Monthly Update || October 2018
Greetings from inside Ikigai Asset Management1 headquarters in Marina Del Rey, CA. This document marks the first formal written external communications we have had to the Ikigai community, and I speak for the entire organization when I say that we are thrilled to be here. This inaugural edition may be a bit longer than future letters, but I think we have a lot to share with you.
When Timothy and I first began building Ikigai in February, it was with the basic thesis that Distributed Ledger Technology (DLT) and Digital Assets will rearchitect the foundational layer of the internet, becoming ubiquitous to the point that we will not even notice them, in the same way we don’t notice HTTP or TCP/IP today. Through this transformation, we believe trillions of dollars in value will be created in the process. We saw a landscape of Crypto investors severely lacking in institutional-grade investment sophistication, and that looked like opportunity to us. Over the last 7 months, our conviction in these theses has been strengthened.
Over the last 7 months, we have been hard at work building Ikigai Asset Management into a world-class Digital Asset investment firm and I’m deeply proud of the work we’ve done thus far. I can tell you that investing is a lot of fun and something I really enjoy. Building a hedge fund is not a lot of fun. It’s tedious. It’s pushing a lot of balls up hills- legal documents, legal entities, fund administrators, banking relationships, auditor relationships, custody relationships, hiring a team, office space, building out strategies, building out tools for those strategies and building out the infrastructure to execute those strategies. This tedious work is foundational to creating a world-class organization that can not only excel, but excel at scale at generating attractive risk-adjusted returns in this exciting new asset class. While the building is never done and of vital importance, I am currently transitioning away from building the nuts and bolts of the hedge fund and back really dialing in to investing. This is a welcomed transition.
1. Ikigai Asset Management is the trade name for a collection of advisory and consulting businesses operated by Travis Kling, Timothy Lewis, Anthony Emtman, and their team.
The following table features numerous public communications about the fund. The podcasts are especially informative and go into extensive detail on Ikigai’s broad views and thoughts on the Digital Asset space. We’re honored to share some of those views with the community.
IKIGAI INTERNAL VENTURES
A lot has progressed at Ikigai since February. We now have 15 full time team members and consultants under the Ikigai umbrella. These include data scientists, software developers, market researchers, globally-dispersed traders, product managers, operations specialists and investor relations. This is a highly talented, highly motivated group of individuals all working in unison to drive value for Ikigai. It’s a special place.
Alongside the investment management and operational roles, we have several team members that are focusing some or all of their time on Internal Ventures. Internal Ventures is the catch-all for early stage Digital Asset opportunities that are not simply capital deployment opportunities for our investment management business. In many cases, these opportunities are only in the beginning stages of ideation when Ikigai sees them, either because the opportunity is brought to us very early on in its life cycle by a third party or because Ikigai becomes aware of a need in the industry and begins to craft a solution for that need. In many cases, these opportunities need to be developed into business plans, action plans and go-to-market strategies. These opportunities may need a management team to be hired to execute the opportunity and may need the first seed-stage round of funding to be raised, both of which Ikigai helps with.
Evaluating and executing on Internal Ventures opportunities positions Ikigai as a solutions provider in the Digital Asset industry. Internal Ventures allows Ikigai to learn about, develop relationships in and contribute to the buildout of a number of subsectors within Digital Assets broadly.
Ikigai’s early stage involvement in those potential candidates grants not only close access to the project and team for due diligence purposes, but also the ability to shape projects in ways we believe will set them up for the most success possible. Internal Ventures is highly synergistic and value-add across Ikigai’s other business lines.
Ikigai most commonly receives allocations of minority equity ownership stakes in Internal Venture opportunities but may also be compensated in USD on a monthly retainer basis or in newly-created tokens.
In early June, Timothy was instrumental in helping launch the EOS Mainnet. He worked literally nearly around the clock for 10 days to help ensure the EOS network would be safe and functional when it went live.
Timothy was an early investor in EOS, knows the founding team well and has actively supported the community for over a year. In April we began discussing running for a role as an EOS Block Producer. Block Producers are voted on by the EOS community to provide computational processing to the EOS Network to verify transactions on that network. We partnered with Everipedia, an acclaimed EOS project run by a talented team, to form LibertyBlock.
