Bear nowhere in sight as we see a crypto funding bonanza

All the cool kids are talking about inflation, Fed rate hikes, and a stretched money and credit cycle that obviously spells "bear market." Facebook collapsing 26% last Thursday and bitcoin spiraling down 40% recently just confirmed the obvious.

Then...well, bitcoin has since rallied 30%+ and this last week has seen over $1 billion of crypto venture deals in just the few projects I'm tracking.

• Secret Network announces $400 million for an ecosystem fund and an accelerator (HINT: Expect a lot more investment)
• Aleo $200 million in a Series B for privacy-preserving DeFi
• Polygon clocks a $450 million bet led by Sequoia

Again, these are some of the guys I'm tracking. I'm sure there are many more.

Will the real macroeconomics fans please stand up? Remember the Taylor Rule? I just listed to John Taylor on EconTalk, where he discusses inflation, rates, and what he thinks the Fed should be doing right now.

Long story short: even with the Fed's "aggressive" multiple rate hikes planned throughout the year, we're only looking at a Fed funds rate target of 0.9%. That's still way under "normal" and way under the 5% to 6% Taylor thinks would be rational given inflation, GDP growth, and 2% inflation targeting.

I'm as concerned as the next guy about a shifting monetary regime, but thus far it's way too early to think we're in a bear market. We're literally still in a bull market, and with so much capital being raised by major blockchains, that elusive bear seems further than the scary financial headlines would have us think.

"Bad-boyfriend-style" central bankers make me love crypto

It's easy to bash central bankers. Maybe too easy and we (in crypto) probably do it too much, but...

On Friday morning, England’s central bank chief Andrew Bailey surprised his country with a controversial quip that people should hold off asking for pay raises in the name of fighting inflation.

When the head of the Bank of England tells workers not to ask for pay raises to offset the obviously much higher costs of living they're experiencing, it just makes the bashing thing hard not to do.

If there's one thing the COVID pandemic instilled in me, it's a deeper appreciation for workers. Service workers, factory workers, transportation workers, basically anyone and everyone who put their necks on the line so we could keep the essentials flowing while everyone else huddled at home and dialed into Zoom.

I (-1)*heart politics, so please don't take these pointers to mean I weigh in one way or another towards a political position, but I believe that:

• Loose monetary policies benefit those with assets
• There is wide disparity in ownership of financial assets
• This is a major contributor to wealth inequality
• Loose monetary policies are inflationary, even if inflation doesn't manifest for a long time

The cynical amongst us could surmise that central bankers cause wealth inequality and inflation. At a minimum we can probably say that the "Greenspan put" kind of mentality of bailing out financial markets and banks with every stock market drop shuffles wealth from U.S. dollar users (everyone) to asset holders or bankers (not everyone). If nothing else, a central banker asking workers not to push for higher wages amidst the highest inflation we've seen in decades is simply distasteful.

BONUS MATERIAL:

A good finpunk isn't cynical. Cynicism is a systematic bias that we should go out of our way to stamp out with clear hypotheses and data. So if I'm not cynical do I think that central banks have caused wealth inequality and inflation? I have no idea, but the story sure does make sense.

I don't share the common meme in crypto that central bankers are either conniving or morons. In fact, I think most are extremely intelligent and deeply sophisticated subject matter experts in subjects that most critics simply don't understand. The world is much more complex than the stories we tell ourselves.

On inequality...I recommend The Grumpy Economist in general for deep economic thought and Inequality mirage in particular for a contrarian view on income inequality. There is a big difference between wealth inequality and income inequality.

How's that chart for a bombshell? For all the talk of rising inequality, we have to be careful we're measuring apples-to-apples. Wealth inequality may be increasing, but how we measure income inequality matters big time. Accounting for taxes and transfers wipes out the seemingly shocking jump in income inequality.

The changing winds of the market...or not

Are we all so negative on markets these days because it's winter in the northern hemisphere, or is there good reason to be skeptical? Hirshleifer and Shumway (2003) did show that framing matters and sunshine, in particular, could actually predict stock returns! (Unfortunately for my rhetorical starter, when controlling for sunshine it seems that bad weather doesn't predict returns).

