The Pomp Podcast - #1074 Frank Downing | Wall Street Analyst Compares Bitcoin & Ethereum

Starting point is 00:00:00 What's up, everyone? This is Anthony Pompliano. Most of you know me as Pomp. You're listening to the Pomp Podcast, simply the best podcast out there. Now let's kick this thing off. Frank Downing is an analyst at ARK Investment Management. In this conversation, we break down their brand new monthly report on Bitcoin, Ethereum, and the macro environment. I really enjoyed this conversation with Frank, and I hope you guys enjoy it as well. Before we get into this episode, though, I first want to talk about our sponsors. This episode is brought to you by Unstoppable Domains. They've partnered with Blockchain.com to create NFT domain names ending in .blockchain.

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Starting point is 00:01:40 Learn more at bullish.com slash pomp and follow at bullish on Twitter today. Anthony Pompliano runs Pomp Investments. All views of him and the guests on his podcast are solely their opinions and do not reflect the opinions of Pomp Investments. You should not treat any opinion expressed by Pomp or his guests as a specific inducement

Starting point is 00:01:59 to make a particular investment or follow a particular strategy, but only as an expression of his personal opinion. This podcast is for informational purposes only. All right, guys, bang, bang. I've got Frank here with me. Frank, super excited to break this down. ARK Invest is now putting out the Bitcoin Monthly.

Starting point is 00:02:15 And I figured a great place to start would be with the analysis on the macro environment. It feels like the backdrop is really important and increasing in importance for Bitcoin and other cryptocurrencies. Where's kind of the best place to start inside of macro that really captures your attention over the last month or so? Yeah, thanks for having me. Super excited to talk about this report, something we've been working on for the past, you know, six to 12 months, you know, internally. And it's finally at the point where we're ready to bring it externally and kind of show the world how we view the markets. And this report, you know, on a monthly basis summarizes that up really well.

Starting point is 00:02:47 So from the macro, I think macro is interesting to set the stage because it's really what everybody is watching across all asset classes, not just crypto. And you kind of need to understand where that's headed and where it's been to put crypto in context. And some of the things we're looking at in the on-chain world, you know, crypto specific sentiment. I think one of the biggest driving factors has been sentiment around the Fed and the rate hikes that have been going on and the expectation of those rate hikes going into the future. Jerome Powell's been extremely hawkish over the past six months with inflation at record highs. We're seeing that narrative start to change just very slightly at the margin, where in his most recent comments, he's indicating that if the macro economic indicators start to decline, the Fed's willing to change their tone and ease on those rate hikes. As rates have been

Starting point is 00:03:40 hiking, as anticipation for rates hiking, all asset classes have sold off and crypto is definitely not excluded from that. Crypto has been trading at a higher than normal correlation to equities really since the beginning of COVID. And so as anything that gets affected by a discount rate, especially high growth tech stocks sell off, Bitcoin obviously sold off a lot as well. Crypto specific contagion tangled in there that really amplified it. But as those overarching macro narratives start to change, as the anticipation for red rate hikes at the Fed start to slow. We're seeing asset classes, equities stabilize, crypto stabilize with it. So a good example of that is the prediction for rate hikes one year out from the Fed that we

Starting point is 00:04:24 talked about in the report. This is based on the survey of members of the Fed, where they think the rate hikes will be in one year. And if you look back just one month, the probability that rate hikes were going to take us to a high rate of 350 basis points or above was at 95% That's come down now, based on some of the things we're seeing in the economy, down to below 5%. So a dramatic change in where we think rates are going to head. And there's a few leading indicators and a few lagging indicators that lead to that. You can look at the prices of gold and copper that have significantly sold off, copper especially,

Starting point is 00:05:01 which is really an indicator for where the economy is heading, if you look historically. And then gold, as well as an inflation hedge, typically tends to perform better when the anticipation for inflation is high. Gold price has been coming down, indicating that the market thinks that inflation may be coming down in the long run as well. I think the Fed, if you listen to their commentary, is very focused on employment and seeing employment numbers. The jobs report came in very hot last week after the close of the month of July. It's throwing some confusion because if you look at the initial jobless claims or a few other indicators, they're starting to see employment start to turn down in the crypto market we've obviously seen a lot of uh layoffs you know

