Investment Opportunity in the Bear Cycle
The crypto market has fallen from highs after a year long bull run in 2021. This coincided with general risk-off in traditional asset classes, largely due to inflationary factors, and subsequent interest rate hikes around the globe.
The bearish sentiment, resulted in significant distressed situations within the crypto ecosystem, Luna, 3AC, and now various lenders, to the extent market confidence has been hit.
Most of us have been through one cycle. Some have been through several, and with that in mind, we took a deep dive covering the focus points below:
- Logic: Cycle-Based Market
- Historical Analysis on Past Data
- Timing — Valuation — Vesting
- The NEXT Cycle
Cycle-based Market
Bitcoin is very much a cycle-based asset — mainly due to its nature of the Halvening mechansim. The Halvening event occurs every 4 years and this causes Bitcoin to be highly volatile both before and after the schedule of the decrease in mined supply. Bitcoin has had two independent full cycles from 2009 to 2016 almost fully by itself and has already created a general standard on the cyclical movement of the industry.
If we were to compare the macro economy to the cryptocurrency industry, the FED controlling the supply of cash to “control” the economy is a key factor that arbitrarily influences the general market. Similarly, Satoshi envisioned an uncontrolled, arbitrary factor that changes fundamental factors such as supply based on a fixed time without the control of a centralized entity. Therefore, there is not much we can do about the general 4 year cycle that we will predict to see in the next cycle.
Past Halvening Dates
Bitcoin has exponentially grown each cycle and has never gone below the previous low. Therefore, Bitcoin is projected to increase over-time as we elapse each cycle. Bitcoin has had 4 cycles until now while Ethereum and other altcoins have only had 1 meaningful cycle with the development of DeFi, NFTs, Metaverse, DAOs, and other sectors in the industry. Although, there are times when these assets move in opposite directions, the longer time frame correlation of the BTC marketcap and altcoins marketcap have remained meaningfully high until now. We predict this will most likely remain the same. However, as Bitcoin marketcap grows in size, we expect it to have less direct influence in the altcoin marketcap in the future.
However, the influence of Bitcoin Halvening events will always remain an important point in time -creating the spark to the next bull-cycle. The past ICO (2017–2018) and DeFi Summer (2019) has all trailed after the explosive growth of BTC after its Halvening and we expect it pattern to repeat.
Historical Analysis on Past Data
With the groundworks of the logic of the crypto market being built upon a cycle-based movement, it is important to determine the perfect timing of any trade or development activity. Because the market is heavily cycle-based, we need to spot meaningful patterns that have occurred in the past such as the timeframe from the BTC Halvening event to the next ATH or the number of days from ATH to the ATL.
Although there are multiple factors that exist outside of crypto that directly or indirectly influences the price-discovery of crypto, a large portion of these factors are unpredictable and we have witnessed a lot of similarities of how these patterns turn out despite different events happening in macro situations (such as COVID-19). No one could have predicted these occurences in the first place. Additionally, the premise of the cycle-based theory already being naturally embedded in the thinking process of a majority of market participants, traders, hedge funds, VCs, naturally leads market to structure itself in a way that is very similar to the past.
We have created a chart displaying the performance of both BTC and Altcoins marketcap after the 3rd and 4th Halvening cycle. We have excluded the first 2 cycles as it was relatively hard to compose a meaningful correlation with BTC’s halvening to other assets as there were not many fully “working” blockchain protocols with real use-cases.
The chart shows how long it has taken for the Altcoin Marketcap to hit ATH after the Halvening. Both cycles have had a timeframe of about 1.6 Years until market reached its peak and transitioned into a Bear Market. Although the future is unpredictable, a pattern timeframe may act as a useful source of reference.
The Big Three: Vesting — Timing — Valuation
So now, with the information above, we can construct a few actionable points as simple as: when is a good range to start taking positions / profit? Although it is not as simple as simply putting a t + n date to when we convert our portfolio exposure to stables, having a strong conviction backed with data and reasoning on when is a reasonable range is important.
