I often get asked intro questions about how things work and how to navigate the crypto industry as a new user. This document aims to give an introduction to most of those questions and give new entrants to the industry a solid foundation to stand on when navigating this crazy world. It will be incomplete, so buyer/builder beware, there is a lot to learn and the industry constantly changes.
Each section will be marked by a question that people ask that represents an area of knowledge that needs diving into deeply and explain separately. Hopefully by the end you’ll see how it all fits together and know better question to ask.
As with most things complicated that are intertwined with humans, there is no simple, one shot, answer to anything; It will always be subjective to your situation. Everyone’s “a lot” is different, everyone’s risk tolerance is different. The solution to this is to provide generally “good advice” and then give people the tools to make the best decisions for themselves.
Note that this is the hallmark of this technology: giving people tools to make decisions for themselves, and also take on the burden of responsibility for those decisions. If you fuck up, it’s probably your fault, so get ready to deal with that. But also, if you succeed in your endeavor and make good changes for your life situation, it’s all your fault too. ;) The key to being able to make good decisions for yourself is understanding. So let’s get you some understanding.
Here’s my disclosures page, your choices are not my problem. Now let’s get into it.
WTF is “Blockchain”?
The simplest way I’ve found to explain it is:
A "Blockchain", or "Blockchain Network" is a collection of computers that have agreed on a way to securely add information to a database (called a "blockchain") that is very resistant to people coming in and trying to fuck that process up. This process plus the database it creates allows for digital scarcity, which comes in the form of "tokens", e.g. bitcoin (on the Bitcoin network) or ether (on the Ethereum network). The information that is typically added to the database is how these tokens are moved from one person (or identity) to another.
Now there’s A WHOLE LOT that can be added to that, but that’s basically what we’re doing here, moving tokens around in an environment that’s pretty secure. What you should take from this is that there are multiple networks at play here, meaning there are different groups of computers that do things differently, and the tokens that are associated with those networks are different. For instance, here’s a few differences that come into play:
- What the agreed upon process is that allows new information to be added to the blockchain, colloquially called “consensus”.
- The properties of the network:
- How many transactions per second the network can handle
- The functionality of the network: just move coins around, “smart contracts”, how to make an account, etc
- How private and secure the network is.
- The cost and resources required for participating in consensus.
There are many components to a Blockchain Network that make it work. For each network, these components can be functionally the same or different, which makes navigating things so difficult if you’re viewing things solely from the perspective of comparing tokens. In order to keep this post somewhat self-contained and manageable, I’ve created (or will create) separate documents to dive into each of these things.
There’s many ways to skin a cat, but here’s a generally good way to do it that’s worked for me in the past:
- An “account” or “identity” within the network
- The consensus protocol that allows people to add new information to the network
- The Blockchain data structure
[LOTS TO ADD HERE]
What do I buy?
This is the standard questions everyone gets from new people who are interested. Especially since the vast majority of blockchain use case today is pure speculation. They’ve seen their friends “make some money” or heard it on the news that prices are rising and they want to get in.
For me, the answer to that question is very much dependent upon what the interests are of the person asking it, and their level of knowledge with respect to personal finance, investing, and the technicals of blockchain networks.
What do you want out of all of this?
This is an important question to ask yourself when thinking about buying some tokens/digital currencies/NFTs/etc. What is your end game and why are you deciding to get into this now?
Myself? I'm fascinated with the technology.
How it all fits together, what properties come from the various networks, removing humans and our trust assumptions from the loop and how that affects society, you name it. The process of owning an asset, for me, forces me to care about it more and learn about it. I personally believe that I should have a strong understanding of the things I own so I can make good decisions about them. Thus, I tend to purchase an amount of of something I think is interesting in direct relation to my desire to understand it.
Also, I feel a diversified asset portfolio is a good thing to have. One that covers all the bases w.r.t. security and potential for growth. What exactly is my personal portfolio? None of your damn business.
Are you wanting to play the market and dip in and out of high volatility assets in an effort to make fast gains? Are you setting up a retirement portfolio such that the long term value of what you have (hopefully) allows you to retire earlier? Are you setting up a college fund for your newborn in a market not directly tied to the traditional financial markets? A bit of all of that?
