THE FED’S TWIN POLICY ERRORS

 

The Fed has really created a self-inflicted disaster here.  It’s the two worst policy mistakes I’ve seen in thirty-five years of investing.  There are two separate policy mistakes – only one of which the Fed seems to have belatedly realized.  They seem to not understand the larger one.

 

The simpler one is keeping overnight rates way too low, way too long.  They are beginning to correct it, slowly.

 

However, the more destructive one is their massive manipulation of the bond market.  For the first ninety-five years of their history, the Fed never touched interest rates past the overnight rate.  They certainly didn’t loan tens of millions of individuals and institutional investors almost free money with which to speculate on houses.  They have created a bubble in housing that is even impacting the labor market.  Two million Americans have left the workforce – mainly from the wealth effect of home prices going up 38% in the past two years. 

 

This will be painful to unwind.  Unfortunately, the Fed still doesn’t seem to understand what they’ve done.  They have yet to reduce their massive bond holdings in any meaningful way.

 

#1.  ZERO FED FUNDS WITH DOUBLE-DIGIT INFLATION !??!?

 

Their first mistake is easily visible in this graph of the real policy rate.  The difference between inflation (their mandate) and their policy tool (fed funds) is much larger than at any point in history – including the disastrous 1970s.

 

 

When things got really out of control in March 1975 – before Paul Volcker became chairman – the Fed allowed the overnight rate to hit five percentage points below year-over-year CPI.  The modern Fed broke that record over a year ago.

 

The current Fed has the benefit of hindsight.  Research easily shows they should have tightened.  By May 2021 the real fed funds rate had already hit a record low.  That was past time to begin the fight against inflation.  That they waited another nine months of their forward guidance Kabuki theater is astounding. 

 

They left rates at zero.  Fed funds were 1.55% before the pandemic.  They’ve just gotten overnight rates to back where they were before the pandemic policy eruption when inflation was only 2.30%.

 

They still need to tighten by three or four hundred basis points.

 

OWNERS’ EQUIVALENT RENT

 

To compound this, the official CPI figures don’t measure housing inflation in real time.  We’ve been writing about this very important point since November.  True CPI – even excluding food and energy – is in double digits.

 

In 1982 CPI was changed to measure housing inflation in a very slow-moving index called owners’ equivalent rent – theoretically the amount a property owner would have to pay to be equivalent to the cost of ownership.  The OER component of CPI is up only 5.1% YoY.  Anybody trying to rent or buy a house or apartment knows that’s not reflective of reality.  The real inflation people experience is much higher. 

 

The S&P CoreLogic Case-Shiller U.S. National Home Price Index reports 20.6% YoY.  OER is 23.8% of CPI.  If OER were reported at 20.6%, our adjusted measure we’re calling True CPI would be 12.5%, 4 percentage points higher than reported.

 

The Fed prefers to look at core inflation (CPI less energy and food).  Year-over-year core CPI was up 6.0% in May, the highest since October 1982.  Using Case-Shiller in place of OER, True Core CPI would have been up 10.9%, 4.9 percentage points higher than core CPI. That’s higher than any time since 1980.

 

Monetary policy looseness is measured in the real fed funds rate, i.e. the nominal fed funds rate minus inflation.  Here we use the True Core CPI.  This reading is at its most negative point in history – almost four full percentage points lower than the previous low in February 1975.

 

 

Eventually the OER component of CPI will catch up with reality.  This will make it difficult for reported YoY CPI to fall very much over the next year. 

 

POLICY GAP

 

Fed policy is as stimulatory as at any point in history – including the dark days of the 1970’s.  Real fed funds – the fed funds rate less true core inflation – is as loose as ever (white line below).  At the same time inflation (gold line) is higher than at most times in history.

 

Even in the 1970’s there was never such a large gap between the real fed funds rate and the rate of inflation.  The gray bars represent the so-called “policy gap”.  We’re way past the 70’s.

 

 

Not sure why all the debate about 25 vs. 50 vs. 75 basis points.  They need to raise rates by hundreds.  Fed funds are going to 4-5%.

 

#2.  THE FED’S PONZI SCHEME

 

That issue is dwarfed by the biggest Ponzi scheme in history – the Fed’s manipulation of the government and mortgage bond markets.

 

Back in the day, the Fed only controlled the overnight rate.  They let free market actors allocate capital in the economy.  Those free market actors – such as banks, mutual funds, pension plans, and insurance companies – lent money to enterprises, those seeking mortgages, and the Federal government at appropriate rates.  The Fed did not manipulate the bond market. 

 

The free market system worked well.  For example, in the two years prior to the Fed’s Ponzi scheme, those free market actors lent $2.4 trillion to Americans looking to buy homes.  The Fed was not involved in the mortgage market.  30-year mortgage rates averaged 4.24%.  A normal amount of Americans bought homes with mortgages.  The price of housing was fairly stable.

