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How Accredited Investors Can Beat The Institutions In Monetizing The Unfolding, Misunderstood Paradigm Shift In FinTech Featured

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This is a step-by-step guide for accredited investors and high net worth individuals to make money investing in the bitcoin ecosystem guided by the lessons learned (not) from the previous paradigm shift, consequent bubble and ultimate burst. For the first time in modern history, we are experienecing a second paradigm shift within the same 100 year period. But... What is a Paradigm Shift?

To be absolutely honest, it's probably best to look at this as not two separate paradigm shifts but two separate steps to the evolution of mankind from an analog civilation to a fully digital one.

 

  1. Evolutionay step one: Pre-popular internet (1980s, early 1990s), it was perfectly acceptable - and actually mandatory to do things the analog way: by hand and slowly. To communicate the written word, you went to the post office, bought a stamp, put a paper package into a physical mailbox to be picked up by a person and physically driven/flown to its destination post office to be sorted and delivered by more people and eventually walked to your doorstep days and hundreds of thousands of dollars later (hopefully). Fastforward to a new paradigm, and you type a message, insert digital contents (video/picture/signed document) and hit send for near instantaneous and trackable delivery. This ability among thousands of others made the world significantly more efficient, and made a group of prescient entrepeneurs and their investors, trillions of dollars. Of course, one reason why such a relatively close knit group made so much more money than everyone else was because the introduction of a new paradigm was:
    1. 1992 - at first unrecocgnized;
    2. 1993 - then resisted because it broke convention;
    3. 1994 - derided because it broke convention;
    4. 1997 - became the subject of malinvestment because it was misunderstood, yet became the newest "buzz" through the pop media;
    5. 1999 - soaked up a lot naive money at the peak of the bubble because of step 4 above;
    6. 2000 - and finally burst as the bubble popped.

Such is the history of the birth of the popular Internet in America (and the ROTW). The Internet, and its universal graphical overlay, the World Wide Web, changed the way the developed world works - and made trillions in investor profits, entrepenuerial wealth and business efficiency savings and new revenues. Yet, it was incomplete as a paradigm shift. It alowed the instantaneous movement of data anywhere in the world for extremely low cost, but it did not address the one thing that was needed to complete a business cycle, and that is trust. Enter the second part of this paradigm shift - the zero trust distributed consensus network. Put in grades school terms, the Bitcoin Blockchain. 

Most lay people and the vast majority of investors still have no idea what Bitcoin and the blockchain are. Due to pop media indoctrination, the first thing that pops to mind is digital currency, hacking and crime. They coudn't be more incorrect. Bitcoin solves what is known in engineering circles as the Byzantine General's problem, and in doing so, allows entities to use Paradigm Shift pt 1 (the Internet) to take advantage of Paradigm Shift pt 2 (the Blockchain) without having to trust or know anyone in the transactions. Here's a quick education from Wikipedia on the Byzantine General's Dilemma:

Two armies, each led by a general, are preparing to attack a fortified city. The armies are encamped near the city, each on its own hill. A valley separates the two hills, and the only way for the two generals to communicate is by sending messengers through the valley. Unfortunately, the valley is occupied by the city's defenders and there's a chance that any given messenger sent through the valley will be captured.

 
Positions of the armies. Armies A1 and A2 need to communicate but their messengers may be captured by army B.

While the two generals have agreed that they will attack, they haven't agreed upon a time for attack. It is required that the two generals have their armies attack the city at the same time in order to succeed, else the lone attacker army will die trying. They must thus communicate with each other to decide on a time to attack and to agree to attack at that time, and each general must know that the other general knows that they have agreed to the attack plan. Because acknowledgement of message receipt can be lost as easily as the original message, a potentially infinite series of messages are required to come to consensus.

The thought experiment involves considering how they might go about coming to consensus. In its simplest form one general is known to be the leader, decides on the time of attack, and must communicate this time to the other general. The problem is to come up with algorithms that the generals can use, including sending messages and processing received messages, that can allow them to correctly conclude:

Yes, we will both attack at the agreed-upon time.

