Author: CloudY, Sihan
Editor: Vincero, YL
Review: Crystal
Let me tell you a fable from The Three-Body Problem:
There was a group of turkeys on a farm. The farmer came to feed them at 11 o'clock every day. A scientist among the turkeys observed this phenomenon and kept observing it for nearly a year without any exception. Then he also discovered his own great law in the universe: "Every morning at 11 o'clock, food will fall." He announced this law to the turkeys on Thanksgiving morning, but the food did not fall at 11 o'clock that morning, so the farmer came in and caught and killed them all.
In the investment field, people are eager to observe the laws of truth, attempting to be scientists among turkeys, and use the laws of truth they have mastered to predict the market, guide investment, and be invincible. However, can the market really be predicted, or is there a law that can be followed once and for all? We try to compare the cryptocurrency cycles from different dimensions to see the changes and differences between different cycles, and explore whether we can really treat the crypto investment market with an empiricist mindset.
1. Macroeconomic cycle
Macroeconomic cycle factors mainly include the stage and level of economic development, fiscal and monetary policies, CPI index, PMI index, black swan events, etc. Among them, the fiscal and monetary policies of various countries are regarded by investors as the vane of market trends, and often directly affect the capital market; black swan events form the alpha factor of the market, which is a major influencing factor beyond investors' expectations and often has a greater impact on the price of risky assets.
Looking at the crypto market, it has been 14 years since the emergence of Bitcoin in 2008, and its bull-bear conversion is closely related to global fiscal and monetary policies. For example, the bull market in the crypto market in 2017 originated from the Federal Reserve's original plan to raise interest rates four times in 2016 in 2015, but the actual pace of interest rate hikes slowed down. Only one round of interest rate hikes was implemented in 2016. In addition, the tax cut plan launched by Trump after he took office, and then the prices of risky assets such as US stocks and Bitcoin continued to rise in 2017. The bull market of crypto assets in 2021 also obviously benefited from the global central bank's loosening of funds. Unlike the previous interest rate cuts and loosening of funds, the social life and economic development environment have encountered unprecedented situations. The outbreak of the new crown epidemic in 2020, home isolation, home office, closure of public places, city blockades, and suspension of flights have become conventional means for countries to fight the epidemic. Compared with the financial crisis in 2008, the impact of the epidemic on the real economy is more serious. Not only is international trade blocked, but it has also had a serious impact on people's daily life and consumption. All countries have lowered their expectations for economic growth, and unemployment has surged, consumption has been sluggish, and economic recession has followed, and global pessimistic expectations have risen sharply. Under the influence of the black swan event of the COVID-19 pandemic, countries have rarely moved in unison, not only fighting the pandemic together, but also introducing unprecedentedly proactive fiscal and monetary policies to boost the economy and prevent economic recession, injecting a large amount of liquidity into the capital market.
Take the Federal Reserve, which has received much attention, as an example. During the COVID-19 pandemic, the time chain from the Federal Reserve's policy formulation to its implementation was significantly shortened, and the policy intensity and tool innovation were significantly higher than during the financial crisis. In just three months, the scale of the Federal Reserve's asset purchases has approached the total scale of the four rounds of quantitative easing policies after the financial crisis. At the same time, the Federal Reserve purchased corporate bonds and commercial paper through SPVs (special purpose vehicles), which not only achieved precise assistance but also quickly lowered the market credit spread and stabilized market volatility.
Specifically, in order to stabilize the market, the Federal Reserve cut interest rates by 50 and 100 basis points twice in the first half of March 2020, bringing the federal funds rate down to a low of 0.25%, and announced an unlimited quantitative easing measure. In the second half of March, 15 monetary policy tools were introduced to inject liquidity into the market and directly provide credit support to real enterprises. Central banks around the world have also joined the ranks of interest rate cuts and liquidity releases, and the epic liquidity has driven a super bull market in risky assets such as Bitcoin.
Figure 1.1 Changes in the Federal Reserve’s balance sheet from 2008 to 2020 (million U.S. dollars)
Figure 1.2 Changes in the total market value of cryptocurrencies from 2016 to 2022 (in US dollars)
Source：https://coinmarketcap.com/zh/charts/
Although each round of bull market is inseparable from loose fiscal and monetary policies, sufficient liquidity support and a loose market environment, the background, motivation and economic environment of each central bank's implementation of various policies are different in each cycle. Therefore, the specific details of policy formulation and implementation (such as the scale of quantitative easing, duration, interest rate level) will also be different, and the impact on the crypto market cannot be generalized. In addition, the frequent occurrence of black swan events in recent years will also have an impact on various economic policies. Therefore, the analysis of macro fundamentals should be realistic and realistic. We cannot simply draw general conclusions based on experience. We need to make judgments on the subsequent development of the market through meticulous observation.
