Author: FELIX HARTMANN
Translated by: Kate, Mars Finance
Today, we’ll take a bird’s eye view of the digital asset landscape for the remainder of 2024, including a closer look at two major catalysts at this point in time – regulation and liquidity. Portfolio-level insights from the second quarter review will be shared with LPs in a separate email.
Cryptocurrency's six-year rise from obscurity
6 years ago, the Hartmann Digital Assets Fund had its first close. We (or rather “me” at the time, as a 23-year-old one-man show) entered a very new scene with probably no more than 100 crypto funds in existence. It was easy to get to know everyone and everything. There were only a handful of OTC desks like Circle and Cumberland, one or two custodians like Kingdom Trust, a bank willing to support the space (Silvergate), and really, and I mean this seriously, no actual products or users beyond sending and receiving Bitcoin. The industry was built almost entirely on vision and ideals. This was a time without DeFi, DePin, Web3 Gaming, and all the stuff that has come out in recent years. In fact, most of the “basic” financial fundamentals that are taken for granted on a daily basis, like on-chain swaps, lending, and borrowing, were virtually non-existent — so much so that in that year, global DeFi banking totaled about $300,000. For context, that number has risen to over $100 billion.
In 2018, Larry Fink of BlackRock said he couldn’t think of a single client in the world that requested or wanted cryptocurrency exposure. Today, BlackRock’s Bitcoin ETF has the record for the most successful ETF launch in history, raising $20 billion in less than 5 months.
If we scale down the entire trading history of Bitcoin and ETH to 10 days, I have traded and witnessed 5 days for Bitcoin and 8 days for ETH. Each candle and wick tells a story that I miss. Similarly, as a young CIO/GP with 6 years of experience in digital assets, this crypto journey has occupied 25% of my life and 64% of my adult life. Having been in this emerging industry for so long, I would say that both being in this industry and growing up around it has profoundly shaped my perspective.
The industry has gone through many phases on its way to maturity. A fairly homogenous, ideals-driven libertarian community has splintered into many subcultures — from the suit-wearing digital asset crowd pushing institutional adoption, to the meme-coin casino millennials living on Twitter, and finally the original missionary crowd who push the ideals of privacy and decentralization while often being targeted by government agencies. The first question became my job, the second made me question my job, and the third was why I was able to get over the stink of the second question and remember what got me here in the first place.
Regulatory bottlenecks are heating up and about to burst
While the industry continues to grow, especially in terms of scale, innovation and adoption have been hampered in the regulatory battleground in the United States. It’s now been almost exactly one year since I published that letter about regulatory bottlenecks. While Ripple and Grayscale have won their respective cases, and the Bitcoin ETF was ultimately approved, as expected, the regulatory war has yet to be won. As recently as April, the SEC continued its crackdown on the industry’s most prominent players, issuing a Wells Notice to Uniswap Labs, a U.S.-based unicorn. Uniswap Labs has millions of users and has never stolen a penny from anyone. Instead of going after the countless scams and frauds that are endemic to the financial and crypto space, they chose to go to war with industry pillars like Coinbase, Kraken, and Uniswap. This is not a war to “protect investors,” this is a war against technology.
This war against tech is already having real impacts. When considering how the current toxic regulatory environment is leading to an erosion of industry fundamentals, a few challenges come to mind:
1. Unless builders are willing to go to jail for their mission, many are shying away from cryptocurrencies. Running a startup is hard enough, the last thing you need is the Fed threatening your freedom.
2. Regulatory pressure is unevenly tilted toward legitimate products. In other words, if you scam someone directly with a pump-and-dump meme coin, you may not be penalized by the SEC, but God forbid you develop a new technology that could actually change the financial industry. As a result, we see more worthless garbage being launched rather than truly valuable tokens that attempt to capture value and return it to holders.
3. DeFi has not really grown in three years. While we have a staggering $100 billion in assets on the decentralized track (down from $180 billion in 2021), significant growth requires institutional capital, which will not come on-chain until regulation is clear.
Digital asset trading does not need the support of regulators to climb from innovators to early adopters. However, the next stage of digital asset trading, from early adopters to early majority, very much needs the support of regulators, or the collapse of the old system.
In other words, tokenization and the growing adoption of blockchain are technologically inevitable. But it’s up to regulators (and voters) to decide whether we start using this technology today, or wait until the ashes of despotism and currency debasement emerge.
