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