Ledgerstat Capital 2Q 2021 Letter

SoundMoney Strategy: Quarter 2 2021 Review

“Well, when are you going to sell your Bitcoin? I look at them and I say, into what? Why would I ever sell the currency of the future for the currency of the past? That would be like saying, I’m going to take dollars and turn them into confederate dollars or are going to take Euros and turn them into French francs. No, you don’t want to do that!” -Tim Draper

SoundMoney Strategy Performance

The SoundMoney Strategy ended the second quarter of 2021 at $35,037, up 23% net of fees (1%) compared to Bitcoin, which is up 21% so far this year. Since inception, Nov 1, 2018, when Bitcoin’s price was $6,300, the Sound Money Strategy is up 593% net of fees and carry (1%/10%), while Bitcoin is up 456% by comparison. We have significantly outperformed Bitcoin net of fees by applying a long-term approach of being under-invested in bitcoin during the bear market, fully invested at the bottom and using minimal leverage in this current bull phase.

For example, we increased our Bitcoin allocation to 145.66% in the 2nd quarter of 2020 when Bitcoin was below $10,000. At year-end, with Bitcoin at $29,000, the SoundMoney Strategy’s leverage dropped to 13% due to price appreciation. Because we are still early enough in this cycle, and the risk/reward of this network gaining in value remains favorable, we borrowed an additional 10% and bought more Bitcoin at $33,000. This month, we will add an additional 10% to our holdings during this sell-off below $35,000.

Today, with Bitcoin at approximately $35,000, our research indicates that we remain in the midst of a bull cycle for bitcoin, which should take us through 2021. We are going to stick with our price targets of $100k by the end of September and $200k by year end. This is based on adoption trends and the ever-important fact that there will only ever be 21 million bitcoin in existence.

Despite the recent price collapse (down 50% from its most all-time high), the speed at which Bitcoin is being adopted supports a target value of $100,000 but we believe that target will be exceeded during this halving cycle. We plan on removing all leverage and taking advantage of other tools that allow us to mitigate some of the volatility that may occur should Bitcoin trade back down to and below its intrinsic value as defined by Plan B (for more information about Plan B see below) and some of the other models which we are using.

SoundMoney Strategy: Quarter 2 2021 Review

We will continue to use Unchained Capital to hold our collateral against our bitcoin. It is held in a multi-signature vault whereby we hold one of the three keys, and the bitcoin will not be re-hypothecated (lent out again).

2nd QTR YTD Inception (Nov '18) SoundMoney Strategy -45% 23% 593% Bitcoin -41% 21% 456% Gold 5% -6% 49% Gold Miners (GDXJ) 4% -14% 67% S&P 500 9% 16% 55% Berkshire Hathaway 9% 21% 27%

Bitcoin’s Volatile Performance:

“I want to buy an equity when 99% of the people disagree with me but everybody needs it, and nobody can stop it. That is how I described Apple, Amazon, Facebook, Google, even Microsoft in 2010.” -Michael Saylor 1

Over the course of the 2nd quarter, the price of Bitcoin moved from $59k to $65k to $29k to $35K. The move to $65K came as no surprise to most that follow Bitcoin closely. It seems that each market segment: retail, institutions, high net-worth, and ultra-high net-worth individuals were adopting Bitcoin. Unlike previous cycles, we even saw major life insurance companies and corporations adding to treasury. So why the 50% correction? I credit Dan Moorehead from Pantera and manager of the first Bitcoin Fund for helping me understand the trading dynamics of this past quarter2. It seems there has been a convergence of two factors: tax-day and the China ban of bitcoin.

1 Michael Saylor interview with Sven Henrich 2 Pantera Capital BlockChain Letter

Tax Day

As you can see in the below chart, the week of May 17th was the largest weekly trading range in history of bitcoin.

We have learned that Tax Day can have a strong impact on crypto prices. In the previous two previous big run-ups –2013 and 2017– Bitcoin peaked four months before Tax Day while hitting a low about a week before the respective Tax Days. We see prices decrease as we approach Tax Day because some holders of Bitcoin and other digital assets liquidate portions of their holdings to pay their tax bill.

