BACK TO INSIGHTS

The Node Ahead 6: Bitcoin City, DAOs and Validating Our Strategy

grain overlay

Good Morning!

On-Chain Analysis

Friday, December 3rd started off as a great day. Onramp publicly announced its partnership with Ritholtz and WisdomTree to launch a crypto index managed through the Onramp platform and the response was overwhelming. It’s amazing to see how far the company has come in just 6 months since we first launched. I was looking forward to catching my breath this weekend when all hell decided to break loose in the crypto markets. Bitcoin plummeted 18.6% in a matter of hours and most of the other cryptoassets got hit harder than that. So much for my relaxing Friday evening.

To understand what happened on Friday we must dive into the futures market, futures open interest, and the recently approved bitcoin futures ETF. Futures open interest is the total number of outstanding future contracts that have not been settled for an asset. Increasing open interest indicates that more contracts are being opened and additional money is flowing into the market. Back in early October, the SEC approved a bitcoin futures ETF. Despite being an inferior product to a spot ETF (as we covered at length in a previous Node Ahead), there was still huge demand for this product which led to a large increase in the bitcoin futures open interest over the last two months.

Source: https://www.coindesk.com/markets/2021/10/18/cme-sees-record-open-interest-in-bitcoin-futures-ahead-of-etf-debut/

Here is the thing about open interest: it can also serve as a proxy for measuring leverage. If there’s a relatively high amount of open interest there’s a good chance there’s a high amount of leverage in the futures market, as contracts are often purchased using leverage. So as the ETF came onto the market, leverage in the system had been building.

Now this isn’t inherently a bad thing except when sudden price movements cause a trader to fall below margin requirements and result in a forced liquidation. When longs are liquidated, they may be forced to sell, putting downward pressure on price. Because of this, liquidations tend to be self-reinforcing — liquidations trigger more liquidations. This can lead to liquidation cascades, which can sometimes cause large, sudden downward movements in price.

And this is exactly what happened starting around 8:20 pm PT on December 3rd. Liquidations accelerated as we moved down through the $50k price for bitcoin which resulted in $4.4 billion of futures open interest closed out in less than 3 hours. That was 21% of all futures contracts that were open at the time.

This is what a leverage flush out looks like. Now I know a 18.6% drop in a day seems like a lot. If traditional markets were to fall 18.6% in a day, headlines would be claiming that the world is ending. What I am here to tell you is this type of dip is not only normal, but also actually healthy. Perhaps some historical context may help.

Let’s start with the 2013 bull run. From January 1, 2013, to November 29th, 2013, bitcoin went from $13.22 to a peak of $1,158. Not a bad 8,660% gain in less than a year. However, that run wasn’t a constant up and to the right. During that time span, bitcoin had 5 separate drops greater than 20% before it hit its peak.

In 2017, we saw a very similar dynamic. Bitcoin grew 4,443% from May 2016 to the peak of the cycle in December 2017. Again, this was hardly a straight line to the top. There were 6 dips of greater than 20% prior to hitting a peak of $19,800.

So fast forward to Friday night when bitcoin fell 18.6% and is now down 28.7% from it’s all-time high. When viewed on a larger time scale, this type of volatility is very similar to previous bull markets.

The key thing to understand is that when price drops dramatically, it’s often useful to look at who is selling. We know this dip in price Friday was all due to leveraged liquidations because none of the long-term holders sold. Coin days destroyed, a metric we have covered in previous newsletters, is calculated by taking the number of coins in a transaction and multiplying it by the number of days it has been since those coins were last spent. CDD is an important metric because coins held for longer time periods are considered economically important and have a high number of accumulated coin days. When those high value coins are spent, it serves as a strong signal in the change in long-term holder behavior. However, Friday’s sell off did not show any significant profit-taking or movement by long term holders. In fact, CDD didn’t move upwards at all on December 3rd thus we know none of the selling on Friday was done by any long-term oriented holders. This liquidation cascade was essentially forced, non-organic selling of speculators and gamblers.

We can confirm this by also looking at Long Term Holder Supply which hasn’t changed since November 25th.

While liquidation cascades have dramatic effects on price, they don’t change underlying fundamentals. All the metrics that we have been covering in past newsletters from MVRV, long term holders, balances on exchanges, illiquid vs liquid supply, coin days destroyed, and more are still very bullish. Although painful in the short-term, leverage flushes are typically healthy over the long-term. Overleveraged flash crashes can help flush out some of the riskier contracts and reset to healthier levels creating a more solid foundation for building towards the next leg up. Despite the short-term price drop, the ecosystem should continue to grow over the long run as crypto gets adopted by more and more people around the world.

