January 2019 - Market Update
Monthly Update || January 2019
Greetings from inside Ikigai Asset Management1 headquarters in Marina Del Rey, CA. We welcome the opportunity to bring to you our fourth 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, we continue to ingest, synthesize, analyze and draw investable conclusions from the river of new information that is made available every day about this technology and asset class. The framework through which we execute this process is our Four Foundations: 1) Qualitative Research; 2) Fundamental Valuation; 3) Quantitative Tools and 4) Event-Driven Catalysts. We believe that if we have a clear look into these Four Foundations, then we will have courtside tickets to the basketball game. Because of the work we’ve done, we now have those courtside tickets scattered around the parameter of the wood. With these tickets from these many angles, we believe we are seeing the game clearly.
Some of the insights we have gleaned from these courtside tickets we have shared publicly over the last several months. The video below is a short compilation of clips from podcasts where I share some of these insights and make predictions. Many of these predictions were contentious at the time but turned out to be accurate, nevertheless.
In our December 1st Monthly Letter and December 14th Market Update, we discussed some of our expectations for the coming months, and the opportunities we see. The month of December saw some of these expectations beginning to be realized while others continue to gestate. None of our views shared previously have fundamentally changed – the bottom is unlikely to currently be in for crypto markets. January and February will likely continue to deliver choppy price action. Volatility will remain elevated, and with that volatility comes opportunities on both the long and short side. We captured many of these opportunities in December and believe we will continue capturing the opportunities that will present themselves in the coming months. The work put in over the last 7+ months and continuing to be put in today by our outstanding team at Ikigai is serving us well. We are ready for whatever this market gives us.
Making big, splashy prognostications about crypto in 2019 is not a fruitful exercise – too much is changing too quickly to give specific projections a year out. What we can do is analyze all the avenues of information we are intaking, draw conclusions and communicate those conclusions to you. To that end, we are hosting our first Quarterly Update conference call on January 8 at 10am PT. If you have not already received an invitation to that call, please email us.
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.
December Highlights
Coinbase Adds New Tokens
CFTC Issues 32 Page Primer On Smart Contracts
SEC Chairman Jay Clayton Calls Almost All ICOs Securities And Pours Cold Water On Bitcoin ETF Approval
Consensys Lays Off Staff
Amazon Launches Two New Products For Building Blockchains
ICO Project Basis To Cease Development And Refund Investors
Kraken Launches Fundraise At $4bn Valuation
Facebook Contemplates Stablecoin Project
India To Lift Cryptocurrency Ban in 2019
Traditional Asset Class Stress
December saw traditional asset class performance go from bad to worse with a significant increase in volatility.
More asset classes generated negative returns in 2018 than any year since 1901.
Goldman Sachs bull/bear indicator, based on measures of equity valuation, growth momentum, unemployment, inflation and the yield curve, is now at levels last seen in 1969. This is not an indicator that has historically given false signals.
Investors often ask us - “what happens to crypto in a recession”? The answer is it’s hard to say, as crypto has only existed during a bull market for traditional asset classes. Bitcoin was created at the beginning of the largest monetary experiment in human history – globally-coordinated Quantitative Easing. The effect of QE is deeply distorted asset prices worldwide. Trillions of dollars of sovereign debt carry negative yields. Central banks around the world are now trying to ween markets off of this money printing, and it is causing pain in asset prices. Crypto may very well have been the canary in the coal mine- the valuations of 2017 were telltale signs of cheap money, mispriced risk and irrational exuberance. Crypto prices started crashing a year ago. Shortly thereafter Emerging Markets cracked. And over the course of 2018 one asset class after another broke down.
Crypto isn’t ready for a financial crisis yet (which probably isn’t happening) or a recession (which probably is happening unless the Fed blinks). Historically, recessions are when disruptive technologies are tested, implemented and adopted. Some of that will happen in this potential looming recession but many of the most exciting promises of DLT and crypto assets won’t be ready for several more years. For now, crypto still acts as a risk-on asset, but as the technology evolves and matures some crypto assets will have characteristics that allow them to outperform other asset classes in an inflationary recession.
What we can say with a high degree of confidence is this- if central bankers and governments around the world are unwilling to tighten monetary and fiscal policy in an attempt towards ending the largest monetary and fiscal experiment in human history- this is deeply, fundamentally, bullish crypto.
