H1 2023 Investor Letter
Coral Investors,
As we cross over the halfway point of 2023, we want to update you on our current market thoughts as well as share updates with Coral. The past six months have been pleasant for crypto prices, despite macro headwinds and lingering insolvency concerns of existing crypto lenders. The SEC is actively targeting the crypto industry with?lawsuits against Coinbase?and?Binance?for selling unregistered securities.
Most recently, we have seen a wave of traditional finance players such as Blackrock and Fidelity file for spot BTC ETFs, giving the market a wave of optimism heading into the summer. The approval of a spot ETF for one of these players would seemingly pave the path for Grayscale’s GBTC product to finally convert into a spot ETF as well, notable given that this trust currently holds ~650,000 Bitcoin.
As it stands now, Coral is optimistic for the remainder of 2023. We expect the next six months to be similar to the previous six months, where traders are punished with choppy price action, but longer-term investors sit comfortably knowing that the worst of it is likely in the rear-view mirror. With most of the leverage flushed out of the system and several new vehicles to onboard substantial amounts of capital into the industry, we believe now is an excellent risk-adjusted entry point on blue-chip digital assets.
With BTC breaking $30K and ETH trading at $1920, we expect both to hit new 2023 highs over the next few months. Price targets are difficult with how often and how pronounced any single piece of news can impact prices. In the middle of March, prices were significantly losing momentum, and it was only the banking crisis and the Fed’s announcement of the Bank Term Financing Program (“BTFP”) that spurred interest in BTC. Similarly, earlier in June, SEC lawsuits were pushing tokens lower until Blackrock announced its spot BTC ETF filing. The point is that at any given time, the trend can reverse, and the next move can accelerate quickly. The chart below illustrates how quickly BTC erased 65 days of slow bleeding.
BTC finished H1 2023 up 84.32%, with ETH underperforming at 61.79%. This is not surprising given the two narratives over this period: 1) higher expected inflation across the US with government intervention into the banking system and 2) BTC spot ETF applications from the largest financial institutions in the world.
Even though BTC has been leading the charge over the last six months, significant developments in DeFi have us excited moving forward. It is not uncommon that BTC dominance front runs massive 4-year bull cycles, typically kicked off the year prior to a BTC halving event (the next BTC halving is estimated to occur in April 2024).
The flows we have become accustomed to are BTC -> ETH -> altcoins. Most altcoins have continued to lose value against BTC and ETH this year, again unsurprising. Our thesis is that investors typically reallocate their BTC and ETH at elevated levels. This “new-found wealth effect”, as we like to call it, is amplified by a higher price in USD terms. The flywheel effect continues as prices increase and investors push further out on the risk curve.
We view the current landscape as an opportunity to research the most promising projects that will allow investors to accumulate ETH and altcoins. Q4 2023 is our target for the accumulation of specific altcoins, with the expectation that we can front-run the wealth effect prior to investors rotating their risk profiles heading into 2024.
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Digital Asset ETFs
In order to understand the potential implications of an approval of a spot BTC ETF, we must understand the history of similar products to date.
The most notable of these products are the Grayscale Trusts. In our opinion, these vehicles were the driving force that kicked off the most recent cycle and created a credit cycle that ultimately wiped out a majority of the well-known institutions in 2022.
Unlike a spot ETF, the Grayscale Trusts allowed institutional investors to subscribe to the vehicles in-kind at NAV, meaning an investor would deposit Bitcoin or Ether and receive a commensurate amount of GBTC or ETHE shares, relative to the NAV (or the value of BTC & ETH on spot markets).
“Savvy” institutional investors realized that they could subscribe to the trust vehicles at NAV and then sell their shares at a premium when they unlocked six months later. Some of the largest winners from 2017-2020 ran this cycle on a loop. As long as the premium stayed elevated, investors would outperform BTC, or they could short a proportionate amount of spot BTC and lock in the arbitrage on the premium.
It is important to note that retail buyers largely supported the premium, who found GBTC & ETHE as the only vehicles to access exposure to crypto markets in their 401k & traditional brokerage accounts. These investors were either unaware or did not care that they were paying substantially more for their exposure relative to the spot price, in hindsight, a very hefty fee for the convenience of a publicly traded vehicle.
