Week 6: Earnings Are Here and Crypto Updates

Briefing: Prices are down, but earnings are up. A strong showing in earnings season helps rebuild investor confidence in the face of Fed tightening. Since its inception in Nov 2021, our crypto fund has avoided 30%-40% drawdowns by waiting until this selloff ended to start allocating. | The Boston Fed has completed Phase 1 of its CBDC, Central Bank Digital Currency.

Strong Earnings Increase Confidence:

Earnings season continues to deliver strong results. The three months that sit between earnings cycles can feel like a lifetime, especially when markets and investors have to contend with inflation releases, rate hikes, quantitative tapering, covid data, and political drama. Fortunately, now that investors can see new positive earnings numbers, they have the evidence they need to help regain confidence. Returns in many equity assets look great from here for cash that has been sitting on the sidelines.

This year, market anxiety has focused on inflection points rather than impending disasters. When I say inflection point, I mean questions like, “Are we going to stop seeing growth in our best public businesses?” (no), “Are we finally through the worst of the worst of Covid?” (seems likely), and “Is the Fed going to induce a recession by raising rates too quickly?” (seems less likely). These inflection points significantly impact future growth, so investors are justified in worrying about them and reacting to them.

There are always valid and rational reasons to be fearful. We’ve written about our list of significant risks before, with the top risk being a Chinese invasion of Taiwan and the impact it would have on the semiconductor market. The lack of healthy fundamentals in the SPAC market is another risk we’ve profiled in the past. The SPAC bubble ended up popping, which should not come as a surprise. SPACs can raise money purely on future expectations, while traditional IPOs can only raise money on actual historical results. You can see how this opens the door for intentional and unintentional bad actors.

Sharp drops in markets tend to be followed by strong rallies. Today there is plenty of cash on the sidelines to allocate to growth opportunities. While valuations have reset lower, the future still belongs to the top innovators who can scale in e-commerce, cloud computing, digital finance, digital health, semiconductors & AI, and digital entertainment.

Many Crypto Updates: 

Quick Crypto Fund Update: We sent our first investor letter last night. Since our launch in mid-November 2021, we’ve held the entire balance in cash and subsequently avoided a brutal December and January downturn primarily driven by the Fed. “Don’t fight the Fed” remains an undefeated market mantra. We are now beginning to deploy at 30-40% lower prices than when we started. We plan to invest in both public tokens and private crypto-related assets.

BitFinex Hack: By now, everyone has heard about the $3.6 billion in Bitcoin recovered by the US Department of Justice from the 2016 BitFinex Hack. Here is what caught my eye:

  • The private passphrases for the BTC wallets were stored in a dropbox account. Your crypto wallet passphrase is not just a password; it effectively IS the wallet itself. Basic cyber security is pretty straightforward, and many people are surprisingly bad at it. If you’re wondering how the DOJ recovered the $3.5 billion in BTC assets, it was sitting in a dropbox account.
  • On page 5 of the DOJ report, you can see the transaction details as the couple attempted to wash/launder the BTC. Bitcoin is not anonymous, and this level of record-keeping and transparency on the blockchain is valuable to regulators. You might be able to do illegal things with bitcoin, but you’ll leave a trail of inescapable breadcrumbs if you do.

Amex: American Express CEO Stephen Squeri hinted at the possibility of allowing users to swap credit card points for crypto. The Amex user base is traditional and affluent, so the authority and social proof of Amex embracing crypto would be a significant signal that it’s finally “safe” to join the crypto crowd.

Fed’s Digital Dollar: The Federal Reserve Bank of Boston released documentation on Phase 1 of Project Hamilton, the Fed’s take on CBDCs (central bank digital currencies). Project Hamilton is an excellent name, by the way. The project demonstrated throughput of 1,700,000 transactions per second (TPS).

Bitcoin can handle roughly 7 TPS (extremely slow), but the layer-2 solution Lightning Network aims to make it dramatically faster and cheaper. Ethereum is slightly better at 30 TPS, and Polygon exists to speed that up as well. Solana can natively handle 50,000 TPS, a core driver of its early success. Any network that operates at an industrial scale will have to reach millions of TPS at peak volumes.

Government adoption: Russia announced that they are drafting regulations to formally recognize Bitcoin as a currency. The brave first movers are the first ten government organizations to adopt Bitcoin standards or add the position to their treasury. After that, the pressure will be on for other governments to act fast or risk being way too late to the game.

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