3Q2022 Quarterly Letter: Asset Allocation in Crypto for the Next Decade

by @0x992

This past quarter, we launched two new “Long Only” strategies and have grown our assets under management to $145 Million. Below is an excerpt from our 3Q2022 Quarterly Letter.

Asset Allocation in Crypto for the Next Decade

The single most important factor that might have a greater impact on an investment portfolio than any individual investment, is the decision of which types of investments to pursue, and how much to invest in each type. A disciplined approach that considers long-term goals dramatically improves chances for success.

Back in the beginning of 2018, BAI invited me to give a talk about the crypto landscape and investment opportunities. I was asked what best strategy to capture value in the crypto market was, and my response was to dollar cost average BTC and ETH for a 48 month period. However, when the market turns bearish, everyone loses interest in crypto beta returns. And thus, no one in the meeting room executed the DCA strategy which could have returned 6x in nominal value.

Based on KPMG Cayman’s information, 300 crypto funds existed in 2017, but only 30 had survived the bear market afterwards. Out of the 30 that survived, very few managed to beat the BTC/ETH dollar cost average strategy.

But when it comes to the question of holding, how should one time the pace of buying and decide what to hold? What we have learned throughout our experience, is that we should build better solutions to help our investors navigate and capture the rapidly growing opportunities that this asset class has to offer. There are two strategies that we believe can best prepare our investors for the coming decades-long wave of blockchain-enabled innovation: a beta strategy for consistent execution, and an alpha strategy to capture the fastest-growing networks in crypto.

Why We Think the Public Market Might Outpace Crypto Venture Investment in the Next Decade?

Figure 1. Gartner Hype Cycle for Technology
Figure 1. Gartner Hype Cycle for Technology

The problem in venture investment is that it highly depends on the Vintage Year of Investment, which is the milestone year in which the first influx of investment capital is delivered to a project or company. The valuation of companies that share a common vintage year, may grow or decline as a group, thereby resulting in a particular “good year” or “bad year” of investing. According to Cambridge Associates, as of December 2020, 9 out of 20 vintage years accounted for more than 88% of the Venture Capital index’s value.

Exhibit 1. 2000 was a bad year that had a long lasting effect for investment returns (Source: Cambridge Associates)
Exhibit 1. 2000 was a bad year that had a long lasting effect for investment returns (Source: Cambridge Associates)

If we were an institutional investor that believed in the dotcom industry in the year 2000 and faced:

• The dotcom bubble had just burst.
• Companies that went public during the bubble had no profit, and little revenue.
• NASDAQ-100 dropped 78% from peak and it took eight years for Amazon to retake its all-

time-high during the dotcom bubble
How would we have allocated capital to tech investment from 2000 onward?

It is the same question that we are asking ourselves today. How should one invest in crypto during the next decade?

  • Crypto total market cap plunged to $1 trillion.

  • Major public chains have little revenue and are still massively subsidizing the network

    The statement that “public markets outpace crypto venture investments” sounds bold and improper, as venture capital and public market investment have completely different risk profiles and methodologies. A key caveat that we observed during this past cycle however, is that there is a huge amount of capital chasing relatively few good ideas.

Since 2021, there is clearly a surplus of private market funding and shortage of “Initial coin offerings” via direct listing or Launchpad. As an example, Binance only listed 15 tokens via direct listing and launchpad this year. We should note that some of the most traded coins or tokens on major centralized or decentralized exchanges are usually not VC-backed, like Dogecoin and Shiba for example.

Today, US venture investors are sitting on $290 billion. The massive liquidity injection into capital markets over the past three years has not only inflated the public market, but the private market as well. Looking back at the dotcom crash, Amazon’s stock price fell 95% following the burst, however, the inflated valuations in primary markets tend to stick around for a while.

We believe the crypto industry is still in the early stages of its development, with a lot remaining to be built still. Venture capital is essential in smoothing cyclical forces and supporting builders in market downturns. The most successful tech companies were funded during and after the tech bubble burst. As investment managers, it is also crucial to take a wholistic approach, and be extra cautious of a “bad vintage year”.

The reason we’re named Smrti Lab, instead of Smrti Capital/Hedge Fund, is because of our belief that the best mental model for crypto investments is to stay nimble and flexible, so that we can react to inexhaustible varieties of hypothesis and results. Many assumptions will likely be wrong or fruitless, however, we intend to act nimble in order to size bets and learn from the mistakes.

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