Announcing The Arrington ALGO Growth Fund

We are big fans of Algorand. We first invested in their private rounds years ago and have accumulated additional ALGO since. And over the years we have stayed close to founder (and Turing Award recipient) Silivo Micali, CEO Steve Kokinos, COO Sean Ford and VP Marketing Keli Callaghan. This is one of the best all around teams in crypto. Professional, zero hype, all signal.

In 2019 we published a research report on the Algorand product and burgeoning ecosystem, titled The Monetary Experiment: Algorand. In that report, we outlined how we see Algorand, and gave a glimpse of what the project could become with hard work and just a little luck. They have exceeded our expectations, and have grown in ways we did not foresee (it’s time to update that research).

Today I’m happy to announce that we are partnering with Algorand for the long term. We are launching a dedicated $100 million fund to invest in the Algorand ecosystem and other promising crypto products. The fund is called the Arrington ALGO Growth Fund and will begin deploying capital soon.

You can read the news on this:

Coindesk: Arrington Capital Launches $100M Algorand Ecosystem Fund

The Press Release

CoinTelegraph: Arrington Capital to back Algorand projects with $100M growth fund

We now run two publicly announced funds – Arrington XRP Capital and Arrington Algo Growth Fund. Arrington XRP Capital was formed in 2017. We continue to grow and manage that fund, and work with the dozens of companies and protocols that we have funded along the way. Now we will also manage this new ALGO fund, and I’m quite sure that in a few years time, I will be able to say the same things about this fund – amazing things will come from our investments in founders.

Thinking back to those days, none of us really had any idea of the roller coaster ride we were on. Crypto has its ups and downs, but the amount of founder passion for building, deploying and growing new infrastructure and apps is sort of stunning. And that’s coming from someone who’s been building and investing in Silicon Valley since the mid 90s. Crypto moves faster, a lot faster, than the old tech world. Things you learn become redundant almost before you’ve mastered them. I consider that a feature, not a bug.

It’s survival of the fittest, and ALGO, along with XRP, have proven that they are here to stay. I don’t know exactly what’s coming next, but I feel comfortable that ALGO will be a big part of it. Thank you, Algorand, for choosing us to be your partners.

Here’s to the Pirates. Here’s to ALGO. Let’s build.

The Space Race For Open Markets: Vega

Are modern markets open markets? Markets are part of our lives in unimaginable ways yet have never been more mysterious. Today, trading is a game of warring algos and enigmatic finance, addicted to obfuscating collateral and hiding system risk. Crypto promised to get us a step closer to open markets, gifting us perfect and incorruptible collateral as well as the power to verify everything without a ratings agency or bank.

Yet the mysteries of market structure linger, and are in some new ways worse than TradFi. Nobody can contest the pristineness of crypto collateral, but crypto market infrastructure is addicted to its own redlining – from the existential CeFi cascade to HFT’s adversarial cousin, MEV.

Vega is the world’s first open protocol for creating, maintaining and aligning markets. It is a decentralized launchpad for all trading. In some sense, Vega concepts are more than a subset of DeFi – they represent an evolution in the history of markets. If Vega succeeds, it will become a modular galaxy for everything from market creation to risk modeling and incentive alignment. It marries active and passive liquidity, encourages risk model experimentation and ultimately solves the derivatives trilemma.

A true Blue Ocean opportunity, Vega is the multi-verse of markets, dragging humanity out of an adversarial war of all and leading us to a new space race for open liquidity.

DOWNLOAD OR VIEW THE REPORT HERE.

Buy My House

In 2017 I bought a condo apartment in Kiev, Ukraine. This wasn’t a normal purchase – I used the then-nascent Propy protocol to make the purchase and have the property title recorded, for the first time ever, to a blockchain. I also paid for the condo in Ether. These days, property title transfers on Propy are an everyday occurrence. The Wall Street Journal, Newsweek and others covered the news.

Today Propy announced a new first – that same home, which is owned by a U.S. domiciled LLC, is being auctioned and sold as a NFT. The auction begins on June 8, 2021 (a couple of weeks from now).

The auction information page is here.

