BOND BUBBLE POP
Our last two investor letters forecast a pop in the U.S government and mortgage bond bubble. The next mega-trade has just started.
Ponzi schemes keep going until the perpetrator is stopped from the outside. They never stop by of their own volition. Bernie Madoff kept going until federal agents arrested him. Senator Manchin and 7.0% CPI growth are what stopped this one. The Fed is so far out on their Wile E. Coyote moment.
Financial gravity just locked on.
If you have not yet sold your bonds to the Fed, you might want to. By March they’ll be out of the bond manipulation business. They won’t do it again in my lifetime. If you are thinking of refinancing your mortgage, do it quickly. With the Fed shut down, mortgage rates will revert to the free-market rate. We will likely never see these rates again.
We’ll take a deep dive into the massive gap between the Fed and reality later in the letter. First, Joey, Paul, and I want to review the incredible dynamics in the crypto markets.
THEN & NOW :: 2017 RALLY VS. THIS RALLY
Bitcoin peaked in 2017 at $19,783.21. It’s amazing how much everything else has changed since then. This graphic has the top-20 coins at the peak of the 2017 bubble vs. today. Bitcoin is the only constant. Everything else has changed. Only six are in both lists (shown in gold). The majority of coins in the top-20 today didn’t even exist in 2017! They are shown in gray. Fourteen of the previous top-20 fell out – and fell a long way. The average position of those 14 is #90.
(This is not including the stablecoins.)
Lately I get asked a lot: Is this rally different?
Ken Rogoff wrote a fantastic book, Why This Time is Different: Eight Centuries of Financial Folly. Having read the book with humility and thought about some of my own experiences feeling “But, this time is TOOOOTALLY different”, I will take the plunge and share some of the differences I see – this rally vs. 2017. (Hopefully these will read well in a couple of years.)
With hindsight, 2017 is now officially a bubble.
The first massive difference is 2017’s rally was all about hype. In mid-2017 the world fell in love with newly-issued tokens – initial coin offerings (ICOs). They had existed since 2013. My Co-CIO Joey Krug did the first token on Ethereum in 2015 – Augur. There were incredibly important projects. However, they were very rare – only a few meaningful projects a year. A variety of factors came together and the second half of 2017 was ICO mania. By the end of the year, we were getting fifty whitepapers a week. Obviously it’s impossible to come up with 50 genius ideas each week, every week. Most of these projects were not useful. The market didn’t know that yet. A huge amount of money went into them. When bitcoin peaked in December 2017 it represented only 39% of the market cap of the industry and Ethereum was only 12% — non-Bitcoin+Ethereum peaked at 53% of the market.
There have been two huge changes:
- There was a massive shift from highly speculative, mainly non-functioning tokens having half of the total market cap in 2017 to a point a year ago when the market cap was mainly in the two proven, functioning chains: Bitcoin and Ethereum. Bitcoin had almost doubled its share to 70% while Ethereum held steady at 14% — the other 5,000 non-Bitcoin+Ethereum chains were only 16%.
- Another huge shift occurred as decentralized finance (DeFi) came on. Bitcoin is back to 40%. However, this time Ethereum increased its share to 20%. A totally new mix of very interesting coins like Solana, Terra Luna, Polkadot, Uniswap, and NEAR have proven their value. Collectively, they are worth 40% of the market.
PREDICTIONS FOR 2022 BY PAUL VERADITTAKIT
I recently published an opinion piece on Coindesk on what 2022 may hold for the cryptocurrency and blockchain space. I’ll summarize my main predictions below, but the full piece is available here, which also includes an assessment of predictions I published a year ago.
Predictions For 2022
L2s and Rollups: The biggest criticisms of Ethereum today involve its ridiculously high latency and gas fees, which inhibit the computational capacity of decentralized applications (dApps) and discourage users who lack substantial capital. Layer-2 systems have tackled this problem by executing transactions off-chain (reducing the amount of slow, expensive on-chain computation) and then posting batched transaction data (a rollup) on-chain.
Layer 2s have become incredibly popular in the last year. Arbitrum, an optimistic rollup solution that launched only in September, reached a peak total value locked (TVL) this year of $2.78 billion and has amassed over 50 dApps, including 1inch, Balancer, and Coinbase Wallet. Zero-knowledge rollups rose in TVL from $43.5 million to $1.9 billion, and are already being leveraged to scale transaction throughput for dApps like dYdX.
As mainstream adoption of crypto continues to grow, Ethereum’s network congestion will only become worse, exacerbating its problems with latency and fees. Rollups are critical to sustaining the growth of Ethereum by ensuring that compute infrastructure is highly scalable, allowing users to interact with dApps with similar or even better expectations around usability as with traditional web apps. Both optimistic and ZK rollups (a smart contract that takes hundreds of transactions off the main blockchain and bundles them into a single transaction) will gain even more traction in the coming year, with optimistic rollups likely to dominate in the short term while ZK rollups, which are much more technically complex, advance as a long-term scalability solution.
Non-Ethereum/Bitcoin Chains: At the start of the year, 97% of DeFi’s aggregate TVL belonged to Ethereum; today, Ethereum possesses only 63% of that TVL. Competing layer one, or base, blockchains have grown explosively over the past year, largely thanks to their considerable expansion advantages and differentiated use cases from Ethereum. In particular, Solana, which offers unparalleled transaction throughput, saw an incredible 2021, reaching a peak TVL of $15 billion and a peak price of $260 in November versus $0.22 when it began trading in April 2020. Recent activity in the Solana community, including the launches of massive funds for decentralized social media and gaming, suggests that the ecosystem will continue to grow immensely in the coming year.
Beyond specific blockchains, many technological developments from this year have set up 2022 to be a major year for the multi-chain universe. Bridges (which enable interoperability between vastly different networks), such as NEAR’s Rainbow Bridge, will help accelerate the growth of non-Ethereum ecosystems by expanding access to liquidity and allowing easier composability of digital assets. Ethereum virtual machine (EVM) platforms, like Aurora on NEAR, are also making it easier than ever for Ethereum-based dApps to launch on other chains, enhancing cross-chain engagement within DeFi. Overall, these advancements in cross-chain infrastructure will accelerate the speed at which alternative layer one chains gain traction, fostering the development of a truly robust, diverse multi-chain crypto ecosystem.
