TRR Weekly Meeting Recap: Week of March 6th 2023
We are back! Apologies for the longer-than-expected hiatus, but we are back and ready to get back into sharing our thoughts around the markets. There have been some big developments over the last few weeks in the economy and with crypto markets. Major themes from a macro perspective have been continued layoffs in the job market - noticeably for high growth / tech companies. Inflation still remains to be a persistent issue, and the Fed now has to navigate managing inflation and the huge banking meltdown happening with Silicon Valley Bank, Credit Suisse, and more regional banks. Zooming into crypto, we have seen Bitcoin gain extra attention with Ordinal NFTs and most recently; the narrative of Bitcoin being a decentralized store of value has also returned given the tradfi banking liquidity crunch. Ethereum has also been at the center of attention given that the 2023 theme for Ethereum has still been around Layer 2 projects; what does this mean for the other Layer 1 networks out in the market?
Are Companies Strapped For Cash?
As we enter the final stages of the first quarter of 2023, major tech companies still seem to be performing cost cutting exercises, mainly in the form of layoffs.
Figure 1: Monthly Tech Company Layoffs
The continued layoffs for the year points towards these companies having a weak business outlook for the year, hinting that a recession may be on the cards (although this has been hinted at for quite some time now dating back to 2022). Unemployment still sits at 3.6% for the US, which still isn’t a worrying % yet. If the reason for these layoffs are related to cost-cutting, the next chart further supports this point - a lower quality of earnings.
Figure 2: S&P 500 Quality of Earnings
As mentioned by Chamath on the All-In Podcast, the current quality of earnings we are seeing is the worst it’s been in the last 20 years. This can be seen by the gap between the net income adjusted for depreciation & amortization (what is reported to the public) vs cash flows from operations (what actually sits in the bank account). How long can we uphold and make earnings look good when in reality, it’s the opposite. The worsening quality of earnings points to the narrative that business is slowing, and a recession could be on the cards.
SVB & Credit Suisse Backstop, What Next?
Now, with Silicon Valley Bank and Credit Suisse needing some sort of liquidity backstop, it has brought turmoil into the financial markets. From the surface, you may think that since both SVB and CS managed to receive intervention to get them out of their respective holes, the capital provided is very likely so that they can fulfill 100% of current withdrawals. The issue though, is the strike in consumer confidence which would result in a bank run at these banks; how does a bank continue to operate if no one is depositing into them? The argument made here is that Credit Suisse is too big to fail, but the same was said about Lehman back in 2008. However, it is evident that the US and Fed are not willing to let confidence in banks falter as they frantically stepped in to backstop SVB over the weekend - meaning that QE might be on the cards with additional capital injection + tapering off rate hikes.
Stubborn Inflation
The Fed is still in their battle with inflation as it continues to be a pestering problem for the economy. The markets have mixed opinions on inflation, but a simple argument is that if inflation does continue to rise (or even maintain at these levels), it would prompt rates to stay high or move even higher until inflation is managed. This results in short term US T-bills providing ~4%+ yield to investors for relatively lower risk. This puts further capital entering risk-on assets in jeopardy because there is a better alternative in T-bills which offers relatively good yields at much lower risks. If I was a whale, I’d be much more comfortable parking my money with 3-12 month T-bills as opposed to crypto purely due to the R:R in this scenario.
On the other hand, despite all the struggles with inflation, the recent banking crisis in the US with the fall of Silvergate, Signature Bank, Silicon Valley Bank, and now Credit Suisse has forced the Fed’s hand. The US had to intervene in order to prevent more dominos from falling. The liquidity backstop serves as an indirect form of QE, which according to textbooks contradicts the act of trying to bring inflation down. The Fed is caught between a rock and a hard place, and ultimately the decision has to be made between saving the banks and the trust in the American banking system, or risk even higher inflation (potentially even hyperinflation in the future) due to early QE. At the end of the day, liquidity moves markets - if we do see continued QE from here on out, markets could make a move to the upside in the near term.
BTC, Ordinals, Decentralized store of value narrative
Followed by the fall of SVB and the need for a backstop, Bitcoin and the rest of the crypto market rallied; presumably with the decentralization and store of value narrative. The fall of banks of such size definitely struck a chord within consumers and the trust in the centralization of banks. As Stanley Druckenmiller pointed out in an interview a couple months back - he believes crypto will eventually gain adoption when the masses lose faith in the banking system. We are already seeing the first steps of this, so we can only hope that the pivot to decentralization begins to happen more aggressively over the next few years.
Over the last few weeks, we also saw the emergence of Ordinal Inscriptions. In simple terms, they are essentially NFTs inscribed on the Bitcoin blockchain. Some NFT projects have taken notice of this and moved early; Pudgy Penguins already announced that they have inscribed onto Bitcoin. It is good to see extra utility brought to Bitcoin, and provides another potential avenue for fees to be made.
With regards to the price action of the orange coin, it is key to remember that we have been in a bear market for almost 2-years. The macroeconomic situation is still uncertain, but with the Bitcoin halving coming in 2024 and the duration of the crypto bear market, there might be a bullish argument to be made here. If the Fed decides to indeed continue with injecting liquidity into the market, it then shouldn’t be surprising to see risk-on assets like crypto to rally.
Will Ethereum Remain King Of Layer 1s?
If you have been sticking around the markets in 2023, then you should be no stranger to the whole Layer 2 and Rollup narrative that is taking place, most notably with Arbitrum and Optimism with their optimistic rollup solutions. The zK-rollups will also enter the space when these projects are ready to launch, with projects like Polygon and ZK-Sync aiming to capture this market. Taking a step back, L2 rollups allow transactions on Ethereum to be processed at faster and cheaper rates as the settlement, execution and data layer are split into different layers rather than being structured in a monolithic manner - hence the ability for L2s to enable lower transaction fees and relatively faster transactions.
One interesting point that we see here is, what does the emergence of L2s mean for the other L1s out in the market today? Many of the value propositions other L1s have are mainly faster transactions and lower fees (Solana, Avalanche, Aptos); this is something that can now be done on Ethereum due to L2s. Ethereum remained at the top of its market even before the emergence and maturity of L2s. With L2s introduced, we find it hard to believe that activity on Ethereum as a fundamental layer drops. This raises the question - will other L1s end up being ghost chains in the future? We will take a deeper dive into this, so stay tuned for an upcoming post around the Layer 1 landscape.