"Irreverent buzz machine" and prolific blogger and serial entrepreneur, Howard Lindzon, is someone I respect quite a bit. He has a cool podcast called Panic With Friends, and is one of the handful of people who make both my RSS feed and my workout audio playlist. That is blush-worthy praise, isn't it?

Earlier this week Howard posted "Multiple Compression...What Next?" where he seemed a bit down on markets for the same reason I've been blogging about recently: that big, multi-decade, money and credit cycle sure does look tired!

"For a long long long long time we have been in a multiple expansion world."

Emphasis on "long."

"Now the FED is battling inflation and hinting they will pull that supply back at the same time as wounded ‘newbie’ investors see their beloved stocks and crypto crumble."

Psychology matters quite a bit in markets. When so many new investors enter at the tail end of a hype cycle it makes the subsequent correction super painful. Even Howard says he's getting tired of trying to "handicap" or rationalize all the headwinds in the market to craft a positive narrative.

And then you have others who have entirely different opinions. Isn't it great to have people argue different sides of a story? Remember that a good finpunk doesn't like to confirm his or her natural biases...we relish in discovering new points of view!

Rich Rosenblum, the President of GSR Markets, points to the pause of a decade-long drop in rates and regulatory uncertainty as short term catalysts for volatility, but persists with a bullish thesis. I know Rich personally and respect what he and his partners have built with GSR.

If you're HODLing for the long term and want to use this market to up your crypto positions, he recommends staying away from leverage and scaling into positions as prices fall.

Markets are much more complex than we think

It feels like everyone paying attention to markets is worried about inflation and interest rates. Higher rates would certainly set a strong headwind for stocks, real estate, cryptocurrency, and basically most investments.

What's worth remembering, though, is that there are thousands of factors at play in markets. Inflation and rates are certainly two big ones, but when we look to history we can see that there's clearly more going on.

In "How Do Stocks Perform When the Fed Raises Rates?" Ben Carlson does the obvious and actually looks at how stocks performed historically under different Fed rate regimes. The answer might surprise a good Finance 101 student!

I love Ben's disclaimer that "this data requires a dump truck of salt." Don't just take the average return of 23% and shout from the rooftop too quickly that rate hikes are good for stocks! You have to consider the context.

Stocks crashed almost 50% in 1973-74.

The market surged into 1981 but fell 27% in a brutal bear market that extended into 1982 (which included the aforementioned recession induced by the Fed).

The 1985-1988 period includes the biggest one day crash of all-time in October 1987, which saw the market fall 34% in a week.

And it goes on...

Fed rate changes are endogenous, they depend on the proximate context for the market. Did the Fed hike rates because the economy and inflation were overheating? Markets are forward looking and in many instances tend to sell off before the Fed takes action, which is exactly what has happened this last month, or three in the case of crypto.

Higher expected returns make sense after a sell off, and maybe markets like a responsible central bank that tackles inflation. Who knows? There's so much going on, this is just a reminder not to let the stories we tell ourselves be taken too seriously. Rate hikes do sound scary for stocks and crypto, but when you actually look at the data it gives us hope that we might survive.

'Permanent' inflation and expected returns post-Satoshi

When the world's largest sovereign wealth fund weighs in strongly convinced that inflation is here to stay and therefore investors should expect a prolonged period of low returns, it's worth paying attention. Or at least writing a SNARKy blog post!

Nicolai Tangen, who runs Norway’s $1.3tn oil fund, calls himself “the team leader for team permanent” in the fierce debate over transitory versus persistent inflation.

Tangen said the oil fund, which owns the equivalent of 1.5 per cent of every listed company in the world, thought inflation “could be stronger than what is generally expected” as the world experiences high demand and lingering disruption to supply chains.

OK that sounds pretty bad. And AQR Capital Management, a quant group I highly respect, is forecasting 2% after-inflation expected returns on a 60% stock and 40% bond portfolio over the next 5-10 years. 2% doesn't exactly inspire.

I also recently finished Ray Dalio's "The Changing World Order: Why Nations Succeed and Fail" which is a cool blend of history, markets, geopolitics, and (maybe most importantly) the money and credit cycle. With decades of expansionary money and credit looking like it's plausibly exhausted, it's entirely reasonable for investors to expect lower returns.

