Quiescence & Volatility

From: Ari Lewis and Sagar Rambhia
Date: 03/31/2018
Subject: Quiescence & Volatility

March 2018 recorded Fund I’s worst performance since launching mid-2017. We lost 45.4% during the month. The cryptocurrency market saw a broad sell-off attributed to retail investors covering tax payments for the year of 2017. Many investors amassed significant tax bills due to the substantial run-up in prices in 2017. Additionally, many investors did not know they had to pay taxes on gains made in cryptocurrency. This tax event left many investors scrambling to sell at the last minute.

Tom Lee of Fundstrat1 estimated $25B was owed in taxes for cryptocurrency-related gains. If this is true, $1 of outflow equated to about $20 in market capitalization decline. The sell-off highlights thin liquidity and the immaturity of the cryptocurrency markets. We do not believe capital outflows were significant compared to the total capitalization of the markets. We think these and other recent events are creating opportunities.

We continue to remain optimistic for 2018. We were net buyers in March and believed institutional money would soon pave the way for a resurgent bull market in 2018. One factor is particularly attractive. Although the development around custodianship tools progressed more slowly than anticipated, custodianship challenges show signs of resolution. We believe this will be a pivotal catalyst to inflows from pensions, sovereign wealth funds, and institutional investors poised to bring significant capital into the market.

Thanks,
Ari & Sagar

Regulatory Arbitrage

To: Limited Partners of Grasshopper Capital Fund I LP
From: Ari Lewis and Sagar Rambhia
Date: 02/01/2018
Subject: Regulatory Arbitrage

Innovation or Regulatory Arbitrage?

In the early days of the industry we believed we were entering a wave of innovation. The concepts of blockchain and smart contracts brought with them facinating transformative implications. For the first time, we could program money or manage records in a trustless manner. Recently, promoters in the market began speculating on how ICOs and security tokens could provide new pathways for investors to get in early on the next Facebook. We disagree with this premise, and it is not why we started Grasshopper Capital.

People are confusing innovation with regulatory arbitrage -- opportunities to exploit loopholes in regulatory systems and strategies falling outside the purview of regulators. Arbitrage also exists simply because governments are only now defining rules for who can and cannot invest in private companies and funds. At the moment, there is a standstill as investors, inventors, and regulators position themselves in their repective corners awaiting clarifying moves. Regulatory silence is temporarily creating unrest. In time, regulatory agencies will wrap their heads around the notion of programmable money and smart contracts and create regulations appropriate for ICOs and security tokens. At that point, the regulatory landscape will take another step along its predictable path to maturity.

Portfolio

Fear.

We believe the powerful motivator of fear is driving the recent changes and volitility in the market. We expect to see fear further create opportunities as each party acts with predictable irrationality to drive hightened volatility. We are modifying our initial long-only thesis to take advantage of long/short fund strategy opportunities. We are identifying products to satisfy this strategy as well as our criteria for adequate liquidity. We expect to begin implementing this strategy in the coming days while there is still significant unrest in the market.

We are looking forward to updating you as significant news, opportunities, or changes present themselves.

Thanks,
Ari & Sagar

Reflections

Subject: Reflections

To: Limited Partners of Grasshopper Capital Fund I LP
From: Ari Lewis and Sagar Rambhia
Date: 01/31/18

Reflections

New Years is always a time for reflection. For the cryptocurrency industry, 2017 was its coming out year. The cryptocurrency market cap increased ~3000% while Bitcoin increased ~1500%. For any asset class, gains like these are unprecedented. The big question is will it continue? We believe yes and the month of January reinforced that answer for us. Famous companies such as Kodak announced they were launching their own coin while asset management firms such as Direxion announced cryptocurrency ETFs. Founder’s Fund, Peter Thiel’s venture firm, announced a large position in Bitcoin and the founder of Ripple was briefly the richest man in the world due to the appreciation of Ripple’s value. These are all signs of cryptocurrency becoming mainstream. Robinhood also launched their own cryptocurrency brokerage to make it easier for people to invest in Bitcoin, Ethereum and Litecoin with no fees. Katy Perry put cryptocurrency on her fingernails and Mark Zuckerberg mentioned cryptocurrency in his annual review.