Starting point is 00:05:44 for everybody coinbase blockchain.com uh every crypto lending player uh they're all affected by this the broader market is as well especially in kind of you know more consumer spending uh sensitive areas um so as these things start to kind of cool off uh bad for the economy i mean we've seen two two consecutive quarters of negative gdp growth um technically a recession by most people's definition, but it's apparently up for debate these days. And, you know, indicators that things are turning down to the point where the Fed may change their tone, turn more dovish, less hawkish. And that's been good for both equities and crypto just over the past, I would say, three weeks. So in the report, you guys specifically mentioned the fact that the two

Starting point is 00:06:31 consecutive negative GDP quarters could cause some sort of Fed pivot, or at least, you know, change people's minds. Talk a little bit more about how important kind of the technical definition of the recession is versus maybe some of the other metrics or things like the NBER and kind of their, you know, in some way, officially unofficial labeling of is it a recession or is it not? Like, how do you guys, you know, kind of put weight on the technical two consecutive quarters versus maybe some of the other metrics? Yeah, I think for us, I mean, we look at it definitionally as two quarters of negative GDP growth as a recession. We've been thinking we've been in a recession or headed for one for a long time. And so for our perspective, we think we're

Starting point is 00:07:12 now, you know, by definition in a recession. There's a lot of things out there that impact who wants there to be a recession or not. If you look at, you know, we're in an election year, it's not good to be the economic leader or the political leader in a recession. So that's weighing on it a bit as well. But, you know, overall, if you look at consumer sentiment is at lows, you know, since as far back as the metric goes back to the 70s, the consumer feels like we're in a recession. And we're starting to see kind of some of the earnings reports come out that indicate that is slowing. Interestingly, there's this feeling of a very bad sentiment, but at the same time, banks report strong consumer spending. So maybe we feel worse

Starting point is 00:07:59 than we're acting, which is kind of an interesting counter-narrative there. And obviously, we've seen the Inflation Reduction Act and a number of other kind of government proposed solutions, whether they end up being successful or not is up for debate. But it does feel like given that inflation is so high and there's this technical definition of a recession, policymakers, central bankers, they feel like they have to do something, right? It's almost like as humans, if we're doing nothing, then we're not in control. Is that kind of how you guys view it as well? You can debate what is being done, but pretty much they're going to do something because that's where they feel like they've got some level of control and levers to pull on the economy. Yeah, that's exactly right. I mean, the Fed's entire job is to control inflation. And so when inflation is high, they feel they need to act. And they feel they need to act strong enough to I think they think they need to, you know, declare victory. And they're not going to declare victory until they see inflation coming down. And those employment numbers, especially coming down as well. That seems like what they've been indicating. The question is, do they go too far and have what they call a hard landing where they impact the economy more adversely than needed to cool down inflation? It seems, and we mentioned this in the report as well, they may be willing to overstep a little bit, raise rates a little bit too high, cause a harder landing and really be able to declare victory on inflation rather than take some of the leading indicators as, hey, we're going there, we can ease off right now.

Starting point is 00:09:30 I think they're more in the former camp than the latter, but we'll see kind of, I think, the next two Fed meetings that gradually start to change just based on kind of, you know, the last meeting they said they're willing to consider it for the first time, which is kind of that first step. Yeah, it makes sense. Let's jump to Bitcoin.

Starting point is 00:09:47 In the report, you all really highlight kind of the first thing is that Bitcoin has retaken that 200 average. Talk a little bit as to why this average is so important. And then what is really driving kind of the retaking of it? And does that mean that maybe the bear market is actually bottomed? Yeah, we look at the 200-week moving average as an important indicator, just to put in perspective the market activity, how big the drawdown is that we've seen versus past cycles.

Starting point is 00:10:16 And if you look, the 200-week moving average, Bitcoin's only touched it seven times in its history. And it touched it when it broke below $22,000 earlier this month. And historically, that's been a good time to average into Bitcoin. Not a recommendation to buy, sell, or hold anything, but the average returns of Bitcoin 12 months out after breaching the 200-week moving average is over 200%. So historically, it's been a good indicator of capitulation and a bottoming event, though not necessarily predicting or indicating the exact bottom because we see times where Bitcoin's price

Starting point is 00:10:55 drops dramatically quickly below and then recovers sometime after. So it's kind of just a global signal that we're close to a bottom, though you need to look at the more specific on-chain indicators to see where that bottom might actually occur. So seeing Bitcoin now reclaim that 200 week moving average, just last week was the second week in a row that it's closed above it, is a sign that we may be getting more bullish heading above those ultimate lows. I think it's still important to put this drawdown in context to previous drawdowns. So Bitcoin in general for global bottoms has typically bottoms below 80% drawdown from all-time highs.

