December 2019 - Market Update
Monthly Update || December 2019
Opening Remarks
Greetings from inside Ikigai Asset Management1 headquarters in Marina Del Rey, CA. We welcome the opportunity to bring to you our fifthteenth 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, Bitcoin’s explosive move on October 25th was faded hard in November on the back of opaque, dynamic, conflicting and confusing newsflow out of China. Just glancing at a price chart of BTC, it’s as if the October 25th move up never should have happened. If you remove that single day from the chart, BTC has been in a firm downtrend since June 26th, making a series of lower highs and then, starting September 24th, a series of lower lows. We’ll dive into some potential explanations of that below.
In November, traditional asset classes continued to climb a wall of worry around China trade wars, stagnating economic data, Trump impeachment noise and repo market hiccups as the SPX made a series of higher highs while the VIX made a series of lower lows. Unemployment is at all-time lows. The SPX is at all-time highs. Home prices are at all-time highs. This is the longest but weakest economic expansion in US history. Bitcoin price has doubled YTD and is the best performing asset class by a wide margin. So why does it feel like a bear market in crypto?
This was a question that’s been gnawing at us for months now. We’ve spoken about it for months here. On August 1st we talked about a new, bearish market regime shift potentially starting. By September 1st our conviction around this view strengthened. On October 1st, after the market breakdown on September 24th, we said downside risk continued to linger. Finally, on November 1st, after the massive move up on October 25th, we said it appeared BTC had found a bottom, but it was too early to have high conviction that the move up wasn’t a headfake. It turned out to indeed be a headfake, as BTC not only walked back the entire October 25th move but also subsequently made lower lows.
While the last five months of price action has been disappointing, we believe it is transitory and explainable. The macro backdrop for BTC has unequivocally strengthened, despite lackluster price action. The whole world is racing to see who can devalue their currency the fastest by cutting interest rates and juicing QE. Governments are spending more than they bring in at an increasing rate – the US budget deficit will be a trillion dollars this year and another trillion next year. The risk of a recession in 2020 has declined over the last two months. Fundamental newsflow for BTC has been largely positive, despite China’s “blockchain is good, but crypto may not be” edict. New BTC mining operations announced in Texas are loosening China’s grip on hashpower. And in less than six months, the BTC block reward will be cut in half. The backdrop is strong.
In the meantime, we continue to evolve our investment process at Ikigai. This market necessitates that evolution. We are in perpetual beta mode here – constantly improving on our ability to deliver attractive risk-adjusted returns on a consistent basis. We are tireless in that endeavor. December 1st marks our one-year anniversary of launching the fund. We’re meaningfully better at our job today than we were a year ago and we’ll undoubtedly be better a year from now than we are today. I’m proud of that and I’m proud of our team.
November Highlights
Lots of Opaque and Confusing Newsflow Out of China Broadly Walking Back Crypto Bullishness
Bitcoin Mining Company Canaan, Inc Goes Public on NASDAQ
Canadian Company 3iQ Wins Approval & Files Prospectus for Bitcoin ETF
Crypto-centric Bank Silvergate Goes Public on NYSE
German Parliament Passes Law Allowing Banks to Trade and Custody Digital Assets in 2020
CME Announces Bitcoin Options Starting January 2020
China Releases Initial Plans for Digital ID Cards
World’s Largest BTC Mining Operation Breaks Ground in Texas
Andreesen Horowitz To Launch Crypto Academy February 2020
Argentina Central Bank Bans Bitcoin Purchases with Credit Cards
Tunisia Becomes First Country to Issue Digital Currency Backed by Paper Money
China Giveth, And China Taketh Away
The weak price action following October 25th was, in our opinion, driven by three factors: 1) China walking back “blockchain is good” to “blockchain is good but crypto may not be”; 2) PlusToken scam selling; and 3) potential miner selling. To be clear, all three of these factors are opaque and it is not possible to have high conviction that we are seeing these situations fully or with total accuracy. So below we will lay out what we think is going on and leave you to decide for yourself.