There still are many problems in the industry. You have tokens like TRON reaching a $14B network value with a stolen white paper and no product. Many publicly traded companies are adding blockchain to their name without any plans to actually be in the cryptocurrency business. For example, Long Island Iced Tea company changed its name to Long Island Blockchain. We do not know how a beverage company is going to use blockchain, but its shareholders were ignorantly elated when its stock was up +183%. We see federal regulators stepping in and warning against both companies that engage in pump-and-dump behavior as well as ICOs that are not registering as proper securities. Ultimately, we are optimistic for 2018 and think the bad actors that come with any budding industry will be sanctioned while pure-of-heart creators’ and their products will flourish. 
 
 Trading Positions

We decided to sell our entire Litecoin position. The decision rested on Charlie Lee, creator of Litecoin, liquidating his entire Litecoin position. We believe it’s important that someone who is quasi CEO of the cryptocurrency should have a vested interest in the cryptocurrency. In addition to this factor, we believe Charlie Lee has made no attempts to differentiate from Bitcoin and continues to promote Bitcoin despite it being a direct competitor to Litecoin.

Thanks,

Ari & Sagar

Wrapping up the year

Subject: Wrapping up the year

To: Limited Partners of Grasshopper Capital Fund I LP
From: Ari Lewis and Sagar Rambhia
Date: 12/31/17

Crypto is a new Asset Class

Exchanges and OTC desks have exploded with new interest from users and have provided necessary liquidity to the market. Over $10B in token assets are traded each day which will be critical as institutions prepare themselves for crypto exposure. Outside of the exchanges and their order books, transaction value for crypto is also increasing although there is inequality with correlation of returns and valuations with certain tokens. It is undeniable that assets are being traded at over 100x of transactional volume normalized for their circulating token supply. More thought needs to be given to true circulating supply versus perceived circulating token supply by understanding token distributions, and ownership.

Survivorship

There is a conflict that exists when buying crypto for the short versus long term. We at Grasshopper Capital are long term investors that look to minimize the tax liability for our LPs while outperforming key benchmarks such as Bitcoin. This is fundamental to the decisions we make as traders in terms of what tokens we trade. Our strategy to hold tokens rests on the assumption that we think it will be critical for the crypto ecosystem for the 2–5 years, or it will be critical to bridging the gap between traditional industry and blockchain by way of providing full institutional support. This needs to be moderated with valuation of the token, team behind the product, and network usage statistics as important metrics. Teams can be building fantastic products that users want, but what is currently undervalued [most are overvalued either by gross market cap (total token supply) or circulating market cap:liquidity ratio]. The search for dominance will continue as investors look to justify their purchase of currently overvalued digital assets.

The irony is that the gross inflation of the space will keep many early adopters of crypto afloat in times of turmoil. A company that raised $2–5MM in an ICO in 2015, 2016, or early 2017 in ETH or BTC will have seen their assets appreciate by several orders of magnitude. In fact, the assets raised may have appreciated to greater than that of the total market cap of the issued token at current prices. Most token sales raised in Ethereum, which has appreciated roughly +8000% YTD. Bitcoin has also appreciated over +1100% YTD not including the “dividends” paid by Bitcoin Cash and Bitcoin Gold. A $10MM dollar raise prior to the run-up would be $800MM in assets and $100MM in assets at today’s prices. It is important to remember that this space thinks in terms of crypto as the trading pair. 1 BTC == 1 BTC and 1 ETH == 1ETH. Amidst market volatility, this will hold true the most for community driven and owned tokens like Dogecoin- where participants are relatively price agnostic.