As always, the on-chain data is provided by Glassnode. If you would like to have access to the data yourself, you can sign up here:

Glassnode Sign Up Link

Good Validation of Our Strategy

The core philosophy behind Blockforce is that we are in the early innings of a technological and financial transformation which will result in the crypto industry outperforming every other asset class over the next couple decades. With that as our foundational assumption, the driving force behind Blockforce’s investment strategy is to position ourselves to capture the gains we believe the crypto asset class is likely to generate and compound that growth over the long term. In order to achieve that goal, the team has constructed a portfolio that is positioned to produce outsized gains, but also withstand the volatility and occasional market crashes that come along with this asset class. For example, in 2021 our fund has significantly outperformed a bitcoin passive strategy but has done so with less volatility.

If you are wondering how we simultaneously have been able to outperform a passive crypto strategy and do so with less risk, the answer comes down to the various strategies we use within our portfolio. Most crypto funds on the market today are long only and thus susceptible to downward market movements. However, at Blockforce, we integrate systematic algorithms and market neutral strategies in addition to our long only portion of the portfolio to give us the exposure we need to generate exceptional returns but still protect against the downside volatility.

Months such as November really highlight why we believe so strongly in our diversified investment strategy. While bitcoin was down about 7.2% in November and most of the crypto markets were down more than that, the Multi-Strategy Fund was up 2.8%. Even with our reduced volatility and risk, we have 3x bitcoin’s performance for the year (296% YTD for the fund compared to 96.2% for bitcoin). We continue to stress the advantages of including investment strategies other than long only and months such as November is where that philosophy really pays off.

We built this city, we built this city on BTC

The pace of innovation within the crypto industry has been breathtaking to watch over the last several years. First it was bitcoin, then Ethereum, and more recently DeFi, Web3, NFTs, gaming, new smart contract platforms, and Layer 2 scaling solutions have exploded in popularity. However, that innovation was always confined to the digital realm. Crypto innovation is now beginning to bleed into the physical world as city governments are leveraging crypto to reshape how cities might run more effectively.

Let’s start in Miami where Francis Suarez launched the first ever city coin aptly named MiamiCoin. City coins are a city specific cryptocurrency powered by the Stacks Protocol (which enables smart contract functionality on Bitcoin similar to that of Ethereum) that provides an ongoing crypto revenue stream for the city and its citizens. Citizens can mine MiamiCoin by simply running software on their personal computers and 70% of mining rewards are distributed to those miners while the remaining 30% is sent to a custodied wallet owned by the city of Miami. Users or city officials can easily convert their MiamiCoin into dollars anytime they like.

Because city coins are programmable, the hope is that over time we will see increasing utility built into city coins beyond financial speculation. In theory, cities will be able to build applications that provide local benefits, access control to digital or physical spaces, and give tax breaks to incentivize the use of their local token. For example, local businesses could offer discounts for those who pay in the city coin.

While the utility of city coins has a lot of future potential, we do not have to wait to see what financial impact city coins can have. MiamiCoin was launched in August and after only 3 months, has already generated over $21 million for the city of Miami. If you were to annualize that revenue, it would equal roughly one-fifth of Miami’s total annual tax revenue. The city of Miami can use its growing crypto treasury to benefit its citizens by funding new public spaces, improvements to infrastructure, hosting city events, recruiting businesses, and more. Suarez estimates the effort could generate as much as $60 million for Miami over the next year and ultimately “revolutionize” how the city funds programs that address poverty and other societal issues.

“When you think about the possibility of being able to run a government without the citizens having to pay taxes. That’s incredible

— Francis Suarez, Mayor of Miami

Suarez then took it a step further last month when he announced that the city would begin staking a portion of its MiamiCoin holdings and use the yield generated to pay a “bitcoin dividend” to all Miami citizens. As of writing this, New York and San Francisco are also rumored to be looking to issue a city coin and the mayor of Philadelphia announced they will be rolling out their own blockchain initiative for city government. I suspect they won’t be the last.

But city coins are nothing compared to El Salvador’s “Bitcoin City.” The country has already made bitcoin legal tender, accumulated a large supply of bitcoin to hold as a treasury asset, launched a bitcoin wallet that over 50% of its citizens have already downloaded and actively use, and built a 100% renewable bitcoin mining facility powered by geothermal energy from a volcano. Now President Nayib Bukele wants to build a fully functional city, complete with an airport, housing, shopping, restaurants and more that will be powered by the volcano that sits adjacent where they want to build Bitcoin City so that the city has zero CO2 emissions. (Quick tangent, if the airport code isn’t BTC it will be a giant missed opportunity…but I digress). But the best part of the experiment is the lack of taxes. Other than a 10% sales tax, there will be no other taxes for citizens of Bitcoin City. No income tax, no capital gains tax, no property tax, no payroll tax…you get the idea.

So, if there are no taxes, how is he planning on funding this new city? Through bitcoin of course.

