Global Marcroeconomics
Let’s start with the big picture.
There has been tremendous reduction of wealth in 2022. A lot of this has to do with the reversal of easy monetary policy. In the U.S. the Federal Reserve is withdrawing liquidity and reducing M2 money supply.
Across asset classes, there has been no safe place to hide in 2022. Most asset have negative returns, with the exception of energy stocks and a few value stocks with strong cash flows. This shows the market sensitivity to discount rates. Some assets with long-maturity cash flows, like tech stocks (NASDAQ) have particularly come under pressure.
There is a clear common factor across markets in 2022, which is monetary policy. The Federal Reserve has been extremely aggressive in tightening. We believe this is due to a fundamental policy error in 2021. The Fed was late to recognize the growing inflation problem.
Capital will be more scarce as financial conditions are tightened. We believe that this will be a severe drag on growth.
Even before the monetary tightening, growth was slowing. This will likely transfer in lower cyclical inflation. However, “supply side” inflation might continue to persist, as monetary policy cannot address these issues.
Our view is that inflation will persist above the Fed’s 2% target. Inflation may have peaked, but will likely remain structurally higher going forward. We expect roughly 4-5% inflation in 2023.
There is a toxic mix emerging for policy makers of high inflation, declining real incomes, and slowing growth. Consumer confidence has crashed.
The employment market has remained relatively strong. Consumption patterns indicate that the consumer is spending their excess savings from the pandemic and adding more debt.
Here are our takeaways:
Crypto Macro & Web3 Fundamentals
Over the past two years, the correlations between Ether and Bitcoin with traditional assets like the S&P 500 have increased. While many view this as a drawback, that crypto cannot hedge against other risk asset classes, it could actually be a sign of further integration. We view this as a maturation of the crypto landscape. Crypto might be emerging as the 5th portfolio asset class, in addition to stocks, bonds, cash, and real estate.
Crypto is following a familiar market pattern. Flight to quality, as the market cap for the collateralized stablecoin (USDC) increase after the Terra collapse. Liquidity premiums are also repricing as shown in NFTs. Even blue-chip projects like Bored Apes have declined significantly. Both of these trends are very common historically in traditional markets as well.
There has been a massive influx of VC and private capital in the crypto ecosystem over the past 2 years. This suggests a potential price and valuation floor across the ecosystem. Many private capital allocators take a long-term view, so this could help support many projects during the down market.
In public markets where equity is traded daily, valuations have fallen significantly. Fintech has fallen the most. The environment has become more attractive for investors and acquirers (M&A), as valuations seem more reasonable.
In this market environment, macro factors have outweighed fundamental performance. However, there will be a strong divergence between token models that will survive and others that will not. New models will also emerge that are more durable.
Crypto activity has declined due to traditional and crypto macro events. Since Terra’s implosion, as shown in the left chart, TVL across top chains dropped 46%. As a result, it has strengthened the TVL ranking for Ethereum, which dominated 77% of top market share, up 14% since prior month. We expect to see more consolidations happening this year and beyond.
When thinking of ETH and the macro view, it is important to differentiate between structural and cyclical views as it has been highly correlated with the market. From a structural perspective we are bullish. We find that the fundamental factors of ETH such as addresses, flows, TVL all have positive correlations and is supportive of ETH. This is evidence by the correlation matrix to the right. From a cyclical perspective ETH is also highly correlated with the market as evidenced by the orange box to the right. As we’ve witnessed, macro headwinds and geopolitical risk introduces systemic risk which impacts ETH. However, we believe much of it has been priced in though we are still cyclically cautious.
Traditional investors may find ETH attractive due to positive real yield, attractive valuation (a result of cash flows, dividends and buyback) and deflationary supply. It also will have an ESG element where it will be 99% more efficient in energy consumption relative to PoW.
The key takeaway here is that over the last year, institutions were net buying Bitcoin and net selling Ethereum. Overall, institutions collectively purchased $506M Bitcoin and sold $357M Ethereum.
These charts are a visual representation of Ethereum and Bitcoin activity on centralized exchanges. Net inflow (green) signals that users are sending their assets to an exchange with the implication that they are selling the asset. Net outflow (red) signals that users signals that users are taking their assets off of exchanges with the implication that they are holding the asset. This behavior is quite different than the data shown on the previous slide.
Total value locked (TVL) in DeFi has declined significantly as the price of $ETH dipped and users withdrew funds for safety. A key implication is that DeFi user activity has dropped. NFT volume has also declined, however user activity remains consistent.
Conclusion and Takeaways
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