Tag: venture capital

Bitcoin and the broader cryptocurrency market have seen a resurgence since Trump’s election victory became clear. An industry formerly on the fringe of finance has drawn in institutional interest, interest from young investors, and interest from those interested in disrupting the current financial system.

The recent shift in the political environment is likely to lead to a change in the regulatory perspective on the industry, and recent financial innovations have made cryptocurrencies more accessible than ever. Furthermore, various interest groups associated with the industry lobbied the Trump campaign heavily and have touted his victory as a major win for the ecosystem

Following the election, crypto assets and equities associated with the industry, such as crypto exchanges, have seen significant appreciation. The recent performance, breadth of the market, and the potential for a shift in the regulatory environment necessitates a discussion around whether or not crypto deserves to be viewed as an independent asset class in a broader diversified portfolio. In particular, advocates for the asset class have touted its value as ‘digital gold’, as a potential payments platform, and as a disruptive component of the modern financial industry. Skeptics have pointed to its lack of utility, substantial volatility, and speculative nature.

Can You Use Crypto As a Payment System?

One of the primary arguments for crypto to investors is that it offers a cleaner and faster way to transact payments. But from where we stand today, crypto’s volatility undermines its utility in any payments ecosystem. The price swings for most large crypto instruments are dramatic: Bitcoin, the largest crypto asset, went from being below $1,000 in 2017 to reaching $69,000 in 2021, followed by a crash to $30,000 within months. You need an iron stomach to block out the noise that comes with owning an asset like that. Such volatility is almost unprecedented compared to other stable currencies like the Dollar or the Euro. Rather, that volatility even stands above that seen in far more speculative equity markets or bond markets. The ability to use Bitcoin for peer-to-peer transactions is significantly undercut by its price swings. Reliability and price stability is essential for a payments network.

Real world evidence supports this perspective. Crypto generally isn’t used for transactions in a place where a stable currency is available. According to the Federal Reserve, only 7 percent of U.S. households held or used cryptocurrency in 2023, down 8 percent from 2021. That number encompasses the broad crypto ecosystem with more than 10,000 different cryptocurrencies – no single asset has any sort of significant payment volume, even if some assets like Bitcoin have seen dramatic price increases in the past few months. Furthermore, when crypto is used in payment it’s often not for the kinds of purchases an ecosystem wants to be proud of. Crypto assets like Bitcoin are the preferred route for dark web transactions, ransomware attacks, and illegal gambling sites even though it’s estimated that less than 1% of Bitcoin transactions are criminal.

However, while a significant payment ecosystem has yet to mature, digital currency technology continues to advance. Large players like Visa and Mastercard are excited by blockchain technology and there are a lot of start ups and small companies working on building blockchain systems explicitly for payments.

Is Crypto Digital Gold?

So, if your average Joe isn’t going to use crypto to transact, then where’s the value?

Many advocates have pointed to the potential for Bitcoin and other crypto assets to be a hedge against inflation and normal market volatility. Bitcoin in particular draws attention as its total future supply is capped at 21 million coins. This artificial scarcity sets it apart from fiat currencies, where central banks have control over how much to print into circulation. In an era of rising inflation and unprecedented monetary stimulus, Bitcoin evangelists see it as a potential hedge against the devaluation of traditional currencies and bet on its recognition as a store of value worldwide. An advocate’s perspective is not that Bitcoin is a replacement for stocks, but rather an insurance contract for a fiat currency meltdown – similar to the argument used to push for gold.

Gold has served this function for investors for a long time – nobody uses gold to transact, yet many investors still incorporate it into their portfolios, thereby giving it value. Outside of its few industrial applications, gold bugs use the metal as a hedge against volatility and inflation even though imagining a situation where we barter with gold bars is pure fantasy. The argument for Bitcoin to still be worth something while not being a particularly useful asset may lead it down a path similar to the metal’s – a speculative asset devoid of intrinsic value and entirely dependent on sentiment.

Are Crypto Ecosystems Disrupting or Conforming?

Crypto has gone mainstream over the past few years through a combination of consistent promotion from the exchanges, outsized returns, and some dramatic collapses. The collapse of exchanges like FTX and the subsequent pushes to regulate the industry have made crypto feel less like a disruptive new wave of finance, and more like another part of the broader financial system. Rather than pioneer new ways to run the financial system, crypto assets have actually come closer to traditional finance. In particular, the introductions of ETFs to allow investors easier access to crypto assets like Bitcoin is noteworthy. Institutional offerings like ETFs bring ease of access to the previously esoteric market.

