Arca’s fundamental investment process begins with a thematic approach. At the beginning of 2020, we published a predictions piece highlighting those themes that we were especially excited about. The realization of these themes was a driving factor in what was one of the best years in digital assets’ young history. We believe that 2021 is going to be another incredible year of growth, especially around certain themes that we have identified.
Thematic investing will once again be a major driver of 2021 investment gains
In 2020, there were a few sectors (DeFi, store of value) and narratives (low token inflation, velocity sinks, user rewards) that drove most of the positive price action. In 2021, we believe the list of sectors, and their corresponding narratives, will expand, while continuing to drive relative outperformance.
Themes
Digital Money
Bitcoin has become a store of value for now, but after enough people own it, it will turn into a useful form of digital money. But Bitcoin was not the only form of digital money that grew in 2020. The growth in stabletokens was perhaps even more robust, reaching over $1 trillion in transactions. Not every digital asset is used as money (in fact most are not), but those that are can fuel a lot of secondary businesses such as lending, borrowing, and user-facing payment apps.
NFTs / Gaming
Gaming is still the most natural non-money use case for blockchain, and with the rise of Non-Fungible Tokens (NFTs), there will be strong growth in specific games and ecosystems. These gains will most likely not come from the platforms built to facilitate this growth, but rather from the individual games and NFTs themselves. Finding these opportunities will be lumpy, with a few huge winners and a lot of losers (similar to financing a movie). And since one will have the ability to see growth metrics in real-time via public blockchain data, the winners will be obvious and investable. Further, NFTs will expand beyond current use cases such as collectibles, art and gaming into more traditional use cases like KYC, asset-backed loans (i.e. putting the value of your house/car on chain to collateralize a loan), and fractional ownership of specific properties.
Digitization of the Fan Experience
This is a continuation of our 2020 sports theme. The live fan experience is never coming back to what it was pre-Covid. Instead, sports teams, artists, musicians, athletes and other celebrities are going to engage their fans personally, combining the connection of social media with the ability to monetize this audience using a digital asset. From Chiliz (CHZ) monetizing the fans of sports clubs, to Audius (AUDIO) monetizing songs and music royalties, to a host of new developments involving individual athletes, celebrities and sports networks like ESPN, we believe individual fans will soon become financially incentivized to back the teams and individuals that they love so much.
Web 3.0 / Lack of Middlemen
Web 3.0 broadly describes the next evolution of the internet - one which incorporates new technologies to promote greater connectivity and openness. The ability to create peer-to-peer systems using blockchain technology, essentially cutting out middlemen, is one component of Web 3.0. We believe the growing distrust of institutions over the last decade, particularly financial corporations and governments, will foster a move towards systems and organizations reducing middlemen and relying less on centralized intermediaries. The impact of this change is twofold: first, eliminating middlemen reduces costs and processing times across a number of industries. Second, the act of decentralizing control from single entities redistributes wealth and power into the hands of many. While a full transition to Web 3.0 has a very long time horizon, it is also happening in real-time today with projects like Arweave (AR) that offer permanent, decentralized storage solutions, or decentralized exchanges (DEXs) such as Uniswap (UNI) and Sushiswap (SUSHI) who cut out centralized intermediaries for trading.
Growth in India
While Binance has made the first real steps towards penetrating consumers in India, we feel that having a strong presence in India will be of utmost importance for token issuers and infrastructure companies. This is a largely untapped corner of the world -- the world's second-largest population is still primarily underbanked/reliant on cash. Adoption has been held back by overregulation and fear, but is slowly being opened up.
Narratives
In addition to the investable themes identified above, we also believe a few broader, market-based narratives will shape the investment landscape of 2021.
“Asset-backed” tokens will attract new investors
A common out of touch narrative is that digital assets have no intrinsic value. While the argument can certainly be made regarding cryptocurrencies like Bitcoin, many of today’s digital assets are backed by real assets and income streams. Tokens like Uniswap (UNI) and Sushiswap (SUSHI) have fees that accrue directly to token holders, while tokens like Axie Infinity (AXS) and Nexus Mutual (NXM) have tokens that are backed by assets in a corporate treasury. Even Gnosis (GNO), after Arca battled with the company over the misuse of its Treasury, finally converted its formerly worthless GNO token into a token fully and explicitly backed by the ETH in its Treasury. This narrative will continue to grow as it has proven to be a useful mechanism for both investors and participants to understand and accrue economic value. Token holders now have provenance over real assets, which provides a quantifiable intrinsic floor.