2. Traditional institutions enter the market, more long-term holders
Unlike the bull market in 2017, the attempt to pass the BTC ETF in 2018 failed. The bull market that started in 2021 was obviously driven by the entry of traditional institutions. These institutions, such as JPMorgan Chase, Standard Chartered Bank, Citigroup, Deutsche Bank, DBS Bank Group, Fidelity Securities, etc., have large funds, decisive decisions, and almost all hold for a long time, which makes BTC's increase huge and continuous. Of course, various well-known companies, with the endorsement of major traditional institutions, have also participated in it and used Bitcoin as an asset allocation. The most well-known of them is Elon Musk's Tesla. Musk once caused BTC to rise and fall by nearly 20% in a single day with two Twitters, and was dubbed the "King of Shouting Orders" in the currency circle. In addition, BTC ETF and Grayscale Fund are the biggest boosters of this bull market. Various BTC and ETH ETFs (Figure 2.1) have given traditional financial market funds the opportunity to participate in the crypto market. The approval of BITO, the largest BTC ETF in the United States, has brought billions of dollars of incremental funds to the crypto market. Grayscale Fund, as the largest cryptocurrency trust and compliance business benchmark in the United States, has truly opened the channel for traditional funds to enter the market, bringing tens of billions of purchases to BTC (Figure 2.2). Since customers have a 6-month lock-up period after purchasing Grayscale's GBTC, and even after the lock-up period, customers cannot redeem it and can only exit through the secondary market over the counter, most of the buyers of GBTC are long-term holders. Even El Salvador has defined Bitcoin as legal tender and has successively purchased $150 million in BTC. With the participation of many institutions, companies and even countries, retail investors have the confidence to participate further. It can be seen that this round of bull market is almost jointly promoted by major investment institutions, emerging companies and sovereign countries seeking change.
When it comes to traditional institutions, we have to mention the primary investment funds of cryptocurrencies. With the surge in the amount of funds in the entire market, the scale of funds of these VCs is also much larger than that of the previous bull market. Therefore, they can do a lot in this bull market, and the larger market also gives them more space. For example, unlike the simple investment in tokens in the previous bull market, since VCs have more resources and greater influence, they will also call orders and incubate investment projects. At the same time, the entire financing cycle has also been extended thanks to this long bull market. The most obvious phenomenon is that this time, the altcoins not only achieved a far greater increase than BTC and ETH, but also gradually walked out of the independent market, causing BTC's market share to drop below 40% at one time. Take A16Z as an example. They look for potential projects in various sectors, and once the target is determined, they will not only provide funds for it, but also start to build momentum for it on various media platforms through their own influence. Sky Mavis and Yuga Labs are typical examples of companies that have grown up under the resources of A16Z. Axie Infinity was once the absolute leader of GameFi, occupying most of the market value of the GameFi sector, although the emergence of StepN has changed this situation; and Yuga Labs is more convincing. Even in the current market downturn, BAYC still has a 7.1% market share in the NFT market. If Otherdeed, Crypto Punks and Meebits are included, it is about 23% market share. The influence of primary investment funds in this bull market is self-evident.
Figure 2.1 Market value of BTC holdings of some BTC ETF funds
Source：https://www.coinglass.com/zh/BitcoinTreasuries
Figure 2.2 Grayscale Fund BTC holdings history and BTC price changes
Source: https://www.coinglass.com/zh/Grayscale
3. Changes in narratives and sources of bubbles
The change of narrative is often one of the powerful driving forces of the bull market: after Bitcoin broke through the foreign exchange controls of centralized countries and organizations, the birth of Ethereum also laid the foundation for the ICO boom in the crypto industry. The emergence of the ICO market is essentially an impact and subversion of the existing securities market structure and system, which directly or indirectly led to the magnificent bull market in the crypto industry in 2017. Different from the bull market in 2017, the concept of decentralized finance (DeFi) emerged and became the initial engine of the 2020-2021 bull market (Figure 3.1 TVL on the chain), because DeFi provides a new way to leverage funds - on-chain lending. This allows users, especially traditional institutions, to further leverage on the chain after obtaining financing, which is also confirmed by the 3AC explosion incident. GameFi after DeFi is nothing more than a shell-changing model of DeFi, and its essence is still DeFi with game attributes added. But the difference is that with the rise of GameFi, along with the popularity of NFT, NFT series such as Crypto Punks, NBA Top Shot, BAYC, etc. have pushed NFT to the top step by step, and quickly became popular on the entire network, completing the out-of-circle of NFT. NFT has thus taken the baton from GameFiI and become the hottest concept and new financing method in the capital market. NFT fundraising is independent of traditional private placement and IEO/IDO. The key lies in the particularity of NFT's own attributes (for details, see our article: "NFT, a paradigm shift in fundraising forms").
