Previous quarterly update:
Fund Update Q1 2023
Q2 2023 Portfolio Company Highlights
Market Moves and Outlook
Q2 was a great quarter for technology stocks and crypto assets as inflation has continued to cool off. As predicted, we had stated inflation was much more likely to rapidly decrease by the summer and calls for hyperinflation and the death of the US dollar were completely exaggerated and inaccurate. This lowering of inflation has benefitted risk assets to an extent, but there is also a bigger picture to highlight.
With rate hikes topping or near a top, the S&P and Nasdaq are more heavily weighted than ever with the big ~7 technology stocks carrying the majority of market cap and growth. The indexes continue to be misleading in painting an overall picture of the economy, as investors look at "big tech" as a safe haven bet in a potential recession environment. We expect this polarization to continue.
With that said, the "S&P 493" has begun some positive movements and may continue to do so through the summer. Mid-market and small cap equities may get a windfall from house money flowing downward from big tech gains. We are still cautious in terms of an economic slowdown having a lagged effect into late 2023 and 2024. The consensus is that 2024 will be the big recovery year where rates begin to taper and clarity of a bull run comes. Rate tapering in and of itself does not constitute a full recovery because it ignores lagging second order effects caused by rate hikes to get us to this point. It's quite possible that the AI boom and other deflationary forces could catapult the market into a higher conviction bull market but we see a strong probability of more economic issues in 2024 before things are truly able to come back with more confidence. It does not mean a new low is required or that there aren't worthwhile assets to buy now, just more chop to come and another bout of 'uncertainty' before higher conviction capital is deployed. The money currently coming into the market does not seem deeply confident just yet and a percentage of it certainly has a fleeting quality to it.
Risk-on appetite has come back to an extent this quarter, which we believe is portrayed best by looking at crypto, the ultimate risk-on barometer asset. Bitcoin rallied to $30,000+ this quarter as BTC dominance also took off. We had predicted Bitcoin dominance would rise this year and it has by ~10%. We've been continual weekly/monthly buyers of Bitcoin since Q3 of last year as mentioned in previous updates. Bitcoin dominance will ebb and flow, as some catalysts around regulation will come (Coinbase, Binance, Ripple, etc) and will see a mixture of good and bad news. "Bad news" in the enforcement or securities laws sense is positive for Bitcoin dominance, and vice versa. The biggest catalyst otherwise has been an increased likelihood of a Bitcoin ETF being accepted as BlackRock enters the space.
Ethereum remains a strong core long position in the fund but at this stage in the cycle, the liquid fund's focus has been more on Bitcoin and deploying dry powder with optimal risk management in mind given all the moving parts. As the cycle persists and risk levels change, you can expect to see more Ethereum, L1/L2, and altcoin buys taking place. We generally believe if crypto regulation comes down to Congressional legislation, it will end up on a relative positive note for the space. The SEC will still enforce and attack certain projects, but eventually we believe legislation will be the ultimate deciding factor. We believe there is enough bipartisan agreement to put guidelines in place to not stifle innovation onto the asset class itself or kill off exchanges (although they will be hit in some way, particularly Binance US). What this legislation may mean for things like privacy, self-custody, KYC, etc. is another question and we are perhaps less hopeful on an ideal outcome there.
Our strategy in crypto has become far more focused on liquidity as we've written about previously. We don't believe the top 5-10% of token-focused crypto VCs will come close to outperforming the top 5-10% of liquid funds – particularly when talking about realized gains versus paper (vesting) markups. Many "crypto VCs" got trapped in long vest periods before the correction and are stuck holding bags and dead projects. The real feature of crypto is liquidity and optionality and more activist investment behavior. There will undoubtedly be strong venture returns (realized) in a small percentage of tokens, but playing to the cycle and being able to be both proactive and reflexive in crypto is foundational. We've continued to remain nimble and more focused on the liquid fund. Aside from a few selective, early-stage token bets in the portfolio, we've remained mostly clear of the "crypto VC" world outside of buying equity in crypto businesses.
On the Venture Fund side, we've mostly been focused on investing in follow-on rounds and helping our existing portfolio companies weather through the slowdown. Survivability is paramount at this time. We had a number of big rounds occur in existing portfolio companies recently and more to come we are excited about (TBA) in Q3. We expect new investment activity to pick up there later in the year and into 2024. We've also made a number of AI investments we will announce next quarter and speak about more. Despite a lot of noise, untenable valuations, and rushed ideas (for what are essentially ChatGPT wrappers), AI is impossible to ignore. Given our prior background in big data and machine learning startups, we've been investing in data and AI companies since 2016, long before the OpenAI hype began. While crypto and AI are at odds in some areas philosophically and technologically, there are also clear use-cases and needs for crypto in an increasingly AI-based internet. We will be writing about that in future dedicated posts and updates.
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