The Breakdown - The Fed vs. VC: What’s Driving Crypto Short-Term and Long-Term Market Outlook

Episode Date: May 3, 2022

This episode is sponsored by Nexo.io, NEAR and FTX US.  In the short term, crypto is firmly a part of the larger macro cycle driven by the Fed’s fight against inflation. In the long term, however, there is much evidence that the market downturn won’t be anything like the crypto winter of 2018-2019. NLW explores the funding and events of the past month that tell the story of these two different crypto markets.  - Nexo is a secure crypto exchange and crypto lending platform. Buy 40+ hot coins with your bank card in seconds and swap between exclusive pairs for cashback. Earn up to 17% interest on your idle crypto assets and borrow against them for instant liquidity. Simple and secure. Head over to nexo.io and get started now.  - NEAR is a blockchain for a world reimagined. Through simple, secure, and scalable technology, NEAR empowers millions to invent and explore new experiences. Business, creativity, and community are being reimagined for a more sustainable and inclusive future. Find out more at NEAR.org. - FTX US is the safe, regulated way to buy Bitcoin, ETH, SOL and other digital assets. Trade crypto with up to 85% lower fees than top competitors and trade ETH and SOL NFTs with no gas fees and subsidized gas on withdrawals. Sign up at FTX.US today. - Consensus 2022, the industry’s most influential event, is happening June 9–12 in Austin, Texas. If you’re looking to immerse yourself in the fast-moving world of crypto, Web 3 and NFTs, this is the festival experience for you. Use code BREAKDOWN to get 15% off your pass at www.coindesk.com/consensus2022.

This view that Travis has, that the Fed simply structurally, based on the U.S. debt-to-GDP ratio and other factors, will not be able to stay in tightening mode for all that long, is one that's shared with many outside crypto as well as inside it. If that's right, I think you have to give a lot of credence to this view and a discussion about what's going to pop most and fastest once another secular shift happens. Welcome back to The Breakdown with me, NLW. It's a daily podcast on macro, Bitcoin, and the big picture power shifts remaking our world. The breakdown is sponsored by nexo.io, near an FTX, and produced and distributed by CoinDesk.

What's going on, guys? It is Monday, May 2nd. Welcome to a new month. Today we are talking about a tale of two markets and why things are looking really different short-term versus long-term. Before we get into that, However, if you are enjoying the breakdown, please go subscribe to it, give it a rating, give it a review, or if you want to get deeper into the conversation, come join us on the Breakers Discord. You can find a link in the show notes or go to bit.lee, that's LY slash breakdown pod. Finally, a disclosure, as always, in addition to them being a sponsor of the show, I also work with FTX. Now, as I was prepping this show, the obvious thing from over the weekend is the other side land NFT sale from Yuga Labs. A big chunk of the Web 3 and Metaverse space was paying attention

to this. All 55,000 other deed land NFTs sold out within a few hours. The mint price ended up being 305 ape coin or about $5.8.00 at the time of the mint. In total, it brought in 16.7 million Apecoin, making it worth about 317 million and making it the biggest NFT mint of all time. It also created a total shi-show. There was effectively a gas war which ended up resulting in $172 million worth of transaction fees. And already emotions were running high. And then they tweeted, We're sorry for turning off the lights on Ethereum for a while.

It seems abundantly clear that Apecoin will need to migrate to its own chain in order to properly scale. we'd like to encourage the Dow to start thinking in this direction. Many people are losing their crap about this, and I actually think it's a fairly significant event for the metaverse side of the crypto industry. So given that, I want to spend a little bit more time distilling the myriad of hot takes around it, so expect that sometime later this week. In the meantime, today is the first weekday of May. That means, among other things, we got the Aikigai Asset Management Monthly Market Update from Travis Kling and the crew over there. Now, if you're not a subscriber, I suggest you go check it out. There are two great things about these newsletters.

