Letter to shareholders, Q1 2019

Letter to shareholders, Q1 2019

Dear investors,

year 2018 was rough for crypto-market. We have seen more than 80% fall from previous all time highs. After such a rapid growth as we have seen in 2017, corrections are to be expected. Despite that, this correction came much sooner than I expected.

Institutions are coming

My expectations stemmed from increased activity of institutional investors. Many new investment structures, vehicles and legal frameworks were being built, in order to allow institutional money to flow into previously retail-dominated crypto market.

However, we realized that institutional investors will be slower than expected. Some regulations take longer and many companies slowed down their involvement in the space or gave up altogether. Also expected institutional vehicles, such as ETF for Bitcoin got delayed.

But “Institutions are coming” narrative is not all wrong. Sophisticated investors are doubling down on their bets, and use the time of distress to accumulate positions and gain significant market share. For example financial group DCG accumulated  more than 1% of all bitcoins in circulation. Others manage to fundraise even despite the bear market. Investment fund Morgan Creek aimed for 25M USD but oversubscribed and raised more than 40M USD. Their investors weren´t high risk appetite individuals either. They were mostly institutions such as pension funds, university endowments or insurance companies.

Institutional infrastructure is also improving. Crypto platform Bakkt (by NYSE) is launching this year, as well as Fidelity’s custodian solution for crypto.

Facing fear, uncertainty and doubt

That being said, it is true that investors (retail and institutions alike) who entered the space in late 2017 are booking significant losses. We see a lot of despair and disdain for crypto in media. This is very common during the crypto winter times. Bitcoin “already died” more than 350 times in media, yet it always returned stronger and reached new all time highs in the new wave up.

We believe investors should maintain a long term vision and should not withdraw their capital now, if they only invested small fraction of it into this wild and nascent market. Corrections should not deter sophisticated investors. As old adage goes – buy when others are fearful and sell when others are greedy. These cycles of markets are usually good times to scale in.

According to Gartner, blockchain (and crypto) technologies already left the “hype” cycle, where everyone claimed blockchain will solve all kinds of problems. Now we are slowly entering the “productive” cycle, where we start discovering real use cases and added value of this technology.

Despite the prices tanking, fundamentals are much better than in midst of 2017 hype. According to some points of view, we could even argue that assets like Bitcoin or Ethereum are undervalued. Lightning network on top of Bitcoin is seeing silent but significant progress. Some other projects have also seen unprecedented advancements. For example Monero introduced Bulletproofs, new technology that increases privacy while decreasing transaction costs by up to 96%.

Our investment theses for 2020+

Our dominant investment theses for crypto and blockchain hold strong. During 2018 we put them to hard scrutiny and some were adjusted to reflect new information and research. We follow four main theses (which are complementary to each other).

1. Programmable, unstoppable money:

This is the oldest and most well known thesis, pioneered by Bitcoin. Programmable money is the first and simplest use case of blockchain (digital ledger), while also utilizing other technologies such as asymmetric cryptography or Proof of Work (mining).

Although still nascent and volatile, we believe that existence of open, digital, uncensorable, sometimes transparent and sometimes fully private cryptocurrencies is inevitable at this point. They do not necessarily need to overthrow our current monetary system. However, they provide a healthy experimentation ground for alternative monetary policies. They also provide non-sovereign safety belt – alternative for people to escape to in case sovereign (government backed) money and monetary policies fail.

Unseizable, private cryptocurrencies could also provide a safe haven for capital from offshore and Swiss bank accounts, which are slowly losing their ability to protect privacy of their clients. There is a popular comparison, saying that Bitcoin is comparable to “digital gold”, but more liquid and easier to store and transfer.

Sub-theses of this thesis are also “sound money thesis” (supported by austrian economic school) and “ideal money thesis” (concept pioneered by inventor of Game Theory, John Nash). Arguably both sound money and ideal money should be independent of central banks and individual nation states.