LibertyBlock has been voted a top Block Producer by the EOS community, hovering in the rankings from #22 to as high as #5. That team, run by Timothy, Anthony, Alex and several members from Everipedia, has been instrumental in helping EOS become a functional blockchain. Ikigai remains in close and constant contact with the EOS project and its community members.
PROFESSIONAL SERVICE PROVIDERS
Ikigai is committed to serving our clients in the absolute highest manner possible. A significant facet of that commitment is bringing together the best professional service providers in the world to build Ikigai into a world-class asset management firm. To that end, we have retained and are currently engaged with the following outstanding organizations-
• Perkins Coie – U.S. Legal Advisor; Regulatory Legal Advisor
• Campbells – Offshore Legal Advisor
• Zuber Lawler & Del Duca LLP – Transaction Legal Advisor
• KPMG Cayman – Auditor
• Friedman LLP – Tax Advisor
• Trident Trust – Fund Administrator
• Digital Asset Custody Company – Custody
Simply stated, we believe we have assembled the best group of professional service providers in this business. We feel confident about that because we spoke with many of their competitors. We sleep soundly (the little sleep we do get these days) knowing that these highly competent organizations have our back, and you can too.
MARKET UPDATE – VENTURE DIGITAL ASSET INVESTING
As expected, the seed-stage Digital Asset investing landscape continues to evolve rapidly. The current environment is drastically different than it was a year ago, and we believe that the environment a year from now will be materially different than it is currently. U.S. regulatory clarity, in conjunction with a large downward price correction in the liquid markets, has slowed down U.S. Venture Digital Asset deal flow significantly. This is also a function of the market maturing in its understanding of value accrual in this nascent asset class. Many venture-stage Digital Assets do not have a token structure that accrues value over the long term. This has kept them from being able to raise much or any money in the current market environment, which is a healthy and necessary change from the market dynamics a year ago.
Broadly, deal flow has slowed down, raises are smaller and quality of projects getting funded has increased. Valuations have come down meaningfully from their absurd levels of late 2017 and early 2018, but popular deals are still getting done at multi-hundred $mm valuations. The market feels like it has some room to go on the downside, and we remain patient. There are a few projects that we believe are attractive, usually due to a combination of factors. Such factors could include the team; technology; token structure; current user base; go-to-market; and customer acquisition strategy.
While we have been passing on a lot of deals and may continue to do so, we do feel confident about our deal flow pipeline. We are in frequent dialogue with hundreds of active Digital Asset venture investors, spanning from angels to large funds. If and when a captivating project does come to the market, we believe we will be positioned to see it.
MARKET UPDATE – LIQUID DIGITAL ASSET INVESTING
|Top 100 Aggregate||-1%||-64%||-73%|
Source: Bitfinex and CoinMarketCap. As of 9/30/18.
Needless to say, it’s been a rough year for Digital Assets so far. Market Cap has been decimated and the asset class is exhibiting the reflexivity we now know to be fundamental in nature. The YTD Crypto price action can be explained by the aggregation of the following occurrences:
Blow off top late 2017 overbought conditions
Lack of institutional-grade infrastructure
Volatility killed the SoV thesis near-term
The rise of Stablecoins
Flood of ICOs, many with unreasonable or bad value propositions
Focus on token structure
In the aggregate, we believe these are the main factors that have driven BTC down 54% YTD and the Bottom 99 (#2-#99 largest Cryptos by market cap on CMC) down 71% YTD. My team and I have and continue to evaluate and track these factors in detail. I have presented on this topic to multiple conferences and the presentation resonates with the ecosystem. Feel free to reach out if you want the detailed slides.
This correction is healthy and completely to be expected (see Carlota Perez2). But the multi-hundred-billion-dollar question is, when will it end?
Unsurprisingly, the answer is “I’m not sure”. But it’s worth mentioning I’m “more not sure” today than I was a month or two months or three months ago. There are numerous cross-currents to consider. From May to mid-September, BTC Dominance (the % of Top 100 Aggregate Mkt Cap is from BTC) has been steadily increasing from a low of 36% to as high as 58%. We think this is a trend to take notice of.
Source: CoinMarketCap. As of 9/30/18.
2 Carlota Perez, Technical Revolutions and Financial Capital: The Dynamics of Bubbles and Golden Ages (2002).
Over the last several weeks, BTC dominance has eroded from 58% to 51%. This could be a sign of a market bottom, where you would likely expect BTC to underperform “higher beta” small caps. Whether this trend continues is important.
