Welcome to the free version of the Art of the Bubble!
The 1.2 Labs's Art of the Bubble is a free educational service. The 1.2 Labs subscriber plans make use of the same base algorithm that our crypto hedge fund, 1.2 Capital Management, does.
We have two primary data offerings for stocks: (1) a risk parity “Bubble Portfolio” and (2) a “Leveraged Index Portfolio”. They are pictured below relative to their benchmark: the QQQ, which is an ETF of the Nasdaq100.
Hello Bubble Riders!
The Decentralized Autonomous Organization (DAO) is an idea announced in the whitepaper for Ethereum (written by Vitalik Buterin when he was just 19).
It got off to an inauspicious start, as the world’s first DAO, called The DAO, was hacked. The matter was so bad that Ethereum (ETH) decided to unwind the hack and launch a new version of their blockchain. The old coin would be called ETH Classic (ETC) and the hacker retained all the funds on it. The new coin became ETH as we know it.
This was the DAO v1. It was characterized by the idea that “code is law” but the hacker showed how problematic that was in practice. With the launch of ETH as we know it, the DAO v1 passed on, and it was some time before others tried using the DAO concept again.
But eventually new projects did start to pop up which used the DAO concept and some of them were even decentralized. Yet if anything characterizes the DAO v2 it was that these projects were centralized corporations, often literal Limited Liability Corporations, which paid lip-service to the idea of decentralization.
They actually wanted to launch IPOs using tokens as shares but without all the SEC regulation. This is partly how the crypto world has landed in its current legal struggles with Gary Gensler and the SEC.
To be clear, I think the SEC has not acted to support consumer interests and I disagree with Gensler's actions in the strongest possible terms.
Nevertheless, DAOs need to start off as centralized entities, launched by a few people, and eventually become decentralized. The problem with the DAO v2 is that even the good actors, those who genuinely wished to achieve decentralization, have run into problems with the SEC. And since venture funds don’t want to tangle with that mess, VC capital into the crypto space has dwindled to a trickle...hence our present crypto winter.
But the demise of DAO v2 has led to the birth of the DAO v3. The core quality of this iteration: that its complaint with existing securities laws in the United States, which is where most of the world’s money and tech development talent is.
Here’s how they work in a 5 step process.
Step 1 - Get your project off the ground with funding from somewhere (angel funding? Kickstarter?).
Step 2 - Continue in existence for 2 years and get your books audited (ugh, I know).
Step 3 - Use a firm like tZERO to tokenize your shares and sell them to the public, raising up to $75m using a Reg A exemption. The Regulation A exemption requires those 2 years of audited financial statements. You’ll need yearly reporting if you follow the $75m route, but you won’t if you only want to raise $20m.
- Note, you’ll need to use a broker-dealer (such as tZERO) for this and they’ll take 10% of all the funding that you raise.
Step 4 - Build and grow your project with your now well-capitalized firm. Owners of your tokenized shares can even trade them on secondary markets (with limitations).
Step 5 - Fully decentralize your firm and put the rest of your tokens on the blockchain to operate as current tokens do. Since you’ve got a decentralized firm, your shares have become commodities–you might need some sort of CFTC registration, but that’s usually manageable.
The path is harder, especially in steps 1 and 2.
If you want to avoid those steps, you could try following a Reg D route – selling to accredited investors. Of course, you’re giving the wealthy a first bite at the apple if you do that.
- Because the wealthy will be first purchasers, when regular folks get the opportunity to purchase the tokens, they’ll have smaller potential gains.
Something dies in each version of the DAO. In order to be fully compliant, the DAO v3 gives up equity--putting the poor on the same footing as the wealthy.
My sense is that either version of this path (Reg A or Reg D) is what we’ll see for most projects going forward. They will be regular, centralized firms (likely C corps located in Delaware), that tokenize their shares. After growing for a time, they’ll decentralize and put their tokens on-chain.
Holders of these DAO tokens can earn fees because they’re shares after all. Your ownership will represent a share of the protocols’ fee collection, just like shareholders earn dividends in traditional stocks. Long-term holders will thus gain rewards directly from their HODL-ing.
