A reflection on 2022
This last year has been a tumultuous one, to say the least. Nonetheless, from a Fundamental Analysis perspective, we can easily make a case for constant progress, as cryptocurrency’s technology and governance keep improving regardless of the boom and bust cycle.
Historically some of the most important technologies and projects have been developed during bear markets; this year has been no exception to this phenomenon; away from the exuberance of the bull market, diamonds are being created under pressure:
Fundamental progress
Fundamental breakthroughs often go unnoticed, only appreciated years after their invention. The same is true for cryptocurrency. 2022 was filled with huge leaps in capability, preparing us to continue to take the world by storm as this cycle inevitably reverses. Our belief in cryptocurrency is founded on the fundamental merits of this technology. Requiring a token of value for existing in a permissionless and decentralized state: The most valuable quality of cryptocurrency, enabling massive utility with tangible and measurable economic benefits by removing middlemen. This is why Cyber Capital focuses on Fundamental Analysis and value investing for a long-term perspective on this market. Reading whitepapers, not price charts. This puts us in a unique position to shed additional light on some of the most exciting developments in 2022:
The Merge
The Merge has proven to the entire world that Ethereum’s (ETH) new security and economic model works! Something that we at Cyber Capital now consider to be the new standard that all cryptocurrencies should from now onwards follow, strong words that should not be taken lightly.
The Merge has solved the long-term security dilemma of BTC while simultaneously making any asset using this model far more scarce and secure, thereby solving one of the biggest existential problems in the entire blockchain design space!
This is achieved by combining a tail emission (supply inflation) with fee burning. Introduced with EIP1559 (Ethereum Improvement Proposal), which ensures that the Ethereum blockchain remains secure during periods of low and high economic activity while also making the ETH token far more scarce based on the underlying usage of the ETH token. The best of both worlds, so to speak. Striking a perfect balance between security and scarcity. This is a problem some major blockchains, such as BTC, are still facing and cannot solve, creating a clear divide between winners and losers.
Proposer Builder Separation
A less well-known but critically important development is PBS (Proposer Builder Separation). Currently exclusively developed within Ethereum & Polkadot, this is another technology we will expect all high-quality cryptocurrencies to adopt in the future. PBS makes blockchains far more censorship-resistant by separating the roles of validation & TX ordering into separate entities. This shift can be compared to the historical separation of miners and nodes in the early days of Bitcoin history, as our ecosystem’s roles become increasingly specialized and efficient in that process.
This is important because it removes the compliance demands on validators by separating this out into a new class of entity. Solving the effect we have most prominently witnessed in the form of OFAC regulations forcing ETH validators to create compliant blocks. Even though this has not led to any censorship, a significant strengthening of censorship resistance is still very welcome in the face of that potential risk. As censorship resistance is a critical aspect of cryptocurrency’s value proposition.
It is also important to consider that this vulnerability is inherently present in all cryptocurrencies. Ethereum was just the first where this effect was noticed due to the disproportionately large amount of economic activity on that blockchain. Explaining why this critical breakthrough is currently being exclusively developed on Ethereum and almost nowhere else.
Execution Sharding
We have seen a lot of progress in on-chain scaling, as cryptocurrencies such as NEAR & EGLD are making considerable strides in the development of execution sharding. This a technology we consider absolutely vital for the development and further mass adoption of cryptocurrency in the wider world moving forward. As it allows for horizontal scalability allowing cryptocurrencies to scale to meet demand without it being a case of it becoming an exponentially harder problem to solve over time. Sharding allows blockchains to add more shards as usage increases instead of hitting the wall we are now all too familiar with.
Enshrined roll-ups
Even though we are vehement supporters of on-chain monolithic scaling such as the before-mentioned sharding. The development of roll-ups in the Ethereum ecosystem is still incredibly significant, though maybe not for the reason most people think.
