Monthly Update || May 2020

Opening Remarks

Greetings from inside Ikigai Asset Management headquarters in Marina del Rey, CA. We welcome the opportunity to bring to you our twentieth 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, April brought the most hated rally in the history of rallies, driven by the most radical monetary and fiscal stimulus in the history of stimuli. For the first time ever, all G7 central banks are conducting asset purchases at the same time. The Fed bought more Treasuries in the last six weeks than the entire global foreign sector bought in the last six years. Acute and exotic forms of monetary stimulus never before seen were enacted by the Fed and Treasury. In the United States, in the last 60 days, we have crossed the Rubicon in terms of accepting and even expecting levels of monetary and fiscal stimulus previously unimaginable, while simultaneously ceasing to ask “how are we going to pay for all this?”

It was with that backdrop that risk rallied hard in April. SPX was +13%. VIX -36%. BTC +34%. The SPX is 15% below all-time highs. Bitcoin was up ~1% from the end of February to the end of April. Risks assets were able to compartmentalize Boris Johnson going to the ICU for Coronavirus. They were able to compartmentalize an obviously devolving US-China relationship. Compartmentalize Fallen Angels. Compartmentalize 30mm unemployed in the last six weeks. Compartmentalize a negative $40/bbl WTI price on April 20th. Risk assets were able to do this for two reasons – Coronavirus being better than feared and this chart.

The crypto ecosystem enjoyed a host of positive news flow in April while central bankers and governments globally did their part to make the mass adoption of a non-sovereign money increasingly inevitable. Many traditional market participants are insisting that the bounce in risk assets from the March lows has gone too far and must pull back because the fundamentals of the economy are so poor relative to stock prices. The latter is certainly true. The fundamentals of the US economy have never been so divorced from the S&P 500. Ever. But we have never seen this level of monetary and fiscal stimulus. Ever. So we find ourselves in uncharted territory.

Bitcoin is a technology and an investment purpose-built for uncharted territory. When you don’t know, you want to be antifragile. An investment in a non-sovereign money is by its very nature a contrarian investment. It is a bet on a world that is different than the world we’ve lived in in the past, and the world we find ourselves in currently. We strongly believe over the last two months the world has moved decisively in a direction where a non-sovereign money will be demanded and highly valued.

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.

April Highlights

• A16Z Crypto Raises $515mm Second Fund

• Renaissance Technologies Begins Trading CME Bitcoin Futures

• China Rolls Out Testing of DCEP App

• Facebook Further Redefines Libra, Releasing New Whitepaper

• Congress Introduces 32 Bills Relating to Cryptocurrency & Blockchain

• Binance Acquires CoinMarketCap for $300-$400mm

Ikigai Team Member Post: Whales & Retail

Hans Hauge
Ikigai Senior Quantitative Researcher

What drives the price action of Bitcoin? The same thing that drives the price of anything - supply and demand. The problem has always been quantifying these forces. If you can do that, then you may have solved an important piece of the puzzle. As you might expect, we are interested in chipping away at this problem here at Ikigai.

Bitcoin’s circulating supply is easy to determine at any point in time, and the total supply is also known. At the highest level, 1) the number of participants and 2) the level of their activity, is the ultimate source of demand. However, we also know that there are different groups of participants in the Bitcoin space. A HODLer with Bitcoin in cold storage has an impact on supply (decreasing the amount that is currently in circulation), but on a daily basis the price discovery falls to exchanges where fiat, stablecoins and BTC are traded.

Now, each exchange has their own supply of Bitcoin and we have rough estimates of these amounts. Furthermore, we can estimate the number of Bitcoin deposits and withdrawals from these exchanges each day (sometimes with even higher granularity).

Additionally, we have data (thanks to Coinmetrics and Digital Assets Data) that estimates the total amount of Bitcoin moved in and out of these exchanges each day.

Now all we need is some clever way of looking at this data to help us make sense of it all. This introduces a twist. Ponder this:

• What’s the qualitative difference between a single deposit into an exchange of 100 BTC, and 100 small deposits of 1 BTC each?

• Do they have the same impact?

• Going further - who sent those 1 BTC transactions? Do you think it was the same kind of market participant that sent the 100 BTC deposit?

That’s a lot of questions in a single paragraph, and we need to get visual. But first I’ll bury the lead:

• I’m going to suggest that we might be able to draw some lines between “Whales” and “Retail” when it comes to exchange participation.

• I think the marketplace thrives when it has both kinds of participants.

• I also think that the behavior of the Whales differs from the behavior of the Retailer.

