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“That’s Our Two Satoshis” — Where is “Crypto Carl Icahn?”

Jeff Dorman, CFA
Dec 17, 2018
Note: This will be the last Two Satoshis of the year due to the upcoming holiday schedule, but we’ll back in 2019 with more weekly crypto analysis. You can, of course, contact us directly if you want updates on the crypto markets. We hope you have a wonderful holiday!
What happened this week in the Crypto markets?
Crypto Needs More Carl Icahns
Easier said than done of course. We’ll get to Carl Icahn in a second but as we alluded to last month , in order for cryptoassets to find their footing, other players need to emerge in this space that aren’t involved in the day-to-day trading of crypto. This includes M&A professionals, crypto projects/companies via corporate actions and buybacks, and distressed/value buyers. These fringe investors only show up opportunistically to restore order in broken markets — and let’s face it, crypto is broken right now. Without them, crypto is susceptible to large swings in a zero-sum game of trader-on-trader crime. Basically, the crypto market needs more Seth Klarmans (value investors), Dan Loebs (activist investors) and Carl Icahns (distressed buyers) who can point out inefficiencies and take advantage when others are running away.
Until that happens, much of what you see in the crypto markets is largely the result of algos and bots, with price shaping the news rather than news shaping the price. Take the recent meltdown:
The crypto market dropped over 30% in November, and is now down over 50% from the highs reached earlier that month. Last week, prices fell for a 5th straight week, with 6–8% declines across the board (this follows a string of -15, -14%, -24%, and-14% the past 4 weeks). There are now only 69 tokens with market caps exceeding $50mm. Granted, very few investors care much about crypto right now given heavy losses in oil, equities and corporate bonds, which are obviously much larger pieces of investor’s portfolio right now. And crypto is no stranger to declines this year. But the speed of the decline since November was different. From November 14th to November 24th, 5 of the 10 trading days witnessed intra-day declines exceeding 10% — compared to just 11 total moves of this magnitude over the previous 10 months. And even though crypto market participants are becoming quite used to these types of crashes, they usually don’t come with the speed and unforgivingness of this past month. Make no mistake about it — — these were scary moves reminiscent of the equity and debt market collapse of late 2008 and early 2009, condensed down to just 10 violent trading days.
Over the past 5 weeks, many market participants chose to speak loudly on social and traditional media about how great it was to see volatility returning, and how big institutional buyers were waiting for a move like this to wave in “cheap crypto”. There’s only one problem… None of this is true. A quick look back to market reactions in other asset classes from past crises like 2008/2009 in the US, or even 2011 in Europe when European banks almost collapsed, reveals three common misconceptions and fallacies heard over the past month and a half:
Misconception #1: Volatility is good for crypto market makers and exchanges
False — Heightened volatility doesn’t increase trading volumes, and anyone who claims that it does is probably trying to convince you to trade with them. The truth is, most investors stay on the sidelines until market conditions improve, or are unable to execute at the prices they want. Market makers move their bids/asks around quickly to try to find the support levels where both buyers and sellers exist, and this makes executing nearly impossible. Despite tight bid/ask spreads on the “screens” painting the picture of liquidity, the real bid/ask in any meaningful size widens considerably, as sellers are hesitant to hit bids that are down so much from the day before, and buyers have no incentive to catch a falling knife. Consider the following scenario:
Market maker makes a BTC market 5000–5050 and someone sells them 100 BTC at 5000. Their natural reaction is to lower their market, to say, 4960–5010, to see if someone will lift their offer slightly above what they paid for it. But instead, they run into another seller who is willing to sell at 4960. Since the market maker still can’t sell what they bought at 5000, and doesn’t actually want to buy more at 4960, they fade their bid to avoid buying more, and move their market down to 4600–4700 just to see if anyone will buy from them at these lower levels and ensure that they don’t run into more sellers. Now the 4960 seller who never sold their BTC has to decide if they want to sell at 4600, and they decide to pass. Then a buyer comes in looking to buy at 4650, but the market maker doesn’t actually want to lose money selling at 4650 since they bought it at 5000, so they move the market back up to 4650–4750. The buyer never bought; the seller never sold, and all of the price action up and down resulted in almost no trading. The price moves didn’t reflect real trading levels. They were just quotes looking to figure out the right market level. Unfortunately, these non-traded quotes dictate what pricing services show, and this causes real mark-to-market gains/losses, stop-losses and limit orders to trigger, and Bitmex levered unwinds.
