History does not repeat, but it does rhyme. Blockchain is like 1993 - early days of the Web before the Netscape browser helped the Web go mainstream. That mantra has been repeated so many times that it is also like 1999 - hype and overvaluation in many areas.

This is Part Three (Chapter 1) of The Blockchain Economy serialised book. Part Three is where we focus on investing in the Blockchain Economy.

Future Chapters about Investing in The Blockchain Economy will cover:
- Early Stage Equity (fka Venture Capital)
- Payment Tokens (aka Coins aka new currencies)
- Utility Tokens (a key to a network/platform)
- Tokenised Real World Assets (fractional ownership of some “hard value” asset)
- Ethical Investing (any of the above but with a dual mandate that includes doing good in the world)

So, stay tuned for those chapter posts. BTW, staying tuned is easy, simply subscribe by email (button to the top right of Daily Fintech, you can join a lot of smart Fintech people from all over the world - 22,958 as I write).

In the meantime, this chapter/post will give the historical perspective on why 2018 in the Blockchain Economy is like 1993 and 1999 in the Dot Com era and how to build a portfolio based on that knowledge:
- Blockchain is the 4th Wave of disruptive change in the digital era
- The 5 lessons we learn from past waves of disruptive change.
- What those 5 lessons teach us about building a portfolio.
- Why this time is different because the funding model is different.
- Humans say don’t classify me, I am an Investor/Contractor/Entrepreneur.
- The Blockchain Economy is like 1993: not very useful yet.
- The Blockchain Economy is like 1999: hyped and over valued.

Blockchain is the 4th Wave of Disruptive Change in the Digital Era

- Wave 1 was the pre Web Internet. This was invented as a decentralised network for use by the US military by DARPA (the network survives even if one node is destroyed). This was pre-commercial, only used by higher education and military. It was also decentralised, which is why the current Blockchain wave is referred to by some people as redecentralisation - it is a back to the future phase.
- Wave 2 was the Web wave, from the Netscape browser and through the Dot Com bubble and burst. This is when the Internet went commercial. It is easy to mock the hype of the Dot Com era, but in hindsight almost all the innovations we now use were started in the Dot Com era. Most failed and many of those ideas were picked up later by entrepreneurs riding the next wave. Even digital cash, which we now call Blockchain & Cryptocurrency, appeared first in the Web wave (and failed in that era).
- Wave 3 was the Social Media wave, emerging from the rubble of the Dot Com nuclear winter. The book that inspired me at the time was Wikinomics (How mass collaboration changes everything), which was published in 2006. Dan Tapscott did an amazing job of describing why social media was not just a fad but something that would change the world; it inspired me to start blogging in 2007 and then become the COO of ReadWriteWeb in 2009 and then create Daily Fintech in 2014.
Waves 2 and 3 are the Centralised Internet. Today centralised looks like the norm, but the verdict of history will be that it is a brief interlude between the original decentralised DARPA and the new decentralised Blockchain Economy.
- Wave 4 is the Blockchain wave. This wave is even bigger and rolling even faster because it builds upon the two earlier waves. The ability to transfer assets over the Internet matters because more than half the 7 billion people on our planet already have access to the Internet.
One fundamental thing changes in the Blockchain wave. In earlier waves you could transfer copies of content over the Internet. In this wave you can transfer value over the Internet, because the Blockchain protocol solves the double spend problem (if I give you a $10 bill, I no longer have it, whereas If I send you a digital file, it is only a copy and each digital copy costs virtually nothing).

The 5 Lessons we learn from past waves of disruptive change.

1. Change takes longer than forecast.
2. Change, when it happens, is even bigger than even the wildest forecasts.
3. The winners are hard to forecast early and those winners are massive.
4. The early adopters are critical but totally different from mainstream.
5. There is a valuation crash between early hype and eventual value creation.

What those 5 lessons teach us about building a portfolio

Portfolio diversification is critical for investors - some things don’t change. The number of investments in a portfolio is a debatable point, but less than 10 is certainly considered high risk. So, how do investors get diversification?