Allowing that it is quite simple for the generals to come to an agreement on the time to attack (i.e. one successful message with a successful acknowledgement), the subtlety of the Two Generals' Problem is in the impossibility of designing algorithms for the generals to use to safely agree to the above statement.

The Blockchain, through its consensus network, allows these two generals to communicate in near real time, with absolute certainty and authority as to the message and its contents. Before the blockchain, this was not possible on an untrusted (read the Internet or any widely available WAN) network. Now, the circle is complete. You cannot only use the Internet to transfer data, you can use the blockchain through the Internet to ultimately trust that data. If you think a lot of money was made in part 1 of the paradigm shift, you ain't seen nothing yet! Now, the real value will be unleashed. Think about it. 

The Accepted Paradigm

The accepted point of view: Trusted third parties such as banks, brokers and exchanges are needed to transfer value. Individuals and entities cannot do this themselves.

The Paradigm Shift

Networked Smart Contracts (like those used in Veritaseum's Platform) for transacting in value WITHOUT so called "trusted" third parties. All transactions of value can now be conducted directly between the parties - funding, loans, sales, purchases, exchanges, complex contracts, etc. The anomaly in the current paradigm: Transactions of value are cheaper, faster, more secure and more transparent when performed without the so-called "trusted 3rd party" that has been the lynchvpin of the trading, broking and banking model for centuries.

How Do I, As An Accredited investor, Make Money Off Of This?

For those who have not followed me through the years, I am known a strong fundamental investor and analyst that has called many big booms and busts.

One reason for my accuracy is that I stick to core fundamental valuation precepts. Let's review a few in the historical context of Paradigm Shift part 1 using real world examples compared to the mistakes being made today in Paradigm Shift part 2: 

Precept #1: Learn to Value Opportunities on Their Face by NOT Prejudging

You don't know everything. The plus side to this is that no one else does, either. With that in mind, you should always objectively vet every idea that comes across. That doesn't mean put everything as a high priority, but it does mean never dismiss an opportunity as "out of hand" by instinct. You simply don't know! Understand what it is you're passing up before you pass it up.

 

1990s Search Engine Company eXcite got an offer to buy Google for $750,000, and passed. Founded by Stanford University students in 1994, search engine company ecXite was offered to buy Google's tech for $1,000,000 by Sergei Brin and Page (who wanted to be academics, not business operators) but passed on it. Excite's VC and board member talked Page and Brin down to $750,000 and the company turned them down again, according to Minyanville. Excite was bought by cable conglomerate @Home for $7.2B a year before the bubble popped, and was bankrupt a year after the bubble popped. It's founder now works for Google Ventures and Google is valued at $400B.

Precept #2: NEVER Put Economic Cash Flow Generation Below Market Share Grab in  - - Prioirty

Or, don't worry about negative margins, you can always make it up on volume! Heh, heh!

Textbook lesson on how to blow $7.5 million per month as a startup! Boo.com launched in the autumn of 1999 selling name brand fashion apparel retail over the Internet. It spent $135 million of venture capital in just 18 months (yes, $7.5 million per month burn rate as a brand new startup), was placed into receivership on 18 May 2000.   

Pets.com's raised $300 million from investors but had negative margin on practically every single sale made. That's right, the more they sold, the more money they lost!

Wikipedia: Pets.com was a dot-com enterprise that sold pet supplies to retail customers. It began operations in August 1998 and closed in November 2000. A high-profile marketing campaign gave it a widely recognized public presence, including an appearance in the 1999 Macy's Thanksgiving Day Paradeand an advertisement in the 2000 Super Bowl. Its popular sock puppet advertising mascot was interviewed by People magazine and appeared on Good Morning America.