Prohibition — A Case of Deja Vu

In the era of the United States of current drug prohibition, we think that survivorship extends via example by alcohol prohibition in the 1920s. This phenomenon produced a criminalized industry that ran in so called “gray markets” with the social/labor capital keeping the new industry alive. Demand, Supply, and market makers. The same applies to current attempted prohibition in many government markets (e.g. China). It doesn’t solve the ultimate underlying problems of addiction. The idea has been extremely romanticized with marijuana prohibition in the United States which has now invited regulation. Lessons from incremental government regulation* combined with rising value of the asset class of marijuana companies provide indication that regulation, when it comes, will bring growth and capital injection into the space, and also provide for revenue streams for the government to build programs to help people fighting addiction. If you are not yet sold, we also have tobacco and firearms as example.

Constituents are addicted to the idea that there is a non-government backed, non-centralized currency that is uncorrelated to any asset. If governments choose to follow such programs of moderation and regulation rather than “cold turkey,” they will not limit the positive benefits that blockchain assets can have on their constituents and be left behind as the technology and development race continues elsewhere. Cryptocurrency is not about finance, or technology, it is a philosophy that decentralization distributes power back to the individual and representatives.

*State-based regulation for our foreign friends/investors

Crypto and the Public Equities Markets- The Search for Alpha

We have had a lot of discussions on crypto increasing risk of a portfolio, thus dissuading investment advisors from recommending exposure for their clients; however, putting 2–3% of a portfolio in crypto reduces risk as it is uncorrelated to the rest of the portfolio. After nine bullish years pushing the public equities markets to all-time highs, it seems prudent to add crypto exposure to all investors portfolios in 2018. The exposure is so small that the operational risk from self-custody is compensated from the alpha that it can provide. Institutional money will be the last money in and there is a conservative minimum of six months until this is expected.

I still don’t buy that it is the volatility of bitcoin that is keeping investors from investing in the space. It is that this challenges the way that people have transacted with each other both monetarily and otherwise. The Bitcoin protocol serving as a well-tested, dumbed-down, rock-solid, backbone network for monetary transactions. When the BTC monetary base gets much larger, volatility should decrease and it will serve as a good store of value and numeraire. For such a network, it is best to keep it as simple and single purpose as possible. The Ethereum platform is a decentralized version of Apps and The App Store. But it will enable far more applications than can be accomplished with centralized services. Ether is a fuel that is endlessly mined and burned. And it will be burned for applications, many of which we can’t yet fathom as they don’t exist.

Thanks,

Ari & Sagar

What Drives Growth of Cryptocurrencies?

Subject: What Drives Growth of Cryptocurrencies?

To: Limited Partners of Grasshopper Capital Fund I LP
From: Ari Lewis and Sagar Rambhia
Date: 11/30/17

An Opportunity to Invest in the Future

As managers of a hedge fund, our goal is to make money for our LPs first and foremost, but at times it is important to take a step back and realize the absurdity and craziness of the products in which we invest. In the month of November, Bitcoin traded past $10,000[1], which is insane considering every mainstream economist had doomed it to fail[2]. They have called it a bubble[3], scam, and Ponzi scheme[4], but we have now exceed a valuation for Bitcoin of over $100B USD. A financial product that is not tangible is more valuable than Twitter, Snapchat Wendy’s, and FedEx combined. It is an amazing feat!

When one thinks about money, there have few innovations that have transformed currency. People used bartering as a means to exchange goods. Pastoral societies used livestock, while the Romans used cattle and salt[5]. These were known as commodity money. The next evolution was metallic money such as Gold or Silver. Then finally we had paper money which refers to notes issued by the government or a central bank. We have seen changes in paper money, such as governments moving to fiat or people accepting credit and electronic money. However, in a time when we can instantaneously contact anyone in the world via email, why can we not send them money instantaneously as well?

ACH transfers are free, but take days; using SWIFT can take as little as 10 minutes, but costs $20. This is where we think cryptocurrency can truly derive value and be a global, low-cost, instantaneous payment system. This is why a $100B valuation is anything but a bubble; rather, it is an opportunity. An opportunity to invest in a protocol that could replace our retail and institutional payment systems.