Starting point is 00:11:41 COVID was one exception where the drawdown was very quick and there was the V-shaped recovery in pretty much all assets where it didn't. This time as well, we didn't get down to those 80% levels. So if there was, say, increasing macro headwinds that drove the whole market down, if equities reach new lows, I don't think crypto will be spared. That ultimate low looks around the 13 to 14K range. So we're not ruling that out as a possibility. But at least crypto specific, things are looking a lot healthier now than they were, say, the past three months. And I think, you know, just to put in context, what's happened that's driven a lot of this chaos in the market, really starting back in May with the collapse of the Terra and the UST stablecoin, that was a

Starting point is 00:12:32 like a $50 billion event. If you look at the 20 billion market cap of UST and the 30 billion market cap of Luna, that really evaporated overnight and also had Bitcoin-specific selling pressure in there because the Luna Foundation guard was buying Bitcoin to backstop that peg, which obviously didn't work. But that was a massive selling event. The markets all sold off from it uh and then over june and july we saw the contagion of that event uh start to show itself in the market um we we had a strong feeling there would be some we didn't know exactly who would be affected uh two of the main ones turned out to be celsius and three arrows capital um celsius they both had exposure to terra um three arrows taking a bit on that ecosystem took a big

Starting point is 00:13:20 to their balance sheet that rendered them unable to weather two other trades that they made that also went bad. One of those was the Grayscale Bitcoin Trust. As that discount widened, their trade moved against them. And then also the Lido's Liquid State Ether that they had a large position in as well was also trading at a discount. These two products trading below spot essentially put them underwater in a way that rendered them unable to meet their margin calls, which it also turns out they were borrowing for pretty much everybody in crypto. So that we learned kind of throughout the entire month, more and more about that story. Three Arrows, at their peak was managing between 10 and $18 billion. So we went from a $50 billion accident

Starting point is 00:14:12 Terra, you know, 10 to 18 in three euros capital Celsius as well, which halted withdrawals on their platform, ultimately filed for bankruptcy in the beginning part of this month, they were managing over 20 billion at one point. The, the, the tail has been getting longer in terms of who's been halting withdrawals, filing for bankruptcy. But the, the actual magnitude of those events, if you look at, you know, even another lender Haldel not, which I hadn't heard of before, but paused withdrawals this morning. much smaller in magnitude. And it seems like that overall contagion has now been

Starting point is 00:14:47 contained to some extent, which has really allowed the market to settle here. People are less worried about the next shoe to drop and more kind of thinking about that overall macro context that I mentioned at the beginning. Given kind of that storm, if you will, in the report, you all identify that Bitcoin is stabilizing and you kind of break down Bitcoin across a number of different aspects. You start off with the network and specifically break it down to network security and network usage. It appears that you all are neutral on the network security kind of change month over month, but you're bullish on network usage. Maybe give us a little bit more color there as to kind of

Starting point is 00:15:23 how you arrive at neutral versus bullish and why you guys are excited about the network usage specifically. Yeah. So I think on the security aspect, one of the entities in the network that's most affected by price drawdowns is miners. And we've seen many of the publicly traded mining companies sell off Bitcoin from their balance sheet, which they had been holding during the month to pay down loans, basically meet their obligations of operations. Mining revenue is down 45% from where it was year on year. So it's not easy to be a miner in this environment, especially with long-term purchase agreements, plans to expand capacity. So that leaves us, and hash rate as well has come down a bit,

Starting point is 00:16:08 partially driven by the sell-off miners going offline. That leaves us neutral. It's not a massive capitulation in hash rate like you saw with the China ban of mining, which in terms of absolute security was a negative in the short term, but in the long term led to a broader decentralization of the hash rate base that I think was very positive for the network. That would have been something that short-term would be negative. Here we're relatively neutral with that.