“Community tokens” will outpace “VC tokens”
Tokens with the strongest communities derive the most value. This doesn’t necessarily mean a company or project can never raise VC capital, but it does mean that if the company doesn’t also develop a strong community that participates actively, then they are less likely to find success. We’re beginning to see a rise in fully community-backed and funded projects (LINK, SNX, SUSHI, YFI) which are outperforming those that raised VC capital (COMP, ATOM, FIL, UNI). As Ryan Watkins at Messari put it, when communities were built by token holders getting in on the ground floor, token holders feel empowered. This does not happen when tokens are only available to the public after VCs already generated 10x - 100x gains. People like to invest in what they know and use - and these community growth stories happen because the investors are the biggest users of a company/project.
Value tokens will outpace growth tokens
Today’s most valuable companies will finally outpace the “maybe someday in the future” stories. This not only suggests that the reliance on early stage VCs may be reduced, but it may also have structural consequences. To date, “show me” stories with high upside but low probability of success have dominated the digital assets landscape because VCs love to back the “next XYZ killer”. But in 2021, we expect to see more money flow to those tokens issued by projects and companies that are already having success rather than those that might one day grow into a success story. Early stage projects and companies that carry lofty valuations despite making little to no progress (i.e. Layer 1 protocols and upstart competitors), will take a backseat to the incumbents that will likely grow their already substantial leads and moats (i.e. Uniswap, Binance, Chainlink, Deribit). The allure of “what could be'' has trumped “what already is”. Further, as the digital assets space matures, the companies and projects that do the best will begin to generate significant revenue and cash flows. As such, utility tokens that have yet to find utility, and “cryptocurrencies” that still trade for the sake of trading, will get pushed out of favor and surpassed by tokens that accrue real economic value today. This new crop of tokens can be analyzed by those that know how to crunch numbers on real cash flows and income streams. Utility value still matters, but the utility leads to financial analysis. For example, many investors own Binance’s native token, BNB, because it gives you access to new tokens issued on the Binance platform, but ultimately you still need to value what these new tokens are worth to determine the utility value of the BNB token. Fund flows are increasing to value investors who understand these cash flow analyses and token-economics, and as such, money will pour into companies and projects that are already succeeding at the expense of those that might one day. A tech background is simply becoming less important than a finance background, especially pertaining to DeFi.
A growing priority will be placed on transparency and governance
Decentralized governance is less about ideology or risk transfer, and more about capitalism. Governance tokens (those that exist purely to give token holders the right to vote on how a company or project operates) have largely been uninteresting and ineffective to date. They carry a negative connotation because voting participation has been low, and there is no demand for the tokens if no one cares about governing. Historically, the reason for this has been that none of the projects with a governance token have had anything worth governing. But that is finally changing. Many DeFi protocols and other companies are starting to generate significant revenues, and as such, there is finally something worth actually fighting over. Uniswap may be the first test of successful governance, as over $400 million in annual revenue generated by Uniswap is up for grabs when a fee switch vote comes to the table in March 2021. Token holders will vote with their wallets, not with their ideologies. “Governance” is just another way of saying “equity”.
Gone are the days of 2017 when a company issued tokens with a flimsy whitepaper, and could then go dark for years while they supposedly build a working product. Today’s most valuable companies and projects are being more transparent than ever, and others will follow suit as the market rewards this transparency with token price gains.
- YearnFinance (YFI) issued what appears to be the first ever 10Q for a token issuer.
- Axie Infinity (AXS) is setting a standard of transparency, releasing details on how to view and track its revenue.
- Hxro (HXRO) released a detailed report with data on their business, and a walk-through regarding its token value accrual.
- Thorchain (RUNE) is perhaps the only major non-Ethereum DeFi project with a public treasury.
Redistribution of Wealth
Pass-thru token models, those where financial gains flow directly to the users of a platform or company, are central to the redistribution of wealth. Look no further than the recent Airbnb and Doordash IPOs as good examples of why this is so important. A handful of already rich investors made hundreds of billions of dollars from ABNB and DASH IPOs on the backs of regular people who own houses, vacation, cook, ride bikes and eat food. Those who provide and use the services didn’t make any money. This is why digital assets matter, and why companies (and thus Wall Street) will begin to issue them. Digital assets turn product users into quasi-equity owners. While this may not happen immediately in 2021, it is a trend worth watching as the development is happening now.
Concluding Thoughts
This space has come a long way in the last three years while the majority of investors ignored, or weren’t aware of its growth. Imagine the possibilities now that the entire world is watching, and is actively trying to find ways to invest in this asset class. Blockchain is not revolutionary, it is evolutionary, and we’ve just now learned to walk.
Stay tuned for updates on these themes and predictions as we progress through 2021.
The Arca Portfolio Management Team
Jeff Dorman, CFA - Chief Investment Officer
Katie Talati - Head of Research
Hassan Bassiri, CFA - PM / Analyst
Sasha Fleyshman - Trader
Wes Hansen - Head of Trading & Operations
Alex Woodward- Analyst
To learn more or talk to us about investing in digital assets and cryptocurrency
.jpg)
