May + June 2023 Investment Newsletter
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May + June 2023 Investment Newsletter
Disclaimer: This page, including any links or posts, is not an offer or invitation to subscribe for shares in the fund. Please read the full disclaimer at the end of this page.
NOTE: This newsletter was originally sent to investors of Orca Global Management on 26th July 2023. Sensitive information has been redacted.
1. May and June overview
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This leads us to the current hot topic of US regulation, which has been a popular topic we have been asked about by our investors.
2. Thoughts on recent regulatory headlines
In this section, we use the term “crypto” as the mainstream word to mean all things Web3 (crypto = cryptocurrencies = Web3 = blockchain technologies = virtual assets = etc.). Different jurisdictions prefer different terms so we stick to the most commonly used “crypto”.
2.1 The global crypto acceptance level hasn’t changed
Our view regarding regulation and the tangential risks has basically been that on a global scale, and for our style of hedge fund (liquid token trading), there is not much to worry about. It’s true that for specific jurisdictions, and perhaps for VCs, regulatory uncertainty or rulings may prove to be existential threats for both institutional and retail participants. However, we believe that what’s more important for the industry is some net global “acceptance” score (for lack of a better term - something that represents how friendly or harsh the local regulation is), that exhibits how crypto is regulated or viewed globally.
Figure 1 above was created as an arbitrary illustration of how we think. Let’s say each jurisdiction has some score representing regulatory “acceptance” out of 10: for simplicity, we just weigh each region equally. For Period n in our example, the US was scored 6/10, Singapore 8/10, Japan 6/10 and so on, to create an aggregate world acceptance score of 41 out of 70 (since there are 7 jurisdictions in this model). Let’s say that after Period n, there was some egregious event to the industry (maybe some major crypto exchange goes bankrupt due to illegal activities by the founder who also happened to be one of the biggest individual donors to US politicians heading into the 2022 midterm elections to “buy bipartisan influence and impact the direction of public policy in Washington”, for example). Looking at Period n+1 we naturally see crypto acceptance in certain locations deteriorate: the US score halves from 6 to 3, Singapore from 8 to 6, etc. However, this is politics, and politicians are opportunistic: one state closing doors to an industry is an opportunity for other states to capitalise on. As the US and Singapore become unfriendly towards crypto (which hypothetically may be overcompensating after their own politicians and regulators treated the hypothetical crypto exchange under favourable terms before its fraud-ridden demise…), other places such as Japan, Hong Kong, and the UK open their doors, offsetting the US and Singapore decay, allowing the global net acceptance score to remain at 41. And as we will explain below, we believe this is actually a pretty accurate depiction of the change in acceptance from pre-FTX to now.
So this is what we mean when we say what matters most is this net global acceptance rate. Depending on the frequency in which we measure this score, the function that represents the global acceptance rate may not be monotonically increasing (i.e. may not be strictly increasing) as there could be event-driven dips, but on quarterly or yearly measurements, the function probably is strictly increasing. This is because government statements, drafts, and ultimately policy changes take time; the week FTX went down, there was actually zero material policy changes regarding crypto, and by the time certain regulatory bodies had started announcing harsher outlooks (e.g. US), prices had already recovered and other regions were publishing fairly crypto-positive headlines (e.g. Japan). Sentiment may be down in many places (maybe less so now), but what actual regulatory changes have there been post-FTX?
2.2 After global acceptance comes antifragility
So how does this regulatory offset dynamic actually materialise and how does this play a role in our framework? We think the important concept here is that once an idea (or perhaps in this case an industry) reaches the level of “global acceptance” (which we can estimate by gauging the consensus level of how “it’s-not-going-to-go-anywhere” something is) during its growth stages, the idea attains antifragility (a concept coined by Nassim Taleb to describes the ability to thrive in the face of volatility and uncertainty and becomes more adaptable and capable of handling future challenges). This is because being in its growth stages, the idea itself is still figuring out its own unknown future; by virtue of resolving challenges, ideas that cannot die are essentially replacing its uncertainty with certainty, without jeopardising its existence.
