Investing in Small Cap Projects
Well, the crypto bull market is (somewhat) back —last few days excluded, I suppose. And back with it is renewed talk of Lambos and mooning. Much of this is from relative newcomers to the space, sharing their dreams of getting rich quick and asking all the associated questions. The common narrative suggests that the easiest (ha! “easiest”) way to do this is by finding the “next Bitcoin”. The principle is simple enough: pick a coin with a very low market cap (and therefore, a lot of room to grow), buy in, and watch it shoot up 20,000%, thus creating tens (if not hundreds) of millions of dollars in value… oh, and all of this ideally happens over the span of a week or two.
This is hyperbole, of course, but there’s no denying the incredible amounts of greed in crypto. It’s what causes Twitter scams to work, lets ICO fraudsters walk away with millions, and turns otherwise rational humans into risky, impatient traders. Now, this should go without saying, but I’m very pro-crypto. However, I also realize that a lot of what’s happening in the market is unsustainable over the long term. Most small cap coins won’t survive, and investing in such a volatile asset is extremely risky. I can’t tell anyone whether or not to jump into low market cap projects, but I can say this: most individuals do so without a full understanding of what they’re getting into. And to that end, this is not a post about whether one should or shouldn’t take these moonshots — it’s about a small part of what should be understood while doing so.
I’ll start somewhere intuitive, and point out that most people who invest in small projects will lose most of their money in the end.
Yes, even you. Now, I’d be happy to be wrong, and I’m the first to admit that nobody knows what the future will look like. Perhaps crypto genuinely and thoroughly takes over the world, and every coin in existence today proves absolutely necessary and moons. This is unlikely, but technically possible. However, given the odds of this scenario, it seems prudent to prepare for… other outcomes. Like the very real outcome where 99% of the projects in existence die out, and along with them, all of the value. In light of all this uncertainty, how ought one proceed?
I see a lot — a lot — of moonshot portfolios. And I see something interesting over and over again: people diversify, but they diversity as if they’re building a regular portfolio (which, by the way: in crypto, we don’t really diversify all that much. It’s tough when a| we have such a limited number of options; and b| so many of them are terrifying and just seem “scammy”. Being in 5 projects isn’t really “diverse”, at least not traditionally). This is a fair way to invest, but only if you fully understand the risks you’re accepting. “Diversifying” means more than just “not being all-in on one coin”, it means taking on the full challenge of risk mitigation. By investing in 5–10 coins, you’re basically saying, “I’m 100% fine with losing every cent that I put in here, unless one of these projects miraculously survives”. If you’re not okay with this, you’re assuming that you have the mental ability to outsmart most other people on the planet, and out of a few thousand losers, one of your 4–5 coins will be a winner. And while you’re thinking this, so it literally everyone else. And this is really, really important to keep in mind.
There is, however, another way to approach moonshot portfolios, and this tactic is much less common. Is it better? Possibly, possibly not. But I think it’s a little scarier, and this may contribute to why it’s not intuitive for some people. And this way is to think like, say, a venture capitalist: really lean into the idea that most of your investments will fail, and use this as an impetus to really, really diversify. In practice, this relies on a different set of assumptions: rather than assuming you’re able to pick a few solid coins, you’re assuming that you’re average, and playing the odds. It seems kind of strange at first to assume that most of your investments will fail, but the better way to look at it is that you’re giving yourself the best chance to pick a successful investment. Sure, you’ll have less of each coin, meaning that if you’re somehow able to pick a coin that moons, you’ll make less… but that seems worth it if you’re increasing your odds of any payout in the end.
Let’s look at the math — but first, here’s a simplified question. Let’s say you have $1000, and I offer you a game. Give me your $1000 to keep no matter what, and I’ll let you do one of two things. If you want, you give me your $1000, and I give you a bag of 500 blue marbles, and one red one. If you blindly reach in and pull out the red one, you get 4 million dollars. Or, as a second option, you give me your $1000, and I give you a bag of 9 blue marbles, and one red one. If you blindly reach in and grab a red one, you get $100,000. The extremely risk-tolerant among us might opt for the former, but I suspect that most people would take the second game. When you put it in actual mathematical terms, it seems like a no-brainer: you should take the significantly better odds of winning a smaller but still pretty gigantic amount of money over the astronomically tiny odds of winning a much larger amount of money. And, strangely, this reflects a moonshot portfolio pretty accurately: if you invest $1,000 in five coins with a $1,000,000 market cap ($200 per coin), and one of them reaches a $200,000,000,000 market cap (approximately that of Bitcoin), you stand to make $4,000,000. Similarly, if you invest that $1000 into 200 coins with the sameone million dollar market cap ($5 each), if one of those coins moons up to Bitcoin levels, you make $100,000.
Of course, this is meant to be illustrative more than mathematically airtight. There are a lot of moving parts in the crypto market: some tokens are obviously excluded because they’re clear scams, or maybe all five of your tokens will moon (which will, of course, happen to some — but not most — people), and yes, research does a lot to mitigate risk.
But the larger point is that, in a world of unknowns, a significantly larger chance at making a smaller but healthy profit can sometimes be the better play over an impossibly small chance at making a significantly larger amount of money.
And the crypto world is full of unknowns. I mean, look, I’m sure you’re a genius, and you’re smarter than most people, and I’m sure your picks are meticulously researched. But there are a lot of tokens out there, and most of them will fail. Let’s just pretend, just for a second, that everyone else wants to profit just as much as you do. Let’s pretend that other people are just as convinced that their picks are going to be the ones that succeed. Let’s pretend that you’re a human, and susceptible to things like marketing and greed and emotions. If there’s even a chance of these things happening, those are risks that need to be mitigated. And one of the best ways to do this is through diversification.
As a last note, I’ll say that one of the major confounding factors is each individual’s personal risk tolerance. I started this post by saying that there was no right or wrong answer — what’s important is going into your chosen strategy with a complete understanding of what you’re doing. Some people will happily take a 1/1000 chance at losing their money for the chance at those Lambo gains, and some people wouldn’t take the 1/10 risk for larger (but still pretty darn good) gains. It’s a spectrum, and it’s important to know where you are comfortable.
I hate to say this (actually, no, I don’t), but if your investment strategy relies on being smarter than most people, it’s probably not going to work.
Even if you’re smarter and a better researcher than everyone else, so much is out of your (and the coin project’s) control — FUD, regulatory scrutiny, market sentiment, competitors… the list is endless. So go in with open eyes. Think about what your investment looks like if you’re actually not the best investor alive. A portfolio with four or five moonshots will work for some people, and one with thousands of coins for complete risk diversification will work for others. But I bet most people are somewhere in the middle. Think about how many coins are out there, and how many could reasonably stick around, and what percentage of those coins you’re holding. Do your research, make an honest assessment about where on the risk/reward spectrum you should be, and then hold on for dear life.
-VEVA team
http://www.veva.one
DISCLAIMER: This is not investment advice, nor is it intended to be. This is purely a description of a few different ways of thinking about investing in small market cap coins — for financial or investment advice, please consult a licensed professional.