Updated: Nov 24, 2022
The FTX blow-up and its aftermath are still unfolding so things could be fluid, but enough time has passed and info revealed such that we feel comfortable summarizing what this means for our portfolio, our investment processes, and our forward-looking views on crypto markets.
We will refrain from pontifications of what should have happened and what should be happening going forward with regard to the FTX debacle. Let's leave that to the court and newspapers. Our role as investors is to be market mechanics, not crypto moralists (though the moral lessons shall be quite apparent in this case).
1. Factual Update
Maverick was not affected at all by the FTX blow-up.
No counter-party exposure: We have no counter-party risk exposure to FTX, and generally don't park our assets on a singular platform over a long period of time for any substantial amount.
No portfolio exposure:
We had been sitting in all cash prior to and throughout the incident, as a result of our proprietary indicators flagging bearish macro/liquidity conditions, unfavorable crypto market regime, and calling for cautious positioning (details below).
We chose not to put on net shorts throughout because the highly idiosyncratic, event/news-driven short setups aren't where our edge is. Our time horizon is medium to long-term, and the factors we understand the best are crypto-asset fundamentals, macro conditions, and structural flows. We will gladly let legendary news traders and discretionary "big shorts" duel this one out.
Specific to FTX/Alameda-related assets:
We researched the FTT token as part of our examination of CEX tokens and found a couple of red flags. Overall, we deemed it unfavorable vs. BNB and other alternatives (more details below).
In 1H2022, we were offered an opportunity to invest in secondary FTX equity twice, at a slightly discounted valuation vs. prior venture rounds, but refused out of caution of its overhyped valuation vs. competitors (Coinbase, Binance).
We are long-term constructive on Solana, but have zero exposure to it prior to the event or at the moment. May accumulate positions going forward, contingent upon renewed organic developer activities (more details below).
We have no exposure to any other ecosystem assets related to the FTX/Alameda complex.
Whenever this type of tail event transpires, it's always a good opportunity to look beyond the investment results per se, and deeply reflect on the system (”the machine”) that governs how we invest and manage risk. These cases don't come often and are therefore rare stress tests to compoundable investment frameworks and risk management processes.
2. Transparency into Our Investment Process
Our investment framework has three crucial pillars:
Fundamental thesis formation
Macro, portfolio risk management
We only bet big when our investment picks and the general market conditions check all these boxes.
2.1 Top-down risk exposure management
We combine 1) fundamental and macro indicators, 2) flows-based market indicators, and 3) tracking of investor sentiments, to get a sense of the level of risk associated with the current market and the type of market regime we are in. This then determines our top-down control on the total risk exposure of our portfolio at any given moment in time.
Prior to the FTX incident, the market was pumping for a bit, but we remained all cash throughout because:
Our macro fundamental read was adamantly bearish, especially after a particularly hawkish FOMC meeting. We have said multiple times that a macro pivot is nowhere in sight given elevated inflation, lack of imminent liquidity breakdowns in USD bond/credit markets, and the Fed's inherently backward-looking nature (being data-dependent).
(Note: A list of my tweets on overall market direction.)
Our flows-based market regime reader painted a market "meta-game" that we deemed highly unfavorable to us, hence 100% cash position.
"On net, little new capital is flowing into the crypto market. Stablecoin dry powder is decent but has no big catalyst to prompt deployment. A big overhang of token unlocks in the next 6-12 months."
"This is a clear PvP market. No clear trends, capped range, and rotations getting harder and harder to chase. Uptrends don't sustain beyond short news cycles, i.e. Instagram pumps, Twitter baskets, etc.."
"Not fit for our time horizon and investment style."
2.2 Considerations around (not) shorting
Our investment system doesn't hesitate to put on hedges and (capped) net shorts when warranted, but in this case, we have chosen to remain net zero exposure. Shorting in this type of environment is very idiosyncratic/news-driven and unusually risky, for various reasons:
Highly idiosyncratic news-driven short setups:
Prior to the incident: Sans insider info prior to the event, hard to predict how things would have developed for this type of discrete event. To be frank, we thought the odds of FTX blowing up in the fashion it did was relatively low.
During the event: As things started to unfold and new info came in, the probability of insolvency got higher, but the event transpired very quickly (< 48hrs from significant bank run, suspected buyout to declared insolvency). Throughout the process, it would have been risky to put on any significant shorts on FTT, Sol, or related assets, as lots of the short-term market action was driven by speculation on the probability of a bailout deal going through with various actors (Binance, Justin Sun), which we had little edge on.
Aftermath: As the initial vol calmed down, the risk/reward for shorting was greatly diminished. We believe that things will continue to unravel and dominos will fall, but these types of things are inherently hard to capture in real time because insolvent actors have strong incentives to lie and fake solvency until they cannot.
