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Financial services and technology are inextricably linked to speculation.
Options were invented as a tool for risk management, and are now commonly used as a tool for leverage.
Mortgage backed securities were created for purposes of risk diversification, yet found themselves at the center of the global financial crisis.
Ethereum was developed as a globally accessible, decentralized, permissionless network for finance and has found its primary use cases to be trading and leverage.
A market is simply a place where two or more parties can transact. If a buyer and seller can agree on the terms of a transaction, you can have a market.
As markets evolve and mature, so too do its participants. Some market participants are drawn in for real, fundamental reasons. For example, let’s say you are a local business that makes and sells its own strawberry jam. You would be a natural participant in the market for strawberries.
Other participants may be drawn in for speculative purposes. Perhaps you believe that strawberry jam is going to dominate the jam category which is expected to grow mid to high single digits a year. Being the commercially motivated speculator that you are, you decide to buy up the strawberry suppliers in California and jack up the prices.
The varying needs of these participants dictate the terms under which they will transact, the parties whom they will transact with, and the prices at which participants will transact at. For example, the local jam maker may have no choice but to accept the higher price of strawberries if he is to continue producing and selling jam. A multinational jam maker on the other hand may turn to Florida for his strawberries and chisel down the prices of those producers in exchange for high volume and offtake agreements.
These participants may compete in the same markets for the entirety of the lives of their companies and never interact.
Over the years, financial markets and social markets have converged. The rise in eCommerce was fueled, in part, by an increase in time spent online due to social media. This rise meant that there was a growing need for warehouse space, fueling higher valuations for warehouses.
There is no financial market more influenced by social markets than digital assets. We recently wrote about how fake interactions on social media can drive asset prices in both crypto and traditional finance.
Social influence on asset prices is most apparent on Crypto Twitter (“CT”), crypto’s public forum.
Part of CT’s allure is the anon culture where people can speak freely. The downside is that this creates drama, misinformation, and a general lack of professionalism. This is neither good nor bad, it just is what it is.
Why are we bringing this up?
DeFi Education believes we have reached a point where the crypto community (both socially and financially) will be split into two groups in the coming years.
Just like our two jam makers, “degen” CT and the Blackrocks of the world do not need to interact to do business. In fact, for many institutions, participating in the social dynamics of CT represent a liability.
The way we see the future of crypto breaking out is 1) builders + institutions and 2) degens. We have already seen the desire to fund anon founders evaporate from the market since the last cycle. This trend is likely to continue.
We’ve written in the past that in crypto, you inevitably arrive at a crossroads where you either build for the existing participants with capital largely trapped on-chain for one reason or another (i.e. clear demand), or for a future group that may or may not find real use cases for on-chain applications (uncertain demand).
Payments, messaging, social apps are among the web’s most important use cases. If “web3” is to be a real thing, it has to have a real presence in at least one of the three. Otherwise, web3 is just a sideshow.
While some may argue that payments are already a dominant use case for crypto in emerging economies, our perspective is that you have to account for global wealth distribution to make that argument. Mass adoption in the U.S., China, and Europe would yield outsized results relative to other economies.
To be clear, we’re not saying that retail capital is irrelevant. Nearly every successful crypto project started out at a small scale for a group of niche individuals before it picked up steam and institutions took notice. Our point is that these two worlds approach trading and markets in entirely different manners, and will interact with projects differently. That means we are likely to see more and more projects launched outside the scope of CT, instead launching with or directly to institutions building their crypto businesses.
Let’s explore why this separation between retail and institutional participants exists and is likely to widen.
Institutions tend to have a longer time horizon than retail participants. Blackrock is a 35 year old company. They are likely planning to be in the business of asset management forever. Many banks are hundreds of years old
Retail participants with a small capital base can access small scale opportunities that institutions cannot, which may allow them to turnover their capital more quickly
Retail participants are not bogged down by lengthy investment processes, corporate hierarchies, and red tape that plagues many large institutions
Institutional managers are often not risking their own capital! Not all of it, at least. They may receive performance incentives for good results, but staying alive to collect fees is far more important to them than 10x’ing their portfolio
Retail participants are not bogged down by investment mandates, whereas an institution may have very specific investment criteria that limits the opportunities they can invest in at a given time
Institutions are highly regulated, forcing them to narrow their focus
As a result of these differences, institutions have to adhere to a higher degree of professionalism compared to someone managing their own capital. Keep in mind that “institutions” are just a collection of people that are beholden to their investors, shareholders, bosses, and the public eye. They can’t “troll” on Twitter without risking their position among their stakeholder groups.
Someone who manages their own capital is far more nimble both in how they trade and how they participate in the market socially.
These forces combined are why in the years to come, the best performers (both individually and at the project level) will be the ones that have a foot in each door. Projects that maintain enough professionalism for institutions to be able to bring to their investment committees, while providing enough upside and speculative attention to gain traction among retail participants.
For individual participants in crypto, it’s important to start considering which segment to lean into more. “Doxxed” participants (people who reveal their identity) are likely to experience a significant advantage over anons in the crypto space in the years to come. We plan to remain anon and recommend that people do the same for personal reasons, but if you think purely economically, doxxed participants are likely to command a greater share of the pie.
Trade Update (for paid subs only)
We finish with an update about a trade we took on August 11…