And then something funny happened on January 3, 2009...

Blockchain-based digital assets represent a $1.8 trillion market that came entirely out of nowhere just about 12 years ago. Even that timeline should be adjusted to when things really took off in 2020 when the overall market cap was around $250 billion. For better or worse, those of us in crypto just think differently. How could we not? We've been part of an industry going from nothing to trillions and every day new assets and innovations are hitting the market. It's hard to imagine this stopping.

So how does crypto effect how we should think about being in the tail end of an expansionary money and credit cycle? Of living in a world of higher rates after decades of no inflation? How should we think about expected returns for cryptocurrencies, NFTs, or DeFi assets? You can probably guess my usual answer: no one knows! But I do know that it changes things.

Forecasting winter is for lemmings

With the S&P 500 down 10% in the last month, crypto collapsing 40% in the last 90 days, and the latest U.S. inflation readings coming in at over 7% it's all too easy to run for the exits and hunker down for winter. Before you take either expert opinion or the wisdom of the crowd too seriously, just remember that no one knows what's going to happen next!

Here's a nice reminder of the historical efficacy of expert forecasts. What do Warren Buffett, Elvis Presley, and Michael Lewis all have in common?

One of the biggest headwinds for markets will surely be the fear of substantive changes to monetary policies and therefore interest rates. We learn in Finance 101 that the value of an asset is the discounted stream of future cash flows it generates, and the rate at which we discount matters. e.g. the higher the rate, the less we value future cash flows.

It sure does look like the Fed has to raise rates and maybe this means that the extreme expansionary policies since...Greenspan?...are nearing an end. I wouldn't count on it. If we think of the constraints of everyone involved, it's hard to believe that any Fed Chair or politician wants to preside over the reversal of decades of an expansionary money and credit cycle. Easy money and credit means lots of jobs, corporate profits, soaring asset prices, and happy voters. I just don't think anyone has the stomach for taking away the punch bowl. But...they all have to pretend they do and that means starting down the path of nudging rates higher.

So where does that leave us? The Fed's unprecedented COVID-related bond purchase program (unprecedented since...QE...that...never...ended) is going to wind down. Until the next crisis. This means that the rate of new money created might slow down. On top of this, markets seem to expect three or four interest rate hikes this year. Ceteris paribus, this is not so bueno for asset prices because loads of new money and cheap credit tend to inflate prices.

Tightening monetary policies aren't the only threat to perpetually booming markets. After the $1.9 trillion American Rescue Plan it doesn't seem Congress works anymore and would have a tough time sending trillions of dollars more into the economy. Russia seems obsessed with attacking Ukraine despite denying it every day since the troop buildup started months ago. China and the U.S. are having a tougher time than usual getting along. And the list of potential catalysts for market chaos goes on. But there's always a list and we can always be pessimistic.

And there's always a flip side. How much of the -40% of crypto returns is baked into future expectations? Meaning, what if the next inflation report comes in lower than expected? What if Omicron ends the COVID chaos and supply chains whip back to normal sooner? What if Putin actually doesn't want to terrorize Ukraine and ends up dismantling the invasion force? OK, maybe the last one isn't so likely, but you get the point.

In particular, the Fed will be looking for any reason not to end the party and so we're getting this weird buildup of negativity driving prices lower mixed with a tense hope to dive right back into markets as soon as anything changes.  

The moral of this particular story is that markets could go either way and we'll just have to wait to see what happens. Crypto tends to be the canary in the coal mine of risky assets, which also means it can be the first to recover sharply when things reverse. Is a 40% drop already deep enough a discount to wade back in? I have no idea and I'm way too biased anyway to make that call. The one certainty I can leave you with is that the more confidently you hear someone speak about uncertainty, the more confidently you can discount everything they're saying!  

Some summer crypto reading: DeFi and The Infinite Machine

In case you were missing the finpunk, I took a vacation! While laying by the pool and enjoying some Caribbean sunshine, I was able to power through Cam Harvey's DeFi and the Future of Finance and listen to The Infinite Machine on Audible about the founding and early days of Ethereum. The former is hot off the press and the latter is something I should have read last year.