In the case of crypto, having secured “global acceptance” status and becoming antifragile, it now experiences a monotonically increasing state of progression (+ effort that goes into it + attention) due to the competitive nature of global states: if the US is trying to adopt crypto, then there’s a positive feedback loop as other states try and loosen regulation and compete for talent, whilst when the US is against crypto, other states see it as an opportunity to attract the outgoing innovation and talent (and perhaps capture capital + tax revenues). This latter mechanic (when one region suppresses the idea, another region will actively try and grow it) is exactly what we’re seeing now, particularly from Beijing-backed Hong Kong and to an extent, the UAE. For example, in 2023 alone:
HK allocated 50mm HKD to its 2023~2024 budget to expedite the Web3 ecosystem development. The exact words used in the budget speech were “We must keep up with the times and seize this golden opportunity to spearhead innovation development.”
HKMA (HK’s central bank) and CBUAE (UAE’s central bank) announced to strengthen financial cooperation in three major “mutual areas of interest” including “virtual asset regulations and developments”.
Mr Eddie Yue, Chief Executive of HKMA, responded directly to US’s strengthening of crypto regulation and HK’s relaxation saying that HK is opening up to implement strict and clear regulations (taking experience from Singapore and Dubai) and that the US did not have clear regulatory requirements.
According to a report from local news outlet The Paper, Beijing published a white paper with the objective of fostering innovation and advancement within the Web3 industry. Named the "Web3 Innovation and Development White Paper (2023)," the document highlights that Web3 technology is an "inevitable trend for the future development of the Internet industry."
And many more headlines (if any investors are interested, we have compiled a full list of these).
Human capital and even institutions are now more geographically fluid than they have ever been, and therefore the consequences of this dynamic is suffered not by the industry but rather by the states that are falling behind in acceptance, particularly those that are earnestly stuck in refusal.
Did the SEC’s obsession in painting Coinbase as Public Enemy No. 1 doom Coinbase or crypto as a whole? No - in fact, not only did it just convince Coinbase to open offices outside the US (even prompting HK politicians to invite them to apply for licenses and set up shop), but after a decade of only offering spot products, it took the opportunity to launch derivatives trading via a new offshore exchange in Bermuda. Similarly, a16z - the largest VC in the crypto space - in response to increased US regulatory scrutiny surrounding crypto, simply opened up their first non-US office by partnering with the UK government to help set up a crypto hub in the UK.
Of course the US can pivot and change the calculus but this will take time and it will be a long uphill battle for them to catch-up to the jurisdictions that are being proactive now.
2.3 Being long crypto is being short US bureaucracy
In fact, even disregarding the opportunistic nature of states and focusing solely on US (/SEC) regulatory efforts, the landscape for crypto is not as bearish as headlines make it out to be. Of course the easiest argument for this is the one that points out “who cares about the US? Despite being a recent driver of innovation in crypto, the US is not the only relevant region and crypto’s early retail roots (i.e. bull market drivers and trading volumes) are in Asia (Japan, Korea, etc.) and the trend of crypto-friendly institutions setting up shop in Asia has been a theme for quite some time.” There is truth to this but we are interested in a more metaphysical diegesis.