 

 

But, boy, when the Fed got into the mortgage lending business, they really went for it.  They completely crowded out ALL other lenders. 

 

 

In 2020 the Fed decided that controlling the overnight rate was not enough – it wanted to control all rates, all the allocation of capital in the economy. 

 

They forced 30-year mortgage rates to hit 2.68%, basically daring people not to buy a house (or two or three), which would obviously create a bubble in housing, which itself contributed to a labor shortage as two million Americans retired early or otherwise left the workforce. 

 

Spurred on by the Fed’s crazy low yields, Americans borrowed a record amount of money to buy leveraged homes – $2.9 trillion in 2020-21.  But even that record appetite wasn’t enough for the Fed.  They pumped twice as much money $6 trillion in total  into the mortgage and bond markets.  That massive excess crowded out all types of private holders of bonds.  In their voracious drive to acquire more than all newly-issued mortgages, they drove 10-year treasuries to 0.54% and 30-year mortgages to 2.68%.

 

When the Fed is offering to lend people money at 2.68% to buy houses which are going up 20% per year on leverage – they do!  Not just homeowners, but investors. 

 

For example, the most prolific real estate broker in Atlanta lives in Florida and hasn’t visited Georgia in two years.  He sells leveraged homes to institutional speculators over the internet with neither side even seeing the house.

 

“Atlanta’s No. 1 Broker Bought Homes for Investors From 600 Miles Away”

 

“Atlanta’s top-performing residential real-estate agent lives in Florida. He didn’t set foot in Georgia for two years, and he sees no reason why he should.

 

“A.J. Steigman runs his own real-estate brokerage firm from his house in Parkland, Florida.  From 600 miles away, he bought or leased more than 300 homes at a total value of more than $86 million, according to the Atlanta Realtors Association. That was the most combined sales and leases in the Atlanta metro area for any broker last year, the group said.

 

“While his competitors in Atlanta shuttle between home showings and plant ‘For Sale’ signs in front lawns, Mr. Steigman’s client base consists entirely of institutional investors, he said.  He has no employees but relies on a $20,000 laptop and proprietary software system to buy single-family homes on behalf of his clients, which lease them out to capitalize on soaring rents.

 

“Redfin said investors bought one in every three homes sold.

 

“Atlanta home prices have risen more than 49% over the last five years and 24% in the 12 months ended February 2022, housing data firm CoreLogic said.

 

“He is also helping investors buy homes in Pennsylvania and Florida and said he has sold a total of $130 million worth of homes across Georgia and those two states.

 

“Mr. Steigman declined to elaborate on his selling process, other than to say he relies on a system he built and calls ‘Steignet,’ a reference to Skynet, the menacing artificial intelligence network depicted in the ‘Terminator’ film series.”

 

Wall Street Journal, May 17, 2022

 

Policy failure.

 

OVERVALUATION

 

Over the past two years the Fed bought government and mortgage bonds equivalent to over 200% of all mortgage lending in the U.S.

 

What happens when somebody buys more than the total supply of something?  A short squeeze.  You can corner a market for a while – like the Hunt brothers did in silver in 1979.  Those colorful Texans drove the price from $6 an ounce to $49.  Ultimately an outside force stops the reflexive cycle.  They were bankrupted by margin calls.

 

The Fed was stopped out by the CPI print. 

 

Before they were stopped out, the Fed’s manipulation of the U.S. Treasury and mortgage bond market was so extreme that the markets became $15 trillion overvalued (relative to the 50-year average real rate).

 

 

Market participants are still not grasping the scale of this move.  With the Fed finally stopping their manipulation of the U.S. bond market, bonds are experiencing a Wile E. Coyote moment.  No free market buyer would even consider buying bonds yet.  Prices are likely to free fall.

 

As bond prices fall interest rates rise.  10-year interest rates are likely to quadruple — from 1.34% to something like 5%.

 

The Fed is still buying mortgages to replace some that mature. They need to SELL.

 

 

“UNEXPECTED WAYS”?!?!

 

“Making appropriate monetary policy in this uncertain environment requires a recognition that the economy often evolves in unexpected ways.  Inflation has obviously surprised to the upside over the past year, and further surprises could be in store.”

 

— Fed Chair Powell, News Conference, May 4, 2022

 

I’m very concerned that the Fed doesn’t seem to have any sense of what is causing inflation – their own manipulation of the mortgage market.

 

You offer to loan people money for thirty years at 2.68% when house prices are going up 20% a year, they’re going to take it!  If the house goes down 20%, they give the keys to the bank.  If it goes up 20%, they win.  A record number of Americans did that incredibly expected thing.

 

The Case-Shiller Index of home prices is up 38% since the Fed began buying mortgages.  A huge win for those homebuyers and home speculators.  A big hangover for the rest of us.

 

This won’t be over until the Fed unwinds its manipulation in the bond market.

