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The Beauty of Zero

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As 2022 comes to a crashing close, a year that will go down in the annals of crypto as perhaps its most devastating yet, there is no better time to appreciate the beauty of what a coming zero represents.

What is a zero? To most people, the number carries little significance, but to traders, especially those who have lived through times like these, it represents a fresh start. The reset to zero on January 1 will be comforting to all those who trade or invest. It's a release from the heaviness of a year of bad choices, bad investments, and bad luck. The zero brings optimism, an optimism that next year can and will be better, a year where we will see a reversion to the mean, a year where performance is bound to improve.

From a financial perspective, 2022 will be remembered as a year where almost all bad things that could happen, did. In fear of inducing unnecessary further trauma, we won't recap the entire litany of events, but the fed hiking rates to pre-global financial crisis levels and the spectacular extinction of so many household names in crypto must certainly be the highlights.

The former has put stress on the global financial system as a whole, and the latter has revealed all the inconsistencies we may have noticed but were unwilling to face while the party was still raging. Now that sobriety has been forced upon us, it's time to look back at what we learned over the past year so that we may refine our approach going forward.

First, the macro. We continue to be in a bear market for equities which continues to bounce off the descending trend line established between January and March, with further rejections in August and earlier this month (December).

On the positive side, the USD dollar has broken out of its relentless strengthening surge and appears to be entering a downtrend. Couple this with the recent move by BOJ and we can feel pretty confident we have seen peak dollar strength. While the Fed is expected to add another 100 basis points over the coming 3-6 months, the market is pretty confident the top of the cycle is in view, especially with confirming inflation data over the past few weeks. Commodities like oil and lumber have dropped sharply and are heading back toward pre pandemic ranges.

The forward indicators are clearly calling for a recession in 2023 with job cuts at some of the most well-known firms littering the tape on a daily basis. While this feels bad, recessions are necessary to clear out excesses from the previous cycle and set the market up to cure. Seeing a recession on the horizon gives me confidence we are closer to the end than the beginning. History has shown us time and again that some of the strongest rallies occur during recessions, this time will be no different.

Moving on to crypto where the highs and lows mimic the macro markets but on an unhealthy dose of steroids. We have seen narrative shifts while wealth has been created and destroyed at a blistering pace. We still feel very confident in the core themes and prospects that got us all excited coming out of covid but with perhaps a more realistic approach to valuations and opportunities.

Trading markets will have to go through a massive restructuring. Players will have once more to price in counterparty risk and will encounter a new world in which there is minimal access to leverage.

Many "free money" trades will be exposed for what they really were, “risk mispricings.” Furthermore, the true cost of leverage will finally be revealed and unfortunately many strategies that thrived in the recent past will no longer make sense. Those that are quick to acknowledge this shifted landscape, accept the new reality and adapt, will benefit from less competition even as the market consolidates. Best practices will have to be adhered to as coming up short will reduce access to funding and capital.

This new, strict environment will allow for the next stage of growth to occur on a more solid and risk conscious foundation than the last one. New players will emerge who will have learned valuable lessons from the first cycle. This will pave the way for the next generation of financial intermediaries who will be better suited to handle the looming demand from traditional, regulated institutions.

On the VC side, one can expect ‘immediate liquidity’ investments will continue to decline as regulators wake up to the reckless behavior these investments promoted. This behavior has damaged investor confidence and the stability of the overall ecosystem and must be corrected. VCs will focus more on current use cases where blockchain technology and Web3 investments can be used to solve currently defined problems and inefficiencies. While there will be less appetite to fund projects that create efficiencies assuming a much larger breakthrough occurs or adoption reaches scale.

For those projects that were able to dollarize at least some portion of their treasury, those would need to invest their cash wisely with a better focus on security. For reserves, that are earmarked to fund a project's runway, those funds should be either in self custody earning zero or in safe treasury based yield products with reputable financial institutions. This money is to sustain the project and not hit a homerun.

Other cash intended to grow the ecosystem should be focused on projects that are aligned to the values of the ecosystem and have a core use case within it. Institutional investors will want to ensure their capital is going to its intended purpose and not used as liquidity in someone else’s unauthorized and unregulated investment vehicle.

There will and must be an increasing focus on monetization and exit strategy. This topic was rarely mentioned when allocating funds over the past two years, but will become a mantra in the current cycle. The days of "give me money, I’m brilliantly smart and have a good idea" will become "what problem am I solving and how do I expect to monetize this idea." Too many times founders focused on the question of "can i do it" vs asking the question "should I do it." This type of rigidity and structure by its nature will weed out projects that were ill-conceived from the start.

Furthermore, the cash allocation process should slow as more clarity around the value proposition will be required before investment. We see these as positive developments that will give investors more time to follow through on due diligence resulting in better outcomes. Overall we think things are going to get better as the industry matures and the focus shifts back to ‘how do we reduce our dependence on centralized intermediaries, democratize finance, and provide access to billions of the unbanked?’

Cryptocurrency is a nascent technology with significant potential for growth and adoption in the coming years. Unfortunately, worthwhile journeys are not always easy and we have had to take a great deal of pain this year.

The macro environment has done us no favors as many markets are going through a generational shift on the back of unexpected geo-political changes that will continue to shape every facet of our lives. These forces have acted as headwinds for the industry. However, with many new realities priced in and valuations much lower than the start of 2022, there is room for optimism.

The positive effects of a new calendar year, the beginning of a new investment cycle and the liberation that the beautiful zero provides, January could prove to be an opportune time to put capital back to work. As they say, fortune favors the bold, and if you have lived through 2022 and are still standing, then welcome to the club.

Happy Holidays and good luck in the new year.

By Anthony DeMartino, Matrixport US CEO

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