Although sales rose dramatically due to the attention, the company was weak on fundamentals and actually lost money on most of its sales. Its high public profile during its brief existence made it one of the more noteworthy failures of the dot-com bubble of the early 2000s. US$300 million of investment capital vanished with the company's failure. 

Precept #3: Just Because A Name Brand Investor Pays a Lot of Money for Something Doesn't Mean It's Worth What Was Paid   

Most of the VC funded deals that you see being cut for $XXX million are not what they appear on their tabloid media surfaces. That money is usually put in as:

  1. preferred stock, which is essentially common stock with an embedded put option. The means that you have to automatically ratchet that valuation downward when comparing this investment with a common stock investment of the same nominal face value. The investors are getting much more for their money than the $XXX million valuation you read/hear/see in the media leads one to believe (in common stock terms that is);
  2. with liquidation preferences - clauses that pretty much guarantee that the investor gets paid before the founders and orginal team/management/employees, often to the tune of 2x-3x the original investment, and then at that point they participate pro rata in all other gains! While this is fine and dandy for later stage investors, it distorts the economic formula for success in early stage, high risk/high reward ventures. Let's break it down mathematically, which would you prefer, a $10 preferred stock with put options in a company with a 10% chance of a 300x return and near zero chance of salvage value (meaning this is pretty much a binary deal - boom or bust), or much cheaper common stock at $1 with the same upside but no liquidation preferences? Since this high tech/FinTech venture is probably going to either succeed wildly or fail dramatically with not much in between, the energy should be put in deal flow analysis and due diligence, not financial engineering to pull money out of deals you shouldn't have been in in the first place. As for the answer to the question, 3,000x ROI vs. 300x ROI on the upside, and a nearly equal return on the downside [nothing, close to it, or best case scenario 2x-3x multiple of your money back after 7 years] - the common stock investment will win every time for the true fundamental investor that vets his/her deals properly.
  3. investment from investors who (with all due respect) may not have grasped the potential (or lack thereof) of the situtation at hand. Let's face it (and some of you smarter, more realistic VCs can corroborate this) a lot of VCS really don't know what they are doing once it comes to seeing opportunity that the broader market (read, the crowd, the herd, muppets, etc.) don't. They simply follow what the big boys do, and the big boys follow each other. So, where are the truly unique, hi-risk/hi-reward ideas coming from? Good question.

Mark Cuban created Broadcast.com, an early internet radio company. It specialized in sending internet radio to listeners over the web through broadband in the late 1990s internet boom, but almost no one had broadband in the late 90s.

 
The company never made a lot of money, but Yahoo acquired the company in 1999 for $5.7 billion anyway, minting Mark Cuban as a billionaire ($2.9B). Despite that, the company still didn't make any money and now it doesn't exist.
 
 
GeoCities' was allegedly the third most traffic site on the web behind AOL and Yahoo, was purchased by Yahoo for $3.57B in 1999 at the peak of the dot.com bubble and now no longer exists. It is widely believed that Geocities was NEVER profitable.
 

Precept #4: Just Because A Name Brand Investor Passes On An Opportunity Doesn't Mean He Made The Right (or even a Good) Decision

In terms of part two of the paradgm shift, reference (and these are serious reads!):

  1. The Evolution That Is Veritaseum: Benchmarking It To Venture Funded Competition
  2. Update on the State of "Intelligent Money" As Wall Street Moves Into Space That We've Staked A Claim In Almost 2 Years Ago
  3. Bitcoin 2.0 Investment Will Trump the Risk Adjusted Returns of Early Movers In Digital Currency Space - VC's Enter Vertitaseum aka The Truth!

SV Angel Ron Conway passed on  Salesforce.com because the $30 million valuation seemed too high at the time. Salesforce has  a $22 billion valuation today. If you truly believe a company to be deci-billion dollar opportunity, investing at a $10 million pre-money or a $30 million dollar pre-money is pretty much a moot point, particularly as it starts to hit a billion dollars or so. Don't be penny wise and pound foolish. This is not meant as a slight to Mr. Conway, but as a general observation.upon. 