Composability and Web 3: Web 3 was arguably one of the biggest buzzwords of 2021. The scope of Web 3 is incredibly broad, and it’s difficult to pinpoint what exactly it entails. Generally, however, the term refers to technologies that prioritize user ownership of data and/or assets and interoperability between distinct applications.
2021 was a massive year for digital ownership. Nonfungible tokens (NFTs) now constitute a $7 billion industry, and continue to grow as more and more artists and consumers of art seek forms of verifiable ownership within the digital sphere. Beyond NFTs, digital ownership has grown through initiatives towards decentralized crowdfunding (such as Kickstarter’s announcement of decentralizing on Celo) and decentralized identity projects, which allow users to maintain full, more precise control over personal data and reputation, enabling use cases around un-collateralized loans, know your customer (KYC) rules, and more. In 2022, we’ll see more projects expand the scope of on-chain ownership, allowing users to have full, functional control over their identity and holdings in the digital world.
In terms of interoperability, bridges, as mentioned earlier, have enabled significantly more composability within DeFi, effectively allowing users to transact assets between chains and utilize DeFi protocols across different blockchains. Beyond just DeFi, projects like login.xyz, which offers a Sign-In with Ethereum service, show how the blockchain might enable composability between apps more generally, allowing users to maintain a single login across all services. Altogether, applications and services are seeking tighter integrations with one another, and I expect to see more projects tackle the fragmented nature of how we interact with the web.
Expansion of NFTs: NFTs were undoubtedly one of the hottest crypto trends of 2021. Digital asset marketplace OpenSea went from $1 billion to over $10 billion in trading volume in just three months, showcasing the viral wave of adoption that NFTs have kicked off. Other projects, such as NBA Top Shot and Bored Ape Yacht Club, have given NFTs a remarkable platform in popular culture, so much so that “NFT” was one of Google’s top search queries this year.
Looking ahead, it’s important to note that physical art represents a whopping $1.7 trillion asset class, meaning that NFTs are barely beginning to scratch the surface. As digital art continues to grow in popularity and physical art becomes increasingly tokenized, to facilitate better verifiability and more liquid markets, NFTs will continue to grow immensely in popularity through the coming year.
Beyond the classical use case of images, NFTs are making significant headway in other verticals, namely gaming and music. Games like Decentraland and Axie Infinity have demonstrated the value of offering in-game assets as tradable NFTs, allowing players to have full, versatile ownership of their assets and state within the game. In music, projects like Audius and Royal are building mechanisms to help fans directly support projects by their favorite artists, and to share in their artists’ success through royalties. NFT projects in 2022 will show substantially more diversity in use cases and will reconfigure how we interact with and think about ownership of digital media more broadly.
Decentralized Autonomous Organizations: DAOs were also one of the hottest crypto trends of 2021, garnering mass attention with the promise of being a vehicle for equitable, decentralized collective action. We’ve seen DAOs launch around a shared digital cultural identity (e.g., FWB and pleasrDAO), crowdfunding and capital allocation (e.g., BitDAO and ConstitutionDAO), and even social impact causes (e.g., the KlimaDAO tackling climate change). Given their heightened prominence, I expect to see DAOs become a mainstream vehicle for online organizing and collective action, helping individuals across the globe get actionably involved with causes they care about.
Beyond the rising number of DAOs, the crypto space has also begun to recognize (and tackle!) several gaps within DAO tooling, operations, and onboarding. Platforms like Syndicate, which simplify the process for establishing DAOs for collaborative investing, and Station, which helps onboard users onto DAOs, are making it easier than ever for folks to get functional DAOs up and running in record time. As DAO operations grow in complexity, I expect to see even more projects building out DAO tooling and infrastructure in 2022.
DeFi Security: 2021 has arguably cast more doubt into the security of DeFi than any year yet. More than $610 million were stolen through DeFi exploits in 2021 (a staggering eightfold increase from $77 million in 2020), and an additional $704 million in funds were stolen and then later returned by white hat hackers, like those behind the $600 million PolyNetwork exploit. These incidents are an inevitable, but unfortunate consequence of the growing prominence of DeFi; still, they highlight several major vulnerabilities in the technical infrastructure powering DeFi, which may ultimately limit DeFi’s potential to capture more financial use cases.
To maintain DeFi’s pace of adoption, it’s absolutely critical that we develop even more protocols and tooling to ensure that users are interacting with safe financial products in crypto. Projects like Forta, which enables dApps to monitor runtime security, and Nexus Mutual, which offers dApp users insurance against smart contract exploits, have already made significant headway in securing the crypto financial ecosystem. Still, there remain a great many vulnerabilities in the smart contracts powering DeFi, the majority of which we still don’t know. In 2022, I expect to see security become a tremendous focus for DeFi projects, and anticipate several more projects launch around better smart contract auditing, precise runtime monitoring, and consumer protections.
In summary, 2021 saw massive growth and an incredible number of innovations in the crypto sphere, ranging from blockchain infrastructure to DeFi to NFTs and more. Crypto has definitively asserted itself as one of the most powerful technologies of our time, offering unparalleled privacy, trustlessness, composability, and decentralization, while the traditional web remains highly exploitative, monopolistic, and fragmented.
The public has never been as fixated on crypto as it is today, and crypto’s growing mainstream adoption is likely to shape and accelerate the speed of innovation in the coming year. With this newfound attention, I’m incredibly excited to see how crypto captures more of the mainstream financial and digital sphere and becomes an even more robust, secure platform for powering how we interact with the web in 2022.
EARLY-STAGE TOKEN UPDATE BY JOEY KRUG
Our early-stage portfolio companies roared from success to success in 2021, marking the culmination of years of dedicated work by our founders and their teams.
Each of these individual successes contributed to the exceptionally strong performance of Early-Stage Token Fund over the past year. Both onshore and offshore Early-Stage Token Fund vehicles vastly outperformed the Bloomberg Galaxy Crypto Index and Bitcoin in 2021, with the former up 295%, and the latter 358%, while the index is up just 167% and Bitcoin up 62% over that same period.