Starting point is 00:16:40 In terms of usage of the network, if you look at the active entities, though they always kind of peak during market tops, you have kind of new entrants coming in that are excited and are frankly speculating on the asset. You have this kind of long-term channel of growing active entities at the market lows that's positive to see being maintained here, as well as usage on the Lightning Network increasing as well. I think the Lightning Network is really interesting in that we typically see usage accelerate during bear markets. And I think there's multiple things at play here.

Starting point is 00:17:17 One is that the builders in the space that are really dedicated to the network, they can stop worrying about price and speculation and the new highs in the market, and they can actually get to building and shipping new products. That's a really healthy sign and seeing Lightning Network liquidity reach new highs, even though the market reached price, you know, local lows, I think is healthy. And then also, I think the second thing that impacts this a bit is that there's some amount of lag between markets peaking and every company wants to get in and build on top of Bitcoin and Lightning specifically. You had announcements from Square and Robinhood back in February and March around the Lightning Network. Those are announcements that then take time to build out and launch. And so I think there's some amount of lag of Lightning Network reaching greater capacity after market highs as those products that are kind of thought about in the bull markets get developed and built in the bear markets. Yeah, it makes a lot of sense that kind of the good times bring a lot more capital investment because there's just more capital to kind of go around, but it takes time to actually build out some of that infrastructure. Sure. The same thing is true around holder behavior as well. You kind of get tons and

Starting point is 00:18:29 tons of people who pile in, if you will, at the top or kind of at elevated price levels. It's a thing where as price of financial assets go up, people get more excited and want to buy it. But when they go down, maybe they're not as excited. You don't see as many people coming in and kind of buying discounted asset prices. In the report, you all break down this holder behavior and it seems like you are net bullish. Talk us through a little bit as to how you evaluate holder behavior and arrive at net bullish? Yeah. So I think it's important to look at how much of the activity in the network, where supply is shifting from kind of these short-term speculative holders to long-term holders that are going to be supporters of the network in the long

Starting point is 00:19:07 run and aren't just here for that kind of speculative trade. And as you see markets kind of reaching tops, you'll see that short-term holder base really grow in terms of percent of total supply. We define, we use Glassnode's definition of a long-term or short-term holder, which cuts off at 155 days. So you hold coins in your wallet and you haven't moved them for 155 days. Basically that level hits you into the long-term holder bucket. And during this bear market, we've seen long-term holders accumulating supply. So just over the past year, for example, plus 6% on the long-term holder supply base. That generally means that there's a stable cost basis establishing,

Starting point is 00:19:49 less speculation in the market, more long-term supporters of the network. Interestingly, a similar metric is also locked supply, which uses a different heuristic to get the same kind of notion of this long-term holder versus the short-term speculative holder, which uses a probability that Glassnode has come up with to identify the probability that a supply token will move out of a wallet. And so how much supply is locked in this kind of more illiquid wallets that are more likely to be long-term holders versus illiquid wallets. And that's on the rise as well, overall making us net bullish. And then when you look at long-term

Starting point is 00:20:31 is short-term valuation. You all are neutral in both long and short term. Explain a little bit as to how you break this down. Yep. So I think this concept of the market's cost basis or the realized price is really important here. So the realized price is the aggregate cost basis of the market. If you looked at the price that every coin was last transferred at, and that gives you a sense of the overall kind of cost basis of investors. And when the market cap or the individual price per Bitcoin drops below that realized price of that cost basis, the market's net underwater. Coins are trading below where the market last priced them at when they moved. And we saw during this cycle, Bitcoin's price dropped below that cost basis,

Starting point is 00:21:25 typically another indicator of that kind of bottoming of that. It's not the ultimate bottom. There's other cost basis that we look at to see where a more accurate signal of the kind of what might be the exact bottom but overall breaching that market cost basis. And then now just beginning of this month and end of July, getting back above it typically a bullish sign in terms of percent supply and profit. This is less looking in aggregate of pricing all the assets at where they last moved in the current market price, and instead looking at individual positions and how much of the supply

Starting point is 00:22:03 of Bitcoin is in profit. And so coins that were last moved a long time ago, say in the previous bull cycle or bear cycle, there's still a good amount of profit in that system overall. And so that's what leaves us kind of neutral there. And then I want to jump to this idea of Bitcoin and the investor cost basis. There, what we've seen in the 2018 bear market is that Bitcoin kind of fell completely to this idea of this like delta cost basis. But in 2020 and so far in the current bear market,

Starting point is 00:22:36 we have not seen that. It kind of just dropped and bounced off of the investor cost basis. Describe a little bit the variations or differences between kind of investor cost basis and this delta cost basis. And then why you think that in some cases we kind of fall completely versus maybe it's just bouncing off of investor cost basis?