And yes, you will still see massive returns on these tokens–your 100x returns–for three reasons:
- The protocols will be able to outcompete many existing Web2 technologies using the blockchain. They’ll achieve marginal cost advantages since they’ll have near instant settlement.
- They’ll be more equitable, and so incentivize adoption since users will be paid through real yield bearing tokens, while Web2 tech sends all those funds to the mega-tech firms like Google and Facebook (overcoming the cold-start problem).
- They’ll unlock currently illiquid markets, such as private equity and real estate syndicates. Blockchain tech can still do this in the above framework with full SEC compliance.
For all our followers who are currently involved in a Web3 project–let’s talk. I think this is the right path to follow for the next stage of capitalization.
For everyone else, I think this should explain how cryptos are going to move forward as digital assets. They will honestly make money in this regulated era, but the wealthy will now have a cemented advantage as they do with stocks in the TradFi world.
-Sebastian Purcell, PhD
The Macro Situation
“Yet is there hope. Time and tide flow wide.”
— Herman Melville, Moby Dick
We’re in the economic equivalent of a slackening tide, which is the duration when the tide changes from flooding to ebbing, or ebbing to flooding. Either way, it’s a funny state for the water as the surface can be confused—gentle in some parts, choppy in others.
The US economy is seeing a lot of conflicting, choppy data at the moment.
- Job openings fell to their lowest since March 2021; yet initial jobless claims fell to their lowest in four weeks.
- The core Personal Consumption Expenditures (PCE) Index, which excludes the cost of food and energy, rose 4.2%; yet economists are predicting a significant drop in consumer spending after the summer due to key consumer events propping up numbers (i.e. the Barbie film and concerts by Taylor Swift and Beyoncé).
- Markets broke a five-month positive streak by posting losses for August; yet investor confidence remains almost at its highest since last year.
- The labor seems unperturbed, adding a surprising 187,000 jobs in August; yet unemployment increased 3.8%, with wage growth slowing.
The question is, what will emerge after the slackening?
Most likely, the Fed will be convinced enough to keep rates as they are for September. GDP growth is at 5.6% for this quarter (down 0.3% from last week’s estimate), but if the summer festivities were indeed a factor, we ought to see a drop coming.
Crude oil closed at its highest since January (86.01), with OPEC+ supply cuts working their way through the end of the summer vacation season.
Gold and mid- to long-term treasuries should bounce on this week’s labor market news and likely interest rate pause for September. Note that an increase in November is still on the table unless next month’s inflation data is really compelling.
- Todd Mei, PhD and Sebastian Purcell, PhD
AI Sentiment Report
The following sentiment scores use ChatGPT as part of the AI tech stack to sectors through leading indicators. (Lesson 4 of The Art of The Bubble covers the selection of lead indicators for bubble trades). The scores are most indicative for the next day of trading (a Monday), but they appear to set the general tone for the next week.
The methodology employed is based on this peer reviewed academic article, which produced 550%+ results in back tests over a 2 year time frame. We consider 4 and 5 scores to be positive, but please bear in mind that the AI model is still in its validation phase.
-The Research Team:
Dom Viera, Samantha Russell, Nicole Zinuhova, Aiza Malik
That’s it for this week!
Happy Trading!!
-The Team
Think About Upgrading
Our subscriber plans make use of the same base algorithm that our hedge fund, 1.2 Capital Management does, but modified in timeframe so you don’t have to stare at your screen all day.
Two of our crypto offerings have achieved the following.
This newsletter is provided for educational and entertainment purposes only and should not be relied upon for business, investment, taxation, or legal advice. You should consult your own advisors for those matters. References to any securities or digital assets are for illustrative purposes only and do not constitute an investment recommendation or offer to provide investment advisory services. Furthermore, this content is not directed at nor intended for use by any investors or prospective investors, and may not under any circumstances be relied upon when making a decision to invest in any fund managed by 1.2 Capital Management. (An offering to invest in a 1.2 Capital Management fund will be made only by the private placement memorandum, subscription agreement, and other relevant documentation--all of which should be read in their entirety.) Any investments or portfolio companies mentioned, referred to, or described are not representative of all investments in vehicles managed by 1.2 Capital Management, and there can be no assurance that the investments will be profitable or that other investments made in the future will have similar characteristics or results.
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