Senvest Capital is essentially a publicly-traded hedge fund with a great performance track record. In the second-quarter Senvest exited its position in Silvergate Capital, a crypto bank and inter-exchange payments network.
The management discussion and analysis outlines why the position was sold even though Senvest still believes in the underlying technology.
Silvergate Capital (“SI”) fell -20% in the quarter, due to the deteriorating cryptocurrency price and volume backdrop. While SI’s share price generally follows the price of crypto assets, deposit growth is driven by institutional and retail trading activity. SI acts as the on and off-ramp for fiat currencies into the crypto world, allowing institutions to move money onto and between exchanges 24/7. This is a must-have capability for two types of SI customers: retail trading platforms (Robinhood, for example) and high frequency traders (“HFTs”). The former needs to have fiat ready to be sent on-exchange over the weekend when a significant amount of retail trading occurs and when the traditional banking system is closed. HFTs need to be able to move their money quickly between exchanges to capture various arbitrage opportunities before they disappear.
The recent sell-off in crypto began with the Chinese government banning bitcoin mining, under the guise of limiting carbon emissions. This later expanded into blocking cryptocurrency exchanges in search engine results, suspending social media accounts of crypto influencers, and going after OTC desks, citing concerns over excess speculation and money laundering. The one common thread throughout this timeline is the continued testing of China’s new central bank digital currency (“CBDC”). Unlike most blockchains, which are public and permissionless, China’s new CBDC will be both private and permissioned: the immutable record of every transaction will be subject to scrutiny, but only by the proper authorities. We are of the opinion that their agenda here is twofold: 1) pave the way for China’s CBDC, and 2) stem the flow of money bypassing capital controls via cryptocurrencies.
Given east Asia accounts for a third of all crypto value sent and received, this likely sparked the recent selloff in Bitcoin and other digital assets. Retail trading volume typically follows price performance, and HFT activity generally chases market inefficiencies caused by retail investors. Levered losses likely caused forced selling by some retail investors, meaning favorite arbitrage opportunities such as the “basis trade” dried up. As a result, June crypto exchange volumes fell to ~$960bn1, down -56% from $2.2tn in May.
Beyond these unfavorable business dynamics, SI did announce a new positive development: a partnership with the Diem Association (“Diem”). Diem is a project aiming to leverage blockchain technology, in the form of stablecoins (crypto backed 1:1 with dollars), for commerce and cross-border payments. It is one of the longest awaited projects in crypto, and the association boasts non-crypto-native members such as Facebook, Farfetch, Lyft, Uber, Shopify, and Spotify. Unlike the existing banking system which operates 9-5, Monday through Friday (and settles even slower), blockchain transactions can be settled in seconds. They’re faster, cheaper, and more transparent. The stablecoin value proposition has been validated by crypto traders and we believe that commerce, P2P payments, and remittance are a few of the first real-world applications of this new technology. SI will be acting as both the transaction bank (creating and redeeming stablecoins) and as the reserve bank (holding and investing the dollars backing the stablecoins).
Overall, while 2Q was favorable in the aggregate given record exchange volumes in April and May, we decided to exit almost the entire position given the deteriorating backdrop into June and Q3. We remain bullish on blockchain technology, specifically the Diem partnership, which validated our thesis that SI is “best-in-class” among crypto peers. That said, the current business model’s leverage to trading activity currently outweighs this potential upside.
Senvest Capital, Second quarter MD&A