Narratives Check-In
As we have discussed publicly at length, narratives drive crypto market prices. We monitor these narratives closely and they help drive our investment decisions. Our accurate identification and assessment of narratives has helped us to be on the right side of market moves. Most of the following narratives we have previously discussed with you, but we wanted to provide a quick update on some of the important ones:
Traditional Asset Class Stress – As discussed above, this narrative has accelerated. Fed actions in 2019 are “data dependent”, meaning if the economic data quality declines, the Fed will slow its rate hikes. This push/pull will be a key narrative in 2019.
The Relationship Of Crypto To Traditional Asset Classes – This was a big one in December as traditional asset classes came under significant stress in December. Much discussion was had around the correlation of crypto to equities, interest rates, dollar strength, the VIX and gold. Questions were posed about the “risk-on” nature of crypto, if that will ever change and under what circumstances. We believe this may be a key theme of 2019.
Technical Breakdown Of Crypto Charts – From a purely TA perspective, crypto prices are more likely than not to make new lows, likely in the first couple months of 2019.
Zombie SAFTs – Dfinity, one of the most-hyped ICOs of 2018, announced on December 13th a delay of their product launch from Q1-19 to an unknown later date. We believe this trend will continue in 1H-19. Anecdotal reports of SAFTs being privately offered at significant discounts to the last round’s valuation increased in December. We believe this trend will continue in 1H-19.
Fund Redemptions Into Illiquid Markets – More on this below, but the Bottom 99 declined >25% in the first 15 days of December before rebounding into month end – tax loss selling in conjunction with fund redemptions were likely major contributors. We believe forced selling from fund redemptions will continue in 2019.
Bakkt Launch Delayed – Bakkt will delay launch again past January. The reasoning is unclear and likely some mix of debt ceiling-induced government shutdown and weak demand.
No Bitcoin ETF On The Horizon – Our stance on this remains the same, Q1-19 unlikely to bring a Bitcoin ETF approval.
SEC Enforcement Actions Against ICOs – This narrative was mostly on pause during December, likely due to the holidays. We expect it to reemerge in Q1-19.
ETH Death Spiral Round 2: “The SEC ETH Refund” – More on this below, but ETH selling out of ICO Treasuries accelerated in December. We did not see additional enforcement actions from the SEC requiring investor refunds in December, but we believe we will in Q1-19.
BCH Fork & Hash Wars – This narrative, which crash prices in November, has declined in significance for the time being.
Stablecoin Instability & Uncertainty – Bitfinex launched USDT margin trading to allow traders to take advantage of USDT/USD arbitrage. This appears to be working for the time being, as USDT has remained >$0.99 in December. The overall trustworthiness of Bitfinex continues to be an unanswered question.
Ethereum
Ethereum has been a troubled project for most of 2018 – scaling problems with delayed or scrapped solutions; key personnel departures; Consensys ineffectiveness and layoffs; and competing projects. When crypto prices crashed in mid-November, ETH was hit especially hard, declining 60% in the following month and underperforming BTC by 20%. After bottoming on Dec 15th at $80, ETH rallied 100% to $160 in a straight line for 9 days before stabilizing in the $130’s into YE. The dump at the beginning of the month was likely due to shorts pressing into ICO Treasury selling, both of which were apparent in real-time. Short positioning quick became immensely lopsided and a squeeze ensued.
Currently there is a potential bullish setup for ETH as its Constantinople upgrade is scheduled for January 14th, although we believe this may be getting priced in in real-time. Constantinople decreases the block rewards for ETH by 1/3, a meaningful decline in structural supply that will come to market. On the back of a potential rally into that bullish event, we think it is likely ETH makes new lows. ICO Treasuries sold more ETH in November than the prior five months combined. ICO Treasuries sold >67% more ETH in December than they did in November. At the December pace of selling, ICO Treasuries have more than 6 months of selling to go before converting all their ETH holdings to cash. We do not believe there is ample demand for this supply at current prices.
Market Update – Venture Crypto Asset Investing
Venture opportunities slowed materially in December, likely due to: 1) the holidays; 2) the large decline in crypto prices; and 3) traditional asset class stress. The pipeline for new crypto projects is getting smaller each month. We expect this trend to continue into Q2-19 if not longer.
Last month we discussed the emerging opportunity for “distressed SAFT investing” – buying SAFTs from investors needing immediate liquidity at significant discounts to the last round’s valuation. We believe these opportunities may be among the most attractive venture opportunities in 1H-19. We saw an increase in these opportunities in December but are remaining patient with deploying capital. We believe the discounts will get deeper as we move into 2019. We also need to see development progress further on these projects to have a clearer sense of where the most attractive risk-adjusted returns lie across the venture landscape. We are engaging in active dialogues with many projects’ senior leadership to most accurately assess each project’s unique value proposition. The work we’re doing on that front will accelerate in Q1-19.
