Monthly Update || April 2020

Opening Remarks

Greetings from inside Ikigai Asset Management headquarters in Marina del Rey, CA. We welcome the opportunity to bring to you our nineteenth Monthly Update and hope these are helpful in better understanding some of what we’re doing and what we’re seeing. We have the privilege of deploying capital on behalf of our investors into a new technology and asset class that we believe will fundamentally change the world and create trillions of dollars of value in the process.

We believe we are obligated to be shepherds of this technology – to help the world better understand the powerful potential of DLT and crypto assets, and to fund and be an ambassador for DLT projects that will change our lives forever.   

To that end, March brought the fastest 30% decline in S&P 500 history. Faster than 1987. Faster than 2008. Faster than The Great Depression. These are historic times we are living in.

In our March 1st Monthly Update, we said:

"While near-term uncertainty abounds, we are confident the next move for BTC will likely not be predicated on crypto-specific fundamentals or crypto-specific market regimes. Instead the global macro environment will dictate BTC in the near term. Will crypto-specific quantitative data still be able to shine a light on the next move, even if that next move is dictated by 10yr yields and VIX’s? Perhaps. Not to talk our book, but this an environment where a systematic approach with a discretionary, top-down overlay can shine."

This stance was correct, and we were well-positioned for the ensuing price action in March, generating our best month of outperformance vs BTC since we launched the fund and putting us significantly ahead of BTC’s YTD performance.

That’s not to say March was a walk in the park by any stretch. Far from it. As traditional markets were ramping into peak volatility, crypto experienced “Black Thursday” on March 12th - with BTC price declining >50% in a 24-hour period before bouncing >50% off the lows in the subsequent 24-hour period. This crash was significantly exacerbated by a death spiral of cascading long liquidations on Bitmex, causing the price of the Bitmex Bitcoin Perpetual Swap to severely decouple from underlying spot price. At its peak, the Bitmex Perp traded $990 below the spot price on Coinbase. Violent indeed. The crypto community responded to this Bitmex death spiral with a tremendous amount of commentary, analysis, and broad vitriol. And for good reason. Several notable crypto funds collapsed as a result of this volatility. Many hundreds, if not thousands of individual traders were liquidated on Bitmex due to the death spiral. Currently, Bitmex’s open interest on the Perp is less than half the level prior to the crash and it is not clear that Bitmex will ever return to its prior level of prominence in Bitcoin price discovery. If this indeed turns out to be the case, it would be a good thing for the industry. To learn more about what happened on Black Thursday, see here, here and here.   

In the same way that a subprime crisis metastasized into a short-term liquidity crisis in 2008, the Coronavirus stress, exacerbated by an oil market collapse, metastasized into a short-term liquidity crisis in March 2020. This acute liquidity crisis that reared its ugly head in March is just one part of a broader liquidity issue that’s been years in the making, dubbed “The Dollar Shortage”. Warning signs that The Dollar Shortage situation was deteriorating began sounding in April 2019 as Fed Funds flipped IOER (Interest Rate on Excess Reserves), which is never supposed to happen. Those alarm bells began ringing louder in September 2019 as the repo market blew out, rang louder still as repo market dysfunction worsened into year-end and reached a fever pitch this month as a short-term liquidity crunch threatened to collapse asset prices across the board. It was the severity of The Dollar Shortage that pushed the Fed to quickly inject unprecedented levels of liquidity through various existing and new facilities. We dive into this topic in more detail below.

On March 16th, the VIX closed at its highest level ever. With this unprecedented level of stress as the backdrop, BTC price declined 25% in March, its worst monthly performance since the November 2018 crash. In the same way that traditional markets came into the Coronavirus crisis overleveraged and vulnerable, the Bitcoin ecosystem came into the crisis overleveraged and vulnerable, just on a drastically smaller scale. Bitcoin investors, ourselves included, were bulled up on the coming halving. In our March 1st Monthly Update we stated: 

“By many measures, BTC was overextended to the upside by mid-month, even if Coronavirus had never happened. Funding rates showed bulls were offsides. Contango showed bulls were offsides. Borrow rates for USDT showed bulls were offsides. BTC went up 50% in a more-or-less straight line the first six weeks of 2020.”

