Sunday, July 10, 2022
A Bull Case For Ethereum
From selling his Naruto fan site at 18 and buying his parents' home to investing in Ethereum at $0.30 to becoming a Partner at a San Franciso Venture Capital Firm and running a crypto fund - This is Tom Chen
Hey, Hey 👋!
Today’s investor paid off his parent's mortgage after selling his first company at 18. This cash influx forced him to learn how to compound his money quickly.
After years of trial and error, working for Venture Capital firms and top tech companies, he chose startup investing and crypto as his path to compound his wealth.
Today he invests directly in early-stage startups and crypto. This position enables him to spot technology trends early, which he then uses to predict which companies will be breakout successes in the public markets.
This is a good one. Let's get after it!
In Today's Expert Session:
- Meet Tom Chen: From selling his Naruto fan site at 18 and buying his parents' home to investing in Ethereum at $0.30 to becoming a Partner at a well-respected San Franciso Venture Capital Firm and running a crypto fund - this is Tom Chen.
- Investor Toolkit: How to use early-stage trends to drive exceptional returns in the public markets.
- Personal Capital: Where is Tom investing today, and what system has he developed to win repeatedly.
- New Markets: We asked Tom where he’d invest $100k today. His response is Ethereum. Here are the 3 reasons why.
- Business Idea of The Week: A startup farm for crypto infrastructure.
Guest: Tom Chen, General Partner at Magic Fund (Twitter: @datboitom)
Video Length: 50 minutes
2003 to 2009 - Building Naruto Central: Tom started Naruto Central as a side project. Unbeknownst to him, it would grow to one of the top 1,000 websites in the world by traffic volume.
Before its sale, it had nearly 1 million registered users and sat in the #2 search result for 'Naruto' on Google.
In 2008, at 18, the website was acquired by a large publicly traded Internet company.
Tom paid off his parents' home and college and bought the family a new car. But he quickly realized that learning to invest that money and compound it over time was vital.
To learn how to invest, he joined several investment firms - companies like Goldman Sachs, a well-known investment bank in New York, and Lightbank VC, an investment firm founded by the Groupon founders.
He quickly realized that his technical Software Engineering skill and passion for investing worked well within the technology ecosystem.
2014 to 2017 - Investing $1,000 into Ethereum at .30 Cents: As a technical mind, Tom was always curious about new and exciting projects that were pushing the boundaries.
One day, he came across a white paper for a new crypto project called Ethereum. He immediately grasped the context and thought the project could drive a tangible impact on the world.
In 2014, Tom invested just over $1000 into Ethereum at 0.30 cents.
Only 2 short years later, at the beginning of 2017, Ethereum boomed.
At the peak of the 2017 bull rush, Ether reached a price of $1,386. The $1,000 initial investment was up over 4,600x to over $4M at the time.
Ethereum is an excellent example of an asset with asymmetric upside - he stood to lose only 1x his investment (in this case, $1,000) but could win much more if the project went in his favor.
2018 to Today: Building Equity In Businesses: During the crypto winter of 2018, Tom decided to spend some time away from crypto.
He built Stitchroom, a custom upholstery company based in Brooklyn, New York, that works with designers to manufacture high-end furniture.
Today, the company is doing north of $1M in revenue and has 15+ employees.
At the same time, Tom started consulting with startups on the technical elements of their businesses. Now and then, he’d Angel invest in the project.
He quickly built out a network in San Francisco. That led him to invest more actively, investing $5k to $10k in companies he liked. He began getting access to really good deals.
In 2021, Tom joined Magic Fund to invest in developer tools and SaaS businesses.
Lesson 1 - To Spot Trends Early, Build a Network of “Innovators”: When investing in early-stage companies, you must understand how the market adopts ideas. Per the Innovation Adoption Cycle chart above, Innovation spreads systematically. Those who understand this can capitalize on mega-trends before the rest of the world even knows they exist.
“Innovators” are the 2.5% of the population that hang out on the front lines of the internet, learning how new technologies could shape the world.
They are often technically minded (e.g., software engineers, data scientists, technology investors) and curious risk-takers who love new ideas and ways of doing things. Innovators often adopt new products at their earliest stages and influence the demand for that product.
Tom Chen is an example of an “Innovator.” He’s technically minded and spends his days learning about and testing new technologies.
Every investor should develop a network of innovators. This newsletter is an example of access to a network of innovators that can help you spot early trends.
Lesson 2 - The Best Investments Cause Creative Destruction: True disruption opportunities come from creative destruction. They’re the technological shifts that fundamentally change the way we do things by completely decimating the current way something is done and rebuilding it in a better way.