Cam Harvey is a rockstar in academic finance whose early Cryptofinance paper inspired my own dissertation and the "Bitcoin & Blockchain Applications in Finance" course I taught back in the day. Besides the intro to DeFi in Harvey's latest book and why the field is so important (think changing human society kind of important!), the deep dive into MakerDAO, Compound, Aave, Uniswap, and derivatives like the Yield protocol, dYdX, and Synthetix are crucial for understanding the basics.

DeFi has been around for awhile. I was an early investor, activist community member, and market maker in Bitshares back in 2014 and throughout the first few years of my PhD. It was a precursor platform to DeFi, and had its own DEX and suite of stable coins. I even used it as a trading platform to teach my students about cryptocurrencies and decentralized finance.

Now I can say that despite being way early on DeFi, and ironically an early adviser to Aave when it was called ETHlend, I completed missed the real DeFi explosion. Really, it sounds weird, but despite following most things crypto, and literally being a part of the industry, I was too myopic in what my own organization was doing that I missed the moment when DeFi found true product-market fit. I also missed the moment when NFTs found their product-market fit, but that's another story for another day. Now I'm in awe of both and you should be too.

DeFi and NFT product-market fit happened on Ethereum, and this why it's so important to learn about that ecosystem. From its history, personalities, basic architecture with the Ethereum Virtual Machine (EVM), the power of smart contracts, and its tremendous success today...we should all be obsessed with Ethereum!

Anyone building in crypto should understand everything about ERC standards, tokenization, DeFi protocols, Solidity, NFTs, you name it. What Vitalik and crew built will change human history. The Infinite Machine provides an excellent intro to the Ethereum story.

It goes without saying that DeFi will be coming to a Horizen sidechain near you one day soon!  

My thoughts for the people of Afghanistan

The U.S. and its NATO allies just retreated from Afghanistan, and within a week the Taliban has taken over after one of the most successful insurgencies in history. I feel deeply for the Afghan people. Recognizing that a good chunk of the country views this as a good thing, this isn't about placing judgment on which side is better than the other. Rather, it's a basic humanitarian moment of grief for an entire country that has been suffering for way too long.

I spent almost two years of my life in Afghanistan working as a data scientist. My tour took me from Helmand and Kandahar to Bagram and Kabul. There were many long evenings around camp fires staring out in awe at the deserts of Helmand or the Hindu Kush mountains. It was also while in Afghanistan that I first became obsessed with bitcoin. CoinDesk even published my story about Afghanistan's first recorded bitcoin transaction. In many ways, the country made a deep impact on my life.

Since the world appears to have abandoned the Afghan people to their fate, the best we can hope for is that the new rulers exercise restraint, tolerance, and a great deal more inclusion in society than they're known for. It's a tall order. There are at least some indications that the Taliban will try to keep many things in place instead of tearing everything down. The problem all along has been that many of the ways things have been run by the old government weren't worth saving.

"They are going to assume control of what already exists, at least in the short term, and I think they will try to go for stability, rather than a revolution of any sort.”

There are so many lessons to be learned from the last 20 years, though to the Afghans we should think of the last forty years of perpetual conflict. The prevailing reason for the immediate collapse of the Ghani government was that it was so corrupt and poorly led that few thought it worth risking their lives to defend. This observation by a reporter on the ground perfectly captures the sentiment undoubtedly shared by many Afghans:

"The Taliban’s vehicles do not honk at civilian cars, forcing them off the road, as Afghan military ones used to."

Wishful outcomes aside, there are already worrisome signs that the Taliban's ideas of governance don't bode well for at least half the population.

"In Herat, where 60% of the students at the university were women, female students have been ordered back to their homes. Women at work have been told to give up their jobs to male relatives."

Quick observation on that last nugget: It's a little weird to think that random male relatives can substitute for any job held by a woman, as if any guy can do anything a woman can do regardless of training, education, expertise, etc. The economist in me is screaming at this one and its implications for a productivity collapse. The human in me is just sad.