That setup proved damaging to Bitcoin price performance in March, as the deleveraging occurred violently. It is important to differentiate between capitulation and forced selling. Weak hands and forced hands are fundamentally different. The November 2018 crash was much more about weak hands, while this most recent move down was much more about forced hands. As we currently stand, this deleveraging process is now behind us. Aggregate open interest in Bitcoin derivatives is half what it was on March 1st, which was already 20% off the highs of late February. Many unprofitable miners have closed operations and liquidated their BTC holdings. Other, more profitable miners received equity injections to continue mining. Funding rates now favor longs rather than shorts. Bitcoin is 38% off its February 13th highs but already 68% off its March 13th lows. That volatility is not for the faint of heart, but with sound risk management and adherence to a proven investment process, opportunity to generate attractive risk-adjusted returns in crypto abounds.

This opportunity set going forward will have as its backdrop, an acceleration of the largest monetary and fiscal policy experiment hitherto never seen. The sheer size of the monetary and fiscal stimulus already enacted and assuredly coming down the pipe pushes central bankers and governments out on a spectrum of radicalness that has *never* ended well. Bitcoin is a non-sovereign, hardcapped supply, global, immutable, decentralized, digital store of value. It is an insurance policy against monetary and fiscal policy irresponsibility from central banks and governments globally. The world needs that insurance policy more today than they needed it yesterday. And they’ll need it more tomorrow than they do today.    

Invest

Ikigai is currently fielding interest from new investors globally. We are open to international and qualified accredited U.S. investors. Contact us to see if you qualify.

March Highlights

• Facebook Revamps Libra, Conceding to Regulators

• India’s Top Court Strikes Down Laws That Outlawed Cryptocurrencies

• South Korea Parliament Votes to Enact New Crypto Regulation

• Bitmex Experiences “Black Thursday”, Nearly Collapsing

• U.S. Comptroller Names Former Coinbase Exec As COO

• Fiscal Stimulus Bill Includes and Then Removes Digital Dollar Language

• SEC Calls Telegram A Likely Security Issuance, Halts Token Issuance 

Coronavirus Deaths Grow Exponentially Causing Money Printer To Go Brrr

First and foremost, I am a human and I care for other humans. I have friends who have contracted Coronavirus. I have friends who have lost loved ones to Coronavirus. It is likely that more Americans will die from Coronavirus than the Vietnam War and that is deeply saddening. Full stop. Tens of millions of Americans have lost their job and are under major financial stress. My heart and my prayers go out to everyone affected by this virus. The title of this section is in no way meant to make light of the situation at hand. The title is meant to emphasize the dichotomy of the major factors facing this country and this planet right now. I run an investment fund that focuses on crypto assets for a living. So my job is to generate attractive risk-adjusted returns on a consistent basis and this Monthly Update is an extension of that. The following is my assessment of some of those major factors. 

Coronavirus Stats

They matter. We track all sorts of things closely. We’re not going to go into detail on Coronavirus analysis here. Our view is distilled down to these two charts, as we view them as the most important. Unfortunately and morbidly so.

We need to see day-over-day growth in deaths in Italy roll over. That will be extrapolated to the United States. To the extent US follows this path, that will be taken as bullish for risk assets. Risk assets will bottom in advance and anticipation of this flattening and then if it turns out to be worse than expected, risk will reprice lower, likely violently.

What The Fed and The US Government Have Done and Will Do

It’s easy to lose track because they’ve done a lot really quickly. The Fed essentially deployed its entire 2008-2009 playbook in a few weeks, but an order of magnitude more in nominal dollar amounts. During two rounds of cuts on March 3rd and 15th, the Fed took interest rates down to 0. The Fed restarted full blown QE, as opposed to the “Not QE” QE already started in October. The Fed promised unlimited buying of Treasuries and MBS. No limit. Last week the Fed bought more Treasuries and MBS than they bought in all of QE2. The Fed bought more Treasuries and MBS yesterday and today than the entire market cap of Exxon Mobil.

The Fed established the Commercial Paper Funding Facility. The Fed established the Primary Dealer Credit Facility. The Money Market Mutual Fund Liquidity Facility. The Primary Market Corporate Credit Facility. The Secondary Market Corporate Credit Facility. The Term Asset-Backed Securities Loan Facility. I want to be clear here. This is exotic Quantitative Easing. The Fed will have a hard time reeling these back in once war time is over.