The introduction of regulated access points allows retail investors and institutions alike to start thinking about crypto as a potential asset class, rather than needing to focus solely on the risks associated with a frontier market. The broader financial system has regulations and systems in place to deter and prevent fraud and mismanagement like what we saw with FTX, and the financial system is similarly used to the risks associated with leverage and counterparty risk like what happened with crypto hedge fund Three Arrows. Having ETFs from established financial institutions like Blackrock may allow investors to start looking past systemic problems with the ecosystem.

It’s also important to note that while the push for crypto in developed economies has been towards regulation, it is acting as a disruptive technology in less developed economies. In places with less stable currencies crypto has become a way for people to move wealth outside of the traditional financial system and to hedge against hyperinflation and local currency instability. Peer-to-peer trading platforms are much more prevalent outside of the G7 countries and in many cases this allows crypto to be more well received.

Investing Upstream

While investing in crypto assets is fraught with risk, there are other ways to tap into the growth of the ecosystem and still have some exposure. One area we see talked about a lot right now is with the miners whose stock prices generally follow the price of bitcoin but give investors upstream exposure. Companies like Marathon Digital Holdings (MARA) or MicroStrategy (MSTR) are directly involved in the business of mining and owning crypto assets. However, while the idea of investing in a miner may be attractive, they are essentially leveraged bets on the crypto assets they’re holding. Small changes in the price of the asset they’re working with have outsized impacts on the price of the stock.

If we ignore miners and break down the essential inputs needed for crypto more broadly, we come away with two sectors with substantially stronger tailwinds. Semiconductors and power. These two spaces benefit not only from tailwinds in crypto, but are also exposed to the broader acceleration in AI and technology more broadly. Chip behemoths like Nvidia (NVDA) and Advanced Micro Devices (AMD) not only get to develop chips used for crypto, but also have huge opportunities in the AI data center market.

Similarly, utilities providing energy to both miners and AI hyperscalers will stand to benefit from the ever-increasing competition – whether that be in nuclear with companies like Talen Energy (TLN) and Constellation Energy Corp. (CEG) or broader renewables like NextEra Energy (NEE). The bitcoin mining community is already receptive to renewables with over 50% of its energy consumption powered by renewable sources. Even companies like Tesla (TSLA) are exposed to the renewable space through their sales of their solar panels, battery packs, and energy management systems to power data centers or crypto mining operations that need uninterrupted power.

Final Thoughts

Crypto assets have gone more mainstream by integrating with the rest of the financial system, but we believe they still fall short of being considered an essential asset class. The absence of intrinsic value and exceptional volatility are major obstacles. While the price increases can be exciting, that volatility can go both ways and losses can accrue just as quickly. Despite the significant increase in institutional adoption in 2024, we believe there are other more reliable ways to participate in the market. We prefer looking at the energy consumption or semiconductor suppliers as opposed to the crypto assets themselves.

There are numerous ways to invest in the Artificial Intelligence (AI) boom. Some high flying chip stocks like Nvidia have captured the spotlight, but there are more ways to invest in a broad wave of AI adoption than just semiconductor chips. Chips are essential, but without the infrastructure to support them they’re useless. Investors should also consider the sector powering the data centers needed for AI development.

According to the Electric Power Research Institute, data centers are forecasted to consume up to 9% of US electricity generation per year by 2030, up from 4% in 2023. That doesn’t sound like much, but between replacing old power generation and turning on new power arrays, the step up is significant. The reason is AI. The energy needs for AI computing are immense. To put the energy consumption into perspective, AI queries – just asking ChatGPT to clean up that email to your boss – can require approximately ten times the electricity of traditional internet searches. Training new models and running more complicated queries suck even more power.

The need for more power generation is so intense that it’s actually becoming the primary obstacle for companies looking to innovate in AI. The ideas are there, the computational chips are expensive, but they’re there, but you need to figure out how to meet the energy needs for the data center to function.

As this space continues to play out, we think it’s worth exploring opportunities within energy generation where investors can benefit from partnerships between both the upstream and downstream players in the AI market.

Data Centers Need Electricity…and lots of It

To explore the first-phase beneficiaries providing key inputs for AI advancements, it’s worth breaking down what data centers are used for when it comes to artificial intelligence. Data centers are the backbone of this AI boom as they store the hardware necessary to train AI models. As modern technology companies have grown larger and larger, and the amount of equipment needed to maintain operations and cloud services has skyrocketed, the energy demand from hyperscalers has followed suit.