The first is that Travis always does an intro that's usually pretty macro-focused and gives a great picture of the month that we just lived through. The second is he does a bulleted list of the biggest news from that previous month. This time, I think it's a great way to get a sense of the month we just had, which felt to me, as I suggested at the beginning, as a tale of two months, one that was very short-term and one that tells a different story about the long-term. The short-term side of the story is that the Fed's fight against inflation is shaping everything in basically all markets. As Travis put it, the Fed was in complete control of all asset prices in

April, and crypto was no exception. With year-over-year CPI hitting 8.5% in March the highest level since 1981, the Fed is in a full-blown inflation fighting frenzy. Don't fight the Fed is an adage that's been around since at least 2009, and its all-one trade has been around for at least the last two years. They both speak to the same backdrop. Central Bank actions and the current monetary regime have such an overwhelmingly powerful impact on all asset prices that everything else is just an afterthought.

Indeed, and we're back to NLW here, in some ways April felt like a transition month where the markets really finally started to accept just how much pain they might be in store for. The G7 countries are poised to shrink their balance sheets by $410 billion for the rest of the year. that's opposed to the $2.8 trillion they added last year. It was the stock market's worst performance since autumn 2008

at the peak of the global financial crisis. NASDAQ was down 13.3% in April and 21.2% on the year. The SNP 500 was down 8.8% for the month and 13.3% for the year, which is its worst start to a year since 1939. What's more, this is expected to continue. S&P 500 firms are expected to see 7.1% earnings growth this year, which is below the 10-year average of 8.8% and the five-year average of 15%. Now, Bitcoin has been following the NASDAQ pretty closely, and on the year, it's actually down

a little bit less than NASDAQ is. Alex Kruger called this beyond impressive, but still for many market participants, it's the correlation of Bitcoin to everything else that's been most notable. So why was April a month where markets finally capitulated? And in some ways, I think there was just too much for market participants to ignore. We saw supply chain issues that continue and, frankly, with China's COVID shutdowns might be getting even worse. We have rising energy prices due in part to the war in Ukraine, which shows no signs of abating. We had a surprise decline in quarter one U.S. GDP, not to mention disappointing forward guidance from companies last week. And finally, of course, the Fed is staying on their hawkish tip. This is a theme you're going to hear about a lot more this week with an FOMC meeting

that is likely to produce a 50-bases-point hike. Still on top of that, there are many who think that that's not enough. Bloomberg opinion columnist Alison Schrager asked Dartmouth-Econ prof, Andrew Levin, whether the Fed and the markets were finally taking inflation seriously enough. Levin responded, Unfortunately not. The problem is that the Federal Reserve and its projections is still emphasizing a baseline outlook in which inflation comes back down to around 3%

within the next few quarters. But Fed officials are not talking about more risky scenarios. In fact, there are a lot of factors that may drive inflation even further upward. Now, among those factors, he lists, one, China continuing to have a zero COVID policy, which is likely to amplify supply chain problems. Two, the cost of housing continuing to go up. Levin points to a cost of shelter rising at an annual rate of 5.5% and still going upward. And three, Levin also points out the wage price feedback loop, which is currently clicking

into gear. In short, workers look for wage increases to keep up with inflation. Firms have to pay them, especially in this type of great resignation context where workers are few and far between. But then in order to pay higher wages, they also raise the price of products, which makes the spiral continue and get even worse. When Levin was asked whether he thought sorting out supply chain issues or stabilizing energy prices would be enough to bring inflation down to the Fed's 3% target, he said, quote, probably not. The problem is many of the models the Fed use embed the assumption that inflation will naturally revert back to the target of 2%.

Those models don't incorporate the possibility that a wage price feedback loop can lead to a highly persistent shift in the level of inflation. And many Wall Street economists previously worked at the Fed and continued to use those models and rely on those assumptions. In effect, there's a real risk of groupthink. Now, with all of this context, you see more and more people thinking that a recession is the only way out and that the Fed's chances of a soft landing are very very low. In the short term, this is likely to be the dominant thing that shapes markets from traditional finance to crypto and beyond. Looking for ways to step up your crypto game, then go with Nexo. For starters, you get free crypto for each purchase or swap. How about earning guaranteed

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Through simple, secure, and scalable technology, NIR empowers millions to invent and explore new experiences. Business, creativity, and community are being reimagined for a more sustainable and inclusive future. Reimagined your world today at neer.org. The breakdown is sponsored by FTXUS. FTXUS is the safe, regulated way to buy and sell Bitcoin and other digital assets, with up to 85% lower fees than competitors. There are no fixed minimum fees, no ACH transaction fees, and no withdrawal fees.

