The second quarter in the crypto markets began with a bang and we saw continued euphoria across crypto, culminating in an eventual 50%+ correction which we will delve into in detail and how we performed, along with thoughts on where valuations are headed.
Although we've been proponents of looking at historical data, previous cycles, stock to flow, and analyzing the fractal nature of crypto markets, our selling and/or rotation strategies also depend heavily on market psychology. Things like euphoria, social media sentiment, and complacency all factor into our sell strategies. Ultimately, the crypto fund looks to handily outperform both Bitcoin and Ethereum and we can confidently say we've done so substantially, year over year since inception.
Back in January, we felt comfortable adding some new positions such as Alchemix, BadgerDAO, Mirror, and 0x Protocol. These were always to be shorter/mid term positions that we felt were undervalued at the time or had higher growth potential than our cores (and some with strong staking yields). Across April, we ended up selling these positions (all were up ~300-500%+ from cost basis). These positions outperformed the portfolio in this time period, but believed them to be generally weaker links in the portfolio in any longer term scenario. Additionally, over the last few months we sold various allocations in older, vested venture investments (or where we had staking/LP rewards) into BTC, ETH, and/or USDC.
In March and April, we also sold our remaining position in Ocean Protocol, which was always one of our best performers since the beginning of this bull cycle. As much as we love the project and supported it since 2018, we believe the Data/Blockchain narrative won't be as strong moving into the next cycle and have instead decided to focus more heavily on DeFi and NFTs. For reference, our OCEAN position was up about 5,000% in aggregate, across the various tranches we sold at.
More importantly perhaps, is we still have not sold any BTC or ETH, we actually continue adding to these cores, along with staking a large % of ETH.
This re-balancing and profit-taking ended up being the best possible approach and while selling assets is almost never going to be perfect timing, it was the right move to shave positions down and realize gains (mostly long term aside from the trades above) over the course of March into May. In hindsight, there are certainly things we could have done better, but the real win was selling as much as we did prior to the big correction. We have not needed to sell anything post-downturn because of this and do not plan to. Many crypto funds are holding bags from later buys, questionable BSC projects, and things like treasury diversification offerings (some of which are still locked up and down over 50%). We did not participate in any of these treasury sales and instead chose liquidity and optionality.
As the complacency (and excessive memetics) we saw by mid-May/June ended in a 50%+ correction across the space. Not only strengthening our cash position but also concentrating the portfolio into higher conviction bets such as BTC, ETH, Yearn, and Aave, along with continuing to hold our longer term "venture crypto" bets (Filecoin, Origin, SKALE, etc) is a much more sustainable plan. The portfolio section on the site is now updated to reflect current positions. All of these projects have strong runway and capital to weather through any potentially prolonged downturn. Having this much dry powder also allows us to deploy into fundamentally undervalued assets and in the meantime, stay hedged against further downside risk.
Over 70% of the fund continues to have a long-biased, 5 to 10 year strategy with a very strong cost basis ranging back many years. In crypto investing and trading, it's important to have overarching goals (e.g. consistently outperform BTC/ETH by as much as possible) but to also readjust and rebalance (and take profits) active strategies on the fly. These markets move too fast to become complacent when managing active positions, as sentiment can change overnight. We now feel much more strongly positioned to weather any potential downside, but also capture potential market reversals.
We all know the story by now – but essentially what happened in June was a combination of complacency and weakened demand in the market, along with various negative events. The Chinese government rolled out substantial bans on both trading and mining across many regions, after many years of bluffing. You can see just how intense this assault on Bitcoin was across the month of June here. This coupled with Elon Musk's tweets about Bitcoin's energy consumption and other negative comments brought the market down rapidly. The ESG sentiment coupled with panic across China created a rapid selling event with record liquidations. To learn more about our position on Bitcoin mining, you can read this blog post.
In hindsight, the day of the Coinbase IPO being a non-event ('sell the news') was a red flag, along with the complacency and entitlement that followed those few weeks in late May/early June. It seemed the market needed a reason to selloff and prices could have very well rolled over eventually, regardless of the China news. The market became irrational and unfortunately, the DeFi ecosystem never had a re-rating or a "part 2" summer rally, which was wide consensus (perhaps a red flag in itself) at the time.
To briefly discuss some market mechanics we've been thinking about a lot recently – the vast majority of people in crypto believed we would see a blow-off top similar to 2017/18, including us. What we realize in hindsight, is that a lot of the euphoria was distributed this time, particularly in things like DOGE and other meme coins. In 2017/18, trading pairs relied primarily on BTC and profits were usually first taken into BTC as a "safer" bet, and due to it being the only real liquid on-ramp. USD pairs were limited and stablecoin trading pairs were also rare. Fast forward to 2021, and every major liquid coin has a fiat trading pair of some kind – not to mention DEXs which offer many pairs into ETH, which we did see outperform before the correction. So in short, we simply did not see capital flows back into BTC this time that so many were expecting. The flows have changed in this market and we realize to think that a blow-off top would happen the same way, with the same rhythm as 2017/18, is foolish.