Hyperscalers – companies that operate cloud computing infrastructure – provide the storage and compute power necessary to train AI and are faced with the difficult task of deciding where to source the energy needed for their daily operations. Major players within this space include Amazon Web Services, Microsoft Azure, and Google Cloud, all of which are forming partnerships with local utilities and power providers to ensure their energy demand is met.

With the sweeping transition to cloud data storage, electricity demand has turned into the biggest problem facing the industry. Hyperscalers providing infrastructure and platform services just can’t get enough of it, and the world of institutional finance is taking advantage of the opportunity. As we’ve seen recently, Blackrock teamed up with Microsoft (MSFT) and MGX (an AI fund out of The United Arab Emirates) to announce the launch of a $30 billion AI infrastructure investment fund focusing on building out data centers and energy infrastructure. While this may seem like a massive investment initially, it pales in comparison to the total investment in AI from the top 5 hyperscalers over the next few years. For context, current projections indicate the investment levels will reach a combined $1 trillion in 2027 according to S&P Global Market Intelligence.

Straight to the Source

The way power is generated and sold to large hyperscale consumers is going to change. Whereas in the past many data centers may have tapped into local electrical grids, the future of data center electrification involves dedicated power construction and long-term power purchase agreements (PPAs).

Hyperscalers prefer PPAs over market spot pricing since they’re able to guarantee stable energy prices for an extended period, typically over ten years. This level of certainty provides a hedge against unwanted price fluctuations that would affect hyperscalers’ bottom line and put upward pressure on already substantial model training costs. Perhaps more important though is the desirability of long-term contracts for developers and investors. PPAs from cash flush hyperscalers give developers the ability to secure financing for rapid construction of new power generation facilities. Knowing you have a reliable counter party allows for better profit forecasting! Furthermore, many of the power generation projects are dedicated solely to the data center and disconnected from the broader grid – a contract stipulating a minimum rate of return is essential for a project that takes years to break even and only has a single customer.

Finally, it’s worth pointing out that while renewables like wind and solar are the preferred long term source of power for the data centers, the demand right now is high enough that other options are on the table too. Nuclear power is back in the spotlight and natural gas turbines offer rapid deployment. Each power source comes with pros and cons – some are more flexible and some are harder to ramp up and down with data center demand. There will be a wide variety of solutions to the power conundrum over the next several years and many solutions that start off as off grid or dedicated power supplies may eventually end up becoming part of the larger power system.

Opportunities in Renewables

The long term demand for electricity is an opportunity to accelerate the build out of clean energy solutions. The top hyperscalers have set ambitious goals to reduce their carbon footprints – renewable power is a must for them over longer time frames. Among the top names, Google is targeting to operate its data centers on carbon-free energy by 2030, and Microsoft and Amazon both hope to shift to 100% renewable energy by 2025.

The massive undertaking is already underway as Microsoft (MSFT) and Brookfield Renewable Partners (BEP) signed the biggest-ever clean power deal this year for their data centers in the US and Europe, effectively penciling in 10.5 gigawatts of renewable energy capacity starting in 2026 and estimated to cost more than $10 billion. Keep in mind that 10.5 gigawatts is 3 times larger than the amount of electricity consumed by all data centers in Northern Virginia – commonly known as the data center capital of the world due to its favorable state tax incentives and best in-class access to power and internet connectivity.

With the steadfast increase in renewable energy demand due to corporate mandates, there are several ways to invest. We’ve already touched on the financing side where groups like Blackrock or Brookfield are raising capital to fund the construction of new power projects. Then there’s the manufacturing side, companies that make solar panels or electrical components, or companies who build wind turbines like GE Vernova (GEV). Finally, there are the utilities who want to own and operate the power generation facitlities over the next several decades, companies like NextEra Energy (NEE) or Constellation Energy Corp. (CEG).

Finally, there are cutting edge innovations in the power space that are less proven. As an example, innovative nuclear technology, like small modular reactors, is progressing rapidly and has received extensive backing from the US Department of Energy. These new reactors, built by firms such as NuScale Power (SMR), are smaller than traditional reactors and don’t have to be custom-built on-site. The process of generating electricity through nuclear fission is the same, but the benefits include reduced construction time, enhanced passive safety features, greater flexibility in deployment, and more efficient fuel usage. For broad adoption with data centers in the US, we’ll need to see continued investment in generation capacity and regulatory compliance, so patience is key.

