Sanity Check
Level 1 - NGMI
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We are coming up on two years since the bear market began.
If you made it this far, congrats. If you made it this far and kept your sanity, an even bigger congrats! Hold on to it tightly, as we are almost on the other side.
The last couple of years have been extremely tough on the crypto industry. Thanks to our loyal subscribers, we have weathered the storm, and helped many of you do the same.
In today’s post we’d like to take stock of where we’re at, and what you can expect in the months ahead.
(Some) Bad Guys Are In Jail
After nearly three years of hacks, scams, and blatant rip-offs the metaverse is healing.
FTX/Alameda’s Sam Bankman-Fried, Three Errors Capital’s Su Zhu, and Terraform Labs’ Do Kwon are all behind bars. Each of these disgraced founders face significant legal consequences for losing crypto investors billions of dollars.
The “fake DeFi” companies also collapsed, including BlockFi and Celsius.
We warned of the risks of investing in these unregulated, unsupervised, centralized “banks” which had short term incentives to take excessive risk with customer deposits. The opposite of DeFi - no self-custody, no transparency.
Next year we’ll see the cryptoassets of some major bankrupt firms auctioned off.
We think this is bullish for two reasons.
Limited supply: Once the bankruptcy estates are finished selling their crypto, supply of major computer coins should be very low. Ethereum has a $200b market cap. Since the last bull market, moving to Proof of Stake has reduced inflation by ~3%, meaning that there is $6b/year less selling pressure from miners compared with last cycle. After 2 years of pain, 70%+ drawdowns, and constant media coverage of bankruptcies and frauds we think most investors already sold. After the large estates sell, only a little buying is needed to move prices up and reflexivity could kick off a new bull market.
Funds returned to customers: Some customers will receive their check from the bankruptcy distribution, take their loss and never touch crypto again. But we’d bet those will be in the minority. Human nature ensures that anyone people who participated last cycle and saw some paper gains will believe they have learned from their errors and can do better next time. They’ll be back.
On a smaller scale, the crypto industry is doing a much better job of self-policing, kicking out bad actors and sharing information to help fellow investors spot scams and rug pulls. Investors are now better informed about the risks as well as the potential rewards of investing in crypto.
Regulatory Pivot
US regulators previously had a very hostile attitude to crypto.
This damaged consumers by forcing them into non-compliant, unsupervised offshore schemes from Bitmex to FTX International, stifled innovation, and caused some service providers to refuse to do business with US residents at all.
This is changing.
As we predicted (for paid subscribers) when the SEC sued Coinbase, this case would mark a turnaround - Coinbase is the only entity in crypto with sufficiently powerful backing to take on the US government and possibly win!
Our thesis was bourne out with the stock price more than doubling in a few months.
Last week, Coinbase received regulatory approval to offer Perpetual Futures - a very popular and lucrative derivatives contract - to retail customers. Although US investors are not yet eligible, our prediction that the main venues for US customers to legally trade crypto will be tradFi powerhouse CME Group and Coinbase looks quite likely. As for the offshore Coinbase exchange: as an international customer would you trust Binance - concerns about its liquidity and legal liability / compliance gaps surface weekly - or a compliant exchange owned by a huge publicly traded US company? Although the product offering won’t be equivalent to begin, we expect Coinbase to gain significant market share from Binance over time.
Speaking of product offering, this is where the BASE chain comes in.
Coinbase recently launched an Ethereum layer 2 rollup called BASE using Optimism tech.
Since BASE is in theory decentralized and non-custodial, Coinbase has more freedom to allow its customers access to new, innovative, and potentially riskier products. Coinbase provides the fiat on/off ramp, optional custody services, centralized exchange services and easy access to blockchain apps with a trusted brand and simple user interface. Many people who would use crypto apps don’t know how to get their money into Metamask. Coinbase solves this problem.
Autist note: BASE chain has transaction censorship ability and we wouldn’t call it decentralized, but from a regulatory perspective allowing a customer to access a product built by a third party, and hosting the product yourself are two different things.
The analog here is Binance launching the quasi-independent “Binance Smart Chain” to allow customers and developers to use a cheap alternative to Ethereum which was linked to Binance for easy deposit and withdrawal, but Binance was not responsible for the apps deployed there. Binance attracted more users and more transactions than Ethereum for much of the last bull market. Some of the most egregious scams and hacks also took place there.
In short, Coinbase will gain market share from offering a trusted, regulatory compliant solution. It will also provide easy access to a blockchain where anyone can deploy financial apps, with Coinbase set to earn significant transaction fees (currently ~$10 million / year) from popular apps deployed on BASE.
While Coinbase is positioning itself for dominance next cycle, the SEC has suffered humiliating defeats in its cases against Ripple Labs (whether certain sales of XRP holdings were a securities offering) and Grayscale (refusing to allow the GBTC trust to convert to an ETF). And. Senior politicians are now openly critical of the SEC and the leadership of Chairman Gensler. We think Gensler’s tenure is limited and political changes in 2024 will lead to a more liberal regulatory regime for crypto in the US.
The Institutions Are Coming
The biggest companies in the world are forced to understand trends and demographics. Why are we highlighting major corporations tasking social media teams with making their brand relatable to crypto users? They are betting on digital natives moving their savings and investments to crypto / virtual world products.
