Apolitical Money

Geopolitical Noise

After briefly eclipsing $45k and $3.2k, both bitcoin and ether tumbled on Friday afternoon following indications from the US government that a Russian invasion of Ukraine was imminent. On Tuesday, these fears were quelled when reports surfaced indicating that troops were being removed from the Ukrainian border and crypto rebounded alongside equities.

At the time of writing, the global crypto market is slightly lower on the 7-day chart, with altcoins furthest out on the risk curve still trailing currencies.

Crypto-Natives Find a Safe Haven in Bitcoin

Despite persistent volatility seemingly contrary to its store-of-value premise, bitcoin generally performs “less bad” than other crypto assets during turbulent times. Thus, many crypto natives increase exposure to BTC during times of market consolidation or uncertainty. As expected, Bitcoin dominance has ticked up recently, surpassing 43% for the first time in three months.

Increased Demand for Apolitical Money in the Developed World

We have previously discussed how Bitcoin is viewed as two different asset-types by two very different cohorts of investors. In the developing world, some economies suffer from local inflation well north of the 7.5% in the US, making bitcoin an already-reliable monetary system. Conversely, there is less motivation for adoption in the developed world and it is consequently viewed as an early-stage technology investment. It is no question that a significant obstacle for adoption in developed countries is the apparent lack of need for immutable, apolitical money. Interestingly, this week we bore witness to a relatively prosperous western country weaponizing its banking system against citizens, possibly leading many otherwise comfortable people to see the inherent need for apolitical money.

On Monday, Canadian Prime Minister Justin Trudeau enacted special measures through the rarely implemented Emergencies Act to end protests that have shut some border crossings and brought downtown Ottawa to a standstill. The Emergencies Act aims to deal with the “Freedom Convoy” protests, started on January 28^th by Canadian truckers opposing a vaccinate-or-quarantine mandate for drivers crossing the US-Canada border. The act provides the government with temporary authority to impose special restrictions on public assembly, travel, and mobilize federal support for local police forces. It also calls for banks or other financial service providers to immediately freeze or suspend the accounts of individuals or businesses affiliated with the protests.

Without wading into the political or moral arguments in support of or against the convoy of truckers, we would simply like to point out that this is a clear example of a problem that bitcoin solves, and there are potentially thousands of hardworking Canadian citizens now realizing that an actual problem exists. When institutions fail to listen to or properly incentivize their constituents, and there is the potential for system disruption, the failsafe is to attack the rails on which the constituents’ value is stored and transacted. This is a reliable system because money is, for better or for worse, the access card to the things people need to live.

It does not matter if one “agrees” with the protests because it is the process that matters and not the intent or results. One day, the system will inevitably disagree with a cause that you irrefutably support, at which point you might be the one on the outside looking in. Camila Russo, an author, and entrepreneur in the crypto industry articulated this event’s implications quite succinctly.

We think this story could serve as another stepping stone towards bottoms-up adoption.

Persistent Demand for Apolitical Money in the Developing World

We witnessed a similar weaponization of the banking system against an entire nation. Last Friday, President Biden moved to freeze $7 billion of funds belonging to the Afghan Central Bank held in the United States. Half of the funds will be designated for humanitarian relief in Afghanistan, and the other half will be used to compensate a group of 9/11 victims.

While we must admit that some unique legal elements outside of our purview are being dealt with, wherein the families of 9/11 victims actually secured the right to Taliban-owned assets in a US Federal court, we think it is much more important to understand the implications of the bigger picture here.

By most universal measures, Afghanistan is a battered country spiraling towards economic collapse, suffering from excessive inflation, and subject to a government widely designated as a terrorist group. Now, the US government is deciding to prevent Afghan citizens from receiving the funds that were deposited into US banks during the US occupation of Afghanistan.

Again, it is essential to remove ourselves from any political fighting grounds and look at the broader dynamics at play. There exists one powerful entity that, due to prior economic success, controls the rails on which value can be reliably stored and transferred. Since this entity possesses all the relevant power, it can change the rules mid-game and manipulate the value stored for exogenous purposes that it deems the most important.

While we have already seen stories of oppressed women in Afghanistan turning to crypto to circumvent the local government, we think this story speaks to the potential for increased state-level adoption.

A Reminder of Potential Catalysts

We have spent a substantial amount of time the past couple of weeks discussing news stories and the narrative arc of crypto. While this is a less data-focused approach to the market, it is an important exercise, as we think bitcoin and crypto are gaining momentum on multiple fronts.

