Funds Management Monthly Report – October 2023

Market Commentary

For some time, we have been saying that once we get through the illiquid northern summer months, we believe that the market will be favorable from the fourth quarter of 2023 through 2024. October was a very strong month for crypto and we stand by our prediction.

The DAF was up 19.12% and MNF 4.80% for the month. Crypto’s performance is particularly remarkable considering stock markets around the world negative for the month with the Nasdaq down 3.43% and S&P 500 down 2.20%. It seems that the asset class is decorrelating from equities and trading idiosyncratically.

Crypto

• The start of October saw significant developments relating to spot Bitcoin ETFs, as the U.S. Securities and Exchange Commission (SEC) chose not to contest an August court ruling that criticized its denial of Grayscale’s proposal to convert its Bitcoin Trust (GBTC) into an ETF. As a result, Grayscale’s GBTC saw its discount to net asset value (NAV) decrease from 45% earlier this year to 15%. Additionally, there was a sharp compression of discounts across other Grayscale offerings including ETHE and GDLC, with the hope that the approval of a spot Bitcoin ETF will result in the eventual conversion of other products.

• As highlighted to investors before, a significant portion of our portfolios in both our funds had been invested in Grayscale’s products since late last year. The recent developments have delivered an impressive boost to our performance, and we have begun to unwind and monetize the GTBC trade during the month.

• The ETF expectation has meant that Bitcoin has outperformed most other cryptocurrencies. The outperformance was augmented by the flight-to-safety narrative following the outbreak of tensions in the middle east, and significant comments of support for Bitcoin as a ‘safe haven’ asset from traditional market heavyweights Larry Fink and Stanley Druckenmiller. We have been overweight Bitcoin relative to other cryptocurrencies for a few months now, however we do expect Ethereum to play catchup. We have been rebalancing accordingly.

• While 2023 has been a strong year for crypto, we feel we are just witnessing the first shoots of spring emerge and that the four-year cycle that we have experienced in this market since its inception is intact. Part of the gains this year was pure recovery from the FTX debacle, and part was the beginning of the new cycle. We believe we are in the early stages of the cyclical crypto rally, with the majority of gains still to come. It should be noted that new money is coming into the space for the first time in a while. Of particular significance is the inflow from institutions rather than retail, and that the retail FOMO has not yet started.

• There are three theories as to why the four-year cycle exists and all three catalysts are again present going into 2024, as they were in 2012, 2016 and 2020.

1. Bitcoin Halving Cycle – where the payout to Bitcoin Miners is reduced by 50% every 4 years. The Halving is projected to occur in April 2024. This means that, from the date of the halving, miners who sell the Bitcoin they receive for validating the network, to cover costs and take profits, will receive half as much Bitcoin. With a given demand for Bitcoin in addition to a capped supply and (following the halving) less BTC coming onto the market from miners, the price historically has dramatically risen.
2. Central Government Liquidity Cycle – Post the GFC in 2008 when rates fell to zero percent, governments around the world issued large amounts of debt to cover the liquidity they pumped into the market with maturities averaging three to five years. That debt matures and has to be reissued every 4 years. What we see every four years is the balance sheets of governments start to rise to cover the debt of the previous cycle. Governments also want to reduce interest rates at these times in order to reduce the cost of issuing the new debt. Larger government balance sheets and lower interest rates are both favorable to crypto assets.
3. USA election Cycle – The dramatic increase in Bitcoin’s price has coincided with the USA elections, a time when the incumbent government increases spending in order to attract votes for the upcoming election. Expansionary fiscal policies are favorable for risk assets and in particular Bitcoin.

• These three potential catalysts are present again in 2024 and we believe that the market will behave as it did in the past three cycles. That is, with strong performance relative to other risk assets and the subsequent surpassing of previous highs. The impending approval of a spot Bitcoin ETF over the coming months adds a new catalyst too, as large traditional financial institutions start aggressively marketing their ETF products in a race to capture market share.

• As such, if we are correct, now is the time to be prepositioning for the rally. Though most new investors tend to focus on crypto once it has exceeded the previous all-time high, the total returns as well as risk adjusted returns are significantly higher when funds are invested well before that time. And now is a very attractive time to be adding risk to this space.

Register your interest in MHC Digital Asset Fund, MHC Market Neutral Fund or in any other of MHC Digital Group’s products by contacting our team at enquiries@mhcdigitalgroup.com

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