I bought more $BTC last week. While I’m not putting more than 2-3% of Net Worth in it right now, startin to lean in. Why? Most of my age+ hate it, but we’ll all be dead in 30-40 yrs, and what you’ll have left are the folks who are obsessed with it, running the show. Thx to @BowTiedBull for introduction to it. - @BowTiedBroke
Not Just A Meme
If you’ve been in crypto for a few years, you’ll remember The Institutions Are Coming “meme” from last cycle. Institutional investors would allocate a percentage of the enormous wealth under their stewardship to our newly minted computer coins, making us all multimillionaires in the process.
Well, not quite. First, investors needed to be scared out of the market and then the big boys need to be positioned to earn their fees. We’re almost there now.
Instead of the default option being self custody (financial freedom), a legion of asset managers led by the enormous Blackrock are positioned to offer Bitcoin and Ethereum ownership to main street Americans…for a fee, of course.
While DeFi and self custody allows canny investors to earn yield on their assets, people who have not studied up will be forced to pay fees to TradFi for the privilege of owning crypto. Up to 1%/year. This is 6.5%/year worse than native ETH staking.
And many of these products only offer paper crypto.
The recently approved ETH futures ETF is “paper crypto”, a derivatives-linked product. These funds don’t own any crypto, but generate their returns by betting on a contract linked to the price of crypto. The main arguments of the “gold bugs” about “paper gold” (ETFs and similar investment products) apply to “paper crypto”, too.
But. A US physical Bitcoin ETF now looks inevitable (probably approved in 2024) with a physical Ethereum ETF to follow. What could this mean for the crypto majors?
We surmise that the introduction of the U.S.-traded Gold ETF (GLD) on November 18, 2004 has been in no small part responsible for the persistently good performance of the precious metal for close to 8 years since.
- Oppenheimer Asset Management
A Dollar Bank Account - DeFi’s “Killer App”
Are rate hikes over? Will the Fed Funds Rate remain “higher for longer”?
We’re not here to guess what President Powell will do next. But. If you live in the US you’re lucky to have access to a (relatively) stable fiat currency. This is the envy of many in the developed world, but DeFi gives anyone with a computer and $10 in crypto access to an interest paying dollar savings account.
See BowTiedBull for a real time example of a country collapsing due to inflation.
The most decentralized option is MakerDAO’s DAI Savings Rate, which has recently paid up to 8%, and will offer a stable ~4% yield backed by US treasuries. Some DeFi frontends including Spark/MakerDAO block US users and VPNs for regulatory reasons. Our paid subscribers have access to instructions on how to deposit direct to the smart contract, bypassing geoblocked websites.
Opportunities Next Cycle
Majors
The first obvious thing to do is to get exposure to crypto majors: Bitcoin and Ethereum. Inflows to physical ETFs will result in these cryptoassets being bought off the physical (not paper!) markets and sent to cold storage in institutional custody.
Although we’ve been long since last November (around $16,200 per BTC, announced in real time to paid subscribers), we still think majors are a good value passive investment. We’re overweight ETH due to the passive staking yield.
ETH yield: This isn’t a ponzi scheme like the failed “DeFi yield farming” from last cycle. Ethereum “stakers'“ operate validator software which processes transactions for users, who in turn pay fees to the operator to broadcast transactions on the network. Passive stakers are sharing these fees with the operator of the server software (e.g. Lido), active stakers run the software on their own computer and keep all the revenue.
DeFi
This is our main focus. There is still $38 billion Total Value Locked (invested) in DeFi, relatively unchanged from the start of the year signifying no net capital outflow. Stablecoins (DeFi Dollar bank accounts) have ~$124 billion outstanding (deposits).
You can review our free posts to learn all the DeFi fundamentals and ask yourself the key question: Does DeFi Solve A Real World Problem At Scale?
Our answer to that is yes, since we’ve spent years using the product. There are many use cases to replace expensive middle men with code. This trend will only accelerate as the tech becomes more sophisticated and laws catch up to the new digital reality.
There are tens of billions of dollars still invested despite volatility, and hundreds of thousands of people use the products daily. DeFi is not an accepted solution for international dollar bank accounts and cross border remittance. It takes days to settle a wire transfer, and intermediaries in developing countries charge huge fees.
DeFi also enables innovation which we can’t predict. Ethereum brought us permissionless on-chain IPOs. Now tokenized social apps like friend.tech are launching on blockchains enabled by permissionless finance.
If you’re interested in staying up to speed, subscribe for our deep dives on:
Zero Knowledge Proofs and privacy-enhanced finance apps
Decentralized Exchanges with Options and Perpetual Futures to give a non-custodial, KYC-free, fast and secure trading experience to anyone worldwide
Safer savings and yield products due to crypto native yield and extensive battle testing of smart contract security since last cycle
Product X which hasn’t been invented yet but will probably involve programmable money
Disclaimer: None of this is to be deemed legal or financial advice of any kind. These are opinions from an anonymous group of cartoon animals with Wall Street and Software backgrounds.
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For anything regulatory have to give the nod to @lex_node on twitter. There's a web of lawyers you can find through him
FIT act is concerning as it stands.
Looks likely the next spearhead against crypto will be requiring KYC/AML
Coinbase has been heavily involved with FIT and it would kill p2p in the US. They'd also benefit the most from it as a moat
Good read as always gang
"The main arguments of the “gold bugs” about “paper gold” (ETFs and similar investment products) apply to “paper crypto”, too." I get the main point but can you elaborate on this?