Sources of capital: the path to one trillion

Understanding the sources of capital flowing into the blockchain space is the first macro step towards attempting to value of the future growth of the market. 

Estimated marketshare by investor type 2022

As of Q3 2017 the market continues to be dominated by primarily retail buy and hold investors. Moving forward we will examine how new categories of investors will effect valuations painting with a wide speculative brush. 

Market Size

Global M2 cash reserves stand at between 80 and 100 trillion US equivalent dollars, the highest level in human history. This places the current value of blockchain tokens at 1 out of roughly every 650 dollars on earth (or .15%)

Note: This excludes the development of futures, options, and other derivative markets. Thus a one trillion dollar market capitalization would represent roughly 1% of global cash reserves. 

Assumptions

  • Linear growth rates: The percent year-over-year each category is projected to grow. Better models for shaping growth rates can be added in the future, though for our purposes we intentionally kept the assumptions as simple as possible. 
  • Corrections: There will continue to be large draw downs as the space expands. We will assume continued every other year major draw downs that lessen as an overall percentage of market capitalization as the market matures.
  • Contributions by category: More opaque categories such as pensions, private equity, family offices, and professional traders as a percentage of the current market capitalization must be inferred from limited data sources. 
  • Barriers to entry: We have broadly ranked each category by how high the barriers to entry are before a category can enter the space. We roughly assume the more third party custodial work needs to be done, the higher the barrier to entry. 
  • Institutional desire for exposure to uncorrelated returns. Basic portfolio theory would lead institutional capital to blockchain token assets over time as a risk management strategy. This sounds counter-intuitive, but most fund managers ascribe to modern portfolio theory where pairing two types of uncorrelated risk together mathematically lowers the overall risk profile of an investment portfolio. 

Calculator

We have created a very simple calculator to project marketshare by investor class and market capitalization moving forward. Feel free to change any of the variables as you see fit or reach out to us with a better model. 

While largely arbitrary in percentages, this shows as the market matures retail buy and hold investors will make up less of the overall market. If retail early adopters holding their own private keys make up less of the market share over time, who will take their place?

New Entrants

Let's examine each new category entering the space from highest to lowest barrier to entry. Using this frame helps infer which investor classes will be able to enter first, and how laggard classes will ramp up over time to reach similar levels of exposure. 

Pensions & Sovereign Wealth: This category has the highest barrier to entry. 

  • Fund managers have a fiduciary responsibility to protect the long term value of their underlying pension assets and typically invest in less "risky" asset classes like corporate bonds and real estate.
  • Pension fund managers also have significant personal career risk by recommending an asset class to clients who do not understand the underlying technology have only been exposed to "tulip mania" hype stories. 
  • Self dealing is also a significant hurdle to overcome. Processes for third party intermediaries holding and insuring private keys must be in place before large investment groups can move into the space in a major way. 

Blocktower Capital founder Ari Paul sees pensions as one of the last capital sources to incorporate blockchain tokens into their investment portfolios starting in 2018 at the earliest as the liquid simply does not exist yet to open and close major positions without significant slippage. 

Private Equity: Depending on the structure, private equity can behave closer to pension funds or closer to venture capital. The same self dealing and career risk barriers also apply to private equity though to lesser degrees in smaller, more nimble funds.

New funds take time to form, fund, then finally deploy capital. The formation stage can give some insight by analyzing SEC filings, though actual amount raised by private funds can remain elusive to quantify.

Family Offices/High Net Worth: These categories have even less reporting requirements, with less career risk and self dealing requirements. Many high profile wealthy individuals such as Richard Branson, Michael Novogratz, Mark Andresson, etc. have publicly commented on their investments in the space. 

Public ETFs: This category could overlap significantly with the above categories if institutional capital decides to use ETFs as vehicles to hold blockchain tokens rather than holding the private keys themselves, or trusting services like Coinbase.

While ETFs fly in the face of decentralization and individuals controlling their own wealth peer-to-peer, they do make owning blockchain tokens significantly easier for both retail and institutional investors. 

Professional traders: This category has also yet to enter the space in a major way. Arbitrage liquidity providers have not managed to eliminate arbitrage opportunities between markets showing how nascent professionals in the space still are. Major trading desks like Goldman Sachs have been dealing in cryptocurrencies for years mostly by employees in off hours, but have yet to establish dedicated divisions. 

Retail investors: The original category of investors in the space will continue to grow as individuals look for inflation and geopolitically resistant places to store their wealth. New services that make it easier to buy, store, and use blockchain tokens must evolve for the market to grow beyond its current early adopter phase. 

Takeaways

While not an exhaustive analysis of potential capital sources, a general macro view of capital flows into and out of the space is crucial to position investments for long term success. Over the medium to long term, substantial capital from new sources needs to find its way into the blockchain token ecosystem.

As most projects worth investing in have finite supplies of tokens available to the market, a sawtooth uptrend in appreciation is expected as capital from sources other than retail buy and hold enters the market. 

While most individual projects will likely FAIL, the market capitalization as a whole will continue on an upward trajectory as the market solidifies into a handful of winning projects. 

In the short run, the market is a voting machine but in the long run, it is a weighing machine.
— Benjamin Graham