Misconception #2: A lot of people made money via their shorts
False — There will, of course, be a few fund managers who guessed right and timed the short perfectly, and these investors will become folklore heroes (similar to the one-trick ponies from 2008 who called the mortgage crisis and haven’t done much since). But the reality is, most investors are long-biased and downside moves of this magnitude create heavy losses for almost everyone. Even the best risk managers have models that measure Value-at-Risk (VAR) and downside deviation in normal market conditions, but these models break down when there are frequent abnormal 1- and 2-sigma moves (i.e. price declines or gains that exceed 1 or 2 standard deviations from the mean). As a result, even if you thought you were hedged under normal conditions, you often end up under-hedged and more exposed to the downside than you thought you were. Worse, the increased volatility means that options prices rise, which makes further hedging more expensive — so it is virtually impossible to get risk back “onsides” other than indiscriminate selling. And as we saw above in point 1, indiscriminate selling is difficult when the buyers aren’t there.
Misconception #3: Institutional Investors are waving in “cheap crypto”
False — While there are a few investing legends who can and will wait for market collapses to buy whatever is for sale, the majority of investors do not do this. Buyers generally don’t want to buy something that keeps trading down every day. This is why most investors are more likely to buy after it has risen 10–20% from the lows than to buy it on the way down. This is also why most hedge funds are 30–50% cash right now — happy to wait until it’s safe to go back in the water.
The rare exception are seasoned distressed investors who are willing to buy everything that is for sale, and don’t care if their first purchase ends up 40–50% higher than their last. This is a discipline that takes decades to perfect, and crypto doesn’t have a lot of these investors with decades of experience. Howard Marks of Oaktree Capital said it best, “When buying a distressed asset (below fair value) you must buy on the way down because assets don’t trade very much at absolute bottom and you will miss the largest recovery gains if you wait until after the bounce.” When an asset class is already down 80%, and falls another 50% from there bringing YTD losses closer to 90%… that doesn’t change the fact that those who invested after it fell 80% still lost 50%. But what does change is the expected recovery of those assets. Similar to those who bought high yield bonds in early 2009 at around 20 cents on the dollar, and saw them fall to 10 cents on the dollar almost instantaneously, those who stuck with their thesis and recovered par made 5x returns. Meaning, where in the cycle you start buying in a distressed environment ultimately makes a huge difference.
My favorite example of this disciplined approach came from the legendary investor, Carl Icahn:
In early 2009, casino giant MGM Mirage almost went bankrupt. They were over-levered following massive spending building new Vegas casino hotels, cash flow was eroding as patrons couldn’t afford to gamble, their stock was collapsing, and MGM faced a $1 billion bond maturity in October 2009 that they couldn’t afford to pay. With the equity and credit markets unavailable, MGM had very few levers to pull to refinance this maturity and avoid bankruptcy. Famous distressed investor, Carl Icahn, had a chance to pull off the trade of a lifetime… buy as many of these 2009 maturity bonds as possible and hold MGM hostage. If MGM couldn’t repay these bonds, Icahn could negotiate a deal to keep them out of bankruptcy, and it was rumored to believe that he wanted MGM to sell him the Bellagio Casino in return for these bonds. Over the course of a few days, Icahn’s team bought these bond from 80 cents on the dollar all the way down to 30 cents on the dollar. Not too many investors have the conviction to keep buying at 30 after losing 63% from their original purchase at 80, but Icahn isn’t your typical investor. Ultimately, MGM pulled a rabbit out of a hat and found a way to refinance these bonds without having to sell the Bellagio to Carl Icahn, and Icahn got a “consolation prize” (getting paid 100 for the bonds that they bought between 30–80, generating returns of 20–70% on their investment in less than 6 months).
