What’s eating crypto? A tale of Bitmex, sh*tcoins and opaque valuation

Jonathan Cheesman
Aug 12, 2018 · 9 min read

We (at Distributed Global) firmly believe in the long term value being created by distributed ledger technology. In this nascent stage, price volatility and skepticism from the investment community are no surprise. We would argue fervently that the price momentum YTD is not representative of the momentum of the underlying technology nor the bright minds entering the space.

We believe what has been created — early stage decentralized and immutable stores of value, trustless P2P mediums for exchange, flexible smart contracts, a web stack and decentralized applications — is clearly extremely valuable and will grow in value as more and more economic activity happens in a digital format. This isn’t just about technology, it is a generational shift around the concepts of ownership & barter, a symptom of a more globalized economy and the evolution away from centralized third parties.

In this article I want to address why I think the liquid token market has been so weak this year and how flows and misinformation have shown an increasingly self-destructive nature. The main reason for the weakness is that, so far, crypto has been almost entirely a speculative phenomenon — and it’s this speculative phenomenon I want to examine here. The scams or “sh*tcoins”, popularity of leveraged trading, and opaque valuation are a near term risk and are causing significant wealth destruction within the ecosystem.

Given my background in developed markets, I have spent a lot of time thinking about and analyzing flows and how these affect prices. Given the illiquid nature of many cryptoassets and the power of price momentum to influence a largely retail investor base, flows are an extremely important price driver. Crypto flows are also readily available to analyse as transactions are recorded and public, so it’s a surprise and only a matter of time before more effort is focused here.

Defining the capital pool

Crypto has an uncanny ability to polarize opinion and we constantly see impassioned opinions offered from both sides and given rising awareness, many have now formed an opinion.


The “get rich quick” retail inflow in late 2017 was the largest capital inflow that crypto has ever seen, as the aggregated market cap grew by 300% in 3 months to January 6th this year! FOMO was a huge driver and unfortunately, most of the purchases are now underwater. Subsequently, crypto has seen four large drawdowns (Feb, March, May and August) in which investors who did not buy before the 2017 hype cycle have had a 2nd, 3rd and 4th chance to buy.

Early Adopters

This is an extremely controversial point for crypto. At its essence crypto self proclaims the virtues of the decentralization and the democratization of finance, but the economics benefits of most projects are highly centralized among early adopters and teams. This is where the “Ponzi” criticism is leveled. There are also positives that there are strong hands holding from a low cost base, but for me this is crypto’s biggest ideological contradiction. There is very little evidence to go on to determine flows here, though Charlie Lee’s public Litecoin liquidation in December was probably not the only one.

Institutional (traditional)

This capital faces a number of practical challenges to enter the space. Regulatory uncertainty, custody & insurance, data quality, legal & risk management frameworks, and liquidity are all obstacles. Many established investors have also gone on record to dismiss crypto as a ponzi scheme or overtly manipulated.

Institutional (crypto)

The main source of fresh inflows are new crypto focussed managers or fund of funds. While there have been some high profile launches recently this number is quite small compared to the liquid market cap. Many of these funds are early stage or equity focussed so the fiat inflow to the liquid token market is insignificant. SAFT investing may have been a net drag on the market this year as investments are made out of ETH or BTC.

From a price perspective (tech analysis or simple momentum), there has been little evidence to convert retail bears into bulls this year. It’s therefore unlikely that there is much new capital being added, and is in fact almost certainly being withdrawn. The issues facing institutional investors are being addressed and I would argue there has been progress from the regulatory side and significant progress from the custody side. That said, we are not yet in a place where they feel comfortable participating and the price momentum is far from encouraging.

Overall, it’s hard to see anything but a downward trend in marginal fiat added to crypto for 2018 and though it’s hard to quantify, I expect there were some large withdrawals. A successful ETF or institutional custody could change this, but this is unlikely to happen until Q4 at the earliest.

The leaks

Having determined that the capital pool available for liquid cryptoassets has not grown YTD, we can now look at the leaks that are weighing on prices.

Mining inflation and supply calendars

For a proof of work dominated ecosystem, this is the most persistent but well documented supply channel. The chart (from coinmetrics.io) shows $30m new coins minted daily, or $11b per year, from the six assets in the graph. This should not be a surprise as it’s an essential part of proof of work, but the flow will certainly accentuate a bear market. Miner sales are also difficult to predict, but would expect most are at least covering their costs, selling well over 50% on average.

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In terms of overall supply, experienced participants use 2050 market cap to normalise inflation between projects. One can see that these supply calendars vary significantly, and for example looking at Stellar (XLM), while the existing market cap is $4b, the 2050 market cap is $35b and only 18% of total supply has been issued. Though publicly available, these dilution schedules are not efficiently priced in and many do not appreciate the aggregate overhang in just looking at a projects circulating market cap.

In addition to this, many early stage investing is done with a lock up, so early investors are delivered tokens on a vesting schedule. Even with the significant drawdown from the highs in many off these projects the early investors are still in the money, so will likely use the liquidity when they get it. This can mean that at certain points in time large amounts of supply are unlocked onto the market.


