The first quarter of 2018 has been challenging for crypto- markets. Overall, the listed crypto market is down around 50% in value in February and March alone (we launched the fund on February 1). On the ICO front, projects listed during this period have in many cases seen much bigger declines than more established crypto assets.
Our approach to this market has been to allocate capital in some of the most interesting projects building out the crypto ecosystem. Apart from reasonably established verticals such as store of value, currency and privacy, we systematically research innovations in areas such as general purpose platforms, stable- coins, cross-blockchain and security token platforms. These are in our opinion the likely building blocks of this emerging asset class.
Fortunately, we have been very conservative when it comes to ICOs, and at the end of Q1 a total of 6.4% of the portfolio is allocated to ICOs and newly listed ICOs. We believe regulatory announcements will be a key driver to the ICO market. This is something we follow very closely, especially when it comes to what might constitute a security token.
In terms of ICO investments we have access to great deal flows through our network. Evaluating these opportunities, we look at four aspects in particular. An innovative project within a key vertical (described above). A sound crypto-economic structure that incentivises further innovation and long vesting periods (especially for founders). Thirdly, a team with strong experience in computer science, technology, and entrepreneurship. Fourthly, but not critically, strong backers, in the form of venture capital, key industry players, or communities. It goes without saying that these projects must be aimed at a problem that decentralised trust solves.
During the quarter we hired an additional analyst, James Simpson. This will further help in terms of resources and taking advantage of the the wide range of opportunities in this market. With the addition of Kevin O’Hara, CIO of Tulla Group, our advisory board as grown. Kevin is deeply involved with many crypto projects and has already been valuable in introducing the fund to his broad network.
Despite the recent headlines, there have been exciting developments in the underlying technologies of crypto assets. As an example, a scaling solution for Bitcoin, Lightening Network, is coming live and transactions fees have decreased substantially since the beginning of the year. The crypto industry continues to attract top talent, and the space is moving at a very fast pace.
We believe the recent revelation about the Facebook data leak is testament to the importance of building a more decentralised web, sometimes called Web 3.0. We believe most of the value in this new decentralised web will be captured by crypto assets.
Many top entrepreneurs and investors share our bullish view on the crypto markets. Notably, in March, co-founder and CEO of Twitter Jack Dorsey, in an interview with The Times of London, said that he thinks bitcoin will be the world’s ‘single currency in ten years’. Also in March, PayPal founder and venture capitalist Peter Thiel expressed at The Economic Club of New York that he thinks crypto is one of the most interesting growth investments currently available to investors. He said that he sees bitcoin becoming a ‘digital equivalent to gold’.
With a cash position at a healthy 36.0% of AUM at end of March, we are ready to take advantage of the upcoming opportunities these market conditions present us with.
Portfolio Sector Exposure
After sustained growth in cryptocurrency valuations throughout 2017, most have experienced a serious downward correction in Q1 of 2018. During this quarter, the total cryptocurrency market capitalisation more than halved from a January high of $830.3 billion to $263.9 billion as of April 1 2018. Total market capitalisation has continually fallen each month: -15.4% in January, -14.9% in February, and -40% in March.
This bear market has been reflected in trading volumes, which decreased by approximately half this quarter.
Bitcoin’s portion of the cryptocurrency market capitalisation increased this quarter from 38.6% to 45%. The price of Bitcoin bottomed on February 6 at $5,921. This is 490.03% higher than the same date in 2017. On March 31, bitcoin was trading at $7,003; meanwhile, many alt-coins remain at near low-points for the year. This observation is inline with a trend in Q1; what we consider to be higher quality coins are outperforming the overall market.
The durability of Bitcoin is partly due to a significant reduction in the bitcoin network’s transaction fees. In December 2017 transaction fees reached a high of $55, in January 2018, $26, and on April 1, they were less than $12. There have also been substantial advances in bitcoin’s scalability. On February 20, Coinbase and Bitfinex announced integration of SegWit. A wallet supporting the off-chain scalability solution Lightening Network was also launched on GooglePlay for Android devices on April 4 but was later removed.
The second largest crypto asset, Ethereum has been tightly associated with ICOs. With the current uncertainty around a regulatory framework for ICOs, the value of Ethereum’s native token, ether, has come under pressure lately. Ethereum is working on their own scalability solutions and we expect 2018 to be a year when many of these upgrades are implemented on the live network.
The Q1 performance of some of the top cryptocurrencies by market capitalisation are shown below from least performing to highest performing:
Regulatory announcements and uncertainty have partly driven the market in Q1. In January, there were mixed messages emanating from South Korea and China as to how their governments would regulate cryptocurrency trading through exchanges. On February 6, China officially banned foreign cryptocurrency exchanges. In March, the US Securities and Exchange Commission indicated that exchanges trading tokens that meet the definition of a security under the Securities Act must register with the commission as an official stock exchange. There were also bans in crypto-related advertising across most major social media networks, including Twitter, Facebook, Instagram, and Mail-Chimp. We view these as positive initiatives by the social media networks in the long-term, as many of these advertising channels were used to promote dubious investments. However, in the short term, a downward market reaction to regulation is expected in reaction to the above announcements.
2018 is witnessing an exceptional amount of investment entering the Initial Coin Offering (ICO) market. This quarter, ICOs have been extremely successful in raising of funds and meeting hard caps. Currently, more than $7.4 billion has been raised - more than in all of 2017, where $6.9 billion was raised.
There is very likely a lag from the decline in the overall market and its impact on ICO statistics. This is because the invested amounts are typically included at the end of the ICO raise. Given the current regulatory backdrop, we believe the ICO statistics will show a remarkable decline in the near future.
As expected, the volatility of the crypto market has remained very high. The volatility is partly driven by the disclosed sales of the Mt. Gox trustee as well as potential selling pressure from the April 17 US tax deadline. Nevertheless, we believe we are in a very good position to capture opportunities arising in this market.
It is a great privilege and responsibility to manage the funds you have entrusted to us. We are very excited about the team we have built and our ability to navigate the crypto markets.
If you have any comments or questions, please do not hesitate to contact me directly.
Henrik Andersson, CFA
Chief Investment Officer
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