The Most Attractive Opportunity in Crypto
The Most Attractive Opportunity in Crypto
Where to invest in crypto today
I officially joined FRNT recently. We’ve been working together for the last few months devising a crypto investment strategy. I’m thrilled to partner with them to launch it.
I will continue to write regularly for Crypto Clarity. I love sharing my research and thoughts with the thousands of people that read my articles. The reader interactions have been formidable. I look forward to many more!
The most compelling crypto opportunity
The most compelling investment opportunity in crypto right now is in ‘publics’ and ‘opportunistic privates.’ I define ‘publics’ as public tokens, crypto linked public equity and crypto linked derivatives. ‘Opportunistic privates’ are crypto-linked businesses that require unique capital solutions.
FRNT’s Tactical Opportunities will invest the majority of our capital in ‘publics’ and the remainder in ‘opportunistic privates.’ We are fundamental crypto investors. We’ll have a relatively concentrated portfolio. Our investments are underwritten by in-depth research surfacing differentiated investment theses. Our focus is crypto infrastructure.
‘Publics’ and ‘opportunistic privates’ are the most compelling investment opportunity today for three reasons:
Cycle
Misunderstood
Under-invested
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1. Cycle
Crypto has gotten rocked. Crypto markets are down 65% from peak. Nearly $2 trillion of capital was lost. The industry has been hit on five fronts. First, the macro landscape deteriorated. Loose monetary and fiscal policy that flooded all markets with excessive capital has dried up. Rising rates reduce the future value of assets. Second, crypto was marred by $3 billion stolen in hacks. Third, billions more were lost in CeFi implosions. Quasi-crypto-banks took customer deposits and recklessly lent those deposits to borrowers who couldn’t repay them (read CeFi Casualties). Fourth, FTX absconded $8.9 billion of customer deposits in one of the largest frauds in American history (see archives for FTX articles). Fifth, US regulators are clamping down on crypto in the US (read Crypto Crackdown).
Five crypto factors caused the massive market dislocation:
Regulation: Lack of clear regulation pushed bad actors offshore.
Poor management: Mismanagement of asset and liability duration.
Leverage: Unquantified and under-collateralized off-chain lending.
Experimental tech: Novel monetary technological concepts failed.
Fraud: Stealing customer funds.
None of these factors undermine the underlying blockchain technology. My thesis that crypto will accelerate commerce remains intact (read My Crypto Thesis).
The market dislocation presents a compelling setup. The consensus opinion is that crypto is toxic and uninvestable. The sentiment is horrific. Interest has cratered. Enormous losses have been suffered. Investors have been washed out. They’re hesitant to deploy capital.
I have a contrarian view. The technology remains sound. There are quality assets amidst the pile of rubble. It presents a generational investment opportunity.
I think we’re near cycle lows. Price action suggests we are. The market shrugs off each successive hit crypto takes. 2022 experienced a massive deleveraging in crypto. The list of catastrophic things that could impact crypto is shrinking. If what we’ve gone through didn’t cause you to sell. I’m not sure what will.
Buying quality value-accruing tokens at this point in the cycle is most compelling. The entry price is attractive. I don’t need to ape into some nonsense alt-coin pinned on hopium. I can invest in blockchains and protocols that create tangible value, which accrues to token holders.
Investing in crypto-linked businesses is equally compelling. These businesses tend to sell infrastructure related products to the crypto industry. These are corporate entities that generate revenue. Many have fallen on hard times through no fault of their own. Their valuations have been penalized. Their access to capital is hampered. They’re guilty by association.
The baby has been thrown out with the bathwater.
2. Misunderstood
People misunderstand crypto. It gets painted with the same brush. Everything is a fraud. It’s magic internet money that has no value. The cynicism is warranted in many cases. Lots of crypto is nonsense.
But not all of crypto is nonsense. Therein lies the opportunity.
People broadly misunderstand usage, metrics and value accrual.
Usage
People pay to use blockchains. That’s widely misunderstood.
Users are transacting on chain and paying to do so. There are nearly 4 million daily active users that transact across the main layer 1 blockchains. They execute over 10 million transactions a day. They pay roughly $8 million in daily fees to do so, of which Ethereum comprises $6 million. Dollar based fees eclipsed $100 million per day in 2021. The decline in dollar denominated fees is due to a 65% decline in token price. The number of daily active users and transaction volumes has not declined.