As the market began to melt in 2020, this trade became very crowded, with firms like Blockfi and 3 Arrows Capital applying multiple leverage turns to amplify the return from the captured premium. With ever-increasing subscriptions, retail purchasing could no longer support the premium. This all came to a head in February 2021 when the premium turned into a discount, in the process the beginning of the unraveling of the aforementioned firms.
At its peak, the Grayscale Trusts amassed an AUM of >$30bn, impressive in its own right but still very small relative to ETFs of other commodities. Grayscale holds nowhere near the same distribution network or established relationships as a firm such as Blackrock or Fidelity. In addition, the Trusts traded on the pink sheets, and there are many attributes that are not investor-friendly (high fee structure, no staking yield).
Following the success of Grayscale, Canadian-based 3IQ launched similar vehicles and reportedly has $3.3bn in total AUM. Stateside, the US also has CME futures and recently approved liquid 2x leveraged BTC vehicles.
Under the overarching motto of “investor protection,” the SEC has stonewalled all spot applications to date. Their stance is that spot markets can be easily manipulated, which is ironic since futures and 2x leveraged products are significantly more prone to manipulation. Grayscale is suing the SEC to allow GBTC to convert to a spot ETF. With oral arguments in the case being heard earlier this year, many legal analysts believe that the SEC’s stance holds no merit; we agree with this assertation.
In summary, the path to a spot ETF has long been “the ultimate bullish catalyst” for the crypto markets, some might describe it as the holy grail. Each of the existing vehicles has significant drawbacks, whether it be the reputation of the sponsor, fee structure, or lack of access to larger sources of capital. Ultimately the scale of current vehicles to date is a fraction of what we anticipate a true spot ETF would look like managed by an institution with the size and client reach of a Blackrock or Fidelity.
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DeFi Landscape
Decentralized Finance (“DeFi”) remains the area within crypto with the largest total addressable market and conglomerate of talented developers. The last bull cycle resulted in a massive influx of funding, and while many of these projects ended up stagnant (or worse), several of these projects became the primitives for crypto capital markets (Uniswap, Compound, AAVE, 1inch, etc.).
The three DeFi narratives we are most bullish on are interest rate swap protocols, telegram/discord trading bot protocols, and option derivatives. Watching the progression of DeFi, which hit critical mass just three years ago in the summer of 2020 (referred to as “DeFi Summer”), illustrates the level of development iteration.
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Pendle Finance
Pendle?is an interest rate swap protocol that enables the trading of yield bearing products. It offers various options for DeFi users to manage their yield exposure according to their market expectations and investment strategies.
Coral was one of the core early users of Pendle. We structured trades in 2021 to lock in the deposit rates on USDC at the time, which were substantially elevated at the time given the demand for leverage within the crypto space. Throughout this process, we became friendly with the team at Pendle and have been constantly impressed by their ability to deliver new products to the market.
We sent out a newsletter in March 2023 called?On Coral’s Radar?which talked about some of the projects we were most excited about at that time. Pendle was at the top of that list given our bullish nature on the liquid staking derivative (“LSD”) narrative, which allows DeFi users to hold and earn a yield on a synthetic ETH token.
Pendle’s governance token increased by more than 4x since we mentioned it in our newsletter, and although we believe the PENDLE token has more upside for the remainder of 2023, we expect the rate of growth to fall in line with the overall market. Pendle has matured since the beginning of this year, now managing over $160M on its platform. The most recent price wick seen in the chart above stems from PENDLE being listed on Binance, which has historically been a short-term price peak and a top signal.
One of the features provided by Pendle is the ability to lock in current market yields. This is particularly useful when yields are expected to drop. For example, in late 2021, if a user anticipated a decrease in yields, they could lock in a fixed yield by purchasing Principal Tokens (PT). By doing so, they can secure a higher yield, even if the market yield decreases in the future.?
On the other hand, Pendle also allows users to long yield. In a bull market scenario with increased demand for leverage and higher yields on stablecoins, users can acquire Yield Tokens (YT), which offer exposure to the higher yields.?Furthermore, Pendle facilitates speculation on yield through the trading of PT and YT. When yields are high, users can benefit from buying PT, as they are cheaper and offer higher yields. Conversely, purchasing YT would be more favorable when yields are historically low or users expect them to increase before maturity.?