Apart from Bitcoin, we monitor couple of other cryptocurrencies, such as Monero, Zcash or Grin. The reason why they may make sense from investment point of view is that their monetary policy is usually deflationary and their adoption is still nascent. If their adoption starts growing with exponential rate (as we expect with such networks), it will mean the price (nominated in inflationary fiat currencies) will rise significantly.

2. Open, decentralized financial systems (#DeFi):

DeFi means stack of technologies that allow transparent, open, programmable and decentralized financial services (apart from just money). Services such as creation of assets and derivatives, lending, insurance, exchanges etc.

These services, currently provided by banks, could be provided by decentralized protocols and smart contracts that are enforced by the network incentives, rather than law.

Investing according to this thesis is much more complex, than in simple currencies. We can invest in tokens of underlying smart contract protocols (such as Ethereum, Stellar, EOS), if we believe that these bedrock protocols will accrue most of the value.

Or we can invest in tokens of middleware protocols, that enable specific services, such as MakerDAO (“decentralized central bank”) or Augur (prediction market that allows creating “bets” = markets on almost anything).

Digital assets (tokens) of these protocols are designed to economically incentivize all participants of the network to act on behalf of the network. Thus, if designed correctly, they should accrue value and grow in price if protocol/network will become successful, even though there is no authority – state or private firm – to govern and manage them.

Last but not least, we can invest in equity (or tokenized equity) of companies, building centralized customer facing services on top, such as cryptocurrency wallets.

We at Sigil are looking to invest especially in decentralized tokens of underlying and middleware protocols, which we believe can accrue a lot of value from the new digital financial systems being created on top of them. In couple of years, when technology will become more mature, it will make sense to look into tokenized equities of companies as well.

3. Web 3.0:

This term indicates evolution of structure of the internet. Web 1.0 were first simple HTML websites and communities fragmented among various discussion forums and chat boards. Web 2.0 is what we have now – majority of online traffic and online commerce is increasingly under control of corporations such as Google, Facebook, Alibaba or Amazon. These corporations have access to all our data and can even influence our behavior (e.g. Google can alter our shopping habits and desires by showing us customized targeted ads), thus becoming increasingly powerful.

Web 3.0 is a pushback against increased surveillance and centralization of internet and online commerce. Paraphrasing Peter Thiel – when pendulum swings too much in one direction (centralisation) over-correction in opposite direction (decentralisation) is imminent. Web 3.0 consists of technologies that enable users to reclaim control of their data and possibly monetize them on their own terms. Web 3.0 will be powered by decentralized protocols and crypto-networks, using technologies such as cryptocurrencies, smart contracts and encryption anonymization tools.

In other words, Web 3.0 will become a more decentralized, privacy oriented and open version of internet. We can invest in Web 3.0 thesis by betting on alternative decentralized networks such as FOAM protocol (decentralized community built GPS competitor) or nuCypher (privacy infrastructure). Many of these projects also employ tokens to align incentives of their decentralized networks.

4. Decentralized governance:

Governance basically means ways and processes on how we organize our societies and make collective decisions about them. Today we mostly rely on governments and private companies protected by enforceable laws. Decentralized digital networks enable us to create new ways of organising our cooperation on large scale (as Nick Szabo argues), by transferring some of the rules and processes from our current systems to automatized, digital and decentralized networks.

Blockchain governance is still a very nascent topic. We see many experimentations in this area, solving mainly these questions:

  • How we govern decentralized protocols and networks
  • How we use decentralized protocols and networks to enhance large scale cooperation
  • How we create new types of organisations and entities such as DAOsCOs
  • How we can experiment with alternative forms of governance (such as FutarchyLiquid democracy or Radical markets)

We believe that decentralized blockchains, that will succeed in the goal of creating new types of governance, will accrue significant amount of value, if they tie the governing system to usage of their native tokens. Some of the early examples of such networks are: Decred, Tezos or EOS. These tokens can then become a means how to capture political power within whole ecosystems.

