Things are about to get crazy

Today’s newsletter has been interrupted by a major news event.

The markets ripped higher over the past few hours based on rumors of an imminent approval of ETH ETFs this week. The odds of an approval this week prior to this afternoon were ~zero.

This follows a slew of pro-crypto legislation successfully working its way thru Congress over the past 2 weeks. Leading the way, the House and Senate both passed a bill that would rebuke the SEC’s aggressive and hostile stance toward crypto (reversing the SEC’s SAB 121 rule for digital assets). The bill cruised thru Congress, passing with strong bipartisan (and popular) support.

Jeo Boden had threatened to veto the legislation, but in the face of increasingly loud public disapproval of anti-crypto policies, a large coalition of democrats crossing the aisle to vote for the bill, and Trump publicly voicing his support for crypto, Boden and his politicos may be changing the tune. It turns out crypto is a key issue for swing voters.

The SEC has until Thursday (May 23) to approve, deny, or postpone the decision on the current batch of ETH ETF applications.

If the rumors turn out to be false, then no change to my outlook. The ETH ETF will be approved eventually, even if it is not until next year.

However, if the ETH ETFs are approved this week, ignore everything else and just buy. I will be.

Now back to regularly scheduled content I wrote yesterday before today’s madness.

The silent killer suffocating your returns

I love Arbitrum. It’s a Layer 2 blockchain built on top of Ethereum. Less than a year ago it was my largest crypto position.

On fundamentals, it’s doing great. It has 69% more TVL than the next largest Layer 2 (TVL = total value locked, an imperfect metric that basically says, "how much money is on this thing").

It’s the leading place to do DeFi today. It’s fast. It’s cheap. It has great liquidity. I have lots of great things to say about the product, the ecosystem, and the community.

And yet, I just sold over 75% of my position.

Why sell? Why now?

Because carbon monoxide is filling the room. My upside is suffocating. There’s a silent killer in the order book: token unlocks.

What are token unlocks?

When you are an early investor, founder, or employee of a company, there are restrictions on your equity. If you are so lucky to go public in an IPO, you won’t be allowed to sell your shares immediately. Your shares will "unlock" at a predetermined time 3 or 6 months after the IPO. This is a normal, routine feature of the process.

Most crypto projects follow a similar practice. When the project’s token begins to trade, insiders and investors are locked and unable to sell for some period of time.

These unlocks give the market a little time to settle in, allow for price discovery, and develop healthy liquidity. It gives new investors conviction that the team isn’t planning to dump and run. The show will go on, up and to the right.

Then, over time and in an orderly fashion, early investors and insiders unlock and can sell their bags without cratering the price for the rest of us.

Everyone wins. Usually. Mostly. Except when they win and you lose.

Like most things, crypto takes this normal practice to the extreme. Projects will launch their token with only ~10% of the total token supply available for trading. That means ~90% of the token supply is “locked.”

The shares available to trade are called the float, and a 10% float is very low.

What do you expect to happen when the remaining 90% of the token supply unlocks? What would a rational investor/founder/employee do if they could, for the first time, convert all that magic internet money into a second home and a boat and a drawer full of Patek, AP, and Rolex watches??

They would sell. And they do. While you and I hold the bag.

It's down only, max pain.

Another example of me losing money

Last cycle, I bought a modest bag of Lido (LDO). Lido is an Ethereum based protocol that allows you to deposit some ETH (called “staking”) and in return receive a token called stETH. stETH is exactly like ETH, except it comes with a yield on top. It's a great product. It works. It’s battle tested. It's the de facto smart contract for staking ETH.

So I bought some tokens. Number go up. Let it rip.

The price quickly doubled. I was moonwalking to another 10x. I felt smart. Crypto is so easy. Nothing could go wrong.

Well, a lot can go wrong actually.

The price action got choppy. Volume would spike, typically a sign of momentum, and the price would pop. But then, even on sustained volume, the price would give back the gains. It was like clockwork. Over and over and over.

It turns out that there was a wall of sell pressure coming from the token unlock (read: dump; tank; pain).

LDO token unlocks started in January ‘22 and continued throughout the year. Even as the market cap soared to new highs (as I naively predicted it would), the new token supply hitting the market more than offset any protocol appreciation. The pie was growing, but it was being cut into more and more ever smaller slices.

I was the exit liquidity. I didn’t look at the token unlocks. I knew better. I’d seen what happened to Citigroup investors when they were diluted to Hell in the Financial Crisis. Down. Only. Self inflicted wound.

Fortunately I was able to exit near breakeven. It could have been much worse.

I learned the lesson the hard way; now you don't have to.

Back to Arbitrum

Arbitrum insider unlocks began in March. I'm writing this on May 19. The token price is down 50% since unlocks started.

I learned my lesson from LDO. I really like Arbitrum, but I don't think the token will outperform until at least next year when the token unlock process concludes.

Maybe I’m wrong. Maybe it 10x’s next week. Maybe none of the early investors or employees sell. Maybe demand goes thru the roof and overwhelms all that sell pressure. [last minute edit: maybe the ethereum ETF gets approved unexpectedly]. Maybe.

But I’m not betting on it. I’m going to fish in a different pond for now.

How to avoid unlock pain

Checking a token's unlock schedule is now a non negotiable step in my investment process. A token just isn't going to 100x with an unlock slapping it in the face. They will sell into your bid all day long.

Fortunately, this is easy to avoid and takes all of 2 seconds to check on any decent crypto website. I prefer CoinGecko.

Here’s the link to Arbitrum.

Scroll down about half a page until you see "Arbitrum Statistics." In that table there are two numbers at the top, Market Cap and Fully Diluted Valuation (FDV). Ideally, these two numbers are the same or very close to each other.

If the Fully Diluted Valuation (FDV) is considerably higher than the Market Cap, then you have an unlock situation on your hands.

Market Cap is defined as the price of the token multiplied by the number of tokens available to trade. It excludes the tokens that exist but haven't unlocked yet.

FDV is the same thing, BUT it includes locked tokens. This is a far better representation of what you're buying. The bigger the difference between market cap and FDV, the more locked tokens you have to account for before you buy.

For ARB, FDV is about 3.8 times higher than market cap. Not good for the token price.

Understand what you’re buying

The key takeaway today is to remember that crypto prices obey supply and demand just like any other asset. It’s more fun to focus on the demand side — macroeconomics and policy and innovative new products and optimism for the future. [last minute edit: like for example, an unexpected ethereum ETF approval opening up access to ETH for millions of investors, pension funds, etc]

The supply side isn’t as exciting, but it’s just as important. And it’s easier. You don’t have to predict the future to get it right. The answer is written down for you. Just read it.

This list of the top 300 crypto tokens by market cap, sorted by FDV is a great place to see how prevalent this is across projects. The MC and FDV columns are side by side, making for an easy eyeball comparison.

Having a big token unlock doesn’t mean that a project will never be a good investment either. In fact, tokens approaching the end of their unlock can represent great opportunities to buy right before sell pressures ease.

Before you buy a crypto token, you need to understand it’s token unlock schedule. Make it one of the first things you do when you evaluate an investment and you’ll save yourself a lot of pain on your ride to the moon.

Portfolio Update

Last week I made two trades, taking profit on a portion of my Celestia (TIA) position (speaking of unlocks, TIA has one coming up in October) and reducing my position in ARB as discussed (I still own a small bag of ARB).

I consolidated that capital into SOL.

Market Vibes