One of the largest exchanges in the U.S. FDX U.S. is also the only leading exchange that supports both Ethereum and Solana NFTs. When you trade NFTs on FTCS, you pay no gas fees. Download the FTCS app today and use referral code breakdown to support the show. If that is the short-term side of the story, what is the other, longer-term view? Let's come back to Kling again. He writes, there are plenty of market participants calling for much lower near-term prices in both equities in crypto. There's growing chatter of a sub-10K and DX and sub-24K Bitcoin. Yeah, it could happen, but it wouldn't be my base case. Even if that type of Goblin Town price action were to materialize, it would still be incompatible to the 2018 bare market. Fundraising in the crypto sector continues at a blistering pace. This permanent capital will lead to innovation that will drive adoption. Fundraising in 2018 and 2019 was a barren wasteland relative to what we're seeing now. Yet that didn't stop crypto market cap from growing more than 10x over the last couple years.

Imagine the future growth with the current level of permanent capital investment. Now, this is a story that I've mentioned numerous times on this show. It really is so different out there than in previous crypto winters, and I think to dramatize that, I want to point to some of the key events from Travis's list. Let's stay focused on his fundraising theme. So a few are the bigger ones he mentions. Blockchain.com raises undisclosed Series D at $14 billion valuation, led by Lightspeed and Bailey Gifford. Circle raises $400 million, led by BlackRock and Fidelity.

Near Protocol raises $350 million, led by Tiger Global. Indian crypto exchange raises $135 million Series D at $2.15 billion valuation. BoardApe Yacht Club sells over $100 million of digital real estate and under 45 minutes in New Metaverse Project Otherside. Lightning Labs raises 70 million Series B, led by Valor Equity Partners. Pantara closes new $1.3 billion venture fund. Dragonfly raises $650 million venture fund led by multiple Ivy Leagues and KKR. Framework Ventures launches $400 million fund focused on blockchain gaming.

Fabric VC set to close two Web3 venture funds totaling $245 million. Sony and Lego invest $2 billion into Epic Games to build Metaverse for kids. There's a lot here, but let's extract some of the key themes. Not super surprisingly, the Metaverse continues to be an exciting space for investors. It's interesting to note that while in general, NFT volume and prices are down pretty significantly, these key projects and efforts are still getting a ton of attention, the other side sale, for example. Also within this area, you're also seeing major investments in existing properties to go compete in that space, exemplified by Sony and Lego working with Epic Games.

If it wasn't already clear from Facebook changing their name to meta, this isn't going to be a battle that begins and ends in what is now considered the crypto or Web3 space. Indeed, one of the central battlegrounds will be how decentralized does the metaverse have to be? Part of the reason there's so much outrage of that tweet from Eugel Labs is a contention that this was all set up to give themselves an excuse to launch their own chain. By the way, that contention is why the show deserves more time to get that episode right. Without going into the details of that even, it's still clear that we're going to see a full spectrum of metaverse approaches from highly decentralized to totally not even trying to pretend

centralized. And basically everyone on that spectrum has money to go compete. Speaking of that, in this fundraising, you also have Layer 1 competition. Obviously, the Yucal Labs thing might be part of that now, but so too is the raised by NIR. Layer 1 competition is a good indicator that there is still a belief that things aren't totally settled. Slightly differently, I think moving on through our list, you could make an argument that the lightning investment is sort of part and parcel of layer one competition as well, in terms of how it expands what Bitcoin can do, although that investment is obviously just an indicator of enthusiasm for Bitcoin in general as well. Don't forget that while it wasn't in this list of

funding, we also had the whole Bitcoin fund to back Luna UST this month, which brought a ton of discussion about the relationship Bitcoin to defy and other parts of the crypto ecosystem. Many saw Do Kwan's move as validating the role of Bitcoin as the Cs. central reserve asset of the crypto world. Moving back to this list, however, we've got a global dimension to it, with key global infrastructure like an exchange in India seeing capitalization. Of course, there are stable coins on this list. Stablecoins continue to be one of the most defining and most debated categories in this space, and certainly the one that we'll be seeing potentially the most discussion in Congress and the Senate and among regulators everywhere.

