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“That’s Our Two Satoshis”— Crypto is the Bad House on a Bad Block

Jeff Dorman, CFA
Nov 26, 2018
What happened this week in the Crypto markets?

Crypto went home for the holidays and may not come back
Due to the holiday-shortened week, we had planned to do a lighter Two Satoshis this week. But while you were enjoying your turkey and stuffing, the crypto market revealed itself to be the true turkey, stuffing investors with a string of losses so severe that even oil investors are shaking their heads at the rapid destruction of wealth.

It’s no secret that most global markets are reeling right now, with few places to hide. FANG stocks are -25% from the recent highs, oil is -33% in 6 weeks, and even the US High Yield market is beginning to gap wider due to a high percentage of declining Energy bonds and a wall of maturities awaiting in 2019. Respected macro voices are calling for “risk preservation mode”, and hedge funds once again failed to actually protect against the downside. And laughably, after 10 straight years of crazy central-bank fueled equity growth at the expense of everything else, a mild 2-month correction has the OECD calling for fiscal stimulus.

Despite all of this, the crypto markets not only managed to underperform other asset classes, but also created price swings that few investors will ever be able to stomach. The overall crypto market just witnessed a 40–50% drawdown in only ten trading days, over what is normally a slow holiday-shortened week where you typically don’t need to check the screens every hour. During this stretch, there were five intraday declines of 10% or more out of just ten possible trading days. This was a 2008/2009-like meltdown, that played out in just a week-and-a-half, with little to no relief rallies.

For those of you in the crypto ecosystem already (ourselves included), this perhaps isn’t that uncommon. It’s happened before and it may happen again (though the speed of the decline was still jolting).

For those of you outside of the crypto ecosystem trying to figure out where crypto fits for you, this is the kind of the move that makes you happy you stayed away, and probably sets you back years before you take the market seriously again.

But neither of these attitudes are entirely correct. Both sides can and should be a little more humble, and less definitive. For example:

  1. 1.The crypto community needs to stop acting like everything is fine just because this has happened before. Pointing out each and every other time crypto has crashed and bounced back doesn’t mean it will happen again.Showing a string of massive gains and drawdowns doesn’t prove any points. And being a factless cheerleader on Twitter seems foolish in the face of real investor losses. Similarly, false and misleading statements from well-respected people in the community are more damaging to the overall industry than most realize (for example, we think Jake Chervinsky is one of the most polished and accomplished voices in this community, but there is simply no evidence of institutional buying down here, nor is this the typical behavior of institutional investors — who are usually more willing to pay up in price after prices stabilize than try to catch a falling knife):
  2. 2. Meanwhile, those outside of the crypto community are right to be scared off by moves like this, but shouldn’t be comparing this asset class to anything else that they typically invest in. This is not yet a healthy or mature asset class. It is an incredibly speculative asset class that can and probably will create massive wealth over time, but comes with seemingly unavoidable drawdowns and angst. It actually becomes more investable only after it grows, which is counterintuitive, since most people will have missed the opportunity by then. So instead of avoiding this altogether, spend a few hours with someone you know who has made the leap to crypto (like members of the Arca team), and you’ll see that almost everyone who focuses on digital assets understands its true potential as both a new asset class AND an underlying infrastructure that will one day support other asset classes. But right now, crypto is nothing more than a cross between traditional venture investing (which often takes a decade or more to materialize), with an incredibly liquid and tradeable asset class (which attracts all sorts of strategies, bots, and noise). As such, you cannot invest in this space unless you can accept daily mark-to-market fluctuations that are often unexplainable. But you also shouldn’t dismiss it just because of the painful mark-to-market. Viewing utility through price alone misses the fundamental revolution.
Viewing utility through price alone misses the fundamental revolution
During weeks like this past one, it’s important to remember cryptocurrency and blockchain have uses far beyond price appreciation. So rather than speculate any further on what caused the November plunge, or prognosticate on when the next bull-run will occur, I want to step back and focus on why you’re even reading this in the first place. Some part of you cares about this ecosystem because of its potential, even when that potential is lost in a sea of red numbers.

So while the market once again tries to pick itself up from a death blow, take a minute to remind yourself of some of the real-world examples of where this technology is headed. By the time these become mainstream and fully adopted, the volatility will likely have subdued, and this past week will be long forgotten.

Real-life use cases
  1. Token Curated Registries (TCR): The governance structure inherent in blockchain, coupled with economic incentives in the form of tokens, can give rise to bias free, decentralized databases of information that no single owner controls.
  2. Manufacturing: Increasing visibility across every area of manufacturing starting with suppliers, strategic sourcing, procurement, and supplier quality to shop floor operations including machine-level monitoring and service, blockchain can enable entirely new manufacturing business models.
  3. Trade settlement and corporate actions: While potentially misguided, DTCC is acknowledging the archaic nature of its own infrastructure and exploring change.
  4. A $150mm bank loan solely through smart contracts: eliminating many of the fees associated with high middlemen processes.
  5. Paying taxes: Ohio is set to become the first state to accept bitcoin for tax bills.
  6. Tokenizing LP interests: The start of a trend to increase transparency and liquidity of private assets.
  7. Tokenized everything — from art, to real estate to stocks.
At the end of the day. I can see why most investors are turned off by this volatility. But I can also see why some investors are so turned on.