TechCrunch: Blockchain startup Propy plans first-ever auction of a real apartment as a collectible NFT

Coindesk: TechCrunch Founder’s Apartment to Be Sold as NFT

This isn’t a gimmick – but it is a proof of concept. Ownership of the NFT will allow that owner to claim ownership of the property via the LLC.

Why is this interesting? This NFT, backed by real world property, has value. NFTs are already being inserted into DeFi protocols, allowing, for example, people to borrow against the value of the NFT. In the real world, we can use mortgages. They take months, require the approval of a middleman, and are extremely difficult to get in some countries, particularly if you aren’t a resident of that country. With DeFi, none of that matters.

From the Coindesk article: “We are increasingly excited about the role of NFTs in DeFi,” Arrington said. “With homes and really anything in the real world being tokenized, you can plug that physical item into DeFi, assuming the legal niceties are ironed out, and that’s fascinating.”

I made similar comments to TechCrunch:

Arrington added: “Coming at this from a crypto angle, we’ve seen what happens how DeFi gets plugged into credit markets. If I have an NFT or any DeFi asset I can then borrow against it, without a middleman. Right now, if I have a real piece of real estate, there is no way for me to borrow against it, without a middleman, because I have to go through a bank and get a mortgage or whatever. And it’s also the friction, all of the costs in terms of speed and how long it takes.

“If we can find a way to plug real estate and other real-world assets into DeFi, I think that the amount of credit that can be created around that is in the trillions, eventually. And so I think that has to happen. The questions around this are legal and regulatory… The legal stuff around this is tough, and so Propy has done a lot of work with that. But if they do, I think that the idea of an NFT representation of a real-world asset purely from the point of view of ease of trade and ease of access to credit markets is a big idea.”

If you are interested in participating, details are here.

We’re Hiring! Arrington XRP Capital Hiring Analyst and Developer Roles

Arrington XRP Capital, founded in late 2017, is a crypto-focused hedge fund with a multi-pronged investment strategy. We invest in private companies with new products and protocols, and we employ a variety of trading strategies for the liquid part of our portfolio. We are based in the United States and have additional offices in Asia. We are aggressive investors, fight hard for our companies and trade to win. We are expanding our team to include two new positions:

(1) Investment Analyst: https://pompcryptojobs.com/job/2107/investment-analyst/

(2) Software Engineer: https://pompcryptojobs.com/job/2404/software-engineer/

The software engineer role is ideally Asia based, but we will happily look at all qualified candidates. Our analysts can live anywhere as long as you are willing to travel to the home office at least a couple of times per year. If you think you might fit the roles above or know anyone who could, please send an email to careers@arringtonxrpcapital.com. We look forward to hearing from you!

MobileCoin Cracks The Privacy Code: Marrying Crypto with P2P Messaging

Signal and MobileCoin join forces.

News today on our portfolio company MobileCoin: Read Signal’s blog post here and the Wired article here.

In the last ten years, two parallel trends have emerged: Mobile P2P and group messaging, and crypto. While many have tried to introduce crypto-based P2P and e-commerce payments to popular messaging apps, nobody has cracked the code.

The marriage between mobile P2P and crypto is a powerful proposition: Bring together global communication with global payments. What could arise from this union? Fast P2P payments. Secure e-commerce. Fast & reasonably priced remittances. One possibility is realizing the crypto trope of “banking the unbanked”: In places where financial systems are weak but social messaging apps are mainstream, crypto-based P2P has the potential to create sudden and rapid financial connectivity.

We backed MobileCoin as investors because MobileCoin is the first real attempt to merge these two worlds. The protocol’s unique focus on privacy and transaction speed matches the instantaneous delivery model for popular apps worldwide. Mobilecoin will live inside these mainstream messaging apps, starting with the most cryptographically secure: Signal. As the first massively popular mobile messaging app to include MobileCoin for P2P and e-commerce payments, Signal is the best possible validation of MobileCoin’s privacy, security, and speed, just as Signal set the bar for end-to-end encryption within mobile messaging apps prior.

MobileCoin makes it easy for messaging apps to offer digital payments without compromising user privacy. By integrating a MobileCoin wallet, a mobile app can send transactions without maintaining a copy of the blockchain or sharing keys with a remote server. Transactions are final within just a few seconds, and all transactions are kept private.