- Change takes longer than forecast. Therefore,most entrepreneurs will underestimate how much capital they will need. The single biggest reason new ventures fail is they run out of cash. As an investor, you have to assume that however much cash you put in at the start is only a small amount of what you will need to put in; so plan for that.
- Change, when it happens, is even bigger than even the wildest forecasts. Therefore, there is a lot of money to be made.
- The winners are hard to forecast early and those winners are massive. Therefore, a few big winners will more than make up for all the winners - power law distribution. That mantra had been repeated so often that it has become conventional wisdom and you don’t get an edge from conventional wisdom. The next section explains why this time is different and why we may get a more bell curve distribution - that is less conventional wisdom which may give you an edge.
- The early adopters are critical but totally different from mainstream. Therefore, find an old copy of Crossing The Chasm and read it to absorb one big lesson - you have to win over the early adopters even if they look weird and the market looks tiny. Attempts to market disruptive propositions direct to mainstream are doomed to burn a lot of capital.
- There is a valuation crash between early hype and eventual value creation. Therefore, keep plenty of powder dry to invest after the valuation crash. Nobody can tell you when this valuation crash will come (if somebody claims to be able to give the timing, they probably also have a bridge to sell you). So, don’t wait till after the valuation crash to invest anything. Remember that Google was first funded in 1999. Refer back to point 1 above - invest a little now and a lot later.

Why this time is different because the funding model is different

The phrase “this time is different” is easy to mock. It tends to get used to hype valuations. However in this case, something is different and this difference should impact how investors think.
What is different this time is that the disruptive technology is being used to change how early stage investing is done. That is what the whole ICO and tokenisation change is all about. In all earlier waves of change everything changed - except the business of early stage investing.

In the Pre ICO era, a few elite VC funds dominated the business of early stage investing. This led to few massive winners and lots of losers. In network theory, it was a power law distribution. These big, elite VC Funds, what I call Wall Street West, did not care about the 99% of ventures that failed as long as they got a big stake in the 1% that had massive returns.
In the post ICO era, we may get to a more normal bell curve distribution. (Click here if you need an explanation of power law vs normal distribution)

To use baseball/cricket analogies, investors can win with more singles without relying on hitting the ball out of the park. The reason is the simple but powerful force driving the whole ICO/Token disruption - instant tradeability. You can invest and - subject to lockup provisions - exit/take profit as soon as the price is above what you paid. You may choose not to take profits, because you expect the price to rise more, but it is your choice. That is a game-changer for early stage investors. It also will enable a more normal/bell curve distribution. For example, you may buy in at 3 and exit at 6, or wait in hope it gets to 30 or 300. In the artisanal VC model, cashing in early was tough and the big investors called the shots.

Humans say – don’t classify me, I am an Investor/Contractor/Entrepreneur

When you talk to the people who are making things happen in the Blockchain Economy and you dig below the PR surface, the wonderful rich complexity of human beings eliminates the artificial barriers defining somebody as either an investor or an employee/contractor or an entrepreneur.

Today you can meet many people who are all three. They are investors and employees/contractors and entrepreneurs This blurring of the boundaries is one of the differentiating factors in this wave of change. In earlier waves there was a clean boundary between investor, employee/contractor or entrepreneur. Today you meet people who:
- buy/sell some Bitcoin and Altcoins (they are investors).
- pay the bills by working for somebody else as an employee/contractor.
- build their own venture as a side project in their spare time (they are an entrepreneur) and wait until they see enough traction before quitting the contract/employee gig.

This is one human with three hats. You have to engage in real conversation and dig below the PR surface because that human is practically focussed on pitching one of their three hats:
- If they see you as a smart crypto investor, they will pick your brains to help make them a better investor.
- If they see you as an employer, they will pitch their value as an employee/contractor.
- If they see you as an angel investor, they will pitch their MVP.
So in a normal professional setting you only see one hat, not the human who wears all three hats.

