It's Not Different This Time

When it comes to crypto, we separate ourselves from 'traditional' VCs in most ways. We still believe founder archetype is the same whether the startup is crypto or non-crypto. We believe successful startups at scale follow similar principles and laws whether crypto or non-crypto. But when it comes to understanding open-source software, incentives and community and more importantly, managing the asset class itself, traditional VCs still don't get the crypto ethos and unique cyclicality of the space (or how to manage liquidity).

A combination of venture and active liquid buying is how to succeed in this market. The latter allows you to understand the living, breathing crypto market and why it's unique. It also gives you insights into token economics and which incentives and programs work and don't work. We have our eyes on a number of liquid opportunities over the next 6-12 months. We believe there is still a longer way to go than most to hit a final bottom, but we will be adding to core positions over time, along with other distressed assets that will likely go well below their original VC round sale prices. We'll get to all of this further down.

In crypto, we look at ourselves more in line with a hedge fund that has a substantial amount of our balance sheet in liquid crypto assets (namely BTC and ETH) with active rotations and on-going risk management into cash and stablecoins. We reserve capital to add new or to existing positions in the market after token liquidity opens up, giving us more optionality. While a major part of the fund is taking venture positions (token+equity) and supporting new networks and projects, we also optimized for yield this cycle, did some targeted market making, ran nodes, and actively staked and participated in those networks to help them grow. We've provided a ton of value to our crypto startups over the years and we believe it's because we have a firm understanding of the unique aspects of crypto markets due to being active participants. The vest periods in "crypto venture" can still be long and we have long time preferences in general, but liquidity and optionality is also important to us.

You can read our last few quarterly updates and see we've been voicing our concerns in an eventual market correction scenario for quite some time. We've been strategic with rotations and selling assets throughout the hype cycle because we've experienced prior corrections and told ourselves to do this over and over again. Too many often get caught in euphoria and become entitled and complacent, which never ends well.

In Q3 and Q4 2021, we sold a substantial amount of crypto assets to gear up for any downturn. This move was considered contrarian back then. Cash was "trash" because of inflation, along with all the entitlement that comes with easy gains. Maybe true about cash over a longer period of time (though the Fed will fight that, any many underestimate that), yet here we are with many assets down 50-75% in parallel (even so-called blue chips like Netflix are down over 70%). Cash was still one of the best moves over the last 6-9 months because there was nowhere else to hide that didn't suffer far more. Cash is also a position that allows one to pull new levers and is extremely important in any business, including investing. Many in crypto in particular miss this and rush all-in, when it is a marathon not a sprint. Market participants who rushed all-in are going to be insolvent.

We are undoubtedly long-biased and long-only in our core BTC/ETH positions since 2015/16, but firmly believe in a hybrid approach to capture more value given the cyclical nature of crypto. VCs will never get this side of the space and many get wrecked because of this (we know the horror stories, with many more to come).

In the depths of the 2018-19 bear market, we wrote "Mandelbrot Markets" – a breakdown of the fractal nature of crypto markets and how we put most of our active fund back into Bitcoin around $4,000 and Ethereum around $100 during the deepest despair period (not including our existing long positions from prior). We still hold these positions. Historical data has eerily shown 80-85% corrections in Bitcoin have repeatedly occurred after parabolic, blow-off tops. The only difference is this time is that it's occurring in parallel to a broader equities correction for the first time since the asset class' inception. But we still don't believe it'll play out much differently from a percentage basis. Equities will also find their bottom in parallel, and risk-on will eventually begin to re-enter. We still believe crypto is the fastest horse when that happens, but it will take time.

We believe reflexivity is about to get more violent downwards – the opposite of how 'FOMO' operates in a bull market. Any semblance of net new bad news will cause a cascading downturn from here as bearish narratives pile up. Good news will be deflected as if it never happened. Sentiment has been low for sure, causing some people to push the "Buy" button now and claim the bottom is in. This is still a reasonable buy level if holding quality assets for the long run, but the despair and capitulation just isn't here yet. You can't quite feel it in the air yet (same with equities).

In our opinion, $30,000 BTC officially breaks this time around. If $30,000 breaks, $20,000 probably breaks too (after bouncing around a bunch). We were never believers in the supercycle. The same people who told you the supercycle was inevitable, were the same ones claiming crypto was 'decoupling' and 'uncorrelating' from equities, which is just not the case. These markets are connected and fractal by nature, and it's not different this time. Even though the China crypto bans last year created a unique double wave pattern that differed in how previous cycles culminated, that was an acute, forced selling outlier scenario that corrected itself and has ended up playing out similar in hindsight. The end result of a parabolic run is more likely to be a similar degree and order of magnitude of correction percentages, give or take. The timing and end result of the cycle are still lining up uncannily similar, the path was just slightly different to get there.

Yes, huge companies like Tesla, MicroStrategy and "new believer" whales and funds are holding 9 to 10 figures of BTC on their balance sheets now. We don't believe these types are likely to sell (though it's possible Tesla would to derisk), but it also doesn't mean price stabilizes around where they bought. They will also go through pain. Institutions and corporations can also be underwater on investments–they aren't some magical, infallible market forces that create price floors. It's very likely they are prepared to remain underwater during a prolonged economic downturn. Tesla's breakeven is around $32,000 for reference, MicroStrategy's is just below $31,000. If $20,000 range hits, MicroStrategy will add to their collateral for the Bitcoin they bought on leverage, so its unclear what levels their deepest liquidation risks are at (probably around $5,000).

