@ Scale – Pantera Capital

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By Paul Brodsky
Partner at Pantera Capital

Facebook bought Instagram for $1 billion in 2012 and WhatsApp for almost $22 billion in 2014, acquisitions and sums that led stodgy skeptics to scoff. When the deals were announced, Instagram had 30 million users and no revenues, and WhatsApp had recently lost almost $140 million on $10 million in revenue. Both acquisitions turned out to be very smart and well-timed. Instagram is now generating billions in revenues while WhatsApp has nearly 2 billion users across 180 countries.

Flash forward to 2019: Facebook announced Libra, a permissioned blockchain using a cryptocurrency, also Libra. The same stodgy skeptics are still scoffing, scared this state-of-the-art shift may similarly scale, so sacrificing their sense of sovereign security.

Supreme Social Media…Seriously

As cagy as Facebook has been, the company can’t compete with the world’s largest social media — global sovereign currencies and financial assets denominated in them.

Succinctly…digitization beginning in the 1980s allowed balance sheets to expand by orders of magnitude not previously imagined. It allowed lenders to keep track of unlimited amounts of principal and interest lent and owed. And thanks to the demise of gold-backed currency a decade earlier, the quantity of credit could become infinite.

Wall Street began carving up and re-distributing cash flows for anyone interested. Insurance companies, pensions, endowments, foundations, households and banks began using securitized fixed-income assets to match their future liabilities.

The Great Debt Build-Up that would ensue over the next forty years would require collateral in the form of assets to justify it. Corporate equity filled the bill nicely. The DJIA rose 30x, from less than 900 in 1982 to about 27,000 today. Commercial and residential real estate also rose by previously unheard-of orders of magnitude.

Not only did credit-driven “wealth” rise dramatically, so too has credit-based spending, which has driven output growth and, in turn, rationalized rising asset prices. We have effectively enjoyed a debt-driven virtuous economic boom — output growth free from secular contractions because the only thing necessary to renew faltering growth has been to drop interest rates (i.e. re-financing).

So what happens when rates are already near zero or negative? The longer a credit-based economy goes, the bigger systemic balance sheets become and the less it can tolerate a recession (i.e., credit contraction). The last credit contraction in 2008 was again overcome by central banks dropping interest rates. Today there is over $17 trillion of global sovereign debt in which lenders actually pay debtors to store their “wealth”. The reality today is that sovereign debt cannot be paid back in the currencies they are denominated in without severely diluting the purchasing power of those currencies (i.e., inflation), in turn severely reducing “wealth” measured in those currencies.

Meanwhile there has been a precipitous fall in the amount of wealth stored in risk-free assets like non-interest bearing bank accounts. Almost all our wealth today is tied up in market-priced assets with embedded leverage. These financial assets and the credit-based currencies they are denominated in are not pegged to anything scarce, which leaves their lasting value to be determined socially — by our ongoing collective perception of systemic creditworthiness.

So what happens when the next recession comes? There were no cryptocurrencies in 2008, which is to say there were no non-inflatable digital assets to hedge against hyper-inflatable fiat-denominated assets and sovereign currencies. There are now.

As if on cue, outgoing Bank of England Chairman Mark Carney gave a speech in August to central bankers in Jackson Hole in which he questioned the ultimate viability of the US dollar as the sole reserve currency used in bilateral trade. (When France sells wine to Brazil, Brazil pays for it in USD.) Carney also raised the potential for cryptocurrencies to play a future role in global trade.

So it seems even central bankers are catching up with the idea that crypto asset innovation is simply open-source software that extends the function of the internet by allowing peer-to-peer value transfer through private-sector currencies; not a get-rich scheme for anarchists looking to overthrow governments and their banking systems.

S-Curving

Through its Libra announcement, Facebook seems to have recognized that one day people will be able to gather at a photo-sharing site on a separate protocol and opt-into or out of advertisements. If they opt-in, then the participants on the site — not an intermediary like Facebook — would be compensated directly by advertisers by attracting viewers. In short, one of the biggest social media companies in the world seems to recognize that its core business might be threatened in the future.

On a more assertive level, Facebook also seems to understand that private-sector currency can take market share from an even bigger social media application ripe for disruption — sovereign fiat currencies. This fits with their history. Using Instagram and WhatsApp as case studies, FB knows that the time to enter a market or protect its own franchise from disruption is before a function begins to scale, and the best time to invest in disruptive innovations is when they are in their infancy.

Blockchain assets fit the bill perfectly.

Self-Awareness

According to Forbes, the top 5 U.S. brands today are highly innovative tech companies: Apple, Google, Microsoft, Amazon and Facebook. None of these businesses were around or dominant when baby boomers started investing, which raises two obvious questions: 1) do today’s popular cap-weighted market indexes implicitly assume there will be no disruptive innovations looking forward (seems so), and 2) are tomorrow’s great innovations identifiable and investable today? Facebook seems to be saying “yes.”

So why haven’t more investors begun to discount the inevitable shift of capital investment into smaller assets with better risk-adjusted return complexions, like cryptocurrencies and private equity in blockchain businesses?

Perhaps those responsible for big money have incentive to accept stasis, regardless of prospective returns; to view portfolio assets with ever-lengthening investment horizons (i.e., permanent core holdings)? Or maybe investors know that monetary policymakers must support current asset values at any cost because, if they didn’t, then the value of the collateral backing systemic debt would fall, thereby creating a balance sheet recession like the one that occurred in 2008? Or maybe both?

Against this backdrop, brewing innovation and nascent tech are easily overlooked by investors. Therein lies the opportunity for those who can access it.

The older a bull market supported by credit and central bank liquidity, the more an allocation to potentially disruptive assets should be considered. Inevitable breakthroughs in blockchain technology that allow them to work at scale suggest their market values can scale too.

Paul Brodsky

pbrodsky@panteracapital.com

This letter is an informational document and does not constitute an investment recommendation, investment advice, an offer to sell or a solicitation to purchase any assets or any entity organized, controlled, or managed by Pantera Capital Management LLC (“Pantera”) or any of its affiliates and therefore may not be relied upon in connection with any offer or sale of securities or other assets. Any offer or solicitation may only be made pursuant to a confidential private offering memorandum (or similar document) which will only be provided to qualified offerees and should be reviewed carefully by any such offerees prior to investing.

The views expressed in this letter are the subjective views of Pantera personnel, based on information which is believed to be reliable and has been obtained from sources believed to be reliable, but no representation or warranty is made, expressed or implied, with respect to the fairness, correctness, accuracy, reasonableness or completeness of the information and opinions. The information contained in this letter is current as of the date indicated at the front of the letter. Pantera does not undertake to update the information contained herein.

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