These opportunities are exceedingly rare but can drive outsized returns for investors. Examples of this for Tom include:
- Media & The Internet: Tom got on the internet at 10. He quickly realized the internet had fundamentally changed the way people consumed media. After this insight, he built Naruto Central, which he eventually sold.
- Ethereum & Crypto: Tom’s first thought when reading the Ethereum white paper back in 2014 was, “this is crazy and wildly interesting.” He could see the implications of the technology at its nascent stages. Investing $1,000 in Ethereum at 0.30 cents created massively outsized returns for Tom.
Lesson 3 - New Tailwinds Drive Public Market Returns: Technology trends often start in small nascent corners of the internet. The exact place where innovators like Tom hang out.
If you’re confident in a trend, you can potentially win twice.
When Tom has conviction over a trend, he will make several investments in early-stage companies. He doesn’t know which company will win but knows he wants a horse in this race.
But he doesn’t stop there.
Tom then determines which trends and cycles will create systemic changes and tailwinds for public companies that are battle-tested with better balance sheets.
Unlike early-stage investments, it's unlikely his public markets bets will go to zero.
The result? If he’s correct about the trend, he can be wrong about his startup bets and recoup his losses when that trend hits the public markets.
Let's take a look at an example.
Case Study: Electrification of Transportation
In 2022, Tom is seeing a lot of early-stage investments in the electrification of the transportation ecosystem.
Spurred by the decarbonization policies of most leading nations, consumer demand for electric vehicles is at an all-time high, with new EW sales doubling each year (US EV Sales up 100% YoY). Additionally, EV startups are raising billions of dollars, creating further tailwinds for this broader market trend.
This immense growth creates enormous demand for rare earth metals. Recognizing this, Tom is investing in public markets involved with sourcing rare earth metals. Companies like MP Materials (MP), Lynas Rare Earths (LYSCF), and Texas Mineral Resources (TMRC).
With this strategy, he can better manage his risk across public and private investment opportunities.
- Consulting/Advising: Tom is a software engineer in practice. He consults and advises early-stage companies and gets paid in both cash and advisory shares in the companies he supports.
- Magic.Fund: Tom is a GP at Magic.Fund an early-stage venture capital firm, based out of San Francisco. The fund has raised $50 million and invested in 98 companies with 8 exits. Tom draws a salary and benefits from the upside in the fund in the form of carried interest (e.g., a % of profits if investments perform).
- ShowRoom: Showroom is a custom upholstery business based out of Brooklyn, New York. The company generates about $1M/yr. Tom does not draw a salary but instead benefits from the equity in the business.
- Crypto Fund: Tom is the Founder of a small Crypto Fund investing in early-stage crypto projects. He draws a salary from the business but drives more value in the form of carry in the companies the fund invests in (e.g., a % of profits if investments perform).
- Cash (50%): Tom believes the markets are irrational right now. With so much going on, it's challenging to drive returns. He does not want to catch a falling knife, so he sits on the sidelines, ready to take advantage of opportunities with asymmetric upside.
- Crypto (20%): Because Tom was an extremely early investor in Ethereum and doesn’t plan to sell anytime soon, he’ll always have long-term crypto holdings. For reasons we outline in the New Markets section, he believes Ethereum is the long-term crypto asset to invest in.
- Startups & Funds (20%): Angel Investing: Tom has exposure to startup investments via his carry interests in Magic.Fund, Crypto Fund, and Angel investing. Because of this exposure, Tom typically invests $5k-$10k into ~3-5 companies per year. Fund LP: Tom invests directly into other Venture Captial funds - these investments typically range from $50k-$250k. While illiquid, these investments are protected from near-term market volatility.
- Public Markets (10%): Tom spots trends by investing in early-stage technology companies and then capitalizes on that trend by investing in growth stocks impacted by it. He will typically approach these investments with a long-term mindset, noting that trends take time to influence markets and expect elongated time frames.
The System: How does Tom do it all? He’s built a system that builds upon itself.
- Step 1: Network - Every day, Tom engages with founders and investors across the tech and crypto ecosystem, learning about new companies he could invest in.
- Step 2: Support - Once he meets a founder working on an exciting business, he has a few ways in which he can support: 1) Invest: Invest personally as an angel or via his funds' tech or crypto funds. 2) Connections: Introduce the company to a potential investor, new hire, or customer.
