The first law of thermodynamics states that energy can neither be created nor destroyed, but only change its form. The same law can be seen in investing, where risk and return are never created or destroyed, but only change throughout the investment cycle. You may also have heard the popular crypto meme: "Everyone buys bitcoin at the price they deserve." These two statements say the same thing, albeit in slightly different language: as the various structural risks involved in investing in related cryptocurrencies evolve over time, so do the chances of winning.
Once upon a time, when Bitcoin (BTC) was created, there were many risks. One of the first basic principles was "existential risk". In 2014 it was unclear whether Bitcoin would be successful, especially after the Mt.Gox hack. Those were the exciting days of "fun money" when an unsuspecting pizza lover spent 10,000 BTC (currently worth about $300 million) for a few pies. When the market finally lowered its assessment of existential risk, Bitcoin's value increased and found a new price equilibrium for new investors who no longer needed to worry about this particular risk.
Then there was “funding/financial risk” – the question of whether enough capital would be raised in this asset class to power the predicted technological revolution. This risk was ultimately mitigated by the massive inflow of venture capital, which reached over $50 billion in 2021-2022. When another dimension of the multidimensional calculation of cryptocurrency risk was removed, the price skyrocketed again. One could argue that regulatory risk will be the next domino in 2023. While progress is sometimes a blur, we believe that cryptocurrencies will overcome this risk (as we have already seen outside the US) and pave the way for the transformation of future risk.
Of course, risk is still high, so investors still have the potential for big returns, although with every reduction in risk, returns also fall.
So if this risk-reward energy doesn't break down, what will? As regulatory risk takes center stage, we see the digital alpha investment landscape constantly changing. U.S. too:
Offshore market makers reduce volume, which affects quantitative market makers and high-frequency arbitrage trading strategies.
Government lawsuits targeting altcoins as potential unregistered securities are hampering a viable universe of alpha token options for fundamental investors.
Qualified custody rules affect all strategies in the chain using today's advanced financial engineering technologies and market structure innovations.
In other words, while any additional profit opportunity for beta cryptocurrencies is smaller than the previous one, the opposite is true for alpha cryptocurrencies: reducing these risks in the next stage opens the door to tremendous funding and institutional acceptance. However, this change creates a "distribution dilemma". You can not only invest the biggest money in flying, because this is a sure way to succeed. Instead, we are now living in extraordinary times for smaller, limited funds that have a unique opportunity to outperform. But of course, this won't stay that way forever as the thermodynamics of cryptocurrency investing keep changing. Savvy institutional investors should think carefully about how much capital they want to hold during this transition.