Q1 ‘23 LP Letter
Dear Partners,
This letter marks the end of the first year of the fund. And what an eventful year it’s been! We have weathered the collapse of one of the largest blockchains and the ensuing daisy chain reaction of bankruptcies that culminated in one of the biggest financial frauds in history. Despite the whiplash, our investors were steadfast. I am grateful for your trust and patience.
Performance
The table reflects results net of (after) fees relative to Bitcoin and the S&P 500. Bitcoin, the largest and most liquid cryptocurrency, is a helpful benchmark for broader crypto performance. The S&P 500 is a proxy for the opportunity cost of investing in US equities.
The S&P 500’s annualized average return is ~10% while Bitcoin’s is roughly ~150%. Bitcoin has done this with significantly more volatility than the S&P 500. Given the additional risk versus investing in the S&P 500, I hope the fund will significantly outperform the S&P 500. Bitcoin, on the other hand, is a much higher hurdle. While performance is trending in the right direction, patience will be key to realizing outsized returns. We have a portfolio of high quality digital assets that are in their infancy.
Crypto Regulation
TL;DR:
Blockchains require new legislation
Many countries are passing thoughtful legislation and recruiting entrepreneurs to become crypto hubs
The US, led by SEC chairman Gary Gensler, has turned hostile towards crypto and is regulating by enforcement while refusing to pass new legislation
Crypto is global. Jurisdictions that take the time to understand and embrace the new technology will benefit. The United States risks being left behind.
Regulation is top of mind in the crypto industry. The growth of the asset class and bankruptcies over the past year put crypto in the spotlight of governments and their regulatory agencies. Many countries have taken the time to understand the nuances of crypto and have made it a national priority to embrace it while recognizing the need for thoughtful regulation. In stark contrast, the US has become openly hostile towards crypto.
We’ve discussed crypto regulation for nearly a decade, but no guidelines exist in the US. To understand, we must look at what makes crypto unique. Blockchains enable two parties to transact without an intermediary. This wasn’t possible before. We relied on intermediaries to transact. These intermediaries, such as banks, brokerages, exchanges and marketplaces built our modern capital markets. Regulators created legislation to protect consumers and markets. And, it largely worked. However, with the invention of blockchains, the main tool in the regulators’ toolbox became obsolete. There are no middlemen to regulate.
Blockchains are global and constantly evolving. They do not recognize borders and are available globally. Since blockchains are permissionless, anyone can build on top of them. This property keeps them constantly upgrading and changing, making it difficult for regulators to keep up with the rapid innovation.
Sensible Regulation
Many countries understand that bBlockchains present an opportunity. Europe, UK, Hong Kong, Japan, Dubai, Brazil and more are passing sensible laws to embrace and encourage experimentation with blockchain technology while mitigating risks.
United Kingdom - “Cryptoasset markets continue to develop with increasing pace and complexity. But this is a nascent sector and as with any emerging technology, this brings risk as well as opportunity. Risk taking is a desirable part of the cycle of innovation and we wish to manage, not stifle, this”
Hong Kong - “To allow Web3 to continue its innovative path with prudence, we will adopt principles that place equal emphasis on both “appropriate regulation” and “promoting development””
European Union - “[MiCA] puts the EU at the forefront of the token economy with 10,000 different crypto assets…This regulation brings a competitive advantage for the EU. The European crypto-asset industry has regulatory clarity that does not exist in countries like the US”
These nations are taking a level headed approach. They’ve done their homework and understand why new regulation is needed.
US Hostility
In sharp contrast stands the United States. The US, specifically the SEC under chair Gary Gensler, has grown increasingly hostile towards crypto and refuses to pass new legislation. Instead, Gensler has decided to regulate by enforcement actions and emphasizes the Securities and Exchange Act of 1934 is sufficient to regulate this new technology.
To highlight the lack of clarity on how crypto is treated in the US, let's examine how the second largest cryptocurrency, Ether, is viewed by regulators.
2014 - 2023 - CFTC has repeatedly stated that Ether is a commodity
2018 - SEC director declared Ether to not be a security
2023 - NY Attorney General declares Ether a security
2023 - Gary Gensler refuses to directly answer if Ether is a security: “it depends on the facts and the laws”
Despite avoiding simple questions, Gensler continues to claim that the laws are clear in the US. Numerous examples show that businesses are left confused about how to operate in the US and have a cloud of enforcement actions hanging over their head. As a result, they’re moving their business offshore. Hester Pierce, an SEC commissioner, explains:
“Today’s Commission treats its basic approach to exchange regulation as something that must not—indeed cannot—be altered to allow room for new technologies or for new ways of doing business. Today’s Commission tells entrepreneurs trying to do new things in our markets to come in and register. When entrepreneurs find they cannot, the Commission dismisses the possibility of making practical adjustments to our registration framework to help entrepreneurs register, and instead rewards their good faith with an enforcement action. Today’s Commission treats the notice-and-comment rulemaking process not as a conversation, but as a threat.”
The EU agrees and explicitly promotes its new legislation in the context of US regulatory uncertainty: “The European crypto-asset industry has regulatory clarity that does not exist in countries like the US”.
Where do we go from here?
Crypto is a global technology. Countries that nurture the nascent technology will benefit from job and wealth creation, tax revenue and upgraded capital markets. As a US citizen, I find it unfortunate to see US regulators acting in bad faith and politicizing technology. The irony is that the US has benefited greatly from the playbook that other countries are using: set clear, fair regulations that allow businesses to flourish.
Why is crypto so polarizing in Washington? Rep. Ritchie Torres explains:
“Lack of education. Everyone seems to have an opinion on crypto…but few people can define it…yet everyone is rushing to give an opinion on the subject.
There seems to be an anti-crypto derangement syndrome that has clouded clear and rational thinking about crypto and much of it is rooted in ignorance. What you will find is the pro crypto members of congress are much more knowledgeable about the technology than the opposition.”
Crypto in the US is a generational issue, not a partisan one. As older politicians retire, the ignorance in Washington will fade. The courts will evaluate the legality of the SEC’s enforcement actions, while the benefits of blockchain in capital markets will become clear over time. With offshore crypto growth increasingly becoming a threat to US’s leadership in capital markets, the US will begin to recruit crypto entrepreneurs onshore.
Over the long arc of crypto adoption we will look back on this time as a speed bump in the road to global adoption. Those weaponizing the technology will be found on the wrong side of history. If, and when, the US becomes crypto friendly will be a major unlock for the asset class.