 

 

FED OFFERING MORTGAGES BELOW TREASURIES

 

This analysis by the Federal Reserve Bank of Dallas is truly mind-blowing.  The Fed lent money to home buyers so aggressively that they actually pushed the option-adjusted mortgage yield below where the United States Treasury borrows.  That’s insane.

 

Obviously no free market actor would loan money to a house buyer at a lower yield than they would lend to the U.S. Treasury. 

 

From the Federal Reserve of Dallas:

 

“Chart 1 also includes a metric known as the current coupon option-adjusted spread (OAS), which includes the likelihood of homeowners prepaying mortgages due to changes in interest rates. The OAS is a derived risk premium that equates model-based agency MBS values (using simulations of future interest rate paths) to prices observed in the market.  By accounting for interest rate variability, OAS reflects the residual compensation earned by agency MBS holders arising from noninterest-rate factors, such as the characteristics of the underlying mortgages.

 

“While OAS is typically positive, the measure shown here—produced by Bloomberg for a hypothetical MBS priced at par has declined steadily since March 2020 and turned negative for the first time since 2013, the only other time in the series history that this has occurred.”

 

 

We have had a huge transfer of wealth from taxpayers and renters to those who bought houses with the Fed’s borrowed money.

 

 

BOND VIGILANTES

 

Back in the day, the force that kept the government from doing banana republic things like this were the free markets.  A colorful term was used, “bond vigilantes”.

 

 

— The New Oxford American Dictionary

 

Vigilantes enforce rules when the government cannot or will not.  This is a perfect term for our situation today.  The President, Congress, the Fed have all abdicated any restraint. 

 

At least the Secretary of the Treasury was honest enough to admit they love inflation: 

 

“The burden of the debt in real terms has actually been negative in the last several years, so this is affordable.”

 

— Janet Yellen, U.S. Secretary of the Treasury, March 18, 2022

 

The free markets have to provide this discipline.

 

BOND BUBBLE

 

I believe that inflation is persistent – because the supply shortage is not a few container ships stuck off Long Beach harbor – it’s coming from a labor shortage.  Labor is the major cost input.

 

It’s also coming from a booming housing market.

 

What I believe is that the Fed won’t stop raising rates until at least two of these happen:

 

  • Housing inflation goes negative

  • Unemployment rate goes up 2 percentage points

  • Core CPI gets near 2.5%.  With owners’ equivalent rent taking about two years to fully play out, that’s probably at least a year away

  • The Fed has unwound the majority of its mortgage manipulation

 

 

The 10-year Treasury yield is up +185bps. Without manipulation, I believe Treasury yields will likely go to 5.00%.

 

LARRY SUMMERS IS SPOT ON

 

“We used to have a Fed that reassured people that it would prevent inflation.  Now we have a Fed that reassures people that it won’t worry about inflation until it’s staggeringly self-evident.

 

“The Fed’s idea used to be that it removed the punch bowl before the party got good.

 

“Now the Fed’s doctrine is that it will only remove the punch bowl after it sees some people staggering around drunk.”

 

— Larry Summers, What You Hear vs. What You See? Bitcoin, the Federal Reserve and the ‘Two Percent’ Inflation Doctrine, Consensus 2021, May 26, 2021

 

As we wrote in our November Blockchain Letter, all the arcane theories of central banking were best distilled into this classic line by an old school Fed Chairman — William McChesney Martin, Jr.:

 

“The Federal Reserve…is in the position of the chaperone who has ordered the punch bowl removed just when the party was really warming up.”

        • — Fed Chairman William McChesney Martin, Jr., October 1955, speech to the Investment Bankers Association of America

 

Instead of taking away the punchbowl when the cops are about to be called (inflation is already at a 40-year high, housing affordability is at the worst level in 16 years, and a policy-induced labor shortage has pushed wage inflation to a 40-year high) our modern Fed is doing this:

 

 

Presenting the champagne graphically:

 

 

LARRY SUMMERS ALSO SPOT ON ON OER

 

Larry Summers and colleagues wrote a fantastic analysis which is very similar to our True Core CPI.  The only difference is they chose to take the modern OER concept back in time before 1982.  We think Case-Shiller is a better measure of housing inflation than OER, so we adjusted the period after 1982.

 

 

“New estimates imply that the current policy gap is roughly equal to the peak gap of the Volcker-era.

 

“The March 2022 gap stood at 12.7 percentage points and the estimated peak gap in April 1975 was 12.1 percentage points when adjusting for the treatment of OER.

 

“There have been important methodological changes in the Consumer Price Index (CPI) over time.  These distort comparisons of inflation from different periods, which have become more prevalent as inflation has risen to 40-year highs. To better contextualize the current run-up in inflation, this paper constructs new historical series for CPI headline and core inflation that are more consistent with current practices and expenditure shares for the post-war period. Using these series, we find that current inflation levels are much closer to past inflation peaks than the official series would suggest. In particular, the rate of core CPI disinflation caused by Volcker-era policies is significantly lower when measured using today’s treatment of housing: only 5 percentage points of decline instead of 11 percentage points in the official CPI statistics. To return to 2 percent core CPI inflation today will thus require nearly the same amount of disinflation as achieved under Chairman Volcker.”