MobileCoin takes a defense-in-depth approach to user privacy. This begins with established technologies like ring signatures, one-time addresses, and RingCT. They’ve added a suite of cutting-edge privacy tech on top of this existing foundation, from secure enclaves and information management designed to delete the final traces of Cryptonote on the blockchain. In MobileCoin, even if malicious attackers manage to compromise a node, they can never access user keys or data.

With this privacy layer at the heart of the protocol, MobileCoin also introduces microservices designed to enable mobile usage. This starts with MobileCoin Fog, a service run by apps to help find user transactions, check balances, and build new transactions, all without downloading the ledger (a prohibitively expensive task for mobile devices).

This is where cryptography gives users a feeling of security that no existing messaging app can provide: While Fog will be run by app providers, user privacy is entrusted to MobileCoin technology, not to the service provider. In other words, users don’t need to trust the company; they instead put their trust into the integrity of the MobileCoin Foundation’s open-source software.

We believe MobileCoin is the beginning of crypto’s marriage with mobile messaging apps. We hope to see far more experiments in the next year, as crypto marches us into a new era where users sleep at night with their faith in cryptography.


Toward Credibly Neutral Derivatives: Announcing Our Investment Into Vega

Like a prison tattoo, March 12 2020 is branded into every crypto trader’s mind. Nobody can forget the terror of that fated candle. No trader will ever escape the disbelief of watching a derivatives market that developed over years break within minutes.

Crypto desperately needs credibly neutral derivatives. A year from this PTSD-inducing moment of market history and not much has changed. Put aside the fact that we still don’t know what happened on that day the majority of derivatives volume is still executed off-chain in the opaque land of the centralized exchange. 

The market needs decentralized derivatives that can match the centralized experience, a place where traders can take on leverage, move capital efficiently and hedge risk without worrying about something breaking or someone squeezing them behind a curtain.

We are thrilled to announce our investment into Vega Protocol, which we believe will be the most important player in this emerging world of decentralized derivatives. We are excited to co-lead the round with Cumberland DRW, one of our closest trading partners. The round brings together a strong group of trading firms and DeFi investors including ParaFi Capital, Coinbase Ventures, CMT Digital, Signum Capital, DeFi Alliance, CMS Holdings, Three Commas, SevenX Ventures, GSR, ZeePrime Capital and more.

Vega marries the ingenuity of DeFi with the hard-won wisdom of order books. It unites the AMM with the CLOB, breaking the dichotomy between active and passive liquidity. In Vega, market makers are owner-operators, incentivized to seed markets; while passive LPs provide liquidity to their strategies. The team complements this novel economic design with a heavy focus on risk management and capital efficiency, pioneering solutions to challenges like frontrunning, multi-chain collateral and scalability. 

A snapshot of the Vega exchange interface.

We are stoked to get behind a team of world-class entrepreneurs, engineers, academics and traders and will publish more on our investment in the coming months.

Toward the Wild West Net!

TechCrunch: https://techcrunch.com/2021/03/18/vega-raises-5m-to-give-anyone-the-ability-to-launch-a-derivatives-market/
Crunchbase: https://news.crunchbase.com/news/vega-banks-5m-to-create-derivatives-trading-protocol/
The Block: https://www.theblockcrypto.com/linked/98742/defi-derivatives-protocol-vega-5-million-coinbase-ventures-others

Vega Roadmap: https://blog.vega.xyz/announcing-the-vega-2021-roadmap-4c3c0d80efc0
Vega TestNet: https://testnet.vega.trading/

Twitter: https://twitter.com/vegaprotocol
Telegram: https://t.me/vegacommunity
Discord: https://discord.com/invite/ZNEMCYd

Resurrecting The Saver: Walking Tall With Anchor

The DeFi Standard For Crypto-Native Fixed Income

The macro storm of quantitative easing and record low interest rates has depressed yields in traditional finance beyond measure. Anchor is the first protocol in Decentralized Finance (DeFi) designed to capture the growth of the cryptocurrency ecosystem to offer savers fixed income yield.