China walking back “blockchain is good” to “blockchain is good but crypto may not be”
November brought a torrid pace of news out of China on blockchain and crypto. New events occurred with daily or higher frequency. Most of these events were reported in Chinese and required translation, at the expense of context and nuance. Many of the events were opaque, where answering the question “so what does that mean” was difficult or impossible. Some of the events were from questionable sources. Some of the reports were conflicting with one another. Some of the reports later turned out to be flat-out false.
Below is a selection of some of these events to give you a flavor of what we were parsing through this month. This list is not exhaustive.
Chinese Agency Scraps Plan to Eliminate Bitcoin Mining Industry
Shanghai Regulators Ordered to Investigate Crypto Exchange Companies and ICO’
“Blockchain is not equal to the national rectification of virtual currencies”
Five Small Chinese Crypto Exchanges Halt Services
PlusToken Scam Selling
If this situation hasn’t made it to your radar, read this. TLDR: a Chinese Ponzi scheme milked investors for an estimated 187,000 BTC, 789,000 ETH and 26mm EOS in late 2018 and the first part of 2019 before attempting to exit scam and being arrested by Chinese authorities on June 29th. The subsequent fate of all that stolen crypto has remained in question, with little new information made available from Chinese authorities. On 8/14, ~5.5k BTC moved from PlusToken wallets to many different wallets and mixers before likely ending up on exchanges and sold.
The best wallet forensics work on this situation can be found on this tweet thread. Like many situations in crypto, this one is opaque. From what we can tell, an estimated 129,000 BTC has been moved from PlusToken wallets into mixers or through “self-shuffling”. Most or all of that BTC has likely ended up on exchanges, primarily Huobi and Binance. Assuming all that BTC was sold, this amounts to approximately 1300 BTC sell pressure per day over the last ~4 months.
At current juncture, an estimated ~50k BTC remain to be sold. At the pace of sales seen since August, this amounts to 1-2 months of sell pressure remaining.
To help frame the magnitude of this sell pressure, assuming the above analysis is approximately correct, it is equal to ~60% of all block rewards over that time. That’s a lot of sell pressure.
Potential Miner Selling
This is undoubtedly the situation with the softest evidence of the three. We contemplated not including it at all as we try not to peddle FUD. But we believe there is a reasonable likelihood it is at least somewhat true, and the market has certainly grabbed a hold of the narrative in the last few weeks, which can make a slightly true narrative “act” very true.
The story goes something like this – hashrate and along with it, difficulty, has climbed too far too fast YTD. As hashrate has continued to increase into declining prices, mining profitability has declined to the point of forcing miners to sell BTC to keep the lights on or shut down their business entirely. Potential proof of this selling here.
Indeed, hashrate did peak on 10/22 and has subsequently declined ~25%. In turn, difficulty did decrease by 7% on 11/7, the largest decrease since 12/18, but the subsequent difficulty adjustment saw a small increase period-over-period.
There is an additional related factor of the rainy season ending in China. This ends the period where hydroelectric is a large source of cheap/free power for Chinese miners. As they shut down these hydroelectric operations, they may be selling BTC to fund the transition period. This situation is discussed in more detail here.
So What?
China “blockchain is good” ripped price on 10/25. We’ve subsequently walked all that back and then some. PlusToken has probably been selling a lot. They’ll be done soon. Miners may have been selling some too. They’ll be done soon too, if they’re not already.
What’s the takeaway? This too shall pass.
Market Update – Liquid Crypto Asset Investing
On the back of 1) China walking back “blockchain is good” to “blockchain is good but crypto may not be”; 2) PlusToken scam selling; and 3) Potential miner selling, BTC put in its worst monthly performance of 2019, down 18%. BTC is still up 102% YTD, but 47% off the June 26th highs. November price action came as a steady wave of selling on elevated but not massive volume, as the drumbeat of China news turned decidedly more negative and PlusToken selling weighed on the market.