Bottom 99 Mkt Cap has increased $31bn or 40%. This increase is primarily a result of a bounce in ETH from deeply oversold conditions, a massive run in DOGE and a spectacular pump on large volume from XRP. A few other names have pumped meaningfully over the last month, including XLM and XMR.
Source: Bitfinex. As of 9/30/18.
Source: Bitfinex. As of 9/30/18.
Source: Bitfinex. As of 9/30/18.
No one can pick, in advance, what a bottom is going to look like in a market, but you can think through various scenarios of what a bottom might look like, and why, and develop plans of action accordingly. To that end, we have been keenly focused on the following chart since June.
Source: Ikigai & CoinMarketCap.
This chart is a sensitivity analysis of BTC price, with Bottom 99 Mkt Cap at the market trough and BTC Dominance at the market trough as your inputs. Bottom 99 currently sits at $109bn, down from $548bn on 1/7/18 and up from a YTD low of $81bn on 9/11/18. This Bottom 99 number was as low as $73bn on 11/1/17 and $38bn on 7/16/17, right before the madness of last year really took off. We believe it would be healthy for the space for Bottom 99 to decline to $40-$50bn, more than a 50% decline from current levels. Said plainly, we think there is currently too much market cap currently trapped in worthless projects that are highly unlikely to ever find significant user adoption. That market structure is not normally indicative of a market bottom. We think there needs to be more capitulation to get this market on solid footing to then go and resume what we believe to be its inevitable uptrend. We expect BTC dominance to continue its rise from current levels, as the value proposition for BTC relative to its status quo is vastly better understood than most any other Crypto’s value proposition is understood relative to its respective status quo.
If we could pick a bottom that would be the healthiest, it might be a $40-$50bn Bottom 99 Mkt Cap at the trough, combined with a 65-70% BTC Dominance at the trough. This implies a BTC price of $4.3k-$6.7k. In our view, in this Bottom 99 “flush” scenario, BTC would be unable to hold its YTD low of ~$5.9k and would indeed make a new low. If this scenario plays out, we think we would expect massive selling volume across the board in a series of moves lower.
We are in no way married to this view, and completely willing to change our mind at a moment’s notice as new information becomes available. However, if we continue to move higher from current levels, that rise will feel unsteady, built on an infirm foundation of recent price action. Given the information we currently have, we may be wary of chasing this market higher from here.
If this flush scenario does indeed play out over the next several months, an additional factor will come into play which could drive continuation of the downward price action- Crypto fund redemptions. While we do not know exact numbers, we do know significant capital was deployed into Crypto funds in Q4-17 and Q1-18. Much of this capital likely has a 1year lockup, which is to say meaningful redemptions could be upcoming. We think narratives are a significant driver of Crypto price action, as this market grasps on to any theme possible to help understand the value proposition and outlook of this new asset class. The “fund redemptions” narrative will only need to garner the slightest amount of traction, before this market will press the issue and bring that narrative to fruition with shorting. We have something similar over the last several months with ETH and the “ICO Death Spiral” narrative, and we could easily see it again.
On the bullish side, sentiment may be beginning to turn. Bear markets are characterized by the ignoring of positive news events and the exaggeration of negative news events. The opposite is true for Bull markets. These are hallmark characteristics of regimes and when these begin to turn, it’s worth paying careful attention. We think the market has been able to shrug off several negative news items in the last several weeks, including the BTC CVE vulnerability, the VanEck/SolidX ETF news and the NY AG Virtual Markets Report. In the meantime, incrementally positive news items have been stacking up as well and not really moving price, including Fidelity formally announcing Digital Asset products and a Coinbase Index product.
Another bullish sign is simply the seasonality we’re moving into at this point in the year. This chart says it all.
Source: Bloomberg. As of 9/26/18.
This chart helps to put the current bear market in historical perspective. This would tell us we might have some room to go on the downside, but maybe not a lot more.
Source: TradingView. As of 9/10/18.
One indicator that remains bearish is the Cross-Coin Correlation. Decoupling of price action across names is a sign of risk-on. We’re not seeing that yet.
It is also worth mentioning that BTC appears to potentially be acting as part of a global macro trade on liquidity tightening from central banks around the world. We think that when loose money begins getting mopped up, the first thing people do is get up from the horse track and go home. We believe that Emerging Markets and Peripheral Debt are the horse tracks and it appears BTC could be as well.