The current price action seems somewhat unprecedented after a 50% pullback. In 2013, we saw a 50% drop quickly followed by a full blown 85%+ drop from the highs. This hasn't happened and it's been well over a month of ranging. We've re-tested $30,000 multiple times, along with testing $28,000 support levels and have defended these levels fairly well. In 2018, we also saw the initial 50% drop followed by more downside. Here, we are certainly seeing high volatility but it is ranging sideways for a longer time period. The recent lows could certainly further break down but regardless, this cycle has invalidated fractals from previous cycles, which is why it is likely to play out differently in other ways. Historical price data is important, but it's also important to be open-minded on how this cycle plays out, especially when you factor in crypto's adoption curve. However, the underlying feeling is the "it's different this time" crowd will be directionally wrong (again), even if correct about certain fundamentals.
We are in new territory in many ways and think the market is directionally torn due to the very specific news causing the crash. The biggest question is how much of the Chinese capital flight and mining migration is already priced in at this point? How long will it take for hash rate to re-locate and climb again? It's important to realize that the Chinese mining and the Chinese investing/trading ban issues are separate. Mining migration is one thing and can and will happen over time, but permanent capital lockouts from the world's largest country, which has the highest crypto trading volumes, is a very big deal. It's a real shame the CCP is locking freedom-seeking citizens out of this digital economy – but not surprising, as it's been under threat there for 8+ years.
There are also certainly regulatory risks to consider across multiple jurisdictions that could break price action down further. Back in May, our Founder pointed out that the market is reacting to any negative news in an extreme way, while brushing off any positive news. Even Elon Musk tweets still cause price volatility, although it seems diminishing returns are starting to kick in there. Aside from negative regulatory news, we don't see any reason for much lower levels, unless Chinese capital flight still has a much greater ceiling as the CCP rolls out more enforcement in parallel to their central bank digital currency (but it's very possible most of this is priced in). It's hard to gauge the extent of outflows that have already occurred but the sentiment in China is still extremely bearish.
On another note, we are also seeing private market rounds being red hot. Most rounds are oversubscribed and a ton of good builders and entrepreneurs are launching web 3 projects. This is quite reminiscent of 2018, where private rounds were still hot after the correction and builders looked at it as an opportunity to create and launch. This doesn't point to a bull continuation but it's worth noting. We expect private rounds to continue rolling out even during the current market volatility and if prices do go lower, we will likely see this decrease (a la 2019).
As far as Ethereum (EIP-1559) is concerned, we have the unpopular opinion that this catalyst was pretty much priced-in before the correction. We would actually be happy to be wrong but either way, the new burn mechanics (which will take some time to meaningfully materialize) make us bullish moving forward.
Lastly, the thesis that increased institutional participation would not allow for corrections as deep or as long as previous cycles could be also be viable. Keep in mind however, that many of these "institutions" are hedge funds that will also go short. However, a multi-year bear market just seems unlikely with all the data points, adoption metrics, and context factored in. The reality is, this pullback was based on very acute bad news combined with a certain level of complacency. The macro landscape should also be mentioned, with money supply at records and pandemic stimulus driving equity markets up to new highs (including many risk-on growth stocks). With unprecedented monetary policy and stimulus, we could see unprecedented cycles in crypto as a result as well. We are open to multiple possibilities here.
We are well hedged in the events of a longer bear market with further downside, along with a "double bull cycle" scenario occurring later this year or into 2022, where we see all-time highs met much quicker. It's very possible $30,000 levels hold but it's also crucial to understand that another wave of bad news can also send prices lower.
In closing, the crypto fund has never had this much dry powder to work with, nor this level of concentrated bets into our highest conviction positions. Since launching the fund, we've been able to outperform BTC and ETH consistently and also take that performance and continue increasing and stacking our core conviction positions.
We will be focusing on keeping our cost basis as strong as possible and if there is one thing we learned from previous cycles, it's that patience in this kind of market dynamic pays off. Having this level of cash on the sidelines puts the fund in a strong position to pick up discounted high-value plays. Jumping in too early however, is poor risk management, so we must strike a balance.
As mentioned, our biggest bets all have strong treasuries and runways, with founders and builders who think long term. In fact, some of the best development would happen in a hypothetical longer bear market, so we welcome both scenarios for different reasons. It's possible the market needs a deeper reset to get rid of tourists.
We're also seeing some strong private round deals come to the table raising via DAOs and other mechanisms, all of which we are now well-positioned to participate in. Similar to 2018, we invested in projects during the downturn and they became some of our best performers ever just a few years later. The next wave of web 3 projects will be built during this time period of uncertainty. If you're a builder and believe you fit our thesis, please reach out here.
You can also read our latest Seed Fund update here.
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