With the rise of protocols offering liquid staking services, where token holders can earn a yield on their staked ETH tokens, there is a growing demand for yield management and mitigating the fluctuation in staking rates. Pendle is well-positioned to benefit from this narrative due to its ability to cater to users looking to speculate or secure yields derived from ETH staking.?Pendle's utility extends beyond staking tokens. It can be applied to other yield-bearing tokens, such as GLP, an LP token that earns yield in the form of fees based on trader activity on the GMX perpetual swap platform. As DeFi continues to evolve, we can expect more iterations of yield-bearing tokens, which Pendle can accommodate.?
While other interest swap protocols are available, Pendle focuses less on lending protocols like Aave and Compound and more on yield-bearing tokens related to Liquid Staking Derivatives (LSDs) and LP tokens. This specialization and focus on specific types of yield-bearing tokens make Pendle unique in its offerings.?
Considering the increasing demand for yield management, the versatility of Pendle's platform, and its ability to cater to different yield trading strategies, it is reasonable to expect Pendle to become one of the largest protocols by Total Value Locked (“TVL”) by the end of 2024. As it currently stands, Pendle is the 52nd?protocol by TVL. The expanding range of yield-bearing tokens in the DeFi ecosystem further supports the protocol's potential for growth.
The charts below illustrate some of Pendle’s growth metrics:
The growth in token holders is a combination of speculative buyers in the token contributing to a 4x in price since early March and new DeFi users locking tokens on the platform to provide liquidity for yield traders and hedgers. The increased number of Pendle tokens locked up also contributes to a stronger than average price performance over the past six months. Equilibria and Penpie have been built on top of Pendle further preventing PENDLE tokens from hitting the market.
We forecast that Pendle will hold over $1B by this time in 2024 and be the largest interest rate swap protocol by TVL. As one of the largest sectors within traditional finance, it makes sense that interest rate swaps will continue to grow within the digital asset capital markets. We will continue to update you with new Pendle developments going forward.
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Unibot
Unibot?is the newest DeFi protocol on the block and we are very excited about its potential to generate revenue in a full bull market.
Unibot is a Telegram Trading Sniper that offers a seamless trading experience to both less sophisticated and more sophisticated traders. It addresses the needs of traders who spend a significant amount of time on Telegram to discover new projects and those seeking to optimize their execution and reduce costs associated with price impact and private transactions.
The platform's core value proposition lies in its ability to enable traders to conduct all their trades directly from the Telegram app, eliminating the complexities associated with interacting with blockchains.?As Unibot continues to integrate with additional blockchains beyond Ethereum and Arbitrum and as it integrates with other DeFi applications, its value proposition strengthens further. By expanding its reach and compatibility, Unibot becomes a comprehensive trading solution that can cater to a wider range of assets and trading strategies.?
Currently, Unibot is predominantly utilized by traders who focus on sniping the timing of new projects. However, it also serves as an effective tool for executing buy and sell orders using limit orders. Most projects that launch tokens begin with liquidity in Uniswap V2, where limit orders are not possible due to the price range (0, ∞). Unibot allows traders to execute limit orders seamlessly for these new token launches. This feature opens up new possibilities for traders who prefer to have more control over their trades and execute specific price points.?
Another unique aspect of Unibot is its ability to replicate the trades and returns of other traders with proven track records. This feature is particularly useful for traders who may lack the time or bandwidth to research and discover the newest DeFi projects extensively. By following successful traders, users can benefit from their expertise and potentially achieve similar investment outcomes.
领英推荐
Unibot recently entered into a partnership with Dopex, enabling Telegram users to place options trades directly from the Telegram app. This integration expands the range of trading instruments available to users, providing them with greater flexibility and convenience within the Unibot ecosystem. This is just the beginning of partnerships that Unibot is forming.
Rollbit is a platform that has gained much attention over the past few months. They offer services ranging from casino games and sport betting to crypto perps trading. Check out our analysis of Rollbit?here?from our Q1 2023 Investor Letter. Unibot has been hinting at a partnership with Rollbit and while we may be getting ahead of ourselves with such speculation, such a partnership would be enormous to generate bot fees. Let’s take a look at some of Unibot’s metrics below:
While Unibot has generated 1,689 ETH ($3.3M) in 1.5 months since launch, it is worth noting that almost 90% of those fees originate from UNIBOT token tax fees. This is not necessarily the metric that we are boasting about when talking about Unibot’s value proposition.