Several VCs passed up Google for their seed round, stating the founders were too arrogant, and the initial valuation was much too high. I don't know what the valuation was back then, but its over $400B now! Did they do the right thing? With a "true moon shot company", within practical bounds of reason, it is nearly impossible to overpay in the very beginning. At this stage, the error is in the analysis and the due diligence, not the price. Let's say I offered you Veritaseum at a $45M seed valuation instead of $3M (15x the price), and no VCs wanted it due to percieved excess valuation, so I went to my Aunt Judy for the first $250k. At $20B today, did Aunt Judy outsmart the VCs? 

A story from Fred Wilson, one of the most respected east cost VCs in the game (Union Square Ventures), from his blog AVC, on how and why he missed out on AirBNB:

 

The Airbnb founders came out of the winter 2009 Y Combinator class. They came to see us during their time at YC. They told us about a great stunt they pulled at the Democratic Convention in Denver (in which Obama was nominated). They bought a bulk supply of generic cheerios and made up these cereal boxes to generate seed capital for their startup. Here's how one of the founders Joe Gebbia describes it:

We made 500 of each (Obama O's and Cap'n McCains). They were a numbered edition on the top of each box, and sold for $40 each. The Obama O's sold out, netting the funds we needed to keep Airbnb alive. The Cap'n McCains… they didn't sell quite as well, and we ended up eating them to save money on food.

I asked them if they'd leave a box of the cereal for us and it has been sitting in our conference room ever since. Whenever someone tells me that they can't figure out how to raise the first $25,000 they need to get their company started I stand up, walk over to the cereal box, and tell this story. It is a story of pure unadulterated hustle. And I love it.

This sort of reminds me of how I sold my expertise to fund Veritaseum (see What Are Veritas?).

At that time, Airbnb was a marketplace for air mattresses on the floors of people's apartments. Thus the name. They had ideas for taking on other listings but they had not yet made much progress on them.

We couldn't wrap our heads around air mattresses on the living room floors as the next hotel room and did not chase the deal. Others saw the amazing team that we saw, funded them, and the rest is history. Airbnb is well on its way to building the "eBay of spaces." I'm pretty sure it will be a billion dollar business in time.

I've been here before. Many "smart" people have a hard time wrapping their heads around replacing the banking system with P2P software. Those that either get it, or see the hustle in the entrepenuer, will reap the rewards that others fail to recognize.

We made the classic mistake that all investors make. We focused too much on what they were doing at the time and not enough on what they could do, would do, and did do. I am proud that our portfolio is full of companies where we saw the vision before other investors did and backed a great team. But we don't always get it right. We missed Airbnb even though we loved the team. Big mistake. The cereal box will remain in our conference room as a warning not to make that mistake again.

Precept #5: During a paradigm shift, adhering to the "old boys club" rules wll, by defintion, shut you out of many (if not most) of the best potential opportunities. The best, brightest and most driven may (and probably are) not part of your network, and they shouldn't have to be in order for you to make money together.  

According to Business Insider, Nextview Ventures' Rob Go missed out on Skillshare because he didn't know the founder well enough.

 "I met Michael of Skillshare in November 2010," Rob Go of Boston-based Nextview Ventures tells us. "At the time, he had a vision for creating a learning revolution through in-person classes.  He believed (as did I) that everyone has something to teach, and that the barrier to teaching and learning from peers should come way down.

 
"I loved the idea, and am a big fan of the democratization of education. But although Michael was well regarded, I only really knew him by reputation.  He didn’t have that much to show – product ideas were mainly thesis that needed to be tested.  He was also raising a very small amount, and I was concerned that the team may not reach enough value-accretive milestones given the modest raise.  We were also in the process of doing a close on our fund, so I was distracted.  I declined to invest, thinking that we’d have another bite at the apple at a larger institutional seed round.
 