The Anchor Protocol is a money market built on the Terra blockchain, leveraging the only stream of unlevered, reliable yield in cryptocurrency: Proof-of-Stake (PoS) block rewards. Anchor synthesises DeFi yield with PoS rewards, creating a fundamentally new economic primitive – the Anchor Rate – providing lenders a stable rate of return. In time, we believe the Anchor Rate will become the reference rate for DeFi investment – a Decentralized Funds Rate – and eventually the gold standard for passive income on the blockchain.

Anchor launches with LUNA as the initial primary collateral asset for borrowers, with a roadmap to integrate other PoS assets including DOT, ATOM and SOL, and decentralize ownership of the ANC governance token through a liquidity mining program.

DOWNLOAD OR VIEW THE REPORT HERE.

Arrington XRP Capital Joins The DeFi Alliance

We are proud to announce Arrington XRP Capital has joined the DeFi Alliance. The DeFi Alliance is an incubator launched by a notable group of Chicago-based trading firms in early 2020, including CMT Digital, Volt Capital, Jump Capital, and DRW.

Today, the Alliance has evolved into the primary hub for DeFi startup incubation and mentoring. When I founded TechCrunch, I witnessed first hand the rapid rise and popularity of Y Combinator, and the immense value that these kinds of organizations provide to startups. We hope the DeFi Alliance grows to have a similar impact.

At Arrington XRP Capital, we have been investing behind the scenes with projects in the DeFi Alliance program, and welcome the Alliance’s support as our portfolio companies go to market. Stay tuned.

The Standard For Synthetic Assets: Mirror

The emerging world of synthetic assets is one of DeFi’s most powerful bridges into traditional financial markets. With the backdrop of macro change accelerated by COVID-19, we argue that synthetic assets can create a gravitational pull on capital, as investor appetite moves deeper into the risk spectrum. Notably, we examine the growing international demand for US equities and the challenges faced by investors in the existing e-brokerage model.

This context leads us into the primary focus of the report, Mirror: a new protocol for synthetic asset creation. Mirror synthesizes the primary innovations of DeFi – including Automated Market Makers (AMMs), oracles, stablecoins and liquidity mining – to enable permissionless minting and trading of traditional assets. Mirror is uniquely positioned as a capital efficient system using stablecoins, reducing collateralization requirements to only 150%, a vast improvement over comparable systems which are typically collateralized upwards of 300-400%.

Mirror will launch with support for a select number of US equities, and will decentralize ownership of its native governance token MIR via a community-first distribution strategy.

DOWNLOAD OR VIEW THE REPORT HERE.

Bitcoin Risk and The Once-In-Cycle Trade

Contributions From: Michael Arrington, Ninos Mansor, Ron Palmeri, Heather Harde

The contents of this report are the opinion of Arrington XRP Capital and do not constitute financial advice. We cannot guarantee the accuracy and completeness of the information contained herein.

DOWNLOAD THE REPORT HERE.

Risk management frameworks are rare in the world of Bitcoin. For overexposed market participants, the asset’s volatility invites extremes in investor psychology at a pace unlike any other market. Somehow, Bitcoin continues to dance between two distinct worlds: today on the brink of a death spiral and tomorrow the future of currency destined for world reserve status.

Arguments for Bitcoin exposure stress its long run outperformance, yet often fail to address the concerns of the non crypto-native investor. Since inception, Bitcoin has outperformed virtually every other asset class. This outperformance is undeniable, point-blank. Still, traditional portfolio managers stick to their skeptical guns, cautious of a one-sided focus on returns when the answer to double digit drawdown is HODL.

In this piece, we attempt to build a framework for risk-adjusted Bitcoin investing. Our goal is to filter out the noise of investor psychology and find the nuances of Bitcoin risk and reward at different stages of the macro cycle. We do this through a simple rolling Sharpe Ratio that analyzes Bitcoin risk-adjusted returns over time.

Ultimately, we conclude that timing matters: while the individual investor may be satisfied with long-run outperformance, Bitcoin’s macro cycles urge further nuance. We find that historically, the trade following the Halving represented the most attractive risk-adjusted opportunity. As the next Halving is just around the corner, we briefly speculate on why this was the case.