High leverage and narratives are the bubble-making machines that push up the market value of crypto assets, and they are also the catalysts that accelerate their decline: since DeFi became popular, the use of leverage has become the norm for funds in the circle. For example, the recent crypto lending platform Celsius crashed, because users ran a large number of deposits under market panic, and the problem of severe liquidity shortage was highlighted. The deeper reason is that there have been serious problems in the project operation mechanism and risk control strategy for a long time, which led to this crash. Another example is the 3AC explosion. On the basis of financing, 3AC added leverage on the chain, and at the same time, it was not clear enough about its own leverage multiples and liquidation points on the chain. Therefore, after experiencing major accidents such as UST and stETH depegging, it was surrounded by users and exploded. With more and more CeFi/DeFi projects in the crypto industry running or crashing, the problems covered by the industry's rapid growth in the past two years finally broke out in the bear market. In addition, many expensive NFTs and Gas Wars in NFT issuance have absorbed and destroyed countless ETH while pushing up the market value of the NFT sector, which has increased the bubble and increased the risk. Because although the market value of a number of projects has increased, the real silver in the market is decreasing, so once the tide recedes and the bubble begins to subside, there will inevitably be a spiral collapse like the DeFi run. Especially after NFT, although everyone is trying to find opportunities in the Web3.0 concept and DAO model, they have not separated from the DeFi and NFT concepts, so as the narrative is exhausted, the decline of the market can be said to be "just around the corner."
Therefore, we need to re-examine the source and composition of this round of bull market bubble, rather than simply judging it by empiricism. In this round of bull market, DeFi, NFT and many infrastructures have continued to develop, providing substantial value to the Crypto industry by providing practical technological progress and solving a series of problems. On this basis, capital has blown up a huge amount of bubbles using various new and old financing methods and stories that are linked together. The entry of traditional institutions and the continuous emergence of Crypto have also brought sufficient incremental funds and incremental users to this round of bull market, providing growth space and expansion rate for the bubble. Another point that needs to be paid attention to is the valuation method of Crypto projects. Unlike the ICO era, the current project valuation is more traceable. Project fundamentals, official website quality, economic model, token distribution, project experience, institutional endorsement, etc. are all taken into account; and compared with traditional Internet companies, Crypto projects do not rely entirely on traffic itself for pricing. At the same time, due to the characteristics of the code and the openness and iterative capabilities of the project, Crypto projects can be regarded as "enterprises" that are almost permanent. Therefore, there is also a "relatively reliable time bonus" in the bubble of this round of bull market. Driven by the high base and many additive factors, the total market value of Crypto has risen from the peak of $700 billion in the previous bull market to $3 trillion in this round, and BTC has also reached a peak price of $69,000. Its market value once surpassed Tesla and ranked sixth in the world (Figure 3.2). However, since profits and losses come from the same source, once a factor reverses and a downward trend is formed, the speed at which its market value declines is also extremely terrifying. This also explains why the bubble of this bull market has expanded so quickly and unexpectedly, and why it burst so unexpectedly when everyone expected BTC to reach $100,000.
