Advanced Blockchain AG: Investor Letter Q2, 2022
BWQ.DE
Dear Investor(s),
The second quarter (Q2) of 2022 has come to a close. Advanced Blockchain AG had a very active second quarter, with numerous internal and external events taking place. First, some thoughts on the current state of the industry and the major events that occurred.
The market capitalization of cryptocurrencies fell in Q2 from $2.1 trillion to approximately $930 billion (current figure). Besides macroeconomic events such as the Russia-Ukraine war, energy supply shortage, supply chain shock, and alarmingly rising global inflation, there have been three incidents in our industry that have made things even more challenging.
Stablecoins are pegged to fiat currencies like the US dollar (USD) and therefore prices are supposed to be stable, for example, $1 at all times. Algorithmic stablecoins are one such concept with which this peg can be maintained. What backs them is an on-chain algorithm that facilitates a change in supply and demand between them (the stablecoin) and another cryptocurrency that props them up. In the case of the Terra blockchain, this was performed by TerraUSD (UST), the stablecoin, and Terra (LUNA), Terra's native cryptocurrency that backed the stablecoin. Here is how the UST-LUNA mechanism worked:
When the UST supply was less than its demand, the price of UST went above $1 (to let's say $1.01). To bring UST back to its peg, the Terra protocol allowed users to trade 1 USD worth of LUNA for 1 UST. This trade burned 1 USD of LUNA and minted 1 UST so that users could sell for 1.01 USD and secure a profit of 0.01 UST. When the supply was higher than its demand, the opposite happened: the price of UST went below $1 (to let's say $0.99). Then the protocol permitted users to do the opposite: users could buy 1 UST for 0.99 USD and then trade 1 UST for 1 USD of LUNA - netting the arbitrage trader a profit of 0.01 UST.
One of the earliest signs that things were going wrong for the stablecoin appeared when UST deposits on Anchor Protocol (Anchor offered a yield of up to 20% for users who deposited their UST - this in itself seemed unsustainable from the start) started dropping. The massive drain of UST from Anchor onto the open market contributed to major selling pressure and the price of UST went down. Market participants started to sell UST for LUNA which then inflated the market with LUNA. Therefore, the price of LUNA plummeted.
Eventually, the market cap of LUNA flipped that of UST for the first time - which meant there was no longer $1 worth of LUNA for every $1 of UST. To shore up UST's price, the LUNA Foundation Guard (LFG), Terra's official peg defenders, deployed over $2 billion from its newly-formed Bitcoin (BTC) reserve. They started selling BTC to defend the peg which accelerated market pressure on BTC. This in turn made the whole market more insecure. Eventually, the collapse of LUNA and UST wiped out $60 billion in investor value.
Celsius Network, a CeFi company (a centralized provider that offers access to DeFi services), has stopped withdrawals for its customers. As of May 17, Celsius claimed that it had 1.7 million users and assets under management (AUM) of $11.7 billion. The company said that it had given out more than $8 billion in loans and until recently had offered high APYs of up to 18% on cryptocurrency deposits - which much like Anchor's yield offering on UST, seemed unsustainable from the get-go.
To generate these returns, on one hand, large portions of Celsius assets were firmly locked onto various DeFi applications for a significant period, which made them illiquid. On the other hand, probably, various leveraged positions were taken which could not be serviced (due to the latest market crash) and thus were liquidated. This again, like in the case of the Terra ecosystem, could have led to a downward spiral. Currently, it is not certain whether Celsius is insolvent and/or whether the company will find a buyer.
Three Arrows Capital (3AC) is a crypto-focused hedge fund with roughly $3 billion in AUM. In April 2022, 3AC had failed to meet margin calls on several of its undercollateralized loans from crypto lenders such as BlockFi and Genesis. In addition to the leveraged positions that could not be serviced and led to liquidation, 3AC was also an investor in the Terra ecosystem. During Terra's last investment round, the hedge fund invested $200 million in the project. It is uncertain how many 3AC assets in the form of UST had been locked on Anchor, how quickly they were converted, and therefore how high additional losses were. Furthermore, 3AC holds illiquid assets which were locked onto various DeFi applications for a significant period. The Terra investment and numerous illiquid assets may have led to 3AC not being able to meet its margin calls. It is currently still unclear what the future holds for 3AC.
Our industry is still at a nascent stage and gradually, through these turbulent cycles, coming to maturity. In general, such phases often help reduce leverage (for example, as described above) and constitute a natural selection in favor of fundamentally strong projects. However, market maturity cycles are not linked to product innovation cycles. For example, in 2007-2009, Uber, Venmo, Snapchat, and Instagram were created amid the then financial crisis. During this period, there was a blend of technological advancement, talent, and capital amidst financial turmoil - innovation never rests. The blockchain industry today has many fundamental issues/market opportunities that should be solved at the earliest/explored.
The industry certainly does not lack talent and capital. Digital currencies, DeFi, and NFTs were the first "it" applications of blockchain technology that continue to evolve. Countless more use cases, regardless of the market situation, will find their product-market fit and thus, due to their massive value adds, turn industries upside down. No one can exactly say what the next "it" application in our industry will be, but we are closely monitoring developments across all fields of application to identify trends as they emerge and thus invest and build products accordingly. Furthermore, we will continue to support and carefully expand our current investments and projects to cater to current and future needs and market requirements.
For the next two quarters until the end of the year, we have set several guidelines according to which we will act. As already announced and partially implemented, we will downsize our organization to essential responsibilities and roles. As personnel costs are our biggest cost driver, we have already taken steps to reduce costs extensively, in the short term. However, deep industry- and development-expertise remains within the company, ensuring that we do not lose our leading role in the industry, as a Web3 enabler.
Since this is a tough time for the industry as a whole, including for some of our investments, we want to make sure that they receive sufficient support. Therefore, we are in extensive contact with their founders to identify current problems and develop solutions accordingly. We will also reduce our investment activity and focus on projects that precisely fit our investment thesis and have a resilient team in place.
For the time being, no new incubation effort will be made, and if so, only those that can be covered internally with manageable effort will be birthed. We have a strong portfolio of incubations with a variety of different use cases, each solving a specific problem in the market. Now, more than ever, the focus is on developing these projects, securing further rounds of funding, and ultimately building profitable and scalable businesses in the long term.
As already mentioned, market and product development cycles differ. It is uncertain how and when the macroeconomic situation will change. However, Advanced Blockchain AG has various valuable assets, ranging from software code, to IP, and rare licenses. These internal resources are being utilized to develop disruptive technology and empower entrepreneurs. Therefore, the inherent and added values of our projects and investments are steadily increasing. Once the market regains momentum and our scaling solutions, essential infrastructure, and talent and capital are advanced enough, these product innovations will unfold their appropriate values.
We will take all necessary measures to protect our company and shareholders in these difficult times and emerge even stronger from this crisis.
Further information on Advanced Blockchain and our other projects and investments can be found at https://www.advancedblockchain.com/.
Thank you for your trust!
The Advanced Blockchain AG Team
Disclaimer
Advanced Blockchain AG published this content on 30 June 2022 and is solely responsible for the information contained therein. Distributed by Public, unedited and unaltered, on 30 June 2022 11:52:09 UTC.