Starting point is 00:22:55 Yeah, I think this is probably one of my favorite charts of the report this month. The market cost basis is the green line on this chart. It's kind of what I just identified as this realized price over time. The price that coins last moved at essentially in aggregate. The investor cost basis takes a similar methodology, but subtracts out coins that were mined, newly mined coins or the value of newly mined coins. And so the idea is to take kind of the aggregate cost basis, but subtract out the cost basis of miners specifically, which if you take the market and you take out miners, what you have left is investors. And that's the origin of this investor cost basis. And this is a metric that we actually originated

Starting point is 00:23:41 at ARK through work done by Yasin and David, our other crypto analysts, to come up with this. And it relies on that latter half of the metric, the minor cost basis, in the on-chain world is called ThermoCap, a metric coined by Nick Carter. And so this gives you a sense of the cost basis overall, then segmented down by miners versus investors. And so seeing where the market price bottoms relative to investors gives us some sense of the severity of the drawdown. And this has been hit in all the major bear market bottoms, including the COVID bottom in 2020. The next level down below that is something called the delta cost basis that was actually also invented by David on our team that gives you a more accurate signal for a very, very severe market bottom that we've

Starting point is 00:24:33 seen in 2018 and 2015 and 2012, for example, that takes that top line market cost basis and subtracts the average price of Bitcoin over its history, this average cap concept. And so it's kind of combining a fundamental metric that uses on-chain analysis with a technical metric that uses price, which is an interesting combination, but it gives you this sense for, or this bottoming level for very severe correction. And that's what we saw in 2018. And what we actually didn't see in 2020, kind of that V-shaped recovery and that very quick bounce after the world started to understand the potential impacts for the COVID pandemic that resulted in us not kind of going all the way down to that level. If we look at the current environment in July of 2022, Bitcoin's price breached below market cost and it just barely dipped below the investor cost basis. But it didn't go all the way down to the delta cost basis, which kind of it correlates to the idea that price sold off severely, but not as severe as it has in other capitulation events like 2018 when Bitcoin sold off.

Starting point is 00:25:50 uh, down to, down to, uh, below, uh, that, uh, Delta cost basis. Um, so when we look at this one, the fact that, uh, Bitcoin's price has reclaimed the investor cost basis and the market cost basis as a signal of a bullish turn in the market, but also still caution that, uh, until a few more indicators tip, uh, you can't rule out, uh, a drop down to the Delta cost basis, which would again be around that 14k level um the um yeah so we're kind of weighing those two this episode is brought to you by ftx us they're the safe regulated way to buy and sell bitcoin and other digital assets trade crypto with up to 85 lower fees than the top competitors there are no fixed minimums no ach transaction fees and no withdrawal fees download the ftx app

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Starting point is 00:27:16 and on the Canadian NEO exchange under DEFI. For more information or to subscribe to receive company updates and financial information, visit their website at valor.com. That's V-A-L-O-U-R.com. One of the pieces is you follow up kind of that analysis by saying, hey, look, there could be more downside. we talked earlier about kind of 85% being a line or more than 80% in some of the early bear markets all the way through 2018. But then in the 2020 kind of COVID pull down, we didn't get there

Starting point is 00:27:50 in the summer of 2021. Again, we had a big drop of like 50%, but we didn't actually get the full 80. And right now we've been sitting around 70% or so. And so is there a thought process or an argument where, uh, you could make, Hey, there's just stronger holders. And so naturally there should be less and less volatility over time. Uh, and a more kind of, uh, distributed, uh, holder base, uh, dampens that volatility. And so like this would be a natural progression or is that, you know, kind of bag holder quotes and people are super excited to make that argument, but, uh, maybe the data tells us something different. Yeah. I think it's, I think it's definitely dangerous to say that, uh, you know, the network's more adopted, so we'll never reach lower lows.

