"People have this perception that bitcoin and ethereum are completely anonymous when that is not the case."
That's one of the insights Linda Xie gleaned over three years working at Coinbase - understandings that are now guiding strategy at the as-yet-unnamed cryptocurrency hedge fund she's leaving to start.
One of a growing number of vehicles seeking to help investors capture the market's meteoric growth, Xie's is perhaps distinguished by her resume.
Most recently a product manager at Coinbase, Xie left her position last week to join up with another company veteran, software developer Jordan Clifford, on the venture. Their move is notable following the departures of Nick Tomaino and Olaf Carlson-Wee, both of whom also left Coinbase to found investment vehicles.
But Xie wants her fund to be known by the strength of its bets, and she says she's gambling on the idea that gains will be found in the growing market of cryptocurrencies beyond bitcoin. In particular, she described privacy-focused cryptocurrencies as "extremely undervalued" given their potential to help solve what she perceives as limitations of the bitcoin protocol.
In her first public interview about her fund's strategy, she told CoinDesk:
"You can actually reveal information on the blockchain. ... This isn't well known right now. Even people that I talk to inside the space are kind of surprised that it's so easy to actually trace."
Not simply an academic observation, Xie learned this firsthand at Coinbase, working in the San Francisco startup's compliance investigations department.
While helping law enforcement catch cybercriminals by tracing transactions through the public ledger, she realized that same transparency could eventually aid phishing attackers and scammers, who may use the blockchain to identify potential victims with large holdings.
Buy and hold
Broadly, however, the fund will follow a long-term, buy-and-hold strategy, reflecting another insight she said was gained at Coinbase: "Don't try to trade on the news."
In this way, investments will be primarily in large-cap cryptocurrencies, coins with smaller market capitalizations and token pre-sales, she said.
Bitcoin and ether will be the base of the new fund's large-cap investments. Bitcoin is regarded in the crypto market as a store of value, according to Xie, so the fund wants to maintain continued exposure, while ethereum, she reasons, is likely to maintain value as a key platform for the development of decentralized applications.
Despite her enthusiasm for bitcoin and ether, though, Xie sees big potential in certain smaller market cap coins.
"It's important to diversify your portfolio in this space because I don't think there's ultimately going to be only one winner," she said, pointing to the iterative nature of technical development.
Governance and scaling
In addition to privacy holes, Xie sees governance issues and scaling problems as risks that some investors aren't fully thinking through before buying.
If you're going to buy something and hold it for the long term, she said, you're going to need to ask yourself: Will this really scale? Novice investors, she said, often don't realize that a coin that may be "fine for now" could become a victim of its own success as more people join the network.
As Xie put it:
"If there is one killer app built on top of this, will anyone actually be able to use it?"
A closely related issue is governance. Xie contended that one major red flag from a governance perspective is the concentration of coins among a few holders.
"If they're going to be doing a decentralized governance system, the project founders or the coin creators themselves shouldn't have a majority of these coins," she said.
The flip side of risk is opportunity, and Xie is especially excited about coins where she considers the creators make shrewd decisions about governance.
Some recent examples of coins that did governance correctly from the start, in her view, are Tezos and 0x. These coins, she explained, are widely held, and allow their users to vote on protocol upgrades to mitigate scaling problems.
Only about 20 percent of the new fund's portfolio will be dedicated to token pre-sales, the earliest stage of investment in initial coin offerings, the process by which entrepreneurs mint new cryptocurrencies to fund startup development.
That's not to say Xie doesn't want to invest in more pre-sales, but she also has concerns.
"This is the stuff that actually really excites me. This is more of the VC-type investing - but I just don't think there are enough projects," she said.
In fact, there are only a "handful of projects" that have conducted ICOs where she sees a real need to issue a token. The key question, according to Xie, is: "If I were to take this project and replace the token with ether, would it still operate the same way?"
If the answer is yes, the token may not be a good, long-term buy-and-hold opportunity.
Further, the current popularity of token sales is distorting markets. "People are seeing that there's a lot of easy fundraising in the space and they are taking advantage of it," Xie said.
New investors, especially, should be concerned about this risk.
Pitfalls and best practices
One more potential pitfall for investors is technological risk.
To address that risk, Xie said, the ability to conduct code analysis prior to investing is critical for institutional funds. While her background is mostly financial - she worked in portfolio risk management before joining Coinbase - Xie knows how to code.
Still, that wasn't enough. "I wouldn't have started this fund without a technical co-founder. That's the hard requirement for me," she said.
And that's where co-founder Jordan Clifford, who worked as a software engineer at Coinbase for nearly two years, comes in.
The importance of technical skills, according to Xie, became obvious last week when a critical security flaw was discovered in IOTA -- and several hundred million dollars evaporated from its market cap.
As a final word of advice, she suggested that, if you're a newcomer to crypto and you're fortunate enough to realize gains, you should sell off the amount of your initial investment.
If you're lucky enough to be able to do that, she said:
"Everything you're holding onto is gains ... and that helps people have more peace of mind."
Disclosure: CoinDesk is a subsidiary of Digital Currency Group, which has an ownership stake in Zerocoin Electric Coin Company, developer of zcash.
Portrait provided by Linda Xie