Figure 3.1 Total TVL (all chains)
Source: https://defillama.com
Figure 3.2 Ranking of asset market value in 2021
Source：https://images.bitpush.news/cn/20211109/163641542751445079.png
4. The Empiricism Trap
At the beginning of this article, the story of the turkey scientist described in Liu Cixin's novel "The Three-Body Problem" is called the "Farmer Hypothesis". This hypothesis comes from the philosopher Hume's view on causality. Hume subverted the objective necessity of causality and believed that causal connection is often nothing more than: the constant meeting of two things + subjective psychological association. In the 14-year history of the crypto industry, we may ourselves be the turkeys on the farm: "a bull-bear cycle every four years", "a big bull market every time the output is halved", but in this cycle, more and more empirical laws are broken: the S2F model advocated by planB (the high stock-to-flow model S2F refers to the model obtained by dividing the total number of assets in the reserve by the total amount of assets produced each year. It is mainly used to highlight the relationship between scarcity and market price, and is mainly used for popular metals such as gold and silver. It was proposed by PlanB in 2019. He believes that this can eliminate price fluctuations caused by accidental events. It can be inferred from the S2F model that the value of Bitcoin will reach an astonishing $288,000 in 2024.) has been proven to be distorted. Even Ethereum founder Vitalik Buterin criticized the Bitcoin S2F model (Stock-to-flow) on Twitter for giving people a false sense of certainty, believing that "predetermined numbers will give people a harmful feeling, and blind followers should be ridiculed." Coincidentally, in the recent round of decline, Bitcoin has quietly fallen below the peak of the previous bull market, breaking the historical rule that the bottom of each bear market is higher than the peak of the previous bull market.
When we look back at the past two rounds of bull and bear markets, we will also find that the obvious sign of the bull market in 2017 was the ICO led by ETH, while the bull market starting in 2020 came from the outbreak of DeFi and the global interest rate cuts and water releases. Both rounds of bull markets were accompanied by revolutionary innovations in narratives and drastic changes in the economic environment. So is there a possibility that the advent of the past two rounds of bull markets (because the market size was smaller during the bull market in 2013, so it is not compared here) was actually just because of the progress of narratives and technological innovations, which formed the four-year bull-bear cycle? In other words, with such a small sample size, perhaps each round of bull and bear markets in the past has nothing to do with factors such as halving of production, but is just accidental. And is it possible that with the increase in the size of the industry, the exhaustion of narratives, most of the experience of cycles and regularities will be broken, and even enter a long winter that has never been experienced in the past? Are we welcoming the Thanksgiving in the farmer hypothesis? These questions are worth pondering.
Figure 4.1 S2F model
Source: https://twitter.com/VitalikButerin/status/1539167095312850944
5. Reflection and principles
The crypto market is naturally financial in nature. Constantly looking for new narratives is an important way to attract funds and talents to continue to enter the market. Only when funds and talents continue to enter this market can new narratives be realized. It is undeniable that in this process, the influx of funds, the marketing hype of various project teams, and the boost of users' FOMO emotions will cause crypto assets to form a huge bubble. Although bubbles mean bad growth far exceeding their own value, they are also sparks that ignite the enthusiasm of the industry and promote the development of the industry. In the last cycle, as long as there is a white paper, a team of several people, and a decent story, you can be popular in the crypto market. In this cycle, there are more landing applications than in the last round, the business model is more mature than before, and the fundamentals are better. Therefore, the bubble of this bull market is not completely "sourceless water". However, as investors in the crypto market, we must remain absolutely rational as much as possible. We must always remain skeptical, be vigilant against bubbles while embracing them, and control risks while gaining benefits from bubbles - this is the most important thing.
At the same time, as a "rational person", we must avoid falling into the trap of empiricism. Crypto assets have only been around for 14 years, which is a very short history compared to other assets. Therefore, the "laws" observed in this process are not necessarily the real "truth". They may be coincidences caused by multiple factors, or it may take a longer time to verify the observed phenomena. The past does not represent the future, and the law does not represent the truth. No one knows which will come first, tomorrow or an accident. Therefore, adhering to technological development as the basis and adhering to the concept of value investment is the fundamental way for the development of the industry and the core of investment.
Although simplistic empiricism is not desirable, we can still reflect on history. The market is currently in a bear market, and we can summarize and learn these principles so that when the bull market comes, we can deal with it more calmly. These conclusions include:
(1) Always respect the market, because black swan events are unpredictable. Do not fall into the trap of empiricism;
(2) Embrace and be wary of bubbles. Bubbles are the spark that ignites the market. You can gain profits from bubbles, but you must also remain skeptical of bubbles.
(3) The core of industry development is continuous innovation, achieving progress in underlying technologies, and ultimately returning to value investment;
(4) Technology and macroeconomics have their own laws and cycles of development. Following the trend and continuously improving productivity is the foundation;
(5) Market fundamentals are improving. The bear market is a touchstone for testing applications and projects. Therefore, only by remaining optimistic can we win the future.