Regulatory infighting in the US (which unfortunately come in many forms including Democrats who want to regulate crypto versus Republicans who don’t, the SEC who want to categorise cryptocurrencies under securities versus the CFTC who want to label them commodities, etc.) harms everyone: it harms the pro-crypto camp to the extent that the industry has a cloudy overhang of uncertainty, but we think it harms the anti-crypto camp (including everyone in the “I want crypto to be heavily regulated!” crowd) even more, which is to say this all may be net-positive for the industry. The more this infighting (or more accurately, infightings) drags on, the possibility of ultra-strict regulation being passed gets slimmer and slimmer, while the possibility of a temporary “bandaid” regulation increases. In policy making, there exists this idea of the Overton window, which refers to the range of ideas and policies that are considered acceptable and mainstream in a given society at a particular time. This is highly relevant for ideas that exist on the fringe, or are considered radical or extreme. There is a tremendously limited window to strike the iron if what you want is extreme regulation, and what better time than the period after American retail got burned via the largest crypto lenders and exchanges going bankrupt due to (alleged) illegal activities? Eight months after the event, the Overton window for Gensler and the SEC to kill crypto (at least in the US) is closing, if it hasn't yet already (it will probably close when the media gets bored and moves on with SBF’s trial). Beyond the headlines and first derivative takes, the recent Ripple summary judgement (13Jul23) not being max bearish crypto is probably a cardinal event in context of this opportunity window. When the window is well and truly shut, the infighting will probably continue a while longer before both sides decide to settle for a middle ground - if the crypto industry in the US can simply come out of the FTX-aftermath having avoided max regulation, there is probably nothing more bullish as we head into the next cycle. Being long crypto is, in a way, being short US bureaucracy.
It’s clear that once something has reached “global acceptance” (as defined earlier), it is extremely negative expected value for a state to actively try and kill it, particularly when it poses little to no threat to a state’s control or sovereignty; of course, here it can be argued that actors such as the US (or more specifically the SEC + democrats) do consider crypto as a threat to its control, particularly in regards to their currency. However, from comparing how a similarly concerned Beijing is allowing Hong Kong to capture this moment, its clear than even when an idea poses such a risk, it can simultaneously be good/innovative, and that there is a fine line between being able to understand the nuances of the idea and regulate whilst encouraging innovation versus being tunnel-visioned in only seeing the risks and trying to shut it down completely. And due to states’ competitive nature, it is actually the inability to see this line that poses the largest threat to themselves.
The current sequence will be, as Asia improves its own aggregate acceptance score, it will start winning the “flow” (the flow of crypto-related capital, talent, interest, cooperation entity set-ups, etc.), the Middle East will expand the industry a staggering amount, Europe will slowly but surely continue to adopt it, and all the while, North America will watch from the sidelines. With the industry still in the growth stages, the pie is ever-growing, allowing all states to benefit, but if you’re North America, the game may as well be zero-sum. In regard to price action, this backdrop is turbo-bullish for crypto. BTC is currently at ~$30k: when considering the past 16 months the industry has experienced (with trillions being wiped out from the industry, the largest hedge funds being liquidated, the largest lenders and exchanges going bankrupt while their CEOs are arrested, and the country that was the source of innovation in the industry actively trying to destroy it), it’s extremely exciting to imagine what happens to prices when America decides that crypto cannot be killed and that they need to regulate it in a way that embraces it. In using simple logic (if-this-then-that if you will), if you think this technology and industry is going to die, the scenario we envision clearly won’t play out, so you load up on some puts (not financial advice). But if you think that crypto will NOT die and will survive this US onslaught, it MUST follow that America will have to embrace it one day (unless policy makers and regulators opt for political suicide and decide to continue their crusade against it as the rest of the world continues to adopt it). With crypto achieving global acceptance, the burden of proof (and all the efforts that come with it) is on the side that wants crypto gone. A quick look at the history of many industries reveals that that the dynamic of states having to pivot to embracement due to a natural progression in the world around them is quite common (not dissimilar from the security dilemma or competitive coercion). Whether its in medicine (biomedical research, qualified personnel migration, etc.), technology (weapons, chips, robotics), etc., even if a state is initially against a growth stage idea, once that idea validates itself via global acceptance, states will inevitably embrace it as to not be left behind in innovation. The pivot and desperate catch-up will further accelerate the innovation and we believe that this will be next big cultural shift for the industry: it’s hard to predict specific trends within crypto or which sector might explode, but on a macro level, the US’s inevitable decision to constructively regulate the industry will be an immense catalyst that will exponentially propel innovation and retail volumes. And this is a catalyst every portfolio should be positioned for.
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