Our bet on the DeFi space in particular has exceeded even our wildest expectations. The total value locked in DeFi protocols was negligible just one year ago, but now exceeds $250bn. Over the past 12 months, over $1 trillion was traded on decentralized exchanges. This surge in use and adoption has propelled returns on our investment in Kusama, for example, up 296% in 2021. Our investment in AMP has similarly soared 610% in 2021. New and emerging verticals have posted equally impressive results. Our position in Livepeer, a decentralized video streaming network built on Ethereum, soared 2,733% in 2021. Origin, a platform for decentralized, peer-to-peer marketplaces, up 438% in 2021.
Our ability to continue deploying capital across such a range of promising new projects is due not only to our exceptionally strong deal flow, but also to the fact that private market valuations remain attractive on a relative basis compared to those on public markets. While this isn’t true across the board, we continue to see many projects that we expect will offer multiples of upside when they hit the public markets.
CNBC ALT COINS FOR 2022
Melissa Lee: “Top coin, Polkadot. What is Polkadot for those out there who are not familiar? And, and what do you think drives it in 2022?”
Dan: “It’s developed by the former CTO of Ethereum, a blockchain to allow value to transfer from one blockchain to another. I think we’re all coming to the conclusion that there won’t be just one blockchain in the future. There will be maybe 10 or 20 very important blockchains. Polkadot will help you move value from one to the other. And their first DeFi protocols are going live in Q1 – we’re very excited about it.”
Polkadot’s value proposition is in connecting different blockchains, which is important when we now have different blockchains that need to work together like Ethereum and Solana.
Some of the best developer teams that we’ve met have been gearing up to launch DeFi applications on Polkadot for the past two years, like Acala.
We’re also seeing interest from enterprises like Deutsche Telekom and traditional FinTech platforms like Current, which are actively preparing to launch on Polkadot.
Where Polkadot is today is where Ethereum was in 2016 – with major applications getting launched that will be market leaders in a year or two.
Melissa Lee: “Okay, number two coin, Terra Luna. What is it? Is this for the Terra blockchain?”
Dan: “LUNA allows algorithmic stablecoins to be built. They have the fourth most valuable stablecoin, UST, built on top of it. It’s growing at a very rapid rate.”
Luna is the native token of the Terra ecosystem, which is the second-largest DeFi ecosystem today behind Ethereum with $18 billion of value locked.
Melissa Lee: “A very rapid rate, up 15,805% in 2021 with a market cap of $31 billion. Do you see the returns being similar in 2022?”
Dan: “We think it’s one of the most promising coins for the coming year. Many people are just discovering it and just starting to trade it. It has a $31 billion market cap right now, so it still has plenty of room to grow.”
Melissa Lee: “And of course it’s all about the developers — who are going to develop the applications to run on these particular blockchains? It’s got strong developer activity as well?”
Dan: “Terra is just beginning to gain traction in the South Korean gaming market — one of the leading markets for gaming in the world. They are starting to broaden out from just stablecoins to do much more interesting things.”
Melissa Lee: “The last one is a pick in the DeFi insurance realm. What would that be?”
Dan: “We’re very excited about a project called Risk Harbor. They’re building a decentralized insurance market. All of these different types of insurances that we need in the real world, and in particular right now for the DeFi ecosystem, can all be done in a decentralized way on Risk Harbor. Risk Harbor’s already protecting $250 billion of deposits in DeFi, but it could broaden out to all kinds of insurance products in the future.”
Risk Harbor is the next stage of DeFi’s evolution, where the first stage has focused on helping people to invest or earn income.
Risk Harbor is creating a decentralized insurance marketplace and will soon be powered by a token.
Imagine being able to create a market for every type of insurance policy you can think of. There’s a ton of risks or types of customers that today’s centralized insurance companies refuse to cover or flat-out deny payouts. A decentralized version of this makes sense and is tackling one of the biggest aspects of our financial system.
If Risk Harbor starts with protecting the $250 billion locked in DeFi today, I think that proves that it can help protect any asset class in the world.
Melissa Lee: “When we talk about stocks, and we talk about some of the upcoming disruptor stocks, we think about source of funds. I’m wondering if you think the same way in crypto land — if there are coins that are sources of funds for these? If perhaps, you sell some Ethereum and buy some of these coins? How should we think about this within a portfolio?”
Dan: “I think you’re right. That’s the way to look at it. There was a time when just holding Bitcoin and Ethereum was kind of a good proxy for the industry as a whole, but now there are so many exciting projects. We’re actually invested in 80 different tokens at Pantera. If someone’s going to be converting from something into these new things, they’re probably selling Bitcoin and Ethereum.”
— Dan Morehead, CNBC Crypto Night w/ Melissa Lee, December 29, 2021
2021 was a seminal year for the cryptocurrency and blockchain industry. We witnessed the largest US-based cryptocurrency exchange go public, the first Bitcoin (futures) ETF approval in the US, a country recognize bitcoin as legal tender, a single NFT sale for $69 million, and more. Many corporations continued to pile into bitcoin. Other major cryptocurrencies have made tremendous strides over the past year – Solana, Terra, NEAR.
Here is a recap of some of the major highlights of 2021:
2021 FUND PERFORMANCE
Investing in these new protocols has helped Pantera funds out-perform industry benchmarks and a bitcoin buy-and-hold strategy. We anticipate continued out-performance through 2022 as many of our early theses underpinning discretionary investments in our hedge funds continue to develop.
BLOCKCHAIN FUND FINAL CLOSING
Many investors view blockchain as an asset class and would prefer to have their managers allocate among the various asset buckets. This caused us to create Pantera Blockchain Fund, a new “all-in-one” wrapper for the entire spectrum of blockchain assets. We believe this new fund is the most efficient way to get exposure to blockchain as an asset class.
The Blockchain Fund is like the super-set of our four existing sector funds.
The most important feature is that we can invest against the large swings in value between tokens and venture. Tokens reset very quickly whereas venture is slow-moving.