Starting point is 00:28:31 Uh, that obviously could happen, but I think overall there is truth to it. Um, there is a more distributed holder base and crypto now is seen, um, is more legitimized as an independent asset class. Um, I think that's one of the big things that's changed in this cycle versus previous cycles is nobody's, um, nobody knowledgeable at the space is saying, oh, crypto is going to totally go away. now they're saying crypto's here, how are we going to deal with it? And I think that's a big change that contributes to this quite a bit. And if we then look at Ethereum, you all included

Starting point is 00:29:11 that as well. So you have macro, you have Bitcoin, and then you have Ethereum. Talk a little bit, maybe just about how you at ARK are looking at Bitcoin and Ethereum. Are they competitive? Are they two different assets? Just even before you dig into the network fundamentals, what is going on with the two different assets and the way you all look at them as either technologies or as investment opportunities? Yes. So I think this is a really good point to highlight. Yeah. Before getting into the charts, just how we look at the market. And it's something we've spent a long time thinking about since we started researching crypto back in 2014 and 2015. But really over this cycle, it's gotten interesting and more important because the market is bigger than just cryptocurrencies

Starting point is 00:29:52 now. And I don't think they're competing on the same dimensions. When we look at the market of public blockchain innovation, we see three kind of parallel revolutions that are all happening. The revolution in monetary policy, this money revolution, is the first and probably most profound application of public blockchain infrastructure, which is really Bitcoin, a self-sovereign form of money that is displacing government-issued money, displacing the Fed, displacing traditional international settlement rails like FedRAMP or FedWire, sorry. And I think that is really important. But if you look at the total crypto market cap, that's not all of the market cap. And especially since 2018, we've seen kind of new

Starting point is 00:30:47 uh revolutions emerge in addition to that monetary revolution uh which we kind of classify as this financial and internet revolution it's uh innovations built around smart contracts like uh decentralized finance displacing traditional financial intermediaries and it's kind of what we've just seen the fruits of which has a lot of speculation around it still but uh web three and broader kind of user-owned internet, displacing traditional Web2 intermediaries. And we think there's room for all three revolutions to grow in parallel on the fundamental basis of public blockchain infrastructure, just that there's going to be different lanes that they compete that are important to recognize and different trade-offs that they have to make. So for example,

Starting point is 00:31:33 Bitcoin's not trying to facilitate smart contracts or NFTs or all this kind of like crazy stuff you see out in the financial and internet revolution and nor should it because to support those you need to make sacrifices on the ultimate level of decentralization the the solidness and the credible neutrality of your base layer that bitcoin is uncompromising on because it needs to because you can't have a nation-state adopted currency that undergoes a massive transition like ethereum is about to uh like the merge that could disrupt your monetary base like when you're thinking about something at that level you need this conservative uh lane that bitcoin takes Now, when you look at those financial and internet revolutions, you have this more competition on technology rather than kind of monetary soundness. And so that's why Ethereum, Solana, everything in this space has to kind of advance and iterate on its technology.

Starting point is 00:32:27 And also, if you look at, you know, some of the more ultra high throughput, low value transactions like gaming, you need to sacrifice that level of decentralization that you have in the network. You have Solana that costs, you know, hundreds of thousands of dollars a year to run validators on. They need to do that to support what they're trying to do. Bitcoin doesn't need to do that to support what it's trying to do. And so we look at the market across those three lanes. And I think that's really important context for kind of understanding and dissecting that crypto market overall. One of the things that you all point out initially is the upward trend line of ETH over BTC or kind of ETH-BTC trading pair. Why is that so important? And then what is the significance of some sort of uptrend there? Yeah. So I think this represents a few things. One, over time, ETH has grown in value relative to Bitcoin. I think this is, at least for me, this starts after the 2017-2018 market cycle where you saw this massive speculation in ICOs for this kind of first use case for smart contracts, which is just crowdfunding. hey, we can raise a bunch of money and we'll probably use it to build stuff in the future.

Starting point is 00:33:38 That had a massive hype cycle. It was a bunch of money raised before innovation really had time to take roots and technology was actually built that you didn't see happen until more 2020 that kind of catalyzed some of the market activity that we saw over the past two years, namely around DeFi. Seeing kind of the ETH-BTC pair as a surrogate for the growth and the broader adoption of crypto, which includes those two other revolutions, that financial and that internet revolution. That's what we think is healthy for crypto becoming bigger overall in the long run. And then on the more shorter term, we typically see in a risk-off environment, this kind of newer frontier, the financial and internet revolution,