• Furthermore, you might even say that the behavior of the different groups of market participants reacts to the market and also creates action.

A quick caveat: Exchange flow data is imperfect. Hot wallet and cold wallet movements are complex, unique to each exchange and change over time without warning. As such, this broad area of on-chain analysis cannot be relied upon in a vacuum. Instead, at Ikigai we glean signal from this area of analysis in conjunction with others to utilize a multifaceted approach.

In Zen they ask, “Does the fish move the water, or does the water move the fish?” The correct answer is “Both!”

What you’re seeing here is what I call “retail direction.” What this shows is the general direction of the retail participants. When the orange bars point up, retail participants are moving their Bitcoin to exchanges. When the orange bars point down, the retail participants are pulling their Bitcoin out of exchanges.

How do we know these participants are in fact, retail? At the risk of sounding Socratic, let me ask you another question. Are there more retail participants, or whales? The answer to this should be simple - we can say with certainty that there are more retail participants than there are whales simply because of the distribution of wealth. Therefore, the one thing we know for sure is that the Retailers have numbers on their side. And that’s where this chart gets the signal from. The retail direction is simply a mapping of the divergence from the mean of the total number of deposits less the number of withdrawals.

Let’s look at this same chart again, but this time with some annotation so we can extract some deeper meaning.

Now we can see that the behavior of the retail participants is to buy Bitcoin and to pull it off the exchange as the price goes down, or if the general trend is bearish. The reverse is also true, Retailers start taking profit when the price goes up, or if the general trend is bullish. This is actually not a bad strategy for Retailers. The obvious downside is that in long bear markets, they may be duped into buying well before the bottom is in. Additionally, when prices start to increase again, they tend to take profits too early.

Let’s turn our attention to a second group of participants, the Whales. I’ve heard people say that retail doesn’t matter, and we should focus most of our energy on the Whales alone. But we should bear in mind that from a Wyckoffian perspective, the Whales seek to malign the Retailers in order to increase their slice of the pie. If there are no Retailers, then the Whales must feed on each other, which is not as lucrative. Therefore, the Whales actually depend on the Retailers and as you might have intuited, the Retailers also depend on the Whales to do what they cannot - bring huge piles of cash into the ecosystem.

In the chart above, we see the “Whale Direction.” How do we know they’re Whales? We look at the average deposit or withdrawal size. The Retailers show their colors with their numbers, like vast schools of minnows. The Whales however, are identified by their sheer size. In order to determine the direction of the Whales, we use average deposit size and average withdrawal size.

Notice how different the Whale Direction is from the Retail Direction? You might even think they’re simply mirror images of each other. I’ll show you a better view of that in a minute.

In general, the Whales seem to accumulate during bull markets and distribute during bear markets. Could it be that Whales are playing the momentum game and Retailers are playing the value game?

Here’s the same chart again with annotations.

Let’s bring all this together in the last chart below, which simply displays the Whales and Retailers at the same time. Then we’ll talk about what it means for the market as a whole.

First, a word about the mechanics of this chart.

• If the Whales and Retailers have the same direction, the bars will stack. So blue on top of orange means both groups are moving towards exchanges. Blue on the bottom of orange is
  the opposite situation, where both groups are moving away from exchanges.

• The blue-gray slices are what happens when one group’s net deposit counts move one way, and the other group’s net average deposit size moves in opposition. On the far left we see the situation where Retailers are -1 and Whales are +1. At the line of “Halving II” we see the opposite situation. Retailers are +1 and Whales are -1. As before, let’s look at this chart again now that you’ve had some explanation about what’s going on.

One of the most important features of this chart is the Phase Transition. What you’re seeing here is the market telling you that the season has shifted. In the first Phase Transition, we moved from a bear market to a bull, and in the second we moved from a bull to a bear.

This leads us to the last critical observation from this chart - the transition signature.

You could interpret the Transition Signature to something like capitulation. These cycles are long, and of course more data would always be nice. But it looks like these Transition Signatures come near or shortly after the market price bottoms and they signify an acknowledgement from the participants (both parties) that the season has changed.

The Transition Signatures actually mean that Whales and Retailers are pulling Bitcoin off exchanges at the same time (a supply shock). Remember how we started this conversation, with price discovery being a factor of supply and demand? Well, exchanges are where that discovery takes place and right now it looks like the stars are aligning.

A few closing thoughts on different topics.