As an advocate of monolithic scaling, we do not entirely agree with the direction that ETH is taking in terms of its scaling roadmap scaling; relying purely on others building out an open ecosystem of L2 solutions. This, in our view, will inevitably lead to a terrible UX and excessive fragmentation as each individual L2 has different trust and security trade-offs. This is why we will continue to advocate that ETH pivots back to its original plans of execution sharding.
However, the technology of roll-ups themselves is extremely compelling from the monolithic scaling perspective; what is required is an “enshrining” of specific L2s by the L1. This would transform a roll-up-centric approach from modular to monolithic. As using the technology of roll-ups as a type of sharded scaling approach makes a lot more sense, as “enshrining” roll-ups in this way solves the UX and fragmentation issues of the L2 modular approach.
I do hope that ETH will be able to pivot and adopt this approach instead of the course it is currently on in the absence of that pivot. We do at least have blockchains such as XTZ, which are piggybacking off ETH’s extensive research in this area and are enshrining their roll-ups natively into their L1, which is an extremely exciting development, to say the least. This form of scaling has a comparable number of trade-offs compared to straight monolithic execution sharding, unlike the roll-up centric modular approach to scaling, which we are so critical of.
Lessons learned in 2022
Cryptocurrency is a still-running social experiment, much like how most countries are still-running social experiments. We learn as much from their failure as we do from their success. Cyber Capital is one of the oldest FA-based cryptocurrency funds in the entire world, and we still continue to learn from our mistakes and those of the broader ecosystem so that we can continue to grow.
LUNA collapse
LUNA, in particular, was a hard lesson for Cyber Capital; we failed to predict that collapse. Even if we were aware of the risks, we did not expect it to fall so dramatically so fast. By the time the collapse had happened, we had already sold the vast majority of our initial position, making it a very profitable trade for the Cyber Capital fund. However, the remaining position in LUNA was not insignificant, and in retrospect, we should have exited that as well.
Diversifying and good risk management saved us from our failure to predict this collapse. Moving forward, we have made several changes to our research process to avoid such oversights from occurring again, specifically increasing the overlap of specialization in specific areas of research. Which will increase our ability to spot such systemic failures before they happen.
Why Luna was different
It is important to point out that the LUNA collapse was a systemic failure or a failed experiment in decentralization if you will. Which makes it distinct from other failures we have seen this year, such as FTX, 3AC, and Celcius. Which predominantly came from misplaced trust in centralized organizations. Ironically this is the problem that cryptocurrency was specifically invented to solve:
The failure of centralization (FTX, 3AC, Celsius)
We should not view failures such as FTX, 3AC, and Celcius as failures that are endemic to cryptocurrency but instead as failures that are endemic to centralized systems. This is why we have the financial regulation that we do within our world; most of these rules come from a long history of jurisprudence and learning the hard way from experience over more than a century of financial history. We see the same failures occurring over such centralized “cryptocurrency” companies exactly because they are fundamentally not that different from the traditional financial system, except for the lack of oversight and regulation.
True cryptocurrency-based financial systems do not require such oversight and regulation as the protections against such fraud are inherently built into these systems. This is why it is so important that we create a strong distinction between centralized “cryptocurrency” companies and truly decentralized financial systems, as decentralized finance is the solution to the woes of centralized financial institutions, like the failures we witnessed again in the failure of organizations such as FTX, 3AC, and Celcius.
Security at Cyber Capital
Ultimately, due to the strict risk management policies of Cyber Capital, we did not fall victim to any of these centralized failures ourselves. We have been incredibly careful in selecting our custody partners through the application of solid Fundamental Analysis. We use Kraken as our primary on and off-ramp, which has maintained a blockchain-based proof of reserves system for many years. While the vast majority of our assets now reside on BitGo, who takes custody extremely seriously, employing solid proof of reserves systems combined with the highest reputation. We are confident that with such partners, we will not fall victim to such failures as these two partners are in an entirely different class of custody compared to the companies involved in these recent failures. Both in terms of proof of reserves, security & regulatory oversight.