We’ve already seen that in the short life of the fund. In May and June tokens got slammed — DeFi down 65%. However, in venture people were still executing term sheets from April, entrepreneurs still wanted the valuations at the peak — so venture pricing takes nine-ish months to reset. In that circumstance, we were able to buy Ethereum and DeFi tokens at an attractive price relative to venture. Over the years they will become expensive and we’ll sell the tokens to fund venture deals. For that reason, I think the new fund will out-perform the arithmetic average of the four sector funds.
We’re wrapping up the January closing now. If you still would like to subscribe in this closing, we can take additional investments until a material move in the markets
We are committed to keeping the fund open through the April final closing.
For investors who prefer venture, the new fund offers a Venture-Only Class. This class will have exposure only to the equity deals we do – and will not invest directly in tokens. It is essentially “Pantera Venture Fund IV”.
The summary of terms can be found here. Click the button below to begin the investment process online.
Also, please join us for Pantera Blockchain Fund Final Closing Call on February 8th at 9:00am PST. You can register here.
BLOCKCHAIN FUND INVESTMENT HIGHLIGHTS
Pantera Blockchain Fund has invested in 20 early-stage token projects and venture equity deals, with a record pipeline behind it.
Arbitrum is a leading layer-2 scaling solution powering some of the largest decentralized applications in the ecosystem. In addition to a handful of DeFi investments, we participated in the $30 million Series B round for BitOasis alongside Alameda Research and others. Pantera has led or co-led 9 deals, with more to be announced in the coming months.
One of the fastest growing sectors in 2021 was the rise in blockchain gaming and the metaverse, underpinned by unique in-game assets enabled by NFTs. We want to highlight a couple of those investments within the Fund:
GuildFi is a platform enabling an interconnected ecosystem of games, communities, and NFT assets, based on the play-to-earn model and emergence of the metaverse. We participated in their $6 million seed round announced in early November alongside investors like Coinbase Ventures and Alameda Research. GuildFi also raised $140 million through their Token Launch Auction on Copper. GuildFi began trading publicly in early December and has returned 100x within the Fund as of December 30th. The team has been tirelessly building out their platform since launching almost five months ago, onboarding new users and establishing game partnerships.
Genopets is a play-to-earn gaming application built on Solana that allows users to earn in the game by moving around and doing things in the real world. We co-led their $8.3 million seed round announced in mid-October alongside Konvoy Ventures, with participation from Alameda Research and others. In the three months since we invested, our position is up 55x (as of December 30th) after being listed in mid-November. The game is still in the early stages of its roadmap with the private beta phase 1A launch slated for January 20, 2022.
The early success of these projects strengthens our conviction that the ease with which players understand and interact with gaming applications will make them a leading use case outside of DeFi applications. Over the next year or two, we expect a vast swath of successful blockchain-based games to draw the gamer audience into the realm of crypto.
GROUND CONTROL TO FED, CAN YOU HEAR ME?
“Ground Control to Major Tom
Your circuit’s dead, there’s something wrong
Can you hear me, Major Tom?
Can you hear me, Major Tom?
Can you hear me, Major Tom?
Can you “Here am I floating ’round my tin can
Far above the moon
Planet Earth is blue
And there’s nothing I can do”
— David Bowie, Space Oddity, 1969
When I was a kid, the Fed reacted in real-time to reality.
They now have this bizarre notion that they have committed to some complicated minuet that cannot be altered. They have to continue the dance even though the music stopped like six months ago. Also, they believe they can see years into the future. Not seeing the 40-year record inflation that is happening right now proves they aren’t omniscient.
“There’s a real risk now, I believe, that inflation may be more persistent and. . . the risk of higher inflation becoming entrenched has increased,” said Mr. Powell at a news conference Wednesday afternoon.
“That’s part of the reason behind our move today, is to put ourselves in a position to be able to deal with that risk.” Fed officials in early November agreed to reduce their then-$120 billion a month in bond purchases by $15 billion a month, to $90 billion this month.
“On Wednesday, officials said they would accelerate that wind-down beginning next month, reducing purchases by $30 billion a month. As a result, they will purchase $60 billion in Treasury and mortgage securities in January, putting the program on track to end by March. “If they could wave a wand, I think they would want to stop it altogether, because it’s not needed in the economy at this point,” said Kenneth Rosen, housing economist at the University of California, Berkeley. “There’s so much money flowing through every single asset class.”
— Fed Chair Jerome Powell, News Conference, December 15, 2021
Whaa? What is going on? They are still manipulating the mortgage market $90 billion a month?!?!? If anything they should be going the other way – selling mortgages to cool off the obviously over-heated housing market.
What is this bizarre notion that they don’t have a magic wand? They are the problem – their manipulation in the mortgage market is the problem causing record housing inflation. They **can** waive a magic wand. Just stopping is the magic wand. Not “taper” – the appropriate policy is called “cold turkey”.
“We could raise interest rates in fifteen minutes if we have to,” stated then-Chairman Ben Bernanke in a 2010 “60 Minutes” interview. “So, there really is no problem with raising rates, tightening monetary policy, slowing the economy, reducing inflation, at the appropriate time.”
The next step in their complicated minuet – after “taper” comes “run off”. That’s not going to get it done either. The Fed’s holdings make it impossible to fight inflation by waiting for higher interest rates based on runoff. More than 97% of the $2.6 trillion in mortgage-backed securities owned by the Fed won’t mature for at least ten years. Only 20% of the Fed’s $5.6 trillion in Treasury securities will come due in the next year. 42% have maturity dates longer than five years out.
WHAT MOVIE IS THE FED WATCHING?
“The Federal Reserve is committed to using its full range of tools to support the U.S. economy in this challenging time, thereby promoting its maximum employment and price stability goals.
“The Committee seeks to achieve maximum employment and inflation at the rate of 2 percent over the longer run. With inflation having run persistently below this longer-run goal, the Committee will aim to achieve inflation moderately above 2 percent for some time so that inflation averages 2 percent over time and longer‑term inflation expectations remain well anchored at 2 percent. The Committee expects to maintain an accommodative stance of monetary policy until these outcomes are achieved.”
