Birkoa Newsletter 8 (recent crypto pullback)

Dear Birkoa LPs:

Wanted to write to you re: the recent pullback in crypto over the past 6 days. Please note that this is very common within this asset class and I'm only writing about this in order to alleviate any doubts/nervousness/questions you might have because I believe communication is the most important aspect in money management, and that investors should at all times know why things happen to their portfolio.

I hadn't planned on writing a newsletter until the end of the month but given the recent pullback, changed my weekend plans to take a deeper dive into the present market microstructure behind crypto. I even cancelled my golf tee time at the last minute today because I simply could not do anything that didn't get me closer to the answers I want, so here is the reason for the pullback:

Essentially what analysts and the trade flows seem to be suggesting is two-fold - 

1. Expectation of a continuing hawkish Fed post-Fed minutes release this Wednesday - That has explained equities' underperformance the past week and while cryptocurrencies were showing signs of uncorrelation with the equities markets, unfortunately this past week that took a step back. This is not abnormal neither is it concerning in any way. In frontier markets like crypto, these back-and-forths often happen. The only way through is to stomach it and ride it out, as mentioned several times before. With regards to the Fedspeak and fears of continued hawkishness, I believe the markets are reading way too much into it. Inflation, while high, has been steadily coming down and decelerated from two months ago. The markets want a 50 bps rate hike for September instead of 75, which I think is what they'll end up getting. However, a couple of Fed Governors this week seemed to signal more bullishness than the markets wanted to see, thereby leading to the pullback. All said and done, this is an overreaction I think.
   
   The expectation of more-than-expected hawkishness of the Fed has once again (temporarily) appreciated the Dollar to crazy levels. That is possibly further reason that Bitcoin and Ether are nosediving. Once again, this is temporary.
   

2. Strategic selling prior to Ethereum Merge - Merge for Ethereum 2.0 will happen on September 14th. It is possible that prior to that, some strategic selling is happening with the intent to buy back again to benefit from the rise up following a successful merge. That's a point of view expressed by Vitalik Buterin (founder of Ethereum) and some analysts, as mentioned in this article from yesterday.
   
   "Meanwhile, Hal Press, an investor and founder of crypto hedge fund North Rock Digital, wrote in the latest issue of the Bankless podcast’s newsletter that the Merge is “not priced in,” suggesting higher prices should be expected as the event nears.
   
   Explaining the reason for this, Press said that any selling that is occurring in ETH now and over the “next few weeks” is mostly tactical selling with an aim to buy back later, either before or immediately after the Merge occurs."
   
   So long as the merge is successful, crypto prices and especially Ethereum will continue to rise up.

One thing to note - the pullback in crypto over the past 6 days has also hurt our position in the crypto ETF $FDIG that I had mentioned during last week's newsletter. As of today, the positions's gains have been cut down in half from 45% to a comparatively measly 22% due to its high correlation with crypto. While it's certainly very irritating, please know that these positions come back up as quickly as they go down. The price chart I had attached last time showing the multiple local peaks and troughs for $FDIG should give you an indication of that.

Another interesting longer-term thing to note is that after Ethereum 2.0 goes live and Proof-of-Stake becomes the underlying blockchain mechanism, staking Ethers will become commonplace. Coinbase, which is about 20% of $FDIG ETF, has 15% Ether reserves in its balance sheet and with its promised staked Ether yield of 5%, expected to benefit significantly beginning next quarter, with an annual revenue increase of $650M per JP Morgan. As a side-note, each time Coinbase goes up 5%, our ETF usually increases by 2%. Coinbase was as high as $98 ten days ago and now all the way down to $72.8, thereby the carnage. Coinbase will eventually keep rising, albeit choppy at times, to $200 by 2023-end. This is why it's very important to continue to keep our eyes on the prize and not be too bothered with the daily price swings and volatility. As with other positions, until the situation changes fundamentally at the ground-level, I will continue to hold. Thus far, as with other positions, nothing on the ground has changed for crypto, and I hope you this little note alleviates any concerns you might have.

As Warren Buffett says often, the average mutual fund investor performs worse than the average mutual fund. The reason is due to trading positions in and out every time something happens in the markets. In frontier markets like crypto, it is especially important to never forget that point. Anytime you feel even a hint of nervousness, I urge you to pull up Birkoa Newsletter #6 from late-July 2022 that showed the different scenarios for our various positions along with the script I had written to perform that analysis (for the purposes of transparency).

Sincerely,

Pranjit Kalita
CIO