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Active contributors also get free access to the SA PRO archive.
Click here to find out more »
As a dividend growth investor, my interest in the decentralized world of cryptocurrencies and blockchain technology has been at odds with my investment thesis.
I’ve reinvested and traded mining rewards, but it has never aligned with my strategy designed to build an ever growing passive income stream from dividend returns. It has been exciting to watch the crypto space grow and participate from both a cultural and technological perspective, but until now it’s had little effect on my progress towards financial freedom.
With the proof-of-stake cryptocurrency Tezos ( XTZ-USD ), we now have a decentralized alternative that can further diversify our passive income portfolio and set us up for the borderless, digital future.
My investment thesis I’ve set up a baseline for income where I’ll live comfortably. When I have passive income that exceeds this baseline, I have financial freedom and can choose to spend my days however I like, whether it’s taking the job that’s interesting instead of paying the most, devoting my time to personal projects or startups, spending time with the family or something completely different.
The goal for my stock portfolio is to generate cash flow to cover this level of living as well as to raise it over time. This is done by buying stocks with a clear policy of distributing part of the profit as dividends and also to grow the distribution over time.
Once the passive income level is reached, the majority of the distributions are taken out as a type of salary and the rest is reinvested. This provides a margin of safety as well continual compounding returns from dividend growth as well as re-investment.
Compounding, exponential returns is the magic sauce that makes it possible for anyone to build a stock portfolio that generates a significant cash flow from dividends – without ever having to sell the underlying stocks. All that’s needed is consistent investments and time.
To choose stocks for this passive income strategy, I screen and evaluate potential candidates along three dimensions:
Yield and dividend growth: What is the actual value for me to own this stock?
Price to fair value: Is it a good time to buy this stock?
Fundamentals: How sustainable is the company and the dividend?
Every month, I go through my existing portfolio to evaluate if I need to sell something and what new stocks to invest in.
Crypto as dividend stocks What does all this have to do with cryptocurrencies and blockchain? Until now basically all cryptocurrencies and tokens have been either decentralized digital money or based around some type of utility model to skirt existing securities regulation.
This means that just like stocks without a dividend they haven’t had a place in my passive income investment strategy. In order to reap benefits, you need to speculate in a price increase and then sell the underlying asset to realize any value.
What started the whole blockchain revolution was the development of a distributed and trustless consensus mechanism for agreeing on the next set of data to be part of the blockchain, such as transactions. Proof-of-work, where computers try to solve cryptographic puzzles to randomly be selected as the next block producer, has traditionally been the dominating consensus mechanism.
To get part of the reward, you’ve had to invest in hardware that solves these puzzles.
In a proof-of-stake consensus mechanism, block producers are randomly chosen based on the amount of tokens they put up as a stake. As a reward for the stake once the block has been validated, a set amount of tokens are paid out. Over time the stakers get to endorse a proportional amount of blocks to the staking amount.
Block rewards is the source of inflation on these blockchains.
The Tezos blockchain , which went live June 30th, 2018, is based around a delegated proof-of-stake model , where you can either stake your tokens yourself (“baking blocks” as it’s called) or delegate your tokens to someone else for them to bake and for you to get baking rewards minus a fee. It also has an on-chain governance system with a self-amending technology (for community-driven organic upgrades instead of hard forks) with a code base suitable for formal verification (more information in the Tezos whitepaper ).
Going back to my investment strategy, how would Tezos rate as a dividend instrument using my stock rating and screening system?
1.
Yield and dividend growth
The maximum block and endorsement rewards per block will be 80 tokens, resulting in a 5.51% inflation at the start. Not all tokens can be used for baking though; baking locks the tokens for a period of a couple of weeks. Tokens on exchanges, the ones used as a medium of exchange, for gas and transfer fees and so on need to be unlocked. This means that if 50% of all available tokens are used for baking, the effective reward will be 11%. Current network parameters are set at a fixed amount per block, which means that the inflation, and block rewards, denominated as a percentage of investment will decrease compared to all available tokens over time.
If you believe that the tokens will appreciate in value compared to fiat, the result is that the dividend will grow in relative terms anyway – and quite strongly if Tezos reaches mainstream use. Until the entire world runs on public, permissionless blockchains, there’s still a risk though.
If the value of Tezos goes down compared to fiat, we will be losing relative value with negative growth rate. However, getting more than 5% is a very strong dividend no matter how you see it.
2. Price to fair value
Tezos is a new blockchain where the market is just finding its value.
As of right now, it hasn’t reached mainstream awareness or begun trading at the larger exchanges.
A long period from the fundraiser has led to many people selling their tokens as soon as it became possible with a sharp initial drop in price. Without any tried model to use for fair value, it’s a guessing game for what it will be. I believe it’s a top ten cryptocurrency in significance, probably top three, which should result in buying pressure over time.
The proof-of-stake mechanism in itself will also drive a price increase.
With a significant share of the tokens locked up in baking, there will be a limited amount of tokens for all the other use cases.
As new investors find out about baking, the unlocked supply will only decrease further.
3. Fundamentals
Tezos is the first third-generation blockchain. The first was Bitcoin with its distributed ledger for trustless transactions and store of value based on proof-of-work consensus. The second was Ethereum with its smart contracts and possibility to create distributed applications.
The third generation is based on proof-of-stake and features on-chain governance in addition to smart contracts. Tezos’ governance model is built around a self-amending technology, where token holders vote on whether code upgrades should be included or not. When they are included, the blockchain code amends these changes and propagates it to all nodes. With this model it’s easier to reach consensus on future upgrades to avoid the inaction and forking that’s been prevalent in Bitcoin and Ethereum.
In addition, Tezos is built around formally verifiable code.
Formal verification through mathematical proofs is something that makes it easier to be certain that the software and smart contracts on the platform really do what they are supposed to do. Tezos has had a testnet running since the fundraiser in July 2017 and so far the blockchain technology has been solid.
There are some other blockchains that feature hints of the same technology and direction, but no other is as clearly based on the core values of the blockchain revolution as Tezos.
Especially EOS has been used as a comparison since it’s also based around delegated proof-of-stake and on-chain governance. But, from my opinion, the EOS model with 21 block producers and a central arbitration function to freeze accounts or overturn transactions, it’s not an agent for open, borderless, permissionless and trustless economic activity.
So, the technology is both sound, significant and a clear step forward.
This is what will drive adoption of Tezos in the emerging blockchain economy. The inflation level is set by the stakeholders, and I believe it’ll be very hard to reduce this level significantly once it’s established and bakers get used to their payouts.
The Tezos foundation has a sizeable war chest from its $232 million fundraiser (much larger by now from the appreciation of collected Bitcoin and ether) and a strong community that develops apps and tools independent from the foundation. Differences in opinion between the original foundation leadership and the original founders and community led to a longer-than-expected wait for the live network to go live.
The foundation board was replaced in February 2017 and has since got its act together in working for the network.
I believe the combination of utility, governance and baking rewards will eventually limit the supply of tokens and result in upwards price pressure.
Based on how I usually evaluate stocks, I find the fundamentals of Tezos acceptable, with the biggest risk factor being the non-existent dividend history and early stage of the network at the time of writing.
Summing up I invest for passive income and financial freedom. To choose whether I have to go to work or not, what I want to work with, and which people I want to spend my days with.
For me, Tezos is the first blockchain and cryptocurrency that combines my old-world investment strategy with how I see the world in the future. It’s my first investment to build a hybrid stock and cryptocurrency dividend investment portfolio for passive cash flow.
Disclosure: I am/we are long XTZ-USD.
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