History of Cyber Capital security
When the company was first founded in 2016, we did extensive research into potential custodians; with the help of world-class white hat hackers, we determined that the commercial solutions at that time were insufficient to meet our needs, both in terms of security and asset selections. This is why we embarked on the arduous task of designing our own self-custody systems, from secure rooms to cryptographic rituals & sharded key setups involving multiple parties storing keys in separate, underground vaults.
This is because we have always seen security as a central pillar of Cyber Capital, and it is how we have been able to avoid all of the major pitfalls that brought down the numerous other funds from that time. To this day, we maintain our world-class security protocols as the ecosystem continues to mature around us. We found a partner truly deserving of our trust; BitGo. Who Allows us to specialize more in Fundamental Analysis while our new partner continues building out the Fort Knox of cryptocurrency. This shift was inevitable as the ecosystem matured; a larger and more specialized party will always do a better job of security, just like how Cyber Capital does a better job at Fundamental Analysis.
Cyber Capital price targets
We have also embarked on an internal project to create five-year price targets starting with the top fifty cryptocurrencies in market capitalization. We are doing this in the tradition of value investing and will release these targets first to our investors and later to the broader public, demonstrating how cryptocurrency can be evaluated similarly to traditional assets.
We do not want this to be a case of dumb “price talk” but instead serve as an example of sophisticated fundamental analysis, which we hope will serve to further add to the respectability of this asset class for traditional investors.
Our focus on these price targets should not come as a surprise; as always, we are focused on utility and identifying value flows from this utility (in the form of fees) back to the investors (token holders) from the users. We believe now more than ever that cryptocurrency possesses immense tangible economic benefits for the entire world.
Cyber Capital’s future
The company is in good shape heading into the new year, with the experience of several bear markets behind us. We can remain consistent and continue offering our services regardless of what happens in the market. Putting us in a position to continue to build, develop and refine.
We are also building a new website that will help promote our unique message of due diligence and deep research into cryptocurrency. Despite but also thanks to the negative price developments in 2022, we continue to see new clients coming in, including fund of funds and family offices that are “buying the dip.”
This shows that even amidst all of this drama, the cryptocurrency ecosystem is continuing to grow in critically important areas, and sophisticated investors recognize this. As institutional investment becomes more confident over time: Cyber Capital is perfectly positioned to provide a vehicle for such investment as we continue to take on a more active role in research and education.
Looking forward to 2023
Progress is not going to slow down and is likely to only accelerate in the new year. As cryptocurrency researchers, we understand that we are still just scratching the surface of the potential we are gradually unlocking in this field. I am sure that just like the internet in 1996, cryptocurrency will continue to exceed the imaginations of what is possible.
What we can already see was enough reason to dedicate most of our lives to this movement while it continues to exceed our expectations in sometimes unexpected ways. Of course, there are pitfalls, unexpected problems, and failed experiments. But that is part of what makes it such an exciting movement to be a part of. In that sense, we are all blessed to be a part of making this history.
None of this would have been possible without the support of our investors, who, through the highs and lows, have always believed in us. For this, we are eternally grateful and wish that your new year will also be filled with happiness and meaning.
About the Author
Justin Bons is the founder and CIO of Cyber Capital; Justin discovered crypto assets in 2013 and immersed himself in this new technology. This led him to actively invest and research cryptocurrencies full-time in 2014 as a generalist with a specialization in the politics and decentralized governance of cryptocurrencies. Over time, with a critical mindset toward evaluating cryptocurrencies including, Justin has developed his own theories on blockchain governance as a major factor to the competitive evolution of cryptocurrencies. Through writing articles, giving lectures, and regularly participating in public debates surrounding cryptocurrencies, he gains insights to further hone the fundamental analysis-based investment strategy that remains his primary focus.
About Cyber Capital
Cyber Capital, Europe’s oldest cryptocurrency investment fund, is a fund manager that specializes in providing exposure to the crypto-asset markets as an alternative asset class. Cyber Capital is fully registered by the Dutch Authority for the Financial Markets under the AIFMD-light regime and the Dutch Central Bank.