At the moment, trading bot fees are very low compared to tax fees, but to us, that does not matter. We are more concerned with future Unibot partnerships and the target market size that will utilize Unibot in a bull market. As long as Unibot users continue to grow, which is evidenced in the above Dune Analytics Dashboard, bot fees will continue to grow and others will speculate on the rate of growth of new and existing users choosing to trade with Unibot rather than directly trading on-chain. If this number strengthens, then tax fees are just an added benefit that accrues to UNIBOT holders.
We predict that Unibot will generate $1M per month in trading bot fees by the start of 2024.
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DeFi Options
Aevo?is another new DeFi protocol that specializes in derivative trading products. Aevo is primarily known as a decentralized order book for options, which is the first of its kind. Most existing DeFi option protocols are structured in the same way GMX is structured for perp contracts. Check out our?Q1 2023 Investor Letter?to see our breakdowns of the various option protocol classifications.
Aevo is structured as a hybrid orderbook where order matching occurs off-chain and trade settlement occurs on-chain. This allows the protocol to circumvent scalability concerns that fully on-chain option protocols must deal with, especially with an orderbook model that supports so many strike prices and expiration dates. Aevo also recently launched its OTC options that allow its users to trade many popular tokens such as SUI, ARB, PEPE, and LDO.
Although there is not necessarily a token that directly benefits from Aevo’s success, we are keeping an eye on RBN, the governance token of Ribbon Finance, since the team behind Aevo is the same team behind Ribbon. There could be a future where fees accrue to RBN holders, but we are not holding our breath. For the time being, we are just watching volume, and TVL on Aevo tick up. The fact that Aevo has a perpetual swap market alongside their option orderbook makes it an attractive venue for market makers to hedge positions. Aevo is the only protocol with an options and perp market on its platform. We believe it could serve as an alternative to centralized exchanges as people look to take control of their assets.
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On The Radar
Good Entry?is a new iteration of perps trading where traders are not liquidated by adverse price movements. Instead, traders can only be liquidated by time; while paying protection fees over time. It could be helpful to think of protection fees like an option contract premium but paying the premium over time rather than upfront. Of course, premiums decay quickly as expiration nears due to the theta component of the option whereas protection fees are more constant as a function of supply and demand in the underlying LP vault.
Let’s breakdown how Good Entry works: First, liquidity providers choose a vault to supply an underlying token into. For example, LPs can deposit directly into the ETH-USDC pool which is then distributed amongst four Uni V3 ticks. The trader then chooses a strike price and deposits collateral to borrow up to 10x the margin.
The trader pays funding for the strike price they selected which is displayed on the front end as hourly funding but is actually paid out on a per block basis. That funding is a combination of borrow fees and swap fees that accrue to the LPs in the vaults. If the underlying price surpasses the strike price, the trader may choose to close the protected perp position for a profit. The payoff for a long position would be the underlying price – strike price – fees paid. The chart below is an illustration of the process explained above.
Good Entry has been slowly increasing the capacity on their three live vaults: ETH-USDC, ARB-USDC, and BTC-USDC. The protocol holds $675K in TVL and will continue to increase the vault size in line with trading demand. The vaults are yielding 200-300% APR with about a quarter of it stemming from supply interest and swap fees. The remainder yield is subsidized in GOOD governance tokens.
We are excited about the potential of Good Entry. Using Uni V3 positions to facilitate option-like payoffs with low margin and high leverage allows users to increase the convexity of their winning trades. We will continue to update you on the progress of Good Entry going forward.
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Venture Update
We are continually running due diligence on new projects, though our rate of allocation to venture deals has slowed down from previous years. The following are notable updates on featured investments we have made since inception:
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HMX
We are happy to announce that we invested in?HMX, a perpetual swap protocol that builds on the best pieces of GMX and Gains Network (the leaders in on-chain leveraged trading). With this, we are active liquidity providers to help boost usage on the platform. We believe from the liquid side alone; we can take in 15-20% per year on fees and subsidized tokens.