China “bans” crypto:

This is NOT the first time China has “banned” Bitcoin or other cryptocurrencies:

• China Bans Financial Companies from Bitcoin Transactions (Bloomberg, December 2013) • China bans banks from Bitcoin transactions (Financial Times, December 2013) • Bitcoin drops $500 after more reports China will ban cryptocurrency exchanges (Business Insider, September 2017) • China has banned ICOs (TechCrunch, September 2017) • Cryptocurrency exchanges officially dead in China (Forbes, November 2017) • China reiterates crypto bans from 2013 and 2017 (Yahoo! Finance, May 2021) • China bans financial, payment institutions from cryptocurrency business (Reuters, May 2021)

But this ban was entirely different. I was among the many investors that expected this China “ban” to be like all the others. However, the market seemed to realize in mid- June that this ban was different. In fact, China was cracking down on Chinese miners (responsible for 65% of the hash rate) during this time. Just look at the drop in the hash rate as the Chinese miners were forced to dismantle their machines and move out of the country. This was the largest downward revision in difficulty in the history of Bitcoin and is evidence of a real China ban as oppose to the threats in the past.

In mid-June China also cracked down on Chinese exchanges, forcing them to exit the country. This combined disruption to the Bitcoin network has been enough to push Bitcoin price down to the lows of the year, around $30,000. Bitcoin is now selling at below trend and below our valuation models.

The China ban must be bad for Bitcoin, right?

Well, history has shown that investors who sell on China “bans” usually end up missing some serious upside…

China blocking Google and Facebook, in an attempt to censor the internet didn’t destroy the internet. The same is true with Bitcoin. Now let’s take a look at where we are with Bitcoin on a valuation basis.

The Plan-B Model

Otherwise known as the Stock-to-Flow model, Bitcoin is currently below the lower-bound. There has been frequent talk that the model is “broken.” However, keep in mind that other moments when the model appeared “broken,” happened to be great times to BUY.

The bitcoin price (colored dots) has a 95% correlation to its stock-to-flow ratio (white line):

Dan Moorehead has great graphs showing Bitcoin is currently trading 36% below its 11-year exponential trend. Bitcoin has only spent 20.3% of its history this far under trend valuation. Note also that during the most recent peak in April, Bitcoin went just a touch over trend value. As you can see, past peaks were many multiples of trend value.

The year-on-year return never went off-the-chart like in past peaks. It’s currently trading at 281% year-on-year. This seems entirely plausible given the money printing that has occurred in the fight against Covid called the “Great Monetary Inflation.”

As we discussed in our previous letter, in the same way that we can see Microsoft, Apple, Amazon, and Google as digital networks that have “dematerialized” a physical good/service, which in turn unleashes enormous economic value to the benefit of the equity holders, today, Bitcoin is the fastest growing digital network. It attained its $1 trillion dollar valuation in under twelve years, which is less than half the time it took each of these other digital networks. Below is our attempt at valuing the network.

BITCOIN IS A DIGITAL MONETARY NETWORK

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Given that Bitcoin has “dematerialized” the scarcity of gold; making it harder, faster and better, we anticipate that Bitcoin will achieve at least gold’s market value of $12 trillion (over $500k/bitcoin) over the next seven years.4

3 Off The Chain Capital 4 LedgerStat Capital Q1 letter

I like to think of Bitcoin as humanity’s most important innovation, which is currently at the base of its S-curve of adoption. Based on this thesis, both its volatility and its long-term return potential appear certain. According to S-curve analysis, however long it takes a good/service to gain 10% penetration will be how long it takes it to achieve 90% penetration. As of today, we are twelve years into the adoption of the Bitcoin protocol. It has taken 10 years for Bitcoin to achieve 10% penetration, which means, over the next decade we can look forward to it achieving 90% adoption.

BITCOIN FOLLOWING CLASSIC S-CURVE ADOPTION CURVE

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If it is so easy to see that Bitcoin is undervalued, why is it so difficult to buy?

My daughter just graduated with a degree in Psychology and Neuroscience, and she can attest to the notion that our animal instincts are tough to tame. Humans have an innate herd instinct. It’s what kept our ancestors alive – when those with the wild lone- wolf/contrarian tendencies were Darwined out. For most of us, trading with your “gut instincts” can be disastrous for your returns.

• It’s human nature that we want to eat when it appears there are no threats that is buy when the market is going up and the news is good.

• It is also human nature to want to flee when the markets are “crashing,” news appear bleak and while our family, friends and bosses think we are crazy.

Throughout my career managing equity portfolios, I was always amazed and heartened by the studies that proved that being aware of and having control of your emotions results in great returns over time.

A recent Research study done by Dalbar, Inc., a company that analyzes investor market returns, confirms this notion that individual investors on whole underperform (probably due to poor trading instincts). It shows that the 20 years ending December 31, 2019, the S&P 500 Index averaged 6.06% a year while the average equity fund investor earned a market return of only 4.25%.5 The average investor consistently mistimes the market. Our animal instincts are detrimental to “solid trading”. It is to RUN (sell) when there appears to be danger and EAT (buy) when everything appears safe.