The Fed increased the size of its repo operations to essentially infinity. The Fed dropped the interest rate on repo to zero and eased the terms. The Fed reduced reserve requirements to zero. This is exotic.  

The Fed opened up FX swap lines to most major central banks around the world. This was critical to address the Dollar Shortage that has plagued global finance for years. The Fed’s willingness to take this specific action was a direct acknowledgement of the magnitude of risk present in The Dollar Shortage situation and an express willingness to step outside of the Fed’s direct mandate and take radical measures to address other issues deemed critical. This is a multi-trillion-dollar problem and the Fed will conjure up money out of thin air to make sure its ok. Critically, the Fed did not extend a swap line to the PBoC. China is heavily short dollars and its economy is cratering. We do not know how this situation will be resolved but it’s one of the most important out of all of them. Regardless. the Fed will have a hard time reeling these back in once war time is over.

On the fiscal side, the CARES Act was passed. It’s about $2 trillion. It looks like this.

There is every reason to believe there is more where that came from. Mnuchin has expressively talked about $4 trillion total just on financial support for businesses. Right now, a family of four gets a $3400 check in the mail. If that family runs out of that money and the economy still isn’t running, the government will send them another check. The government will have a hard time reeling these back in once war time is over. Trump wants to pass a multi-trillion dollar infrastructure spending bill. There’s a real chance he’ll get it done.

The deficit spending that will occur in 2020 will only be comparable to prior periods of World War. That actually makes sense to us. But they will have a hard time reeling it all back in once war time is over. I’ll keep repeating this, because it’s an important point. 

All of this happened, and the dollar strengthened against nearly every major currency. That’s called a Dollar Shortage.  

Financial Market Risk  

This is a big one that we think has a low likelihood to materialize in April. At various points in March, we believe some of the largest hedge funds in the world were on the brink of collapse. It wasn’t likely to be a bank collapse because of the Volcker Rule. Because large hedge funds had become critically involved in the overnight funding market, they became de facto Too Big To Fail. But they were close. So the Fed cut interest rates 100bps, cranked up Repo Infinity, cranked up QE Infinity and calmed the market down. We believe these risks have been dampened because of the swiftness and aggressiveness of the response by the Fed. There is a small chance these risks could show up again in April. You’ll know what it looks like if the likelihood of a financial market blow up increases. The VIX has been collapsing for two weeks. The VIX will increase. Stocks and bonds will move with a strong positive correlation rather than inverse correlation. Credit spreads will blow out. Gold price will fall. Fixed Income ETF’s will trade deeply below NAV. CDS will explode. We saw all this in March and it all abated into month-end. If it happens again, you’ll see it coming. Take it level by level.      

The Pace of Economic Bounce Back

This is probably the factor with the broadest spectrum of views of potential outcomes. There are smart folks who I respect a lot that think this whole thing is stunningly overblown, the stimulus response is stunningly aggressive, and the economy is going to coming ripping back in Q3 with stunning velocity. There are smart folks who I respect a lot that think this whole thing is obviously worse than ‘08, ‘87, and the Great Depression and will get much worse over the coming quarters.

Who’s right? The answer is no one knows.

"Markets have to price in all the things that can happen. Many more things can happen than will happen, and as those possible outcomes narrow, the market’s accuracy greatly improves" – Bill Miller

When will the US daily death count drop sustainably below 50? When will non-essential businesses begin opening back up? What happens when people go back to work and then more people get Coronavirus? How much will the consumer spend in May, June or July? What happens if there is a second wave of Coronavirus, like there was with the Spanish Flu? How much pent up economic demand is building right now? How many businesses will shutter and never reopen? How many individuals receiving government assistance will find their quality of life preferable without a job than with one?

I don’t know the answer to any of those questions. But I don’t have to decide right now, and it would be unwise to get married to any particular view on any of these at this point. I don’t run a $200bn bond fund. I run a very small crypto fund. We can take it level by level. We know the economic data coming over the next several months will be stunningly bad. It’s not clear how much of that is priced in currently. Goldman thinks Q2 GDP is going to contract 34%. Is that priced in? Are the knock-on effects of that priced in?      

