Dialogue with Arca Chief Investment Officer Jeff Dorman: Are discounted coin prices a good opportunity to buy the dip?

Guest: Jeff Dorman, Chief Investment Officer at Arca

Host: Laura Shin, Writer and Host of Unchained

Compiled by: Deep Tide TechFlow

Key Takeaways

The recent cryptocurrency crash has left many investors puzzled. In this episode, Arca's Chief Investment Officer Jeff Dorman delves into the factors behind the crash, its macroeconomic impacts, and why he remains optimistic despite the market downturn. He expresses surprise at Ethereum's poor performance this year, believes the Democratic Party's handling of cryptocurrency is a misstep, and discusses the differences between traditional finance (TradFi) and decentralized finance (DeFi) during market turbulence.

Two Main Reasons for Last Weekend's Market Crash

• Jeff points out that when he sees significant price fluctuations, he first analyzes the differences between new information and previously known information. He believes there are six main theories behind the market weakness, with two factors having the most significant impact in the past 72 hours.

• Global Macroeconomic Issues: The first is the unexpected interest rate hike by the Bank of Japan (BOJ), which caused the Nikkei index to drop nearly 8% over the weekend and another 12% the following day. This erased all gains made in the year within a week. Meanwhile, the VIX index surged, affecting the digital asset market. Nevertheless, the cryptocurrency market's reaction was far more pronounced than other markets, highlighting its characteristic of abnormal responses.

• Massive Sell-off by Jump Trading: Jeff believes that Jump Trading sold nearly $600 million worth of Ethereum on Sunday, possibly related to liquidity issues they were facing. He proposed three possibilities: first, they were forced to liquidate due to collateral issues; second, they were preemptively avoiding an anticipated market crash; third, they were engaging in "stop-loss hunting" in a low liquidity market. These factors contributed to the market's extreme volatility.

How the Macroeconomic Environment Recently Affected Cryptocurrency and Why the Market Moved Too Quickly

The Relationship Between Macroeconomics and Cryptocurrency

• Jeff explains that the relationship between macroeconomics and cryptocurrency has been interesting over the past six to seven years, as this relationship has been intermittent. He recalls his experience in traditional debt and equity markets, noting that early in his entry into the crypto space, the market did not pay attention to macroeconomic data, but after 2022, as the correlation between the crypto market and other markets increased, the importance of this data began to rise.

The Impact of Employment Reports

• Jeff notes that the recently released employment report showed the unemployment rate rising to its highest point in three years, and the significant revision of unemployment figures for June caused panic in the market. He emphasizes that the market's reaction is not solely due to the employment data itself, but because Federal Reserve Chairman Powell's remarks on Wednesday were ambiguous regarding interest rate cuts, failing to provide a clear timeline. As a result, the market is concerned about the Fed's slow response to economic slowdown.

• He further explains that the history of interest rate cuts over the past 25 to 30 years indicates that the market's reaction to Fed rate cuts depends on the reasons for the cuts. If the Fed begins to cut rates only after clear economic weakness has emerged, the market typically experiences significant declines; however, if the cuts are preventive measures taken before economic slowdown, the market may rise. Therefore, Jeff believes the challenge for the Fed now is to act before the economy requires rate cuts to avoid further market declines.

Reasons for Overreaction in the Market

• When discussing why the market overreacts, Jeff points out that despite some negative data, the overall economy is still performing well, and corporate earnings remain strong. He believes the market's reaction to a single data point is overly severe, especially when other economic indicators are relatively stable. He mentions that although the market experienced extreme volatility on Friday, the actual decline in the stock market after opening was not as significant as expected.

Why Ethereum (ETH) Fell More Than Other Cryptocurrencies

The Impact of Jump Trading

• Laura mentions the significant drop in Ethereum's price over the past week and asks if it was solely due to Jump Trading's sell-off.

• Jeff responds that market volatility is usually not caused by a single factor but is the result of multiple factors working together.

• Jeff explains that the wallet activity of Jump Trading triggered panic in the market, especially before the sell-off of Ethereum began; the news of a large amount of Ethereum being transferred to exchanges by Jump Trading was undoubtedly the "last straw." Although Ethereum was already affected by other market factors before Jump's sell-off, Jump's selling exacerbated the downward pressure on the market.

• He emphasizes that while Jump Trading's trading behavior may have impacted the market, overall market sentiment and other macroeconomic factors are also at play.