While it is easy to accept that Bitcoin is the fastest growing digital network, the volatility can cause us to buy high and sell low. As Bitcoin has more than four times the volatility than equities, the emotions can be that much more helpful or harmful to an individual’s overall return. As managers of the SoundMoney Strategy, we aim to help our clients do the opposite. We do our best to fight (BUY) the fear and resist (SELL) the FOMO (Fear Of Missing Out).

Let’s take a look at the Pantera Bitcoin Fund

It is the oldest cryptocurrency fund and has the most complete data on investor behavior over three cycles, as it relates to Bitcoin buys. While it’s too early to call 2021 a peak, here is an update directly from Pantera:

“The following graphic plots the percentage of time that the price of bitcoin was in each price bucket. We’ve added a new perspective this time: the buckets are a logarithmic progression. Each bucket is a 33% rally from the lower bucket. They are labeled in terms of the percentage of the trend price bitcoin was trading.”

5 Dalbar report

The gray bars are the percentage of time bitcoin spent trading in each price range. The price distribution is normally distributed. Most of the time, at or near trend. A little bit of the time it is super-cheap and a sometimes way above trend.

The gold bars show the percentage of inflows in each valuation bucket. The inflows are very skewed – massively pro-cyclical. Very little inflows when bitcoin is extremely weak. Very few investors wanted to buy when bitcoin was trading at or below 37 cents on the trend dollar. This is amazing because going along with the flow is part human nature. Going against the flow is rare, difficult, but highly profitable for those that can do it.

Now, see below, an interesting chart that shows that there have been very large inflows when Bitcoin is trading well above its trend.

The majority of the money has come in well into the rallies. For example, the market spent only 10% of the time above 500% of fair value, but 39% of inflows came in at or above that level.

That is why we hear so much about Hodl’ng bitcoin. If at the very least, an investor would just NOT SELL, Bitcoin has more than tripled on average annually for ten years. Anyone that has hodl’d bitcoin longer than 3.25 years has made money. Bitcoin has only printed one calendar year with a lower low. So, even those investors that “chased the highs” are up big-time if they held on. The lesson, at least, is to resist the urge to sell, if you have the emotional and financial resources, do the opposite, and buy.

For new investors, it’s best to buy when the market is below trend. Now is one of those times. The market has only been at least this cheap relative to trend 20.3% over the past eleven years. Since launching SoundMoney Strategy about two and one-half years ago, we have applied a disciplined approach toward “managing our stack”. In fact, $100k invested in the strategy is now $593K (net of fees), which is $137K more than an investment in Bitcoin itself. We believe that our experience and knowledge of Bitcoin and the psychology of trading, has helped us “create value” above and beyond Bitcoin. It is our opinion that volatility will continue to enable us to outperform Bitcoin going forward.

Why focus 100% on Bitcoin?

“Imagine working so you can earn a money whose value can be taken by another man simply by increasing its supply.” -Saifedean Ammous

As of June 1, 2021, there are over 9,000 altcoins, accounting for 40% of the total digital assets market. Although many of these digital assets are derived from Bitcoin, Bitcoin is the only cryptocurrency that is sovereign. All of the other cryptocurrencies are built on a platform that they have to obey; a small group of stakers, a foundation, a person, a government as well as the rules of the jurisdiction where they reside.

6 Pantera Capital BlockChain Letter

Bitcoin is the only cryptocurrency that is sovereign. A sovereign only obeys its own rules. Bitcoin is ruled by rules, not rulers. No one can change the transactions that already exist in its database, and nobody can keep the system from accepting new transactions. Therefore, Bitcoin is: • Scarce and undilutable (fixed 21 million supply) • Uncensored (it is free for all to use) • Immutable (network effects and hash rate make it impervious to attack) No other cryptocurrency can make these claims. This is what makes Bitcoin the most important digital asset to focus upon. Bitcoin separates the money from state and for the first time in history, we have a technology to guarantee all humans both the right and the means to protect their own property. Bitcoin is an instrument of economic empowerment for all.

When considering digital assets, it is easiest to separate the cryptocurrencies into two broad categories: crypto-assets and crypto-applications.