"Fast forward a few months, and the Skillshare team has executed brilliantly. 

"Lessons learned – follow your hunches, especially about people.  It’s too easy to think to yourself, This is too early, especially when it’s someone you don’t know. I should have pinged our friends at Founder Collective who knew Michael well and gotten more direct feedback. Instead, I let pattern recognition take over and saw something a little outside our standard zone and moved on."

I have a strong reputation in many circles, but am not part of the "club(s)". As such, I know from first hand experience the situation above. As noted 

Precept #6: An open mind and a willingness to analyze and move quickly on opportunities and markets poo-poo'd by the big boys have yielded some of the largest returns in private equity history.

Let's revisit the Google story from Wikipedia:

When Page and Brin tried to find buyers to license their search technology, one portal CEO told them "As long as we're 80 percent as good as our competitors, that's good enough. Our users don't really care about search."

A significant misreading of the market by entrenched management. This is currently rampant in the bitcoin space - reference "Watch As Blockchain Startups & GAFA (Google, Apple, Facebook, Amazon) Send Slower Banks The Way of the Classified Ad".

The first major investor, Andy Bechtolsheim, one of the founders of Sun Microsystems, wrote a check for $100,000 in August 1998 after seeing a quick demo on theporch of a Stanford faculty member's home in Palo Alto. On June 7, 1999, a $25 million round of funding was announced,[54] with major investors including theventure capital firms Kleiner Perkins Caufield & Byers and Sequoia Capital. Google is worth in excess of $400 billion today.

A lone HNW angel investor moved in one day to make what was likely the best investment in the Internet space - ever!

Precept #7: Margins mean a lot! In the technology and software space, margins are closely correlated with intellectual property protection, ex. patents. Those that have them have a material advantage over thoses that don't.

[In 2000, Google moved] toward an advertising-funded search engine,[76] Google began selling advertisements associated with search keywords. Keywords were sold based on a combination of price bids and click-throughs, with bidding starting at five cents per click.[30]

This model of selling keyword advertising was first pioneered by Goto.com, an Idealab spin-off created by Bill Gross.[77][78] When the company changed names to Overture Services, it sued Google over alleged infringements of the company's pay-per-click and bidding patents. Overture Services would later be bought by Yahoo! and renamed Yahoo! Search Marketing. The case was then settled out of court; Google agreed to issue shares of common stock to Yahoo! in exchange for a perpetual license.[79]

Google has agreed to give Yahoo 2.7 million shares of its stock to settle patent infringement and other legal claims, the companies announced on Monday.

As part of the deal, Google has agreed to license several patents from Yahoo subsidiary Overture Services, ending a two-year court battle that threatened Google's primary source of revenue: advertising. Overture, a pioneer in commercial search, holds intellectual property rights to pay-per-click and bidding systems that grant Web sites higher placement in search results--both fundamental to Google's ad network.

Today's value of that share grant for patent licensing is $2,862,320,814. 'Nuff said! Just imagine if a startup were able to patent the economic plumbing and processes of the Internet in the early to mid 1990s. Just imagine... How much would that be worth?

Now you see the Veritaseum advantage for putting in for very early (before all of the big banks and other startups) patent protection.

Anybody who wants to know more about investing in the bitcoin/blockchain space and/or wish to find out more about what Veritaseum does should feel free to reach out to me - reggie [at] veritaseum.com.

More interesting reading on this topic:

Venture Capital Misallocation, Illiquidity & Disintermediation: Veritas Use Case #1 

Watch As Blockchain Startups & GAFA (Google, Apple, Facebook, Amazon) Send Slower Banks The Way of the Classified Ad

Update on the State of "Intelligent Money" As Wall Street Moves Into Space That We've Staked A Claim In Almost 2 Years Ago

Bitcoin 2.0 Investment Will Trump the Risk Adjusted Returns of Early Movers In Digital Currency Space - VC's Enter Vertitaseum aka The Truth!

 

 

 

 

 

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