The answer to that question is the foundation to most of the best practices you need to follow, and the general answer I get is “I don’t know, all of it?”
To this end, it is worthwhile to consider everything in “crypto” as a high-risk investment, and as such, it should be related to the way you’re setting up your high-risk investment portion of your larger personal finance portfolio. Don’t have one? Maybe take a step back and consider that first. Don’t feel like it? Then follow the general advice we’ve been giving throughout the entirety of crypto:
Only invest what you can afford to lose. Nothing is promised in this ecosystem but a LOT of people will try and sell you promises. Do your own research. Don’t trust, verify.
It’s all a mater of risk
Now that that’s out of the way, you can now further break up assets within crypto along their relative risk category: low, medium, high. Now we can think about diversifying our crypto portfolio appropriate to our risk appetite and what we’re wanting to get out of it. In short, a token’s risk is directly correlated to the amount of people that dedicate their careers and business to it and depend on it working as intended.
A low risk asset in the blockchain industry is one that is backed by a very large network of people who actively make their careers out of pushing the development of the token’s ecosystem forward. It’s been around for a while and has a bunch of stuff built on top of it that relies on its functional stability. Note that this has nothing to do with price stability, only that the network that functions is resilient to being stopped or shut down, a business can rely on it being there and available in the future. Examples of such are foundational networks like Bitcoin and Ethereum. These are projects that are being relied on in some form or fashion by businesses and projects. They have integrations throughout the ecosystem and provide utility and function to many. The process of making changes to them is hard and takes a while as it requires a huge amount of social consensus and up front planning such that the changes don’t break things.
A medium risk asset is one that is around a project trying to find market share, but has shown to have a good idea that rationally makes sense, is backed by reputable projects and people, has been around a while to produce some level of service to users. It has a product you can use and get your hands on it, or a product that is being used and providing utility. Note that the token associated with it should have an obvious use. A good idea with a forced token into it that doesn’t make sense is now a bad idea. This is probably the largest group to newcomers (higher risk projects are less likely to be easy to obtain by newcomers through standard on-ramps).
A high risk asset is basically anything “new” that has come out or is trying to come out (even more risky). It hasn’t had time to validate its purpose for existing or gain a customer/userbase that relies on it for a significant amount of time. There’s a lot of hype around ideas and maybe what people involved have done in the past with other things, but not around what has been done with the project itself. It probably says “revolutionize” a LOT in the literature about it and by its fans/paid shills. You should be looking at the stability/reputation of the founding team, where the startup capital is coming from and how sustainable it is, how rational are their goals and are they capable of reaching them. Most of all, who has the ability to walk away with all the funding without recourse and what is their (dis)incentive to do so?
The problem here is identifying where a given project you’re looking at fits in. I have been around for a long time and still have trouble, so don’t feel bad if you do too. A good rule of thumb though is that the crappier the project, the more they spend on marketing and ridiculous claims and less they spend on actually developing a useful product. The goal is to try and bucket them into these categories. The process of doing so forces you to learn about them and the ecosystems that support them, and make more educated decisions on how you interact.
A brief note on evaluating a project by its market capitalization (how much the whole thing is worth if you add up each token of the total amount of tokens available). While this is a somewhat useful metric to use if you want to see “what kind of people can buy the whole thing up and manipulate the prices,” it should be understood that for many projects, this number can be faked or artificially inflated. So use it as a part of a larger evaluation process, but don’t rely on it too much.
Portfolio allocation
Now that you understand what your intended goals are and how to look at a token w.r.t. its risk, it’s time to think about how you diversify what money you have to throw at crypto across the tokens you’re interested in.
The difficult is in the risk assessment (and on-going education) of the tokens you care about. Allocation is a bit easier.
For instance, if you’re looking to set up something that is long-term that isn’t touched often, then emphasize tokens that are lower in risk and less on high risk assets you have to keep track of more often. Save some for a few projects that are higher in risk that you like and want to support but won’t break the bank and wipe you out if they fail or don’t work out (this happens A LOT).