Conclusion: November is now over, and December is off to an equally bad start. After 4.5 months of losses, the crypto markets will once again try to find a way to get back on track and deliver positive returns. But just because crypto believers spent most of November chanting “we won’t die”… the reality is, many did, and will continue to die until we see new entrants in this market.
There are very few reasons to be bullish right now, and plenty of reasons to be bearish. But longer-term, this asset class is almost certainly going higher with or without the current crop of tokens. Those in the game today will be the ones who first figure out where value can be captured. And since the overall size of the market is now so small (relative to global wealth), we will likely start seeing new entrants soon.
Notable Movers and Shakers
After 5 straight weeks of correlated declines for seemingly all crypto tokens, there is a light at the end of the tunnel. Certain projects are gaining steam as fundamentals improve and user adoption grows.
What We’re Reading this Week
Basis announced last week that it was closing down and returning the remainder of its capital raise from earlier this year. You may have heard of Basis — which raised a megaround from investors like a16z, GV, Bain Capital Ventures and others. Their goal was to create a stable token that acted as a “central bank”, algorithmically adjusting its supply in order to keep the price of its token stable. However, as Basis began exploring everything necessary in order to create their token in a compliant fashion, they encountered numerous hurdles that ultimately limited the project’s scope. Although Basis was one of the more interesting concepts, we have to ask why so many projects undertake the task of creating a stable token, only to make it so complex. Simpler sometimes is better.
The bloodbath of the last five weeks has seen numerous projects fold, many seeing their runway depleted or their token value disappear. Those of us who are seasoned investors have recognized the possible M&A opportunities that exist during times like these. Mike Nov of Kesha Ventures discusses the acquisition of Heptacoin by Domocoin, where Domocoin performed a token swap. We’ll continue to watch this space over the next several months, as things look to heat up next year with projects folding and consolidating .
Pantera Capital, one of the largest crypto hedge funds, spoke out last week stating that 25% of its portfolio holdings may be in violation of US securities law. As the SEC has begun clarifying and settling with projects that ran unregistered securities offerings, many fund managers are looking at their portfolios and seeing they may be in trouble. While some projects have successfully launched their technology giving their tokens a true utility or currency value, many have not, so their price has been driven purely by speculation.
Every year, Google releases a list of the most searched for terms and phrases. This year’s most searched for “what is…” term was “ What is Bitcoin ”. Despite the massive market decline this year, there is no denying Bitcoin’s staying power given so many people are interested in learning more about Bitcoin and blockchain technology. Equally promising are stats around the growth of job openings in crypto , with the number of openings in August 2018 up 300% from August the previous year. We’re bullish on crypto and blockchain technology and the rest of the world is too.
Arca in the Press & on the Streets
  • Arca’s Research team led by Katie Talati and Hassan Bassiri recently started a monthly event-driven analysis called “[Block] Chain of Events,” covering thematic events affecting crypto prices. Check it out. “That’s Our Two Satoshis” will continue to be written weekly for all types of crypto investors, while the “[Block] Chain of Events” is geared towards those looking to employ actual crypto investing strategies.
  • Not familiar with Arca CEO Rayne Steinberg yet? As if co-founding Arca isn’t enough of a reason, he was also co-founder of WisdomTree (WETF) back when no one really cared about ETFs (sound familiar to blockchain?). The Building the Future podcast sat down with Rayne for a 2-part series discussing how Arca is combining the best of centralized finance with blockchain technology to become the new digital finance standard for the 21st century.
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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©2020 by Arca Funds Past performance is not indicative of future results. Past performance is not indicative of future results. Investors should carefully consider the investment objectives, risks, charges and expenses of funds sponsored by Arca Funds (the "Funds"). Other important information about the Funds are in each respective Fund's offering documents. A Fund's 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.