• Jeff believes that market reactions are often based on emotions and expectations rather than actual economic data. He points out that while the crypto market may be subject to extreme volatility in the short term, fundamentals remain the key factors determining prices in the long run.

Market's Forward-Looking Reaction

• Jeff also mentions that the market often reacts in advance when it knows that supply is about to enter the market. He uses the high-yield bond market as an example, explaining that when the market hears that a large fund is about to sell a significant amount of assets, other investors will preemptively sell to avoid price declines, resulting in actual sell volumes far exceeding expectations. This phenomenon is particularly pronounced in the low liquidity crypto market, leading to amplified price fluctuations.

Macroeconomic Factors

• Additionally, Jeff points out that the market was already weak before Jump Trading's sell-off, primarily influenced by macroeconomic factors such as the BOJ's interest rate hike, the rise in the VIX index, and the increase in U.S. Treasury yields. These factors collectively led to a particularly strong reaction from the market towards Ethereum.

Unexpected Performance of Ethereum ETFs

• Laura mentions that although the recent launch of Ethereum ETFs was seen as positive news, Ethereum's performance remains surprising.

• Jeff states that if someone had told him at the beginning of the year that Ethereum ETFs would be approved and that there would be significant changes in the U.S. political landscape, people might have predicted that Ethereum would perform very well. However, in reality, Ethereum's performance has not matched that of Bitcoin, Solana, BNB, and other assets, and in many cases, it has performed poorly.

The "Most Important" Shift in Cryptocurrency Policy This Year

Key Moments of Policy Shift

• Jeff mentions that May of this year was a key period for significant shifts in cryptocurrency policy. He believes it was one of the most important weeks in crypto history, marking a notable change in the U.S. attitude towards cryptocurrency.

• Jeff lists a series of events, including Trump's statement on May 8 that "voting for Trump is voting for cryptocurrency," and the Senate's vote on May 16 to repeal accounting rules SAB 121 that negatively impacted digital assets.

Expectations for Ethereum ETFs

• Furthermore, Jeff mentions that on May 20, the research team raised the approval expectation for Ethereum ETFs from 0% to 75%. These events collectively represent a significant shift in the U.S. regulatory environment, indicating a clear increase in policy support for cryptocurrency.

Misjudgment of Cryptocurrency by the Democratic Party

• Jeff points out that the Democratic Party's stance against cryptocurrency during an election year is a significant misjudgment. He believes there are a large number of voters in the U.S. who support cryptocurrency, while the opposition is minimal.

• Jeff emphasizes that if the Democratic Party continues to oppose cryptocurrency, it may alienate a significant number of voters, making this strategy extremely unwise in an election.

Market Reaction and Political Dynamics

• With Trump and the Republican Party viewed as more friendly towards cryptocurrency, Jeff observes that market expectations for the upcoming elections have also changed. When Biden exited the race and Kamala Harris was nominated, the market's expectation of Trump's victory dropped from 76% to 52%. This shift in political dynamics negatively impacted cryptocurrency prices, further exacerbating market weakness.

Yen Carry Trade as One of the Key Factors Leading to Market Collapse

Concept of Yen Carry Trade

• Jeff explains the basic concept of the yen carry trade, noting that it is a widely practiced arbitrage strategy across multiple markets. Simply put, this trade involves borrowing low-interest currencies (like the yen) and converting them into high-interest currencies (like the dollar) for investment, to earn interest rate differentials. Japan's long-term negative or near-zero interest rates allow investors to borrow yen at relatively low costs, thus achieving higher returns in other markets.

Market Reaction and Risks

• However, recently the BOJ raised interest rates from negative to zero and subsequently to 0.25%. Although this seems like a minor adjustment, it means higher borrowing costs for highly leveraged traders, forcing them to quickly liquidate positions to avoid losses. Jeff points out that when the yen appreciates, traders who borrowed yen to invest in dollars face significant loss risks because they need to repay loans at higher interest rates.

Technical and Fundamental Factors

• Jeff emphasizes that market volatility can be divided into technical selling and fundamental selling. Technical selling is usually triggered by leverage-induced short-term market fluctuations, while fundamental selling is closely related to economic indicators (such as unemployment rates, consumer spending, etc.). He believes that the current market decline is primarily driven by technical factors rather than fundamental deterioration.

