Funds Management Monthly Report – May 2023

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Market Commentary

 

• May was a month in which we saw sizeable swings in the crypto market but no real direction. This mirrored the movements in traditional markets with macroeconomic uncertainty around the debt ceiling and interest rates keeping a lid on the performance of all risk assets.

 

• With the debt ceiling raise having been agreed in Washington, attention now moves to the speed and form of the debt issuance. If the Fed issues large amounts of long-term debt quickly, liquidity will be drained out of the financial system and be negative for risk assets in the short term. That headwind will persist until the Government spends the money it has raised. If they stagger the issuance to better match the spending profile, and use reverse repo facilities, the impact is likely to be far less.

 

• Much debate also surrounds the next move from the Fed regarding interest rate hikes, with the market approximately evenly split between one further hike in June and a pause. We feel that the impact of that decision is overestimated, as a pause merely increases the probability of a rise in July. The most important consideration is where the number will peak, as opposed to when. Our guess is that there is one more rise to come.

 

• Interestingly, in crypto itself, BTC found itself at the behest of meme-coin-mania with a meteoric rise in ordinal inscriptions (similar to NFTs minting) which saw BTC surpassing Solana and become the 2nd most popular NFT blockchain after Ethereum.

 

• As a result, May recorded the maximum number of transactions on the Bitcoin blockchain since its inception in 2009. The subsequent strain on the network caused major centralised exchanges to temporarily suspend BTC withdrawals, which weighed heavily on price. Meanwhile, ETH outperformed BTC, potentially due to profit-taking by miners and concerns about BTC’s network efficiency. Although this episode revealed a potential drawback of the blockchain, the introduction of ordinals highlights an expansion in the Bitcoin network’s added utilities and possibilities, other than the traditional treatment of the asset as a store of value.

 

• The Ethereum network showed bolstered strength amid developments in Layer 2 solutions, specifically Arbitrum, Optimism and Zk-rollups (another technological solution to ease network congestion on Ethereum). Interestingly, May produced the highest burn rate of ETH tokens due to strong narratives, namely AI/ metaverse developments and adoption of liquid staking derivatives, making the asset increasingly deflationary and scarce.

 

• Also of note was the increased staking activity after a smooth Shapella upgrade in March, with users chasing higher yields resulting from heightened network activity, sometimes above 8% APR. Consequently, the quantity of staked ETH rose sharply, indicating a potentially higher degree of organic user growth and positive prospects for the Ethereum ecosystem in the long term. As previously mentioned in our monthly updates, we had been anticipating this flow of funds and were able to capitalize on the opportunity. Over the month, we saw ETH outperform BTC which was in line with our in-house expectations, giving the DAF an uplift as we were positioned overweight ETH relative to BTC across the month.

 

• With the increased regulatory scrutiny surrounding centralised players and their business offerings, we predict that the assets currently staked by these entities will flow to their decentralised counterparts. We have positioned ourselves accordingly. As capital preservation is at the centre of our investment mandate, our capital exposure to centralised entities continues to remain minimal.

 

• The increasing regulatory pressure on cryptocurrency in the USA is in contrast to the clarity and encouragement given to this asset class elsewhere in the world. With the election cycle getting closer and possible favourable (for crypto) judgement in the XRP court case imminent, any moves by the regulator to curb activities in crypto must come fast. As such, we expect to see the SEC on the front foot through to September.

 

• Other countries around the world including HK, UK, Europe, Singapore and UAE, see the pressure being exerted as an opportunity to grab market share and development expertise from the USA, and are providing a more accommodating regulatory environment. There is no doubt that crypto will be a part of the political debate in the USA once the election cycle starts in November, as 20% of USA households now have some sort of exposure to the cryptocurrency market. This can only be considered a good thing as it brings crypto into every living room around the world. Notably, the Republicans have already proposed a much more accommodating bill for cryptocurrency.

 

• The cryptocurrency market goes through defined four-year cycles which are based around the ‘Bitcoin Halving‘. Typically, this event tends to be very bullish for the market. The next halving is in April next year.

 

• In summary we expect to see a choppy market over the coming months due to:

 

• • • • Huge debt issuance out of USA – draining liquidity out of the financial markets
      • Aggressive actions from the SEC against cryptocurrency in the lead up to the election cycle in the USA
      • Increased attention on recessions around the world
      • Potential large sales of assets from the USA government and Mt. Gox (which we have discussed in previous monthly updates but the longer we go without it happening the more concentrated the sales will be)

 

• However, we turn bullish come the 4th quarter due to:

 

• • • • The proximity to the Bitcoin Halving
      • The US government spending the money raised through high debt issuance that they have already completed
      • An interest rate pivot from central banks around the world
      • An election cycle reducing aggression of USA regulators against crypto, and political debate bringing more attention to crypto.

 

 

Disclaimer

 

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