Digital Asset Portfolio Construction
Crafting an Investment Thesis, Understanding Narratives, and Sizing
In early 2021, my partners and I spent a month constructing the Titan Moon Fund portfolio, went through multiple iterations after heated debates, and eventually launched and managed a fund that generated ~2.5X returns for our investors. The portfolio construction process jump started Four Moons’ Portfolio Advisory service business, which we plan to scale in the coming months.
Before diving into the process, it’s important to understand why portfolio construction is critical for any investor or manager. It’s very easy to get caught up in our personal biases, be reactive to the latest shiny object, and miss the forest through the trees. Portfolio construction encourages a thoughtful and collaborative exercise that provides a framework for ongoing asset management.
In the beginning, there was an Investment Thesis
My top-down portfolio construction begins with an Investment Thesis:
Multiple, interconnected blockchains will support the growth of Decentralized Finance (DeFi) and digital asset management over the next several decades.
If you read between the lines, you’ll notice this sentence includes many relevant verticals.
“Multiple, interconnected blockchains” characterizes my belief in a multi-chain world where multiple base layer (Layer 1s and Layer 2s) coexist. Interconnected describes the market's demand for portable liquidity.
“Growth of Decentralized Finance” is self-explanatory, but we are witnessing a liquidity black hole thanks to the outsized DeFi yield opportunities for both volatile and stable cryptoassets.
“Digital asset management” includes the ability for individuals, protocols, DAOs, and even TradFi to trade and track fungible and non-fungible tokens.
“Next several decades” - Yep, we’re in this for the long haul, and crypto has the largest TAM of any asset class in history thanks to its accessibility and borderless nature.
The Investment Thesis drives the next set of big decisions. These are the most difficult and imprecise due to the lack of robust historical datasets and the hyper-competitive and dynamic nature of crypto. The big questions to drill down into are:
How do I select my assets, and which teams are building the blockchains and protocols that contribute our investment thesis?
How many assets in my portfolio?
How should I size my investments?
There is no perfect formula to answering the above bulleted questions, so I have created my own themes to help hone in on the highest probability selections for success. Highest probability of success also implies the lowest risk, which is critical when building a robust portfolio over a multiple year horizon.
How do I select my assets?
Narratives - Narratives are everything in speculative markets where fundamental investment metrics are still being fleshed out and debated. Narratives capture attention share, drive the conversation, and attract investment. Narratives are fluid, can be as short as 24 hours and as long as decades, and provide a compass for picking verticals and specific protocols.
Stablecoin yields in DeFi will continue to hoover in liquidity from legacy finance.
Stablecoin wars surrounding Curve are well known and understood. Now protocols and teams are getting creative about how to increase liquidity for their stablecoins and create value for their native token (e.g. 4pool alliance between Frax and Terra).
In order for DeFi to validate its stablecoin value proposition yields must remain higher than legacy savings and inflation, which I believe it will.
Blockchain scaling will be required in order to onboard the next 10 million users.
Layer 1 blockchains will need a path to cheaper and faster transactions.
Liquid staking derivatives creates yield generating leverage opportunities.
Proof of Stake, Layer 1 and 2 tokens, generate yield through various mechanisms. Long term, L1 and L2 capital assets will produce consistent returns regardless of the applications built on top of the underlying chain. These tokens are not necessarily locked due to the invention of liquid staking derivatives, which represent your staked position. This composable token can be used as collateral across DeFi for additional yield generation and leverage - a powerful primitive.
A multi-chain world requires bridge infrastructure to enable movement of liquidity for users and protocols.
Emerging ecosystems need access to liquidity from the powerhouse ecosystem of Ethereum. Crosschain bridges and DEXs are competing for deep liquidity to enable rapid movement of tokens.
NFTs will be incorporated across legacy and blockchain gaming ecosystems.
