"That’s Our Two Satoshis"  — A Violent DeFi Short-Squeeze

Jeff Dorman, CFA
Nov 9, 2020
Thats Our 2 Satoshis LogoWhat happened this week in the Digital Assets markets?
Week-over-Week Price Changes (as of Sunday, 11/08/20)
Bloomberg Galaxy Crypto Index
S&P 500
Gold (XAU)
Oil (Brent)
Source: TradingView, CNBC, Bloomberg
Uncertainty Removed by more Uncertainty?
That was a violent rally. Four weeks ago, we wrote this about the election uncertainty:
"At this point, you could elect a Martian president and risk assets would rally simply because the uncertainty discount would be removed."
It was nearly impossible to find an investor who hadn’t de-risked at least a little, if not substantially, ahead of the Presidential election. As the theory went, as soon as it was safe to get back in the water, risk appetites would return. The premise was quite simple, yet it proved accurate even though very little of the uncertainty was actually removed.   Somehow risk appetites returned even though we still don’t technically have a President-elect, and the current President of the United States spent most of the week tweeting about fraudulent, made up votes, while Twitter itself was censoring him. Not exactly how anyone envisioned the uncertainty cloud dissipating, but it does suggest that we may rally further into the end of the year. Central banks around the world are basically daring people to hold cash. Last week’s market reaction may have just been further evidence that investors can only stay on the sidelines for so long, and that ultimately, any inflation-protected asset or yield bearing instrument will remain well bid unless something truly disastrous occurs.
Assuming this was indeed the end of the election, the market narrative will start to shift towards other focuses. On the positive front, we may now see real progress towards a much needed fiscal-aid package from Washington. On the negative front, the increase in COVID-19 cases without a vaccine in sight may stall the health and pace of the economic rebound.
With this backdrop, it’s not surprising that so many new investors are flocking to digital assets, as the bull case created by stimulus and an improving economy is similar to that of other risk assets, but the bear caused by a deteriorating health crisis and economic malaise would likely have little effect. And as new investors enter, it doesn’t take much additional buying power to create outsized gains in such a small asset class.
The institutional desk at Coinbase illustrated just how deep and diverse the demand side has become, at least as it pertains to Bitcoin itself:
"What struck [us] this week was the range of interest we're now seeing in Bitcoin. It's not just financiers, VC's, family offices or corporates… we're now seeing interest from those in other industries such as media, real estate, entertainment and other segments not always seen in crypto." 
One by one, each and every Bitcoin naysayer is beginning to change his tune, and those that had already seen the light are beginning to buy more aggressively. From Jamie Dimon to Nouriel Roubini to PayPal, prominent figure heads and companies are getting involved. Early Bitcoin advocates will of course rejoice as their vision continues to play out. And years later, in an ironic twist, those who only supported Bitcoin will likely change their tune as well, realizing that Bitcoin maximalism was an equally foolish stance now that a new batch of value accruing, equity-like instruments have emerged in digital assets.

It’s simply becoming too hard to ignore this asset class anymore.
Short-squeeze alert: DeFi Was up How Much?
Bitcoin and Ethereum had cute 12% weekly gains last week, at least relative  to DeFi, which generically gained 36% week-over-week. Many blue-chip projects (those seeing the most user growth and product traction), gained 50%+. These moves are not for the faint of heart, but can actually be explained partially by developing market structures.

For most of the past 10 years, Bitcoin was the only game in town, and as such, most of the infrastructure was built around Bitcoin. An active derivatives market has developed, with Bitcoin futures and options markets growing exponentially, resulting in both positive and negative impacts on the market. In the past year, however, much of what was learned with Bitcoin is now being applied very quickly to the rest of the digital assets universe, perhaps earlier than they should be. FTX and Binance, two of the most popular Asian exchanges, now offer perpetual futures markets on a variety of DeFi assets, including many that are still considered microcaps. OTC desks are also starting to structure bilateral options contracts on a variety of off-the-run assets. And decentralized lending protocols, like Aave, are enabling anyone to borrow tokens to get short. If we’ve learned anything from Robinhood customers’ expansion into options and bankrupt stocks, it’s that retail investors will trade assets without necessarily understanding how it works.
In the case of DeFi, you could make an argument that the fast rise in prices this summer and the subsequent reversal this fall were both warranted. However, in both directions, price overshot by a lot, largely due to the recent addition of levered derivatives markets, often used by market participants who focus a little too much on momentum. Last week, shorts got eviscerated in DeFi, and the real money buyers started to gain confidence that the buyer’s strike could end. After the fastest bull and bear markets in history, we may now be back to fundamental value investing in one of the fastest growing areas of digital assets.
What’s Driving Token Prices?
In a week driven by election news and a general risk-on environment, Bitcoin dominance rose 2.4% (the sixth consecutive positive week) while the rest of the market reminded us just how volatile this space can be. Whereas Bitcoin is considered a mainstay at this point (for good reason), the rest of the Digital Assets market goes through significant growth spurts (and subsequent growing pains) as it matures before our eyes. This week, we find notable idiosyncratic events, as well as sector based movements:
  • Axie Infinity (AXS), a blockchain game that leverages Non Fungible Tokens (NFTs) to provide economic value (and ownership) of in game assets, successfully completed their Launchpad event on Binance last Wednesday  (22,096 participants, 9.38% winning tickets). On Thursday, they announced that Aave would be sponsoring the 13th season of their Community Alpha, where players can earn AAVE by climbing the leaderboards throughout the season. The team announced that 180 ETH in marketplace fees were accrued over the last month (which AXS holders have claim to via the Community Treasury once activated), which is noteworthy considering they were the number one NFT game by volume last week. The project boasts over 10,000 MAU, and per Nansen their token holders and Marketplace participants are experiencing hockey stick growth. All of this translates to a 101% price gain for the token, which leads the charge in the emerging NFT sector.
  • Ethereum (ETH) released v1.0 of the ETH2.0 specs on Wednesday, including the mainnet deposit contract address. At the earliest, the genesis of ETH2.0 would be on December 1st (if certain criteria are met) - this has been a long time coming for the Ethereum community and the entire space as a whole. After 2.5 years of theory, the market reacted to the hard timeline, with ETH finishing the week up 15%.
  • Decentralized Finance (DeFi) as a sector outperformed the rest of the market, ending a nine-week slump dating back to August. As a basket, the DeFi Index finished the week up 36%.
    Centralized Finance (CeFi) as a sector underperformed the rest of the market, as concern over regulatory enforcement against top exchanges Huobi and OkEx continues to fester. As a basket, the CeFi Index finished the week down 1%.
What We’re Reading this Week

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
Alex Woodward- Analyst
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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