— Federal Reserve FOMC Statement, November 3, 2021
“Inflation persistently below its goal”? This is embarrassingly behind the curve. Measured inflation is at 7.0%. That includes the spurious owners’ equivalent rent of only 3.1%. If real housing inflation were included it would be double-digits – all 1970’s style. (The lagged effect of true housing inflation will show up in CPI over the next two years.)
The Fed forecasts that it can ever-so-slowly raise the Fed funds rate to 2.1% in a few years. It takes more than 2.1% fed funds and 2.5% 10-year rates to stop 7% CPI and 19.1% housing inflation. Fed funds will go to at least 4-5% and mortgage rates will likely double.
A former Secretary of the Treasury and a former Fed President are starting to agree:
“My own view is that the Fed and the markets are still not recognizing what’s likely to be necessary.
“The market judgment and Fed’s judgment is that you can somehow contain this inflation without rates ever rising above 2.5% in terms of the fed funds rate.
“What we’re going to find out is what the vulnerability of the economy is to rate increases. It may be, as some argue, that because of greater levels of debt, because asset prices are substantially inflated, the economy is more vulnerable than usual to rate increases or to quantitative tightening.”
— Larry Summers, 71st US Secretary of the Treasury (1999-2001), Bloomberg, January 7, 2022
“It can’t remain in the fantasyland of its dovish forecasts indefinitely.
“I have news for those who think the U.S. Federal Reserve has turned more hawkish on inflation: It has only just begun.
“True, the minutes from the Fed’s December policy-making meeting display growing concern. Officials are acknowledging that the labor market is already very tight, and that factors such as wage growth probably won’t be entirely transitory. They seem to be losing hope that more people will come off the sidelines to satisfy demand for workers. They’re looking increasingly likely to raise interest rates immediately after the Fed’s asset-purchase program ends in March — though there’s still the wildcard of how a resurgent pandemic will affect the economy.
“Yet Fed officials remain incongruously dovish over the longer term. Consider their latest set of projections, released following the December meeting: In an economy with above-trend growth pushing unemployment below the level consistent with stable prices, the median forecast has inflation melting away, falling to 2.6% in 2022, 2.3% in 2023 and 2.1% in 2024. This could be justified if they expected to tighten monetary policy sharply, but they don’t. Their median projection for the federal funds rate at the end of 2024 is just 2.1%, well below the level they deem to be neutral.
“This is a remarkable, even surreal forecast: Inflation won’t be a problem, even if the Fed does little to rein it in.
“I see only a couple ways for this Alice-in-Wonderland fantasy to come true. First, today’s inflation could prove transitory, allowing the Fed to keep interest rates low — but this is inconsistent with the Fed’s own near-term analysis and hardly plausible when the ratio of unfilled jobs to unemployed persons is at an all-time high and wage growth is picking up markedly. Second, the neutral federal funds rate could be much lower than officials’ 2.5% median estimate, making the 2.1% rate projected for the end of 2024 much tighter – but there’s no evidence to support such a hypothesis, and indeed no Fed officials changed their estimate of the long-term neutral rate in December.
“More likely, the Fed will have to leave the enchanted forest. This means becoming a lot more hawkish, both in the near term and over the next few years. As the economic recovery pushes unemployment unsustainably low — something that may already have happened — wage growth will spill into consumer price inflation. The Fed will have to respond by taking interest rates above neutral well before the end of 2024.
“How high might rates go? If inflation is running above the Fed’s 2% target, they must adjust both to compensate for higher inflation and to achieve tight monetary policy. So if inflation subsides to 2.5% to 3% as supply chain issues dissipate, then a federal funds rate peak in the 3%-to-4% range seems reasonable.
“This is a much steeper path and higher peak than financial markets currently anticipate — roughly double what Eurodollar futures imply. Markets are starting to catch on, but only very slowly. At some point, the reckoning is likely to become disruptive, triggering a sharp rise in interest rates and a large drop in bond prices. The “taper tantrum” may have been merely delayed, not avoided.”
— Bill Dudley, Former President of Federal Reserve Bank of New York (2009-2018), Bloomberg, January 10, 2022
I worked with Bill Dudley – great guy. New age Fed Presidents are day-trading stock and mortgage bond funds – on the job, during a pandemic.
Fed officials should put their assets in blind trust. However, they are allowed to buy things as long as they hold them more than a month. A Fed President sold his stocks when he heard how severe the pandemic would be. Two days later he spoke with the Fed Chair who presumably shared that in a few hours the Fed would slash rates, and he bought the same stock fund back. That’s total banana republic stuff.
As we quoted two months ago:
“You don’t need a Presidential task force to figure out why state-less money is appealing to millions of people.”
— Brett Messing, SkyBridge President & Co-CIO
The Fed’s policy is negative for the majority of Americans. 35% of Americans do not own a home. The majority have no direct stock ownership. The majority have yet to buy cryptocurrencies. Artificially driving mortgage rates to record lows is bad for the majority of Americans. It’s creating the inflation which has driven after-inflation average hourly earnings negative.
“Ask renters, who tend to be middle and lower-income earners. The costs of rents and owner’s equivalent rents (or OER), by far the largest share of the CPI, have risen only 3.5% and 3% in the past year, a fraction of the 14.3% rise in Zillow’s Observed Rent Index and the 19.5% increase in the Case-Shiller Home Price Index. Because of how they are calculated, OER and rents are notorious laggards and will pick up sharply at least through the end of 2023.”
— Mickey D. Levy, High Inflation Needs a Policy Solution, WSJ, December 19, 2021
“The median existing home price rose 13.9% in November from a year earlier, NAR said, to $353,900.
“The share of first-time buyers in the market fell to 26%, the lowest level since January 2014 and down from 32% a year earlier.
“On a seasonally adjusted basis, the number of homes for sale in November fell to a record low, according to real-estate brokerage Redfin Corp.”
— Nicole Friedman, Homes Sold in November at Fastest Pace in 10 Months, WSJ, December 22, 2021
“Home prices rose 19.1% in the year that ended in October. Sales of existing homes in 2021 were expected to reach their highest level since 2006.