Being the obsessed-with-crypto kinda guy that I am, it's hard to ignore the often thoughtless and uninformed commentary from bitcoin personalities on Twitter, captured well by Decrypt. You can gauge how smart I think these comments are with this tongue-in-cheek response:

"It's true. Little-known fact: The Kabul airport is still running because it's built on Ethereum."

Ideology aside, while crypto wouldn't have done much to stop the advance of the Taliban, getting assets into crypto in advance would have gone a long way to protect peoples' financial lives. Being a disaster asset has always been one of the killer use cases for bitcoin touted from its beginning, and what I was teaching in seminars while there.

Keeping some of your wealth outside your local jurisdiction, or any centralized financial system, is just prudent. The only questions are how much and where to put it.

What's behind the Horizen Labs $7 million Seed round?

This week we announced that Horizen Labs, Inc. raised $7 million in a Seed funding round led by Kenetic Capital, Digital Currency Group, and Liberty City Ventures. Other super notable participants were Sound Ventures, Deribit, Artist Capital, LionTree, and a hot new crypto opportunity fund called Deus. Kudos to the team for pulling together such great partners. You can read more about the round in the CoinDesk article and you can see a summary in Fortune's Termsheet, in this post I'll share some of the background and implications.

Crypto, blockchain, whatever you want to call this new industry is exploding. No, I'm not talking about rekt DeFi protocols, I mean that we've stumbled upon an important technology that has big promise to change our world.  The problem is that we don't really know what all the implications are yet, we just know that something big is brewing.

Between borderless cryptocurrencies, privacy-preserving cryptocurrencies, smart contracts, DeFi protocols, NFTs, and a variety of other dApps experimenting across industries, we already know there's tremendous market value and a lagged explosion of end user value (not just speculators). The core value prop amongst all of this madness of innovation is a tech that enables a decentralized and immutable (or, at least, highly costly to alter!) source of truth. What we do with such truth is the value add of this tech over legacy centralized systems.

The Horizen Labs, Inc. vision is to provide certainty for the world's information.

We're a blockchain-first company, but at our core we build cryptographic circuits that enable zero knowledge proofs (ZKPs) for a variety of data privacy and security applications. That's a mouthful, but what it means is that we're a tools company that greatly facilitates blockchain infrastructure that matters.

Blockchains are distributed databases open to a public that can see every transaction. The "seeing every transaction" thing doesn't lend itself well to most business models or to a world revolting against infringements on privacy (e.g. think user data and financial transactions).

Our technology bridges two worlds: one in which we want the power of transparency (open blockchains) with one in which we still have privacy.  ZKPs are the critical bridging technology, and this is what we've invested in for years and become an industry leader. Others focus on ZKPs for transaction privacy, sending digital assets anonymously. We've been generalizing this tech to other types of data and entire systems of operations, like keeping the workings of entire blockchains private but still connected to a public source of truth.

This is all pretty abstract and can apply to so many use cases, so let's motivate with an example. We recently partnered with Celsius Network, the largest p2p lender in crypto, to provide real-time audit of their reserves. Why does this matter? The way this would work for any company pre-crypto is to pay a lot of money to one of four or so big auditing firms to manually go through your books certifying that what you declare publicly is true.

zkAudit changes the game entirely  with an automated blockchain-based audit tool that constructs cryptographic proofs of reserves on-chain in real-time, uses ZKPs to preserve the privacy of users and fund flows, while outputting precisely what everyone wants to know: does Celsius actually control the reserves they claim they do? The tool can, and will, be adapted to include all kinds of audits and proofs of any digital asset on any of the popular blockchains for anyone. Big auditing firms that think they'll make a windfall in the crypto space should be worried.

What we've found in this five year journey in crypto org building is that talent is the biggest bottleneck. In the early days of launching Horizen, we were starry-eyed crypto-anarchists dreaming of changing the world through open source. Bitcoin was doing it so why couldn't we? Everything was decentralized, we had a super enthusiastic community, and we hoped that devs would follow. Some did, but in the end a small group of hobbyists without resources and without a compelling differentiator from other poplar blockchain communities wasn't enough to draw the right talent to innovate or deliver substance.

Horizen solved this over time by carving out a resource pool from the block reward, which I still think is under-appreciated as a venture financing channel. The first few years were rough going, but there's something magical about sticking with something relentlessly where persistent small gains really do add up.