This wearing of multiple hats goes against conventional wisdom. When reality diverges from conventional wisdom it means that the (usually unspoken) theory behind that conventional wisdom is no longer valid:
- Theory = only a wealthy person can invest. Reality = tell that to the techies who invested early in Bitcoin or Ethereum, most of whom had way more tech smarts than cash (they now have both). There is some move by regulators to only allow wealthy people to invest in early stage tech, but it is likely that the toothpaste is already out of the tube. You can argue that investing in these coins is dumb, but you cannot deny that people are investing, some of whom are way smarter than the wealthy investors who are supposed to be the clever guys at the table.
- Theory = An entrepreneur must quit their day job. Reality = it is so cheap to build a Minimum Viable Product (MVP) and nobody wants to fund this stage of a venture, so a side-project is the best way to get past this stage. Being an investor makes you more conscious of what may work for your own venture.
- Theory = Employees are expected to follow orders and complete tasks. Reality = many employers are entrepreneurs with relatively young companies who prize employees who can think outside the box and bring innovation to the table.

This matters because building a portfolio - so essential - is is much harder for entrepreneurs and contractors/employees.

Entrepreneurs cannot get this level of diversification. They are the risk takers in this ecosystem. Most big waves create a window of opportunity of about 10 years when the market is open to new venture; the wave lasts much longer, but most of it is after the market has consolidated and the winners have been declared. It also takes about 10 years to build a business with sustainable value. An entrepreneur can create one, maybe two ventures in that time; you could build one to Product Market Fit, sell it before it is big, move onto the next one. So, the maximum diversification for an entrepreneur is 2, which is a massive concentration risk in investor terms. That is why entrepreneurs need so much equity to compensate for that risk; after exit they can build their own portfolio as investors. More on this in the future chapter aimed at entrepreneurs.

Contractors/employees can get more diversification than entrepreneurs, but less than investors. A contractor/employee can work for 3 to 5 ventures during that 10 year window. That is better diversification but still high concentration risk. If you change jobs every two years, you can work for 5 ventures during those 10 years. If you get options in all of them, you now have a portfolio of 5. That is concentration risk, but with some luck it may pay off. Note that with a 4 year vesting, you will only get 50% of those options if you leave at 2 years; if the venture looks like a winner you may “roll the dice” and accept concentration risk by staying.

Whether you are investor or an employee/contractor or an entrepreneur, you are sitting on the same surfboard looking at the same wave. Don’t worry, this is a huge wave with masses of opportunity.

The Blockchain Economy is like 1993 - not very useful yet

The key word is yet. The direction of travel is clear.
Imagine somebody in 1993 telling you how to make money in the Internet Economy. All I got in 1993 was somebody showing me how to send an email over the Internet (thanks Charles). My takeaway was:
- I can only send an email to a few people and none of them are people I know.
- It is harder than sending a fax.
- Fuggedaboutit.

Wrong takeaway. A couple of years later we had the Netscape browser and then Hotmail. The rest is history.
The Blockchain Economy is like that today. There are not yet services that make our lives easier/better. The only thing that gets attention is investing/speculating/trading - should I buy/sell xyz token? We will come onto that later. There are some use cases with real traction today, but they are niche (for example raising capital). Ask somebody whose work is totally unrelated to Blockchain if anything Blockchain related has made their lives easier/better and at best you will get a blank stare.

History does not repeat, but it does rhyme. Each wave is different in subtle ways, but all waves have a lot in common and so you can learn from looking at past waves.
The Blockchain Economy is like 1999: overhyped and over valued.

Egregious overvaluation examples are not hard to find:
- ventures that do not even have a Minimum Viable Product (with only a Minimum Viable White Paper) raising over $1m.
- Raises over $1 billion (first Telegram and then EOS with $4 billion).

There are still reasonable deals at reasonable valuations and don’t forget that the investors who put money into Google in 1999 did well. They might not have done so well if they had invested at a multi-billion valuation. You could argue that Google’s huge valuation today - about $782 billion as I write - would have justified them raising $1 billion on a $4 billion valuation in 1999. The problem is that raising $1 billion makes an entrepreneur less motivated to do the hard work of building a valuable business.

Bernard Lunn
Founding Partner, Daily Fintech Advisers
www.dailyfintech.com

Bernard Lunn is a serial entrepreneur, senior executive, adviser and a strategic dealmaker. He worked in Fintech before it was called that with startups, growth stage and turnaround ventures (incl. Misys, Temenos, IMS, ITRS). He has lived and worked in America, India, UK & Switzerland and is adept at cross border deals.

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