“Mortgages are less affordable relative to income than at any time since 2008, according to the Federal Reserve Bank of Atlanta. In early 2021, Americans needed about 29% of their income to cover a mortgage payment on a median-priced home, the Atlanta Fed estimated. That rose to 33% by October.”
— Orla McCaffrey, Red-Hot Housing Market Fuels Mortgage Borrowing Record, WSJ, January 1, 2022
The Fed is basically daring people not to buy a house. They have driven mortgage rates to a record 16.3 percentage points below the rate of house price inflation. It’s entirely rational to borrow as much money as you can from the Fed (indirectly) and buy a house.
The corollary to this is there is no chance to stop this runaway train with just 2.1% rates. Mortgage rates will double before this ends.
“Widespread inflation always comes from people wanting to buy more of everything than the economy can supply. Where did all that demand come from? In its response to the pandemic, the U.S. government created about 2.5 trillion new dollars, and sent checks to people and businesses. It borrowed another $2.5 trillion, and sent more checks to people and businesses. Relative to a $22 trillion economy, and $17 trillion of existing (2020) federal debt, that’s a lot of money.
“People are now spending this money, the economy can’t keep up, and prices are rising. Milton Friedman once joked that the government could easily create inflation by dropping money from helicopters. That’s pretty much what our government did.
“The Federal Reserve failed at its most basic job: to figure out how much the economy can produce, and to bring demand up to, but not beyond, that supply. To that end, the Fed controls interest rates. If people get a higher interest rate on money in the bank, they will leave it there rather than spend it. But the Fed failed to see inflation coming, and kept interest rates at zero, where they remain. The Fed says it is keeping interest rates low to improve ‘labor market conditions,’ despite the widespread worker shortages and the eruption of inflation.”
— Nick Timiraos & Gwynn Guilford, How Do You Feel About Inflation? The Answer Will Help Determine Its Longevity, WSJ, December 12, 2021
THE SUPPLY SHORTAGE IS THE POLICY-INDUCED LABOR SHORTAGE
As my Econ 101 teacher said:
“The old aphorism that inflation arises from ‘too much money chasing too few goods’ is close, but ‘too much demand chasing too little supply’ is spot on.”
— Alan Blinder (Professor of Economics & Public Affairs at Princeton; Vice Chairman of the Federal Reserve, 1994-96), December 29, 2021
The supply shortage is a policy-induced supply of labor.
Chair Powell said, “We’re making rapid progress toward maximum employment.”
I don’t see it that way. There are three million people who were working in March 2020 who are no longer working or looking for work.
That’s what’s causing wage inflation, which is causing CPI growth.
According to the Labor Department, there are 11 million job openings and only seven million people looking for work. This is the lowest ratio of unemployed people to job openings in history.
A record number of people are quitting their jobs – four million in one month alone.
The share of the working-age population that is either employed or seeking employment, known as the labor force participation rate, is near a 50-year low: 61.8%.
First-time claims for unemployment benefits, a proxy for layoffs, fell to 184,000 in the week ended December 4, the lowest level since September 1969. (The labor force is also much much larger now than it was in 1969.)
This sounds great, but it’s not. Although wages are rising, policy-induced inflation is outstripping any gains. After-inflation average hourly earnings are now negative. The average over the last thirty years is real wage gains of 0.40% per year. Workers are now going backwards, -1.19% per year.
Workers would be much better off without current Fed policies.
Before the pandemic, it was very difficult to raise prices – domestic companies had to meet the “China price”. Now Asia is having a problem delivering goods. For the first time in decades, labor has bargaining power, and even nonunionized companies are raising pay. We risk a leapfrog – raise pay to get labor, raise prices because demand exceeds supply, raise pay because of higher prices, etc.
Mohamed Aly El-Erian is President of Queens’ College, Cambridge and chief economic adviser at Allianz, the corporate parent of PIMCO, where he was CEO and co-chief investment officer (2007–2014). He was chair of President Obama’s Global Development Council (2012–17) and is a columnist for Bloomberg View and a contributing editor to the Financial Times.
“The underlying cause of the current surge in inflation is deficient aggregate supply relative to aggregate demand, part of which will likely prove more persistent than many, including the Fed, expect, and could change behavior in ways that risk triggering an inflationary spiral; this risk isn’t well reflected in market-based measures of inflation expectations given that fixed income markets are heavily distorted by the Fed’s massive bond buying program; the Fed has already fallen behind inflationary pressures on the ground by not easing off the monetary stimulus accelerator months ago; this has increased the probability that the Fed will have to slam on the brakes by raising rates very quickly after tapering and at a more aggressive pace, which would result in an undue blow to growth, and maybe even in a recession.”
— Mohamed A. El-Erian, President of Queens’ College, Cambridge University, and Chief Economic Advisor at Allianz
“US worker shortages reflect a perfect storm of factors that have significantly reduced the supply of workers who are currently looking for jobs at the same time that labor demand has surged to all-time highs; we expect labor shortages will ease considerably in the near term as the impact of fiscal transfers and other pandemic-related disruptions diminish; however, we expect longer-term drags on labor supply, combined with still-solid labor demand, to keep the labor market tight in the coming cycle; this suggests that wage growth will likely remain relatively strong in coming years.”
— Joseph Briggs, Goldman Sachs US Economics Research, Unpacking US Worker Shortages
19 OF THE TOP 20 PROTOCOLS ARE OUTSIDE THE UNITED STATES
The U.S. government funded the original internet. ARPANET (Advanced Research Projects Agency Network) was an experimental computer network to link computers at Pentagon-funded research institutions over telephone lines. Congress enacted many laws that helped the internet thrive. As a direct consequence, almost all of the leading internet companies are based in the United States. The United States has enjoyed tremendous advantages from that reality.
The SEC has not been so helpful in blockchain. Regulatory uncertainty and fear have driven most blockchains out of the United States. In fact, nineteen of the top twenty protocols are now based outside the United States. The only protocol still based in the U.S. is in a lawsuit with the SEC. It’s not hard to imagine the last protocol deciding or being forced to leave the United States as well.
“I came not to call the righteous, but sinners to repentance.”
