Weekly Thoughts #15: Classic Brick Breaker


AUGUST 30, 2018

At press time, the price of bitcoin is trading around $6800, which is roughly 3% lower than levels yesterday at the same time. The overall market of liquid digital assets has followed in lockstep. This recent weakness runs counter to the bullish trend the market has exhibited since the middle of August. On August 13th, the price of bitcoin hit a local minimum of just under $6000 but had since rallied 20% to nearly a recent high of $7200. The popular narratives that have been drummed up to explain this move have revolved around the recent Tether printing as well as the dwindling of short interest on Bitfinex. We believe these narratives are interesting and they make for great conversation starters however it can be difficult to assign strict causality. Within our own team, we tend to believe the market is in an ultra reflexive state currently. It moves within a range in response to seemingly every bit of news. This is likely the result of trading having been dominated by short term players that are using structured derivative vehicles with leverage to express intraday speculation. Watching the current price of bitcoin almost feels like that moment in the classic Brick Breaker game when the ball was stuck bouncing aggressively between two rows of bricks. Eventually one of the rows always gave, making room for the ball to move much higher or fall to the bottom. Anyway, now that we’ve aged ourselves, here are our other thoughts for the week:

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1. An important distinction is developing between the types of practitioners in this space. There are practitioners in the space that are abundantly articulate with the gift of gab. You’ll usually catch these people headlining most of the conferences across the globe or appearing on podcast after podcast. It’s no coincidence that the public personas in cryptocurrency are often times made up of the same sample set of individuals. They know how to massage very complex concepts into simplistic narratives for the average person to understand. They were likely very early investors in the space with the likely byproduct being the accumulation of significant wealth. Our hats off to these people. But then there are the practitioners that are not in the public eye. These are the people that are actively building. These people may be at conferences as attendees but will likely not be speakers. These people also know how to consume very complex concepts but are less focused on massaging them into public narratives and more focused on how to use them to benefit their respective business. One type of practitioner is not worse than the other. We’re just highlighting that there are two types of practitioners playing out in the space. And it is therefore necessary to place each into their respective bucket to fully appreciate the types of intellectual capital in our space. Ironically enough, this distinction runs very analogous to that of the old school trading floor, a world that has for decades managed the seesaw dynamic between salespeople and traders. The former group was in the public eye. The latter group was not. The former was concerned with the narrative. The latter was concerned with risk. Perhaps something’s won’t change as Wall Street continues to pervade the digital asset space.

2. HODLing is not a prudent investment strategy. Of course we jest when we use the term “HODL” but for better or worse, it is a phrase that has been proliferated by the media and what is associated with a basic ‘buy and hold’ approach to investing (for the sake of this argument, you can lump long only, passive, index and smart beta all into this ‘buy and hold’ category). Within the fund, we remain long term bullish but we are extremely cautious in the short term. This means we believe that the technologies being built today in our space will have as transformative an effect on human society as did the internet. However it may take several years for the effect of blockchain technology to permeate our daily lives. It may take several years for the market capitalization of cryptocurrency to hit a trillion dollars. It may even take several years for the price of bitcoin to breach its all time high. The markets are extremely nascent still and subject to wild price swings and dislocations. And as a result, a simple buy and hold strategy runs the risk of severe short term drawdowns and volatility. The popular narrative we’ve been hearing from those preaching the HODL mantra is something on the lines of “if you bought bitcoin a year ago, you’d still be up x%”. This is true. And valid. As of August 30, bitcoin has seen a year­over­year gain of 50%. That is by and large some of the best annualized returns an investor can ask for in an alternative asset. But this narrative is experiencing significant decay. At some point, it will not hold true. At some point bitcoin will be worth less today than what it was a year ago. And to help illustrate, we refer to the graph below which charts the YoY growth multiple of bitcoin. Once the beginning of November hits, the multiple will move into negative territory unless prices start moving higher in a meaningful way. What’s the lesson? Risk should be actively managed, not just left alone.

3. The bitcoin network hash rate continues to grow, and the latest growth numbers indicate that miners are still willing to allocate more capital to build even larger farms, even at these price levels. Every once in a while, we come across headlines or discussion about how the bitcoin network hash rate has made a huge jump and reached an all­time high. In fact, the network hash rate has consistently grown over time and is constantly reaching all­time highs. Periods of negative growth in the network hash rate are almost non­existent, and the few instances that do exist are very short lived.

The following plot shows the 90­day growth of the bitcoin network hash rate. Starting in January 2013, the first ASIC­based miners started joining the network which caused a huge two­year cycle of growth in the network hash rate. Growth rates peaked in late 2013, but throughout 2014, the network hash rate was still growing by large amounts even as the price came down due to the Mt. Gox hack. Growth flatlined for most of 2015 which coincided with the bottom in prices. Since then, the network hash rate has been consistently growing between a range of 10 to 30 percent every 90­ days.

Commercial­-scale bitcoin mining farms require a long lead time to set up. So the increase in hash rate we are seeing earlier this year is likely a result of decisions made even earlier when prices were much higher. But now we are nearing eight months in this bear market, and that has given enough time to mining farm operators to update their profitability projections and decide whether increased capital expenditures make sense. The very latest growth rate numbers indicate that the growth in the hash rate may have already bottomed and that even at these price levels, miners are willing to allocate more capital to build even larger farms.

Thanks for reading everyone. Questions or comments, just let us know.

Portfolio Management Team

Thejas Nalval  | Kevin Lu


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