Institutional Growth

Most growth in the cryptocurrency markets has come from retail investors. If the head of CALPERS bought Bitcoin, he would be fired. It does not matter if the investment returns ten fold. No one gets fired for buying IBM. This is especially true in a time when volatility is at historic lows. Large asset allocators are afraid to take risks; even more so, they are afraid to diverge from their peers. It is not about risk in an absolute sense, but risk in a relevant sense. The downside of being wrong outweighs the upside of being right.

One remains optimistic though: CBOE and CME remain poised to launch Bitcoin futures while one of the largest hedge funds, Man Group, announced it would buy them[6]. Genesis Group launched an investment trust to invest in Z-Cash and even JP Morgan might offer Bitcoin Futures[7] [8].

Much work remains to be completed on the underlying products though. One reason pension funds cannot buy Bitcoin is that they do not have many custody options. They can hold their Bitcoin on Coinbase, but there is significant risk because they do not control the private keys. They can store it in cold-storage, but we don’t not really see the head of CALPERS creating a risk program for key splitting, hardware wallets, and paper wallets. It would be funny to think that an investment can go up 100 fold, only to realize that the first year analyst you hired is in Brazil where he has a $10-million-dollar mansion and drives a Lamborghini. (We hear it is dangerous to drive nice cars in Brazil so he would probably still drive his Prius. We would also like to believe he is environmentally conscious).

Coinbase announced a product dedicated to institutional clients like pension funds to store their cryptocurrency[9]. The minimum is $10M, which for an agency like CALPERS is nothing. But who is Coinbase to them? They are not a Goldman Sachs, JP Morgan, or Bank of America. We think stakeholders would be skeptical of trusting them with their money.

Governance of Bitcoin

The Bitcoin2x fork was abandoned. Many cheered, some cried, but most new investors were just happily ignorant as the Bitcoin price went up.

It is easy to address governance in centralized systems. There are standard practices developed in public companies around corporate governance. Typically, you have a CEO who reports to a Board of Directors, then the shareholders vote on the Board of Directors, the CEO hires few delegates, and the few delegates hire employees under them (add a few layers of middle management for flavor). Such a system of corporate governance has worked since the Dutch East India Company (minus the occasional scandal) despite the principal-agent problem[10].

Bitcoin is a whole other animal. There are two groups of stakeholders: Miners and Users. A miner is someone who validates transactions and issues new Bitcoin while a user holds Bitcoin. Yes, a miner also becomes a user when they are given a reward. Bitcoin is decentralized so one miner cannot take over the system, and it is extremely expensive to cheat. A state actor, like China, could probably take over the system, but it would be nearly cost prohibitive. A user is typically an investor who wants the price of Bitcoin to go up and the transaction prices to go down. This poses a problem. Miners want higher fees so they can make more money and users want lower fees because they do not want to pay a lot to move their Bitcoin. Obviously, this creates conflict and breeds political and ideological battle. Here is the key difference between being a shareholder in a public company and being a user or miner of Bitcoin. You can take Bitcoin and fork it. Take all the things you like and keep them while changing all the things you do not like. It is too early to see if forking a cryptocurrency will have sustained value, but Bitcoin Cash (BCH) and Ethereum Classic (ETC) have both been top 20 cryptocurrencies and continue to increase in value. This is not to turn into commentary on the fork, but rather make people aware of the innovative solutions a stakeholder now has when in dispute.