Looking beyond returns: the Sharpe Ratio

For the professional money manager, Bitcoin’s systematic risks are daunting. How can a conservative PM embrace Bitcoin as part of a diversified portfolio given the frequency and severity of its drawdowns? Investors with personal savings and unconstrained time horizons seek comfort in the story of Bitcoin’s long-run outperformance. This is not enough for newcomers with fiduciary responsibility. For the traditional PM, every market risk represents redemption, career and reputational risk; and for this reason, we need a more serious understanding of Bitcoin’s relationship with drawdown.

Even if over 90% of all Bitcoin days are profitable, individual paths to profitability range from months (buying December 2018’s bottom) to years (buying the 2014 global top). This illustrates the concept of path dependence: while long term Bitcoin returns are disproportionately skewed to the upside, timing matters. Much like a call option, Bitcoin risk-adjusted returns rapidly decay or improve depending on market timing.

We look to the Sharpe Ratio to analyse the path dependence of Bitcoin returns. The Sharpe Ratio is a simple yet powerful metric, measuring the ratio of excess returns to excess return volatility:

If we view volatility as a placeholder for risk, the Sharpe Ratio measures how much reward is generated per unit risk. A highly volatile portfolio would thus have a low Sharpe Ratio if returns were not extraordinary, and vice versa. A Sharpe Ratio of 1 is considered the baseline standard for investment performance.

Animal spirits, why a long-run Sharpe Ratio doesn’t cut it

Over any rolling four-year period, Bitcoin’s Sharpe Ratio historically outperformed virtually every other asset class. If an investor had held for at least four years during any point in Bitcoin’s history, they would have demonstrated superior risk-adjusted returns relative to almost all other investment opportunities.

This still falls short for most non crypto-native investors. Thinking about Bitcoin’s Sharpe Ratio over four year intervals may be correct in theory, but it is limited in practice. In reality, markets are governed by animal spirits – the swings of fear and greed – and most investors are more likely to enter the market after periods of non-linear growth. Many new entrants are thus destined to enter mid to late-cycle, fated to experience grueling drawdowns after buying local or even global highs. The assumption that investors can and will HODL underwater positions for multiple years is unfeasible, especially with the prospect of underperformance relative to other asset classes. The financial and emotional burden of drawdown will likely lead many to capitulate their positions before they are able to realise an entire four year cycle.

Given the path dependence of returns, the long term Sharpe Ratio fails to adequately capture Bitcoin risk.

The one year forward looking Sharpe Ratio

Instead of four-year intervals, we search for the optimal entry within a macro cycle. To do this, we employ a one year forward looking Sharpe Ratio.

Figure 1 calculates the Bitcoin Sharpe Ratio at any point in time looking forward one year. This metric is inherently forward looking, describing the Sharpe Ratio at any point in time based on future data. It is thus a lagging, descriptive (rather than predictive) variable. We select the one year period as it is approximately the time required to capture the brunt of a Bitcoin bull or bear market.

Figure 1: Bitcoin’s one year forward looking Sharpe Ratio.

Oscillating around a value of 1, the one year forward looking Sharpe Ratio peaks at the beginning of Bitcoin’s price inception, the 2012 Halving and several months following the 2016 Halving. After these three periods, we find an interesting dynamic at play: aggressive Sharpe Ratio decay from a high of 3 (spectacular) to a low of −1 (abysmal).

Further, examining the 1-4 year forward looking Sharpe Ratio for Bitcoin from the Halvings (see Table 1), we find a similar effect:

  • Exposure to Bitcoin for 1 year after the 2012 Halving nets a Sharpe Ratio of over 3, and holding for an additional 3 years degrades this to approximately 1. From a spectacular investment to a “good” investment.
  • Exposure to Bitcoin for 1 year after the 2016 Halving nets a Sharpe Ratio of over 2, and holding for an additional 3 years degrades this to less than 1. From a great investment to a sub-standard investment.
Table 1: Forward looking Sharpe Ratio at 1-4 year intervals following the Halvings.

How important is market timing when managing Bitcoin risk?

