The Sea Of Change For Crypto

In the wake of Howard Marks’ recent memo on the concept of “Sea Change,” I’ve been compelled to contemplate the intriguing phenomenon of cognitive dissonance that seems to pervade the minds of investors. As Marks sagely notes, “self-delusion permits opinions to be held long after information to the contrary has arrived.”

Over the past half-year, a lingering disquietude has taken residence within my thoughts, specifically in relation to the future of cryptocurrencies. Immersed in Crypto Twitter, I’m ensconced within an echo chamber of perpetual optimists - people who are forced - whether by the nature of their job, or their circumstance - to maintain allegiance to the industry. This circumstance distorts our perceptions, and imbues the information we consume, everyday, with inherent bias.

Take Arthur Hayes, for instance. He writes many great articles about macroeconomic conditions, yet without fail, his narratives invariably culminate with a reverential nod to the great “Lord Satoshi”. And why wouldn’t it? A man that once founded a crypto exchange, who now runs a family office fund that invests in the “Decentralization of everything” has to be bullish crypto, right?

Therein lies the dissonance. The nagging feeling in my chest has prompted me to take a step back and actually ask myself:

Is this time different?

sea change (idiom): a complete transformation, a radical change of direction in attitude, goals . . . (Grammarist)

Howard Marks calls this a sea change. Today, as we head towards an uncertain geopolitical future and an even more unstable economic climate, I find it prudent - necessary, even, to re-evaluate our beliefs about the crypto markets.

As asset allocators, and more importantly, as people who have staked much of our future on crypto, we have to constantly challenge what we believe. We cannot, and should not, rest peacefully on the groundwork that “the next halving will pump us”.

As such, this article serves as a thinkpad for me to ponder about how the future of crypto will be shaped.

Let’s start with some simple, but highly probabilistic truths.

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1. More likely than not, the future is non-zero interest rates

“Sea Change” by Howard Marks

In line with the observations set forth in Howard Marks’ insightful “Sea Change” memo, it seems increasingly improbable that the Federal Reserve will revert to the era of zero-interest rates. For over four decades, we’ve been beneficiaries of a trend toward declining interest rates. The argument for maintaining a “neutral interest rate,” one that neither stimulates nor restricts, appears to be more plausible. Such a stance would offer the Fed a degree of flexibility in future economic stimulus, a concept it seems keen on preserving.

The path ahead likely involves a transition from the current interest rate status quo. The question revolves around the extent of the decline - rather than favouring the 2-4% range, I lean more toward the 0-2% trajectory.

2. As Such, A Bull Market The Likes Of 2020-2021 Will Not Be Repeated

This is an important point to hammer home because as investors, we have to adjust our expectations.

2020-21 was not merely a zero-interest rate phenomenon; it was an amalgamation of diverse factors: venture capital inflows, the emergence of billion-dollar exchanges, algorithmic stablecoins, and highly leveraged hedge funds, all contributing to a remarkable crescendo.

Every corner you turned, every cafe you entered - people were talking about crypto. Even if we saw return to zero-interest rates, it seems improbable that we’ll witness a bull market of equivalent scale and velocity.

3. Returns Will Compress, But Crypto’s Selling Point Will Still Be Its Outperformance

That is not to say that we won’t experience a bull market. It is just prudent to recalibrate expectations. Anticipate more condensed, less sustained returns.

Returns and Sustainability will be compressed further and further

This doesn’t negate the intrinsic appeal of the cryptocurrency market. The overall market capitalization of the crypto sector remains 23x less than the market capitalization of Apple. With substantial room for expansion, the value proposition should not be underestimated- An entire industry, with technological applications that are still in its nascency, up for sale for barely the price of one FAANG company.

This, combined with the fact that, BTC has outperformed virtually every other asset returns wise YTD, makes an argument that investors find it hard to ignore. This trend has prompted asset managers to earnestly consider regulatory-compliant onboarding of clients into the realm of Bitcoin investments.

Digital assets emerging as an entirely new asset class is seeing parallels to commodities in the 90s - both were faced with massive skepticism regarding their investment suitability.

