The PDF Version of this report can be found here.
General Market Update
At the beginning of the month, investors' expectations were split on whether the Fed will raise rates by 0.25% versus 0.50% at the FOMC meeting on March 22. Many investors were cautious that a 0.50% increase in interest rates would erase the gains they’ve seen so far this year.
One week into the month, cracks from interest rate increases started appearing after a series of banks started collapsing as a result of the aggressive rate hikes by central banks over the past year. One of these banks was SVB (Silicon Valley Bank). Circle, the issuer of the stablecoin USDC, confirmed it had $3.3 billion in deposits at SVB (which is backing the value of its stablecoin USDC). The market panicked, and on March 11th, USDC broke its peg to the dollar. At this stage, investors no longer expected a 0.5% increase in rates but rather 0.25% or even a pause in rate hikes.
USDC returned to its original value of $1 after about three days of depegging following the stepping in of the FDIC, the Fed & the U.S Treasury. Those calmed down the market by kicking off the Bank Term Funding Programme (BTFP), a new emergency lending facility that would allow banks to deposit treasuries in return for cash advance worth face value of the asset. This however had an adverse effect as many investors started worrying that this effectively means an increase in money supply that will erase all the tightening done by the Fed over the past year and will fuel inflation further.
On March 22, the Fed raised the rate by 0.25% showing that its priority remains fighting inflation. This is troublesome as the longer financial conditions remain tight, the greater the risk that stresses spread beyond the banking sector, unleashing greater financial and economic damage.
Impact of the bank run and steps taken
USDC was seen as one of the safest stablecoins before the depegging event that occurred in March, and therefore, the majority of our cash reserves were held in USDC. When the depegging occurred, many feared it could cause a bank run and USDC loses more of its value. To protect against any such risks, we converted most of our USDC holdings to other stablecoins for 0.92 on the dollar, by diversifying into different stablecoins but mainly in what we believe is the safest of them all, LUSD. The overall impact was a 5% loss on our cash holdings and less than 3% on the overall portfolio, which we see as an acceptable loss for the sake of protecting our holdings.
In light of these events, we thought we’d give a quick deep dive on stablecoins (see appendix below).
3GI Strategy Breakdown Performance
Momentum Strategy
Given the latest developments in markets and the overall economic outlook, we reversed our strategy of increasing our cash reserves by deploying over half of the cash reserves held at the end of last month into new momentum picks that we believe will benefit from the upcoming narrative of a banking crisis that could lead to loss of confidence in fiat currencies, and the subsequent return to Quantitative Easing.
We made a new investment in Bitcoin as it is well positioned to be the biggest winner from any bank related crises as it will likely be the gateway into crypto for mass adoption including retail and institutions.This is due to its characteristics offering the highest security, highest liquidity and most likely to be classified as a commodity rather than a security as most other cryptocurrencies. We plan to increase our exposure to Bitcoin over the next few weeks.
We made a new investment in a protocol called Timeless, a yield market protocol and a liquidity engine for the Decentralized Exchange Uniswap. We also made a new investment in a protocol called Cat-in-a-box, a new type of 0% interest lending protocol with no risk of liquidation. This is a risky play but has the potential to produce outsized returns. You can check out our short twitter thread explaining how Cat-in-a-box works here.
The highly anticipated Arbitrum (blockchain scaling solution) airdrop finally took place this month and we were among the top percentile in terms of the amount of airdropped tokens we received. As a reminder, Airdrop is a marketing stunt performed by the project owners to increase awareness, by distributing free tokens to heavy users. . We then increased our exposure to Arbitrum, as our view is that it is trading at a very attractive price on a relative valuation basis.
Swing Trading & Yield Farming Strategy
For the same reasons that we are bearish on cash, we opened a low risk leveraged position longing Ethereum by depositing Ethereum as collateral on Liquity and borrowing stablecoins against it at a healthy Loan-To-Value. We converted the borrowed stablecoins into more Ethereum and repeated the process to achieve a 1.5x leverage to long Ethereum. Note that Liquity does not charge any interest on loans.
3GI Performance
3GI remains top performer relative to benchmark assets on a Year To Date basis with a return of 75% followed by Bitcoin’s return of 68.4%, Ethreum’s 49.4% and the total crypto market return of 45.9% as illustrated in the chart below.