We’ve got the most aggressive fiscal and monetary stimulus measures ever being undertaken at the same time that Bitcoin is approaching its next phase of Quantitative Hardening, at the same time that Whales and Retailers are both pulling their Bitcoin off exchanges. The last time we had a Transition Signature it was well before the halving,and we had none of the tailwinds from the Fed, which was actually decreasing their balance sheet at the time (much to the chagrin of the markets).

The last thing I want to address is the issue of scalability in Bitcoin. You’ve heard the old troupe about “Blockchains don’t scale.” Well, that’s kind of like saying my MacBook Pro doesn’t scale, so the internet can’t work. It misses the point entirely.

True, blockchains do have limited capacity on the base layer. However, there are many efficiencies to be gained from simply using existing solutions (such as batching and SegWit). Furthermore, Bitcoin now has highly performant L2 solutions, such as Lightning and Liquid. If push comes to shove, people will start onboarding directly onto the Lightning Network, which actually gets more secure, more private and faster as the number of participants increase.

If we enter a massive secular bull market right now, the Bitcoin network will become congested again. This time however, the ceiling will be much higher than it was at the end of 2017. And if it stays congested, then exchanges will simply be forced to allow deposits and withdrawals from the Lightning Network.

Scaling is not ever a problem that’s solved from a technical standpoint. Scaling is kind of like customer service in the business world. You’ve got it down when it’s just “mom and pop.” But when the business starts to grow there are new challenges and you need to expand. Then when you go online, then go global, new challenges emerge again that need new solutions.

Remember, they said the internet wouldn’t scale too. Sounds pretty ridiculous now, doesn’t it?

Bitcoin is the most important technology in the world right now. It has the ability to topple dictators; enforce strong property rights; provide privacy; protect free speech; and deliver sound monetary transactions to the level of a basic human right, all outside the scope of national borders and political interests. Powerful.

Cash won’t be around much longer. And when cash leaves all transactions will become digital. We have a very important choice ahead of us. Do we want to live in a command-and-control surveillance state? Are we going to allow “contact tracing” to simply become “tracing” even after the pandemic is over?

Bitcoin has the power to change the world for the better and the people are waking up to this reality every day. We believe now is the time to deploy capital into this technology for the greater good, and because it just makes sense to be a part of the best performing asset of the last decade. Wouldn’t you agree?

- Hans

MARKET UPDATE – LIQUID CRYPTO ASSET INVESTING

This is a Monthly Update letter about crypto and this is the second month in a row I’ve posted this table showing global asset class performance. That should tell you a lot about the state of Bitcoin. It is behaving like a risk asset garnering worldwide attention and global capital flow. We have said all along that Bitcoin is a risk asset, but it is a risk asset with a specific set of investment characteristics that become increasingly more attractive the more irresponsible monetary and fiscal policies are from central banks and governments globally. Bitcoin is a speculative store of value. Investors in Bitcoin today are speculating that it will become a good store of value because it has the characteristics to be a good store of value. During the months of March and April, amidst one of the most catastrophic events in economic history, Bitcoin’s price was up 1%. That is a store of value.

Many Bitcoin bulls hate the chart below. They want BTC to stay uncorrelated and I get that. It helps a lot with the narrative. So you can hate it or love it but the chart is what it is.

What’s this chart telling us? That it’s all one trade? If it’s all one trade – what is the trade? We think it’s simple.

Worth noting those numbers above are nearly a month old, have already grown from those levels and will continue to grow meaningfully. Governments globally have replaced lost GDP with stimulus of every shape and size. Nowhere was that bazooka stronger than the United States. The United States responded to Coronavirus with unprecedented levels of stimulus to combat unprecedented levels of fear in financial markets. And as is so often the case, markets got most bearish at what was likely the bottom.

With now more than $7 trillion of total stimulus announced in the United States, you very reasonably could have expected the USD to come under significant pressure relative to other currencies. And you would have been wrong. This is not your parents' world reserve currency status and its definitely not your grandparents'. This is The Dollar Shortage and it lets you do things previously unthinkable.

This is the third month in a row we’ve shown this weekly BTC chart with some key horizontal resistance levels. When looking at this level of granularity, there has been some major volatility.

However, when looking at 2-month candles, March and April were nothing more than the longest bottom wick in BTC history, by a wide margin. Steady as she goes!

Which brings us to this chart, one of my all-time favorites. Here we are.

And the world is paying attention.

The chart below shows the incredible $1.7bn increase in Tether supply since March 20th.

Much discussion has occurred around this Tether situation. A meaningful portion of that $1.7bn in new Tether found its way on to exchanges, was presumably used to buy crypto, and is presumably available to buy more.