Historical Context of the Market

• He also mentions that similar situations have occurred multiple times in history, such as the Long-Term Capital Management incident in 1998, which was caused by excessive leverage leading to market collapse. While yen carry trades may cause short-term shocks to the market, they typically do not trigger systemic risks unless the trading scale is large enough to require bailouts.

Overall Market Condition

• When discussing the overall market condition, Jeff states that although the Japanese stock market (Nikkei) has seen a significant decline, other markets have experienced relatively smaller drops, indicating that this event has not caused widespread impacts on global markets. He points out that current fundamental data from the U.S. economy does not show signs of recession, and there is a mismatch between market reactions and actual economic information.

Does Genesis's Distribution of $4 Billion in Assets Impact the Market?

Background of Genesis Asset Distribution

• Laura mentions that Genesis has begun distributing about $4 billion in cryptocurrency and cash to customers after its bankruptcy and asks whether this has affected the decline in cryptocurrency market prices.

• Jeff responds that viewed in isolation, this asset distribution may not cause significant impacts, but combined with other factors, it indeed exacerbated market weakness.

Potential Impact of Asset Distribution on the Market

• Jeff explains that Genesis's asset distribution is primarily due to the conclusion of its bankruptcy proceedings, meaning creditors will receive cash and Bitcoin returns. While some customers may choose to hold these assets long-term, there is also the possibility of selling them. Market participants may preemptively sell to prevent price declines in anticipation of asset distribution, which increases selling pressure.

Comparison with Historical Cases

• He mentions that similar to the Mt. Gox situation, the market has been discussing the Bitcoin return issue for nearly a decade, and the actual market impact has not been that significant. Although a large portion of the $900 million in Bitcoin from Mt. Gox has been distributed, it did not cause a major shock to the market. This indicates that the market's reaction to supply issues is often excessive, and short-term traders may exploit these expectations for arbitrage.

Recent Market Supply Pressure

• Jeff further analyzes the recent supply pressure in the market, including Bitcoin from Mt. Gox, Bitcoin seized in Germany, and sales of locked assets after FTX's bankruptcy. All these factors have contributed to an increase in asset supply in the market. He emphasizes that market participants often react in advance to these supply changes, leading to price fluctuations.

Future Market Outlook

• Regarding the future, Jeff notes that FTX is expected to distribute cash by the end of this year or early next year, with an estimated amount between $12 billion and $14 billion. This could impact the market, especially if these funds are reinvested into the cryptocurrency market. He states that the benefits and challenges of real-time on-chain analysis coexist; while it provides immediate information, market participants may act preemptively, amplifying price volatility.

Why Jeff Believes Current Data Does Not Indicate a U.S. Economic Recession

Views on Economic Recession

• When discussing the possibility of a recession, Jeff states that he does not have a strong view that the economy will enter a recession, but he firmly believes that current data does not show any signs of approaching recession. He points out that a recession is typically defined as two consecutive quarters of negative GDP growth, and the GDP growth for the second quarter is expected to be between 1.5% and 2%, indicating that the economy is still growing.

Corporate Earnings and Economic Activity

• He mentions that recent second-quarter corporate earnings data shows a profit growth rate of 12%, exceeding the expected 9%, further supporting the view of a healthy economy. Despite some mixed data, such as rising unemployment rates and declining revenue expectations for some large tech companies, the overall economic performance remains relatively strong.

Current State of Living and Consumption

• Jeff also notes that personal life experiences reflect the economy's vitality. He mentions crowded airports, difficulty in renting cars, and fully booked hotels, indicating that people's travel and consumption activities remain robust. He recalls the 2008 economic crisis when airports were nearly empty, many people were unemployed and unable to find work, which is starkly different from the current situation.

Market Reaction and Data Dependency

• He further analyzes the market's reaction to economic data, noting that during the early stages of the COVID-19 pandemic, the market reacted extremely violently, while recent market fluctuations have not shown the same degree of intensity. He believes that while some unemployment data may suggest an economic slowdown, it is not enough to trigger a strong negative reaction in the market. He emphasizes that the current market still presents a good buying opportunity.

Future Outlook

• Finally, Jeff states that although signs of economic slowdown may emerge in the future, based on current data, he does not believe the economy is heading towards recession. He reiterates that the market is highly sensitive to data, and if more data indicates that the economy is indeed slowing down, the Fed may take quicker action. But for now, he believes there is no evidence supporting the recession narrative.