 

Marijn A. Bolhuis, Judd N. L. Cramer, Lawrence H. Summers, Comparing Past and Present Inflation, Abstract, June 2022:

 

https://www.nber.org/system/files/working_papers/w30116/w30116.pdf

 

 

BIZARRE KABUKI THEATER

 

When I was a kid, the Fed reacted in real-time to reality.  Now they have this bizarre notion that – although they admit they have had no clue what’s been happening during the past 18 months – they can see years into the future and must follow a pre-determined policy path.

 

“So, 75 basis point increase is not something the committee is actively considering.  What we are doing is we raised 50 basis points today.  And we said that, again, assuming that economic and financial conditions evolve in ways that are consistent with our expectations, there’s a broad sense on the committee that additional 50 basis increases should be on, 50 basis points should be on the table for the next couple of meetings.”

 

— Fed Chair Powell, FOMC Press Conference, May 4, 2022

 

Forward guidance is said to reduce volatility.  It’s quite the opposite. 

 

“We therefore will need to be nimble in responding to incoming data and the evolving outlook.  And we will strive to avoid adding uncertainty to what is already an extraordinarily challenging and uncertain time.”

 

— Fed Chair Powell, FOMC Press Conference, May 4, 2022

 

Every month they continue this Kabuki theater, the cumulative damage becomes greater.  They need to catch up to reality.

 

 

POLICY-INDUCED INFLATION

 

The Fed insisted that inflation was “transitory” for a period much longer than transitions take.  Now they blame it on Putin, some container ships stuck off Long Beach Harbor, semiconductor shortages, and insist it’s a global thing.

 

“I think I was wrong then about the path that inflation would take.  As I mentioned, there have been unanticipated and large shocks to the economy that have boosted energy and food prices, and supply bottlenecks that have affected our economy badly that I didn’t at the time didn’t fully understand.”

 

— Treasury Secretary Janet Yellen, CNN, May 31, 2022

 

“We’re seeing high inflation in almost all developed countries around the world.  And they have very different fiscal policies.  So, it can’t be the case that the bulk of the inflation that we’re experiencing reflects the impact of the ARP (American Rescue Plan).”

 

— Treasury Secretary Janet Yellen, Senate Finance Committee, June 7, 2022

 

Unfortunately, it’s a U.S. policy-induced problem that is specific to the U.S.

 

PEERS’ INFLATION

 

It’s always fun to blame problems on other things or outsiders.

 

Everybody eats food and even people who live in yurts use energy, so it’s wrong to exclude them.

 

(California Governor Gavin Newsom wants to give everyone who has a gasoline-powered car $400 to buy more gasoline.  How are we going to solve global warming that way?)

 

However, even if you exclude food and energy, core US inflation is double our peers.  It’s a U.S. policy thing.

 

 

HOUSING IMPACT

 

In the July letter we’ll share thoughts on the odds of a recession.  Here’s a sneak peak of the road ahead: 

 

  • Never in history has the Fed allowed house price inflation to go so high above mortgage rates (In this case they literally controlled mortgage rates)

  • And, the previous two bubbles – which were half as big – ended badly

 

 

 

BOND BUBBLE

 

A synopsis of our writing on the Fed and the bond bubble are found here.

 

 

RECENT EVENTS IN CRYPTO

 

The cascading collapse of major projects exposed the incredible amount of excess leverage in the system.

 

In this section we review some of the major meltdowns.  However, there are probably a few more to come in the next month or two.  Each bankrupt leveraged entity leaves a string of problems for their counterparties.

 

 

TERRA LUNA

 

While our industry’s detractors will obviously make a big deal of this failure, it doesn’t say anything about the overall promise of blockchain.  It’s similar to the dot.com era.  Lots of experiments were tried – some worked, some didn’t.  The failure of Pets.com didn’t mean the internet was stupid.  It just meant that one business model wasn’t right for the time.  LUNA’s failure only means that that one type of algorithmic stablecoin didn’t work.

 

There’s a ton of stress about whether Tether is fully backed by collateral.  In 2019 they admitted it wasn’t.  It serves its purpose – shadow banking system.  However, most stablecoins, like Coinbase and Circle’s USDC are fully backed with treasury bills, very transparent, and audited. 

 

You have to work through some of these experiments.  Ultimately, that vast majority of the stablecoin market will look just like USDC and FedCoin.

 

Some well-said takes on LUNA:

 

https://newsletter.banklesshq.com/p/ust-luna-meltdown-what-happened?s=r

 

“‘Algostable’ has become a propaganda term serving to legitimize uncollateralized stables by putting them in the same bucket as collateralized stables like RAI/DAI.”

 

“We need to emphasize that the two..(algorithmic stablecoins and asset-backed stablecoins)..“are very different.”