If you recall, the potential catalysts for BTC that we highlighted for this year in our annual outlook included both top-down emerging market adoption and bottoms-up emerging market adoption. Above are two anecdotes from this past week that suggest movement toward numbers 2 and 3 below, with one caveat – in our outlook, we specified the potential for bottoms-up adoption in emerging markets. We think it is probably appropriate to revise this to say “global bottoms-up adoption.”

To be fair, we did not anticipate this week’s story out of Canada, nor that it would have such a significant impact on the global crypto narrative.

Bonds Looking Like a Small Cap Crypto Token

TINA is the first item on our list of possible tailwinds for crypto in 2022. Thus far this year, we have seen most bond market segments suffer losses. We expect this dynamic to continue as forward rates continue to rise in lockstep with inflation. We think it is likely that once the uncertainty surrounding rate increases clears, at least a portion of investors with dry powder will realize that the risk-adjusted returns on major crypto assets are much higher than those on many low-yielding fixed-income investments. The narrative supporting TINA is as strong as ever.

Options Markets Looking Cheap

An opportunity we wanted to surface for our clients is in the form of long-dated options. While we are unable to provide specific guidance surrounding exposure levels or instruments, we think that the derivatives markets are severely underpricing the potential for a crypto bull market in the latter half of this year. Presently, options markets are pricing in a 50% probability of BTC being above $40k in September, and a 4% probability of it reaching $100k. Whether or not you think $100k is a wild expectation, this seems like an intriguing risk/reward.

Similarly, markets are pricing in a 50% probability of ETH being over $2.5k, which is $600 below the current spot price, and a 2% probability of reaching $10k.

Options markets have historically been unable to price parabolic moves in crypto accurately. Below is a headline from 2020, when derivatives markets were similarly skeptical of bitcoin’s ability to hit a new all-time high.

Avalanche Outperforms

Over the long term, we are constructive on most of the leading smart contract platforms, including Solana, Terra, Polkadot, Cosmos, and others. Still, we wanted to briefly highlight Avalanche’s recent outperformance and speak to how this is indicative of a post-cycle crypto industry, and how the assessment of these networks might change over time.

Below, we can see that of the top smart contract platforms by market cap, Avalanche is the only name in the green over the past 7-days.

Given the resurgence of Avalanche’s native token AVAX since the market bottom in late January, it is no wonder that the total revenue collected by the protocol far exceeds that of the next-highest revenue-generating smart contract platform.

(Note that Ethereum was excluded from this graph due to its significant level of maturity, and Binance Smart Chain was excluded due to centralization concerns).

Clearly, investors are still flocking to the Avalanche network, locking up capital, and transacting in high volumes. But does revenue generation alone point to a new paradigm in crypto? Not exactly. In prior bull market cycles, most crypto networks would garner fees due to transactions at the base layer. For example, Ethereum generated revenue because people were paying to send ETH to another wallet. This was real revenue to the network, but it was not substantiated by any additional economic value creation beyond the ability to transfer value.

In contrast, we now have several base-layer platforms with vibrant dApp ecosystems built on top of them. We can directly link the performance of the base layer to the performance of the entire ecosystem of applications.

As demonstrated by this chart from data provider the Tie, the entire Avalanche ecosystem, or the native tokens of the dApps built on top of Avalanche have outperformed over the prior 7-days, indicating surging usage of these applications. This is value created at the application layer trickling down to the base layer. 

Stepping back, this dynamic is quite similar to how one would measure or value a modern economy.

People build companies within the framework stipulated by an economy’s governance structures, and these companies create economic value that is ultimately realized by the country’s broader economy. The difference between legacy governance structures and crypto is that these crypto networks allow for a more significant percentage of the value created to be captured by network participants at the base layer.

In summary, the major takeaways from Avalanche’s recent performance are twofold:

1. This cycle is much different from previous ones due to the increase in reliable applications built on top of base layer protocols.
2. Moving forward, we think framing the value created within a layer-1 network as analogous to GDP might be a helpful way to assess the network’s progress and investment potential.

Bottom Line

The crypto market is still showing signs of uncertainty and a lack of broader sustained increases in demand. We think it is wise to maintain long positions with time horizons beyond six months but be prepared to buy on dips. As narratives surrounding the need for censorship-resistant money grow, the asymmetry for crypto further skews to the upside.