— Luke 5:32
In our investor letters, we’ve shared the views of many long-time blockchain believers. It’s more powerful to quote those who have only recently converted. Jay Clayton served as SEC Chairman until Christmas Eve a year ago. He started that lawsuit on the day before his last day on the job. He is now advocating blockchain. I wholeheartedly agree with his pro-blockchain focus as a national security issue. He wants the U.S. to win.
“Dollar primacy and stability are critical to global economic development, financial stability and U.S. national security. In the face of broad technological change, primacy of the U.S. dollar is by no means certain. China views this technological shift as an opportunity not only to achieve operational efficiencies but to extend the reach and influence of yuan-based payments and lending. Chinese authorities are driving digitization and tokenization in their core payment and credit markets, allowing greater government monitoring and control. And there is no doubt Chinese leadership plans to extend similar practices to international trade and finance, expanding their influence over global commerce. The U.S. must recognize the reserve currency race is on, and winning is the only rational objective.
“We have a head start in both traditional markets and new tokenized markets. More than 95% of stablecoins by value are based on the U.S. dollar. In other words, at the incipient stages of this global shift in financial technology, dollars — actually U.S. Treasury securities — have remained the preferred liquid store of value for new and traditional markets. But stability and leadership can erode quickly in times of technological change. Another nation seizing control of global credit and payment systems would not only affect our global standing but also could destabilize the global financial system.
“Time is of the essence. Emerging as the standard-setter in any technological shift has great and one-time-only multiplier effects. Investment capital and ingenuity flow quickly to the emerging standard, further enhancing its acceptance and related economies of scale. The U.S. should use its head start to set the standard for tomorrow’s marketplace.”
— Former SEC Chairman Clayton, Wall Street Journal OpEd, December 17, 2021
HEIDI VON ALLMEN REJOINS PANTERA TO MANAGE SPECIAL OPPORTUNITIES PROGRAM
We are excited to have Heidi von Allmen rejoin Pantera. She is managing the Co-investment Program and expanding our platform to invest in special opportunities such as later-stage venture and secondary offerings.
In 2021, our limited partners invested an additional $35 million in 46 deals, including 35 venture and 11 early-stage token deals, through our co-investment program. We have been able to offer investors opportunities to allocate capital to venture deals such as Amber, Arbitrum, BitOasis, Bitso, and FTX; early-stage token deals such as Genopets and GuildFi; and secondary offerings such as Blockchain.com. The demand for these offerings has been strong, often oversubscribed multiple times.
To expand our product offering, we are launching the Pantera Special Opportunities Fund. The objective is to offer our investors access to compelling deals in the crypto space and to enable them to allocate capital at their own discretion to specific venture and token deals.
The Special Opportunities Fund will also allow our investors increased exposure to break out growth companies and projects which are at an inflection point, scaling up their business and fundraising efforts. We are positioning the firm to continue to serve founding teams and innovative technologies that are accelerating the development of the blockchain ecosystem.
Heidi originally joined Pantera in 2004. Prior to Pantera, she worked at Belgravia Capital and Morgan Stanley. Heidi received her M.B.A. from Harvard Business School.
If you are interested in the Co-investment Program or would like to learn more about the Special Opportunities Fund, please register your interest on this page or email firstname.lastname@example.org.
OTHER SENIOR HIRES
Pantera now has sixty fantastic people. Some new senior hires include:
Joseph Cisewski, General Counsel
Joe brings a tremendous track record of public and private sector achievements to his role at the firm, where he will oversee our legal team’s transactional and regulatory efforts. At such a critical moment in the realm of crypto regulation, no one could be better qualified to provide projects in the portfolio with expert regulatory guidance on managing compliance and mitigating risk. Joe will also lead the firm’s policy efforts by engaging with elected officials and with regulators to support their ongoing rulemaking processes.
Joe has spent 14 years in public service, holding senior positions at the U.S. Commodity Futures Trading Commission (CFTC) and at the U.S. Securities and Exchange Commission (SEC).
Terence Schofield, Chief Technology Officer
Terence will provide the technical vision and strategic direction to drive the development of our engineering function. Terence will manage the design and operation of our trading systems, enterprise technology stack, information security infrastructure, and proprietary software. Terence will help grow our team of engineers to continue providing technical support to projects in the portfolio and to help build crypto-specific tools to service the firm’s asset management activities.
TOP-5 READS 2021
We want to share some of the most-read content of 2021:
Bitcoin Rally (2017 vs. Today) – January 2021
We revisit the Bitcoin halving stock-to-flow price projection published in our May 2020 investor letter which showed the potential for bitcoin to rise to $115,000 by summer 2021. We also analyze the differences between 2017’s rally vs. today, discussing market concentration of top cryptocurrencies and the overall growth in digital assets compared to traditional public companies.
Five Orders Of Magnitude – April 2021
When analyzing bitcoin’s price in relation to the number of people using it, there’s an incredible, consistent relationship showing that for every million new users, price rises by $200. We discuss this relationship in detail, providing an expected terminal value of the price of bitcoin should it hold. In addition, we talk about portfolio construction and how owning digital assets beyond bitcoin and ethereum is prudent.
The Next Price Era – October 2021
A post-halving analysis put us at the conclusion that the 4-year halving cycle ended mid-April, coinciding with Coinbase’s direct listing amongst other factors like China’s third ban on Bitcoin and E.S.G. FUD, and the market is now onto the next price era. We also unpack a viewpoint discussed on Dan’s SALT panel on how the majority of future gains will come outside Bitcoin.
“All-In-One” Blockchain Fund – May 2021
Ahead of the first closing of our “all-in-one” fund, Pantera Blockchain Fund, we discuss the offering in detail and how to get invested. We also provide market commentary from a macro lens, showing that perhaps a better perspective to viewing asset inflation is that most things are stable relative to the value of paper money that is moving.
Bitcoin Coming Of Age – March 2021
In March 2020, we wrote “Bitcoin was born in a financial crisis. It will come of age in this one.” This letter discusses the incredible growth of blockchain as an asset class since making that prediction. We also touch on the unprecedented amount of monetary and fiscal stimulus that has largely contributed to the increase in asset prices across different sectors.
