How to invest in crypto in 2023 | Interview with Jeff Dorman

Is the worst of the crypto winter behind us? Can we expect a new bitcoin bull run in 2023? And what are the hottest crypto projects for investors at the moment? These are the questions that everyone is asking as we enter the new year. The result? Crypto Twitter filled up with all sorts of predictions. In this video, we try to cut through the noise to identify the main trends that will mark the crypto industry in 2023. Jeff Dorman, the chief investment officer at hedge fund Arca, joined us in our quest.

I don't think bitcoin's correlation to the market will go away. When you look at Ethereum and you look at Polygon and you look at Solana and you look at ftt, their returns had nothing to do with macro.

I'm Giovanni. On this show, we challenge the ideas that shape the world of crypto. In each episode, we assess a crypto narrative, a price outlook or a potentially disruptive technology. Only the most solid ideas will make it to the other side. This video is presented by our sponsor, Web3antivirus, a security solution that helps protect users from from online threat and scams on the decentralized web. Talking about prices for 2023, you said that we are likely to have reached the bottom, but you don't know what could push us higher. So tell us more about that.

You know, there's a couple of factors that lead me into believing that the worst is behind us. Most of the forced selling is over, right? Any funds that needed to unwind before year end have largely done so. There's not nearly as much leverage in the market. There's also really very difficult to short anymore. Right. FTX was one of the easiest places to short the market, as well as getting loans from places like Voyager and Celsius and Blockfi and Genesis, all of which are now defunct. So it's hard to short the market. There's a lack of supply. I think that is encouraging for bottom, but also know generally when investors are all on one side and for the last few months, everybody was negative, everybody was high cash balances, everybody was short. You start to see negative news no longer matter. And I think that's what we're seeing now is most of the FTX dump has retraced. You're seeing negative news about DCG and Genesis and Nexo and the market just doesn't care anymore.

You can't see what this catalyst or this catalyst could be that will bring the market higher in 2023.

You know, probably my biggest thesis with regard to this is that we're going to continue to see an onboarding of Web2 and other corporations coming into, you know, Web3 and DeFi. Companies that have been around for 50 to 100 years are starting to utilize blockchain, right? We've seen financial companies like KKR and Apollo start to tokenize funds and securitizations. You've seen Goldman and JP Morgan and BNP start to get involved in some defi transactions. And then you're seeing on the NFT side, you've seen companies like Nike and Starbucks and Reddit start to adopt NFTs and start to find different product lines and revenue enhancing functions there. And what happens is, you know, you look at the total digital asset market, there's only, you know, estimated 200 or 300 million people who have ever really interacted with the blockchain. That's smaller than some of these companies I just mentioned. I mean, visa alone has 200 million users, right? Apple and iTunes has 300 million users. You start to port over, you know, Starbucks has 60, 70 million users. You start to port over some of these user bases that already exist in the non blockchain world and you start giving them blockchain tools. So I think when we see that, that's going to be a massive catalyst to the upside, certainly for layer ones and layer twos, but ultimately for DeFi and for NFTs and other projects.

On the other hand, we saw that in 2022 crypto was tightly correlated to the stock market. We saw how these two types of assets were responding in the same way to the macroeconomic picture. So why would you think that in 2023 it will be different?

Sure. Well, first of all, not all that is true in my opinion. So bitcoin has definitely been very correlated to traditional markets and to traditional macro factors. And largely because bitcoin has just become a 24.7Vix, right? It's just a trading vehicle now for large funds who want to get in and out of risk, you know, on weekends and overnight trading hours. So I don't think bitcoin's correlation to the market will go away, but the rest of the market decoupled back in May. You know, again, the first four or five months of the year, the entire, every single market was being hit by the central bank policies and by the speed with which central banks were raising rates relative to expectations and the fact that inflation was much stickier. But we, you know, the digital asset market decoupled in May when Terra Luna blew up. You know, the digital asset market got crushed where the traditional equity and debt markets didn't move. And that's because that was a very idiosyncratic event that was specific to Luna and ust. Now, we decoupled to the downside, not the upside. So most people don't want to admit that that was a decoupling because everyone wanted us to decouple up, not down. But we decoupled down. And then in, you know, July and August, when the Ethereum 2.0 merge roadmap became reality, we decoupled to the upside and we rallied pretty hard because of Ethereum. That, again, had nothing to do with Macro.

But don't you think that that decoupling was just a short, a short term one, so one that was strictly related to that specific crypto event in the macro picture? We really haven't noticed, like, consistent decoupling of these two types of assets.

There's no reason to lump all of these assets in the same category just because they're all digital assets. When you look at Ethereum and you look at Polygon and you look at Solana and you look at FTT, their returns had nothing to do with macro. FTT went bankrupt, right? Solana basically went down 95% because of its ties to bankrupt and failing entities. Polygon went up. And that leads into really what I wanted to get to, which is most investors three years ago, two years ago, even last year would say, okay, I'm starting to believe in blockchain, but I don't believe in tokens because tokens have no intrinsic value. I want to own equities where it's safe. Okay, well, how'd those equities do? How'd your equity and BlockFi do? How'd your FTX equity do? How'd your coinbase equity do? So in equities, what drives the value of equities is if you're a going concern, meaning if you're a company that's not bankrupt, it's the multiples that you can get on your revenue and your cash flow stream. Well, if we head towards a recession and we have higher rates, well, two things happen, right? Those revenues and those cash flows go down and the present value of those cash flows go down because of higher rates. But also you may have trouble refinancing your debt and you might end up in bankruptcy, where all of a sudden your equity gets wiped out in a liquidation and creditors take over the new equity of the reorg business. Well, that's very different from tokens, right? How do tokens generate their value? Well, there's two components. One is a financial value very similar to stocks. Right. If you look at the revenues and the fees of Ethereum or a Uniswap or a Binance or any of these companies or projects that have real revenues, there's certainly a financial component to the value of token. And if those financial values go down, then those tokens will go down. But the other component of a token's value is the rewards or the loyalty or the usefulness or the utility of it. That doesn't go away in a recession. So I think we're headed into an environment where you're going to see a lot of stocks get punished under the weight of restructurings and under the weight of lower revenues and lower cash flows. And you're actually going to see a.

