“It is always darkest before the dawn” seems to be particularly apropos when looking back over the first half of this year. At the turn of 2023, the digital asset industry was reeling from frauds uncovered during 2022, fresh US bank failures, and regulatory enforcement actions. Since then, we’ve witnessed a couple of rays of positivity. Last month, a spate of established TradFi asset managers applied to offer spot bitcoin ETFs. Then on July 13, after a prolonged two and half years of legal uncertainty, the industry received a ruling that XRP, the token itself, is not a security. While this is a welcomed win in the US, the details and conclusions are quite nuanced.

What a dramatic turnaround in the sentiment we’ve witnessed in June! In early June, the US SEC charged both Binance and Coinbase with various securities law violations, quickly dampening market spirits. In both lawsuits, the SEC listed a dozen or so indicative “crypto asset securities” that, noticeably, excluded both bitcoin and ether. Emboldened perhaps by the exclusion of bitcoin as a cryptoasset security, various institutional asset managers in mid-June submitted their respective applications for their physical bitcoin ETFs/ETPs, leading to a rebound in market sentiment. Meanwhile, equally exciting in Web 3 have been the conversations around Eigenlayer and its promise for permissionless protocol innovation for the Ethereum chain.

One year! It’s been a year since we launched our Liquid Digital Assets Fund back on June 1, 2022, and oh what a year it has been!

Given the negative crypto headlines in 2022 and the March bank convulsions, did you know that bitcoin has appreciated over 70% in the first quarter, besting all the major asset classes most investors would allocate to?

The phrase “unknown unknowns” was coined by the US Secretary of Defense Rumsfeld back in 2002 in reference to Iraq’s alleged supply of weapons of mass destruction. It falls under a broader category of Knightian uncertainty, a concept attributed to economist Frank Knight who in 1921 made the distinction between risk and uncertainty. Risk is quantifiable, with stochastic parameters, while uncertainty refers to occurrences that may not be quantified or even expected. Both the US banking liquidity crisis and the hack of the Euler DeFi lending protocol seem to be prime examples of this unquantified uncertainty.

Given the shenanigans we witnessed in digital assets over 2022, it may be surprising to see the digital assets space post a strong January, followed by strong supported levels in February, despite the spate of regulatory announcements made globally over this past month. We should keep in mind that the markets did drop over 21% in the last two months of 2022, not only due to uncertainty about asset valuations and growth prospects, but also in anticipation of regulatory overreach. We view the recent regulatory announcements as emblematic of the tension the regulators and legislators face between trying to keep the public safe and promoting financial stability while not being seen as being behind the curve and not fully understanding the capabilities of DeFi.

Investors were certainly glad to put 2022 behind them and enthusiastically embrace the new year. US CPI inflation for December was reported to have risen 6.5% from the prior year, a continual deceleration from the previous month’s reported rate of +7.1%. In early February, the US jobs report indicated that 517,000 jobs were added in January, compared with an expected 185,000. The increase in the number of jobs in January is particularly interesting when considering the number of layoffs technology companies and centralized [crypto] exchanges (CEX) have made over the past 6 to 12 months.

We’re glad 2022 is behind us. Hopes of a pandemic recovery were dashed early with the Russian invasion of Ukraine; supply shocks ensued, sparking global inflation particularly in energy; central bankers deployed their only tool, that of monetary tightening vis-à-vis withdrawing quantitative easing and raising interest rates. Rates, being the fundamental element that prices risk assets, amplify investors’ animal spirits, and rising rates expose the sins of past excesses.

As long-term investors in digital assets, we must look beyond the markets. We remain heartened by the continual infrastructure development to address the core blockchain challenges of scalability, security, and decentralization. We think the Bitcoin Lightning Network deserves some airtime.

“Be careful of what you wish for” seems to be the most appropriate warning for crypto investors who rue the rising correlation between digital assets and traditional risk assets. While bonds and stocks enjoyed a relief rebound in November, it couldn’t have been more different for digital assets. The FTX collapse caused digital assets to shed another 15% of its market cap. We do recognize that the impact on millions of customer accounts and the loss of billions of dollars in funds will bring about a strong global regulatory response as we head into 2023. This is worth a closer look.

In the long run, the market will converge on the fundamentals. For digital assets, it is important to focus on the fundamentals that exhibit positive momentum despite the market volatility experienced over the last several months. With this in mind, we turn our attention to Ethereum Devcon 2022 that was held in mid-October in Bogota, Columbia.

Rising US Fed Funds rate, higher than expected inflation, and geopolitical uncertainty led many investors to flee to the US Dollar. The flight to safety drove global equities down over 9% for the month and over 26% year-to-date (in USD terms). The digital assets market did not fare all that badly and had a drop of a tad over 4% for the month.

Weighing down on the crypto markets was also the concern about the long arm of two of the US financial regulators, the CFTC and the SEC. Despite the macro and regulatory clouds, the sun was shining on the Ethereum protocol. In the wee hours of Sept 15, Ethereum completed its Merge, switching from its previous Proof-of-Work consensus mechanism to Proof-of-Stake. Both the regulatory actions and the Merge deserve some attention in this month’s commentary.

In early Aug, U.S. Treasury’s OFAC added Tornado Cash to its Specially Designated Nationals (SDN) list, throwing into question crypto’s promise of permissionless peer-to-peer interactions. August may be considered a short-term reversal after the strong July rally, but the OFAC action will have long-term consequences which are only beginning to play out.

Crypto markets have rallied in line with the improvement in macro assets. One of the most important upcoming events, The Merge, is finally nearing its completion.

June was volatile for the digital assets market. But with evidence indicating that marginal liquidity seekers may be exhausted, a strong foundation may be forming.