May 10, 2023

Insights and analysis for the professional investor

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Welcome to Crypto Long & Short!

This week, Glenn Williams Jr. gets into Web3 and explains what you need to know about it.

Then, Alex Botte of Runa Digital Assets explains why crypto isn't ready for passive investing.

As always, get the latest crypto news and data from CoinDeskMarkets.com.

– Nick Baker

From the Analyst

Web3 Represents a Strong Alternative to Today's Internet

Conceptually, the value proposition for Web3 makes perfect sense to me. Web 1.0 covered the earliest days of the text-based internet, an era of read-only websites that users "surfed" to consume content written by others.

Roughly two decades ago, Web 2.0 emerged, representing an expansion of the "read" era, characterized by users' ability to contribute their own content, interact with others in real time via social media and garner attention for themselves (both good and bad) via their actions. This is commonly referred to as the "read-write" era, and incorporates a lot of what we do in our day to day lives.

Web3 is meant to add the concept of "ownership" to the first two, where users have control over their data, payments within the network are done on a peer-to-peer basis and data itself is decentralized, rather than being warehoused by a few centralized entities.

But why is this important? Well, speaking for myself, I'll say this. We're all the sum of our own experiences, to one extent or the next. And those experiences can often be distilled down into individual data points that can tell what we've done in the past, and heavily infer what we may likely do in the future.

Simply by interacting with this very content, you've likely revealed something about yourself – to an entity that you're unaware of and that you may or may not be comfortable with.

Those pieces of information about yourself are extremely valuable to third-party businesses, some of which have built billion-dollar operations with all of our personal data at its foundation. And like an undisciplined fan revealing the ending of a movie, we're all essentially just giving it away.

In many ways, we've exchanged our data as the price of admission to centralized protocols with robust networks. One mental model would be the idea that everything that you use in the physical space is rented, from your house, down to your shoes.

As far as content creation is concerned, that which you create is within your control only to the extent that the centralized entity allows. In these instances you are surrendering personal data and what amounts to intellectual property.

Web3 would conceivably turn that concept on its head, resulting in users having complete ownership and control over their data and content, with digital assets or tokens – see, there's an angle here for a crypto publication – providing each user with property rights.

Instead of businesses being given unfettered access to your personal habits and preferences, they would conceivably have to compensate you for it.

As an individual, you would personally warehouse your own inventory of data and tokens, which you would bring with you from protocol to protocol, supplying and removing them as you see fit.

In an ideal world, the attractiveness of robust networks that we find in centralized networks would be married with greater ownership of personal data, with the blockchain acting as a trustless and permissionless vehicle to govern peer-to-peer interaction.

And if we can own something that truthfully belongs to us, and decide how and to what extent we want it distributed, I expect that people will find value in that.

Read more here for my take on why I think Web3 doesn't yet have adoption.

– Glenn C. Williams Jr., CMT

Cboe Digital is a U.S. regulated exchange and clearinghouse bringing trust and transparency to the crypto spot and derivatives markets. Cboe Digital honors a separation of duties and includes intermediaries as a key tenet in managing risk and avoiding conflicts of interest. Our unified spot and derivatives markets are underpinned by responsible innovation and enable collateral efficiency. www.cboedigital.com.

Institutional Outlook

Crypto Isn't Ready for Jack Bogle

Active versus passive investing is one of the oldest debates in traditional investment management. What is the best approach when investing in the liquid token market?

We believe active management in this asset class is critical. Similar to the results observed in the stock market over decades, we anticipate a fat right tail in digital asset returns. Only a handful of assets may drive the majority of the wealth creation in this asset class.

Historically speaking, bitcoin (BTC) has been the primary wealth creator in the asset class. Simple, passive portfolios have underperformed BTC over most calendar years and over a multiyear, full-market cycle.

We compared BTC's returns to passive, market-cap weighted portfolios of the top 10, 25, 50, and 100 tokens over the past five years. None of these passive portfolios were able to outperform BTC. And some of them lost money over this period. BTC is also one of the lowest volatility digital assets, so this outperformance is impressive on a risk-adjusted basis as well.

It's not enough to simply hold the top assets and expect they will continue to outperform. Assets that fell out of the top ranks of the market have historically not been able to re-enter. We analyzed the annual rankings of the top digital assets by market cap. If a token fell out of the top 10 or top 100, how often were they able to re-enter?

We found that there were 12 assets that fell out of the top 10 rankings, and none were able to re-establish their position in the top 10. There was more turnover in the top 100: 115 assets fell out of the ranking, and only 12, or 10%, were able to re-enter.

This analysis suggests that value investing in digital assets may be challenging. An asset that has fallen out of favor and may look cheap relative to others has historically had a difficult time outpacing the market to re-establish its highly ranked position.

If you're going to invest in digital asset markets, we believe it's best to either buy and HODL BTC or use active management to outperform by finding the tokens that have the fundamental momentum and potential to rise into the top ranks of the market.

– Alex Botte, CFA, CAIA, Runa Digital Assets (with assistance from Charlie Perkins and Catherine Dovetta)

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Takeaways

From CoinDesk Deputy Editor-in-Chief Nick Baker, here's some news worth reading:

BITCOIN TURMOIL: As often discussed here and elsewhere, bitcoin (BTC) has had a terrific year as an asset, zooming higher by a hard-to-believe degree amid an avalanche of bad news. It has also been a time of, let's say, creativity around how to use the Bitcoin blockchain, with the emergence of what amounts to NFTs (called ordinals) now offered on the protocol. But this has caused strains in the ecosystem, triggering a surge in transaction fees that was so intense that Binance temporarily halted BTC withdrawals. It's also shaking up the economics of bitcoin mining in a way that miners may welcome, especially given the pain the industry has suffered over the past year or so. The big question is this: Ordinals are a relatively modest addition to the blockchain, and they're creating problems. Could Bitcoin handle a bigger (but not necessarily big) flood of mainstream use as a transaction processing platform?
PEPE MILLIONS: The rise of meme coin pepecoin (PEPE) has been covered lots of ways. A relatively fun way of looking at it is this: It turned somebody's $263 pittance into a more than $10 million fortune in just a few weeks. (Past performance does not guarantee future results, etc.) The point of bringing this up in an institutional-focused newsletter is not to spark a run into PEPE – and recent returns have been terrible, presumably as newly PEPE rich folks pare back. Is this a sign of unsustainable froth for the whole crypto market? Is this the kind of thing regulators and politicians will seek to tamp down? Am I overthinking this? Time will tell.
NORTH CAROLINA: The movement against central bank digital currencies (CBDC) notched a victory last week as North Carolina's House of Representatives passed a bill that would ban state agencies from receiving CBDCs as payment. Not being able to pay bills to a single state would be a pretty minor setback for these government-issued digital currencies, but the unanimous passage of this particular piece of legislation may say something about the prospects for getting crypto-y things incorporated into everyday American life anytime soon.
FTX'S BILLIONS: FTX is seeking to get $4 billion back from Genesis Global Capital (which, like CoinDesk, is owned by Digital Currency Group). Both (arguably systemically important) companies are in Chapter 11 bankruptcy. The reverberations from last year's crypto collapses continue.