NFTs are already permeating through art and identity, and the next major product market fit will be in gaming - both legacy and blockchain based. The protocols that can find big partnerships and scale the demand will be winners.
How many assets in my portfolio?
A full-time analyst should only cover 4-5 assets at any given time. This may not sound like a lot, but it includes thoroughly understanding everything from the token economics, partnerships, project roadmap, governance proposals, team members, and tracking important growth/usage metrics on a regular basis. I am part of a team of 4-5 full time experts, so our portfolio may hold up to 20-25 liquid investments. An individual investor is likely going to be better off with a small portfolio of high conviction assets, especially in a volatile market like crypto.
How should I size my investments?
Typically, the risk/reward ratio is used by many traders when it comes to making investment decisions. For multi-year investment horizons, calculating the r/r ratio is nearly impossible for a hyper-competitive, nascent industry like cryptocurrency. However, investors can source objective data to compare metrics from blockchains and protocols, stay up to date on development progress and roadmap, and interact with the applications directly in order to assess fundamentals. My long term portfolio sizing is based on four components:
Conviction - This matures as projects overdeliver on promises, continue to grow and innovate, and are solving problems covered in the narratives
Catalysts - Events, both roadmap plans and unforeseen/stealth catalysts are major drivers of inflows.
Lindy - This helps assess the downside risk (going to zero due to risks from technology, key man, etc). The longer a protocol has been around, the better the network effects, loyal/sticky the users, and less likely it is to disappear.
Growth velocity - If more users and more assets are interacting on the protocol than their competitors, they warrant a bigger bet.
For example, many portfolios currently are overweight ETH. Ethereum is the leading Layer 1 smart contract blockchain in terms of fees generated and total value locked. It has been around since 2014, and although the roadmap has changed significantly, it’s reached Lindy status thanks to the Ethereum Virtual Machine (EVM) and Solidity network effects. It also has a significant catalyst this year; The Merge.
Ethereum is also scaling with Layer 2 technology, however, other L1 smart contract blockchains are seeing faster growth in terms of TVL and active wallets. There is no ‘sure thing’ in digital asset investment, and it’s important to weigh all of the data before going all in.
OK, but what’s in your portfolio?
This article isn’t written to shill my bags, it’s a framework for how I make the decisions to confidently invest in digital assets. Rather than talking about exact allocations in the portfolio, I’ll give you an example of when things change and what’s required for good asset management.
Fantom (FTM) and Synapse (SYN)
FTM has generated outsized returns over the last 2 years as it tackled blockchain scaling with cheaper/faster transactions. Fantom’s ecosystem blossomed with EVM compatible DApps, experimenter devs, and liquidity bridges. Andre Cronje was an early investor and contributor to Fantom, which raised its status significantly. When he released his Solidly platform, a low fee AMM that incorporated novel concepts for token emissions, Fantom had the lowest TVL to market cap for a significant period of time. Fantom had several catalysts for growth including Solidly, liquid staking on the way, attractive on chain metrics, and all of the liquidity bridge requirements to continue outperforming as a base layer. Thus, we carved out an allocation for FTM that fit into our Layer 1
On March 6, 2022, Andre and his partner suddenly quit; an example of “key man risk” playing out. We were forced with the difficult decision of holding
I alerted the team and quickly sold our FTM and BOO (Spookyswap) positions into stablecoins. At the time of writing, those coins are down 53% and 59%, respectively. In addition to price underperformance, Fantom’s TVL has dropped by over 50%, and the entire ecosystem has since underperformed the broader market during this downtrend.
The stablecoins were reinvested into another high conviction bridge play, Synapse Protocol (SYN), which was $2.08 on March 6 ($3.27 at time of writing). Synapse is a good fit for our portfolio because it’s critical bridge infrastructure to building the multi-chain, interconnected world.
Thanks for reading. I encourage you to use this portfolio construction framework (or build your own) and challenge your thinking or the thought leaders you get tips from.
Additional reading on Asset Management:
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