Global Frictions, SDR and Massive Gilt Trip

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In This Report…

• Global Frictions to Remain High, Digital Assets a Good Hedge… Digital asset secondary market prices remain resilient and primary market investment activity is suppressed but is active. Facing geo-political frictions, the liquid digital asset market; i.e. BTC and ETH, ‘punches well above its weight’ within a portfolio hedge context given the skew towards ‘national sovereign neutrality’.
• The UK Gilt Trip Turmoil and Japan’s FX US$ 30bn Interventions provides supportive data-points for alternative portfolio allocations. Additionally, another fundamental long-term support for liquid alternative market allocations, Japan’s governing body that deals with crypto assets plans to further ease crypto laws in the country.
• Monitoring Sector Flows… as a direct consequence of digital assets moving into the mainstream, it has never been easier to move investors’ asset allocation between traditional and digital assets. We see a slow bleed in liquidity within the public stablecoin market, likely in direct competition that higher core (G4) interest rates have versus alternative markets.
• IDEG’s Asset Management Team Aim to Uncover Strategies to Generate Stable Income… Innovation continues during bear markets. DEFI protocols, with lower costs, can help generate yield whilst in a sideways / low vol trending market.
• ?Kakao co-CEO Resigns After Mass Outage… after a fire at a centralised datacentre disrupted services for its messenger’s 53 million users. Blockchain technology, with its decentralised and non-censorship aspirations at its core could have help to mitigate against this single point of failure. Our sister company, Fundamental Labs, aims to deploy assets into such infrastructure to enable and realise a Web3 future, sooner.

Global Frictions to Remain High, Digital Assets a Good Hedge…

The digital asset market has come a long way. Growing as a response to the 2008 Global Financial Crisis to now becoming a possible digital alternative to current global sovereign instability and frictions. ?Sovereign GDP growth outlooks are set to flatten alongside increasing global frictions. Further, as governments attempt to outmanoeuvre each other we should expect drastic changes in policy. Additional outright monetary, fiscal and political experiments are not off the table, yet.

IMF’s Special Drawing Rights (SDR) is neither a currency nor a claim on the IMF. Rather, it is a potential claim on the freely usable currencies of IMF members. Exhibit A shows the digital asset market may be small compared to the major sovereign reserve currency markets but its growth potential, supported by Web3, likely offers a material alternative opportunity to hedge against increased frictions. Blockchain (DLT) is driven by underlying decentralised communities that retains their own unique network sovereignty and are relatively neutral to sovereign nationalist crosswinds.

Both users and investors, unwillingly towed along with nationalist trends, could push the marginal person to vote with their feet (Russians males fleeing military mobilization) and wallets (investors) to allocate to liquid digital assets, untied to sovereign effects. Exhibit B reflects that digital asset have recently had lower risk and stronger resilience to macro headwinds while Exhibit C, incoming VC interest supports views for an outright secular allocation for a portfolio hedge, unimpeded by sovereign frictions. This will likely yield the ‘biggest bang for buck’ versus short term tactical trades within crypto markets themselves, e.g. Sell Calls, Buy Put yield strategies in the longer term.

UK Gilt Trip...

The UK is in midst of major tumult and uncertainty. Current PM, Liz Truss, ousted after just 6 weeks in office tiggered a financial tsunami with her proposed unfunded tax cuts. Exhibit D shows that GBP / USD FX markets, a reflection of deep selling of the UK Gilt (bond) market, reached historical levels of uncertainty and under extreme pressure from a hawkish market. There was almost a collapse of the UK Defined Benefits pension fund market, only offset due to additional intervention by the Bank of England (BOE). Now, Rishi Sunak, prior finance minister, has been appointed at the new PM. He has a tall task ahead. In our view, uncertainty in the ‘old empire’ has never been greater. Unnerved investors are actively seeking alternative asset allocations to mitigate the current environment.

Japan - Land of the Rising Intervention…

On October 21, the yen exchange rate once fell below 151.9, a new 32 year low, but recovered to above 146. The Bank of Japan (BOJ) bought at least US$ 30bn to prop up yen, the second time Japan has intervened since September 22. One of the main concerns of the market now, as the "largest U.S. creditor" with $1.2 trillion in U.S. debt on book, Japan will likely fund JPY FX support by selling U.S. debt, leading to a negative global feedback loop with a further rise in U.S. bond yields. Finally, the Japanese rules around crypto are likely to loosen. The Japan Virtual and Crypto Assets Exchange Association, the governing body that deals with crypto assets in Japan, released documents of plans to further ease crypto laws in the country. We see this as another fundamental point to positive on digital asset markets for the longer term, giving local Japanese investors access to hard currency digital markets.

Slow Bleed in Public StableCoin Market…

While remain optimistic for the long-term allocation for investors into digital assets, there are challenges that remain. We keenly monitor new money flows into the digital asset sector. One way to monitor is to look at dedicated fund flows, which on a YTD basis, has remain intact. Another, more direct way, is to monitor the public stablecoin market (Exhibit E) which, unfortunately, continues to show a short-term decline in market capitalization over the last few months, indicating a withdrawal of liquidity from the sector, while of BTC and ETH remain rangebound in price.