DSV encompasses both markets of secondary market trading and private deals. Although the following points are more relevant to primary market deals, it is also very valid and provides meaningful insight for the secondary market exposure.
ATH is instinctively a point where a fund or any individual would want to take all or most of their profit. This is natural because investments’ primary purpose is increasing PnL, other than complementary utilities that come along with holding tokens (such as governance). Therefore, we naturally aim to buy low and sell high. Although there are no restrictions for secondary market trades on when they can exit, there is a very important “limitation” in the VC side of things.
As a VC, we need to take into consideration three key factors:
- Vesting
- Timing
- Valuation
Total Vesting — Vesting is mainly divided into two parts: a cliff and vesting period.
Cliff — The period in between the TGE (Token Generation Event — when a token is transferrable and naturally tradeable) and the start of the distribution schedule.
Distribution Period — This is the range in where VCs or private investors receive their allocated tokens over an n amount of period. Vesting period and distribution portions differ across projects and companies, however, there also is a general pattern.
Historical data can provide a good overview of how the next cycle cliff and vesting may turn out. @robindavidji has provided an excellent overview of average token cliff and vesting schedules for a range of projects in the past.
With a very simplified analysis on the information above, we can conclude majority of projects have a total vesting period of 24 months and most of these projects will have a cliff of 12 months (half of the vesting period). It is important to figure out the optimal point of investment timing to maximize liquid tokens towards ATH.
The optimal timing of investment can be found with a very simple calculation. Our optimal TGE targeted date would be around 6 months before the next halvening. Obviously, TGE release is a flexible and may be delayed than a scheduled date.
Lastly, the third factor, valuation, is a relatively value-based approach as it has less to do with the factor of “time”. The logic is, with a fixed valuation as a “successful” target valuation (such as 1 Billion FDV), projects with lower valuations will obviously have higher multiple than projects with higher valuation. Assuming both projects reach 1 B FDV, Project A raising at 25 M valuation will have a multiple of 39x while Project B raising at 50 M will have 19x multiple when it only raised at 2x the valuation of the first. If the invested amount is 5% of the total allocation, Project A would be up $48.75 M with Project B at $47.5 M, a $1.25 M difference. Obviously this multiple is much more impactful as the size of the FDV grows, but the overall trend of valuation is very important for maximizing PnL.
This is to show that valuations of project investments increase in bull markets and decrease in bear markets. This makes investing in a project with identical fundamentals simply much more attractive during the bear market due to cheaper valuations. They simply do not get as aggressive funding as they used to in the bull market and majority focus on fundamentals compared to market-hype or trend-based traction.
In a bull market, average project valuations during pitch becomes much higher than they used to be the previous quarter. There are multiple reasons behind this effect; however, because more VCs want to deploy, this causes more projects to raise with poor fundamentals decreasing potential PnL in terms of potential projection of exit price.
Like the chart above, bull markets have a big magnitude of influence on pumping median project valuations in private markets. According to Galaxy Digital Reserach, crypto project/blockchain startups had a pre-money valuation of $70 M, which is 141% higher than average of $29 M that was seen across all of VCs investing in other sectors such as robotics, AI, CloudTech, and many more.
The NEXT Bull Cycle
Understanding that the market is cycle-driven and time-sensitive, our goal is to find the most capital and time efficient range for capital deployment. Based on the past analyzed data above, we can come up with the following conclusion:
- It takes about 1.5 years to reach ATH from the Bitcoin Halvening event
- VCs have an average 2 Y total vesting (1 Y Cliff, 1 Y Vesting Distribution)
- Valuation becomes much cheaper during bear market (capital is scarce compared to bull market)
Investing 6–12 Months before the 5th Bitcoin Halvening may be a very good range for potential capital deployment as we can deploy capital at a cheaper valuation with most of the vesting released in the market for liquidation without negatively affecting the market.
Obviously, the next cycle may not turn out to be similar in pattern of hitting ATH exactly 1.6 Y after the Bitcoin Halvening just like we did in the past two cycles. However, we expect the market to repeat its cycle in a similar manner.
Do look out for our regular market insight series as we take a deep dive into AMM models and it’s significance for crypto.
