Titans and Tightening

September 8, 2022

There is an old Chinese curse which, summed up, amounts to “May you live in interesting times.” I think we can safely say that these times are Interesting indeed. Let’s dive in…

Tight, Tighter, Tightest

August was a month of dichotomy. We started off with a really nice CPI announcement of 8.5%, which is a 0.6% drop from August and, wow, the markets sure reacted well. With hopes and dreams of a more Dovish front from the Fed, crypto (and all markets) began a nice little bullish run. For a couple of weeks. Jerome Powell then came out of the Fed’s meeting in Jackson Hole, pulled out a shotgun and shot all the doves, promising a very hawkish continuation of policy for the time being. Unsurprisingly, all markets responded negatively with a bearish retreat.

Importantly, we also have the announcement of a doubling of efforts of Quantitative Tightening starting in September. They are raising the sales from $45B to $90B, thereby reducing the balance sheet at twice the prior rate, in an effort to reduce the monetary supply and pulverize inflation into oblivion.

While there are those that tout this as the end of the beginning (of these policies), with more to come, consider, however, that this may be the beginning of the end. Markets don’t like tightening, and dislike twice the tightening twice as much. When you combine this with a strengthening dollar that is nearing all-time-highs and battering other economies, it’s clear the Fed wrecking ball is going to do some damage. From our view, this damage cannot be sustained long-term. Yes, rates may continue to rise for a while, but we’re already seeing signs of a lower CPI. Should this trend continue, we think the current tightening of the tightening may truly be short-lived.

If we are correct, what this does create is an incredible buying opportunity. Last month I noted that we may have one more pretty good down-leg and the stars seem to be aligning for that. This means, for value investors, it could be the time to get into the markets.

Now, let’s address one of the elephants in the room. For years bitcoin has been touted as a hedge against inflation but, right now, bitcoin (and the rest of the crypto markets) seems pretty tied to the Fed’s actions. That’s actually OK because, distinguished as such, this correlation can be used to one’s advantage. It’s here I need to address one of the main points of debate about bitcoin. I need to distinguish that bitcoin is a hedge against monetary inflation not consumer price inflation. Against monetary inflation, it does its job just fine. When we start to see more money printing from the Fed, we expect bitcoin will be going up once again like it’s done the last four times. In the meantime, for more information, I highly recommend the first six chapters of Crypto Asset Investing in the Age of Autonomy, which unpacks the history of money and what that bodes for the future.

Ok, enough about bitcoin. For those that like value and understand that any crypto investment is a technology investment, that will take a little time to mature, I argue there may be no better time to buy than right now. For the contrarians, even if these markets don’t go any lower, then that would make this the bottom. Still a great time, if that’s the case.

Et Tu, Brutus?

As a buttress to this, if there was ANY question about the validity, longevity or credibility of crypto assets, I will allow such questions to be addressed via the actions of the world’s largest money manager – the one, the only, the titan, BlackRock. BlackRock, a firm that manages almost $5.7 trillion dollars, announced a historic deal with Coinbase that will allow their clients to trade via the Coinbase platform. This can only be the beginning of the next big step for the institutional players, and I would argue the validation here is obvious. Importantly, institutional money now being able to access these markets with a green light from their counterparties (banks, managers) is one of the harbingers of growth for which we have been waiting. Once the naysayers, the banks are now beating the drum. It is a glorious sound.

Merge Musings II

Speaking of Titans, let’s look at one in the world of smart-contract platforms. As noted in my last missive, Ethereum is on track for “The Merge,” whereby the current Ethereum Chain is combined (merged) with the Beacon side chain to create a proof-of stake Ethereum. This process began on Sept. 6th with the Bellatrix upgrade to the Beacon Chain and then is expected to consummate on Sept. 15th. This is being touted as one of the seminal events in the world of blockchain technology and will reduce power consumption, set the stage for a faster and less expensive Ethereum and, importantly, create a more-deflationary token. With success, some think the Ethereum market cap will exceed that of bitcoin. For more information, please see my last blog. There’s also a very good fortune article for those so inclined. Importantly, this is yet another event that positions the technological footprint of blockchain to grow in the coming months and years.

Blocks Aren’t Rocks

Archimedes, the Greek mathematician, was also a titan of sorts, who mathematically proved the power of a lever. He even mused that, given a long enough lever and a place to stand, he could move the world. Indeed, levers are an amazing invention and allow us to not only move rocks but build buildings, transport heavy loads and even cut steel. This is the power of leverage.

Leverage is also the same power that toppled Three Arrows Capital (TAC) and plagues many traders. Leverage is awesome when it works your way, for, with a very small investment, one can yield very big gains. If markets don’t go as expected, however (no one is right 100% of the time), one may find oneself on the wrong end of the equation and as TAC proved, this can be catastrophic. This is pretty simple from our view. I argue that when investing in technology one does not need to employ such tactics. Revolutionary technologies have proven over time that they have great worth, and blockchains are a great revolutionary technology. But blocks aren’t rocks, so long leverage in your portfolio may well be misplaced. It certainly was for TAC, Celsius, and many other funds that you may not have even heard of. The Age of AutonomyTM points to this technological breakthrough and, I’m proud to say that this concept has caught the attention of those at Pepperdine’s Graziadio School of Business, where our own CIO Jake Ryan’s Crypto Asset Investing in the Age of AutonomyTM is now a part of the curriculum. (A feat achieved without leverage!)

Yes, yes, I know I’m conservative here, and I can already hear my detractors. However, hear me out. You can’t play a baseball game in one inning. Things take time to fully mature. So it is for technology investments. When positioned right, one does not need accelerators – what is needed is an understanding of this new world, which then leads to patience, fortitude and conviction. All key qualities required for technology investors.

In Closing

So, this blog may have been a little repetitive but hey, sometimes things bear repeating. There’s nothing fun about watching the Fed pummel inflation into submission, but, given that we can see the game unfolding, why not play given its constraints? It just might be that those constraints can be used to advantage. That’s what Archimedes did. That’s what Blackrock is doing. In many ways, that’s exactly what Ethereum hopes to do with this historic merge.

I’ll keep this one brief, until next time, be well, stay safe, and I’ll keep Decrypting: Crypto for you!

About the author James Diorio

James is a Principal and Chief Executive Officer of Tradecraft Capital.