Anatomy of the encryption cycle: I will definitely escape this time

Original title: But They Won't Trap Me The Anatomy Of The Cycle

Original author: Matii, Zee Prime Capital

Original compilation: Kaori, BlockBeats

Editor's note: Matti, partner of Zee Prime Capital, wrote in this article that with the gradual increase in capital flows within the market, especially the influx of institutional funds, it is driving the development of the market and price action. Despite relatively limited innovation, the market remains active, and investors are constantly faced with the balance between the pursuit of immediate wealth and the exploration of new opportunities. However, the market outlook has become more complex and uncertain, and overexposure can lead to catastrophic consequences. Still, opportunities for exploration and development continue to present opportunities for those working in the cryptocurrency space.

Disclaimer: This article does not constitute investment advice, but is merely a curious discussion of the cryptocurrency cycle. Zee Prime says long-lasting bullishness, a bullish view.

Some things seem inevitable in hindsight. Sometimes the difference between "inevitable" and "impossible" is minute, maybe just a few weeks of price action. I want to explore this distinction in hindsight. The crypto bull market is formed by two interacting forces: the top-down flow of resources (capital) and the bottom-up flow of products (ideas). Combining capital with the right ideas leads to innovation or at least opens the imagination. At this point, exploration becomes exploitation. I'll share personal insights from the past few years and then discuss the differences between the exploration and development phases of the cycle. To conclude, I will summarize possible future scenarios and make a personal comment.

Resources

In the field of encryption, we have experienced from extreme fear to extreme The rapid transition from apathy to high expectations, all within about 12 months. We could say that collectives always lack vision, but the momentum created by groups can limit individual decision-making.

After the extreme fear of late 2022, most investors are cautious about allocating capital, while some have given up on cryptocurrencies entirely. During the period of extreme apathy in the summer of 2023, many gave up on allocating capital as capital constraints (present and future) and macroeconomic momentum painted a bleak outlook.

As markets surge into late 2023, fueled by the ETF top-down narrative and opportunities presented by an oversold Solana, this begins to create a perfect storm of capital allocation in the market. Talking to many fellow investors in 2023, I have to say that there is little to no optimism expressed. The few who have the resources don't actually deploy them either.

Many investors in the cryptocurrency space, both in terms of liquidity and venture capital, were surprised by the sudden turn to bullishness, and at least they expected six more months of winter. The prospect of a gold bull market emerged almost overnight, and investors suddenly felt trapped.

Those with liquidity are rushing to buy coins they should have bought a year ago; while venture investors, even with the resources, are chasing the hottest narrative – mainly second-tier solutions and AI. We can judge by observing the following situations:

1. Oversubscribed

2. Only KOL/angel investors

3. Aggressive pricing

4. Weekend closing

Those who feel over-allocated in December 2022, in 2024 March felt under-configured. Liquidity inflows began to accelerate in late 2023, followed by capital calls from VC funds to those few who still had resources available.

Based on my personal experience raising crypto VC funds from mid-2023 to present, it is nearly impossible to find actively allocated LPs. On the FoF side, most are struggling, delaying capital allocations each quarter, while those few with resources have opted for larger institutions.

In the summer of 2023, a Partners at large FoFs say they are nervous about every $500,000 check. Another FoF revealed in private conversations that they have had conversations with around 100 crypto VC funds raising capital in 2023 (I can’t even name that many), but have not allocated to any of them. This is not just a phenomenon in the crypto space, as venture capital is declining globally.

For the encryption field, in addition to the general macro crisis, there is another micro crisis-the FTX incident. I had a conversation with a US FoF shortly before the FTX explosion and they said they had committed tens of millions of dollars to crypto fund managers, but the FoF itself would only start raising funds in late 2022 and I had heard of no real success with them Funds raised. When cryptocurrency funds seek funding, many limited partners find themselves unable to meet their funding commitments.

The situation with FTX has also delayed the entry of new money into the cryptocurrency market, with many smaller and larger family offices and funds hungry for cryptocurrency exposure losing interest. Very few investors can truly think for themselves, which is why we experience mania and disillusionment.

However, comparing the crypto winter of 2018 with 2022/23 shows that traditional finance’s expectations for a cryptocurrency rebound are more optimistic. In fact, before the FTX incident, I talked to many people in the traditional financial field, many of whom were not involved in cryptocurrencies or were only involved in fringe markets, and believed that cryptocurrencies were here to stay, which is definitely not the case in 2018. .

To summarize, in my (limited) personal experience, VCs and liquidity allocators are crowded out by the rapid changes in sentiment, which means that around current There is a narrative forming a funnel and the market is accelerating.

The catalysts for the bull market are inflows into ETFs and liquid crypto funds, repricing the secondary market (which is already happening). On the primary market side, I expect inflows into the cryptocurrency venture space to increase in the second half of 2024, but primarily in 2025, which will drive an already competitive primary market.

Idea

The bear market was quickly cleared by the Luna crash and the FTX thunderstorm , sellers sold off quickly and those who were still in the market were shocked. If they have position allocation, they will feel uneasy. The influx of founders diminished as many turned their attention to the AI craze.

The reset of the narrative comes quickly. Periods of disillusionment in cryptocurrencies serve to explore new ideas, select the best ones, and exploit them in a narrative that takes a turn toward mania. The exploration phase lays the foundation for the later imitation competition. Exploration is about finding the legendary “innovation trigger.”