Remove the time frame and there is only one correct trade: long decentralization and short fiat, institutional inertia, and any country that suffocates at the hands of bureaucracy.
However, when managing a liquid fund, time horizons are important. For example, the AI industry, while clearly breaking records in terms of speed of adoption, experienced two-year winters in the 1970s and 1990s. Over the past few months, as Bitcoin has struggled to defend its all-time highs, I have spent a lot of time thinking about whether the industry will win the regulatory war in the West or will be put on hold until a more friendly (or as the media likes to call it, radical) government takes over.
However, over the past three weeks, things have begun to change… We are beginning to see a sudden shift in tone in Washington as former President Donald Trump has publicly voiced support for the digital asset industry:
1. Contrary to everyone’s expectations, the Ethereum ETF was hastily approved by the SEC
2. Congress opposes the SEC's strict cryptocurrency custody rules under SAB 121, with numerous Democrats who were previously hostile to cryptocurrency voting to pass
3. The Financial Innovation and Technology Act, which has been widely welcomed by the digital asset community as it provides more regulatory clarity and limits the SEC’s jurisdiction over the asset class, has passed the House and has been sent to the Senate.
4. Noticing the sudden influx of support for Trump’s campaign from the digital asset community, the Biden campaign suddenly began their own community outreach. But a few days later, Biden vetoed the congressional repeal of SAB 121 and lost all support from the community.
Ending Gensler's ambitions
To get a better sense of the situation, two weeks ago I found myself in a room with most of the industry’s policy and/or leadership teams at the annual CoinCenter Gala in Austin, Texas. The mood was fairly euphoric, with speakers acknowledging that “we are finally starting to win” given recent victories in Washington. House Majority Whip Tom Emmer also addressed the audience and warned SEC Chairman Gary Gensler: “Listen to my voice, Gary — your days are numbered.” As I sat there, I asked myself, “Is it really time?”
The presidential election may be just the hammer that breaks the regulatory bottleneck. If Trump wins, Gensler will resign at worst and go to jail at best. In addition to his authoritarian abuses of power as SEC chairman, which are now being pointed out more frequently by courts, Gensler served as the chief financial officer of Hillary Clinton’s campaign, which has branded him as an enemy of the Trump administration.
If Biden wants to win, taking out Gensler could be his most direct path to winning the crypto vote and distancing himself from the radical left, especially Elizabeth Warren, whose mission is to “build an anti-crypto army.” Warren has been the de facto face of the Democratic Party on all things crypto, and that dissent was evident in the FIT 21 vote, where even former House Speaker Nancy Pelosi voted in favor along with Republicans.
I now give the Gensler era a 70% to 80% chance of ending in the next 6 months. By that date, I expect the global digital asset market cap to have appreciated by more than 30%, or in other words, to around $1 trillion.
If the dice lands on the remaining 20-30% (or my estimates are totally off), and we have four more years of Biden and another two years of Gensler before the Biden presidency ends, I’d bet on the continued erosion of what Capo Gensler likes to call “crypto-asset securities.” The good guys will lose, and the only winners will be the law firms that collect checks from crypto companies and the American taxpayer as they go head-to-head over the next four years.
However, two asset classes have been largely spared this blow: Bitcoin, officially recognized as a crypto-commodity, and meme coins, which didn’t even attempt to create value and were born as literal parodies but evolved into proxy transactions for the cultural zeitgeist. These two camps of assets will continue to grow due to the fiscal irresponsibility of central banks and the financial nihilism of Generation Z and Millennials. Monographs exploring these markets are also being written, but that will have to wait until next time.
A new era of digital assets
Beyond Bitcoin’s digital gold theory, for the broader digital asset space, the most meaningful transition from speculative assets to investable assets occurs at the moment when tokens can accrue value without running afoul of regulators. While one part of the debate is whether digital assets are commodities or securities, another meaningful debate is how crypto assets can be compliant without violating the underlying technology. For example, requiring KYC for every holder is impossible when the fundamental principles are privacy and permissionlessness.
