Perceptive Capital Insights
July 16th, 2023
Perceptive Investors and friends of the firm,
We trust this message finds you in good health and high spirits. It is our privilege to bring you our latest insights into the ever-evolving world of digital assets. Whether you've been with us since the beginning or are just joining our community, we're delighted to have you on board. Our aim is to not only keep you informed but also to inspire and engage you as we explore how advancements in this technology continue to revolutionize business, communication, governance, culture, and beyond.
First, we appreciate that many of you have inquired and we’re happy to share that our esteemed partner, Jamis, has been steadily recovering. He is now receiving care at a facility in Utah, where he has closer access to a support network of family and friends. We’ll continue to keep you updated as his recovery progresses. Next, we are absolutely thrilled to announce that Ali and wife, Natalia, welcomed their third (!) baby boy, Noah, to the family on Tuesday. Both mom and baby Noah are happy and healthy.
Reflecting on a busy first half of 2023, what stands out most is the evolving interplay of regulators and institutions. The intensifying regulatory offensive, particularly here in the U.S., reached a crescendo in early June, as the SEC filed two complaints against Binance (the world’s largest crypto exchange) and Coinbase Global Inc (NASDAQ: COIN) for offering unregistered securities, et. al. Considering U.S. regulators’ growing list of legal complaints and challenges against crypto operators, one might be tempted into thinking that crypto is being pushed out of the U.S.. And while it’s true that numerous entrepreneurs and companies have left U.S. shores for more crypto-friendly jurisdictions, there remains significant U.S. support for our industry, and the judicial system has emerged as the arena where crypto advocates stand to make progress.
Ripple Lawsuit
This week, crypto company Ripple Labs, the team behind the Ripple blockchain (token: XRP), notched a landmark legal victory for the digital asset industry in a three-year battle against the SEC, as the judge ruled that some of Ripple’s token sales on public exchanges did not violate federal securities law as the sales did not constitute securities offerings. While there is nuance to the circumstances of the case, and Congress still needs to clarify the status of digital assets, the broader crypto market reaction was overwhelmingly positive. The ruling offers potentially wide-ranging implications for the industry, namely around initial token distribution and employee token compensation. Some of you may be familiar with the 2017 Initial Coin Offering (ICO) boom wherein crypto companies distributed digital coins to early institutional investors and employees much like a traditional business might distribute shares or equity in an Initial Public Offering (IPO). In both cases, an offering price per coin or share is established and marketed ahead of time. Given the similarities in process, many have equated ICOs to unregistered securities offerings. In response, and as smart contract technology on Blockchains such as Ethereum advanced, many crypto companies began issuing tokens/coins to early investors using new methods, such as “Airdrops”. In this approach, tokens are distributed to early users of the platform or project, the founding team, and investors without a predetermined price. Market forces subsequently establish a price as the tokens are traded in the secondary market. Additionally, the results of the Ripple case also establish that the context of a token sale must be considered when determining whether or not the token is a security. This means that it is possible for the same token to be considered a security in some instances and not a security in others. This is a fundamental divergence in how stocks and bonds are treated, as they are always considered a security, and whose sole purpose is to give owners a claim on company earnings or assets. Blockchain-based digital assets have wider varieties of applications. Breaking this framework challenges US regulators’ long-standing mental model about crypto regulation. Disclaimer, *This is a high-level, non-legal professional interpretation of the differences* But the big picture is that the Ripple case might set a precedent for other companies that utilized similar token distribution methods and those who opted for Airdrops or other strategies in an attempt to avoid unregistered securities offerings. Finding an appropriate way to distribute utility or governance tokens to their communities is key to establishing decentralization for these projects. A perfect example of this is the Uniswap (UNI) airdrop in September, 2020. The potential legal threat of an unregistered security offering has, in our minds, suppressed token valuations for projects such as UNI, but the adjudication from the Ripple case bodes well for projects that opted for distribution methods such as airdrops. So far the market seems to agree, as UNI is up more than 10% since the ruling was made public, outpacing the broader crypto market.
Shortly after the ruling, House Majority Whip, Tom Emmer, took to Twitter to raise attention for his bipartisan bill, The Securities Clarity Act, which distinguishes digital assets from an investment contract and would “...provide the regulatory confidence needed to make sure the next iteration of the internet is designed with American values.”.
BlackRock Files for Bitcoin Exchange Traded Fund (ETF)
Earlier in June, following the SEC’s complaints against Binance and Coinbase, BlackRock surprised the market by filing for a “spot” Bitcoin (BTC) ETF under their iShares brand. A “spot” BTC ETF means that the ETF would directly hold the underlying BTC rather than derivative exposure. For background, while BTC spot ETFs exist in other jurisdictions, to-date the only BTC ETFs that are available in U.S. markets are futures-based, and leveraged-futures ETFs, both of which are known to be more convoluted, more expensive, and generally less efficient investment products than a spot ETF. Our research suggests there have been over 77 different crypto-related ETF filings in the U.S. which have either been denied, approved or are in a period of review. A BTC spot ETF, despite being a somewhat basic concept, has remained an elusive goal for many. While there are justifications for opposing any crypto ETF product over holding the crypto assets directly, much of the industry still considers a spot ETF necessary for the maturation of our market and increased adoption from existing financial structures.
