CAOF June Update – Brandon Elsasser
In June, the CAOF was estimated to be up 18%, Bitcoin was up 25% and the Bloomberg Galaxy Index was up 8%. June was the fifth consecutive positive month for the overall digital assets market. As we want to continue to stress, bitcoin and digital assets trade with more momentum and volatility than any other asset class we have seen, and June was no exception. For example, on June 26, bitcoin broke through $12,000 in the early hours of the morning, continued to climb to nearly $14,000 before falling in a matter of minutes back to around $10,500, which is around where it ended the month.
For the last few months we have been particularly focused on our performance relative to bitcoin, as we have said, “We believe if we are indeed in the early stages of a new bull market, it is possible bitcoin may continue to outperform more diversified portfolios such as the CAOF and the index in the short run. However, in the long run we are confident our more balanced approach will pay off and we will remain patient with our allocations as this process plays out. “
While this focus has paid off and we have benefited from a high exposure to bitcoin and bitcoin derivatives, at this time in the market we believe the time has come to begin to over allocate to the highest quality assets which have underperformed bitcoin of late. Therefore, at the end of the month we began reducing our exposure to bitcoin and increasing exposure elsewhere. In doing so, we are accepting the fact if bitcoin continues to dominate the rally, we will underperform bitcoin in the short run, however we are confident in this allocation decision in the long run.
We will delve into what has factored into this decision in more detail later in this newsletter.
Volatility in the Market and how we Navigate it
In markets, we believe volatility begets volatility, which to some can be a somewhat counterintuitive concept. We also believe the digital assets market is inherently more volatile than any other asset class than we have encountered. When you combine these two beliefs you can begin to understand the basis of the philosophy which drives the trading/allocation strategy of the CAOF. For a, actively managed fund like the CAOF, volatility leads to opportunity.
Due to these beliefs, in times of low volatility we are conscientious to not force trading opportunities and be patient. As an active manager, over trading an idle market can be a costly mistake. However, when the market starts moving trading opportunities present themselves frequently and it requires discipline and conviction to capture these opportunities amidst the volatility. The concept of the “market moving” can be quantified by examining the implied volatility of a market. June saw implied bitcoin volatility begin the month at 87%, peak at 135% and end the month at around 100%, it historically trades in a range between 60–90%, so even at its low points in June, it was at historically elevated levels. Elevated volatility is a market condition in which we thrive.
If anyone is interested in learning more about the conditions we are seeing or the trades we are making, we encourage you to reach out and schedule a time to speak with us.
News and Market Conditions
Federal Reserve Signals a July Rate Cut is likely, as Bitcoin seen to respond to Global Monetary Easing
We don’t often draw insights from the traditional financial markets to explain the movements in the digital assets market. While we believe there are patterns, correlations and conclusions which may be eventually drawn, we primarily believe that the digital assets markets is too immature to draw such conclusions with a any degree of conviction.
However, one trend which has emerged which is unmistakable is the positive correlation between global monetary easing and the price of bitcoin. To us bitcoin, has always been akin to gold in the world of digital assets. It’s programmatic supply scarcity, built in inflation controls and superior network security make it a store of value in the digital world. In the first half of this year, global central banks have been easing their monetary policy, through rates cuts, dovish rhetoric and quantitative easing in response to global political and economic tensions. This has culminated in a high likelihood of the Federal Reserve following suit with a rate cut in July. The effects of this global easing can be seen in relation to the price of bitcoin in the chart below.
Bitcoin was created on the heels of the financial crisis which saw an unprecedented period of global monetary easing as interest rates went negative in many situations due to quantitative easing, which attempted to spur inflation as the world recovered from an economic crisis. A large part of the design of bitcoin was intended to create a monetary system immune from these central bodies, in short to put the power to control monetary policy into code and take it out of the hands of human central bankers. As the world embarks on a new period of easy monetary policy it has been interesting to see bitcoin respond positively.
As we will discuss later, much of the digital assets space has lagged behind the recent performance of bitcoin. Bitcoin is perceived as the most secure and scare digital asset and its outperformance of less secure and scare assets makes perfect sense to us if a contributing factor is indeed global monetary easing.
Facebook Formally Announces Libra, its Proposed Cryptocurrency
For much of the last year major technology companies globally have been linked to reports of imminent launches of their own crypto currencies as the corporate world has become enamored with the intersection (if any) of enterprise blockchain and public crypto currencies. The crypto community has loudly voiced its opinion on just what actually is or is not a cryptocurrency and many believe anything centralized or permissioned simply doesn’t fit the bill. This is a technical, political and nuanced argument and simply a conversation we have and will not involve ourselves. For the sake of the conversation, let’s consider all public crypto currencies as well as corporate efforts such as Libra as part of a broader classification of digital assets. In our eyes, digital assets are assets that are native to the internet.