Far from Being Over

The rapid expansion of artificial intelligence and pursuing energy demand are creating significant opportunities in the energy sector. As hyperscalers like Amazon, Google, and Microsoft ramp up their AI infrastructure, the need for massive amounts of electricity will drive investments in both traditional and renewable energy sources. While fossil fuels may provide immediate solutions due to existing infrastructure, the long-term focus is shifting toward renewables, such as wind, solar, and even nuclear power to meet sustainability goals.

Well-established and innovative companies in the energy sector, especially those forming strategic partnerships with hyperscalers can offer an alternative method to invest in the AI market besides buying chip companies or hyperscalers directly, even if the full societal benefits of investment end up taking years to play out. The ongoing collaboration between energy and AI firms will be crucial for supporting AI adoption and addressing challenges that lie ahead. Regardless of any short-term uncertainties, the unrelenting demand for energy remains far from being satisfied, and investors should continue to monitor the space for opportunities.

 

Everyone knows how Amazon started as a simple book store or how Meta began in a dorm room. At some point all of today’s great companies were just a passion project, a great idea in need of capital, employees, and the first real customer. While some ideas grow to become companies organically without outside investors, most companies need help. They need capital, they need expertise, they need connections and support.

Venture capital investing is the process by which these great ideas get funded and become dynamic companies capable of scaling and growing profitable. The return profiles for successful companies can be huge, but it’s an incredibly nuanced and risky part of the investing world and not suitable for everyone. Nonetheless, it’s where the best ideas are tried, tested, and eventually brought to fruition.

Investing in Venture Markets

You can’t invest in the venture space without recognizing that failure is an essential part of the creative process. Venture companies are dreaming big – and not every moonshot works out. In fact, most small companies end up failing and shutting the doors. Investing in the space successfully hinges on one or two ventures succeeding within a much broader portfolio. The companies that make it often hit escape velocity – they can hyperscale and the the returns can be exponential. The returns on a single venture investment could be enough to justify dozens of failures.

The complexity of the market is further complicated by the lack of transparency and minimal reporting requirements. The environment is rife with fraud and exaggeration. A great idea may be nothing more than an idea and may have no substance or practical marketability. Successfully navigating the venture space consequently requires a nuanced understanding of how businesses are run and an astute approach to avoid falling prey to exploitation. Subject matter expertise is also essential to see through the sales pitch and understand the substance of the idea.

Finally, we have to take a moment to discuss how hyperscale growth can be risky even when it succeeds. Unlike mature companies who are kicking off cash to investors, most venture investments are purely growth oriented. That growth can be awesome, but can also lead to long investing time frames – venture investing is not for those who need liquidity, even if they can handle the risk.

However, for those with the risk appetite, the time, and the expertise, the venture space can be incredibly rewarding. Diversified and done properly, a venture capital fund can be a vehicle for cutting edge ideas to become wonderful portfolio investments experiencing exponential growth over time.

Timing The Economic Cycle

This already exciting space is even more intriguing because of where we are in the market cycle. Smaller companies are typically the most exposed to the broader economic cycles and the venture space is no exception. The past two years are a great example. Inflation and interest rate hikes put a damper on the economy and small companies took it on the chin. Exuberance in 2021 turned into austerity in 2022; it’s hard to overstate the monumental shift in perspective. Think about some public market companies with established user bases and real products – companies like Teladoc or Zoom or PayPal. In 2021 their valuations were extended, and in 2022 and 2023 those valuations came tumbling downwards.

The same thing happened in private markets and in venture capital markets. In many cases it was actually worse in venture markets as the underlying products were far less tried and tested. The stress on the venture space was further exacerbated as soaring interest rates and a crisis of confidence caused the collapse of the venture-oriented bank SVB. Consequently, raising funds in venture markets today has become much more difficult. Many ventures have shut their doors and those still standing are fighting to raise capital at any valuation. Rather than looking for growth and appreciation, founders are looking at flat fundraising rounds as a victory.

This is also reflected in the IPO market. Many successful venture companies have delayed their public market debuts and have opted to stay private until capital markets start to open back up. The lack of activity in the last year or two stands in stark contrast to the successful listings of companies like Snowflake or Doordash when markets were less troubled.

However, companies resilient enough to weather downturns tend to flourish when market conditions improve. Difficult market conditions make it essential to not only have a good idea, but to become a good operator. Conserving cash, focusing on profitability, finding ways to efficiently acquire customers – these are lessons that companies learn during downturns. Taking that expertise to the broader market when capital markets start to unlock can lead to rapid growth both in terms of profitability, and in terms of the valuation of the firm.

Read the full article in Forbes.

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