The month of May, 2021 will be remembered as the most brutal sell-off in cryptocurrency history. Despite Bitcoin and Ethereum trading nearly 40% off of their highs, they are up over 300% and 1000% respectively, year on year. This kind of runaway trend was always going to see profit taking so we are neither surprised at the correction, nor worried.
Although it could be off-putting for some, the truth is that the recent volatility should be seen as a cleansing event – a reset if you will. We feel it is too early to tell what the next move is on crypto and despite our belief that the macro bull structure is still intact, the V-shaped recovery that everyone is hoping for might not occur for reasons we’ll explore later on. We would not be surprised to see a rather wide range between USD $26,000 – $42,000 to develop on Bitcoin, and $1,600 – $3,200 on Ethereum and last for most of the rest of 2021. Although, the cryptocurrency market is unique and the probability of a V-shaped recovery can’t be discounted due to the freak nature of the sell-off and there being plenty of cash on the side-lines.
It is worth noting that the exaggerated appearance of the sell-off was in large part due to both the exceedingly high number of leveraged positions (up to 125x) liquidating as prices slipped lower, and major exchanges freezing up under the heavy load. We feel that these factors are risks inherent to the current market structure and speak to its infancy, and will serve as the impetus for a more robust market structure to emerge. We’re pleased to have seen the stablecoin pegs remain largely 1:1 throughout the moves and for buyers in size to have stepped up to the plate. Even the doomsday crowd didn’t get the satisfaction of seeing the most unloved coins go to zero. What may be even more impressive is that throughout the chaos, all of the top DeFi (Decentralized Finance) platforms continued to function as intended without a hitch.
Much of the volatility in this market can be attributed to the volume flow mainly consisting of highly levered market participants eager to short into any media “FUD” (Fear, Uncertainty and Doubt) which was indeed the catalyst for the sell-off. Tesla, which announced it would be accepting Bitcoin for payments, abruptly reversed their position citing environmental concerns regarding mining, at the same time condemning Bitcoin for its inefficiency. The price impact was immediately felt across the market which was greatly exacerbated by the broadening and now more tangible ‘annual crackdown’ from the Chinese government on dirty Bitcoin mining and cryptocurrency derivatives trading. A significant number of Chinese Bitcoin mining operations went offline (evident in the drop in Chinese mining hashrate) and various Chinese exchanges were forced to either shut shop or discontinue the trading products targeted by the crackdown.
These developments were sufficiently negative to take the wind out of the bull run but the implications can be viewed as generally positive. We’ll be seeing less Chinese miner centralization, more action relating to sustainable mining, and less hot money in the market which should result in a more robust and orderly market structure. A side concern that some commentators were quick to point out was that the dramatic effect that the words or actions of a single company/person (Tesla/Musk) could have on cryptocurrency prices was setting a dangerous precedent and could be levered to their advantage. In addition, shortly after Musk’s comments, he and another popular Bitcoin advocate, Michael Saylor, jointly announced that they were establishing an organization designed to help bring a dialogue between Bitcoin miners (not unlike the oil cartel, OPEC). Although the intentions behind this may be benevolent and help “clean up” cryptocurrency mining, such a development is likely to have longer term ramifications that may impinge on the decentralized nature of the mining industry.
DeFi – The Future of Finance
Much has been happening in the DeFi (Decentralized Finance) landscape with new possibilities opening up as a result of the evolution of node infrastructure which has captured the attention of investors and developers alike. What was designed to be a scaling solution for Bitcoin and Ethereum (taking certain transactions off-chain and batching them, settling to the main chain later) has flourished into a variety of new business models. While we’d like to see more businesses in this niche operating without issuing a utility or governance token (i.e., exist as a traditional business with marketable equity instead) what is being released to the market is very exciting.
It is the writer’s opinion that a blockchain centric business does not have to be as decentralized as the blockchain it operates within. “Decentralizing” a business in the blockchain space generally implies distributing an element of it’s governance via a token sale to the public and rewarding it’s token holders with more tokens should they choose to lock them up in a process called “staking”. This is a popular method of distributing profits to token holders, rather than issuing dividends directly out of the profits generated from the platform. Another method to reward token holders (of many) is for management to allocate a proportion of fee revenue to buy back some of the tokens on market and destroy them in what is known as a “buy back and burn.” Both methods are aimed at rewarding token holders and illustrate some of the creative ways DeFi has evolved around securities legislation.
While these methods of distributing ownership can serve to reduce liability, more rapidly secure funding and help bootstrap the ecosystem, it remains to be seen whether or not they will be the winning models over the long haul. Scaling issues limit the number of transactions possible on the blockchain at any one time and this inhibits the flexibility of these structures. It’s quite obvious however, that a business utilizing a blockchain’s ledger (Ethereum for example) for its unit of account, for smart contracts and automation, fraud prevention and data integrity, is a massive improvement over the legacy model. What is less obvious is the ideal structure of that business.
Current valuation methodologies of a DeFi project and it’s token are contentious and can often become circular, (e.g., the perceived value of the token being primarily derived by its similarity to another project). What we’re seeing lately is that the price of a project’s token is heavily reliant on the project’s social media presence, their exchange listings and their closeness to venture capital firms and market makers. Other factors include the value locked within the project’s ecosystem and the current or potential partnerships and integrations with entities in the traditional world. Traditional analysts are the first to point out that none of these factors are directly linked to the PnL captured by the project and the utility value of it’s token and make accurately deriving a fundamental value (and even a floor price) nigh impossible. A more ethereal metric, and one that is not particularly easy to calculate is the perceived current and future network capture. An example of this in traditional finance is Uber which is able to maintain an eye-wateringly high valuation while recording one losing quarter after the other by capturing and retaining a significant percentage of the markets it operates within. In DeFi however, this is a metric that is likely to violently ebb and flow with volatility reflective of the ease that DeFi customers have in switching from one platform to another.
As the DeFi industry matures, valuations should converge on more traditional metrics (like profit) but with a twist. The future DeFi platform can have it’s equity trading as a regulated token (as opposed to paper shares) and still classify itself as a DeFi play as it’s platform can be accessible to all, globally. It will reap the rewards of being blockchain native, e.g., generating verifiable revenue in real-time by “clipping the ticket” on the activity that occurs within it. If we assume these transactions are made in Ethereum’s native currency Ether, you then have a business that can be valued in real-time on a P/E basis, verifiable through the blockchain. Such a business would be accumulating Ether and as a result, would see it’s equity act as a high beta proxy to Ethereum. This accumulation of Ether can be directed into the Ethereum ecosystem’s staking mechanism to generate passive income paid out in Ether, which itself could be reinvested introducing compounding to the equation. Such ideas can exist only on the blockchain and one day we may see a new bull market in projects designed in such a way to attract and accumulate Ethereum.
Interesting happenings in the industry:
- SWIFT integration with Chainlink is rumored to be in trials
- Google to take ads from FinCEN registered or Chartered cryptocurrency companies
- Apple Pay hiring someone with “cryptocurrency experience” supposedly to integrate cryptocurrency for purchases
- Promising new Ethereum scaling solution, Arbitrum, schedule for imminent public release
- Two of the biggest Bitcoin skeptics, Nouriel Robini and Nassim Nicholas Taleb are to speak at a conference with the self-proclaimed inventor of Bitcoin, Dr. Craig Wright
- El Salvador’s President to put forward bill making Bitcoin legal tender
- Paraguay is also considering following in El Salvador’s footsteps