The crypto landscape is highly dynamic. The space continues to iterate at a breakneck pace. Evolution is occurring superlinearly. These market characteristics make the ability to change one’s mind highly valuable – I can buy something today because it has attractive return characteristics and then change my mind and sell it later as new information becomes available. Simultaneously, the average hold time for a venture-stage crypto investment is increasing. This prohibits me from changing my mind quickly if new information becomes available. The combination of these factors leads us to being highly selective in our venture investing capital deployment, as we lose our ability to quickly change our mind. The return proposition must be especially captivating- at least 10x returns under conservative assumptions with significant opportunity for additional upside. Above all, we remain patient.
Market Update – Liquid Digital Asset Investing
Crypto prices generally declined in December, with the notable of exception of ETH, as discussed above. Under the surface, the month was really bifurcated into a first half and second half – with strongly negative price action followed by a substantial bounce. We believe this V-shaped month was primarily a function of tax loss selling, retail capitulation, ETH ICO Treasury selling and fund redemptions. Overall, in December crypto price action largely took a back seat to traditional asset classes.
We do not believe crypto prices have bottomed yet. This view is informed by literally dozens of quantitative and qualitative signals that we track internally across our Four Foundations. Put simply- the preponderance of evidence leads us to believe prices will head lower in the first part of 2019. It is enormously difficult to call specific prices or specific timing. It is a more fruitful exercise to: 1) weight the probability that prices have bottomed; 2) discuss scenarios of a potential bottoming process as measured across various signals; and 3) constantly reassess as new information become available. We execute this process on a daily basis at Ikigai.
Purely from a TA perspective, BTC projects to as low as <$1,000. While this is not our base cases, the most dominant TA pattern present in the market today is the descending triangle that was broken in November. This pattern projects a tremendously bearish final low.
We have been publicly calling for months for the Bottom 99 to decline to $40-$50bn. This call was initially met with disbelief from some crypto market participants because it was so low relative to current prices at the time. On December 15, Bottom 99 reach $45bn.
As discussed last month, we do not believe that initial $40-$50bn projection was low enough and we expect Bottom 99 to make new lows in Q1-19, potentially <$30bn. Put simply, the YE-18 Bottom 99 market cap of $61bn is still overvalued. This view is informed by the thousands of hours of fundamental research we have performed and continue to perform on each of these projects. We believe many of them are worth zero or effectively zero. We are not certain the market will reprice them this low, but we believe current prices are not low enough.
Cross-coin correlation increased materially over the month of December. This is a telltale sign that the bear market is not over.
One of the many signals we track is the Crypto Fear & Greed Index. This Index is based on a combination of Price Volatility; Market Momentum; Volume; Social Media; Surveys; BTC Dominance and Trends. In mid-December, this Index reached levels typically associated with price increases, and a subsequent price bounce ensued.
NVT Ratio declined materially in November and 1H December as prices crashed but subsequently began increasing again. We believe this important on-chain metric is unlikely to currently be low enough to signal a market bottom here.
On the other hand, MVRV is looking much closer to bottoming after the price crash in November. This is encouraging.
Last month we discussed the decline in BTC hash rate and subsequent decline in mining difficulty – a key feature of BTC PoW mining. This has worked as expected and December saw a 30% increase in hash rate off the mid-month low. The BTC “miner death spiral” is a fallacy.
Closing Remarks
In many ways 2018 was a tough year for crypto. Prices crashed. Projects stumbled. Adoption proved elusive. Scams and charlatans were pervasive. As we sit here today, challenges abound. The good news is they’re all surmountable. They are all being solved. A year ago, there were many roadblocks preventing more money from flowing into the space: regulatory clarity; institutional-grade infrastructure; custody; price volatility; reliable valuation frameworks; bad UX. Each of those roadblocks and more made significant progress towards impactful solutions in 2018. Each will continue to make even more progress in 2019.
We are highly convicted in our broad, directional bullishness on this technology and asset class. And while we are cautious on prices in the near-term, we believe our flexible investment mandate allows us to profit from volatility while constantly assessing the investment landscape for signs of bluer skies. We believe compelling risk-adjusted return opportunities are present today in our strategies that profit from volatility and generational buying opportunities may be just around the corner. We aim to capture both to the extent they are available. As such, we remain patient, objective, vigilant, and flexible.
“The bamboo that bends is stronger than the oak that resists."
– Ancient Japanese Proverb
Travis Kling
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 :)
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