THEMATIC CALL :: WHY WEB3 MATTERS
Following the recent debate stirred up by Elon Musk and Jack Dorsey’s comments on the merits of Web3 applications, we want to host a discussion on Why Web3 Matters. The agenda for the call will consist of a panel discussion with Head of DeSo Foundation, Nader Al-Naji, and Audius Co-Founder and CEO, Roneil Rumburg, followed by prepared remarks from the Pantera team.
The call will take place on January 18th at 9:00am PST. You may register by clicking the button below.
THE FED PRINTS $9 TRILLION AND GOLD’S DOWN?!?!?
It’s just wild that the Fed printed $9 trillion and old-school gold was down in 2021 – massive market share loss to digital gold.
“Put the alternative back in Alts”
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.
Thematic Call :: Why Web3 Matters
A discussion of why Web3 matters, the challenges that lie ahead, and how founders are contributing to the next evolution of internet applications.
Tuesday, January 18, 2022 9:00am PST / 18:00 CET / 1:00am China Standard Time
Please register (in advance) via this link:
Pantera Liquid Token Fund Investor Call
Tuesday, January 25, 2022 9:00am PST / 18:00 CET / 1:00am China Standard Time
Open only to Limited Partners of the fund.
Pantera Early-Stage Token Fund Ltd Investor Call
Tuesday, February 1, 2022 7:00am PST / 16:00 CET / 11:00pm China Standard Time
Open only to Limited Partners of the fund.
Pantera Early-Stage Token Fund Investor Call
Tuesday, February 1, 2022 9:00am PST / 18:00 CET / 1:00am China Standard Time
Open only to Limited Partners of the fund.
Pantera Blockchain Fund Final Closing Call
A detailed dive into our new “all-in-one” blockchain fund.
Tuesday, February 8, 2022 9:00am PST / 18:00 CET / 1:00am China Standard Time
Please register (in advance) via this link:
Thematic Call :: Metaverse, Gaming, and NFTs
A discussion of the metaverse, blockchain-based gaming, and how NFTs create value within the digital realm.
Tuesday, February 15, 2022 9:00am PST / 18:00 CET / 1:00am China Standard Time
Please register (in advance) via this link:
Recordings of past conference calls are available on this page.
PORTFOLIO COMPANY UPDATES
Anchorage Digital Raises $350 Million Series D at $3 Billion Valuation for Strategic Growth
Anchorage Digital is a full-service financial platform and infrastructure provider for the digital asset space with a focus on institutional clients. They were the first crypto-native company to receive a banking charter from the Office of the Comptroller in January 2021 and have experienced over 800% growth for each of the last two years. The team plans to use this funding to enhance its infrastructure solutions and grow its client base. The round was led by KKR with participation from Goldman Sachs, Alameda Research, a16z, Blackrock, Blockchain Capital, Delta Blockchain Fund, PayPal and Kraken. Anchorage previously acquired Pantera portfolio company Merkle Data in January 2020.
Braintrust Raises $100 Million to Expand Web3 Gig Economy
Braintrust is a decentralized web3 talent network. Since June 2020, Braintrust has increased Gross Services Volume by 2250%, increased the number of enterprises by 752%, and grown the community over 70x. Braintrust will use the $100 million from the private token sale led by Coatue and Tiger Global to create a Grants Program that will provide opportunities to contribute to the growth of the network. Pantera previously participated in the $18 million strategic funding round co-led by ACME and Blockchange in October 2020.
1inch Raises $175 Million Series B at $2.25 Billion Valuation to Serve Institutional Clients
1inch is a decentralized exchange aggregator application. They are looking to expand their offerings to serve institutional clients such as banks and hedge funds with their new product, 1inch Pro, launching at the end of 2022. 1inch was started at ETHGlobal New York in 2019 and has since grown to be the largest DEX aggregator with over $100 billion in volume on the Ethereum blockchain. Pantera previously led the $12 million Series A round with participation from ParaFi and Nima Capital.
Kraken Acquires Staked to Develop Staking Products and Expand Proof-of-Stake Networks
Staked offers non-custodial staking solutions for institutional investors and enables those participating in Proof-of-Stake networks to easily and securely earn yield on their positions. The acquisition allows Kraken to strengthen its offering of staking services to customers by expanding the number of supported networks and providing a non-custodial alternative to their current custodial staking products. Pantera previously led Staked’s $4.5 million seed round in January 2019.
BCB Group Acquires Sutor Bank to Expand Crypto Banking Capabilities
BCB Group is a leading banking and financial services provider for the digital asset economy. They have acquired Sutor Bank, a 100-year-old fully-licensed German bank, to drive expansion into the European Union and better serve their European clients. BCB Group has experienced rapid growth in 2021, processing over $40 billion in payments. Pantera previously participated in their $4.5 million strategic funding round co-led by North Island Ventures and Blockchain.com Ventures.
Parallel Finance Wins Fourth Polkadot Parachain Auction Slot With $306 Million
Parallel Finance is a decentralized lending and staking protocol built on Polkadot. Polkadot’s first batch of parachain auctions started in November, with the fifth and final slot being chosen on December 16th. Parallel Finance secured $306 million to win the fourth slot, joining Acala, Moonbeam, and Astar with Clover Finance following as the fifth slot. Parallel Finance will now focus on launching their first suite of institutional-grade lending products on Polkadot. Pantera previously participated in a $2 million round in June 2021 alongside Polychain Capital, Lightspeed Venture Partners, Breyer Capital, 8 Decimal Capital and Hypersphere Ventures.
MakersPlace Expands Trusted NFT Marketplace to Bored Apes and more
Our portfolio company, MakersPlace, known for facilitating the $69M Beeple sale with Christie’s in 2021, has expanded their trusted marketplace to offer verified 3rd party NFTs, like Bored Apes, Pak, Art Blocks and more. Buying and selling high-valued NFTs like Bored Ape can be fraught with challenges and susceptible to hacks. The safest way to buy and sell a NFT is on a trusted marketplace like MakersPlace, which also offers a low seller’s fee of 0.5%.
If you’re looking to buy or sell an NFT, take a look at MakersPlace.