Combining our theses together – emerging Open Digital Economies

These are the main four theses, that we are currently covering in our investment portfolio and approach. They are not contradictory to each other, but rather complementary. If at least some of these visions materialize and get mass adoption, we should think about them as whole new open digital economies with their own currencies, markets, rules, decision makers and services.

There are also other, smaller theses we are researching, such as decentralized game ecosystems (such as Loom Network) or semi-centralized blockchains for industrial and corporate use cases (such as Factom).

What can we expect next?

We at Sigil used the bear market for consolidation of some of our positions, which weren’t holding up to their previously perceived potential. We continue holding our long-term positions in the well researched high quality projects we are invested in. We continue vigilantly researching new high quality projects in our pipeline of opportunities for early investment. We also attended many conferences, sometimes as speakers (see “How to survive bear attack”).

2018 also made us more humble and respectful in the face of ruthless markets. During 2019 we plan to put even more emphasis on qualitative research as well as looking into ways how to efficiently hedge and de-risk our portfolio at the right times.

Nobody knows for sure, if we have seen the bottom of the current crypto winter and if there will be a recovery this year. In short term, prices are subject to fickle moods of crowd, that is why we are looking on longer investment horizons, during which our theses should materialize or be disproven. However current prices of many crypto-assets are on such levels, that I feel comfortable recommending sophisticated modern investors to slowly scale in and start allocating small portions of their portfolio in crypto. All things considered, risk:reward should be much more favorable now than in late 2017, a good time to build positions.

Addendum: Financial markets

Our insights of crypto-market would not be complete without considering what is happening in the rest of the economy. Crypto-market is still just a negligible fraction of global markets.

Traditional markets have seen a notable correction by the end of 2018, after unprecedented growth in past 10 years. According to our view, this growth was predominantly driven by quantitative easing of central banks, which inflated the global money supply by more than 20 trillion USD in that period. Arguably, this caused markets to lose one of their key functions – ability to find “fair price” of assets and distinguish financially healthy assets from the unhealthy ones. In other words – everything goes up together.

According to Global Wealth Report and World Debt Reuters global wealth in 2019 is around 370 trillion USD, growing by 133% in last 20 years while global debt in 2019 reached 247 trillion USD, growing by almost 400% in last 20 years.

This is causing a nervosity on the market and many investors are “expecting” next financial turmoil, however the noise from printing machines of central banks keeps going on (despite recent cautiously hawkish FED attempts)  and the party seem to continue. We believe that this distortion is not sustainable, but we don’t try to predict what and when will give in.

What is interesting to us is to simultaneously watch public losing trust in traditional financial system and grassroot efforts of thousands of smart developers to design new, alternative and more transparent financial primitives and systems from scratch.

It will also be interesting to see how crypto-assets, now uncorrelated with markets, will behave in financial stagnation or meltdown. For this thought experiment, I divided crypto-assets into two categories: systemic – those that try to work with and improve current economic system, and can be driven mostly by innovation budgets of corporations (such as Stellar or Factom) and antisystemic – those that position themselves as alternative or even anti-thesis to current financial system with independent monetary policy (such as Bitcoin or Monero).

I think it is more likely, that financial turmoil and distrust will drive adoption and popularity of anti-systemic cryptocurrencies, while it won’t positively affect systemic crypto-assets.

However, this is just very rough thought process. In such an early stage it cannot serve as a framework for asset allocation, since crypto-assets are still very nascent and heavily correlated to each other. For our investment strategy, quantitative filtering, deep fundamental research and probabilistic approach are the key.

Sigil team and I wish you a successful start to 2019.

Pavel Stehno, CEO of Sigil PCC Limited
Fiskantes, CIO of Sigil PCC Limited

This content piece is performed by Sigil PCC Limited for information and entertainment purposes only and is not to be taken as an investment or a financial advice. Sigil PCC Limited does hold positions in some of the aforementioned projects.

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