BlackRock, the world’s largest asset manager, has a long and intricate relationship with the SEC and has been approved for 500+ ETFs filings with only one rejection. Many found the timing of BlackRock’s filing to be particularly curious, given the SEC’s increasingly aggressive stance against the digital asset industry. Further, BlackRock explicitly named Coinbase as the custodian partner for the ETF and as one of three exchange partners to provide market price data for the ETF. The alliance between BlackRock and Coinbase is important given the SEC’s active lawsuit against the Coinbase. We think BlackRock’s influence here shouldn’t be understated. Within days of BlackRock’s filing there was a frenzy of spot BTC ETF applications from other notable firms such as Fidelity, WisdomTree, Invesco, Valkyrie and Ark Invest. Below are the key dates for the BlackRock spot Bitcoin ETF. Evaluating the merits of the filing, and with BlackRock leading the charge, we think there is a high likelihood that the product, and others like it, will be approved within this timeline. Such approval would spur additional BTC buying just before the next Bitcoin halving in early 2024, potentially kicking off another bull market in digital assets.
One last note on this subject; We want to highlight the personal shift in perspective from the CEO of BlackRock, Larry Fink, an influential Democratic businessman who was largely expected to become U.S. Treasury Secretary if Hillary Clinton won in 2016. In 2017, Fink called Bitcoin an “Index of money laundering”. Well, in the CNBC clip below, Fink expresses his updated view that cryptocurrencies hold differentiating value and that “Bitcoin will transcend every international currency due to broad-based worldwide demand.”. We take this as further evidence of a shift in perspectives on Wall St. as more executives educate themselves on the technology and its use cases, rather than falling victim to hollow sound bites.
Select Investment Updates
In this last section we’ll provide brief updates on a few of our lesser-discussed portfolio investments. Uniswap (UNI), mentioned earlier, recently announced the launch of version 4 (v4) of the Uniswap Protocol. v3 of the protocol has been in action for the past two years and is the largest decentralized exchange, processing over $1.5 trillion in trading volume, at times eclipsing the volume of centralized competitors such as Coinbase. As public infrastructure, Uniswap is a vital part of the crypto ecosystem. v4 will provide a handful of upgrades and new features (e.g. dynamic fee support, on-chain limit orders, and time-weighted average market maker (TWAMM) functionality). Uniswap v4's architecture will also reduce costs and ensure greater efficiency. These advancements provide novel features and functionality, while also improving the user experience which will help close the gap between centralized and decentralized crypto exchanges. Uniswap Labs continues to be on the vanguard of Decentralized Finance, and earlier this year released the Uniswap wallet, where we were fortunate enough to be private beta testers. We’re excited to see the launch of v4 and the continued innovation from our friends at Uniswap.
Elsewhere in our portfolio is 1inch Protocol (1INCH), an exchange aggregation platform which we liken to using Kayak or Expedia vs. booking a flight or hotel directly. Growth on the platform has continued to impress, with the number of monthly unique wallets on 1inch accelerating since the beginning of 2023, breaking the 1 million mark in June. Much of the growth in 1inch users has occurred on Ethereum layer 2 networks and side chains such as Arbitrum, Optimism and Polygon, where we are seeing month over month growth of approximately 20% for the past six months. 1inch launched a new feature earlier this year called Fusion which, in addition to providing some security improvements, also connects users to professional market makers that provide deeper liquidity and superior trade execution.
Warning, this last one is a bit technical: Polygon (token: MATIC) announced their proposal to upgrade the Polygon Proof-of-Stake (PoS) chain to a zkEVM validium, a first-of-its-kind decentralized layer 2, secured by zero-knowledge (ZK) proofs. What on earth does that mean? Well, this is part of Polygon’s broader Polygon 2.0 upgrade that will empower users to navigate through an unlimited number of blockchains and facilitate cross-chain interactions akin to browsing websites on the traditional internet. With this zkEVM validium upgrade, Polygon, an Ethereum compatible sidechain, will become even more secure and more performant. These types of improvements are important, as we continue to improve the user experience, drive down the price to use blockchains, increase the security for users, and increase the amount of data (throughput) that we can include per block. Think about companies like Starbucks (which already announced partnerships with Polygon) and other corporations like airline companies, running their rewards and loyalty programs on blockchains. They need to have super fast, super low-cost methods of recording all customer activity, while maintaining the underlying security guarantees from the Ethereum mainnet. This announcement from Polygon helps them achieve that. You can think of a validium as the lower-cost, higher-throughput sibling of a rollup. Rollups, like Polygon zkEVM, leverage Ethereum to publish transaction data and verify proofs, inheriting Ethereum’s unmatched security and decentralization. On Polygon zkEVM, the cost to prove a 10 million gas batch is just $0.0259, or $0.00005 per transfer. The tradeoff with validiums is that they must ensure transaction data availability outside of Ethereum, which can be challenging. Fortunately, Polygon PoS already has a decentralized validator set of 100+ validators with over $2 Billion at stake, which can serve as a highly secure and reliable guarantee of data availability.
That’s it for now, but for anyone craving more project updates, we’ll serve up the following links that the overzealous can enjoy and that we’d be happy to discuss offline:
Aave activates GHO stablecoin on the Ethereum mainnet
Coinbase's Base launches mainnet for developers, plans public rollout in August
Real-world asset platform Ondo Finance expands tokenized Treasuries to Polygon
We hope you are all enjoying a nice weekend. As always, we’re honored to have you with us, and we are available for any follow-up questions or conversations. We thank you for your continued trust and support.
Your Team at Perceptive.