Starting point is 00:34:23 sell off harder than the original kind of profound monetary revolution. And so this pair will typically perform worse in a risk off environment and conversely perform better in a risk on environment. And so seeing the ETHBTC pair ETH start to outperform Bitcoin in the month of July as another signal of this risk on environment going forward. And how much of this is just people speculating on the merge and kind of, you know, buy the news, or I'm sorry, buy the rumor, sell the news, versus it's signaling something that is deeper, you know, kind of more macro, whether it's risk on or investors, you know, they want ETH, not Bitcoin or any of the other narratives that kind of get pushed by various communities. Yeah, there's a lot of narratives out there. I think if you look at, for example, ETH compared to other, the alt layer one smart contract space, it has outperformed that as well, which signals that there is some amount of activity here from the merge, anticipation of the merge finally getting an estimated date. You know, if you I think how I look at this is that it's almost like a Bitcoin halvening cycle where there's all this anticipation and talk and news buzz leading up to the event. And then there's like kind of not very significant price activity because it's all been priced in and kind of the anticipation. The real effects of that you kind of see at a lag, you know, six plus months after we might see something similar here.

Starting point is 00:35:53 I think it's going to be good for the Ethereum community to kind of get this off their chest, something that's been planned since really before the Ethereum mainnet even launched. Finally, getting over with and having this transition done will be good just from a technical and execution risk that it's been waiting on. The actual impacts and kind of this investor narrative of an ESG-friendly move, reducing power consumption is definitely something that we've been vocal that we don't see as a benefit of this change. We think there's pretty profound aspects of proof of work that make it ultimately more decentralized as a base layer consensus mechanism than proof of stake and are hesitant

Starting point is 00:36:36 to view this transition positively because of that. That's our view, probably the minority of total investors that are interested in Ethereum. But overall, I think getting the Merge kind of out of the way will be kind of net bullish. Yeah. We are a couple of weeks away from the planned Merge. Do you think it goes forward on that timeline or do you think there's room for it to be pushed back in? Yeah, I think they're going to try. The question is, does it move forward without hiccups? They've been doing what are called shadow forks as well as migrating the uh ethereum test nets over the past few months uh they've been increasingly more successful so uncovering less bugs than migrating larger test nets uh the final test net merge is in the middle

Starting point is 00:37:24 of this month um that'll be the best indicator to see kind of where they are um but there's still kind of no true analog to migrating the main network and all the activity that's built on top of it. It's often referred to as changing an engine in mid-flight. But based on how the testnet merges have been going, I think it likely will be successful. Whether they hit that September 19 date that they've talked about, I wouldn't be surprised if it gets pushed. But I think for the end of the year. This episode is brought to you by BCB Group. With a dedicated focus on institutional payment services, BCB Group provides business banking, cryptocurrency and foreign exchange market liquidity for many of the world's largest crypto engaged financial institutions

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Starting point is 00:39:06 slash pomp go check him out for your free download today you all call out in the report defy infrastructure is basically working exactly as it's intended during this uh kind of lending uh and contagion event over the last couple of weeks in crypto many of the centralized uh players ended up being affected. Now, not all of the problems, obviously, things like Terra, Luna, definitely came more from a kind of a DeFi world. So it's not completely black and white. But I think in many cases, things that people thought wouldn't break, broke, and things that people thought would break did not break. Talk a little bit about kind of the DeFi infrastructure and how you all are thinking through kind of the robust and resilient aspect, given kind of the market

Starting point is 00:39:49 stresses in the last couple of weeks. Yeah. I think this is really interesting and important for those kinds of financial and internet revolutions going forward that I mentioned before. Um, the, when you, you know, if you said we'd have a 70%, uh, drop in market prices, who's gonna, who's gonna make it through and what's going to break. I think DeFi is a spot that people would have pointed to and said, that's definitely going to break. Um, and what we saw is that the, the centralized intermediaries that may have been acting in DeFi, we know Celsius was super heavily. They broke because they took outsized risks beyond what people thought they were taking. Celsius had a massive exposure to liquid-staked Ether, to illiquid-staked Ether,

Starting point is 00:40:32 positions in DeFi, loans to Three Arrows Capital, kind of all this stuff. A lot of entities kind of went outside their normal operating rules. So we know, for example, genesis uh loan to three euros capital kind of a sweetheart deal that required less collateral than they require from their other um their other counterparties and that came back to bite them pretty hard they basically broke their typical risk management rules to make a good deal with a friend if you look at defy which is all operating on smart contracts these are examples of ave and compound the two largest lending markets on ethereum smart contracts can't break their rules. They can be programmed with bad rules. And I think Terra is a good example of

