Q4 ‘22 LP Letter
Dear Partners,
In Q4, the fund was down -15.0%, Bitcoin was down -14.3%, and the S&P was up +4.4%. Since inception, the fund is down -17.0%, Bitcoin is down -56.6%, and the S&P is down -8.4%.
“It was the best of times, it was the worst of times, it was the age of wisdom, it was the age of foolishness, it was the epoch of belief, it was the epoch of incredulity, it was the season of light, it was the season of darkness, it was the spring of hope, it was the winter of despair”
– Charles Dickens, A Tale of Two Cities
2022 was in many respects an awful year for crypto. One of the largest blockchains imploded, industry darlings were exposed as fraudulent, and even more went bankrupt. Both newcomers and crypto veterans were hurt. Most lost money, and some lost faith.
Yet, arguably the most important event since the launch of Bitcoin, the Ethereum “merge,” was successfully completed, laying the foundation for the next decade of growth of decentralized applications. The opportunists, fraudsters, and greedy were wiped out, a challenging but essential process that plants the seeds for sustainable growth as assets moved from the impatient to the patient.
Beyond the soap opera of the markets, the fundamentals are solid: Monthly active developers, a leading indicator of value creation in emerging technologies, grew 5% year-over-year, despite the 70%+ drawdown in prices. Ethereum users paid more than $4m in daily fees in the past few weeks to use the protocol, enough to remove tokens from circulation. The result is Ethereum holders owning a larger share of the protocol as tokens are “burned,” similar to a company buying back shares. (see Q2 letter for more info on the merge).
In my nearly ten years of investing in crypto, I’ve never seen a greater disconnect between fundamentals and sentiment.
How we’re positioned
The fund is nearly 90% invested, with a concentration in a handful of core positions and a long tail of smaller holdings. We’ve built core positions in Ethereum, CryptoPunks, Chromie Squiggles, and Polygon. Our long tail of smaller holdings have the potential to do much better as investments; however, their “cone of uncertainty” has a greater radius than our core positions, and the positions are sized accordingly. With the remaining ~10% of capital, we will be patient in looking for new, asymmetric opportunities.
A question I get often is: did we bottom? I don’t know. I typically refer the inquirer to The Illusion of Knowledge, a great memo written by Howard Marks that sums up my view on market forecasts.
“There are two kinds of forecasters: those who don’t know, and those who don’t know they don’t know.” - John Kenneth Galbraith
I do believe, however, that there is more upside in the market than sitting on the sidelines.
Solana update
The fund was spared the worst of the FTX bankruptcy by not having funds on the exchange, owning the FTT token, or lending funds to Genesis. We never had an account with FTX because the fund doesn’t actively trade, and their main value proposition was options. When the fund launched, we held some cash at Genesis through the Gemini Earn product for less than a week. As it became clear that Three Arrows and other lenders were in trouble, we recalled the cash immediately. It wasn’t worth the risk.
However, our holdings in Solana, a high throughput blockchain (approximately 4% of AUM) were collateral damage as the price of SOL fell 68% in the quarter. FTX and Alameda were early investors and large holders of SOL. FTX, Alameda and others put significant selling pressure on SOL as they tried to raise cash and stay solvent. Many projects and funds in the Solana ecosystems held their treasuries on FTX and had significant exposure to SOL, giving a black eye to Solana and its ecosystem projects financially and reputationally.
The fund tax loss harvested the position at the end of the year and bought back the majority of the position. Solana is bigger than FTX and Alameda, but it will be hard to recover. We hope this event will make the Solana ecosystem stronger and prove to be a small bump in the road in Solana’s long history.
Finding diamonds in the rough
We’ve built core positions in high-quality projects at distressed prices. The highest returns in crypto, however, come from being early to new projects. ETH was initially sold for $0.3, CryptoPunks were free to claim, Bored Apes were $300, and Chromie Squiggles were $20 to mint. These projects are often free, or low cost, and available to anyone to purchase.
We’re making venture-style bets in a somewhat liquid market. We’ll get more wrong than we get right. The investments that work should more than compensate for the ones that go to 0.
The investment criteria is pretty simple:
“Fair” token distribution (vast majority of float publicly available, minimal investor lock ups)
Attractive fully diluted market capitalization and token economics
Novel concept
High-quality team
It’s nice to have all of these, but in reality, there is incomplete information and “hair on the deal.” There are always exceptions to the rules, of course, but these filters are helpful when evaluating a potential investment.
The hardest part is letting these nascent investments mature. Early-stage projects are volatile. They can get ahead of themselves in the short term, but it’s important to be patient if you’re looking for enduring, decade-defining projects. Yes, you’ll find that you could have sold at a 5x profit in something that goes to 0 eventually, but you could miss the 100x. Charlie Munger likes to explain: “the first rule of compounding is to never interrupt it unnecessarily.” Said another way, let your winners run.
We’ve seen some success finding new projects with our investment in DigiDaigaku, which is up ~10x since our initial investment six months ago. Friendship Bracelets are a new investment I’m excited about and are up ~3x so far.
Friendship Bracelets
Snowfro, the artist of Chromie Squiggles (one of our core positions) and founder of Art Blocks, quietly released a new collection called Friendship Bracelets. Anyone who owned an Art Blocks NFT was eligible to claim two free generative art Friendship Bracelet NFTs, one for you and one to gift to a friend. The project is a token of appreciation from the Art Blocks team with the goal of spreading kindness and as a symbol of being part of the Art Blocks community. Each NFT comes with instructions on how to make the bracelet for a few bucks with materials easily found at the store.
You’re probably thinking, excuse me, what? In what world are digital friendship bracelets a sound investment? I thought the same at first. There is much more than meets the eye in this seemingly simple collection.
Novel
Viral - both digitally via the mint mechanic and in real life via the physical bracelets.
Easy to explain - as the new introductory collection for Art Blocks, it’s important that it’s easy to understand as someone new to crypto. Chromie Squiggles are a mouthful to explain, friendship bracelets are familiar.
Relatable status symbol - a friendship bracelet is easy to understand. It bridges the digital and the physical for generative art.
Fair distribution: Anyone who held an Art Blocks token was eligible. The holder base was targeted to generative art collectors and could not be gamed. Small holders received the same “airdrop” as large holders. 500 tokens are reserved for giveaways and in-person events. This marketing tactic worked well for Chromie Squiggles and is a great way to onboard people new to crypto and NFTs.
Low cost: Friendship Bracelets were minted for free by holders of ArtBlocks. Valuation is tricky in crypto for a host of reasons, but back-of-the-envelope math works just fine by taking the number of tokens multiplied by the cheapest item for a quick and dirty market cap. CNC’s average entry price was $191. While supply was determined by how many people minted their bracelets (roughly 60% of eligible wallets claimed their bracelets), we had a nice margin of safety with a market cap of roughly $2m to $8m, depending on how many tokens were minted. To put this in perspective, Chromie Squiggles market cap is ~$230m and CryptoPunks is ~$1b.
Team: Snowfro and the Art Blocks have a proven track record of success and operate with high integrity.
I tried to keep this memo brief, although I fear I may have failed. If there is anything you’d like me to cover in the next update, please let me know.
It may not feel like it, but for long-term investors, this is the best of times. It’s always darkest before dawn.
I wish you and your family a happy and healthy New Year.
