The Case for Digital Assets

Author: Will Peets, CIO of Passport Digital Holdings, @WillPeets

At Passport Capital, a singular mantra has guided many of our most significant investment themes:  invest in that which has never happened before.  We combine a top-down and bottom-up approach to investing.  From a top-down perspective, we are macro thematic investors, searching for and anticipating multi-year secular trends through a global lens.  Once we identify a theme, we take a bottom-up approach to identifying and acquiring the requisite skill set to best express our investment view.  This orientation helps us anticipate and uncover unique opportunities and navigate the ever-changing investment landscape.

As a firm, we’ve invested in themes that have had spectacular growth as well as bet against those sectors or markets that have systemic problems or are being disrupted as the result of change.  In the early 00`s, we invested in commodities that underpinned the development of industrial China and later pivoted our view and invested in the Chinese Internet sector, which flourished as China transitioned from an industrial economy to a consumer-centric economy.  We anticipated the financial crisis of the 2008 and bet against the subprime market – which we perceived to be a byproduct of excessive risk-taking, greed, misalignment of incentives and opacity.  Post-financial crisis, we focused on those industries and regions where there was a large and growing concentration of high quality human capital which focused our attention on the technology sector.  While Passport has a long history of investing in technology, our recent focus has been on the deflationary impact of technology.  Over the past 10 years, the impact of this secular trend has been most apparent in the consumer sector with large innovation and deflationary pressure coming from the likes of Amazon and Google and the development of the sharing economy.

We believe the advent of distributed ledger technology and the adoption of cryptocurrencies will continue this deflationary trend/impact of technology.  This emerging asset class will have application and sector specific use cases that will not only be disruptive at the micro level but have far-reaching implications for the broader macro landscape.  It will have large implications for developed and emerging markets alike.  We are in the early days of understanding the opportunity set unlocked by these technologies, but some potential applications we foresee include:

  • Eliminate financial intermediaries

  • Democratize capital markets

  • Enable the sharing economy

  • Decentralize the internet

  • Align companies with their customers

  • Preserve privacy

To better contextualize and analyze the opportunity set, we will discuss the asset class in terms of three cohorts that serve to delineate both the use cases and the potential sequence of adoption:

  1. Currency Tokens - digitize existing currencies or creation of new ones

  2. Utility Tokens - enable new economic models and incentive structures (distributed storage and distributed compute)

  3. Representative Tokens - tokenize existing assets (security tokens and non-fungible tokens)

We will make the case that while the development and evolution of “potential use cases” have evolved in the above order (currencies > utility tokens > representative tokens), adoption is likely to occur in the reverse order (representative tokens > utility tokens > currencies).  While there is a case to be made for digital assets as a hedge to larger macro risks, the immediate investment case is as a hedge to the many companies and business models that may be disrupted in the next one to three years and that are currently held in a typical investor portfolio.  We see the most immediate impact in the financial sector.  Distributed ledger technology has the potential to greatly improve the efficiency of capital markets enabling access, transparency, liquidity, and fungibility of assets and data.  It can also serve as the base layer for future innovation and development of new financial products and services.

In short, we believe digital assets will have a profound impact on global markets, both directly and indirectly, and fit squarely into Passport Capital’s long held investment philosophy— markets tend to do a poor job discounting change—especially changes that have no historical precedent.  We expect the disruption brought to bear by this technology to happen much faster than the market expects.  In the context of a traditional portfolio, we believe the narrative will quickly shift from one focused on the risks of allocating to this asset class to the risks associated with not being allocated to this asset class.

We will be posting a deeper dive into various portions of this asset class over the coming weeks and months. Topics we will cover include: the “Fulcrum Points for the Adoption of Digital Assets” which we believe are the important changes and improvements the asset class needs to allow large institutions to make meaningful commitments; the case for the asset class within an institutional portfolio; and a discussion on ways to invest in the asset class as well as the associated “pros & cons” of various approaches. Additionally, we will post occasional case studies on sub-sectors and themes driving changes in the industry. Please check back to this page frequently or follow us on twitter.