Why Jeff Says He is "Buying the Dips"

Market Reaction and Fed's Rate Decisions

• When discussing the scenario of potential Fed rate cuts, Jeff points out that the market's reaction to rate cuts depends on the reasons for the cuts. If the market generally believes that the Fed is forced to cut rates due to an economic collapse, the stock and crypto markets may decline. Conversely, if the cuts are due to inflation being kept under control and the economy being in good shape, then the stock and crypto markets may rise significantly.

Confidence in a Soft Landing for the Economy

• He says he tends to believe that the economy will achieve a soft landing, and data supports this view. He believes that if the Fed overreacts to the current stock market decline and cuts rates urgently, it could trigger more panic, so he hopes the Fed can remain calm and instill confidence in the market.

Ongoing "Buying the Dips" Strategy

• Jeff clearly states that he is optimistic about the market and is "buying the dips." He believes that the current market sell-off is one of the most foolish in recent years, so he continues to buy without hesitation. The three factors he mentions that confirm his bullish stance include:

• Stability of the Japanese Stock Market: He observes that the Nikkei 225 futures are rising, indicating that the market is warming up.

• ETF Inflows: He hopes to see retail and institutional investors in Bitcoin and Ethereum willing to buy ETFs during market downturns.

• Reassuring Statements from the Fed: He expects the Fed to make some reassuring statements to the market without taking emergency rate cuts, indicating its monitoring and confidence in the economy.

Attention to Potential Risks

• Although he is optimistic about the market, he also mentions some potential risk factors that could lead him to reconsider his bullish stance, such as volatility in the Japanese economy, drastic changes in the crypto market, or ongoing negative economic data. If these situations arise, they could trigger market panic, forcing the Fed to act quickly.

Cryptocurrency as a Political Issue: Harris's Victory May Not Be as Bad for Cryptocurrency as Many Think

The Connection Between Elections and Cryptocurrency

• Jeff points out that elections have become an important narrative in the cryptocurrency space. He mentions that although the market has experienced some volatility recently, this does not necessarily mean it will have a significant impact on election outcomes. While many believe that Trump's victory may be more favorable for the market, he argues that there is no statistical data indicating significant differences in stock market performance under Republican or Democratic leadership.

Market Reaction and Uncertainty

• Jeff notes that historically, the market often experiences volatility before elections, and after election results are announced, the market typically rebounds. This is because the market dislikes uncertainty more than bad outcomes. He cites the example of the 2020 election, where despite Biden winning, the market rebounded after the election, with both the stock market and Bitcoin rising significantly.

Changing Attitudes of the Democratic Party Towards Cryptocurrency

• He mentions that the Democratic Party has recognized the political influence of the cryptocurrency industry, especially in Congress, where more members are beginning to pay attention to voter support for cryptocurrency. Although Trump may use cryptocurrency as a political tool to win voters, the Democratic Party can no longer oppose cryptocurrency as they once did. He believes this shift in attitude will diminish some of the opposition to cryptocurrency, such as the influence of Warren and Gensler.

The Future of Cryptocurrency

• Jeff believes that while Trump's victory may be more favorable for the cryptocurrency market, Harris's victory will not be as bad as some fear. He notes that Nancy Pelosi and Chuck Schumer have recently supported some bills promoting cryptocurrency, indicating a shift in the Democratic Party's internal attitude towards cryptocurrency.

The Future of Gensler

• The discussion also touches on the potential impact on Gensler's position. If Harris wins, there may be new committee chairs appointed, which could change the regulatory environment for cryptocurrency. Jeff believes that regardless of who is elected, Gensler may face the risk of being replaced due to the widespread controversy surrounding some of his policies on cryptocurrency regulation.

Why Jeff Believes Bitcoin Does Not Always Hedge Against Stock-Related or Geopolitical Risks

Bitcoin's Correlation and Market Performance

• Jeff mentions that Bitcoin is often viewed as a non-correlated asset, but this does not mean it will not correlate with other assets in all situations. He points out that Bitcoin's correlation may change with market conditions, sometimes showing negative correlation and other times positive correlation. For instance, during specific events (such as geopolitical crises), Bitcoin may be viewed as a safe-haven asset, while in other situations, its performance may resemble that of the stock market.