Crypto-Assets

Until Bitcoin, there were only two self-custody assets that were both portable and transacted without a third party: 1. Precious metals, which excelled at storing value over time, but its physicality prevented it from being efficient at transacting value over space (portability). 2. Cash and government issued paper currencies were designed to address gold’s portability shortfall. But as the world became interconnected through the internet, 3rd party sponsored credit cards and applications like PayPal became the facilitators and verifiers of transactions through use of centralized ledgers. Both asset types require a 3rd party bank for settlement, either for verification or for facilitation over payment channels. That appears to work fine for the 1.5 billion people with bank accounts but not for the other 6 billion people. Bitcoin, on the other hand, is native to the internet and its properties are derived from the internet’s enabling Bitcoin to be transacted 24/7/365 in all currencies simultaneously across all geographic and political jurisdictions at the speed of light. Additionally, it’s fixed monetary policy of 21 million imbues Bitcoin with scarcity making it the most effective way to store value over time since it cannot be diluted due to governmental tendencies or global circumstances.

Bitcoin is a base layer protocol that is focused on one thing: storing and transmitting value over time and space.

“As a thought experiment, imagine there was a base metal as scarce as gold but with the following properties: boring grey in color, not a good conductor of electricity, not

particularly strong…not useful for any practical or ornamental purpose…and one special, magical property: can be transported over a communications channel” -Nakamoto

Bitcoin is a digital monetary network and as more people use the network, it becomes exponentially more valuable for each user. According to Lynn Alden, “network effects are one of the strongest economic moats that a system can have against its competitors.7 One clear example of how powerful this moat can be is credit card payments. “Merchants won’t accept cards that aren’t popular, because it’s not worth the hassle. Consumers won’t get cards that merchants don’t accept…It would be exceedingly difficult to create a new credit card network.” However, with the rise of the internet, we also witnessed digital payment networks, such as PayPal which was able to use the internet’s properties to offer something that is more efficient, timely, and secure. Now that we have witnessed the evolution of other digital networks, such as Amazon (retail), Netflix (entertainment), Facebook (photography), and Google (information), it is easy to see Bitcoin as the winning digital monetary network. After all, its next biggest competitor is Bitcoin Cash which is less than 10% of its size and less than 1% of its strength as measured in hash rate. Bitcoin has already won despite that it is very early days for “cryptocurrencies”.

What is the Total addressable market for Bitcoin?

Now that we have concluded that Bitcoin is likely to be the winning protocol with close to 100% certitude, the next step is to calculate the addressable market and a timeline. Based on S-curve analysis and other valuation techniques the timeline toward Bitcoin adoption is to subsume the market cap of gold, which is $12 trillion in market cap over the next five to seven years. Long-term, the total addressable global asset market is much larger at over $200 trillion. There is tremendous asymmetry in an investment in Bitcoin. The near-term target is 20X while the long-term potential is greater than 100X.

7 https://www.lynalden.com/bitcoins-network-effect/

“Bitcoin is math. Math has been around for thousands of years. 2+2 will equal 4, and it will for another thousand years. I like the idea of investing in something reliable, honest, secure, and hundred percent certain. Bitcoin is a way to invest in certainty." -Paul Tudor Jones

Over the past three years, the education around Bitcoin has improved by an order of magnitude (greater than 10x). As a result, it is estimated that an investor needs only one hundred hours of study to achieve a sufficient level of confidence to commit at least a 5% investment allocation. Paul Tudor Jones began with a 1% position and now talks about a suggested 5% allocation. For Michael Saylor, he has achieved a level of comfort whereby over 100% is committed to Bitcoin. Assuming a $10 million portfolio and a 5% allocation, that $500k has the chance of creating 10X-100X. Returning at least the entire value of one’s portfolio for an investment of a mere one hundred hours of one’s precious time.

Crypto-Applications

Crypto applications present no such investment certitude. There are many applications, many players and an uncertain business model and different addressable markets amidst a constantly shifting landscape. In this case, it is much more appropriate to apply the venture capital model toward this segment of the market. That means an informed investor that dedicates thousands of hours of research can hope for 1% success rate with 99% failures. It is the “bet” that the one success “pays” for all of the failures. Even if we assume success, it would be tough to anticipate a return of

greater than 15% annualized over a ten-year period. There is the possibility of a 400% return over a decade for countless hours of research for a much lower return with a much higher risk profile. While it may be fun to listen to the stories about all of the applications that MAY be built, the fact is the best risk return is learning about and investing in the asset that does work, Bitcoin.

