Markets Roller Coaster
VeradiVerdict - Issue #76
Global markets have been in chaos. The Dow fell 3000 points, the S&P fell 12%, and the Nasdaq reached its worst day ever, some of the poorest performances in history. The coronavirus pandemic, the Saudi-Russian price war over oil, and abrupt policy by the Fed has made the economy extremely volatile.
Bitcoin, which is supposed to be uncorrelated with these assets, also fell significantly. Over 12 hours, it fell 50% to a low of $3600. It currently hovers around $5400, which is still a significant slash from its price of $8000 from nearly a week ago.
The fall in BTC price may be a reactionary move by investors in response to poor performance in other assets. Because of lost money, investors need to liquidate Bitcoin positions even if it’s not the optimal time to do so. Additionally, appetite for risk has tanked significantly, which particularly hurts “volatile” assets like cryptocurrency. Widespread use of borrowed capital to trade crypto, especially futures, doesn’t help either.
DeFi exchanges were also overloaded with the volatility; several oracles reported inaccurate or delayed prices, and high volumes of trading caused certain services on the Ethereum blockchain to go down or be backlogged. Maker DAO lost nearly $4 million with an emergency shutdown.
Private company investment is rocky too; many industries, like transportation, hospitality & tourism, and in-person commerce, have taken heavy losses with the evolving state of the pandemic. Other companies have shown their value in these trying times, particularly online services (like video conferencing, gaming, e-commerce, telework, etc.) that help people connect and continue with their lives & interests from home.
It’s unclear where the market is headed in the short term, largely because it’s unclear how this pandemic and broader economic trend evolves in the short term. It’s likely to get worse before it gets better, as more testing is available. Longer term, such a crisis may show the strength of having uncorrelated assets. Investors are likely to seek assets that will appreciate the fastest after such a drop –– while public equities are rate-limited by their companies’ earnings reports, productivity, etc., BTC can appreciate as fast as it wants. This may make cryptocurrency particularly appetizing as a recovery mechanism and a long-term hedge to these kinds of risks.
On the markets in the past week
Last week saw huge price crashes across the market. On Monday of this week, the Dow Jones Industrial Average fell nearly 3000 points, marking its worst performance since “Black Monday” in 1987 and its third-worst day ever. The S&P 500 fell 12%, hitting its lowest in over a year, and Nasdaq reached its worst day ever. The market’s overall performance has been painful, to say the least.
These trends haven’t even spared cryptocurrency. Bitcoin agonizingly fell to $3600 last Friday, which represents a 50% decline over 8 hours, the largest daily drop of the last seven years.
The market has been slowly recovering, partially in response to policies by the Fed to inject trillions into the market and also talk about giving Americans money directly. As a result, Bitcoin has also somewhat recovered; it’s currently hovering around $5400, but for context, nearly a week ago, it was $8000.
Such a drop brings into question one of the key propositions of cryptocurrency –– it’s supposed to be an uncorrelated asset, and yet, it’s followed a market trend of heavily decline.
What are possible reasons for the drop?
Intuitively, again, it’s likely macroscopic economic trends –– the coronavirus pandemic shattering business progress and investor confidence, the Saudi-Russian war on oil, abrupt fiscal and monetary policy by the Fed, etc. But these should primarily drive price movement in conventional assets, like public equities, gold, etc. Why is there a trend in cryptocurrency as well?
The most plausible explanation is that it’s likely a reactionary measure to poor performance in other components of investors’ diversified portfolios. When stocks crash, investors need to make up the money they lost somehow, so they might liquidate their Bitcoin assets even if it’s not the most optimal time to do so. Additionally, a lot of it is principled on investor confidence. When traditional markets are doing so poorly and are behaving so volatile, it’s unlikely that investors will look to what are traditionally considered volatile assets, like crypto; the natural reaction is to have consistent, safe strategies and not make big bets. A lot of evidence (based on UTXO timestamps) also suggests that most of the assets that were sold off were fairly new (around 6 months old or younger); that means that the sell-offs were largely reactionary, and there’s still a large community of individuals hodling Bitcoin for the long run.
Trader Eric Thies also hypothesized that this may be the first market cycle where most money is held by institutions, not independent investors. This naturally forces the price of BTC to be heavily correlated with traditional assets, because institutional investors will react to movements in traditional assets with trades in other assets like cryptocurrency; this then forces secondary price movements in Bitcoin.
Additionally, much of crypto trading on exchange comes from futures. Those traders are largely trading with borrowed capital, which has taken a huge hit in the past week. It’s only natural that Bitcoin would also take a hit in succession.
What about other sectors of crypto?
In terms of price, a lot of cryptocurrencies are stablecoins, like Tether for example. As expected, their price remains relatively unchanged because it’s pegged to the USD whose value has maintained even in this turmoil.
Broadly, however, the DeFi sector also took a major toll. Increased volatility made it incredibly hard for several DeFi services to report accurate, real-time prices for various assets; one Maker oracle even had a 20% price deviation.
Why did this happen? Given the volatility, tons of people tried to make transactions on services that primarily execute on the Ethereum blockchain. That degree of throughput slows down services. dYdX and Nuo both were unable to execute trades on Thursday and had to significantly adjust pricing to execute backlogged trades. MakerDAO, to compensate with the drop of ETH from $194 to $124 had a $4 million loss during an emergency shutdown, where a bot claimed the $4 million of Dai not backed by an underlying asset.
It wasn’t all bad though. The increased trading volume was hugely beneficial for some exchanges, like Uniswap which saw volume double to $53 million, and Kyber, which saw an all-time high 24-hour trading volume of $30 million.
Quick aside – what about investing broadly? Outside of crypto?
Times aren’t unusual for crypto –– they’re also strange for private companies, facing new market circumstances and new demands from consumers. With the propensity for social distancing, staying-at-home, and broader medical measures, tons of industries have taken and will take major losses: transportation, hospitality and tourism, sports, apparel/luxury goods, fitness, restaurants, etc. Even blockchain is likely to take a hit, because it serves no clear immediate value to users in these tenuous times and is largely dependent on investor capital, which may be less available at the moment. Overall, it’s likely that the valuation of many startups will decline noticeably.
That said, the pandemic has pointed out the clear need for and the importance of certain sectors and verticals: telework technologies (like messaging, communication, video conferencing, etc.), at-home leisure (like gaming, e-commerce, streaming services, food delivery, etc.), and pretty much anything that is deeply dependent on collaboration or engagement over the Internet. Most successful companies in this period are maximizing convenience for users, particularly in terms of connecting people despite a significant halt in in-person interactions and commerce. What this has shown, above everything else, is that online services are increasingly of value to modern consumers. Investors can target these sectors, and startups can seek interesting ways to adapt their products and strategies to these evolving needs, like introducing virtual and completely-electronic services.
Last week, I talked about strategies for companies at this time.
What’s next for the market?
I believe it’ll get worse before it gets better, looking a bit V shaped, 4-5 months to the bottom and then a slower 12-month-ish climb back to previous highs. I think Bitcoin will bottom with traditional assets, and then potentially benefit greatly.
Once the fear has left and folks are just frustrated with a slow recovery rate in traditional assets, Bitcoin will be well positioned to manufacture greed.
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MEET WITH ME
Walks at the park
Hi, I’m Paul Veradittakit, a Partner at Pantera Capital, one of the oldest and largest institutional investors focused on investing in blockchain companies and cryptocurrencies. The firm invests in equity, pre-sales/IEO rounds, and cryptocurrencies on the secondary markets. I focus on early-stage investments and share my thoughts on what’s going on in the industry in this weekly newsletter.
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