Narrative Alpha: The Beginning of the End

A few thoughts on the blow up of UST and what it means for all of us

Last week was probably one of the top 3 most impactful events in our industry. We had a $40b+ company quite literally go to 0 in a week.

I’ve seen a lot of charts in my Crypto career, but nothing comes close to what we saw happen last week.

There’s a lot that’s gone on in my head with regards to this whole incident but I think the biggest one has been that many truths that have been obscured over the past few years are coming to light.

The Truth & Incentives

During the era of Litcoin and other altcoins, the promise to be “cheaper” versions of Bitcoin was always a fundamental lie because the technology was just the same — only less utilised. During Crypto’s decade long lifespan we’ve had all sorts of truths that get obscured because of the hidden incentives acting in plain sight but hidden from people who aren’t experienced.

Every cycle the truth being obscured gets changed, but the underlying incentives are somewhat similar. If we look back at the various cycles we have the following that come to mind:

• Bitcoins is bad and only used by criminals (traditional establishment vs cypherpunks)

• Litecoin/Ripple/IOTA is a faster version of Bitcoin that will become money (opportunistic copy pasta people vs clueless retail)

• Your average Crypto Youtuber shilling some coin (paid ads disguised as genuine buying advice for retail)

• <insert ICO token> is going to change the world by putting X on the Blockchain (naive/malicious entrepreneurs vs retain investors)

• <insert unproven L1 token> is cheaper, faster & better than Ethereum (funds/founders that missed out on Ethereum vs Ethereum ecosystem)

Now none of these are particularly beautiful truths to admit as an industry and not everyone is malicious/bad/scamming. However, what people don’t understand is the hidden incentives governing why people say and do the things that they do in this industry.

Till now we’ve been kind of okay with this cycle happening because these truths and incentives have one common theme:

Greed versus Greed

In all of these scenarios, we’ve had one set of clueless players who are driven by greed playing against another set of sophisticated players also driven by greed. Ultimately the smarter of the two greedy is crowned the winner, makes money and moves away from Crypto. This is what we typically call “a bull run”.

Whenever a friend asks me “what coin should I buy” to get involved in crypto, I tell them the same thing:

Don’t buy anything outside of Ethereum or Bitcoin, since Crypto is a giant casino where as soon as you step in you’ve already lost.

The sensible ones will typically listen and keep it simple, the ones which let their greed get the best of them will venture into the casino and proceed to lose sums of money till they get jaded and quit by losing to more sophisticated sharks — as they would.

So where am I going with all of this?

This time it was Greed versus Innocence.

This time it wasn’t some speculative asset that was being pumped. It was a high yields savings account being advertised to normal people and treasuries to safely park their money and build on a growing ecosystem meant to be the future of something sustainable.

This excerpt from Matt Levine summarises it very elegantly:

Safe assets are much riskier than risky ones. This is I think the deep lesson of the 2008 financial crisis, and crypto loves re-learning the lessons of traditional finance. Systemic risks live in safe assets. Equity-like assets — tech stocks, Luna, Bitcoin — are risky, and everyone knows they’re risky, and everyone accepts the risk. If your stocks or Bitcoin go down by 20% you are sad, but you are not that surprised. And so most people arrange their lives in such a way that, if their stocks or Bitcoin go down by 20%, they are not ruined.

On the other hand safe assets — AAA mortgage securities, bank deposits, stablecoins — are not supposed to be risky, and people rely on them being worth what they say they’re worth, and when people lose even a little bit of confidence in them they crack completely. Bitcoin is valuable at $50,000 and somewhat less valuable at $40,000. A stablecoin is valuable at $1.00 and worthless at $0.98. If it hits $0.98 it might as well go to zero. And now it might!

What we had as an industry was one set of players who roped in another set of players with the guise of safety when really it was to build immense wealth without creating any real value — or rather hiding behind the guise of real value creation.

I mean look at it this way:

1. You create a speculative coin

2. You create a supposed “stablecoin”

3. You tell people that you can burn a speculative coin for a stablecoin

4. The more stablecoins that are in existence, the higher the value of your speculative coin

5. To keep people in your stablecoin (which retains the value of your speculative coin), you promise them 20% fixed yield.

There’s only one problem.

That 20% is being funded from your bank account. Now, where do you get the money from? Well, turns out you can ring up a few of your rich friends who have an ownership stake in your speculative coin and they’ll keep the fun going longer. It’s only a few billion dollars, right?

