Weekly Thoughts #3 - Sentiment tends to shadow fundamentals

 

ELEMENT DIGITAL MASTER FUND      

April 20, 2018

The market behavior this past week has shown us something we’ve all not seen for some time. Green. And lots of it. This past week we’ve witnessed the overall market rise 20% to encompass a total capitalization just north of $320B. We’ve seen real volumes come back to exchanges and we’ve seen influencer sentiment shift to a more bullish tone. Is this the precursor to a major coordinated pump? Is this some new whale entering the space and positioning a giant book? Is this because the tax deadline is behind us? Are we in a bull market? Maybe. Maybe not. The one thing we know about this marketplace is that it doesn’t behave entirely rational in the short term. Sentiment tends to shadow fundamentals. The market behavior on any given day can almost be explained by a game theoretic type of logic. It isn’t what’s true or false that matters. Its what people believe is true or false that matters (chew on that one for a bit). In any case, there’s been a lot of good news recently and we are certainly welcoming it with open arms. Here are some of our other observations for the week:

  1. The market is possibly showing signs of a turnaround. Emphasis on the word possibly. In the past week, we’ve seen the price of bitcoin distinctively bounce off a 6500 low (thanks to the Bitfinex short squeeze) with enough drift to continue past 8000. This price action has led to some key short-term signals to turn green (ie, 7d MA crossing over the 21d MA indicated by Figure 1). This has also seemingly brought out the all knowing market experts to boldly claim in the media that we are officially past the bottom. Pump the breaks there, son. We’re not so sure of that yet. While we do see some of the weakness from last month beginning to taper off, we don’t believe we’re completely out of the woods yet. For one thing, we’d need to break the 200d MA (Figure 2) at the very least before we can more confidently claim we’re now in a sustained bull market. Plus, on our team, we like to be more thesis driven in the manner in which we construct market abstractions. Technical analysis is great, but at the end of the day, there needs to be a fundamental driver for demand to consistently outstrip supply and for the price to rise over the medium to long term.

  1. Dispersion of returns is coming back. What does this mean? It means that finally there is some kind of order in the digital asset investing universe. It means everything doesn’t move up or down by the same amount, every single day. It means that supply-demand equilibriums are a true reflection of fundamentals and not of hype or speculation. And it means that capital will flow to good projects. Mark our words. This is a necessary thing for a functioning market over the long term and the only thing that will beget true speculation by large investors. To highlight this trend, we refer to the graph below. It shows us the normalized performance of a handful of large cap and mid cap names over the past few weeks.

  1. Transacting on exchange is still not only a manual task but extremely confusing. Even for traditional traders, gauging liquidity and impact costs of an execution is not a trivial thing to do. This is especially true with names that have thin liquidity and no fiat pair. We as humans are just not built to gauge an order book in so many fragmented ways. This level of misunderstanding can lead to bad execution often times and a significant disruption to fair value price. Why is this important? Because we saw a few instances of that play out this week, where a significant amount of money moved into a thinly traded asset on an exchange with subpar user interfaces. The result was a 4-8x spike in price within a few minutes, followed by a massive mean reversion over the next few hours. No professional trader in their right mind would enter a $10m market order for an asset that trades less than $1m per day. This was the result of either a massively unsuccessful pump or a whale that had a clear misunderstanding of how liquidity works. In any case, this type of price action is not good for a legitimate marketplace over the long term. But until infrastructure and basic user interfaces become better, we will continue to have these situations.

Thanks for reading everyone. Questions or comments, just let us know.

Portfolio Management Team

ELEMENT DIGITAL MASTER FUND

Thejas Nalval  | Konstantin Antropov  | Kevin Lu

Disclosures

This Commentary is for informational purposes and does not constitute investment advice, any type of recommendation or an offer to sell or a solicitation to purchase any securities from the Element Digital Funds or an entity organized, controlled, managed by or affiliated with Element Capital Group, LLC (“Element Group”).  Any offer or solicitation may only be made pursuant to a confidential private offering memorandum which will only be provided to qualified offerees for careful review prior to making an investment decision. We aim to educate, report and/or opine on certain developments relating to the digital asset market. These are our subjective views, based on information and sources we believe to be reliable as of the date we publish, but we make no representations or warranties with respect to the accuracy, correctness or completeness of our opinions or any information herein and have no undertaking to update it.  Please do not rely on it.

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