Alts broadly performed about like BTC. Interestingly, the Chinese-centric names that ripped so hard on the 10/25 announcement (e.g., NEO, ONT, IOST, QTUM) managed to hold on to a good portion of their gains and all outperformed BTC in November. Specifically, VeChain, a supply-chain logistics crypto project with close ties to China, moved explosively higher through the first part of November, crashed violently, found support, and as of time of writing found yet another leg higher. We continue to find these projects unworthy of investment, but we monitor them closely, if for no other reason than to gauge broader risk appetite.
Proof-of-stake blockchain project Tezos is another name that performed well in November, up >50%. That performance came on the back of Coinbase launching easy-to-use staking services built into their custody service, as well as an ETP listing on regulated Swiss crypto exchange SIX that is also providing staking services. This emerging trend of staking-as-a-service, which has been in the works for over a year but is seeing larger-scale adoption, is a welcomed evolution of the crypto ecosystem.
To keep it simple, if PlusToken has 50,000 more BTC to sell over the next 1-2 months, number go down, or at the very least not go up much. These flows are trackable and we’re tracking them. It would be reasonable to assume price will bottom in advance of that selling being done, as investors anticipate this significant overhang coming to an end. Where price is at that point is difficult to say. My gut tells me the lows aren’t in yet, but we’re watching closely.
Volumes during the November slide were elevated but not to extreme levels, punctuated by a large surge on the 25th that put the lows in for the month.
Bakkt volumes continue to make significant progress week-over-week. This is bullish.
Relax. Everything is still moving according to plan.
No seriously. Relax. We’re gonna be ok.
We’ve talked for months about the need to reset on-chain metrics after price ran too hard, too fast in Q2-19. Last month we said, “that reset was well underway until the 25th but it appears done, at least for now”. On the back of November price action, that reset has resumed and it is healthy.
Cross-coin correlation increased in November as prices broadly decreased but remains in a healthy range. This increase in correlation during a broad price decline lends credence to our view that high levels of cross-coin correlation are unhealthy. Note XTZ in dark green, going the opposite way of everything else. That’s what it looks like when people *actually* want to buy an Alt.
As discussed, hashrate peaked on 10/22 and broadly declined in November, although did not make a lower low after 10/26. We know about the rainy season ending in China. And we know that hashrate ran too far in the face of declining prices. What we see here is not acutely concerning, but it is worth keeping a close eye on.
Closing Remarks
China giveth news pumps, and China giveth news dumps. China giveth scam pumps, and China giveth scam dumps. China giveth hashrate increase pumps, and China giveth miner forced selling dumps. All normal course of business for the wild world of crypto asset investing.
I say this often, but there is tremendous risk in this asset class. Layers of risk. Esoteric and opaque risk. Risk at every turn. Throughout its 11-year history Bitcoin has produced stunning returns. Even after the 47% drawdown from the highs, BTC is still up >100% YTD and the best performing asset class by a wide margin. Which is to say, the returns have been commensurate with the risk taken.
We believe this combination of attractive returns in the face of high degrees of risk lends itself to active portfolio management. There is no playbook for managing capital in this asset class, so we’re doing our best to take our past experiences in related fields and build on those to create a best-in-class investment framework that will generate attractive risk-adjusted returns on a consistent basis while deploying capital into a technology and asset class we strongly believe will change the world for the better.
We just wrapped up year one of that endeavor. We’ve done a LOT in the past year. We’ve spent thousands of hours honing our investment process to be better stewards of our investors’ capital. We’re excited about how far we’ve come, and we’re excited about where we’re going. Year one done. Bring on year two. That’s what building a business is about. Hitting it over and over and over again and getting better month in month out. You fast forward five years, ten years, twenty years, you’ve built something you’re really proud of. Doesn’t happen by accident. It happens with persistent dedication. Nothing more. Nothing less. Let’s go.
Travis Kling
Founder & Chief Investment Officer
Ikigai Asset Management
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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, Timothy Lewis, Anthony Emtman, and their team.
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