Surely that’ll be enough to ensure a broken model stays alive?

That was the truth that was being covered through myriad incentives. More specifically:

1. Founding members that greatly benefitted from the multi-billion dollar valuation of LUNA and had outspoken voices on Twitter defending the broken model.

2. Early investors who acquired LUNA at sub $1 prices and had made 100 times their capital often resulting in gains in the hundreds of millions or billions. They lent their credibility at scale.

3. Influencers who acquired LUNA at low prices before then selling this “high yields savings account” to their subscribers. They probably had no idea where the yield came from and they didn’t care, their sub numbers went up and so did their bags.

4. The Terra ecosystem that convinced investors, corporate treasuries, and retail investors that this was a safe “20% yield” being offered without highlighting the risks. They didn’t really bother communicating the risks because who cares when you’re selling people a very high yield.

It was the classic crypto game we’ve seen many cycles over and over however again, but this time innocent people lost out big time. People who weren’t trying to get rich overnight but rather believed that crypto was the future of banking & finance and that these yields were safe — like their bank account.

Funnily enough, I wrote about this back last year — just in a more subtle way:

What’s the fundamental trade?

A classic example of using this kind of thinking is when looking at an APY or yield being offered. There’s a ton of startups being funded right now for making “DeFi easy to use” by offering “high crypto yields” to normal people. Great idea right?

No, it’s actually a pretty terrible idea most times haha. Why? Well let’s use our fundamental trade framework here.

First question, where is the yield coming from? It’ll typically be one of two places:

1. The project is burning away giga amounts of free money

   • Where are they getting this free money? Their investors?

     • Why do their investors think giving away this much free money is a good idea?

       • Because they think that it’ll attract people

         • What if the people are only attracted for the yield and don’t have any reasons to stick around? Oops, the trade will eventually be invalidated. RIP.

This is only the Start

As an industry, we have many more truths to uncover, and only once we collectively see the truths will we reach rock bottom. At the moment there are still many more truths that everyone will wake up to and have internalised. Some of them that I predict will come out over the coming months:

1. A lot of DeFi 2.0 or newer waves of DeFi are just abstracted financial schemes that fundamentally don’t create any value but rather use big buzzwords like “liquidity”, “deep”, and “algorithmic” to lure people in but just have circular economies.

2. Many projects have no idea what their unit economics are and will realise they’ve given away billions of dollars in value to promote the destruction of their own ecosystems through a large overhang of supply.

3. Many investors who thought buying early would guarantee them returns will realise that couldn’t be further from the truth and that launching a token doesn’t mean shit. You need real value to be created.

4. Launching a token with a tiny token float and commanding a large fully diluted valuation is smoke and mirrors. Large FDVs will be laughed at until they reflect reality or employees and community members move elsewhere since they realise there’s no upside in the asset they care about.

5. NFTs in their current state are just circular musical chairs guised under the term of art collecting. As they experience a collective disillusionment we’ll finally see real innovation of digital assets unlike what we’ve seen to date.

6. Having a pre-released game or product with a FDV in the billions is pricing yourself as if you’ve succeeded. No one hits a home run out the gate. It takes years of grinding and iteration. Those who haven’t built anything won’t learn this without pain.

7. Alt-L1 tokens that obscure the scalability trilemma will be exposed for what they are: ghost towns that no one actually wants to use outside of Player vs Player games extracting value till the death of the other player.

8. Algo-stables are largely useless since none of them are accepted as a valid medium of exchange but just engineer clever financial games. They might still have a use case but in their current form they aren’t useful outside of money games. Watch for the “Curve Wars” to get a sense of how much people still believe this lie.

9. Things that actually do create value and are “boring” will continue to thrive and stand the tests of time — as they always have. They’ll probably reprice as the truth becomes clearer.

10. Most investors are monkey-throwing darts that don’t have real conviction, thesis or understanding of what they put money in and promote. Many will come to their senses as the market will show them the reality of what they’ve put money in.

I know that all sounds quite bearish and harsh but I think it’s important to call a spade for a spade. Until we don’t acknowledge a problem, we can’t work to build a solution for it. That’s why I’m writing this. Not to scare you but rather to accept the ugly truth so we can collectively work to solve these challenges.

I started my Crypto journey in the depths of the 2018 bear market and I see so many similarities in the attitudes of the market players back then to now.

We’re still far away from the bottom since there are more truths to fundamentally uncover, we’ve only discovered one of many last week.

The rest are yet to fall.