"In this world, is the destiny of mankind controlled by some transcendental entity or law? Is it like the hand of God hovering above? At least it is true that man has no control, even over his own will." ~Berserk
The fractal market thesis has almost fully played out this cycle. There seems to be an invisible hand in markets that dictates how euphoric manias play out, along with the eventual emotionally equivalent collapse and despair in the other direction. We've always believed the same relative level of energy and emotion that occurs in bull markets, has to then be inversely mirrored in bear markets for finality to occur. Free will perhaps exists on micro levels – individual and local – but on a broader scale, the human condition seems to be solidified in its ways and patterns. Markets are a great example where this constantly plays out – especially in the relatively nascent, less-regulated, more free-market crypto space where multiple cycles have occurred, all culminating and correcting in eerily similar ways.
Back in May, we wrote one of our more popular pieces, "It's Not Different This Time", which talks about a lot of this. At that time, many believed crypto had likely bottomed and that prices would 'not fall as much this time' because of metrics around new users or 'big players' entering the space or celebrities getting involed. But everything is relative and many of these things end up being contra-indicators. Reaching a bottom was never going to be simple. Given the amount of arrogance and euphoria that occurred in the bull market, there had to be a gut-wrenching final act that was more extreme than anyone expected. We've forgotten how entitled things got and how many tourists entered the space. All of this had to be reset to eventually be restored.
Everyone by now is familiar with the FTX meltdown and the absurdly unethical behavior that occurred. This is indeed the worst event to ever happen in the space and will echo as such for a long time. It has rightfully given crypto critics tons of ammo for the foreseeable future. For months now, we believed there was going to be another layer of contagion that would have to be knocked out for markets to bottom. That entity being FTX certainly took us by surprise, as it did the broader market, given their deep connections in D.C. special interests and apparent 'cleaner' and 'compliant' appearance (even if it's all otherwise so clear in hindsight). After Terra/Luna and Celsius, we figured contagion would trickle down to smaller exchanges like Crypto.com or KuCoin or various market makers, funds, or trading desks (which may still happen and be the last bout of insolvencies). With this event, we appear to be getting close to capitulation, as hordes of people decry the industry or talk about exiting forever. This one undoubtedly hits hard, but we believe this sentiment will pass and new solutions will come out of this in time.
More broadly speaking, perhaps this is also an enlightening example of what happens to the human hive-mind when interest rates are kept artificially low for prolonged periods of time and when 'easy money' is pumped into the economy for years, particularly after a massive pandemic. Nearly everyone in the market lost their minds to a degree, from meme stocks to irrational VC valuations to digital squiggles worth 6-figures. One reason we were able to avoid this psychological contagion and stay relatively stoic is because we experienced market cycles and vowed to learn from the past. Many will now learn the ephemeral nature of 'paper wealth' and the importance of due diligence, liquidity and balance in investing (i.e. cash should always be treated as a position itself). We also hope this will bring about a new era of self-custody of assets – the heart and soul of crypto.
We have zero exposure to FTX, nor did we ever have exposure to Terra/Luna or Celsius. In the bull market, we remember seeing many token deals, often "treasury diversification" types, where funds like 3AC and Alameda were receiving tokens at discounts with various lock-up periods. Call it luck or intuition, but we passed on every one of these deals, including many venture deals where FTX Ventures, Alameda, or 3AC were involved. Not only did it make zero sense to participate in these from a cycle perspective, as many were being exuberantly rushed out late into the cycle, we also noticed the valuations were often irrational and with some exceptions, many of the projects were subpar (and likely just chasing quicker gains/markups).
More importantly, we never used any of FTX's products and in fact, have actively called for its boycott in the US given their crooked views on regulatory capture in D.C. and never-ending, pretentious virtue signaling. As a general rule, it seems the bigger the virtue signaler, the more skeletons in the closet (the classic "must be over-compensating for something" characteristic).
Our crypto portfolio has been dead simple for the last year+. As we've discussed in our quarterly updates, we became sellers throughout the back half of 2021 and took profit on most non-core (i.e. BTC/ETH) crypto positions throughout 2021 and into early 2022. We now hold core positions of Bitcoin and Ethereum ranging back from 2015/16 cost basis to the present, some remaining single-digit Solana cost basis positions (outside of tranches we sold at ~$180 last year), and some remaining Sandbox and old Stacks positions. Five "active" positions in total. For the record, we think this FTX situation is good long term for Solana and does not change our outlook there. It needed to happen for the ecosystem to move forward (we will post more about this soon). Beyond that, all our (future) token positions are now in pre-launch projects that are still in heads-down building mode, figuring out their business/token models to gear up for a future cycle. The primary focus for the last 18 months has been on dry powder, some venture bets, and more recently, beginning liquid deployment.
We are also one of the only crypto funds that participates in various Bitcoin-only venture rounds in parallel. Many crypto funds have ignored or misunderstand Bitcoin's positioning and game theory and many of these companies are now outperforming their "move fast and break things" peers. They are becoming a safer haven for relative risk, given Bitcoin's status as a far more decentralized network with clearer non-securities status. Outside of that, we have various seed-stage deals over the years that have become 9-figure companies or unicorns, with strong cash flows. We also had acquisitions that occurred last year like Staked (which also yielded a substantial position in Kraken), and various newer deals that we are excited about as they build through the bear market (you can also find these in previous quarterly updates).
