Konza Capital Letter #2: Contagion Edition
It's probably going to get worse before it gets better.
A Search for the Bottom
Not unlike a road trip with young kids, this cycle’s search for a market bottom seems like a never-ending series of asking, “Are we there yet?”
Crypto has experienced greater capitulation by market cap this cycle than in any previous one. While in one sense this is a marker of the fact that the market itself is now much larger than it used to be, in another sense the despair feels even larger as there are now more eyes watching the industry stumble than ever before. The decoupling that everyone wanted to see from the broader markets has finally happened in the last month but unfortunately it was to the tune of a dramatic deviation to the downside. With the prevailing narratives and seeming ties to the broad markets still somewhat intact on a mid-term horizon, we must begin to assess what is likely to happen next. Many of us are left with the following two questions:
What can trigger a legitimate bottom for the asset class? And
What could possibly catalyze a reversal in trend to the upside?
One place that we can look for these answers is in the broad equity markets. For a financial market bottom to occur we typically first see P/E multiples contract to their historical averages. Then, earnings growth stalls and falls, leading to the obvious fallout of job and spending cuts as corporations attempt to stabilize their burn rates and proceed more cautiously until economic conditions improve.
Thus far we have achieved the former, as shown below by the S&P 500 P/E ratio plummeting back down to Earth.
Over the next couple of quarters we can expect to see corporate profits also begin to slip due to worsening financial conditions for the broad market and especially for the average consumer. In summary, crypto will have a hard time rebounding unless broad financial conditions improve.
Moving on to negative catalysts within the industry itself we can also see that some of the bad actors in the space have not done us any favors as market contagion has continued to spread.
Portfolio Manager Travis Kling of Ikigai Fund has perhaps done the best job of illustrating this through his monthly recap of major industry news. Here are just a few of the high(low)lights:
BlockFi loses millions and takes $250 Million loan from FTX. FTX now in talks to potentially acquire BlockFi for only an additional $25 Million and assumption of debt.
Voyager Digital nearly implodes due to bad loans to 3AC, receives $500 Million loan from Alameda Research.
SEC rejects Grayscale spot Bitcoin ETF and within an hour the Grayscale team files a lawsuit against the SEC.
CEO & CFO of Compass Mining resign amid allegations of missed utility payments to Dynamics Mining.
Court orders official liquidation of 3AC.
While the list goes on this should paint a fairly clear picture of how grim things are and how many dominoes are continuing to fall in light of the 3AC Fund blowup. And yet, despite all the pain felt industrywide, over $1 Billion was raised this month by a multitude of participants. With billions of dollars of undeployed dry powder still circulating and still being raised this is where the market bottom of 2022 differs from the one that occurred in 2018. While many of the projects in crypto will have to closely monitor their burn rates in order to survive, there are now well-established rails in place that can provide many of the most promising companies in the industry with a lifeline to develop even in the markets darkest moments. It is on this more positive note that we will change topics and review some other major industry news.
Articles of Note
EU agrees on regulations designed to clean up Crypto “Wild West”. While some aspects of this regulation offer promise, the short version appears that the EU is once again missing the mark with their regulation, not unlike the path they took at the beginning of the Dot Com era.
Euro-Zone inflation hits a record 8.6%, surpassing economists estimates and raising expectations for stronger hikes than initially projected.
Genesis Trading facing hundreds of millions in losses amid exposure to 3AC and Babel Finance.
Crypto companies refuse to learn from the past mistakes made by the industry as CoinFlex offers a $47 Million crypto equivalent of a junk bond with 20% APY to their investors in order to pay off an unmet margin call by one of their clients.
Mining Metrics
Lastly, a look at some of the core metrics that we closely follow to keep a pulse on Bitcoin mining.
Bitcoin Price: ~$19,500 -34% month-to-date.
Hashrate (amount of computing power used by the Bitcoin network): 210EH/s -2% MTD.
Hashprice (expected value of 1 TH/s of mining power per day): ~$0.09 down 33% MTD.
ASIC Prices (the computing machines used to mine BTC): -23% MTD.
With Bitcoin’s price hovering around the $20K mark this past week, the most notable story in this market has been the continued repricing of Bitcoin mining hardware. As Colin Harper, head of Research and Content at Luxor Technologies aptly said in a recent blog post, “Bitcoin mining ASIC firesales are here, and they will probably get hotter.” Depending on the positioning of certain companies within the industry, we are now approaching the all-time lows for certain types of hardware, creating a remarkable buying opportunity for those with capital still available to deploy. Notably, many of the industry participants that acquired hardware in 2021 paid more than double what entrants today would be paying, leading to a wide disparity of outcomes for market participants purely from a timing basis. Bitcoin mining remains one of the few industries where hardware can fluctuate in value as much as it does in large part due to a lack of competition on the supply side. This creates far greater uncertainties for operators as the quality of their entry price typically only becomes evident in hindsight. The parting consideration here is that Bitcoin mining hardware will likely someday move towards commoditization as the industry continues to grow, with sticker prices moving more in response to input costs and less to underlying commodity price.
We hope you all enjoyed with weekly wrap-up and we look forward to sharing better news in the weeks to come.
Until next time,
Artem