With regulatory clarity, the digital asset market could shift, ushering in the biggest bull run yet. Here are some of the standout predictions:
1. The shift from narrative to product-market fit
Since there is no legal way for crypto assets to increase in value, most crypto issuers don’t even bother to create products that can capture value. Ironically, the ability to capture value is a good litmus test for whether a product itself actually has enough demand for consumers to part with their hard-earned cash. Instead, crypto founders often build things that consumers don’t care about enough that they have to pay users tokens to use them. So something happened. The quality of the building improved, and…
2. Projects will have clearer metrics for success
Currently, valuations for many digital assets appear to be free-floating numbers set based entirely on market sentiment and competition. While most markets are certainly not efficient, as even stocks tend to trade far out of line with earnings, the stock market does a good job of elevating the cream to the crème. As a result, tokens with the best product-market fit and earnings may start to dominate conversations and portfolios more frequently. This, in turn, leads to…
3. A more convenient digital asset financing environment
Funding for digital assets is heavily skewed toward private markets, and the ability to raise capital after a token launch tends to become a roll of the dice based on the market regime the founder is in. This has led to cyclical rises and falls in “alternative investments,” with each new cycle bringing a new batch of projects that raised wonderful rounds while private, but often run out of money or fail to fully capitalize in the next bear market, sometimes even if they actually built a great product. The private markets then rotate to the next cohort. There is a fair amount of repetitive cost and value being discarded in this cycle. Therefore, stronger fundamentals will make it easier for protocols to raise capital while making…
4. The M&A market is booming
During 2022-23, we witnessed the stranding of many DeFi projects that would have been prime acquisition targets for better-funded DeFi projects. For example, a well-funded Uniswap or a well-funded AAVE could expand their product offerings and become a DeFi super-app by acquiring some of the well-run but underfunded players in the on-chain trading and options markets, or more substantially move into real-world assets by facilitating token swaps with one of the leading real-world asset (RWA) protocols (the RWA protocol could trade at 1% of Uniswap’s market cap). The maturation of crypto-asset individual and overall markets could open the door for truly savvy dealmakers and operators to create value in ways we haven’t seen in digital assets before, and greatly accelerate product development and innovation, bringing us closer to adoption. For example, some layer 1 blockchains could use M&A to acquire much-needed products and turn them into public goods. This would reduce costs for users while increasing usage and gas spend on the chain itself, driving the value of the network token.
We have been trading catalysts and fundamentals for digital assets since the day they entered the industry, and this may be the most promising era for the future of this market. This structural change may also bring the largest capital inflows into the market as institutional allocators can apply similar models to find true value as they have done in other asset classes for a century.
At Hartmann Capital, our core digital asset thesis is that “most assets will be tokenized in the next decade.” While this is a contrarian view, with the fat protocol thesis expressing its regards, Larry Fink and even Jamie Dimon (who can’t stand Bitcoin) are big proponents of tokenization. While most of these leaders focus on the assets wrapped in tokens, and the opportunities and savings it will unlock, we want to focus on the infrastructure that powers the entire process, own a stake in it, and potentially get a fee on all markets in the final stages — from financials to physical assets to intellectual property and personal data.
Light the Fuse
The timing of the U.S. presidential election, and the regulatory fate of the digital asset space, coincides with an impending central bank pivot. While the ECB has taken the first step toward cutting rates, the Fed has yet to take its first cut and is now expected to cut once in 2024, with rates set to fall to around 4% in 2025, according to its June economic forecasts.
While the Fed has successfully reduced its balance sheet by about $1.7 trillion since tightening began, the M2 money supply remains near all-time highs.
So far, $6.44 trillion of this money supply has been invested in money market funds, earning an annualized return of around 5%. As interest rates fall, not only do risky assets become more attractive because access to capital becomes easier, but risk-free alternatives also become less attractive. When $2-3 trillion of idle funds re-enter the market, we may see a significant increase in digital asset prices, both in the early stages of easing and in the overall low interest rate environment.
in conclusion
Regardless of the political outcome, rate cuts are imminent. With that, money will flow. Where that money flows depends largely on whether the SEC’s leadership or mandate changes or if it loses jurisdiction over digital assets through the courts and Congress. However, the outcome remains binary, with Bitcoin and memes thriving under the current regime, and real innovation in digital assets can begin to serve trillions of dollars in financial value and capture hundreds of billions of dollars in value under a more constructive regulatory framework.
The trade is still twofold, hold the key tightly and choose the right system. Regardless of the outcome, these two teams can serve as a trading space with great potential in the next four years.
I’ll close with an excerpt from digital asset pioneer Erik Voorhees’ keynote speech at the annual CoinCenter Gala on the promise of crypto and why the battle for digital sovereignty must be won in the United States — a country founded on the principles that this industry most closely reflects.