Thanks,

Ari and Sagar

[1] https://coinmarketcap.com/historical/20131124/

[2] http://reason.com/blog/2017/11/30/bitcoin-joseph-stiglitz-crypto-outlaw

[3] https://www.theguardian.com/commentisfree/2017/dec/24/bitcoin-is-a-bubble-the-technology-behind-could-transform-world

[4] https://www.cnbc.com/2017/11/14/dbs-groups-david-gledhill-bitcoin-is-a-ponzi-scheme.html

[5] http://www.ancient-origins.net/history/salt-treasure-ancient-world-and-highly-valued-currency-roman-empire-006794

[6] https://www.reuters.com/article/us-investment-summit-man-group/man-group-says-bitcoin-futures-would-draw-it-toward-cryptocurrencies-idUSKBN1DE232

[7] https://www.cnbc.com/2017/11/21/jpmorgan-reportedly-getting-into-bitcoin-futures-trading.html

[8] https://www.forbes.com/sites/laurashin/2017/11/09/zcash-investment-trust-launches-expanding-investor-options-for-cryptocurrency-exposure/

[9] https://medium.com/@barmstrong/announcing-coinbase-custody-a-digital-currency-custodian-for-institutions-907166d7af85

[10] https://en.wikipedia.org/wiki/Principal%E2%80%93agent_problem

Happy Birthday Bitcoin

Subject: Happy Birthday Bitcoin

To: Limited Partners of Grasshopper Capital Fund I LP
From: Ari Lewis and Sagar Rambhia
Date: 10/31/17

Dear Investors,

We find it hard not to romanticize today, the 9th birthday of Satoshi Nakamoto’s “Bitcoin: A Peer-to-Peer Electronic Cash System.”[1] The new networks created from this thought, are now used by 3M users daily and growing.

Bitcoin Forks and Segwit2x

The majority of the month was largely marked with the bleeding of the altcoin market with prices falling and with the stabilization and appreciation of Bitcoin. There is endless discussion regarding the Bitcoin Gold forks and the upcoming Segwit2X fork. The utility and value of forked coins remain unanswered- yet Bitfinex is offering trading “futures” of Bitcoin Gold. Altcoins lost much of their BTC value vs USD value reflective of the BTC vs USD trading, given the momentum with bitcoin price and the aforementioned forks. For us, at Grasshopper, it brings to mind Vitalik wearing one of his famous t-shirts.

Overall, the rise of forks make us and other economists convinced that cryptocurrencies are akin to the rules of fiat currency with the ability of creation and control of money supply by a group of people. For as much as we like to remove the human aspect- behind every consensus and every computer is a human. The only difference is the manipulation or governance is done by a consensus of participants with a particular set of personal interests rather than central banks.

Political Events

China remains a black box when it comes to cryptocurrency and regulation with today marking the last day before exchanges needed to cease operations. Once a leader in cryptocurrency trading and mining, China’s share of global bitcoin trading went from more than 90% to below 10% according to data published by Coindesk and CryptoCompare.[2] It is still legal to own crypto, and mine the digital gold.

This goes to prove that no government or man (Jamie Dimon) makes or breaks the bitcoin market with us seeing healthy recovery and stability of Bitcoin.

Regulatory Impact

Zcash’s Investment Trust also filed a request with the SEC on Oct 25th that will offer a public listing similar to Bitcoin Investment Trust- a positive sign for ZCash.[3] This will expand the offering for institutional investors beyond Bitcoin and Ethereum Classic. Greyscale Investments and Barry Silbert are doing important work bringing cryptocurrency to institutional investors- and now expanding the offering into privacy tokens. We believe that short-term adoption of crypto will come through the utilization of privacy tokens.

CMEGroup, announced the launch of Bitcoin futures coming as soon as December 2017.[4] This will bring in major capital inflow allowing institutional and retail investors access to crypto. Institutional investors will favor such a product as it removes the operational risk around custody. This is the third exchange to launch Bitcoin futures including Gemini and LedgerX. ETFs, derivatives and futures will make bitcoin trading available to mutual funds and hedge funds and ironically introduce the idea of “hedging” into the space.

Thanks,

Ari and Sagar

[1] https://bitcoin.org/bitcoin.pdf

[2] https://www.cryptocompare.com/coins/btc/analysis/CNY

[3]https://www.sec.gov/Archives/edgar/data/1720265/000095010317010226/xslFormDX01/primary_doc.xml

[4] http://www.cmegroup.com/media-room/press-releases/2017/10/31/cme_group_announceslaunchofbitcoinfutures.html

Our First Memo

Subject: Our First Memo

To: Limited Partners of Grasshopper Capital Fund I LP
From: Ari Lewis and Sagar Rambhia
Date: 9/30/17

Dear Investors,

We are loyal fans of Howard Marks and think his memos are the industry standard for communication with investors. We hope our letters rise to the level of brilliance that he achieves with each of his memos.