Starting point is 00:41:15 that, where the algorithmic stablecoin design was just not weathered to handle a severe market sell-off of all crypto assets that eventually led to its unwinding and kind of the death spiral of the whole nine yards. That was, I would say, DeFi that was programmed wrong. You see other DeFi that's programmed wrong with all the hacks that have been happening, especially around smart contract bridges between blockchains. But the DeFi that's been around and managing billions of dollars of assets for a long time and has really been tested, these two lending markets on Ethereum as an example, really did weather the storm quite well. No major outages and no major insolvencies to report. And that's suffering a 77% decline in total outstanding debt and a 67%

Starting point is 00:42:04 decline in total deposits. So going from $40 billion in deposits down to below $15 billion since the start of the year is a massive deleveraging that they handled no problem. Those that were over their skis got liquidated, and that's how the protocol is supposed to function. And those who had proper collateral, boosted collateral or paid back debt as the market sold off were able to get their positions out that I think is really healthy to see. It's also an indicator just of the total leverage that was in the system that has now come back dramatically, marking kind of relatively healthier leverage environments going forward. The last thing I want to talk about is you've done what I would consider macro down to the network analysis, right? The report does a fantastic job of kind of not only breaking down kind of the data itself, but also ARK's perspective on Bitcoin, ETH and in the macro environment. When you all look out through the rest of the year,

Starting point is 00:43:04 are there any kind of takeaways coming out of this report or any kind of expectations, things you're watching, milestones potentially that you think are important for people to understand? Yeah, I think now through the rest of the year in terms of price action is gonna be driven by that macro component that we talked about to kick this call off.

Starting point is 00:43:24 The correlation to equities is strong and will still have an impact on crypto. I don't think it will be spared if equities reach new lows, say the Fed remains extremely hawkish and we have a stronger than anticipated recession. I don't think that's going to be good for crypto. But what's promising is that the Fed is starting to at least starting to indicate that they could ease up a bit. That's important. And seeing kind of equities start to stabilize is important. And then also seeing, you know, maybe the one chart we didn't talk about is the Bitcoin price activity during market hours is really being led by the U.S., which has typically, at least for the past two years, led Bitcoin rallies.

Starting point is 00:44:18 So when the U.S. is a buyer, especially in an environment where Bitcoin is correlated to equities, that's typically a good thing for Bitcoin's price. um so we're kind of watching all these if i had to say an on-chain indicator that's that's important top of mind we were talking about it just this morning um is the sopr the spent output profit ratio um as coins are actively moving around the network how many of those are moving at a price above or below what they last moved at so are people uh taking losses or taking gains and right now it's right about neutral basically the market's trading uh people are willing to move coins at breakeven. If people start, that could be an indicator that it's going to be strong resistance. People get out as soon as they can to breakeven and the market sells off

Starting point is 00:45:07 more. But if that goes above and the market turns net positive on that metric, I think that's another confirmation point that the worst is behind us. So it's a summary of kind of the major things that we're watching. Yeah, I think it's fantastic. And what I love about it is there's price, there's network, there's kind of, you know, this holistic view of the market and of the assets. Where can we send people to find you on the internet, Frank, or find this report when you release it each month moving forward? Yeah, you can find me on Twitter at Downing ARK. The report, you can find it on Yasin's Twitter, Yasin ARK, or the ARK Invest website, www.arkinvest.com. Awesome. Frank, thank you so much for taking the time to break down this report. We'll definitely

Starting point is 00:45:49 do it again, kind of each month as you guys continue to put this out. And I think for those that are looking for a kind of very high signal, quick understanding of what happened in the past month and how the network itself, the assets and the macro environment are playing out. It's a fantastic read. So thanks for all the hard work to put it together. And I suggest that the people go subscribe to it. Awesome. Thanks so much for having me. Thanks so much for listening to today's episode. I really hope you enjoyed this one. Make sure you're subscribed on Apple, Spotify, or your favorite podcast player. And if you're looking to transition

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The Pomp Podcast - #1074 Frank Downing | Wall Street Analyst Compares Bitcoin & Ethereum

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