Unusual counter-party risk:
Moreover, there's the additional counter-party risk on basically all centralized exchanges where we would be shorting. Capped upside for short bets right now won't compensate for the lost principal suffered if the CEX used were to fail in the coming weeks.
There are plenty of skilled and experienced news and events traders out there, and we will gladly wait and see them battle it out. This is not our time to play and even if we had profited from shorts it would have been due to luck, not skill.
2.3 Specific Due Diligence on FTT token
We had previously done deep dives in exchange tokens (and equity), and ended up preferring other opportunities (BNB, Coinbase equity, for example) against FTT for various reasons below:
Opaque Value accrual: FTT has neither significant natural, organic demand (unlike BNB), nor robust cashflow accrual mechanism (unlike Coinbase stock) other than rather opaque "burns" carried out by FTX exchange.
Conflict of interest with FTX equity: FTT contributes zero value to FTX exchange but is a net non-cash expense on 1/3 of the exchange's revenue. There's a strong conflict of interest between FTX equity holders and FTT tokens.
FTX's commitment to the FTT token is dubious: As FTX was clearly attracting tons of venture capital and looking like they were aiming for becoming a listed company, it was not in their interest to keep FTT if/when that happens.
Why would FTX keep a non-contributing token running that's a constant drag on their exchange top line? Why would equity holders allow them to keep it that way? It didn't make much sense to us. We saw enough red flags on the token value accrual for us to avoid allocation. See our original internal notes here: CEX Tokenomics Study
As it turned out, of course, things were much much worse than we had expected. FTT now looks like a token created and manipulated purely to pump up collateral value and keep the FTX Ponzi machine going. In retrospect, it makes a lot of sense why they kept a seemingly weird token running, despite numerous logical incongruences.
2.4 Transparency on related tokens
2.4.1 Solana (SOL)
We had no exposure to Solana and its ecosystem prior to the incident and as of today. Our long-term fundamental view of the Solana ecosystem, however, warrants a separate piece. You can see our forward-looking commentary on Solana in later sections of this investor update.
2.4.2 SRM and other FTX/Alameda-related projects
We have never been exposed to these assets and don't plan to spend much time focusing on them going forward. The low float/FDV dynamics have always been a turn-off. Generally, we don't follow hot VC investment too closely, as the average quality of popular deals in the primary market has been dubious and, ironically, popularity in earlier stages is often inversely correlated to public market expected returns.
We do, however, remain very interested in central limit order books built on top of high-performance blockchains (whether Solana or elsewhere), as we've believed for a while that that's where the next step for DEXs is headed.
3 Forward-Looking Views
3.1 Macro level: don't catch falling knives
This is crypto's Lehman moment and the trigger for the "final flush" that we've internally been waiting for over the past year. The domino effects have yet to be revealed in full, so this is not the time to play hero and catch falling knives.
We will publish a longer essay to give more perspectives on the market regime today vs. historical cases (in crypto and tradfi), but for now, there’s a simple line of argument to be made.
We won't pretend to know more than what's publicly available about potential contagion, but a multi-billion USD liquidity hole doesn't just get absorbed by a young financial system easily, especially not when liquidity was already drying up as the bear market dragged on. Market makers and prop trading firms will in all likelihood take a pause to regroup themselves after a big hit. Liquidity will be thin everywhere and credit is tight in and outside of crypto.
Crypto has no Fed to bail all of us out. As much as (some) people are hoping for CZ and Binance to take over that role, it's incoherent with CZ's philosophy ("Let the markets do what the markets do", "Prices don't matter in the short term"). Even if he wants to play the savior, there are no prior cases or a long history of "trained market memory" to consolidate market consensus around "CZ the crypto Powell" for a "CZ pivot" to work the same way a Fed pivot does in tradfi market.
Our bet is that we see some consolidation within a tight price range, then one or two more breakdowns alongside further contagion and tradfi market decline. After that, a drawn-out multi-month period of a range-bound market characterized by low-volatility & erratic movements (what we internally call "the nothingness stage"), until some catalyst kicks off the next big uptrend (possibly along with a Fed pivot).
In any case, the risk/reward of a premature long here is pretty bad. Even in the case where we are wrong and this indeed is the bottom, we won't see a V shape recovery given 1) macro and liquidity conditions (bearish), 2) crypto's structural flows pressures (bearish flows overhang), 3) lack of retail, institutional excitement, or any incoming positive catalysts; 4) high likelihood of negative regulatory catalysts in the next 6 months.
It's a tough time to be optimistic about Solana, and yet it's usually when things swing to the extreme of the pendulum that true independent insights could shine and generate outsized returns. Conditioned upon seeing continued organic dev activity in the Solana ecosystem in the next 12m, we think there will come a price where the risk/reward of owning SOL becomes again attractive. We won't make a 90% confidence interval call at the moment for anything in the Solana ecosystem, and we will continue to monitor how things go, but at this point, it's much more +EV to be cautiously constructive with an open mind, than beating the dead horse.
