the above-mentioned assets.
That's right, albeit tiny and indirect, the Fed is indeed holding bitcoin on their massive balance sheet.
Last night, that balance sheet reached a new all-time high of $8 trillion.
I suppose when you have that many assets, it could be difficult to actually understand everything you're holding. |
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Although the days when central banks will buy bitcoin outright to add it to their balance sheets may still be a ways off, it's good to see the digital currency proliferating to the point where preventing exposure is becoming next to impossible for large financial institutions.
Hope you have an awesome weekend! |
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| Mati Greenspan Analysis, Advisory, Money Management |
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