 

— Vitalik Buterin, Ethereum co-founder, Twitter, May 14, 2022

 

 

CELSIUS

 

Celsius is a centralized crypto lending business.  Their business model is:  you deposit USDC, ETH, some sort of cryptocurrency, and they promise a yield on it.

 

What ended up happening is they put a bunch of those assets into either very risky projects or into things that have a long liquidity horizon.  Classic leveraged lending model – borrow short-term, lend long and risky.  The liquidity mismatch where you have customers who expect to be able to withdraw their funds within 24 hours, but you have assets that may be locked up for months.  Celsius ended up freezing withdrawals and were forced to sell a huge amount of crypto over the last week, which is part of what caused a cascade in prices.

 

THREE ARROWS CAPITAL :: 3AC

 

Similar situation with Three Arrows Capital, known as 3AC.  Very leveraged with liquidity mismatches. They weren’t able to meet their margin calls.  They ended up being a forced seller in a time where there wasn’t that much liquidity in the markets.

 

The markets are very efficient.  With a 70-90% downdraft we probably have worked through most of the problems.  We think these events have mostly washed through the crypto space.

 

 

GBTC TRUST

 

For years, when people pitched the Grayscale “arbitrage” I always thought – nothing is risk-free, this could go super-negative, no interest.

 

Well, it has.

 

Bitcoin is down -72%, ETH -77%, SOL -90%.  That kills anybody with leverage.  However, if you’re long via GBTC you’ve lost way more than that.

 

Three Arrows is thought to have owned 6% of the entire GBTC Trust – leveraged.  They are being liquidated.  BlockFi is rumored to have had a large exposure to this trade as well.  There probably are similar firms all being liquidated now. 

 

The Grayscale Trust now trades at a -34% discount to the value of the one asset they hold – bitcoin.

 

 

Investors paid a massive premium to get in – $6 billion at the peak in January 2021.  They now face an $8bn discount to get out.  That’s on top of the movement in the price of bitcoin.  That’s a lot of value destroyed.

 

There’s a SEC decision point on July 6th.  If they approve Grayscale’s application the discount would theoretically go to zero.  If they don’t, it could widen further. 

 

Having read the 80 pages of the SEC’s previous rejection, I can’t imagine that they will think that during a smoldering crash of this magnitude it is a good time to very publicly change their mind.

 

My instinct is after the likely rejection we will see the widest discount possible.  Seems like in the next month or two the washout will be the most extreme GBTC will ever see.

 

 

DEFI METRICS

 

Total value locked in DeFi protocols has dropped to $77bn.

 

 

DeFi protocols have done their jobs better than centralized crypto finance firms.  The decentralized borrowing and lending protocols have been orderly.

 

Decentralized exchanges (DEX) monthly trading volume is also off.

 

 

 

CRYPTO MARKET MOVES

 

In times of stress the mega-cap bitcoin typically outperforms other, smaller currencies.  That’s happening again in this cycle.  Most cryptocurrencies have fallen against bitcoin since the November all-time high.   This dynamic happened in the 2017-19 crypto winter – when investors de-risked out of higher beta tokens.

 

The chart below shows the change in value of major cryptocurrencies against bitcoin – on a log scale.

 

 

We put a large portion of our assets into Bitcoin in late May.  When the market starts to rebound, that’ll continue to outperform.  Once it’s very clear that the market’s bottomed, then it will make sense to rotate out of bitcoin back into higher risk, higher reward alts.

 

While we remain long-term bullish on many of these projects, during the crash we have taken on a larger bitcoin allocation to reduce downside risk.

 

Bitcoin’s share of the overall cryptocurrency market has risen.

 

 

DE-COUPLING

 

Unfortunately, crypto seems to be thought of as a long-duration tech stock right now. 

 

 

Many asset classes are directly linked to interest rates.  The price of bonds is obviously mathematically linked to rates.   In our July letter we’ll show how the price of equities closely follows bonds.  The price/earnings ratio upside-down is the earnings yield (E/P).  That yield closely tracks the yield on treasuries.  Housing is tied to rates via mortgages.

 

However, there are some assets which have no direct connection to rates, such as gold, other commodities. 

 

It’s likely that digital gold can decouple and trade with things like gold.  In the first rising rate environment in 42 years, there will be a rush to invest in things that don’t have to go down as the Fed unwinds its mistakes.  Blockchain and other commodities are likely the only place to hide in a world with massively rising rates.

 

Pretty soon, when the trauma of this macro dislocation is numbed, investors will evaluate where to put fresh money.  It would be very hard to want to put it in bonds, it’d be pretty hard to want to put it in stocks, same thing with real estate, because the Fed really has to get the real estate bubble to stop inflating in order to calm inflation down.

 

I believe things that are fixed in quantity and not connected interest rates, are going to do really well. Things like commodities, agricultural commodities, gold and then also blockchain.