But the majority of the new Tether created appears to not be being used for crypto trading purposes but for something else. These non-trading use cases for Tether are difficult to glean clarity into, but from what we can tell USDT is intimately involved in The Dollar Shortage. The world needs a lot of dollars to satisfy USD-denominated liabilities and financial instruments. We believe the newly created Tether is being used for cross-border payments, international supply chain cash flow management, remittances and capital flight - primarily in Asia and specifically in China. These activities have been ongoing for well over a year but we believe they ramped significantly in the last six weeks.

We discussed multiple times over the last several months how over-levered the crypto ecosystem became in the first part of this year. On March 1st we said:

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.

The violent move lower on Black Thursday reset that market structure entirely, as shown in the chart below. Bitcoin’s 120% move up in price off the bottom has been spot driven, and I cannot overstate how much healthier that is than a leverage-fueled pump. We believe this sets up for higher prices.

On March 30th, Renaissance Technologies, the most successful hedge fund in history, filed a document stating their ability to buy and sell Bitcoin futures on CME. This news became widely known on April 18th. CME Open Interest has fully recovered from Black Thursday and looks poised to head higher from here. With hindsight, RenTech’s entrance into the Bitcoin market may prove to have been a pivotal event.

Spot BTC volumes remained robust in April after the massive selloff on Black Thursday in March, including a large spike on April 29th that accompanied a 15% price increase.

You destroyed some Bitcoin Days in March. Nothing crazy. Again, Black Thursday was a leverage, derivatives-led collapse.

Cross-coin correlation remains very high. We would expect to see this broadly begin rolling over in May. To the extent it doesn’t we will take that a sign to be cautious.

Closing Remarks

A lot of folks have asked me about my expectation for price action into and on the back of the halving, the most widely anticipated event in Bitcoin’s history. I try to be very careful about making any sort of price predictions publicly, because we change our mind a lot at Ikigai. We have said privately for several weeks that we thought it was smooth sailing into the halving. We didn’t think smooth sailing quite meant 15% in a day, but Bitcoin has a tendency to do those sorts of things from time to time.

We believe there is an increased risk of price volatility in the back part of May and June. We believe the Risky Whales, always an integral part of Bitcoin price discovery, may initiate some “downside price discovery” on the back of the halving, to figure out where folks really want to own this thing when the next halving is 3 years and 11 months away.

There is a miner capitulation theory floating around that goes something like - “the block reward gets cut in half so miner revenue gets cut in half; many miners become unprofitable; those miners shut down operations and sell the BTC on their balance sheet, pushing price down.” I get it. It could happen. The mining ecosystem’s capitalization and incentives are opaque and heterogenous, so it’s tough to draw high conviction conclusions. Importantly though, this space has shown a consistent tendency to take narratives like these that may be slightly true and make them all the way true. So the Miner Capitulation™ narrative may become self-fulfilling.

We think there’s good reason to believe we could see a pullback post-halving. It may be violent. We believe that will likely prove to be an excellent buying opportunity. Perhaps a generational buying opportunity. We also believe Bitcoin is attracting new institutional investors in light of the increasingly exotic monetary and fiscal policies that have been deployed by central banks and governments globally over the last several months. We truly believe “the herd is coming” to a degree not previously experienced. That may very well prevent a post-halving pullback from going very deep or very long.

Bitcoin’s antifragility, one of its most attractive characteristics, has been showcased over the last two months. Showcased and juxtaposed against an obviously deeply fragile and eroding traditional financial system. Bitcoin took a big left hook to the chin in the form of leverage-driven forced selling with the backdrop of a massive global deleveraging, found a floor and bounced right back – shedding the adverse market structure that caused the steep decline in the first place. Beautifully antifragile.

Every ~10 minutes a computer solves a math problem. Solving that math problem verifies the accuracy and timeliness of Bitcoin being sent from one wallet to another. The computer that solved the math problem is given some Bitcoin, and then you start over again. The Bitcoin blockchain has been doing this exact same thing for 11+ years. It was doing it when there was no price for Bitcoin. When the price was $1 and $1,000, and $20,000 and back to $3,000 and up to $13,000 and back down to $4,000 and its still doing it today at $8,800. It. Just. Keeps. Doing. The. Same. Thing. All that price volatility, which has obviously been stunningly positive over the life if Bitcoin, is just the world trying to decide what this thing that we’ve never seen before is worth. Beautifully consistent in its operations amidst the chaos of price discovery. We think that price discovery will resolve higher.

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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