Chris and I covered this topic in detail in April, but US & Japanese taxes on 2017 gains were likely a large drain on cryptoassets in Q1. European taxes are ongoing, but due to the calendar year (UK is April-April for example) the taxable profits will be smaller. It is an assumption, but one can expect that some of the tax payments were raised from crypto sales. The negative cash flow and brain damage of accounting for these taxes may also be a deterrent for retail investors going forward.

Exchanges — fees & leverage

Given the highly speculative nature of crypto, centralized exchanges have been the the most profitable businesses to date. Binance has been the poster child for some time, levying about $1b profit since inception late last year. It’s uncertain how much of the commission (taken in crypto, mostly BTC) is sold. From an exchange’s business risk perspective, revenue is positively correlated to crypto prices and activity, so it would be dangerous for an exchange to hodl the crypto. Binance’s profits run at about $2m a day and I would expect Bitmex’s are significantly larger. With over 500 crypto exchanges worldwide, its probable that exchange’s crypto sales outweigh the miner’s sales.

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Arthur Hayes (Bitmex CEO) has been very open and unapologetic about this fact. While he holds no crypto, he is happy to make wildly bullish price forecasts to fuel activity. Bitmex deserves some special attention here because it has become the largest BTC exchange by multiples (if you count the leveraged number as real volume) and it has twice “traded” over 1m BTC in daily volume. The growth in Bitmex volumes has accelerated recently attracting the “get rich quick” retail community.

As much as I respect it from a business perspective, it is negative for the ecosystem for three reasons: 1) The exchange charges fees on the leveraged BTC notional and this BTC is quickly sold, 2) retail trading a high vol asset on a highly leveraged basis (up to 100x!) is a scenario in which “the house always wins” in aggregate and 3) enables large short sellers to bully an already vulnerable retail market. Overall, this not only produces a large negative BTC sale flow, but contributes to trading losses and the negative wealth effect as inexperienced over levered traders add to the volatility.

ICOs and ETH

Despite crypto’s bear market, 2018 has already seen $12b raised by ICO. Investment in early stage SAFTs and equity in search of venture style returns is popular, and may be a drain on the liquid crypto market as investors look to reallocate rather than add to their crypto exposure. Much of these large ICOs (Tezos, Telegram, EOS) are behind us so this should be less of a drag going forward, but it will also reduce demand for ETH which was the largest beneficiary. The next big crypto raise on the calendar is Bitmain’s IPO in Q4 (not an ICO of course).

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ETH’s demand will now need to be met by utility, rather than as a crowdsale conduit. The decline in retail participation in these ICOs is unsurprising given the losses sustained over the last 6 months and it will be interesting to see how this trend continues. Many are now concerned that projects who have raised ETH through their ICOs will be forced to liquidate and this will create a systemic decline.

Demise of alt coins

2018 has been an introspective time for crypto investors. The speculative hype cycle resulted in large and unwarranted gains in many utility tokens. The price declines in most of these projects has been a capital drain from the ecosystem and the outflow has a reflexive impact on the market. The obvious conclusion is that tokens are not necessary for all use cases and many/most/all utility tokens have too high a velocity to accrue value. Meltem Demirors captured this well in her article “Drowning in Tokens” in March.

Many of these tokens have been given the unglamorous title of “sh*tcoins” and are currently gravitating towards $0. These are clearly a problem as investors have been taken advantage of in many cases and has had a negative effect on Main St.’s perception of crypto. It’s also noteworthy that correlations are running extremely high, indicative of an indiscriminate liquidation.

The hype cycle also enabled a number of high profile equity and (pre product!) token launches to raise funding at multi billion USD valuations, which may result in further losses down the road.

Moving forward

Overall, this 18 month period of boom and bust has been extremely challenging for cryptoassets with flows from many directions eroding market cap and soaking up declining demand. Given this is a decentralized retail dominated movement, speculative hype cycles are unavoidable.

This is still an early iteration of distributed ledger technology and the pain may have been necessary to weed out the weaker projects and ensure that future project’s tokens economics are constructed with greater care around velocity and valuation. To accrue value tokens will either need embody store of value qualities or the ability to create a network of a global scale. Big picture, its undeniable that there is public demand for decentralization and trustless P2P exchange.

From an investment perspective we (at Distributed Global) have been in a defensive period for some time, concentrating risks in assets we believe will be durable and have avoided the large market cap early stage offerings.

Coming from a traditional/established asset class, it’s very observable that not enough attention in crypto is paid to market forces. This makes sense as we are still in the early adoption phase which is dominated by those ‘buidling’ the technology, but once the door is opened to Mr Market, it can’t be shut. Flow, sentiment and reflexivity are interdependent forces in cryptoassets and their importance should not be dismissed as extreme price moves can have an enduring impact.

Ownership statistics, inflation rates, supply schedules and vesting schedules for early investors should be made more transparent for token valuation purposes. The sooner that we can move to a more standardized and open valuation framework the better. This rigor will increase transparency, reduce volatility, enable institutional capital to be invested and the consumer to be protected.

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