El Salvador will be issuing a $1 billion tokenized bond that will carry a 6.5% yield for investors. Approximately half of the proceeds will go towards building the city while the other $500 million will be invested directly in bitcoin. The bond is issued on Blockstream’s Liquid network, a Bitcoin sidechain and will be the first in a planned series of bonds.

If you think this is incredibly risky, consider the fact that although bitcoin does have a lot of short-term volatility, it has averaged well over 100% annual returns over the last 10 years (it’s up just about 100% YTD for 2021). Should bitcoin continue to increase at even half or quarter of that rate on average for the next several years, the gains in price will be more than enough to pay off the bond and the interest when it matures. In addition, the 10% sales tax will be used for city maintenance and servicing the annual interest payments.

The bonds will be issued sometime in early 2022. One unique aspect of this bond is that its tokenized which means the bond will live on a blockchain and will be traded similar to how other cryptoassets are traded. In other words, this bond will be available to trade 24/7, 365 days a year. This is arguably the most liquid fixed income product to ever exist. If an investor wants to sell their bond at 2am on a Saturday morning, they can do that. That’s not possible in the traditional world where bonds only trade during business hours during the week and not on holidays or weekends. Forget everything else about the bond, we are witnessing the future of the fixed income market starting to develop.

For El Salvador, they are now able to raise money for the country without the world bank or IMF involved. In much the same way DeFi is eliminating middlemen in the finance sector, El Salvador is leveraging Bitcoin to bypass global intermediaries. Because there are no middlemen to take a fee or a cut, El Salvador gets to keep every single dollar invested in the bond. Furthermore, because El Salvador is free to issue this bond without any oversight, they are able to lower their cost of capital. Previous El Salvadorian bonds had been issued in the 9–10% interest range compared to the 6.5% interest rate they are issuing this bond at.

If you are interested in learning more about the details of the bond, there is a good interview by Preston Pysh with Adam Back of and Samson Mow of Blockstream who helped El Salvador issue this bond.

With a 6.5% yield and backed by an asset that more and more institutions are looking to gain exposure to, it’s possible there could be a lot of demand for this bond. Keep in mind that Microstrategy’s bitcoin bond was the single best performing bond in the entire global bond market. For all those capital allocators who have a mandate to invest in fixed income and may not be able to get direct exposure to bitcoin, this could be an extremely attractive option. Not to mention we are in an environment that most bonds have a negative yield from a real return perspective and by the end of this bond’s life, the return could be pretty lucrative if bitcoin continues on its current trajectory. If El Salvador is able to fill the whole $1 billion or even be oversubscribed like we saw with Microstrategy’s bitcoin bonds, you can bet a multitude of countries, states, and cities will be racing to do the same.

I’ve said for years governments will be some of the largest buyers of bitcoin. But I will admit, I never anticipated that they would be issuing debt to do so. What is interesting to note is that the global bond market is roughly $119 trillion in size (compared to bitcoin’s current $1 trillion market cap) so if we do get several sovereign nations and corporations starting to issue bonds to buy bitcoin, that will put tremendous upward pressure on bitcoin’s price.

Will Bitcoin City become the new model that all cities emulate, end up in financial ruin or somewhere in between? I have no idea. But I can’t help but to admire the pace of innovation and experimentation at a national scale in El Salvador. The world is changing right before our eyes, and I can’t wait to see what results from all of this experimentation.

Not to be OvershaDAOed

On November 18th, one of only thirteen remaining original copies of the US Constitution from 1787 went up for auction. Less than a week prior to that auction, a cohort of 19,000 people crowdfunded $47 million over the course of several days with the sole intention to win this auction. They organized under what is known as a decentralized autonomous organization (DAO). Although the group was ultimately outbid, the effort, largely spun up through Twitter and Discord, is a window into what a community effort could look and feel like in a Web3 universe, where shared ownership and transparency are guiding principles.

First off, what is a DAO? Decentralized Autonomous Organizations are governance structures that are fully decentralized, online, and global. Where traditional organizations have a board of directors and a structured hierarchy that is empowered to make decisions, DAOs operate without a central authority. Instead, everyone who joins a DAO gets a vote and decisions can only be passed if a certain threshold of voters agree (typically a majority). Thus, DAOs are self-governing. Because it’s built on a blockchain and leverages smart contract functionality, once a decision is voted on, the protocol executes that decision autonomously. In other words, DAOs are an alternative way to coordinate and collaborate around shared objectives.

As DeFi and NFT communities continue to grow in the coming years, how these decentralized protocols decide to manage collective decision-making in order to optimize funds and operations will become ever more important. Where traditional structures can suffer from significant coordination challenges, DAOs have the potential to drastically reduce these coordination efforts and enable participants to govern cooperatively almost entirely by code.

