Coffee Series with Steven, Senior Research Analyst

What was your path to DRW?

Before joining DRW, I spent most of my career primarily in equity research across both buy and sell side. I covered a number of sectors but spent the majority of my career covering tech, which has always been a keen interest of mine. As for my route into crypto, I first became aware of bitcoin in early 2013, but sadly dismissed it as a bubble. By the second bull market in 2017, I was far more knowledgeable about the wider crypto space, but again felt the market was in bubble territory. It was not until 2019 that I started reading about Ethereum, which became an ‘aha’ moment for me as I could intuitively see the value in smart contracts (e.g., derivatives trading without a central counterparty) and the benefits of proof of stake over proof of work. At that point, I bought some ETH at around $160 and ‘HODLd’ through the ups and downs over the next few months. Then COVID came along and it became fairly clear that we were entering a new paradigm in monetary and fiscal policy. I started reading books like ‘The Bitcoin Standard’ and really went down the rabbit hole and started investing in alt coins. It became pretty clear to me that there was a powerful macro narrative evolving, but at a fundamental level I could see huge value in decentralized business models that were barely understood by institutional investors. I could see significant alpha potential, so I made the decision to move full time into the space and started talking to people in the crypto industry. I ultimately came across the role at Cumberland, joining in May last year.

What are your thoughts on the overall state of Crypto?

The macro environment is in some ways positive and in others, fairly hostile. On the plus side, we are potentially looking at higher inflation for longer largely due to the impact of geopolitical events on commodities prices. Against that, the Fed and other central banks are hesitant to raise rates given the economic damage this will cause, especially given that much of this is driven by commodity prices which they can’t control. This suggests continued negative real interest rates, which is generally good for crypto, but against that we will have to contend with an eventual rate hike cycle, possibly driven by pressure to take meaningful action ahead of the US midterm elections. My main concern is that if we see double digit CPI, this will be extremely challenging for risk assets and that narrative might dominate. It’s very difficult to call it at this point but I would say that the tail risks have certainly fattened in either direction.

In terms of narratives, as a long duration highly speculative asset, crypto is heavily driven by narratives and hype cycles. I would say crypto lacks many particularly powerful new narratives right now, such as ‘the metaverse’, ‘DeFi 2.0’, ‘multichain’ etc. This is in part due to subdued animal spirits from the recent sell off and therefore a degree of apathy toward any new trend, but a number of these hype cycles have to some extent become played out for now at least. Recent geopolitical issues highlight the importance of permissionless, portable assets and arguably increase the chances of bitcoin being adopted as a reserve asset and I would say that of any theme, this has the potential to evolve into a powerful narrative over the next few months.

As for the actual fundamentals, I think things continue to steadily improve. We are seeing increasing signs of continued adoption and you can see this across publicly available blockchain data, for example Avalanche’s on chain activity metrics such as daily transaction count. To give another example, Braintrust, a web 3 recruitment network, shows daily contract volumes and these have been growing at ~100% QoQ over the last few months. What I would say though is that with the broader sell off, more DeFi native names have seen both declining underlying activity and demand of late (e.g., borrowing demand across the major borrow/lend platforms, trading volumes across decentralized exchanges). Similarly, we are seeing ever increasing competition, particularly with the proliferation of new layer 1 chains, each with their own native DEX or borrow/lend platform. Therefore, it becomes increasingly important to identify names for which there are genuine ‘moats,’ i.e. barriers to entry or sources of sustainable competitive advantage.

Lastly, I monitor on chain activity fairly closely, which is really the analysis of coin movements by age and size bracket. This is generally looking supportive although lackluster. Amongst bitcoin holders in particular, longer term holders are not really selling into strength or weakness and also the age profiles of both bitcoin and ether are maturing - around 75% of bitcoin positions are over 3 months old, suggesting a high concentration of ownership in the hands of long-term investors who are less likely to sell. That said, inflows and signs of retail demand are fairly tepid, which results in a fairly balanced supply demand situation, with weak demand offset by weak supply.

