The Next Leg: Crypto Fund Update

The third quarter of 2021 turned out to be one of the best performing single quarters since the fund's inception. Profit-taking in certain positions through the previous quarter, followed by the strategy of sidelining a strong allocation of dry powder until market clarity gave us some breathing room to make larger, concentrated moves back into the July reversal, as covered below.

As discussed in our last update, we ended up taking profits on a handful of small/mid cap positions across Q2 and re-balanced the portfolio substantially. Some of these Q2 sales were up ~30-50x+ in aggregate such as OCEAN (covered more in previous post). All the selling we did across March-May has been validated by what was to follow. To clarify, not a single dime of BTC or ETH has been sold this cycle. The strategy was primarily about selling certain positions into USD/USDC until we felt comfortable re-deploying after the dust settled from the China market correction in May. We believed new narratives would emerge from this correction (which did turn out to be the case – e.g. Layer 1 competition / NFTs) and this gave us time to re-allocate into new trends. Ethereum-based DeFi has since underperformed the market, which is what we largely sold off back in March through May (e.g. ALCX, BADGER, SUSHI, ZRX, etc). We still have some DeFi exposure via our core long term positions in AAVE and YFI.

In July, we felt ready to begin scaling cash back into the market. We first primarily added BTC and ETH and also added to our position in Sandbox (SAND), which we believe to be one of the more quality, long term gaming/NFT opportunities in the space (and as with most of our investments, we are active users of the product itself).

In July/August, we also took a highly concentrated bet into Solana (SOL) because we saw tons of traction and development going on in the ecosystem, along with a rapidly sold out $70M token sale for Mango Markets (MNGO) that occurred. That sale was the biggest "signal over noise" moment to pull the trigger. No other Layer 1 smart contract protocol had this kind of traction or momentum. Our cost basis ended up being around $32 before SOL skyrocketed to $210+ within just a matter of weeks. We rotated some profits from this (~$192-202 selling point) into BTC and ETH for risk purposes but still hold a substantial allocation of SOL for the longer haul.

One more added position in Q3 was DYDX shortly after their airdrop and launch, which we purchased in the $10-12 range, at substantial size given the quick liquidity and depth added to pairs. DYDX is already breaking DEX trading volume records. Part of the thesis was also the airdrop itself enriching DYDX's loyal userbase – similar to Uniswap's airdrop in that sense. This creates additional loyalty and its own network and social effects. China proceeded to ban centralized exchanges in their country shortly after we bought, and this catalyst gave decentralized exchanges like DYDX a big edge recently, outperforming the market considerably.

Aside from that, we still hold various percentages of our original venture investments from 2018/19 such as TrueFi, Stacks, SKALE, Filecoin, and Origin. Some of our largest upside this cycle has actually come from these longer term pre-sale/seed investments. They are all vesting at different rates and our cost basis remains strong in all of them to capture upside.

Last but certainly not least, our BTC position is now ramped up to all-time highs since the fund's inception. Given potential regulatory and securities laws fears, along with the prospect of an ETF finally coming to market and major lightning network adoption, we believe it's a good time to scale up on Bitcoin. Bitcoin is by far the best risk-adjusted asset in the space and it's the only pure institutional play at any real size. Bitcoin's hardened scarcity and mining ecosystem is why institutions are buying in large amounts and what makes it more of an institutional-grade asset in the present. We expect more big Bitcoin purchases to be announced (and some have been, retroactively) and for Bitcoin to potentially regain market dominance in the coming months.

OUTLOOK

Despite choppy waters due to China's Evergrande situation, China's harsher crypto policies, and the US regulators speaking out against many in the crypto industry, our outlook remains positive. Equities markets and political theater also caused short term turmoil and crypto markets may remain somewhat correlated to risk-on tech stocks for the time being. Any type of decoupling from crypto and stocks would be an extremely bullish signal. The macro forces of inflation, heightened money supplies and debt around the world, growing populism, and overarching digital transformation all give crypto major tailwinds. With all the negative news we can point to in crypto, there is a flurry of positive news. Record fundraises, new big entrants into the space, growing institutional onboarding, and increasing user adoption across the space.

We believe the SEC is approaching the regulation of this industry in the entirely wrong way unfortunately, and does not factor in the importance of entrepreneurship and innovation. However, these things take time, and it will be a relatively iterative process with nuance and the usual stretched legal timelines. There will more than likely be unfavorable enforcement actions in the coming months, whether on larger targets like Coinbase or more likely, an attack on decentralized exchanges, stablecoins, or lending services. A headline around that will certainly create short term issues in the market. Eventual broader regulation and hostile congressional bills may cause longer term issues for some projects. There will also be other parallel narratives to combat this and balancing forces. The dust will settle. There's a growing number of politicians speaking out for better crypto regulation, which could sway or delay bad legislation and sophistry. Hopefully as better education of the industry grows, some of these bad policies are prevented or quelled.

But Bitcoin remains the north star. As institutional and corporate adoption grows, it creates a barrier of sorts around it, along with maximal decentralization of the protocol itself (and very importantly, Satoshi's anonymity and disappearance). SEC Chairman Gary Gensler (nicknamed Goldman Gary) has somewhat dismissed Bitcoin being a security, and seems in line with calling it more of a commodity. It's interesting to see Bitcoin end up becoming the most compliant asset in the space, as it evolved through its various phases and stigmas. DeFi and stablecoins are at much higher risk of scrutiny and true decentralization will become more important than ever.

A Bitcoin ETF may become the balancing force and change the story arc a bit, which would generally propel the whole crypto market forward but also give Bitcoin a chance to reclaim momentum and dominance – so we've begun skating to that puck as a possible outcome.

We plan to write a full blog post about our thoughts on regulation and crypto, so we don't want to give too much away here. From a market cycle perspective, we think any serious regulation or actionable legislation moves slowly enough where overall prices shouldn't get impacted next quarter. Decentralization will finally be challenged head on, which will benefit some projects over others. More clarity will be given when Coinbase fully engages with the SEC in the coming weeks/months, and perhaps the future status of securities laws and tokens will finally start to become clearer (we won't hold our breath just yet).

We remain cautiously optimistic, still have a decent cash position for dip buys or further bull run confirmations, and continue making portfolio tweaks as needed. But overall, we are very happy with the quarter's performance and how we've re-positioned and played the cycle. If you couldn't already tell, we think being heavier weighted in Bitcoin feels pretty good right now.

We also had some exciting venture investments in Q2 – you can read that update here.

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