May 03, 2019, | AtoZ Markets – In the world of cryptocurrency and blockchain, many still do not feel confident enough to dive in that vast sea when it comes to trading, as there is a considerable account of details they need to understand, for better trading and application in the market.
Analysis, asset allocation, the concepts of blockchain, and more details to know how to read in the forex world.
For clarifying the above-mentioned, AtoZ Markets reached out to Miko Matsumura, General Partner at Gumi Ventures and Co-Founder at Evercoin Exchange, and had an interview with, in which he contributed his extensive expertise to the crypto and blockchain community, and those who wish to make a first move in that domain.
What style of investor are you? Is this investment advice?
I am a venture investor principally. I also Angel Invest. I don’t day trade tokens so I’m not a technical investor or a trader. So I want to make sure people understand that. I also want to say that this is all given to you for educational purposes and it does not constitute investment advice. So please consult with a professional investment advisor and do your own homework. With respect to making any investment decisions. So the first question I want to answer is
Why do traders need to understand blockchain fundamentals? Shouldn’t technical analysis be enough?
So I wanted to say that there are many different kinds of reasons why people are buying blockchain based assets like Bitcoin and Ethereum, and other significant blockchain based cryptographic assets. So in order to successfully invest and trade you really should be considering more than just technical analysis, so technical analysis really governs the behavior of commodities and other forms of assets that generally have a fairly stable base of value. So for example, if you look at something like currencies with you know foreign exchange you don’t really see the foundations of this shaking, right.
So you know to me when you see a blockchain based cryptographic assets you’re really looking at an asset class where there may be fundamental volatility right. So to me, I think traders need to understand blockchain fundamentals in order to make wise decisions. And I think that that’s why they need to get some level of understanding over the fundamentals more like an investor. So this is really my mindset. So, while there are technical analysis and there are people using technical analysis some of the largest movements in the space have been around things like hardforks or you know things like hacking.
So there’s a variety of different types of fundamental events that transcend technical analysis things like network updates. So you know I think these are all important factors.
How should I reason about asset allocation and appropriate exposure? Do I need a thesis and what is an example of a thesis?
You know asset allocation is one of the most important things to understand especially when you start to consider things like you know the Sharpe Ratio. So you know when you think about a balanced portfolio you really need to think about kind of what is a balanced you know what does that look like.
And I think you need to really be able to reason about risk. So the thing that I think is interesting about the cryptographic asset class is that it contains a decorrelated quality with respect to other assets that may be common in a person’s portfolio. So you know what’s interesting about that is is that modern portfolio management theory suggests that if you have the opportunity to invest part of your portfolio into a decorrelated asset class, then it actually increases your risk to not expose yourself to the asset. But the question then becomes you know what is the risk inherent to the asset.
And then you have to kind of adjust accordingly your allocation. So I think the conventional wisdom is that a kind of a broad-based portfolio should contain somewhere in the maybe 2 to 5 percent exposure level to cryptographic assets. You know for some people that may be very overly bullish and that may be in extreme exposure. But you know for others they put much higher percentages of their portfolio into cryptographic assets which you know I think everyone has to acknowledge is fairly risky. So I think you know thinking about asset allocation or appropriate exposure it’s important to try to understand you know first of all like How much. And I think also why. So I think that’s when the thesis becomes important.
So why are you allocating into this asset class so you know I think that folks that are allocating into this class you know that that’s where something like a thesis can come in handy right. Now I know that there’s technical trading and day trading you know these are all kind of generally devoid of a concept of a thesis but if you are a little bit more like me you may actually consider thesis investing you know which really may be something you know. Let me give you an example of a thesis.
So there’s something that’s observable in the sort of circulating market capitalization of coins and you know when you see that you may be able to infer for example one of the things I posit is that according to the power law distribution you should expect to the largest cryptographic asset which is currently bitcoin to be approximately 50 to 51 percent of the total value of all cryptographic assets. So this is actually held to be true and it is a factor that is observed by market watchers in the form of what’s called Bitcoin dominance.
So, you know that’s really you know my own personal thesis. So I believe that you know you can create opportunities against that thesis but you know, you should do your own homework right. That’s that’s the way I look at Bitcoin dominance. And you know I don’t necessarily look at this from the perspective of what’s called the bitcoin maximalist because I don’t my thesis is not that bitcoin will always maintain that dominance. It’s rather that whatever cryptographic asset is most highly valued will retain about that much value in the market compared to the other assets.
So that’s my assumption based on the way that I reason about the value of these assets.
How should I reason about risk and asset allocation?
I think that I want to reiterate for you that you know if there is truly a deep correlated asset class then you should expose yourself to that in order to reduce your risk. Right. Because obviously, you know you would be hedging against things like fiat currencies.
