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The past week was brutal for anyone holding stocks or crypto. Everything corrected and then corrected more. đ„đ”âđ«đ„
Some voices are shouting âbuy the dipâ while others are predicting the beginning of âa crypto winterâ.
My framework for thinking about âcorrectionsâ: đ§”đ
Some voices are shouting âbuy the dipâ while others are predicting the beginning of âa crypto winterâ.
My framework for thinking about âcorrectionsâ: đ§”đ
Crashes hurt. Thereâs no denying the fact that when market crashes occur, confusion and panic set in. Uncertainty around what to do creates anxiety and angst.
And the âJanuary 2022 correctionâ is no different. Fear is dominating many peopleâs head space.
And the âJanuary 2022 correctionâ is no different. Fear is dominating many peopleâs head space.
But in times of uncertainty, a framework can be a guiding light that helps one navigate choppy waters.
The mental model that Iâve set as âTrue Northâ consists of two very important concepts:
Ownership Stability and Horizon Contextualization
The mental model that Iâve set as âTrue Northâ consists of two very important concepts:
Ownership Stability and Horizon Contextualization
Ownership Stability
The crypto world likes to remind âno coinersâ that 1 BTC = 1 BTC and 1 ETH = 1 ETH. It took me a while to understand this perspective, but Iâve come to the conclusion that this truism has very broad application if understood at the atomic level.
The crypto world likes to remind âno coinersâ that 1 BTC = 1 BTC and 1 ETH = 1 ETH. It took me a while to understand this perspective, but Iâve come to the conclusion that this truism has very broad application if understood at the atomic level.
The first principle that guides this truism is that the ABSOLUTE OWNERSHIP of an asset is fixed while the RELATIVE VALUE of an asset fluctuates based on market sentiment about the asset.
Internalize that nobody can take away something that youâve bought. You own it. Full stop.
Internalize that nobody can take away something that youâve bought. You own it. Full stop.
This means that if you buy 10 shares of a companyâs stock, nobody can take away your 10 shares. When a market corrects, you still own 10 shares. Unless new shares are issued by the company, you own the same % of the companyâs future earnings. Nothing has changed.
But people canât help but panic when liquid investments correct because thereâs a second-by-second valuation available about what your ownership is worth if you were to exchange your asset for fiat currency.
People care about this translation because fiat currency is a universally agreed upon store of value used to purchase goods and services. If you want to buy food and clothing and cars and houses you will eventually need to exchange your assets for fiat currency.
(Crypto maximalists will argue that this wonât be true forever and there are signs that some tokens are becoming alternative stores of value that society will recognize and accept. Iâll park this for now but itâs a very interesting perspective that if true matters a lot.)
If you donât want to sell your asset now, then the exchange rate of âyour asset to fiat currencyâ doesnât matter. What matters is the quality of the underlying asset. And what matters even more is contextualizing what the asset is likely to be worth when you plan on selling it.
Horizon Contextualization
Good companies produce products and services that their customers love and are run by management teams that know how to grow earnings and create competitive moats.
This doesnât happen overnight. Value creation takes time.
Good companies produce products and services that their customers love and are run by management teams that know how to grow earnings and create competitive moats.
This doesnât happen overnight. Value creation takes time.
The same is true for other assets. High quality assets increase in value if their utility or their desirability increases. Asset values can spike, but typically value creation takes time. Creating utility takes effort and time. Awareness and adoption takes effort and time.
Liquid markets are very good in the long run of pricing assets but they tend to do a terrible job of differentiating the value of individual assets during times of volatility and uncertainty.
Assets move in tandem when thereâs a sell-off and this past week was no exception.
Assets move in tandem when thereâs a sell-off and this past week was no exception.
The important implication is that horizon contextualization matters. Once a market stabilizes and settles into a new norm, investors will do the work to properly value individual assets vs. an asset class as a whole.
Quality assets will be seen for what they are over time.
Quality assets will be seen for what they are over time.
Another important concept to internalize is that liquid assets arenât always superior to illiquid assets. Liquidity is a feature AND a flaw.
Investors in liquid assets have the ability to make buy, sell and hold decisions every second SO THEY DO.
Investors in liquid assets have the ability to make buy, sell and hold decisions every second SO THEY DO.
And being able to mark a liquid investment second-by-second has a massive impact on the mindset of people holding the asset.