As for March 2023 monthly performance, Bitcoin was top performer with a return of 17.6% over the month of March, while the total crypto market delivered a return of 15.9%, Ethereum 8.6% and 3GI remained stable over that period. The main reason attributed to 3GI’s underperformance this month was the unforeseen depegging of USDC but we were able to regain the losses realized from the event.
Overall, we are satisfied that we have been able to recoup our losses resulting from the unforeseen depegging of USDC. We are satisfied with the results given what happened and are confident that we are well positioned to deliver superior returns in the coming months, maintaining our outperformance of benchmark assets this year.
OPERATION CHOKE POINT 2.0
Operation Choke point is a term used to describe a campaign by the US government to de-platform cryptocurrency businesses from the banking system to create obstacles for users' adoption. The government is using its regulatory power to pressure banks to stop providing services to cryptocurrency businesses. The government denies that it is engaged in a campaign to target cryptocurrency businesses but the following evidence suggests otherwise:
Crypto’s top banking partners - SVB, Silvergate, and Signature - were all shut down or seized by the government.
Kraken got sued by the SEC and was forced to shut down its staking services.
Coinbase received a Wells Notice from the SEC for offering unregistered securities.
Binance got sued by the CFTC for offering unregistered futures & options trading
Paxos got sued by the SEC and was forced to stop issuing its BUSD stablecoin
Appendix
Stablecoins
Stablecoins have become increasingly popular in the world of cryptocurrencies due to their ability to provide price stability. Unlike other cryptocurrencies, stablecoins have a fixed value that does not fluctuate as much as others. But how are these stablecoins able to maintain their price stability? There are different ways in which this is achieved, with the most common being fiat-backed (most common), crypto-backed, and algorithmic stablecoins. Each method has its own unique characteristics and risks. Let's take a closer look at each one.
Fiat-backed stablecoins
Stablecoins that have the characteristic that each USD-pegged token issued is backed 1:1 by real USD. Fiat-backed stablecoins require bank accounts to hold USD to back the stablecoin issuing. Fiat-backed stablecoins are usually centralized as someone must issue the tokens such as Circle issuing USDC. It is important to note that fiat-backed stablecoins require auditing to ensure the company has sufficient reserves to back each stablecoin with $1 held at the bank. Another risk associated with fiat-backed stablecoins has come to light recently which is the risk of bankruptcy of the banks that are holding the reserves on behalf of the stablecoin issuer.
Crypto-backed stablecoins
This type of stablecoins is backed by other digital assets such as BTC, ETH, other tokens, or any tokenized asset. It is usually created through decentralized protocols to issue and redeem the tokens. Thereby, digital assets are locked as collateral in smart contracts to issue or mint new stablecoins.
Algorithmic stablecoins
Computer algorithm balancing the supply and demand of the stablecoin to maintain price stability. Usually, an algorithm balances a two-token model with a mint-and-burn mechanism for a second price-floating token. The protocol ensures that investors can always swap one stablecoin for $1 of the price-floating token. Arbitrageurs are incentivized to buy the stablecoin on the market and exchange it for the price-floating token if it's trading below the peg and vice versa. This ensures that the price remains stable at $1 by creating demand when price dips below $1 and increasing supply when price goes over $1.
As illustrated in the Matrix below:
Events that led to the unpegging of the USDC
Circle’s USDC is backed by a combination of cash and US Treasuries, and USDC is always redeemable 1 for 1 with the U.S. Dollar. Circle was already going through turbulent times as it had been impacted by the closures of two core transaction banking partners, Silvergate and Signature Bank.
On March 9th Circle initiated a transfer out of SVB, but $3.3 billion of those assets were held in SVB before Circle’s transfers could be settled. As uncertainty around SVB’s solvency created panic in crypto, many USDC holders rushed to exchange their USDC with other assets due to concerns that USDC will not be fully collateralized in light of the SVB insolvency and hence lost its peg as backers feared that there would be a run on the stablecoin if Circle was unable to be made whole on its SVB deposits. The Federal Government stepped in later on and Circle moved cash deposits to BNY Mellon. Today, most of the Circle Reserve Fund (which helps back USDC) is held in Blackrock and BNY Mellon.