DAOs are already having impact on gaming, art, finance and more. UK-based Nexus Mutual, for instance, is the first decentralized mutual insurance incorporated as a cooperative and managed by a DAO. The policies Nexus Mutual issues currently only cover smart contracts, but the project aims to insure other types of risks which are normally covered by traditional insurance companies. HumanDAO is a social impact community using new crypto economic models such as “play-to-earn” to help those in poverty increase their income.

Which brings us back to ConstitutionDAO. It rallied a large number of people with a shared interest from all corners of this country in a very short period of time. It not only raised a lot of money but would have coordinated what to do with the constitution had it won the auction. Unlike many of the recent NFT projects, ConstitutionDAO did not require an investment in order to gain access to the community. It was open for anyone to join and sparked the interest of a whole new swath of people that had never interacted with crypto previously. According to Dune Analytics, 13% of contributors to ConstitutionDAO were using ETH for the first time. The same platform indicates that about 44% of people who have contributed to ConstitutionDAO had less than 40 historical transactions. ConstitutionDAO wasn’t for hard-core, long time crypto enthusiasts. It grabbed the attention of a whole new crop of people. Although it didn’t end up buying the constitution, it offered a glimpse into the role DAOs may have in the future.

“It is our sincere hope that this project will spark many others that take inspiration from the enthusiasm and accomplishments of everyone involved to use the power of web3 to make a positive impact on the world.” — Graham Novak, ConstitutionDAO core team member

Once the auction was over, something really interesting happened. Although the DAO offered to refund everyone their deposits (minus the gas fees) and the core team that launched the DAO announced they were stepping away, a large percentage of the community decided not to take a refund and instead try to put those funds to some other use. Although the DAO failed in its initial objective and the core team left, the fervor of the community has meant that ConsitutionDAO continues to live on. In fact, since losing the auction, the PEOPLE token (the token issued for the investment into ConsitutionDAO) has skyrocketed in price increasing as much as 2,650% at its peak.

Source: https://www.coingecko.com/en/coins/constitutiondao

I’m not sure anyone knows what is next for ConsitutionDAO or what they plan to do with the funds they raised. It’s perfectly reasonable to have serious doubts about the long-term viability of the PEOPLE token until all that is settled. However, that’s all beside the point. The real thing ConsitutionDAO showed us is the power of community and what can be accomplished when that power can be effectively coordinated using the DAO governance model.

In Other News

Fidelity Digital Assets will allow its institutional customers to use bitcoin as collateral against cash loans

Goldman Sachs is among a handful of tier one U.S. banks figuring out how to issue bitcoin backed loans.

Bank of America sees stablecoin regulation as catalyst to mass adoption.

Morgan Stanley added more bitcoin exposure in its funds.

Fintech giant Square has changed its name to Block in a move that reflects its shift in focus to crypto.

NFTs and crypto culture take over Miami as Art Basel goes digital.

How Paraswap is redefining how to conduct an airdrop.

Fold launches Pokémon GO-like game that rewards players in bitcoin.

Scaling Ethereum & Crypto for a billion users.

New Grayscale report says the metaverse is a trillion-dollar market opportunity.

Virtual real estate plot sells for record $2.4 million.

Metaverse land sales top $100m in one week.

NFT sales for 2021 are reportedly expected to reach $17.7B. NFT sales on the Ethereum blockchain are up 25x from $340M last year and make up 80% of all NFT sales.

Grayscale filed a letter with the SEC arguing that the approval of Bitcoin futures-based ETFs, but not Bitcoin spot-based ETFs, is “arbitrary and capricious,” and therefore in violation of the Administrative Procedure Act (APA).

Disclaimer: This is not investment advice. The content is for informational purposes only, you should not construe any such information or other material as legal, tax, investment, financial, or other advice. Nothing contained constitutes a solicitation, recommendation, endorsement, or offer to buy or sell any securities or other financial instruments in this or in any other jurisdiction in which such solicitation or offer would be unlawful under the securities laws of such jurisdiction. All Content is information of a general nature and does not address the circumstances of any particular individual or entity. Opinions expressed are solely my own and do not express the views or opinions of Blockforce Capital or Onramp Invest.

Disclaimer: This is not investment advice. The content is for informational purposes only, you should not construe any such information or other material as legal, tax, investment, financial, or other advice. Nothing contained constitutes a solicitation, recommendation, endorsement, or offer to buy or sell any securities or other financial instruments in this or in any other jurisdiction in which such solicitation or offer would be unlawful under the securities laws of such jurisdiction. All Content is information of a general nature and does not address the circumstances of any particular individual or entity. Opinions expressed are solely my own and do not express the views or opinions of Blockforce Capital or Onramp Invest.


  BACK TO INSIGHTS

Request More Info

Select all that apply
This field is for validation purposes and should be left unchanged.