Fast forward to today. We've spent the last few years org and team building, hiring and training top talent (especially in the ZKP space), and inventing and building a great interoperability protocol for release in the coming months. As we're nearing launch, it's time to substantially scale up the team and get ready for some massive ecosystem building. Specifically, it's time to get serious about dev tools and use cases that scale. Horizen Labs raising $7 million adds critical firepower precisely when it's needed most.

CEOs are notoriously overconfident and personally I've had a lifelong aversion to unqualified certainty or bragging, but the one thing I'm beyond confident about is the quality and organization of our team.  Combining an elite team with incredible partners and a technology niche that can take the world's hottest new industry mainstream is powerful. This is what our investors have bet on, and it's what I'd double down on any day.

A decision timing framework

I've never been much of a procrastinator. We tend to put off the things we're not too excited about, but these things don't get any more fun the longer you put them off. In fact, all the pent up anxiety procrastination brings just makes things worse.

How we time decisions and how we act goes beyond the mundane in life chores, and plays a big role in our professional lives. This is true for dealing with work flows and also for making big strategic decisions that impact entire businesses.

Here's my rule of thumb: Make decisions when you have to make them, defer them when it's valuable to defer them.

1. If you have all information and there's nothing to gain by waiting, act
2. When you can gain option value in waiting, defer but know what you're waiting for

An example from the mundane. I want to plan my next visit to our Milan office (here's how cool it is to work there), but maybe I'm not all that excited to go through the motions of booking the trip. At first it's just an idea. I know I need to get there and I want to spend more time with that team, but I first have to coordinate dates, sequence, and some other logistics. I mentally bookmark the trip.

After talking to a few people I now have the best dates, I know I can optimize my time by tagging it onto another trip just beforehand, and I even have an open weekend to plan an excursion to Tuscany! What am I waiting for? There are plenty of times in my life where I might have updated my mental bookmark and kept it at just that. Nowadays I'm fairly obsessive about taking actions as soon as I have all the relevant info. Mission complete: trip booked!  

An example from the strategic. Back in 2017 when we launched Horizen, one of the first things we wanted to do was decentralize governance by building an on-chain voting system (a DAO). The big value proposition back then was that our blockchain would be a censorship-resistant platform on which a suite of apps, like private money, private messengers, decentralized VPNs, etc. could be built. If there are people with the keys to the kingdom, you have a point of vulnerability on that whole censorship resistance thing. Coding decision-making into the distributed software, itself, guarantees that the system doesn't rely on the integrity of people (or so goes the logic!).

At the time we had the choice to invest everything into making this goal a reality with our current stack, or defer it to build out better foundational technologies and a more knowledgeable team that could deliver something much more substantial. It was a tough tradeoff, it was a time in the market when blockchain communities demanded constant action (headlines ruled!). Would it be better to dive in immediately with limited tech, an immature team, and a whole bunch of gaps in knowledge, or focus on incrementally delivering key pieces to the ecosystem while building out core competencies? For years the market penalized us for investing in the long term.

Back to our starting heuristic. First of all, we knew there was a lot we didn't know. Ethereum's The DAO had recently been wiped out immediately after launch, we knew that blockchains were starting to hit real scalability issues, and there's that whole incomplete contracting thing in economics we ought to consider before permanently binding law into code.

Secondly, we knew that by taking the time to focus on team building we could take advantage of superior technologies, like Zendoo's sidechain protocol that we ended up inventing and building. Because back in 2017 we lacked the right information and we had the opportunity to create substantial value that didn't exist at the time, it made a ton of sense to defer the project.

A fully decentralized decision-making process still eludes us, but today the project is 20x more valuable (in market capitalization) and has enormous potential to do so much more as a programmable blockchain platform than simply a cryptocurrency with an inferior voting system.

The last piece of the puzzle is to know what you're waiting for when you consciously defer action. Without setting clear and tangible targets for when you'd act you risk waiting for a future that never comes. In the DAO example, we chose to wait for sidechains as programmable blockchains that could support the complex logic needed for the voting system at scale. Now that we're delivering Zendoo at the end of October, the real fun is about to begin.