 

Obviously hasn’t happened yet, but that is something we think is only months away rather than years away.

 

SPIKE IN CORRELATIONS

 

Historically, bitcoin’s correlation with stocks spikes sharply positive during major S&P 500 downdrafts. The have been four -10% of greater downdrafts in the S&P 500 since bitcoin began trading in real size.  Historically, it’s taken 71 days for the correlation to revert to low.

 

The spike in correlation in this downturn has lasted longer.

 

We anticipate correlations to come back down in the near term. 

 

There have been six times where the S&Ps come way down. And the Bitcoin price has been highly correlated with the S&P, but only for on average 71 days.

 

That’s what we predicted in our March 2020 letter at the lows of the pandemic panic.  That crypto and risk assets would go their separate ways.

 

That there really isn’t a reason that Bitcoin needs to be a risk asset correlated thing.  One thing people often say is, “Well, with big institutions are going to make it more correlated.” I think that’s true, but I think that’s in 5-10 years. Most institutions have very tiny exposures.

 

It’s also important to note that they’re net buyers of crypto.  They’ typically subscribe to 10-year funds.  I believe those flows will continue increasing, buoying the markets in the near-term.

 

 

Rates don’t have to drive crypto.  We’ve frankly been wrong on that – so far.  

 

It may take a few more months for blockchain to decouple, but when the dust settles I can easily see a world where bonds, stocks, real estate, and everything with a discounted cashflow is down – and blockchain, commodities, oil, gold, and other things that are truly not connected to rates, are up a ton.

 

 

VALUATIONS BY JOEY KRUG

 

We are pretty conservative on valuation relative to our peers at any part of the market cycle, whether it’s a bull market or a bear market.  It’s one of the most common reasons that we pass on a deal is just the valuation’s too high and unless you’re perfect at selecting which assets are going to go up, if you’re paying too high prices, it’s just going to reduce the expected value of the overall portfolio.

 

We like to pay either fair market or sometimes we’ll pay slightly above what we think the actual true price should be, if a team is insanely great, but otherwise, we don’t really have a policy of overpaying for deals.

 

If you look at the market on a more macro level and then look at valuations – valuations are still quite elevated on the late stage side.   Seed rounds on the venture side are still often expensive while seed rounds on the token side are undervalued right now.  As a result,  we’ve been deploying a lot into seed rounds on the token side.  It’s the area we think has the most value right now.  On the VC side, I expect valuations will start to bubble up to the earlier stage as the market starts to price in stuff, but private markets are just slower to react than public markets.

 

We are being patient on the valuation side and pretty careful about what we’re investing into right now for those reasons.

 

Early-stage tokens have a lot of upside, especially when you’re investing during a bear market.  Some of our best investments have met that profile – token deal, early-stage invested, and bear market.  Areas you don’t want to be deploying heavily into right now, in my opinion, is later stage.

 

There are also a lot of companies right now that raised very sizeable series A’s back when the market was incredibly exuberant.  Now they’re trying to raise series B’s, with almost no traction.  That’s an area that we’re avoiding.

 

If you look more on the liquid side, my view is that altcoins are going to underperform Bitcoin and ETH, probably at least until the end of the year.  If you look at what’s happened in prior bear markets, people tend to sell off alts for the majors, which in this case is Bitcoin or ETH.  We’re very bitcoin heavy right now and made that move in late May.  We have positioned the fund accordingly.  When we think that will start to cool off, we’ll obviously rotate back into stuff that’s higher beta, more upside.

 

FIVE STAGES OF GRIEF

 

Denial, anger, bargaining, depression, and acceptance.

 

In our July letter we’ll focus on the investing after a crash.

 

Crypto prices reset instantaneously.  Valuations for private equity reset much more slowly.  Basically, the founders have to go through the five stages of grief to get down to the correct valuation.

 

Over the next six to nine months, I think valuations will come off in the private markets. And that is literally the best time to invest.  

 

 

PANTERA SELECT FUND

 

When we began investing, Seed and Series A rounds were the only deals that existed.  No company was old enough yet to raise a Series B.  However, the industry has grown up.  27% of the deals now are past Series A. 

 

 

Many of our portfolio companies are now valued in the tens of billions.  We’ve spent almost a decade helping companies like Ripple, Circle, Alchemy, Starkware, Coinbase, Amber, and FTX.  For example, we’re the only venture firm to have invested in every round Alchemy has done. 

 

We are excited to be able to continue to meaningfully back the best companies.  We’re launching a new fund which will be entirely growth-stage investments.  Pantera Select Fund seeks to capitalize on the industry’s transition to more growth-stage opportunities.

 

Over the last 18 months, growth-stage deals had some of the richest valuations in our space, and these are the first deals to meaningfully come down in valuation.  This is why we are excited to be launching the Select Fund and investing in growth-stage companies over the next few quarters.

 

The structure of this opportunity is a concentrated fund:  Pantera Select Fund.  We are targeting $200mm. 

