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Crypto Activism, Distressed & Value-investing Digital Assets

Jeff Dorman, CFA
Jan 27, 2020
What happened this week in the Crypto markets?

Digital Assets are Going to Be Tested by a Lot of 2020 Events

Digital assets chopped around for most of the week on declining volumes due to the start of Chinese New Year, but ultimately gained 1-2% following a weekend surge.  These gains may have been due to rising fears over the spreading Coronavirus, or it may have been due to reports that 3 rockets made a direct hit on the U.S. embassy in Baghdad (to which sources say the U.S. will respond with military measures).  Or it could just be normal volatility. One thing is starting to become very clear though -- Bitcoin and the rest of the digital assets industry is going to be tested frequently this year.
We’re less than one month into the new year, and we already have the following events directly impacting digital assets:
  • The Iran / US conflict
  • The China / US tariff war “he said, he said”
  • The SEC changing the “Accredited Investor” definition 
  • Japan reportedly began work on issuing their own digital currency in response to Libra (Facebook) and the Digital Yuan. Meanwhile, a think-tank has been started by the former CFTC commissioner to discuss digitizing the US Dollar. Needless to say, the digital currency race has officially begun. 
  • The Coronavirus outbreak (which is being viewed as a huge failure of local government containment efforts) may serve as a black swan event for global markets, but it also reinforces the lack of trust in governments.
  • Continued venture capital mark downs
  • Davos bringing world leaders together, where cryptocurrency was a main focus
  • Not to mention the Bitcoin halving coming this May, and the U.S. election focus from now until November
These are unsettling events for individuals outside of finance, but will also be quite the test for digital assets.

Digital Asset Investing Has More Depth Than You Might Think

Digital asset investing goes deeper than most people know. Bitcoin is one component of digital assets.  It’s the most important component, and the only digital asset truly on the world’s stage competing as a “currency”, but it is still just a single component.  The rest of the digital asset space is in its infancy, but has a lot of nuances and depth. The complexity of this non-Bitcoin part of the market is creating fascinating investing opportunities. 
This past week, a project you undoubtedly have never heard of (DigixDao), had a truly wonderful and remarkable outcome.  The project issued a token (DGD) back in 2016, which of course is backed by nothing other than supply and demand. To own this token was to be a believer in non-tangible, future use cases.  BUT, the proceeds to the project creators from the 2016 DGD sale were largely received in ETH, which has appreciated greatly since that time. As a result, in 2020, the DGD token was trading “below book value” -- or said another way, the project had a “cash balance” in Treasury that greatly exceeded the market value of the DGD tokens. 
In December, a proposal was issued by DGD token holders for DigixDao to liquidate their Treasury, and return cash to DGD holders.  Last week, to the dismay of the project’s founders, the vote passed with over 90% of holders voting yes.  This was straight up activism, and it was awesome to watch.  Ultimately, token holders gained 200% over the course of the past few months, and there was even a nice discount to fair value during the voting period, reflecting uncertainty over the outcome similar to now traditional merger arb investors trade spreads based on scenario analysis.
And activist investing is just one of the many “financializations” happening in crypto.  Below are examples of other investable opportunities in crypto over the past six months, that any equity or credit investor would understand regardless of their knowledge of digital assets.  These are simple, profitable investments, where the only thing the end investor needs to get comfortable with is the idea that these are investments in blockchain assets (tokens) instead of debt/equity.
  1. Distressed / Special Situations -- Bitfinex (LEO)
    A company that was cash-flow positive had money seized by a foreign government, and had a temporary cash flow issue.  Similar to 2012 when Jefferies and Knight Capital had balance sheet issues, a "rescue financing" was needed, and the completion of said financing would help both company and investor.  Bitfinex issued $1 billion of LEO tokens, which came with super onerous and advantageous terms for investors including cash sweeps, pay downs and a warrant that gave you the rights to a larger tender offer if they ever received the cash back from authorities.  The token traded up 100% in the first three weeks of trading, before eventually retracting with the rest of the market in the 2nd half of 2019.
  2. Financial Arbitrage - Algorand (ALGO)
    Algorand gave equity investors the right to receive tokens on a daily basis for 2 years prior to launching their token publically.  This stream of tokens was trading at $0.22 prior to their first public “Dutch auction”, where Algorand sold tokens to the public for the first time.  These tokens came with a unique feature -- the ability to put the tokens back to the Algorand Foundation after 1 year at 90% of the Dutch Auction Price. The Dutch Auction cleared at $2.40, which stuck the 1-year put option at $2.16.   Anyone could have played this arb -- buying the token stream at $0.22, buying the Dutch Auction at $2.40, selling tokens immediately after purchasing them, and holding on to the $2.16 put versus the income stream of tokens received over 2 years.  A pure financial arbitrage.
  3. M&A - Binance (BNB) and FTT (FTX)
    Binance recently invested in a new rival, FTT.  In typical crypto fashion, the FTX token traded up 40% ahead of the announcement and has done nothing since, but the mechanics of this investment leave a lot of interesting possibilities.  The importance is not in its strategic value or immediate effect on both companies, but in its potential to change the Crypto M&A landscape — Binance has the potential to fully acquire FTX.
These are just a few examples of how this space is maturing and growing.  As investors (via our Arca Digital Assets Fund), we are incredibly excited.
Notable Movers and Shakers
Bitcoin dominance (BTC.D) posted its fifth consecutive down week, leaking a paltry 30 basis points to 67.47%. Objectively, Bitcoin dominance is showing its first signs of weakness since January of 2018, as interest has picked up in alternative digital assets. This week was no different, with a few worth noting:

  • ICON (ICX) announced Wednesday that they have integrated with Chainlink’s oracle network, noting that this integration will allow “anybody building on the ICON Public bring real-world data into their blockchain based business using a secure and decentralized oracle network provided by Chainlink.” The ability to leverage off-chain data for enterprise blockchain development bodes well for the platform-based token, which reflected in the price last week (+20%).
  • Dash (DASH) released statistics Thursday pointing to a 562% increase in active Venezuelan android device users of the Dash wallet. Venezuela has been a target market for Dash, as the country carries significant currency issues and is the perfect incubator for digital assets (namely BTC and DASH). According to the article, the Dash Text application has been the most successful implementation of DASH, as it allows users to transact without the need of a smartphone (only requiring SMS texts). Venezuela has been actively restricting internet access as of late (most recently during the National Assembly leadership vote), which has coincided with the price rallies of DASH last week (6%).
What We’re Reading this Week
In an interview with State Street’s Head of US Digital Assets, Jay Biancamano unpacks the bank’s digital asset strategy and its latest strides in the space. He explains that to date, State Street’s progress has been muted as much of what the bank does is driven by client demand. However, he discusses five emerging themes that strengthen the use case for digital assets: the role of private money, making the illiquid liquid, the blending of asset classes and emergence of multi-asset trading, asset intelligence and data, and blockchain enabled exchange traded and mutual funds.
According to Bloomberg, stablecoins, which are primarily used by traders, have seen increased usage across international merchants and vendors. These groups in particular benefit from stablecoin usage as they can transact outside banking hours, at much faster speeds, and outside the capital controls of their countries. In essence, they can use stablecoins in place of traditional bank accounts for business purposes.
Central Bank Digital Currencies Heat Up
Emerging from the World Economic Forum in Davos last week is a new theme among countries to pursue central bank digital currencies (CBDCs). Among the announcements, included the former CFTC Chairman unveiling the Digital Dollar Project and the announcement by six major central banks that they will collaborate on CBDC research. The World Economic Forum also released its own framework for CBDCs, called “The CBDC Policy-Maker Toolkit”, aimed at helping countries evaluate the benefits and disadvantages of implementing CBDCs. The flurry of activity and research around CBDCs was likely spurred by China’s strides to create their own digital currency, pushing other governments to consider digitizing their currencies.
Last week, payments company Square was granted a patent for a payment system allowing users to hold different assets to transact with each other in real-time. The technology will be most useful for the retail sector, which has difficulty accepting crypto payments due to the volatile nature and potential long confirmation times. Square believes the new technology will remove the barrier to transacting in crypto although to date they have mostly been supporting Bitcoin as a payment method.
A study commissioned by the Blockchain Association was released last week with its findings on employment trends within digital assets. Not surprisingly, 85% of workers are employed by exchanges, development firms or mining businesses, which generally have the highest revenue streams in the industry to date. In addition, 67% of the largest employers are based outside the US, which include exchanges Huobi and OkEx which are the first and second largest employers. 91% of survey respondents also indicated that the US’s unclear regulations are a barrier to entry, which is most likely why Singapore captured almost 40% of all token launches in 2019.

And That’s Our Two Satoshis! 
Thanks for reading everyone!   
Questions or comments, just let us know.  
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
To learn more or talk to us about investing in digital assets and cryptocurrency
call us now at (424) 289-8068.

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