JANUARY 2019 CAOF UPDATE

The CAOF Portfolio and Performance Estimate

The crypto market picked up 2019 right where it left off in 2018. Much of the news of the month centered around layoffs, exchanges closing, network attacks and delays in regulatory approvals from the shutdown United States Government.

We maintain our cautious allocation and sentiment at the moment. We are hopeful the market has begun to bottom, but remain open to the possibility of further downside.

In January, the CAOF was down an estimated 7%, bitcoin was down 8 % and the Bloomberg Galaxy Index was down 12%.

Estimated Historical Returns

News and Market Conditions

The CBOE Withdraws Bitcoin ETF Application Due to the Government Shutdown

On January 23, the CBOE and asset manager VanEck withdrew their application from the SEC for a bitcoin ETF. The decision on this application had been delayed by the SEC on December 6 of last year as the commission was seeking additional comments and information on steps to mitigate manipulation and concerns over the liquidity of the underlying spot bitcoin market. The SEC was to make a decision on the application by February 27, but concerns were mounting in the crypto community about the negative ramifications of the government shutdown on the process. Therefore, to many, it came as little surprise when John VanEck, the firm’s CEO, told CNBC:

“We will refile when the SEC gets going,”. He continued that the firm has “pretty solid answers” to the aforementioned concerns of the SEC.

The crypto community has pined for a bitcoin ETF since the first attempt was filed in 2013. Advocates argue it will offer investors a safe, regulated vehicle to access the bitcoin market, and could be the impetus for the next bull market in the asset class. Many of these advocates argue the SEC has placed unreasonably high hurdles on an approval due to hesitations the commission may have around crypto. While it is true the SEC has rejected applications from eight firms over six years, when you step back and examine this process historically relative to other first approvals in the ETF industry it actually does not appear to be uncommon.

Bitwise, a crypto focused asset manager, this month also filed an application for a bitcoin ETF. The firm wrote a very comprehensive summary about the historical context of ETF approvals, the maturation the industry has undergone and its effect on an eventual approval and the potential effects of an approval.

We find the comparisons drawn between the first leveraged and actively managed ETF’s and the approval of the bitcoin ETF interesting and worth further examination. Both of these new style ETF’s (leveraged and actively managed) took over six years for the commission to approve as they introduced new risks to investors. The SEC felt it necessary to properly understand the implications of each as their approval didn’t just offer investors access to new assets, but also changed the risks investors must evaluate.

We feel this cautious approach actually may be prudent in the long run both for investor protections and also for the growth of the asset class. Crypto poses a slew of risks (one addressed in the pages below) that are unique and specific to the asset class. Once the SEC approves an ETF, investors will have easy access to the asset class and therefore these risks, in the long run it is best that this is done thoughtfully. We want investors to have easy access, but we want a thoughtfully constructed approval with a high likelihood of success in the market.

As VanEck alluded to, this application was re-submitted on January 31 following the re-opening of the SEC. We are hopeful past precedent holds and at some point this year or in the near future an approval comes.

Wyoming’s Proposed Blockchain Bill Passed by the Senate

As a small business in the crypto and blockchain markets we have been forced to deal with a high degree of regulatory uncertainty that has plagued the entire industry. It has affected how we interact with many of our service providers and in our eyes has certainly been a contributing factor to the struggles of the broader market.

On January 17, the State of Wyoming utilized the information learned from the hearing to introduce a bill which if passed would go a great distance towards offering some of the regulatory clarity needed for the industry. The bill attempts to address many issues causing much of the uncertainty, by clarifying the legal position of digital assets. The first key distinction is the classification of digital assets into three categories: digital securities, digital assets and virtual currencies. The bill will seek to grant cryptos falling into the virtual currencies category, such as bitcoin, the same treatment as money in the state. Which would go a long way in solidifying the property rights of holders of these types of digital assets.

Additionally, the bill would grant banks the ability to custody digital assets rather than rely on qualified custodians. This would be powerful because banks with a national charter would have the ability to do this nationwide and not on a state by state basis. This nation wide cohesiveness would remove a considerable point of friction from the custody market for institutional investors.

Caitlin describes the issues the bill hopes to alleviate.

“Every single blockchain company is operating with some degree of legal risk, whether it’s a start-up or Fidelity Investments because the law in this area hasn’t caught up with what’s happening in the real-world. If you listen to the SEC’s comments, the SEC has been fairly specific about issues that the industry needs to address before it’s ready for institutional investors to enter, ETFs to be approved, etc. Wyoming responded by proposing to fix those issues, and — importantly — doing it in a way that matches how the technology actually works.”

On February 2, the Wyoming State Senate passed the bill, which will now move to the house for debate and vote in March.

What is a 51% attack and Why is the Ethereum Classic 51% Attack Concerning

Proof of work mining, the type of mining which bitcoin and many other blockchains use, relies on the contribution of hash power by miners to solve algorithmic puzzles to verify transactions grouped into new blocks. As long as the majority of the contributed hashpower acts honestly then the next block will be added to the chain that the network’s nodes collectively have verified as the correct chain. No minority miner has an economic incentive to act dishonestly. Therefore, adequate decentralization ensures the correct history of transactions, and as a result the ownership of each coin will be accurate. If, however, dishonest miners control over 51% of the hash power of any given blockchain, the ability to execute a reorganization attack (or 51% attack) comes into play. In a 51% attack, the attacking hashpower can execute a reorganization of the existing blockchain creating a situation where the attacker can execute a double spend of their coins. A double spend is executed when the same coins are spent in multiple transactions in succession. The double spend problem is addressed in the bitcoin white paper by Satoshi and is a known vulnerability of proof of work mining. The issue of a double spend is a considerable risk because it calls into question the true scarcity and soundness of the money supply. Such an attack would undermine trust in the network which experienced an attack.

When monitoring our portfolio we are forced to account for risk that may arise situationally. We believe if the bear market persists the risk of additional 51% attacks of weak networks is enhanced. Our portfolio allocations reflect our concern of this enhanced risk to weaker networks, as we have allocated to networks where we deem this to be less likely.

Articles

Below are some additional articles from the past month that we wanted to pass along.

This PDF may have included some information about the CAOF and cryptocurrencies in general. This information is confidential, and by opening the attachments, you acknowledge and agree that you are obligated to keep the contents confidential and not transmit or forward it to any other person. Performance estimates are subject to future adjustment and revision. The information provided is historical and is not a guide to future performance. Past performance is not necessarily indicative of future results. Any decision to invest must be based solely upon the information set forth in offering documents furnished by Victoria Capital regardless of any information investors may have been otherwise furnished. This is neither an offer nor solicitation for the sale of a security.

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