The most fundamental law of thermodynamics dictates an intrinsic balance in which energy can neither be vanquished nor generated; it just alters its form. Our investing world shares remarkable similarities with this phenomenon where risks and returns are consistently transforming through an investment cycle. This is evident in the cryptoversphere, where each phase of structural risk modifications precipitates changes in return opportunities.
Interestingly, during Bitcoin’s early years, a prevalent ‘existential risk’ was one of its foremost challenges. Remember the puzzling ‘funny money’ days around 2014 when Bitcoin’s future was uncertain, and 10,000 BTC was exchanged thoughtlessly for a couple of pizzas? With the diminishing of existential risk, Bitcoin’s value skyrocketed, setting a new price equilibrium that eliminated the existential fear in potential investors.
Next was the ‘financial/funding risk,’ the concern regarding substantial capital mobilization into the asset class. This risk eventually dwindled due to a massive venture capital infusion surpassing $50 billion in 2021 to 2022, leading to another surge in Bitcoin’s price. As we stride into 2023, it might be the ‘regulatory risk’ bowing out next, despite its current ambiguity. As this risk materializes, it will likely signal the next major risk transformation for cryptocurrency, echoing experiences in international markets.
However, multiple risks persist, explaining why investors can still expect high returns. Yet, it’s crucial to note that as each risk vanishes, returns tend to become progressively marginal. So, where does this not-lost risk-return energy translate? It’s reshaping the terrain for digital alpha investing with regulatory risk taking the limelight.
For instance, decreasing offshore market makers’ volumes affect high-frequency arbitrage trading strategies. Government lawsuits scrutinizing altcoins as potential unregistered securities impact the scope of token selection alpha for fundamental investors. Furthermore, the rules around qualified custody percolate across all on-chain strategies, currently the financial and market structure innovation forefront.
While the return potential for crypto beta becomes less remarkable with each passing risk, the contrary is true for crypto alpha. Minimization of late-stage risk is clearing the path for extraordinary financialization and institutional adoption. But this change also engenders an ‘allocator’s dilemma,’ making a successful low-risk investment in large funds less straightforward.
Currently, we’re witnessing an exclusive era for limited-capacity smaller funds with a unique performance potential. Nevertheless, nothing is forever, and the perpetual cycle of thermodynamics will inevitably transform the crypto investing game. Hence, smart institutional investors need to carefully consider their stake and strategy in this transient phase. Expect the unexpected, as the anticipation of such shifts could potentially be the winning card.
Source: Coindesk