Oil

It’s cheaper to buy a barrel of oil in Alberta, Canada than a beer in Venice, CA. That’s a problem. The oil market, and the equities of the companies involved in it, have been *smoked*. This oil market problem metastasized into a credit market problem because the energy industry is a big part of the high yield credit market and a meaningful part of the IG credit market. Trump realizes the oil market is a big problem right now. That’s why he’s already communicating with MbS and Putin even amidst a global pandemic – because he realizes how critical the situation is. The energy industry provides 5% of all jobs in America, more jobs indirectly, and has been a major driver of pushing unemployment lower over the last decade.

The US government has a spectrum of support it can provide to the energy industry – from very little to a lot. Trump may be able to strong-arm/finagle MbS and Putin into some sort of remedy, but the pure game theory around the situation would tell you Saudi Arabia and Russia should squeeze US shale. Perhaps the moves already made by the Fed in financial markets can calm the storm that comes with a wave of energy company bankruptcies. Perhaps the moves already made by the US government with fiscal stimulus can alleviate the wave of unemployment stemming from the oil market collapse. But there is significant risk to this situation.            

Social Issues

Again, not to be callus. This is how we view the world relative to our job managing other folks’ money. There is risk that NYC or another hotspot begins seeing looting, riots or other forms of social unrest. The US National Guard will respond if a situation like that becomes significant. Risk assets will really hate that. Unemployment will skyrocket to levels not seen since the Great Depression. There is a good chance unemployment levels may exceed those of the Great Depression for several months. This may lead to an increase in crime and suicides. It will almost certainly lead to an increase in drug addiction. Americans will receive financial support from the government to a degree not seen in nearly 100 years. If shelter-in-place/quarantine continues for another 2+ months, people’s daily lives, interpersonal relationships, consumptive habits and spending may change in significant and enduring ways. These things don’t happen in a vacuum. They really matter.      

So What Now?

It’s not clear right now. Flat out. A lot of these things could end up more bullish or more bearish relative to current expectations. It does feel like a good amount of optimism is priced in at current levels. If one or more of these factors break to the downside, we believe risk could head lower. There are many other longer-term factors emerging in real-time as well, but we want to keep our analysis reasonably concise here. We will be back here in a month with updates on these various factors and probably some news things that pop up over the course of April. We remain vigilant.

Market Update – Liquid Crypto Asset Investing

Bitcoin’s price declined 25% in March as the VIX reached its highest daily close ever. Bitcoin is down 11% YTD, outperforming the S&P 500 by 9%. This price performance from BTC came without circuit breakers. Without a Plunge Protection Team. Without a trillion of repo. Without QE. Without credit facilities. Without fiscal stimulus. Without $3400 for a family of four. Bitcoin’s antifragility is juxtaposed against deeply fragile traditional financial markets where price discovery has been deeply distorted by central bank actions. You can’t fully appreciate how antifragile Bitcoin is until you fully acknowledge how rickety and dysfunctional the legacy financial system is. We’ve never seen anything like Bitcoin in a time like this before. Never been anything like Bitcoin before.     

On March 1st we said:

“This setup makes the near-term crypto market environment especially tricky to navigate. On one hand, BTC has shown strength in the last month. If the SPX indeed bottomed on Friday with that aggressive bounce into the close, BTC should fair very well in March. On the other hand, if the risk-off, sell everything environment continues into the next week, BTC may owe a little extra downside to “catch up” to the rest of the de-risking seen in other asset classes.”

We saw that catch up in March. It happened violently and then bounced violently. Currently, we still see the near-term fate of BTC tied to the appetite for risk assets broadly. This chart is undeniable.

This chart is undeniably bad for the narrative of BTC but also to be expected. We expected it and told you we expected it. But it is equally undeniable that whales will decide when this correlation breaks. Not before. Not after. Until then, we see no reason to believe BTC is anything other than at the mercy of risk appetite globally. And to that end, the S&P 500 doesn’t appear to be out of the woods yet to us.

While not our base case, a solemn reminder of what the bear case could look like here.

We remain convicted in our stance that after the dust settles. After economic activity resumes. After central banks and governments inject *many trillions* of new dollars into the world by increasing balance sheets and deficits. Off that bottom, there is no other asset on the planet that will move like Bitcoin.  