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4. Traditional Finance Wants In To The Game

As such, I believe that a world of increasing adoption of digital assets in a portfolio becomes the norm. In a high-rates world where the benchmark becomes the yield of a 2-year treasury bond, the crypto market provides outsized returns with manageable risks - as shown above, a 4% portfolio weighting in Bitcoin does not materially increase the maximum drawdowns relative to other assets, while its annualised returns are close to double that of the comparisons.

In particular, the Coinshare Report shows that:

• Small weightings of bitcoin have an outsized positive impact on Sharpe ratios relative to other alternative asset;
• Small weightings of bitcoin also have an outsized positive impact on diversification relartive to other alternative asset;

Any crypto native has long been exposed to this idea, that “Traditional Finance is coming” - and have grown skeptical. After all, this phrase has been echoed with every passing cycle.

But I truly believe the upcoming decade is one that marks a gradual and consistent surge in capital inflows from traditional financial institutions, as regulatory frameworks and supporting infrastructure begins to take shape. Indeed, we can see that a investors in a survey quote regulation as the biggest impediment in purchasing digital assets.

Survey done by Coinshare to 49 investors who cover $750 billion in AUM

I believe that the greenlight that they’re waiting for is the approval of the Bitcoin ETF - a catalyst that hinges not only on its submission but on the pedigree of the entity proposing it. The participation of financial juggernauts, most notably BlackRock, in granting this approval carries profound implications. It serves as a harbinger of increased confidence among traditional financial institutions in the realm of digital assets.

5. A Shifting Narrative With The Onset Of Tradfi

Bitcoin has had two predominant narratives thus far:

1. In its growth phase, Bitcoin mirrors like a tech stock
2. In its mature phase, Bitcoin behaves like a store of value

I believe that the 2nd narrative will be prevalent in the coming years, with the winds of an unstable economical climate blowing. It also suits Bitcoin as it matures - a reduction in volatility adds weight to the claims of it being a “store of value”.

Narratives play a pivotal role in the crypto domain, and they tend to be propelled by price dynamics. However, the evolving landscape warrants open-mindedness and adaptability.

6. Many tokens, even the largest ones today will trend to their fundamental value

Survey done by Coinshare to 49 investors who cover $750 billion in AUM

This will be a consequence of Bitcoin, and thus the entire industry maturing as an asset class. As surveyed above, many of them aren’t very interested in alt-coins.

The entry of traditional finance will usher in valuation models more typical of the traditional financial world. This transition will likely prompt a reevaluation of the fundamental worth of digital assets, potentially revealing that many governance are indeed, worthless.

Other Less Tenable Beliefs

The 5 truths I’ve listed above are form the steadfast and foundational pillars upon which I believe will be the bedrock of digital assets moving into the next decade. It is from these building blocks that I make the following predictions - which are, obviously, more prone to error, but I will still include.

• The Future Is Permissioned, and Private

Large financial institutions very much need private blockchains to serve the needs of their clients, and probably cannot rely too much on existing blockchains where a single mistake could cost millions in value to be lost.

• De-Fi makes it as a separate “asset class” from the traditional set of digital assets allowed

This lies more on the fringe, but I do imagine that there might be a slim possibility that De-Fi doesn’t get regulated - but traditional finance is just banned from doing business with them.

• Smaller nations will adopt Bitcoin in their sovereign wealth funds

Bitcoin’s narrative as a store of value is a self-fulfilling prophecy, and I will not be surprised if certain countries start buying Bitcoin as a proxy to USD / Gold.

• RWA Tokenization, AI x Crypto, Energy x Blockchain Will Take Center Stage

3 Narratives I think have potential to be the biggest ones in the coming decade. In particular, the energy market did see some interesting innovations in the carbon credit aspects (KlimaDAO, etc.) which I think have potential to be innovated on.

• Validators As A Source Of Yield

I perceive this to be most likely for Ethereum, where clients who want exposure to digital assets with yield can purchase a “LSD-esque” package, denominated in ETH while offering staked ETH APYs.

This about concludes my thoughts on what I believe the upcoming decade will look like. The next ten years will be a pivotal moment for digital assets to take center stage, and I plan on being here for it.

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