Everything is still relative. More market participants drove prices higher, but it also means more market participants and liquidity exists to sell and derisk, and cause a relatively similar amount of downward pressure as seen in previous cycles (especially when there is so much relative money supply existing in assets now). We saw adoption rise, but a large enough relative percentage of that adoption was cyclical, fleeting, touristy, and built on easy money. Adoption is still greater than it was the prior cycle, which is great and why the bottom is likely to be significantly higher than the last one (as has been the case historically), but it doesn't change the % correction that occurs within a cycle.

One common argument we heard over the last 3-6 months was around private markets being so hot, therefore it must mean the supercycle is real and that prices will stabilize soon. We remember hearing similar things in 2018 when "institutions" were getting involved in the space and venture funds were raising fresh capital. It must mean prices can't go much lower, right? It was surprising seeing this incorrect framing come from even some of the smarter people in the space (maybe just talking their book?) because it's always been the case that private markets are not a leading indicator. In fact, massive injections into private investment rounds and large new fund launches usually marks the end of a cycle. We also saw exchanges like Binance and FTX raise massive rounds recently and in hindsight, this was yet another indicator that an expectation of economic downturn was on the horizon.

As mentioned, in 2018 we saw private market activity skyrocket, even after the overall crypto market cap had corrected over 40%. EOS had raised $4B in their rolling ICO, much of which came after the market had corrected. Put simply – once liquidity and risk exits, it often wants to be re-routed through new vehicles, often illiquid venture or private equity. This is why you get a mad rush into 'hot rounds' towards the end of a euphoric period, when everyone is sitting on house money (and founders can also leverage this psychology). The velocity of capital formation rises rapidly and then suddenly declines to much lower levels, as we are just beginning to see. We will see a major decline in deal flow quantity over the next 6-18 months. But this is also when quality eventually rises again (and at reasonable prices), which is a wonderful thing. Nature is healing and the best building and development will again occur in the depths of the bear market.

A quick word on equities: Some macro investors are starting to entertain the idea that the Fed will now reverse course on raising rates too fast and too high because of the market correction. Also, they are saying inflation has likely peaked (even though it will probably remain around at least 7.5%+ and sideways for a while, with possible negative surprises along the way). Therefore, they claim the bottom might be arriving very soon. Sure, that could cause some relief bounces on renewed hope for a "softish" landing, as they put it. But slowed growth and recession are the elephant in the room. In our last quarterly update, we predicted the "R" word (recession) would start to be widely used, and we're almost there. It's begrudgingly being mentioned on CNBC now and by pundits, and soon will be floating around in daily speak (and even on Pravda-style corporate press). Also, the Fed saying recession is not a big concern is the new "inflation is transitory". When growth slows like this, all valuations have to completely reconfigure and the market needs to come up with new "fair value" multiples. And we are in the middle of that reconfiguration – there is no way that is a quick process.

At the same time, we are also not predicting some perfect recreation of the 2000 dot-com bubble or the 2008 financial crisis. It will perhaps be a mix of both and other recession periods, but have its own unique characteristics. It doesn't have to play out in an acute crisis way. This time around, people actually seem far more aware of how much the Fed impacts market cycles and how messed up that is. This cycle is more likely the slow burn of stagflation, shortages, supply chain and energy issues, and not necessarily based on any single financial sector crises. It may feel different in that sense, but likely lead to similar percentage downturns as the psychology unwinds in its Mandelbrot fashion. How long this takes is the harder question. Some stocks are starting to appear attractive at these levels, but that is also all relative from our very manufactured expectations of what "fair value" even means during a decade of easy money (and especially the last few years). All of these models have to reset, they are a mirage. For now, we just don't see where that risk-on demand comes from in size. It will still mostly be fleeting, insecure buyers and traders at these levels. The ultra-high conviction trove of diamond-hand dry powder isn't ready to deploy just yet. Only at max pain.

If Bitcoin is to correct in its historical fractal percentage, we would see prices go down to around $12,500 and bottom out. ~$25,000 levels would become the new ~$6,000 of 2018, where things would go sideways for quite some time, leaving the market dull and disinterested. This disinterest would culminate in a final 40-50% capitulation towards ~$12,500 range. There would still be peaks and troughs and bouts of hope between all these moves (and short term trading opportunities), but this is a wipe out scenario we are fully prepared for. It's also easy to say you'll be a buyer of that depressed market scenario now – we have to keep repeating the fact that we'll buy those levels if we get there, because the risk vs upside should be too great to ignore. For reference, if compared to last cycle's correction, Ethereum would bottom out around $240 (which we could see being less drastic). In terms of altcoins, they are going to fully wash out and correct over 95% – there is no point to have any liquidity in alts. It's also important to note that the strategy isn't simply setting limit orders at these levels and pretending we will time the bottom perfectly. If $30,000 levels are officially breached, we start to become incremental buyers at that point.

People also forget how long market unwinds take. Liquidity and psychology unwinds in its entirety in a slow fashion, as traders trade the ups and downs, and those with low cost-basis take profits or those with max despair take losses and capitulate. Just remember, everything in markets is relative. Name-dropping certain new market participants or big rounds or celebs or institutions "getting involved" is meaningless at this stage. It bodes well for longer term adoption but in the interim, everyone begins to fight for themselves and enter survival mode, which we are approaching. The kumbaya phase always comes to an end.

The supercycle was a farce, it turns out these markets are fractal after all. But life-changing buying opportunities are coming. See you at the bottom.

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