Data powered by Artmis. The easiest way to source crypto data.
Metrics
Crypto metrics are misunderstood. The crypto economy, including blockchains, generates revenue, incurs costs and has usage metrics. The network effects are real. The operating leverage of blockchains can make them highly profitable.
The income statement of a blockchain doesn’t look that different from a company (see Ethereum Q4'22: State of the Network for an example). The major difference is that it’s not denominated in USD, Euro or Yuan.
Metrics lend themselves to fundamental investing. Investors can dissect the underlying performance of a blockchain or protocol like they can a business or an economy. We can extrapolate how that performance could change in the future. There are emerging ways to triangulate absolute and relative value of digital assets.
Fundamentals will play an increasing role as the market matures.
Value accrual
Tokenomics is misunderstood. An equity security represents ownership in a company. A credit security is a promise to be repaid. They are both clear cut standards. A token can represent several things. There is no standard. As a result, investors shy away.
Some tokens have no value and some are ensnared in securities regulation. But not all tokens are valueless. A discerning investor can parse through what is valuable and what is not. It just takes effort. Valuable tokens have common characteristics. They have commodity-like features. They are used as the means to transact on chain. The value created on chain accrues to token holders through a burn mechanism. A burn mechanism is akin to a stock buyback. The more on chain usage, the more revenue, the more tokens are burned. All else equal, the value of the token increases.
Underinvested
Fundamental crypto is underinvested.
According to Galaxy VisionTrack $9 billion of cumulative capital was raised for fundamental crypto hedge funds. I estimate the mark-to-market of those funds is -65%. It’s reasonable to estimate there is roughly $3 billion of capital deployed in fundamental crypto hedge fund strategies.
The ‘publics’ opportunity set is several hundred billion. It’s large relative to the fundamental capital deployed. Two reasons explain the dearth of fundamental investing in crypto. Capital has funneled to venture funds. They have raised nearly $60 billion between 2017 and 2022 according to Galaxy VisionTrack. It makes sense. Seed capital is required to fund the growth of new technology. The second reason is that crypto has not lent itself to fundamental investing until recently. The market was small. There were few protocols and applications. Revenues were de minimis. That all changed recently.
The land is even more barren in ‘opportunistic privates.’ Venture funds aren’t interested in these deals because they’re not typical venture investments. Traditional hedge funds aren’t interested because it's crypto. These crypto-linked businesses find themselves with limited access to capital.
The opportunities that fall through the cracks are the most compelling ones. The ones that few people are looking at. That’s what the FRNT Tactical Opportunities strategy targets.
FRNT Tactical Opportunities
We will be searching for the best investment opportunities in ‘publics’ and ‘opportunistic privates.’ They’re the most misunderstood and underinvested areas of crypto markets. The opportunity is ripe given 2022’s market meltdown.
‘Publics’ and ‘opportunistic privates’ also pair well with our expertise. FRNT is a leading crypto investment bank launched in 2018. It navigated the market turmoil exceptionally well. We’re well capitalized to continue to grow the firm. FRNT runs a large trading desk trading spot, derivatives and structured products. FRNT also advises on restructurings and capital raises. The Tactical Opportunities investment strategy complements FRNT’s existing business. We have a unique vantage point into crypto markets that informs our ‘publics’ investments. We have a proprietary deal flow through our advisory business that surfaces ‘opportunistic privates.’
My professional investment background meshes with our strategy. I honed in my fundamental investing acumen over 8 years at BlueMountain Capital, a $22 billion hedge fund. The firm employed a fundamental concentrated strategy in equity and credit markets and opportunistic privates.
We’re experienced managers. FRNT’s partner firm with overlapping directors and owners manages a large highly successful crypto quant fund. BlueMountain operated best in class systems and processes.
Tying it all together…
I’m pumped!
My decade plus of investing experience is being channeled into crypto. I’m learning a lot. I’m being challenged. It’s exciting. We’re building something special at FRNT. I’ll be continuing to share my takes and insights with you.
Stay curious.