You’d be hedging against things like the stock market you know other economic forces. So I think that that’s an interesting and important mindset. You know obviously reasoning about it from the perspective of fundamentals you know if you do see a pullback in the broad market a decorrelated asset class may actually go up. Obviously, it depends on the scale. Right. If the market goes down a lot at the moment my thesis would be that bitcoin would also go down. And obviously, if the market went down to the point of like an extinction level event you know we would people say things like you can’t eat gold.
So you know if you get down to the level where we’re eating grass then like you know clearly all assets you know eventually we’ll kind of find their way to zero. So you know to me obviously that’s just the extreme case for risk. And the mindset around asset allocation. So another question can be you know.
How can understanding blockchain help me with trading?
So I do think that there’s certain major events in the history of blockchain things like network updates things like mainnet you know things like what’s emerging Lee called initial exchange offering things like the difference between the user activated fork hard for soft for chain split.
These are all distinctions that can help you understand the timing of you know eventually you know it’s not something that you can look at as a macroeconomic event. You know these are all factors that I think people should watch and they’re factors that actually involve quite a lot of understanding. So I think it may be you know it’s a little bit too short of an interview to really go deep there. But I will get into a few of the fundamentals. For example, I do want to define this term which is what is a blockchain?
So when we talk about block chains I think what we really have to do is, first of all, define it narrowly. So when I say defining it narrowly you can really look at it literally as a chain of blocks. So what is known to be a block is essentially a convenience in which was introduced by the bitcoin so-called blockchain. And essentially Satoshi Nakamoto the pseudonymous founder of Bitcoin never really used the term blockchain. So you know it’s in a way blockchain always has to stay kind of in quotes but if you look at the use of whatever one calls a blockchain in bitcoin essentially a block is a collection of transactions and it’s a collection of transactions that gets written down into this record, a historical record called the blockchain.
So the historical record is basically written down in blocks in each block represents a set of transactions and the size of the block is governed by the developers of Bitcoin and the bitcoin core.
So you know there’s a lot of discussion about what the appropriate size of blocks should be. Obviously bigger blocks tend to you know, increase the speed but I think smaller blocks tend to increase the reliability of the record. So you know and it creates really big blocks can create pretty extreme problems as we’re seeing currently in the bitcoin SV network. So we’re seeing a lot of problems where you have contention about who is the longest chain.
So this is getting too far into the weeds. But what I did want to say is what is the chain part of blockchain.
Explain what a block is the chain part is essential that you know in computer science as a concept called a link list and I linked list is basically a set of data constructs each of which are connected by a link. So what connects the links of the blockchain are essentially cryptographic hashes and cryptographic hash is basically a function that takes all the information that as an input and it output something that is essentially mathematically tied to the input. Right. And so the thing that happens that’s really interesting is is that the header of each block actually contains a cryptographic hash of the previous block.
So what that means is it means that it confers this property of so-called cryptographic immutability. The word immutability is a very strong word. It’s actually more like it’s just very very very hard to change once it’s written down. And what happens is that you know one way to visualize how hard it is to imagine a treasure chest with a chain that links it to another treasure chest. And what you’re doing is you’re lowering the treasure chest into a deep hole in the ground. Right. So if you imagine this as each treasure chest is a block and each chain is the blockchain right.
The question becomes how hard is it to change the contents of the first block or a so-called genesis block. Right the heart it’s very very hard because it means that in order to change that block you need to actually access every single preceding block and you need to essentially manipulate every single block that came after. I’m calling it preceding because you know if you imagine yourself lowering this chain of blocks or chain of treasure chests you know the first one that you on earth will be you know the most recent one that you put into the ground.
Right. So I guess what I’m trying to express here is you know what the blockchain does is it’s essentially a recording device that confers cryptographic immutability. So it’s hard it’s harder to change what’s been written down. So the word blockchain is now increasingly used on a wide variety of things that may not produce chains of blocks you know and so if you look at all of the cryptographic asset tokens you know broadly speaking those are all being called blockchain based cryptographic assets. So I think the word is bandied about very loosely.
However, I think what’s important to understand from the perspective of you know the nature of these assets is essentially that so-called block chains consist of multiple layers. So you know the block chaining layer is really just the data storage layer which essentially could be viewed as a database you know as a database that has the properties of world readability pseudonyms city typically. So you know you can everyone can read it but nobody can say exactly whose corresponds to which address. And then it has the property of so-called immutability which is that it’s you know very very hard to slash borderline impossible to change the contents once written.