 

 

Please find the deck here.  The recording of our Select Fund Launch Call can be accessed here.

 

If you are interested in exploring this opportunity further, please reach out to our Capital Formation team at invest@panteracapital.com.

 

 

Pantera will donate 1% of revenue from Pantera Select Fund to 1% For The Planet.

 

 

 

PANTERA BLOCKCHAIN Fund :: NEW JULY CLOSING

 

Given the pullback in the markets, we wanted to give investors the opportunity to capture these lower valuations with a closing in July.

 

The current market environment will bring one of our best relative strengths to bear over the coming months as generalist VCs deemphasize the space.  This is exactly what happened when we raised our last venture-style fund – in the bull market of 2017, tokens crashed, most of the generalist firms left – and we had two years of amazing investments pretty much all alone.  That fund has our highest IRR.  The markets seem to be stacking up for a very similar outcome in 2022-23.

 

The summary of terms can be found here.  You can also click the below button to view the deck or begin the investment process online.  Investors can dial the exposure as they like:  all-in-one Blockchain Fund, or the Venture-Only Class, or the Early-Stage-Only Class. 

 

 

 

BARRON’S FIRST-EVER CRYPTO ROUNDTABLE :: HIGHLIGHTS

 

Q.  “If you’re going to invest in crypto, what’s the best way to do it? And does it have a place in a portfolio as an alternative asset when it appears so highly correlated to tech?”

 

Dan:  “Using Bitcoin as a proxy for our industry, it has grown at an 11-year rate of 2.5 times a year. We are in a short-term bear market here. But anyone who has owned Bitcoin for three years has made money. The internet itself is 50 years old. We have decades more to go. And it has historically had a low correlation with the S&P 500 index.

 

“We will come to a place where investors decide to invest in things that aren’t interest-rate sensitive—like commodities, gold, oil, agricultural commodities, and things like blockchain assets. Obviously, it hasn’t happened for digital assets in the past three or four months. But I think that’s what will happen.

 

“The four major blockchains that we’re excited about are Ethereum, Polkadot, Solana, and NEAR. The important point is that the vast majority of interesting tokens out there aren’t cryptocurrencies—they’re like crypto companies that are replacing traditional companies. There are more than 4,000 publicly traded companies in the U.S. We could easily have more than 4,000 tokens.”

 

 

 

Q.  What are your thoughts on Web3 — the idea that we could have new networks and apps based on decentralized blockchains and tokens?

 

Dan:  “The whole concept of Web3 is about replacing companies like Spotify or Airbnb with decentralized versions.  We’re excited about a range of projects that are competing with the data monopolists.  An example would be Audius, which is a sharing protocol that helps recording artists get more money.  The users get paid for the contributions they’re bringing by curating songs.  Audius already has six million monthly active users.  We’re invested in about 80 different protocols that are doing these different business models.

 

“We’re used to massive data monopolies, like Facebook and Airbnb, sucking an enormous amount of value in their verticals.  Those can be decentralized. Social media, like Facebook, will probably take a decade. But ultimately, we’re going to have a cooperatively-owned and cooperatively-governed version of the data monopolies like Facebook.

 

“It’s going to wonderful for the world, way better for everybody, because these current owners can be pretty toxic.  With decentralized governance, better decisions will be made, democracy won’t be destabilized, and false information about vaccines won’t be sold.  It’s going to take a while, but that’s where we’re heading.  It is one of the most obvious trades I’ve seen in my 35-year career.”

 

— Daren Fonda, Barron’s, “Crypto’s Future Is Even More Exciting, and Maybe More Volatile, Than Its Present”, May 27, 2022

 

Check out the full interview here.

 

 

Good luck out there,

 

@Dan_Pantera

 

“Put the alternative back in Alts”


CONFERENCE CALLS

 

Our investment team hosts monthly conference calls to help educate the community on blockchain.  The team discusses important developments that are happening within the industry and will often invite founders and CEOs of leading blockchain companies to participate in panel discussions.  Below is a list of upcoming calls for which you can register via this link.

 

Pantera Venture Fund III Investor Call

Tuesday, June 28, 2022 9:00am PDT / 18:00 CEST / 12:00am China Standard Time

Open only to Limited Partners of the fund.

 

Pantera Select Fund Launch Call

A detailed dive into our new growth-stage fund.

Tuesday, July 12, 2022 9:00am PDT / 18:00 CEST / 12:00am China Standard Time

Please register in advance via this link:

https://panteracapital.com/future-conference-calls/

 

Investing in Blockchain Conference Call

Tuesday, July 19, 2022 9:00am PDT / 18:00 CEST / 12:00am China Standard Time

Please register in advance via this link:

https://panteracapital.com/future-conference-calls/

 

Pantera Liquid Token Fund Investor Call

Tuesday, July 26, 2022 9:00am PDT / 18:00 CEST / 12:00am China Standard Time

Open only to Limited Partners of the fund.