And then, of course, there is the funding of funds. It's not just startups on this list, but the funds themselves that are raising a ton of dry powder. In April alone, you saw more than $2 billion go into crypto funds. That means they get to stay active and continue to invest in new crypto projects. Even if, in the context of a down market, their quality determination goes up and the valuations go down, the key thing is funds having that capital to deploy. There's also plenty more bullet points on Travis's list that point to the unabated long-term trajectory of the crypto space. Fidelity offering Bitcoin and 401K plans has to be pretty high on that list. Goldman Sachs offering its first Bitcoin-backed loan products.

Countries like the UK changing their tune, saying that they want to become global crypto hubs, stripe-enabling USDA payouts and expanding the payments narrative of crypto. And of course, jurisdictions like Fort Worth becoming the first city-to-mine Bitcoin in the U.S. So, again, there are at least two different markets happening right now when it comes to crypto. One is the short-term market that is completely caught up in the Fed trade, same as everything else. Second is a very different, still long-term oriented market that continues to see progress and investment and belief, regardless of that short-term outlook. Finally, there is one additional dimension to all of this, which is a question of how long the Fed can keep its short-term hawkishness.

You have on the one side the folks like the Dartmouth economist I quoted before saying that we're not taking it seriously enough. But then you have others who think this is a lot of the short-term hockishness. You have on the one side the folks like the is headed one way towards recession and the Fed's hand will be forced the other way. Keeping the theme and wrapping with Travis Kling again, he writes, The other critical factor for the current situation is that the cat is out of the bag in terms of what do you want to own when the Fed eventually slows tightening. There's nothing on planet Earth that will move faster off the bottom than crypto when the Fed even hints at slowing down. There's never been wider agreement on that fact than there is now. It's nothing like

2018-2019 when most of the world's capital had no idea what to think about this asset class. that presents a conviction for the medium and longer-term horizon investor that will put a bid in crypto that makes Goblin Town a difficult scenario for me to have as my base case. That's because we can argue about whether Fed funds gets up to 2% or 2.5% or 3%, but everyone knows it's a pit stop before rate cuts and more QE. Then, once again, don't fight the Fed and it's all one trade going back in the other direction, but with more eyeballs, human capital, and financial capital committed to this ecosystem than ever before. I think on the one hand, there's going to be a lot of attempts to make ourselves feel better,

call it over the next month as things maybe get even worse in the short term. On the other, this view that Travis has, that the Fed simply structurally, based on the U.S. debt to GDP ratio and other factors, will not be able to stay in tightening mode for all that long, is one that's shared with many outside crypto as well as inside it. If that's right, I think you have to give a lot of credence to this view and the discussion about what's going to pop most and fastest once another secular shift happens. For now, cheers to Travis and the team at Iiki Guy for their great monthly newsletter. Thanks to my sponsors, nexus.com, NERNFTX for supporting the show.

And thanks to you guys for listening. Until tomorrow, be safe and take care of each other. Peace. Hey, breakdown listeners, come join CoinDesk's Consensus 2020, the festival for the decentralized world this June 9th through the 12th, in Austin, Texas. This is the only festival showcasing and celebrating all sides of blockchain,

crypto ecosystems, Web3, and the Metaverse, and is designed for crypto-newbies, investors, entrepreneurs, developers, and creators. Don't miss speakers like Kathy Wood, SBF, CZ, Punk 6529, and Joe Lubin to name just a few. Use code breakdown to get 15% off your pass at coindesk.com slash consensus 2022.