We put the decline in stablecoins down to a general lack of yield opportunity compared to core (G4) interest rate markets. This is a direct double-sided issue of mainstream adoption and moving between TradFi and Digital Assets has never been easier.

IDEG’s Asset Management Team Aims to Uncover Strategies to Generate Stable Income

Innovation continues during bear markets. Exhibit F shows the payoff of a example DEFI protocol, with lower costs, that can help generate yield in a sideways / low vol market. The highlighted protocol ‘CRAB’ strategy earned in 14% (in USD terms) and 37% (in ETH terms) since V2 went live in late July. This is an automated DeFi strategy that performs best in sideways markets. Based on current implied premiums:

• CRAB would be profitable if ETH moves less than approximately?5.12%?in either direction between 2-day hedges.
• CRAB hedges approximately three times a week (on MWF).
• CRAB aims to be profitable in USD terms, stacking ETH if price drops and selling ETH price increases.

Now, if the CRAB Strategy falls below the safe collateralization threshold (150%), the strategy is at risk of liquidation. Rebalancing based on large ETH price changes helps prevent a liquidation from occurring. The implied premium which users deposit at impacts their profitability. Depositing at a high premium increases the likelihood of profitability.

USER BEWARE: While CRAB smart contracts are claimed to be audited by Sherlock (an on-chain auditing firm), smart contracts are still an experimental technology. Additionally, investors need to remain vigilant with respect to custody and hack risk.

?Finally, we see this as an example of how investors can harness the complexity of the nascent options market within DeFi format. In our view, this type of product later versions will be more popular where DeFi investors seek stable yield income.

Kakao co-CEO Resigns After 47 Million User Outage

KakaoTalk, an equivalent superapp of Wechat (China) and GRAB (SEA), is the most popular messaging app in South Korea. It has over 47 million users within the nation’s 51.7 million population. The app is also used by government officials and businesses, including banks, ride-hailing services and various payment players.

The CEO resigned after a fire at a centralised data center which led to a mass outage and disrupted services for its messenger’s 47 million users worldwide. Kakao’s slow recovery process was caused by the company’s lack of owned server infrastructure and “high dependence” on the centralised SK C&C data center, which caught fire. To add insult to the situation, Kakao also didn’t have a well-distributed backup system.

Now, Blockchain and Distributed Ledger Technology (DLT), with its decentralised nature and non-censorship proof aspirations, core to limit single points of failure, could have helped to prevent this type of situation. The blockchain protocols and supporting infrastructure allow computers in different global locations to propose and validate transactions and update records in a synchronised way across a network. This could have allowed Kakao users to possibly have degraded utility and speed of the service but mitigate a complete network outage.

Through our sister company, Fundamental Labs, one of the longest running venture capital investors in APAC, the CTH group continues to believe that investing in new infrastructure and bringing the reality of Web3 and digital assets forward in time.

Currently, attractive flattening of valuations allows investors to see which projects are truly game changing in nature. We welcome conversations to hear what investors are thinking about for the future.

Other Crypto News

• On October 19, Binance entrusted its holdings of about 13.2 million UNI to a wallet it controls. Binance Wallet became the second largest entity in UniswapDAO by voting rights, and now has 5.9% of voting rights, second only to 6.7% of the voting power in a16z. It is unclear if and how Binance has plans to participate in the governance system.
• On October 21, stablecoin DAI issuer MakerDAO is voting on a new proposal, “Maker Improvement Proposal 81,” which proposes to transfer roughly $1.1 billion in USDC to Coinbase Custody to earn yields, according to MakerDAO, About $15 million in annual income can be earned by transferring assets to Coinbase.
• On Oct. 22, according to Bank of America, Bitcoin’s movement relative to other assets could indicate that after a period of trading largely as a risk asset, investors are seeing it again as a safe-haven asset. The 40-day correlation between BTC and gold is around 0.50, up from around 0 in mid-August. Although BTC has high correlations with the S&P 500 and Nasdaq 100 at 0.69 and 0.72, respectively, they have flattened out and are below their historical levels a few months ago.
• On October 22, Cosine, the founder of SlowMistSecurity, tweeted that the official Twitter of Gate.io may have been hacked. Hackers sent phishing messages to trick users into visiting gate[.]com. Once "Claim" is clicked, the eth_sign signature phishing will appear, which may lead to the theft of related assets such as Ethereum.
• On October 22, some community users reported that their FTX account had more than 5,000 "crazy" transactions on the evening of October 19, and the account assets of $1.6 million were close to zero, including more than 10 bitcoins, hundreds of Ethereum and Thousands of FTTs, etc., were all stolen by trading small currency DMG pairs. The later feedback was that the API key was leaked due to the phishing website disguised as FTX's auxiliary trading tool 3commas.

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