Should you invest in cryptocurrencies? Only if you can vet them like a hedge fund

There were a lot of lessons the financial collapse of 2008 taught the world. That knowledge was very, shall we say, expensive to acquire; but, it would be lunacy to not heed those lessons given how costly they were to learn. One of those lessons seems self-explanatory when written out, but has been ignored far too often in practice:

Don’t invest in things you don’t understand.

Put another way: the more complex the investment instrument or industry/market segment, the more care you ought to take before investing therein. That sounds simple enough in principle, but can be difficult to adhere to in practice; when everyone seems to making a ton of money off of something, it’s all-too tempting to try and ride that same wave, even if you don’t know what’s actually in the wave itself.

In 2008, the instruments in question were mortgage-backed securities and collateralized debt obligations. Rehashing exactly what those are and why they were dangerous isn’t mission critical for our purposes here, but suffice it to say that many of the major investment houses and investment advisors saw a huge bag of cash up for grabs if they steered clients toward these type of risky financial instruments. The problem was that many of those advisors, their investment houses and certainly the investors/clients didn’t really understand how the financial instruments worked or all the market forces acting on each of them. That meant a systemic problem, if it presented itself (which it obviously did), could unravel everything, and no one really knew how to extricate themselves because they didn’t understand the underlying industry or instrument.

We all saw how that worked out.

Now, that’s not to say you or your company shouldn’t invest in new or risky technologies, companies or industries. Many of the biggest investment winners of all time were hugely risky bets — with greater risk often comes greater reward. And we are certainly of the mindset that you should be aggressive and confident in your investments, whether that’s corporate R&D or personal investing. But, we cannot stress enough, you simply must understand what you’re investing in before you do so or there’s no way to properly vet the company, its industry, its chances for growth, potential roadblocks, etc.

Let me give you a recent example.

Hedge funds are often first adopters when it comes to investment opportunities, which makes sense; they’re quite literally in the business of spotting trends before the market does and capitalizing on those trends. And, one of the hottest investment opportunities in the world right now are cryptocurrencies. There are tons of initial coin offerings going on, and a lot of those will fail. But, in people’s haste to invest in this nascent and growing market segment, there’s very little way to tell who’s going to end up succeeding and who won’t if you don’t have an intimate understanding of the technology, the players and the code.

That’s exactly what one savvy hedge fund did — they jumped into the code to vet the underlying health of the cryptocurrency. From a September Bloomberg article:

“Lucas Ryan of MetaStable Capital took a deep dive into the computer code underpinning the digital currency Monero to see if it worked as promised. He even took a core piece written in C ++, and rewrote it in the programming language Python.

“The extra effort paid off. After taking the time to vet Monero before its investment, the San Francisco-based hedge fund has seen a 100-fold return, said Joshua Seims, who started MetaStable with Ryan three years ago.

That sort of deep dive is exactly why good hedge funds make a ton of money — they do the true vetting required to make intelligent investment decisions. That doesn’t mean those investments aren’t still risky, but it’s truly a calculated risk. MetaStable is spending the time and effort to really understand exactly what they’re investing in before they do so. And so far, it’s paid off (at least according to them).

That sort of due diligence has become vital given the proliferation of initial coin offerings, which have raised “about $2 billion this year and swelled the ranks of digital tokens to more than 1,100”, according to that same Bloomberg article.

“‘If you don’t have a deep understanding of this technology, you don’t know what you are buying,’ Olaf Carlson-Wee, chief executive officer of Polychain Capital, said in a phone interview. ‘There are a lot of projects right now launching. Most of them make very little sense, and the vast majority will fail.'”

This same advice applies across industries and market segments. You shouldn’t be throwing a ton of resources into artificial intelligence or machine learning if you don’t have an intimate understanding of the technology and its potential uses for your business, much as you shouldn’t bet it all on a cryptocurrency you can’t fully vet.

We do believe in being adventurous and aggressive in how we invest our time, money and resources, but we do so from a place of knowledge and understanding. So when it comes to A.I., machine learning, cryptocurrencies, and other innovative software solutions/investment opportunities, you ought to partner with an expert who truly does understand those technologies and their use cases. That way, you give yourself an opportunity to cash in without exposing yourself to potentially crippling risk.