Notable Movers and Shakers
During another week of absolute carnage, the markets didn’t discriminate. Most tokens fell 20–50% with just a select few tokens outperforming the broader wreckage:

What We’re Reading this Week
ICE Delays Launch Date of Bakkt
The much anticipated launch of the Bakkt Bitcoin Daily Futures Contract, which will offer physically backed futures positions, has been delayed until January 24, 2019. Although many hypothesize this is related to the recent market volatility and sell-off, ICE claims this is to ensure there is ample time to allow for customer and clearing onboarding.

Crypto Friendly Bank Silvergate Eyes an IPO
Silvergate has become notable in the industry for being one of the few banks that will accept customers who operate in the digital asset space. They have over 400 customers, including exchanges like Gemini and Kraken as well institutional investors and startups. This is a net positive for the crypto industry as businesses such as Silvergate provide necessary services for players to operate in the space. Silvergate uniquely offers its customers 24/7 transfers and may offer custody solutions at some point in the future.

KPMG Report Says “Cryptoassets are impossible to Ignore”
KPMG released a 42 page report covering the institutionalization of cryptoassets and what hurdles the industry needs to overcome first. Notably, they mention ICOs as an important innovation, despite recent regulatory actions: ”ICOs represent an important innovation, providing new pathways and more efficient flows for capital from a significantly wider group of investors.” The report specifically cites compliance, forks, custody, and accounting as obstacles to adoption.

Swiss SIX Exchange Launches Crypto Exchange Traded Product (ETP)
The ETP, backed by Swiss startup Amun AG, will be listed under the symbol HODL. It will contain five major assets: Bitcoin (BTC), Ripple (XRP), Ethereum (ETH), Bitcoin Cash (BCH), and Litecoin (LTC). The goal of the ETP is to provide investors exposure to the crypto market without having to hold the assets themselves.

Hong Kong-Based Exchange OKEx Accused of Settling Futures Contracts Early
Early last week, a trader accused HK-based exchange OKEx of tampering with BCH futures contracts and changing their settlement date to occur before the fork, costing investors millions. OKEx responded with a statement that their actions were in line with policy and did not cause such a loss of customer funds. Regardless of what happened, these allegations expose the dangers of an unregulated exchange.

Crypto is Capturing Top Talent in Silicon Valley
The last twelve months has seen a shift in Silicon Valley as talent from top tech firms have begun to migrate to crypto startups. According to Coindesk, Facebook, Amazon, Apple, Netflix, and Google, have all seen employees leave their “safe” tech jobs in favor of the crypto space. We look forward to this migration as more high quality talent will lead to greater innovation.

1000% ROI
Altcoin Today compiled an infographic of the Initial Coin Offerings with the highest returns for 2018. This group of ICOs are all well-known large cap token projects, four of which hail from China (compared to only one from the US), raised in the early part of 2017, a period when crypto was largely unknown but gaining speed.

Waste No More — Recycling Bitcoin Mining Byproducts
Heatmine, a Canadian mining company, is repurposing the heat created during the Bitcoin mining process as a way to heat buildings. After originally using the heat waste to warm its own buildings, Heatmine realized the excess heat from mining operations could be used to heat homes and businesses. The company has successfully connected mining machines to heating systems during several pilots and now plans to continue distributing these machines in Canada, and will soon expand to the US.

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 — Portfolio Manager
Katie Talati — Director of Research
Hassan Bassiri , CFA — Junior PM / Analyst

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Statements in this communication may include forward-looking information and/or may be based on various assumptions. The forward-looking statements and other views or opinions expressed herein are made as of the date of this publication. Actual future results or occurrences may differ significantly from those anticipated and there is no guarantee that any particular outcome will come to pass. The statements made herein are subject to change at any time. Arca Funds disclaims any obligation to update or revise any statements or views expressed herein.

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©2018 by Arca Funds Past performance is not indicative of future results. Investors should carefully consider the investment objectives, risks, charges and expenses of Arca "(The "Funds"). This ad other important information about the Funds are in the respective Fund's offering documents which can be obtained by entering Arca Private Investor Portal. All of the offering documents should be read carefully before investing. Disclaimer: This commentary is provided as general information only and is in no way intended as investment advice, investment research, a research report or a recommendation. Any decision to invest or take any other action with respect to the securities discussed in this commentary may involve risks not discussed herein and such decisions should not be based solely on the information contained in this document.