Australia

March 25, 2022

Future Focussed Portfolio – Web 3.0 & Blockchain

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COMPONENTS OF A FUTURE FOCUSED PORTFOLIO – PART III:

WEB 3.0 & BLOCKCHAIN

One of the biggest risks to an equity portfolio is structural change, and investors know it is incredibly important to be positioned ahead of it. What we call a future focussed portfolio must be built to benefit from these changes. In response to that, we recommend that investors invest across the innovation of today, tomorrow and the future.

In our previous articles, including last month’s here, we showed the strength and opportunity of the first two components of a future focussed portfolio, which incorporate companies such as Google, Amazon, Xero, and Intuit. These are what we call Web 2.0 companies, and they are so strong that it seems unlikely that a single company can disrupt them.

However, there is another threat: Web 3.0 or the next generation internet enabled by blockchain technology. The future component of a future focussed portfolio must address this. This represents the next major structural technological change sweeping the world’s businesses, and all investors need to be made aware.

There is a mantra currently doing the rounds in Web 3.0 circles: if you don’t understand Web 3.0 you don’t understand the risk associated with your current portfolio. But fear not, help is here.

REVOLUTIONISING THE INTERNET

Australians may have forgotten the power of technological changes that disrupted entire industries. Only a decade ago, online media effectively swept away the long-established media industry (Figure 1, below). Australian investors were lucky, however, as this represented just 5% of the ASX.

 Figure 1: Share price performance of Australian domestic media stocks

Source: ASX

But they may not be as lucky next time. The next iteration of digitalisation – Web 3.0 and blockchain – is aimed squarely at financial services, which makes up 30% of the ASX.  Blockchains are transitioning us into a new era of the internet by digitising value, a concept that will play out over many decades, just as Web 2.0 has.

What many are calling the internet of value will change the way that we move value across the internet, which spells trouble for our locally focused financial services industry.

Why? Financial services are not natively digital these days. Blockchains on the other hand, are – and that means that services can be offered globally without a presence in the economy. Digital asset businesses could offer financial services at a significant discount in comparison to local operators. Likely this comes with a stronger value proposition too; we’re seeing stable coin yields in the double digits, a far stretch from the 0.5% many of us have grown accustomed to.

And it’s not just financial services that will be affected. In fact, blockchains are much broader, providing a coordination mechanism – or incentives – that drive new business models and value propositions. We know this intimately well through our Filecoin data storage operation.

Filecoin can be likened to the Airbnb of cloud. At scale, it leverages blockchain technology to offer users cheaper, faster and a more secure means of storing data and distributing it globally.

One of the big keys for those new to Web 3.0 (and aren’t we all?) is that Filecoin isn’t competing with Amazon or Google, it is competing with the underlying protocol HTTP.

Source: Daily Mail, December 5, 2000

Filecoin is changing the way that data moves around on the internet, and it’s changing the World Wide Web.

The opportunity is enormous, and the structural change here is tectonic in nature – think film to digital photos. With a future focussed portfolio having a significant investment in cloud services via Web 2.0 companies, its essential we understand this change.

LIKE THE PIONEERING DAYS OF THE INTERNET

Critics of the digital asset space, and indeed some investors, might be quick to dismiss the industry as a fad. But the environment today reminds us of the early stages of the internet.

But you’ve no doubt heard this all before – this is how disruptive technology evolves, it iterates, and it appeals to a sub sector before moving mainstream. New value propositions come to life, drawing in new users. The global platforms we see today would have been impossible to predict in the 1990s.

Similarly, with much of Web 3.0, we are still yet to see the long-term implications. Much of the value of the internet comes from the network effect, as more people moved online it became more useful. The same is occurring here with Web 3.0.

However, there is one key difference, as this network effect is being bootstrapped. What do we mean by that?

BOOTSTRAPPING NETWORK EFFECTS – THE INCENTIVES OF WEB 3.0

One of the many things that makes Web 3.0 different from Web 2.0 is the blurring of users and shareholders. This is critical to understand.