It is fair to say the investment case for Bitcoin changed materially in the last 30 days. The facts and circumstances one would consider when evaluating whether to own Bitcoin have rapidly changed. Bitcoin was birthed during a period of exotic monetary and fiscal policy implementation. Those policies got way weirder in the last month and are set to get much weirder still in the coming months. Bitcoin’s market cap went from $0 to $300bn back to $100bn over 11+ years with a backdrop of mundane inflation. Bitcoin is a speculative store-of-value. Investors in Bitcoin today are making the bet that Bitcoin will become a SoV because it has the characteristics to be a good SoV. The world’s money supply is set to expand at a pace seen only during previous World Wars. What happens if that expansion still doesn’t create meaningful inflation? What is Bitcoin’s fate over the next few years if 5-year Forwards never get over 4%? What becomes of Bitcoin if significant inflation does finally show up?

In the near-term, BTC has seasonality tailwinds, both for April and Q2.

Last month we posted this chart and said, “the halving is a strong narrative, but it is not reinforced steel. If the Tokyo Olympics are cancelled, Bitcoin’s near-term bull run likely will be as well.” Well, the Olympics are cancelled, and this is a rough update to that chart.

Last month we talked about expecting a hash rate decline. That came to fruition.

Importantly, one of Bitcoin’s most ingenious characteristics was on display in March. In response to the hash rate decline, Bitcoin saw its second largest downward difficulty adjustment ever. These are rare and historically have been excellent buying opportunities.

We’ve shown this chart many times before. BTC took a big right hook from Coronavirus in March. The X-man toddler is still standing. And Bitcoin is still having its block reward cut in half in 40-something days.

For the last several months, we discussed the increase in cross-coin correlation and how we viewed it as unhealthy. In light of the price action in March, this increase could certainly be viewed as having been a harbinger. Current levels of correlation are near all-time highs. We need to see this decline.

While on the topic of Alts, they broadly underperformed BTC in March. Most majors underperformed BTC a lot although several are still outperforming BTC YTD. We have discussed at length about how much of a single-asset asset class crypto feels like most of the time. That’s more true today than at any other point. There’s very little to get excited about in the Alt universe. That is disappointing. We hope that changes. When it does, we’ll see it and act accordingly.

Closing Remarks

These are trying times for people around the world. We haven’t seen anything like this before. The magnitude and pervasiveness of uncertainty has people anxious to a degree seen only a handful of times in the last 100 years. But humans are an incredibly resilient bunch. We’ve seen worse, overcome worse and come back stronger than ever. We will overcome Coronavirus and come back stronger than ever as a species. I’m confident of that.

The winds of change are blowing on many fronts. To the extent the quarantine is extended into May, June or even later, it will likely fundamentally alter the manner in which Americans live their lives in numerous ways. Americans receiving financial support from the government is about to be destigmatized to a degree this country has never seen. This will have profound and lasting implications. The government’s response to all this has greatly benefited large corporations relative to small businesses. This will have profound and lasting implications.

And lastly, monetary and fiscal policies from central banks and governments globally have already changed drastically just this year and are set to change further still. We were in no man’s land before anyone ever said the word Coronavirus and the actions taken in response to the pandemic, rightly or wrongly, are pushing us further out into the risky abyss. When looking at monetary history, there is no instance where experiments like this end in anything other than collapse.

Nothing like this has ever happened during Bitcoin’s history before, and nothing like Bitcoin has ever happened in history before. That makes for a great deal of uncertainty in the short-term, but our broad, directional conviction remains unshaken. The world needs a non-sovereign money, and the timeline for that need has been accelerated.

Travis Kling

Founder & Chief Investment Officer

Ikigai Asset Management

P.S.

Included below is an incomplete list of memorable tweets from the last month. Twitter is not investment advice and my views could easily be wrong. That being said, like it or not, Twitter matters for crypto. I have no interest in being a talking head for a living and babbling about on Twitter is a long way away from being a good steward of investor capital. However, this is a community with open-source software in its DNA, and participants want to crowd-source the truth. We believe we have built a team and a process that will produce these truths more quickly and more clearly than our competitors. We are shepherds of this technology. Answers to fundamental questions about this asset class are not currently clear, so having a public platform to share your views with the community is important. After all, you’re helping shape the future :) 

1. Ikigai Asset Management is the trade name for a collection of advisory and consulting businesses operated by Travis Kling, Anthony Emtman, and their team.

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