 

Pantera Early-Stage Token Fund Ltd Investor Call

Tuesday, August 2, 2022 7:00am PDT / 16:00 CEST / 10:00am China Standard Time

Open only to Limited Partners of the fund.

 

Pantera Early-Stage Token Fund Investor Call

Tuesday, August 2, 2022 9:00am PDT / 18:00 CEST / 12:00am China Standard Time

Open only to Limited Partners of the fund.

 

Pantera Venture Fund II Investor Call

Tuesday, August 9, 2022 9:00am PDT / 18:00 CEST / 12:00am China Standard Time

Open only to Limited Partners of the fund.

 

Investing in Blockchain Conference Call

Tuesday, August 16, 2022 9:00am PDT / 18:00 CEST / 12:00am China Standard Time

Please register in advance via this link:

https://panteracapital.com/future-conference-calls/

 

Pantera Select Fund Launch Call

A detailed dive into our new growth-stage fund.

Tuesday, August 23, 2022 9:00am PDT / 18:00 CEST / 12:00am China Standard Time

Please register in advance via this link:

https://panteracapital.com/future-conference-calls/

 

Recordings of past conference calls are available on this page.


PORTFOLIO COMPANY UPDATES

 

StarkWare Raises $100 Million Series D at $8 Billion Valuation

 

StarkWare provides blockchain scalability solutions through its Layer-2 technology on Ethereum powered by zero-knowledge proofs.  StarkWare’s scaling engine StarkEx processes more transactions per month than the Bitcoin network and is used by leading platforms such as dYdX, Sorare, and Immutable X.  They also released StarkNet, which gives developers access to their scaling technologies.  Pantera participated in the $100 million Series D round led by Greenoaks Capital and Coatue.  Pantera previously led StarkWare’s $6 million seed round in May 2018, and participated in the $30 million Series A round in October 2018, $75 million Series B round in March 2021, and $50 million Series C round in November 2021.

 

 

Metatheory Raises $24 Million Series A for Web3 Gaming

 

Metatheory is a web3 gaming studio led by Twitch co-founder Kevin Lin that is building blockchain games with a focus on storytelling and franchise IP.  Metatheory released their first game, DuskBreakers, in December 2021 and created the Play-to-Mint mechanic that rewards gameplay and solves the hyper-inflationary problems of existing P2E games.  Pantera participated in the $24 million Series A round led by a16z.

 

 

Chainflip Raises $10 Million Round to Build Cross-Chain Infrastructure

 

Chainflip Labs is building a frictionless, cross-chain decentralized exchange.  They aim to eliminate the complexities of current solutions, which include the need for wrapped tokens, and compete with centralized exchanges.  Pantera participated in the $10 million round alongside Framework Ventures and Blockchain Capital.

 

 

Jambo Raises $30 Million Series A to Grow Web3 in Africa

 

Jambo is building the infrastructure to onboard and connect communities in Africa to web3 financial services and ecosystems around the world.  They are focused on localized education through grassroots networks to increase web3 literacy and awareness.  Jambo is expanding their operations into 15 additional cities across Africa and doubling their headcount by the end of 2022.  Pantera participated in the $30 million Series A round led by Paradigm.

 

 

InfiniGods Raises $9 Million Seed Round to Onboard Gamers to Web3

 

InfiniGods is a blockchain game development studio focused on building mythology-based strategy games with portable NFTs for long-term utility.  Their cross-platform, interoperable ecosystem will allow users to compound and leverage their assets over time.  Pantera led the $9 million seed round with participation from Framework Ventures, Jefferson Capital, and more.


FURTHER READING

 

Some good material to start with on the development of blockchain technology and cryptocurrencies as speculative instruments:

  •  

And some additional information on DeFi, Web3, NFTs, blockchain infrastructure, and more:

 

Additional information on blockchain regulation:


PANTERA OPEN POSITIONS  

 

Pantera is actively hiring for the following roles:

 

  • Head of Portfolio Talent

  • Chief Compliance Officer

  • IT Desktop Support Technician

  • Content Writing Associate

  • Associate, Accounting

  • Execution Trader

  • Associate, Capital Formation / Office of the CEO

  • Platform Engineer

  • Associate, Investor Relations

  • Co-Head, Capital Formation

  • Associate, Accounting

  • Investment Associate/Analyst

  • Trading & Middle Office Python Developer

  • Director, Capital Formation

  • Associate, Capital Formation

  • Executive Assistant/Office Manager

  • Platform Associate / Analyst

  • Executive/Personal Assistant to the CEO

  • Security + Cryptoeconomics Auditor

  • Associate, Finance & Operations

  • Associate, Investor Relations

  • Tax Manager

  • Senior Associate, Accounting

  • Events Manager

 

If you have a passion for blockchain and want to work in New York City, San Francisco, Menlo Park, San Juan, or London, please follow this link to apply.  Some positions can be done remotely.