China

Much of the volatility and downside is attributed to China. China announced on September 4th that they were banning token sales. One week later, China announced a ban on all cryptocurrency exchanges. The Chinese Yuan has made up the majority of Bitcoin volume. According to Bitcoinity, the Chinese Yuan represented 93% of total Bitcoin trades over the past two years; however, over the past six months, the Chinese Yuan decreased to 18.2%, with 54% of Bitcoin trades being conducted in USD. This reduction in dependency on Chinese traders has lessened the blow of Chinese regulations. Previous attempts at Chinese regulation show that it is extremely difficult for China to enforce restrictions of Bitcoin trading and usage. The Chinese government can make it difficult for the Chinese Yuan to be converted into Bitcoin, but we expect underground trading operations to pop up that will circumvent Chinese regulations. Otherwise, people can take a quick trip to Hong Kong. China has not indicated whether they will be regulating or shutting down OTC operations. OTC operations will most likely be regulated, but not shut down. Chinese miners are not affected by these regulations. China wants to prevent the flow of the Chinese Yuan leaving Mainland China. Miners are just selling BTC for another fiat currency and are happy to continue to see their operations thrive as they produce tax revenue and are a source of pride in terms of technological innovation.

Jamie Dimon

Jamie Dimon spoke at the Delivering Alpha Conference on September 12th. One of the topics he discussed was Bitcoin. Jamie called Bitcoin “a fraud”, “not a real thing”, and said, “someone is going to get killed”. These comments are without justification, and we are disappointed to see a leader in the banking industry making such a polarized statement about Bitcoin. While Jamie Dimon was making his comments, Michael Vaknin, Chief Economist of JP Morgan’s Asset Management firm was conducting a panel for their clients introducing them to cryptocurrency and cryptofunds. JP Morgan also has 40+ people working on a blockchain called Quorum. My favorite quote from their site is, “Wall Street Journal: JPMorgan Chase, led by CEO Jamie Dimon, is building a new system based on the Ethereum platform”. JP Morgan is literally advertising that Jamie Dimon is supporting this project. Some people will tell us that a private blockchain is different from a public blockchain and can exist without a token. We do not believe that private blockchains will succeed in the long run and that tokens (also known as cryptocurrencies are a critical part of blockchain). William Moyagar writes about the different utilities of a token — and the inherent value of tokenomics.[1]

From a PR standpoint, Jamie Dimon’s comments are very smart. They distract from the fact that JP Morgan’s trading revenue will drop 20%. Ultimately, Bitcoin and other cryptocurrencies are a threat to the current banking system, and it is natural for Jamie Dimon to speak against disruptive technology that poses a threat to his core business.

Celebrity Token Sales

What do Paris Hilton, Floyd Mayweather, and Luis Suarez all have in common? They are all promoting their own tokens. Paris Hilton is backing “LydianCoin” along with Gubaksh Chahal, a convicted felon. The token is being described as “a platform that wants to combine the blockchain with targeted, AI driven digital marketing and advertising services.” We are not sure if they used enough buzzwords. This trend is where our bullishness of cryptocurrency diverges. We are optimistic about traditional blockchain tokens such as Bitcoin, Ethereum, and Litecoin, but are extremely skeptical of most ERC-20 tokens, a token built on top of the Ethereum blockchain. We think there are some promising ERC-20 tokens such as Brave Attention Token, Funfair, and Filecoin, but most token sales will end up losing people money.

Thanks,

Ari and Sagar

[1] https://medium.com/@wmougayar/tokenomics-a-business-guide-to-token-usage-utility-and-value-b19242053416