Libra, has a long way to go from white paper, to fully launched digital asset, especially on the political front as the project has drawn scrutiny from just about every regulator globally. However, Facebook has dedicated considerable resources and this month’s announcement has positioned it to be the first mover in a race towards mass adoption of digital assets. Many market pundits, both from the traditional financial markets as well as crypto markets have credited the Libra announcement for much of the recent rally seen in bitcoin. While it is impossible to isolate the impact of any individual piece of news on the market, we certainly agree the announcement has been positive for the asset class.
We see two predominant reasons that the Libra announcement is bullsh for the asset class. First, and most simply it is credentialing for mainstream adoption to have the public involvement of this caliber of companies. The majority of the world’s global consumers interact with many of these companies on a frequent basis and these companies will now be interacting with digital assets in a daily public way. Regardless of the origins and ethos of many crypto enthusiasts, this is a watershed moment for the mass adoption of digital assets.
More importantly, however, is the potential reach of Libra. Bitcoin, which has the most users globally of any digital asset, is estimated to have between 30–50 mm users. Libra is planned to be gradually embedded into Facebook’s many platforms which combined have over 2.4 billion global users, 1.2 billion of which are currently unbanked according to Facebook. Libra, is therefore poised to be the conduit which spreads the mass adoption of digital assets.
In the 2017 bull market there was frequent discussion of the concept of crypto on-ramps, which are exchanges or venues with simple, accessible user experiences that would serve as an entry point to the often fragmented and difficult to navigate asset class. Since then, no application has truly broken through as the easy gateway to crypto. Instead, much of the innovation has been around trading and storage for sophisticated participants. Libra, if successfully approved and launched, alleviates the need for an on-ramp as it will simply imbed digital assets in the user experience of already mass adopted products.
BTC Dominance
In the past, we have discussed the concept of bitcoin dominance, it’s impact on the digital assets market and how we use it to influence our portfolio allocations. As a brief refresher, bitcoin dominance is expressed as a percentage of bitcoin’s network value relative to the network value of all digital assets. Below is a chart from Coinmarketcap.com showing the level of bitcoin dominance since inception of the CAOF through the end of June. When bitcoin dominance is high, bitcoin is expensive on a relative basis to the other assets in the asset class and vice versa. As illustrated below, bitcoin dominance is nearing its highest point since the inception of the CAOF. The last time it was this high was right around the time bitcoin nearly hit $20,000, before beginning its descent towards $3,000.
So what does this mean to us as we construct our portfolio? Our strategy revolves largely around relative value driven re-allocation trades as we select portfolio weightings for our core positions. Many macro factors also influence our decisions, but broadly speaking when bitcoin is cheap relative to other digital assets we want to be selling more expensive assets and using the proceeds to over allocate to bitcoin and vice versa.
Many traders, investors and fund managers that we speak to in the space have struggled to perform relative to bitcoin of late. More or less, we hear the same thing from all of them, “bitcoin is sucking the air out of the room”. This sentiment is supported by the chart above. It is challenging for a diversified portfolio to keep pace with bitcoin during these periods, and largely due to our successful use of bitcoin options we have been fortunate to keep up.
The story is simple, bitcoin has led the way out of the bear market and the majority of other digital assets (often referred to as “alt-coins”) have lagged. Historically, this market action is not uncommon. At this point in time a historical overallocation to alt-coins and under allocation to bitcoin would have proven the correct move as bitcoin dominance has retracted from its peak in the past.
But , is this time different? Has the burst of the ICO bubble done irreparable damage to the altcoin market? Is there some new institutional demand driving bitcoin higher that won’t ever trickle down to altcoins? These are concerns we reflect on daily, and the answers to these questions will reveal themselves over the next few months.
We are pleased with the CAOF’s performance in the early stages of this bull market, both quantitatively relative to bitcoin and the Bloomberg Galaxy Index, but also anecdotally from speaking to our peer’s about their recent performance. That said, we do believe we are approaching a point in the cycle where a bitcoin underweight makes sense and in the last few days of June have increased our exposure to what we believe to be the highest quality alt-coins, in particular ethereum. This decision has nothing to do with the fundamentals of the market or any particular asset, it is driven purely by the market’s microstructure, cycles and psychology.
Articles
Below are some additional articles from the past month we wanted to pass along.
Short positions in CME BTC futures
NY Times on Libra
More on Libra from the NY Times
WSJ On Libra
KIK Messenger vs The SEC
Forbes on Volatility
This PDF may have included some information about the CAOF and cryptocurrencies in general. This information is confidential, and by opening the attachments, you acknowledge and agree that you are obligated to keep the contents confidential and not transmit or forward it to any other person. Performance estimates are subject to future adjustment and revision. The information provided is historical and is not a guide to future performance. Past performance is not necessarily indicative of future results. Any decision to invest must be based solely upon the information set forth in offering documents furnished by Victoria Capital regardless of any information investors may have been otherwise furnished. This is neither an offer nor solicitation for the sale of a security.
Published at Wed, 10 Jul 2019 15:57:20 +0000