Performance During Government and Banking Crises

• Jeff believes that Bitcoin often serves as a defensive hedge when investors lose confidence in governments or banks. For example, during the banking crisis in March 2023, many investors expressed concerns about the safety of local banks, leading to increased demand for Bitcoin. However, he notes that Bitcoin does not always maintain consistent performance during stock market declines or heightened geopolitical risks.

Comparison Between Bitcoin and Gold

• Jeff further states that Bitcoin does not necessarily need to be viewed as "digital gold," as this comparison lacks substantive basis. He believes that many investors are not interested in gold, and only a few macro investors and central banks pay attention to it. Therefore, it is unnecessary to expect Bitcoin to assume the role of "digital gold."

The Influence of Institutional Investors

• As Bitcoin becomes increasingly accepted by more institutional investors, its correlation may also increase. Jeff explains that if an institutional investor needs to sell their holdings, they may sell all assets simultaneously, including Bitcoin, which would lead to an increase in correlation between Bitcoin and other assets.

The True Value of Bitcoin

• Jeff emphasizes that Bitcoin's true value lies in its ability to serve as a tool against untrustworthy government and banking systems. After experiencing a banking crisis, many small businesses are concerned about their ability to withdraw funds from banks, highlighting Bitcoin's importance as a store of value. He believes that in countries with economic instability and currency devaluation (such as Argentina or Turkey), Bitcoin is particularly important as a protective asset.

Jeff's Views on the Proposal for the U.S. Government to Purchase Bitcoin as Strategic Reserves

Trump's Proposal and Debt Issues

• Jeff mentions that Trump proposed at a Bitcoin conference that perhaps Bitcoin could be a way to address the U.S.'s trillions of dollars in debt, which piqued his interest. He believes that while Bitcoin may be one option, there are other investment avenues that could also "surpass" the debt, such as investing in quality companies in the U.S. stock market (like Apple or Nvidia). Therefore, he finds Trump's proposal puzzling, uncertain whether Trump is emphasizing Bitcoin's excess returns or viewing it as an asset that central banks should hold.

The Possibility of Central Banks Purchasing Bitcoin

• Jeff states that he does not believe central banks will purchase Bitcoin in the same way they buy gold. He believes that if Bitcoin were to be confiscated, it might not be sold or auctioned but would instead become part of the government's balance sheet. In this case, Bitcoin's role would change.

Views on Bitcoin as a Reserve Asset

• Although Jeff does not have a strong opinion on central banks purchasing Bitcoin, he acknowledges that if the government becomes a new buyer of Bitcoin, it would positively impact Bitcoin's price. He admits that he does not have deep insights into the internal mechanisms behind such a decision by central banks, but if it were to happen, he would support it.

The Stark Contrast Between Traditional Financial Giants Pausing Trading and the Permissionless Nature of DeFi

Reflections During Financial Crises

• Jeff points out that during financial crises, people come to recognize the limitations of the current financial system: you can only trade when financial institutions allow it, not when you want to. He emphasizes that a crucial lesson from the past decade is that assets stored in banks or brokerage firms do not truly belong to you; they are liabilities of those institutions. Whether or not assets are returned depends on these institutions, which is not common in the U.S. but is more prevalent in other countries, especially where there is a lack of trust in local governments and financial systems.

Issues of Liquidity and Accessibility

• In a crisis, liquidity is often absent when you need it most, and being unable to access your assets for trading is a frustrating experience. This situation arises mainly because the assets do not truly belong to you but are held in centralized third-party systems. Jeff believes that decentralized finance (DeFi) offers a way to trade without intermediaries, allowing users to trade at any time.

Advantages of DeFi

• Jeff emphasizes that DeFi and self-custody layer 1 protocols provide a better system when needed. He believes that the current main issue is that due to regulatory restrictions, users can only trade cryptocurrencies on these platforms, while most people are not interested in cryptocurrencies. He envisions a scenario where if platforms like Charles Schwab, Fidelity, Vanguard, and Ameritrade were to crash simultaneously during high volatility, users could trade stocks like Apple or Nvidia on decentralized platforms (like Uniswap), which would be a significant shift.

Future Possibilities

• Jeff believes that the advantages of decentralized financial systems in owning and transferring assets are evident, but the assets currently tradable on these systems are not attractive enough for most people. He believes that if real stocks, bonds, and other assets could be traded on crypto trading platforms, it would completely change people's experiences, and many would be surprised by this new way of trading.