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Maverick Protocol
We invested in?Maverick Protocol?in early 2022 at a $50M FDV and are happy to announce that it recently launched its protocol and token at $1B FDV, a 20x return for our investors. We are subject to quarterly vesting over the course of the next three years, and, depending on market conditions, are looking into different avenues to hedge downside risk and lock in a portion of the returns.
Maverick also raised an additional equity round backed by investors such as Founders Fund, Binance, and Pantera. Maverick is likely to wind up being one of our best investments and a potential leader in the next cycle.
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Formidium (formerly Sudrania)
Formidium is the preeminent fund administrator in the crypto industry, with an emphasis on serving funds that transact directly on-chain. We began our professional relationship with Formidium in early 2021, and they serve as the fund administrator on all of our investment vehicles. We have been impressed with how they have handled the process of an emerging asset class and have insight into how they extract and consolidate all of the data in the reporting process. In addition, many of our peers whom we respect also utilize Formidium and have had an excellent experience.
As they began raising their Series A in early 2022, we connected with their team and ultimately decided to invest. The fund administrator industry has seen a significant amount of consolidation over the past decade, and we anticipate Formidium becoming attractive to one of the larger traditional fund administrators as the industry continues to grow.
Of note, Formidium has significantly grown their ancillary service lines such as SPV management and tax preparation. In addition, Formidium is launching an allocation marketplace that connects institutional and HNW investors with funds that employ Formidium for fund administration services.
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Deribit
Deribit is the world's largest crypto options exchange, accounting for more than 90% of volume and open interest.?Options are an optimal financial product to hedge positions such as providing liquidity in an AMM.?They also allow speculators to take directional positions on crypto assets at a fraction of the cost of purchasing the underlying.?As the overall crypto asset class grows, we believe that options trading will become increasingly popular amongst both retail and institutional investors.
One of the key holders of Deribit equity became insolvent in 2022 and Coral was presented the opportunity to participate in a round of financing to buy out their equity share at a significant discount to the previous funding round. We immediately jumped on the opportunity to invest in this deal as it presents a unique opportunity to invest in a potential monopoly with strong cash flow and upside.
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Decent DAO
Decent DAO is an accelerator, venture studio, and open-source collective that supports developers who are contributing to decentralized projects. Decent DAO invests in DeFi founders and projects that are ambitious but could offer financial benefits unseen in the traditional financial world.?It offers diversified exposure amongst emerging DeFi projects such as Portis and Sarcophagus.
We’ve been working with the Decent team in a number of respects for almost 2 years now and have the utmost respect for their organization. Ultimately, developing code and a strong team of developers is one of the scarcest resources in our industry, both of which Decent has built a strong foundation in.
Decent will be launching several DeFi projects in the second half of 2023, most notably an onchain credit protocol.
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Tea.xyz
Open-source technology is not a new concept; however, the radical move towards decentralization is accelerating the importance of adequate infrastructure for building out next generation companies. Tea.xyz prioritizes the developers contributing to this infrastructure layer by creating an incentive system that pushes developers to build and collaborate.
We stand behind Tea’s vision to capitalize on the potential of open-source development. We believe that developers will gravitate towards platforms that reward their hard work which is later utilized by other founders and developers building new companies.
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Conclusion
The digital asset industry is in a dichotomy at the moment.
On one hand, interest rates are considerably higher today than they were two years ago, and as a result, the crypto asset class has suffered for a majority of the time period since the Federal Reserve first began raising rates. If we take the Fed at its word, we will remain at elevated interest rates for the foreseeable future.
Over the next few years, rates may or may not come down as inflation stays sticky. Given that the situation has not arisen, it has yet to be seen if digital assets can flourish in higher interest-rate environments.
In contrast, we have seen large-cap tech equities push back to all-time high territories, typically an indicator that market participants are comfortable with paying a premium for growth. Additionally, with several of the largest financial institutions (Blackrock, Fidelity, etc.) in the world lining up their Bitcoin spot ETF applications, we may be on the verge of a massive inflow of capital, the likes of which this industry has never seen before.
Investing comes down to distilling all sources of market information and making the best risk-adjusted decisions based on your view of future events. We believe that the impact of potential bullish catalysts for the industry is at an all-time high, which is not yet reflected in spot prices.