- Step 3: Repeat And Grow - Every time he helps a company, his brand builds within the ecosystem, and he is introduced to more interesting people, invests in more companies, and drives more returns.
We asked Tom where he’d invest $100,000 today. His response was Ethereum.
Ethereum is the world’s second-largest crypto project by market capitalization and was the first to introduce smart contract functionality to the industry.
Here’s the bull case for Ethereum:
- Reason 1: Network security - With cryptocurrency, it’s essential to reduce vulnerability from attacks and hacks. Ethereum 2.0 relies on PoS, which allows for a higher degree of decentralization and ease of recovery from attacks. Builders are betting on Ethereum to survive through volatile market cycles and other security concerns. As a builder aiming to build 3 years down the line, it would be laughable to bet on something that isn’t going to persist through the next few years.
- Reason 2: Organic Growth - Ethereum never raised VC. They raised money in the form of Bitcoin. Thus, the ecosystem grew organically. Pursuing Ethereum from pure interest indicates greater conviction. Ethereum investors are willing to stick with their beliefs.
- Reason 3: Commodity-like Attributes - Ethereum sales pay for “gas” transaction fees that power the ecosystem. It appreciates as the ecosystem grows. Ethereum has 4x more developers than any other cryptosystem. With everyone building on Ethereum, money flows back down to the protocol. In turn, this bumps up Ethereum’s price.
Business Idea of The Week
The Context: The crypto market has exploded over the past 5 years. We can break down the cause of this boom into 3 distinct phases.
- Phase 1: Initial Coin Offerings (ICOs) - An ICO is the process of a crypto company raising capital by selling a new cryptocurrency. Investors may purchase these coins in the hope that the value of the cryptocurrency will increase. Many of these ICOs required Ethereum to make transactions and ultimately play the ICO game. When the SEC started regulating the market, ICOs cooled off - this caused the first crypto winter.
- Phase 2: Decentralized Finance (DeFi) - DeF is a new vision of banking and financial services based on peer-to-peer payments through blockchain technology. DeFi allows “trust-less” banking via blockchain, sidestepping traditional financial middlemen such as banks or brokers. The rise of DeFi caused a second boom in crypto - during this time, standard borrowing and lending products were developed (which is awesome). Still, the industry became overheated with Venture Capital, spurring massive growth.
- Phase 3: NFTs - An NFT is a digital asset representing real-world objects like art, music, in-game items, and videos. They are bought and sold online frequently with cryptocurrency and encoded with the same underlying software as many cryptos. Tom doesn’t believe there’s real fundamental value there just yet, but there is still a lot of demand in the market for rare NFTs.
The Problem: Many crypto projects out there hurt retail investors. They’re designed purely for investors to speculate over crypto asset prices. The industry can only move forward with continued investments into core infrastructure or products that increase cryptos utilization.
An example of this is the borrowing and lending protocols developed for DeFi. This enabled anyone to borrow and lend without intermediaries taking a fee—a step function improvement to the current banking infrastructure.
Many more opportunities like this exist across the crypto ecosystem.
A crypto-focused startup studio explicitly focused on building the infrastructure necessary to propel the industry forward.
As a founder building in crypto, you must have extreme confidence in the chain you build on. Tom believes the safest chain right now is Ethereum - it has the largest community supporting its growth and thousands of companies building their ecosystems on top of it. So he’d start developing infrastructure products for the Ethereum ecosystem.
The structure of a startup studio would allow Tom to test many different product ideas and the infrastructure to transform these ideas into independent companies. The secret sauce of a Startup Studio is the way they work on startup ideas. This process is as follows:
Stage 1: Investigate - This process involves sourcing ideas and determining whether or not the idea has legs. During this stage, you focus on defining the value proposition, understanding the competitive landscape, and making a clear business case. By the end of this stage, the entrepreneur should deeply understand why this business idea needs to exist.
Stage 2: Validate - In this stage, you validate your idea by getting it in front of customers and determining actual demand and willingness to pay.
Stage 3: Create - It’s time to build. By asking potential customers directly, you’ve just validated that the world needs your product. Now you need to make it real. We call this first product your minimum viable product (MVP). MVPs serve as a test for partners and customers to understand their actual usage and to strengthen the market fit.
Stage 4: Scale - By this stage, you’ve proven demand for the product, the ability to build it, and the ability to apply growth mechanisms to scale it. At this time, a startup studio would staff the business appropriately and begin the process all over again with another idea.
The startup studio model creates many opportunities for the business to “win” by developing a repeatable system to launch and scale successful companies.
I hope this got you thinking. See you next week! ✌️