This is a long overdue flush in the system that IMO gets rid of the opportunists who have hijacked the narrative of Solana. The pain will be felt viscerally in the short term - we expect prices to tumble more, flows to dry out, and some projects to leave for another chain.
But the tech itself is differentiating and promising. The Solana founding team was forged in fire during the last bear cycle. They aren't crypto tourists; they are high-conviction highly-capable engineers. This is the time for the organic builder community on Solana to step up and shape THEIR ecosystem going forward.
Counterintuitively, the fall of FTX could be long-term bullish Solana, as it puts the "VC/Strongman supported L1" narrative to rest once and for all. Competing high-performance chains such as Aptos and Sui will suffer the collateral damage of FTX fallout (some directly compromised), but without an authentic community that's already gone through multiple highs and lows in solidarity to outlast this bear market. Path dependency matters and in crypto it's ultimately the people, what brings them together, whether they are motivated to "diamond hand" (not just the token but also the community), that determine the fate of a project (especially for layer 1s).
Let's wait and see how this pans out. It's either a generational buying opportunity or a sad story of a fragile pumped-up ecosystem with little substance to show after an epic fallout.
3.3 Beneficiaries to FTX Blow-up
Not all hope is lost. A few crypto assets will clearly benefit from this FTX debacle, and paired trades can be pretty interesting from here.
3.3.1 Binance Chain (BNB):
Binance consolidates its leading brand and market share. Some projects that were previously built on Solana and/or funded by FTX/Alameda will move under the umbrella of BNB and Binance Lab (we already saw CZ making savvy moves here after his masterpiece of a takedown of FTX).
In general, we have long felt that the BNB ecosystem has been underrated by crypto-native investors. It's the Ethereum of the East, with a benevolent dictator, strong execution, strong grass-root support, and an ability to move quickly. We have been long-term BNB bulls and this is just one additional catalyst in that direction.
3.3.2 Polygon (MATIC)
These guys barely need any others' help as they've been killing it on the execution and BD front for quite a while now. The downfall of FTX and friends is definitely another fuel to Polygon's strong momentum against the bear market backdrop. Pair trades (long MATIC, short SOL) here will be interesting for the medium term after the dust settles a bit.
3.3.3 Native Infrastructure
Code must replace trust. This is the only way crypto can disrupt rent-seeking trusted intermediaries and frustrate high-functioning sociopaths. Such is also the apparent consensus of major funds post-FTX crash. Rebuilding a better and TAM-expansionary financial system on-chain requires robust and high-performance infrastructure. We are not there yet. We will seek to invest in crypto assets of key decentralized infrastructures, conditioned upon 1) the team remaining committed and resilient; 2) the project can become a tech stack centerpiece of crypto's next wave; 3) at the right valuation during a bear market.
We will refresh and publish our internal deep dive into key infrastructure challenges in due course.
3.3.4 Next-generation non-custodial wallets with improved UI/UX
NOT YOUR KEYS; NOT YOUR COINS! But don't expect "normies" to grind through 20 steps of onboarding and become self-custody Maxis. We have to meet the customers where they are. And that requires hardcore security while not compromising user experience. As primarily token investors, we aren't looking to directly capture this trend, but have noted a few up-and-coming next-generation wallets such as OneKey that provide promising solutions.
3.3.5 DEX (esp. Derivatives)
Without a doubt, this is a tailwind for DEX especially derivatives (where FTX was a major player). The market has already responded with GMX and Dydx outperforming. We think of this bet more as a crucial long-term thesis. The Uniswap of derivatives will have more than 10x the upside in the next cycle. We have already been researching here prior to the FTX saga. Expect to read our in-depth derivatives DEX thesis in the coming months.
3.3.6 NFT exchanges
This is not an obvious one, but we believe NFT exchanges will benefit tremendously from what's unfolding. Regulation will clamp down hard on token trading and DeFi, which leaves NFTs (not directly finance-related, non-custodial from day 1) at a relatively better place to gain user and speculator mindshare. We will do a deep dive into NFT marketplaces, but for now, let's just say we are very interested in 1) mobile-first; 2) gaming-related NFT exchanges, particularly if they are built in the Eastern hemisphere where competition is less cut-throat.
4 Final Takeaway
Every once in a while, a catastrophic tail event happens and gives a wake-up call to the industry and everyone involved. This is one of those.
At Maverick, our 1st priority is always keeping our own and our clients' assets safe. Managing risks before shooting for outsized returns. We are here for the long run and continue to refine and compound our investment system, using events like this as valuable stress tests and case studies.
Crypto is here to stay, but we as an industry all have had some overdue "house cleaning" to do. Let's get them over with and move onward and upward.
Founder & CIO, Maverick
DMs are open.