Peter McCormack and Nadav Kohen recently discussed the utility of Bitcoin's proof-of-work blockchain as well as the flaws in proof-of-stake blockchains (minute 49)8:

“…the problem here, at the end of the day is when you do look at it (speaking of proof-of-stake) adversarial, you’re looking at this pseudo-governance structure where you have, maybe some checks and balances, but, usually it’s a straight forward thing where everyone is anonymous and you literally buy your votes and votes are literally just money and you literally take all the worst things about government and amplify them and get rid of the checks and balances and judicial systems and all the rest of it and its just like one small group of people who aren’t elected and rater buy their votes get to decide what happens.” -Nadav Kohen

In summary, there is an opportunity to understand Bitcoin over a concentrated one hundred hours on a first principles basis. With that knowledge, one can invest early and with confidence in a scarce asset at a mere $600 billion market cap that has an immediate addressable market of gold ($12 trillion) and an ultimate addressable market many multiples of that ($200 trillion). Crypto applications require thousands of hours of dedicated research and offer a fraction of the expected value. Finally, if Bitcoin fails, it is highly unlikely that crypto applications survive. Conversely, all of the crypto applications could fail tomorrow and it would have no impact on the survival of Bitcoin.

Technically trading Bitcoin

We have seen large amounts of bitcoin being taken off exchanges throughout the first quarter of the year. However, beginning in mid-April, that trend reversed, and we witnessed bitcoin inventory being moved back out of cold storage and onto the exchanges to be sold. As you can see below, when the inventory on exchanges is high, it typically is left there to be traded, often by “retail investors” employing leverage. Over the past three weeks, we have observed a change in trend. A reduction in on chain bitcoin held on exchanges.

8 https://podcasts.apple.com/us/podcast/what-bitcoin-did/id1317356120?i=1000528122867

Fundamentals and adoption of Bitcoin as a digital monetary network:

• El Salvador makes Bitcoin legal tender, alongside the USD. Around $6 billion in remittances flows into the country annually but intermediaries charge as much as 20 percent for facilitate the transfers. President Bukele hopes to address this leakage by promoting bitcoin through the lightning network, where fees can be as low a fraction of a cent.

• Cash App parent company, Square, announced a purchase of $170 million worth of BTC for its treasury reserve, which accounts for roughly 5% of its reserves. It has also added custom order buying into its Cash App, to allow investors to buy the dip even easier.

• MicroStrategy, has finally amassed over 100k Bitcoin for its treasury.

• Coinbase completes IPO as a direct listing.

• Fidelity Investments director of global macro, Jurrien Timmer, noted that “in a 60/40 stock/bond world, gold and bitcoin are poised, in my view, as potential disrupters to the 40 side of the allocation.” He points to Bitcoin’s limited supply as a unique attribute relative to gold.

• Goldman Sachs restarted its bitcoin trading desk operation, focusing on futures and non-deliverable forwards.

• Visa plans to participate in Cryptocurrencies “in a very, very big way” 1. Enabling consumers to make a purchase of these currencies or bitcoin 2. Enabling digital currency cash-outs to fiat (converting to fiat on Visa credential, which then makes those funds available for shopping at any of the 70 million merchants that accept Visa. 3. Enabling financial institutions and fintech partners to be able to offer a crypto option for their customers (APIs) 4. Upgrading Visa’s infrastructure to allow a financial institution to settle, starting with USDC. 5. Working with central banks for the increased adoption of bitcoin and CBDCs

Here is a great way to educate yourself:

1. The Ultimate Bitcoin 101 with Vijay Boyapati HERE 2. The Bullish Case for Bitcoin by Vijay Boyapati 3. Read our previous quarterly letter 4. SALT Talks: Michael Saylor | Chairman & Chief Executive Officer, MicroStrategy 5. Current Events: Maximize Signal/Noise Ratio…Twitter: Follow Ledger_man. He will keep you up to date on Bitcoin news and important developments as well as important Macro events. From there you will start to have your own favorites. 6. Build your base knowledge: LedgerStat Capital Website is a good spot for beginning videos, podcasts, and readings. 7. Michael Saylor interviews and how he learned about Bitcoin. HERE 8. Stone Ridge 2020 Shareholder Letter – Stone Ridge 9. Contact Ronald Solis to schedule a call to meet with the LedgerStat team

To buy Bitcoin go to River.com, or Gemini.com. Each are great alternatives depending on your needs. For example, River charges 1.2% to buy, learn a ton while they safely store your bitcoin for free. Gemini is tougher to open account, fun to learn to buy bitcoin on their exchange. I can show you how to buy for minimal cost, but you need to always move your bitcoin “off the exchange” to their custody vault which is 40 bps per year (much better than GBTC at 2%). I am also working with Unchained Capital for even more customized solutions and for those ready to begin using an open source multi signature solution for the secure storage of Bitcoin for both themselves and their company. Finally, for larger institutions, we work with NYDIG.

Feel free to reach out with any questions you may have. We can walk you through our most recently completed Slide Deck.

If you are interested in scheduling a call to discuss any of the topics mentioned in this letter, Ronald Solis is happy to assist and provide appropriate meeting materials.

Regards,

Tim

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