In Web 3.0, users own part of the network and receive the financial benefit of that network. This is starkly different to Web 2.0. The users of Facebook, for example, provide tremendous value to the Facebook platform, but those users do not own it or share in the profits.

Web 3.0 is creating a much more aligned model for users, and it is this alignment that is helping bootstrap or incentivise adoption of these networks (Figure 2, below).

Figure 2: Using token incentives to solve the bootstrapping problem

Source: Holon

This is why you may see people getting excited about these businesses, even before it becomes clear their utility is superior to today’s alternatives. But make no mistake, the financial utility – the big upside – will accrue to the early adopters, and it is why we are seeing such rapid adoption of Web 3.0. Because we have learnt to incentivise people to join, the digital asset space is outpacing the internet with 4 billion users predicted to be involved in the space within ten years (Figure 3, below).

This isn’t a fad, this is adoption – and structural change.

Figure 3: Technology Adoption Curve – Crypto vs. Internet Users, 2016 – 2030

Source: crypto.com – World Bank – Global Macro Investor

CRYPTO HAS NO FUNDAMENTALS THOUGH, DOES IT?

Another misconception critics and some investors have of the digital asset space is that there are no fundamentals. Like gold, Bitcoin is difficult to value. But the fundamental reason we would want a hard money (preferably digital) does not change.

Outside of Bitcoin, we are seeing very similar metrics to what you would see in traditional financial markets. Ethereum, for example, has generated $US350 million of revenue in just the last 30 days (as per end of March 2022), much of which is being paid to miners (those helping operate the network) or redistributed back to holders via a burn mechanism (share buyback). Token Terminal is one of many sites that help highlight the fundamentals associated with this new industry. The value being driven into these assets is no different to how Amazon share buybacks create value for existing shareholders. Thus, the focus for investors like ourselves falls back to the value proposition.

Understanding the value propositions is critical because in many cases, these value propositions cannot be replicated using legacy technology. This is a structural change. A fast moving, sometimes confusing infrastructure change that will have long-lasting ramifications for all investors.

PROTECTING YOUR PORTFOLIO

Now for the most important part – how does this affect you? As outlined, we cannot downplay the profound, structural changes that Web 3.0 and blockchain represent in the world today. Web 3.0 will disrupt many industries – particularly financial services – that make up a huge proportion of the ASX and Australian domestic portfolios. However, understanding – and investing – in Web 3.0 isn’t just about capturing the upside of this revolution, it is also about protecting the value in your existing investments.

So, if you don’t understand Web 3.0 you don’t understand the risk associated with your current portfolio. Whether that’s payments, cloud, financial services…Web 3.0 is coming, and investors need to understand it, soon.

Looking for some more information on how to build a future focused portfolio? Click here

This article has been prepared by Holon Global Asset Management Pty Ltd ACN 629 590 585 (Holon). Holon is a corporate authorised representative (CAR number 1276082) of Atlas Funds Management Pty Ltd ACN 612 499 528 (AFS licence number 491395). The information provided in this article is general in nature and does not constitute investment advice or personal financial product advice. This information has not taken into account your investment objectives, particular needs or financial situation. Before acting on any information contained in this article, each person should obtain independent taxation, financial and legal advice relating to this information and consider it carefully before making any decision on recommendations.

Any opinions or forecasts reflect the judgment and assumptions of Holon on the basis of information at the date of publication and may later change without notice. Any projections contained in this communication are estimates only and may not be realised in the future. Returns from investments may fluctuate. Past performance is not a reliable indicator of future performance. All investments carry risks, including that the value of investments may vary and that your capital is not guaranteed.

Whilst all care has been taken in preparation of this article, Holon gives no representation or warranty as to the reliability, completeness or accuracy of the information contained in this article. Holon accepts no liability for any inaccurate, incomplete or omitted information of any kind or any losses caused by using this information. To the maximum extent permitted by law, Holon will not be liable in any way for any loss or damage suffered by you through use or reliance on this information. Holon’s liability for negligence, breach of contract or contravention of any law, which cannot be lawfully excluded, is limited.

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