Lastly, we are becoming buyers again in this market, even if it seems grueling right now. We will discuss more specifics in terms of deployment in future updates.
So where do we go from here? Perhaps crypto is slowly becoming contrarian again. The negative view on the space will not clear up for at least another year after this debacle. There will be aftershocks in the market and likely some final contagion that trickles into smaller exchanges, funds, and trading desks, along with overall battered sentiment that may cause more price drops. Rushed, overbearing regulation is probably the biggest tail-risk for this asset class now, especially for smaller or less decentralized projects.
Many are now calling for Binance and Tether to collapse, but we are not betting on that outcome. We think the final line will be drawn soon on who the winners, losers, and survivors were in this market, and the "losers" won't include these two in our opinion – even if they have been hated by critics for a long time. We believe theories of insolvencies in these two are overblown and unsubstantiated. The same stance applies for claims that Michael Saylor / MicroStrategy are about to be liquidated any minute.
Historically, macro bottoms have not occurred directly after acute panic selling situations (outside of the March 2020 pandemic flash crash, which is an outlier for many reasons). They tend to occur in the months after a final forced selling event – in a longer, dull unwinding. Volume and liquidity contract due to poor sentiment and bidders begin to iteratively place bets lower as order books thin out. If there is additional contagion, we don't believe the market will even have another high volume sell-off unless it's a systemic issue where crypto itself is threatened. It will more likely be slow and monotonous through at least the first half of 2023. More simply put, buyers seem to create the circumstances for a final period of bottoming, not sellers.
It also seems that equities have likely not bottomed yet – and even if they have, crypto may still temporarily decouple for the time being (but instead, in the direction no one wanted or expected!) We still think stocks have another leg down when growth slows and recedes into 2023, despite inflation easing – as there is often a delay between indicators and catalysts. However, many companies are beginning to approach fairer value. We think things are getting closer, which is why we're becoming buyers again. It doesn't make sense to time the bottom – similar to how we began buying Bitcoin at $5,000-6,000 in 2018, along with its final leg down to $3,000-4,000.
From a broader market performance perspective, the elephant in the room for crypto critics is that many technology stocks in apparently "credible and regulated" companies are down over 80% this year. Many SPACs are down over 90% without much criticism. A lot of the behavior in SPACs was also egregious at its core, in supposedly regulated markets – but the establishment doesn't mention this much. The last leg of irrational melt-ups in assets occurred everywhere and warrants a larger conversation about how unprecedented monetary policy impacted markets (especially since COVID) and created a lot of these circumstances.
There is no doubt that crypto suffered uniquely in areas because of leverage abuse, and because it is its own market, on its own rails. It gets unique attention because of this, not because it has underperformed as an asset on a broader level or is somehow inherently corrupt and evil. What happened here was not even a failure of crypto – it was a banking and lending failure akin to MF Global or Long Term Capital Management, or even the Sub-Prime blowups. It was the fault of a few bad actors in various centralized companies, not of core open-source technologies, DeFi apps, or the protocol layer. And we still believe that once the market resets and risk re-enters the arena, that crypto will become the fastest horse again.
The fundamental technology and value that crypto provides has not changed just because bad actors entered the space in a period of unprecedented rallies across all markets. We've felt the magic of using this technology over the years and how far it has come, along with how powerful things like self-custody and P2P swaps and transactions can be. Literally all the chaos that ensued was in centralized entities and exchanges. DeFi protocols continued to perform and operate as normal, given the immutable nature of smart contracts that hold participants to a higher standard of transparency and auditability. Bitcoin is still churning away decentralized global settlements and working as intended every day. Great businesses are still being built on top of this technology, even if that is being overshadowed by all the recent chaos. Stablecoins like USDC still show massive promise for better global commerce and payments. NFTs have not shown even a sliver of their broader potential on the internet (identity, gaming, insurance, etc), which we believe will occur next cycle. The benefits and growth of open-source technology have not faltered here.
Moreover, crypto did not need a bailout here. Bad actors in the market failed and will be punished. These companies failed and will be shuttered into non-existence, as they should be. This failure was allowed to happen because no government came to the rescue to prop up and protect these companies and launch never-ending bailouts via regulatory capture. We have a far more transparent view into what happened here than we ever did in previous financial crises thanks to things like onchain data. Outside of regulators adding a few pragmatic guardrails to help support users and entrepreneurs in the industry, this is how things should be.
We also see on a daily basis the caliber of founders building in the space, who will weather through this and come out stronger. Whether that is the folks building at more established players like Coinbase and Kraken (which have shown dedication to transparency and integrity with user funds) or smaller startups entering. We have no doubt a recomposition will occur and narratives will shift again in time.
Stayed tuned, as we will be writing follow-up pieces on the state of regulation in crypto, along with specifics around the fund's thoughts on timeframe and deployment strategies.
"This too shall pass"
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