As you’ve touched on, crypto has become a talking point amidst the current Ukraine conflict, what are your thoughts on what this conflict means for crypto’s future and how investors look at the asset class?

I think that the inflation narrative is dominating right now. In general, a $10 increase in crude prices leads to around +20-30bp on CPI. Gas and wheat prices have also seen significant spikes. This comes on top of a 7.9% CPI print in the US for February. As discussed, this narrative of ‘runaway inflation’ could be bullish or bearish for crypto, depending in part on the Fed’s response.

The dollar is also very important in this situation and tends to be heavily inversely correlated to crypto, in part due to global de-risking and carry trade unwinds. We have seen this recently in the trade weighted dollar price. However, much depends on the policy response and we may see a more dovish rate hike cycle with some fiscal measures to deal with higher energy prices and fossil fuel dependency (in line with the €220bn being spent on clean energy in Germany) and military spending, which would imply a weaker dollar. If this were accompanied by more QE or at least a delay in QT, this could be very bullish for crypto.

As noted, the bankless/permissionless narrative has clearly gained mindshare. For example, photos of people on the Moscow metro unable to use payment services on their phones and capital controls in Russia. We’ve also seen inflows into stablecoins over the last few weeks. To add to that, for bitcoin in particular, the stateless money narrative has the potential to gather momentum– i.e., hard money that cannot be manipulated by central banks, inflated to fund deficits, or confiscated from reserve assets. This clearly favours bitcoin and ether as arguably the highest quality and hardest assets in the space and also the most likely to be used as reserve assets.

To conclude, it’s a bit of a mixed bag but I would very roughly summarize as ‘short term uncertain, long term uncertain but most likely bullish’.

Within DeFi, are there any emerging trends that you are excited about in the coming year?

I think we are seeing a bit of a lull for narratives right now, but I do see a few things to get excited about over the next 12 months. The thing I’m most excited about is the emergence of real world ‘web3’. By this, I mean businesses like Render (decentralized GPU cloud computing) and Braintrust.

We see these as crypto native versions of successful internet business models. They have a number of compelling reasons to exist on crypto, namely decentralized low cost opex vs. centralized incumbent capex; incentive tokens which can be used for early non-cash marketing spend; crypto payment rails circumventing existing payment networks; token utility value creating tokenholder return over and above profit share allowing for highly disruptive low take rates; and finally, low opex due to automation and decentralised infrastructure. There are really only a few of these names to invest in at this point (e.g., Render, Helium, Braintrust, Arweave, and Livepeer), but we see these as an on ramp into crypto for tradfi investors as these coins can to a large extent be analyzed through the framework of a tech stock. The market hasn’t yet become that excited about or familiar with this narrative, but we think it will pick up steam once people understand how disruptive these businesses can be for existing markets and incumbents (e.g. cloud compute or internet platform businesses). I think one important consideration is that building ‘proper businesses’ like this will be much tougher than for DeFi apps and will likely require experienced management. This sits awkwardly with a crypto native decentralized management structure. Basically, I think these businesses will to some extent need to be run like traditional companies in order to be successful, but for those that make it I see huge upside.

I think the other trend is the Ethereum 2.0 merge, which at this point appears to be on track for some time in Q3. It looks as though initial staking yields will be over 10% with added deflation of ~2-3%. So that’s a total return of ~14-15% for HODLing and staking ETH. Of course, those yields should fall with increased ETH staked post merge, but that’s an incredibly powerful catalyst for the ETH price. This becomes a very compelling risk/reward for the 2nd largest asset in crypto and will likely draw significant capital into Ethereum, possibly away from lower quality assets or other L1s. Net deflation also ties into the ‘hard store of money, stateless/bankless/permissionless’ narrative as we see it. Obviously HODLing in ETH at double digit staking yields can be attractive on a standalone basis, but with the deflationary angle, ETH may also take its place as comparable or even superior to BTC as a store of value.