Throughout 2023, deal flow was the most diverse as there was no particularly strong narrative. In terms of infrastructure, some have come together, such as Intents, Zero-Knowledge Proofs, Rollups/L2, Ordinals, etc. Founders are effectively forced to think about it for a while before piling up VC interest. At this point, founders and investors alike are eager to explore. This is when crypto reaches its creative peak, small improvements to hot things don't work as well as hot things because there aren't enough hot things in a bear market, but excitement about things doesn't last long in a bear market.

With the market soaring at the end of 2023, the search for the "innovation trigger" is over - the card has been played, and I believe that the Overton window of this bull market has been Being certain, however, does not mean that the top performers have emerged and are investable.

Uniswap is probably one of the most copied products of the past cycle, however the second most copied product, OlympusDAO, the founder of DeFi 2.0, did not appear until a few months after the end of DeFi Summer. So there is still room for innovation, but it must be done by leveraging existing narratives.

The narratives with the greatest potential we see today are:

· Crypto AI

· Restaking

· Second Layer Solutions

· Zero Knowledge Proofs

· Infrastructure

· DeSci

· SocialFi/Web3 Social

The above are relatively undefined categories, more like buzzwords used to vaguely identify what people are building. Many products may be a combination of two or more of the above. The winners will be those who can master user acquisition through the two traditional tools: yield and leverage. "Numbers up" and "fingers up" are always the best user experience.

Exploration vs. Exploitation

Let’s briefly discuss the game theory of exploration/exploitation. There are two phases in the cryptocurrency cycle, one where people are forced to come up with something seemingly novel, and the other where people exploit these novelties and exaggerate the narrative to exploit.

In a bear market, we are stuck in a local maximum. As old narratives collapse, they cannot further support the market, founders are forced to explore, and investors are hesitantly willing to follow. The “innovation trigger” is the potential foothill of the new global maximum, which becomes an objective condition for exploration, around which a new narrative can be built.

As previous ideas become dead ends, founders go back to the starting point and expand the exploration space. As prices continue to fall or stagnate, the greater the incentive to abandon the safety of the old narrative and explore greater areas of potential novelty.

At some point, explorers set their sights on what could become a new global maximum foothill. Typically, the formation of the foothill is a function of novelty and price recovery. While this may be more correlation than causation, it is good enough to start the climb and form a broad narrative.

The climb signaled the end of the exploration phase, we set up a camp and started taking advantage of the market kinetic energy. At this point, the reflexive relationship between novelty and price action begins to push the global maximum higher, with price becoming a leading indicator of adoption.

As of March 2024, it seems that we have found the foothill and everyone is eager to climb this new mountain because it seems to have more benefits than exploring further.

What next?

The exploration phase is over. Considering that most investors are passive, they will not waste time exploring, but will double down on the advantageous position they have begun to occupy. , as they must make up for lost ground. The funding round is starting to be oversubscribed, indicating that investors are already in full development mode.

2024 will be a year similar to 2020 and 2016 in terms of internal hype. The actively engaged retail base in crypto is already higher than it was in 2020, which means we are starting from a higher starting point and despite little innovation over the past two years, we are making strides with the resources.

Developers focus on resources, while explorers focus on ideas. There is a subtle difference between investors and "people in the investment business" (investors and allocators).

Development strategy is also a function of scale. Most resource-rich funds focus solely on development because innovation or exploration does not require significant amounts of capital compared to competing on the development axis. There is a lot more dumb money than outsiders believe and insiders won't admit.

Given that during any mania the abundance of capital seeks scarce talent, many will compromise to meet the objectives of its deployment. Or in the words of Hobart and Huber: "While genius is scarce, the demands of the gullible are always met by a healthy supply of fraud." Expectations are inflated, and founders are incentivized to engage in resource wars, subsidizing all kinds of exotic varieties. income.

Top-down flows of capital will also gradually increase as venture capital The company's fundraising machine is already gearing up. Early internal competition for funding rounds means insider and institutional money will support the market until retail investors arrive in force. Additionally, retail investors are not a homogeneous group but rather various waves of adoption within a cycle.

The most fearful are transforming into fearless bull market participants, but this is just the other side of insecurity. Remember that insecurity is the root of greed, and there is a lot of insecurity in the current market.

The reality is that there hasn’t been much innovation in the crypto space over the past two years, so it’s difficult to view this bull run as a separate event from the previous one. Thematically, it appears to be a continuation of the previous cycle, but on a larger scale, as income arbitrage becomes more profitable and institutional doors open with ETFs.

Imagination triggers are more powerful than innovation triggers for a period of crazy mania. Reflexivity is unleashed again, most people in the space are supporting kayfabe (fictional sexual performance), and the role of credit has not been played out this cycle.

A few months ago I wrote in our investor letter:

Every Every crypto cycle tends to perish by overdoing its fundamental principles. 2017 was ruined by overindulgence in the ICO craze, and 2021 is ruined by overexploitation of the DeFi narrative; the underlying principle of each craze was a mimetic scramble for instant wealth.

This rally was started by a top-down flow of institutional capital, with nothing truly shiny new. The underlying basis for the coming mania is the inflow of institutional money (and credit?) and the price action itself. Will this cycle die because institutional money is overexposed?

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