Analysing Sharpe Ratio decay gives us a powerful risk framework. Not all Bitcoin investments are made equal: Bitcoin acquired at different points in a macro cycle should be treated differently as part of a diversified portfolio. To illustrate this concept, consider the idea of “time-to-profitability” (TTP) demonstrated in Figure 2:

  • Bitcoin acquired at the 2011 high has a ≈2 year TTP
  • Bitcoin acquired at the late 2013 high has a ≈3 year TTP
  • Bitcoin acquired at the 2017 high is yet to achieve profitability.
Figure 2: Bitcoin’s days to profitability.

Not only were investors who purchased Bitcoin at these highs faced with absolute drawdown, they were also faced with relative underperformance against worldwide equity indices (and possibly other asset classes). Bitcoin can be an excellent tool within a diversified portfolio, but most professional investors cannot simply buy and HODL for extremely long periods of time if they are likely to face both absolute and relative underperformance.

The legacy wisdom of financial markets sometimes cautions investors against market timing, captured by the dominance of indexing strategies and the underwhelming reputation of the modern hedge fund. Whatever the merits of this argument in traditional markets, we find a fundamentally different heuristic exists for Bitcoin.

This doesn’t mean that other strategies like buy and HODL are not valid. It is simply to say that for investors focused on managing risk, timing matters.

A once-in-cycle trade, but don’t forget to expect the unexpected

The above analysis leads us to conclude that, historically, the best risk-adjusted entry existed at or within several months following a Bitcoin Halving. This heuristic is based on historical data and is not a trading guideline. The market may prove our analysis entirely wrong for future Halvings. Our goal is to build frameworks based on history but there are no certainties in markets, least of all in Bitcoin. We present this Halving idea with its obvious limitations in mind.

While the crypto market’s focus on long-run outperformance might convince some pioneering and brave money managers, it won’t convince the drawdown-conscious. However, Bitcoin doesn’t need to be perfect to make its way into the world of traditional investing. Even today, the argument shouldn’t be to HODL and hope, but to think about Bitcoin with a nuanced vision for risk. This post-Halving window, when combined with hedging practices like protective puts or a managed stop loss, help build a case that, on a risk-adjusted basis, Bitcoin may outperform other asset classes.

If Bitcoin springs to new highs within the next several years, the reality is that investors will eventually demand exposure. Ironically, as these requests pile in mid to late-cycle, money managers will be faced with a dicey dilemma: remain on zero as Bitcoin makes weekly headlines or enter a drawdown-prone asset at local or absolute highs. Rather than enter as greed floods the market, the post-Halving window may grant investors an early buffer to incorporate Bitcoin into their broader macro strategy.

Are there fundamentals that explain this finding?

Why does the Halving trade demonstrate superior risk-adjusted returns? We can only speculate, but PlanB’s Stock-To-Flow model provides some insight. If we slightly modify PlanB’s model to calculate “flow” as a rolling sum of new Bitcoin minted over the past year (as opposed to the past day), as per Figure 3, we find that the market tops as the S2F ratio begins to level off. This makes intuitive sense: assuming demand stays constant, the supply reduction means there is less float for buyers to absorb, shifting prices upwards over time until a new equilibrium is reached.

This could also explain why, in addition to the two Halvings, the early years following Bitcoin’s inception also represented a very strong risk-adjusted entry. With a low initial float (starting from S = 0 at launch), the 1-year S2F ratio grew at a rate comparable to the post-Halving windows.

We speculate that these periods of rising S2F following the Halving are the only times where there is a fundamental driver (outside of speculative demand) for Bitcoin price: a real shift in the supply and demand curve. Thus, it is possible that our conclusion about the Halving trade is not random, but a result of S2F fundamentals.

Figure 3: Bitcoin Stock-To-(1-Year)-Flow

Conclusion

In this piece, we have shown that long term metrics such as the four year Sharpe Ratio are inadequate at capturing the real risks of Bitcoin investing. Extreme swings of the market result in rapid Sharpe Ratio decay and make timing critical for the drawdown-conscious investor. The post-Halving window may represent a rare time to add high expectancy, low-downside Bitcoin exposure. We hope that our analysis builds a case that the Halving is not merely a speculative catalyst, but a fundamental macro driver that may present crypto-natives and newcomers alike with a powerful risk-adjusted opportunity.