Lot of tokens do really well according to your outlook. Basically, we're going to see a decoupling of crypto from equities, but that is not going to concern bitcoin. So bitcoin is not going to decouple the rest of crypto is correct.

That's my view.

And that's because bitcoin does not respond to these logics of being like a token with a utility. It's just a store of value.

Yeah, I think it's a store of value. But more importantly, it's. It's how it's being used. Right. It's being used by macro traders and by long short equity investors and by, you know, other companies around the around the world as a trading tool. As a trading tool to express risk on and risk off.

We saw that 2022 was the year where a lot of CEFI players failed. And that is why a lot of people are now very bullish towards defi. So one of the most widespread prediction is that this is going to be the year of defi. And you are also very bullish in your predictions about defi. You said that in 2023, TradFi will lose market share to defi. So let's get into that prediction and explain what you mean by that.

Three, four years from now, you might come out of this and be. Actually, 2022 was the year that everyone realized that decentralized finance just works better than traditional finance. Right? Code works better than humans. Humans make mistakes. Humans are greedy. Humans do things and cut corners. Code doesn't do that. I think probably the most important thing is when you look at each of the companies that have gone under this year, there is a defi, or decentralized substitute that does the exact same thing with the exact same customers that has flourished. Again, for every Voyager and Celsius and blockfi, there's a Compound and a maker and an AAVE that are doing really well. For every ftx, there's a Uniswap or a DYDX or a GMX that trades the same instruments. You know, ultimately, when you look again where DeFi was two years ago, two years ago, when Defi just started, the spot trading of digital assets was less than 1% of total volume. Now it's 12%. That's a big jump over two years. And that's largely because of the success of Uniswap and some other aggregators. You know, you're going to continue to see that shift happening where more and more people just get comfortable using these decentralized alternatives.

Of course, code potentially is going to be more trustworthy than just like a centralized entity. But maybe we are not there yet because we started in 2022. The highest amount of hacks was directed towards Defi protocols. And so it seems that these protocols still have a vulnerability towards these sort of exploits.

Yep, I agree with that. I think that's a harder one to solve for. I don't actually know if that gets solved for in 2020, but I know that that's a big theme that we are investing out of at arca. I think with record numbers of hacks and exploits and bad actors, there's no question that we need more rigorous security and testing practices. The test in PROD is not going to work. Whether it's products that offer simulation stress testing for Defi protocols, or just greater security of private key storage or more transparency around where your assets are. I mean, these are initiatives that are basically going to have to be taken much more seriously in 2023 and beyond. And there are companies and projects that are attacking that from the excitement that.

They get about Defi. I guess that you are far more bullish on Ethereum, which is basically the foundation of Defi, than you are on Bitcoin. So Ethereum is going to outperform Bitcoin in 2023, according to you?

Yeah, I think so. Bitcoin still has a very large overhang of supply from the inflation rate and from the miners. On top of that, you have again, Mt. Gox distributions. You have government seizure distributions. You have a fair amount of collateral still held on lenders and bankrupt entities that might eventually get sold. The number, I estimate, is about $11 billion of supply is going to come out for Bitcoin next year or this year, 2023. That basically means you need a billion dollars of buy pressure a month just to keep Bitcoin flat. That's a lot. That's a lot of demand. You know, Ethereum is, you know, basically because of its transition from proof of work to proof of stake, is now certainly disinflationary and in some cases even deflationary. I think in the last week and a half, it's been deflationary. There's been more Ethereum tokens burned than there was new eth issued. That flows to stakers. That's a big supply demand dynamic. Now, you know, all else equal, Ethereum can be flat even if there's no new demand, just because the supply is being burned. That's a big deal. And then on top of it, Ethereum has, you know, real revenues and cash flows that come in. You know, you can think of Ethereum as the, like the Apple App Store, right? The more people who build in the App Store, the more transactions, the more volumes, the more revenues that go to Apple. Same thing with Ethereum. Then you also have your utility function, which is you have to still use Ethereum in the ecosystem. Right. It is a currency within its ecosystem. So I just think the usefulness, you know, I look at everything from a financial modeling standpoint and from a growth standpoint, and Ethereum just has more usefulness. It has more revenues and cash flows, and therefore I think it has more likelihood of outperforming Bitcoin.

I'm very excited to see how this all plays out in 2023, and I'm looking forward to talk to you again maybe in one year from now and see how these predictions will have played out. So, yeah, thanks a lot, Jeff, for coming on the show. Good luck for everything this year. And yeah, I hope to see you soon on our show.

Great, I appreciate it. And yeah, we'll see in 12 months how accurate these predictions are.