Digital Currency & Bitcoin (Part 2): Invest in the Currency or the Wallet
It wasn't until I came across Coinbase in August in 2012 that I felt I must look at Bitcoin and virtual currency in depth. I was rooting for bitcoin so I looked for all the evidence that shed a positive light on the new age currency. It seemed like more and more legitimate businesses had started to accept bitcoin as payment, but still no large commerce players. The sheer media attention was creating an upward spiral. While wallets had been hacked, the bitcoin system remained intact. At $10-15/bitcoin the total market value was over a quarter of a billion dollars. One thing that really stood out for me was its cross border functionality. Seeing the number of people and businesses that lose money converting USD to Indian Rupees with their family or subsidiaries, I thought this was one of bitcoin's killer features. This quality would be the area that would grow fastest and create at least a niche market. This "niche" however is MASSIVE, with Western Union alone doing $80 billion annually in consumer to consumer transactions. But these transactions don't have to be done through bitcoin given competitors like ripple or copycats like litecoin could end up having better security or better features. In technology investing I'm always a little nervous of who wins:Yahoo vs Google vs alta vista, lycos, 100s others, Friendster vs Facebook vs Myspace, Xbox vs playstation vs Wii battles. I rather pick 2 top horses than just bank on 1.
So then the big question was, is it smarter to just invest in the infrastructure around bitcoin, namely wallets and exchanges rather than the currency itself? I decided at the time that selling the picks and shovels were better to invest in rather than attempting to mine gold! So in September I made an investment in Coinbase.
For the rest of 2012, I tried to come up with ways to do business in bitcoin based on the hype. By February 2013 with the sharp price rise in the value of bitcoin to the $20s I made a decision to overcome my fear in connecting my bank account, the belief that multiple currencies would compete with bitcoin, the idea that bitcoin's intrinsic value is based on its "true" usage for non-speculative transactions and that Bitcoin's surge would be short-lived. I did a quick calculation with the assumption that if bitcoins are used only in the money transfer market via platforms like Coinbase then a reasonable prediction of a $1 billion market value in the next 2 years was likely. Thus dividing it by the maximum potential bitcoins outstanding, 21 million, the implied value would be ~$50. Furthermore, I figured like all growth stories, the pendulum often swings far away from reality and thus it could end up going to $70 or $80. Thus purchasing some bitcoin via a secure Coinbase wallet in the mid $20s would give me at least a 2x return or a 40% IRR. Given the over 100% increase over the last 2 months and the amount of volatility, I figured I'd space out my purchases over a month:
What I didn't predict was that my Valentine's Day purchase would keep increasing by over 10% on some days to hit $50 within a month of my purchase!
Soon after my first bitcoin purchase, Union Square invested $5 million in Coinbase. My investment was at a seed round that converted at that point. By November, bitcoin started hitting the $500s or 20x of what it was in Feb '13 and 50x from September '12 when I invested in Coinbase. I started feeling like my decision to invest in the wallet over the currency was clearly a bad one, until Andreessen Horowitz, my favorite venture firm, invested in Coinbase at a $140 million valuation in Dec '13. ~20x! On the surface, this valuation actually makes no sense to me, Coinbase has grown dramatically but I don't know how they got to such a steep valuation. I guess I can't complain.