Source: Bitfinex. As of 9/30/18.
If you told me for sure that EM & Peripheral Debt has NOT bottomed, I might say there is maybe a 5% chance the Crypto market has bottomed here. If you told me for sure that EM & Peripheral Debt HAS bottomed, that 5% might move to 25% or even 1/3. These macro winds bear close observation and we plan to do just that.
Finally, we think this is likely the most important chart in Crypto, and has been for quite some time.
Source: Bitfinex. As of 9/30/18.
We are coming to the tail end of a 6-month descending triangle. This pattern, typically bearish, has held as resistance on 3 previous occasions. Realized Volatility has been coiling in advance of large move in one direction or another and the pattern is coming to a point.
Source: Bitmex. As of 9/30/18.
We believe October is shaping up to have some fireworks play out in one direction or another. In this market, which is heavily driven by large, sophisticated, opportunistic whales, a head fake in one direction or the other is reasonably likely. As such, an initial break down or up will be approached with caution, as it may easily reverse trend after appearing to have decided to break a certain way. If this market has truly bottomed and the bear market is over, we may be happy to miss a portion of the first move up to $8 or $9k, to be assured that a regime change has indeed occurred, and the backdrop is more conducive to generating attractive risk-adjusted returns.
This is the most dynamic asset class I have ever witnessed before. Everything happens at hyper speed and technological evolution occurs in a Darwinian, Cambrian Explosion sort of manner. We believe even the most foundational pieces of this ecosystem haven’t been put in place yet. While short-term we are highly uncertain, medium-term we are broadly, highly convicted bullish.
We think the risk required to generate top 5% returns during a bull market is not prudent. We think our highly-informed strategies will outperform the broader crypto market during bear cycles. In aggregate, through cycle, we believe we can deliver attractive risk-adjusted returns. We approach this asset class by architecting data intake, synthesis, analysis, diligence and tracking of a whole host of avenues of information. We think those avenues contain signals…truths. We have built and continue to build the frameworks, processes and tools required to find these truths and invest accordingly, or realize these truths are currently unknowable (as many currently are) and invest accordingly. It will be the architecting and application of these frameworks, processes and tools that will be our competitive advantage in the years to come. We have assembled an incredibly talented group of individuals under the Ikigai umbrella to execute this vision. We look forward to taking that ride with you.
Founder & Chief Investment Officer
Ikigai Asset Management
P.S. Included below is an incomplete list of memorable tweets from the last several months. Twitter is not investment advice and my views could easily be wrong. That being said, like it or not, Twitter matters for Crypto. I have no interest in being a talking head for a living and babbling about on Twitter is a long way away from being a good steward of investor capital. However, this is a community with open-source software in its DNA, and participants want to crowd-source the truth. We believe we have built a team and a process that will produce these truths more quickly and more clearly than our competitors. We are shepherds of this technology. Answers to fundamental questions about this asset class are not currently clear, so having a public platform to share your views with the community is important. After all, you’re helping shape the future :)
The information contained or attached herein is not intended to provide, and should not be relied upon for, accounting, legal or tax advice or investment recommendations. This presentation may contain forward-looking statements that are within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These forward-looking statements are based on management’s beliefs, as well as assumptions made by, and information currently available to, management. Although management believes that the expectations reflected in these forward-looking statements are reasonable, it can give no assurance that these expectations will prove to be correct. This email is for informational purposes only and does not constitute an offer to sell, or the solicitation of an offer to buy, any security, product, service of Ikigai as well as any Ikigai fund, whether an existing or contemplated fund, for which an offer can be made only by such fund’s Confidential Private Placement Memorandum and in compliance with applicable law. Past performance is not indicative nor a guarantee of future returns. Please consult your own independent advisors. All information is intended only for the named recipient(s) above and is covered by the Electronic Communications Privacy Act 18 U.S.C. Section 2510-2521. This email is confidential and may contain information that is privileged or exempt from disclosure under applicable law. If you have received this message in error please immediately notify the sender by return email and delete this email message from your computer. Copyright 2019 Ikigai Asset Management, LLC. All Rights Reserved.
CONFIDENTIAL – NOT FOR FURTHER DISTRIBUTION
NOT INVESTMENT ADVICE; FOR INFORMATION ONLY
PAST PERFORMANCE IS NOT A GUARANTEE OF FUTURE RESULTS