Investors canât help but feel good when their assets are marked up nor can they help but feel bad when their assets are marked down.
Investors canât help but feel good when their assets are marked up nor can they help but feel bad when their assets are marked down.
But guess who else is affected by the ups and downs of a liquid assetâs valuation? The people who are working on making the asset more valuable over time!
Many employees (and the equivalent in a DAO/crypto context) hold equity/tokens in the âthingâ theyâre working on!
Many employees (and the equivalent in a DAO/crypto context) hold equity/tokens in the âthingâ theyâre working on!
This can be dangerous if itâs possible for talent to abandon a mission by cashing out and moving on. And even if they âstay the courseâ, talent can become less productive if theyâre depressed at how much their âcurrent net worthâ has fallen.
For this reason, illiquidity is a feature for companies/projects that require long-term commitment and planning.
In the world of VC backed companies, capital is raised every 12-24 months which means investors and employees can focus on value creation vs. âtodayâs priceâ.
In the world of VC backed companies, capital is raised every 12-24 months which means investors and employees can focus on value creation vs. âtodayâs priceâ.
This âTrue Northâ framework of Ownership Stability and Horizon Contextualization can guide you on what to do during times of volatility like we saw last week. Itâs my personal guide which Iâve found to be very helpful and calming.
The so what:
The so what:
Liquid Holdings
Periods of volatility require a re-evaluation of liquid holdings. Looking for spots where ârelative valuationsâ appear to be mismatched can produce good returns. Rebalancing and rethinking absolute exposure levels to different assets is a good exercise.
Periods of volatility require a re-evaluation of liquid holdings. Looking for spots where ârelative valuationsâ appear to be mismatched can produce good returns. Rebalancing and rethinking absolute exposure levels to different assets is a good exercise.
Illiquid Holdings
As a venture capitalist, most of our companies are illiquid and therefore zero energy is spent thinking about buy/sell decisions. What matters is whether a company has the capital to weather what could be a shaky funding environment.
As a venture capitalist, most of our companies are illiquid and therefore zero energy is spent thinking about buy/sell decisions. What matters is whether a company has the capital to weather what could be a shaky funding environment.
Given the amount of capital thatâs on the sidelines, capital will be available for the best companies but it might be more expensive in the near/medium term if the public markets stay depressed. Helping our companies navigate this environment will be important.
Availability of New Capital
If you have dry powder, then dips are opportunities to buy select assets at great prices. If you like a companyâs long-term prospects, then it could be a candidate for increased exposure. Buying at $100 is better than buying at $120!
If you have dry powder, then dips are opportunities to buy select assets at great prices. If you like a companyâs long-term prospects, then it could be a candidate for increased exposure. Buying at $100 is better than buying at $120!
A crypto example:
If the ETH value of a quality NFT project hasnât changed, then converting USD to ETH to buy more is a great trade.
Itâs the equivalent of traveling abroad when the relative value of the destination countryâs currency has corrected. Everything is cheaper!
If the ETH value of a quality NFT project hasnât changed, then converting USD to ETH to buy more is a great trade.
Itâs the equivalent of traveling abroad when the relative value of the destination countryâs currency has corrected. Everything is cheaper!
In the VC world, itâs possible that some âvalue tradesâ will emerge as the public market correction ripples through the private markets.
But dry powder matters because if the public markets stay depressed, raising new capital could be tough.
But dry powder matters because if the public markets stay depressed, raising new capital could be tough.
VCs need to internalize that many of their LPs think deeply about asset allocation. While VC investments have done well over the past decade, it doesnât mean that more money will flow into the ecosystem if the LPs care about ârelative exposureâ to the asset class.
If a LPsâ public portfolio has fallen, venture allocations could suffer from a âreduced denominator effectâ that will make asking for more money challenging.
This isnât universally true, but it will drive enough rebalancing to make raising venture capital a bit more challenging.
This isnât universally true, but it will drive enough rebalancing to make raising venture capital a bit more challenging.
TL;DR: Donât panic. Itâs great generic advice and advice thatâs difficult to act on.
But long-term thinking solves so many problems and is a life skill if you can master it. Make sure to internalize that you own what you own and act accordingly!
But long-term thinking solves so many problems and is a life skill if you can master it. Make sure to internalize that you own what you own and act accordingly!
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Sahil Bloom @SahilBloom
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Jan 22, 2022
This is an important read.