So that’s the blockchain layer. But there’s another layer that often gets smashed in to that layer called the consensus layer and the consensus layer is actually the most important layer and it’s the layer that has the greatest amount of innovation in it based on what Satoshi wrote in the big white paper which is that the consensus layer is how do the network nodes agree that the contents of the blockchain which are constantly being replicated are true and represent an accurate depiction of history. So this is really the power inside of the Bitcoin and the bitcoin protocol created this thing called Proof of Work.
Whenever you talk about block change you’re going to hear people talk about proof and they’re gonna talk about proof of. They talk about Proof of Stake distributed proof of stake Proof of Work. Proof of space-time. There’s a lot of different proofs. So the thing that’s important to understand is the concept of on-chained proof. An off chain proof so on-chained proof is really something where you are proving something that is basically continuously been under the consensus algorithm of that blockchain. So and on-chain proof tends to be a very strong proof.
So for example, if you look at the trillions of dollars of transactions that have been processed on the bitcoin blockchain there are no transactions that anyone can point to then say that is not an accurate record of what happened. So on chain proofs tend to be strong proofs. There are a bunch of classes of proofs that are so-called off-chain proofs and there are things typically an off-chain proof is something that happened in the world. So, for example, a lot of option proofs are generally referred to as weak-proofs because the question becomes how do you know something happened.
Because the value of a blockchain is correlated to the veracity or truth of the contents of the information. So you know if you don’t have consensus proof that the contents of the blockchain are true then you just have a database and a really slow database and one that may or may not consume a lot of electricity. So the point is is that the proof is the most important thing in a blockchain and that’s generated by a consensus algorithm and the consensus algorithm answers the question of how do you know that the other nodes in this network are not lying because what can happen is is that you know obviously you can attack a network by populating it with fake nodes.
This is sometimes referred to as a 51 percent attack although practical attacks in the world can be potentially done with even smaller groups of nodes. So you can control a network and you can lie and you can double spend attack the network. If you control enough nodes so fairly detailed description of blockchain I think what I’d like to address quickly is you know what is a fork?
What is a hard fork and what does it mean to traders?
So you know what a fork is essentially it’s open source so typically open source projects have the source code of the software so a hard fork is basically this notion that you can take the software and you can just decide to do something different with it. So you know that’s that happened in the history of Ethereum with the creation of a Ethereum classic it happened in the history of Bitcoin with the creation of things like Litecoin things like Bitcoin Cash the split between Bitcoin Cash ABC vs. S.V.. So you know the forks happen again and again in the space.
I think it means something very special to traders which is that you know if it’s a so-called chain split it means that people who are holding the coin and who have custody over the cryptographic private key can actually get coins on both sides of the fork. So for example, if you were holding Bitcoin Cash before the split you know and you had custody over the key then you would get both Bitcoin ABC which ended up being called Bitcoin Cash and you would get Bitcoin SV.
So you know that’s a really interesting event. You know and these forks are typically the result of you know network updates so you know when the software gets updated.
How should I analyze a blockchain on the basis of fundamentals?
Tthat’s really interesting especially as you start to get into you know lower cap alt coins which are much more speculative you know obviously you know Bitcoin is probably the least speculative of a speculative asset class called cryptographic assets.
But if you analyze a blockchain the thing that you really need to kind of look at is you need to look at certain fundamentals like how robust is the developer community, you need to understand you know how quickly the code is being updated, you need to understand things like you know what is the algorithm that underlies the consensus of the blockchain, and you need to understand you know things like what is the sort of technical foundation which is often written in the form of something like a white paper.
So you know I think that’s a lot to understand. But you know honestly I think if you are planning to make investments or trades in this space, I do think that it’s important that you have at least a grasp of the fundamentals of this emerging asset class because I think that the fundamentals are going to be the major drivers of the next kind of bull run right which is that I think that the first Bull Run the major bull run that took you do twenty thousand dollar bitcoin was driven off of pure speculation. I think the next run should be driven off of much more fundamental basis and it should be driven off of things like the creation of primary economic value to network participants.
So you know I do think that in some ways that gets closer to something like a stock market. We’re actually looking at how the network produces value and in the case of stocks obviously, it’s how does the company you know offer value to the market to customers and how does it capture that value in the form of revenue.
So I think we’ll have very similar ideas coming into the blockchain space although I think the blockchain space has more to do with token value capture of value of the network and you know the inclusion of the value capture by the network participants. So I think it’s a much more potentially inclusive model and I think as such it’s potentially quite a non-linear and a viral model.
But you know I do think that we will see increasingly fundamentals driving the growth of these assets. And I think the fundamentals have to do with things like usage, usability and things like transaction daily transaction volume by users.
So that’s about all I have to say on the topic. If you want to follow me, my twitter is @mikojava, you can find that Miko.com and my and you can find my blog at blog.gumi-cryptos.com and you can follow me at those places. Thanks.