5 The Natural Hedge

Market Euphoria What stands out in the 3 graphs below is not that the

respective markets for NFTs and Ethereum cryptocurrencies, the most widely

used cryptocurrency for NFT transactions, and the price of Ethereum grew

exponentially throughout 2021 but that they grew in lockstep. This leads us

to ask ourselves whether there was not a deliberate market play by a handful

of aggressive cryptocurrecny players to use NFTs solely for the purpose of stimulating demand for Ethereum to artifically talk up its price. Such a microstrategy appeared to have worked, judging by the spectacular increase

in the price of Ethereum, which shot up from $2000 per coin in May 2021

to nearly $4500 per coin in November 2021 (it was at $120 in 2018!)

Market Meltdown However, the reverse effect occurred over the first 4 and

a half months of 2022, with the price of Ethereum plunging from its November

2021 peak of $4500 to $2075 as of May 12th 2022, and that of NFTs,

because most of them are priced in Ethereum, falling by 50%. Cost

accountants call this price fall a negative currency price variance. We see

that the half-clever NFT scheme used to amplify many times over the price

of the asset the speculators are actually going after, Ethereum, can backfire

The Natural Hedge To the extend that the price of NFTs is determined by

that of cryptocurrencies, the best way to hedge is to cease pricing NFTs in cryptocurrencies, as Roblox has done on its gaming platform with its Robux

virtual currency by pegging it to the dollar. Treasurers call this hedge a

natural hedge that avoids the risk manager from buying at a cost options

contracts to cover his exposure. This disconnection from cryptocurrencies

kills two birds with one stone. By distancing itself from both the

cryptocurrency market and the broader stock market, it allows it to focus

not on 3 markets, but on its own market, where there's more than enough to

do and to worry about

2 The Business

What Is The Business? It was Facebook, now Meta, who first coined the term

Metaverse, showcasing in July 2021 its Horizon Worlds platform, where users

can develop and commericalize their own original digital content, by putting

at their disposal a set of easy-to-use "no-code/low code" development tools.

The huge new market that Meta couldn't miss and that goes well beyond that

for digital content, is what we can call the Consumer-as-a-Business (CaaB)

market, or to use older acronyms, the C2B and C2C markets, complementing what we've only known so far, the B2C and B2B markets. It appears that for

now at least, Meta will develop this new activity within its core social media business (see our next Metaverse page for more detail).

Definition: like any commercial product, a user digital content is anything you

create digitally, i.e. a website, a jpeg image, a video clip, an online game, an

NFT image, for which you've obtained the IP rights and the regulatory approvals

needed to be authorized to put it up for sale online (the digital IP is a digital

signature such as an NFT token and the legal IP is the patent)

The first upstarts to set up the marketing channels, now known as platforms,

to cater to this new CaaB market came from the online gaming world, with

Roblox leading the way beginning in 2006. NFT platforms appeared only a few

years later, beginning in 2009, as extensions of cryptocurrency platforms

which were secured by blockchain, an encryption method dating back to the

70's upgraded for bitcoin (all NFT platforms today only accept cryptocurrencies

for payment)

The Product The final product is of course the digital object

The Product Markets We have on the one hand the NFT-branded products

which are catered to the emerging C2B and C2C markets, and on the other,

what we can call the Enterprise digital products which are catered to the B2C

and B2B markets

The Product Market Channels There are currently 3 distinct marketing

channels, that is, platforms, serving the above 4 product markets (C2C,

C2B, B2C, B2B)

We first have the NFT platforms which market themselves as blockchain

platforms, and to the extent that blockchain can be used to encrypt both

the digital object (coded by a product encryption key, the NFT token) and

its payment in cryptocurrencies (coded by a payment encryption key, the

FT token), they are also cryptocurrency platforms. They serve, as markeplaces,

all 4 markets. OpenSea, which has processed an estimated $23B worth of transactions since its founding in 2017, is one such NFT marketplace

We then have the Gaming platforms, which use neither blockchain nor

cryptocurrencies but are considered to be NFT platforms (because they also

sell digital objects). They serve all 4 markets. Roblox, launched in 2006, is

one such gaming platform

See our NFT case study for a more detailed explanation of both platforms

Finally, we have what we can call the Enterprise platforms serving the B2C

and B2B markets. For example, Microsoft has embraced Meta's Metaverse

by adding what it calls Metaverse layers to its existing platforms: Mesh to

MS Office 365 and Connected Space to MS Dynamics. Because it can tap

into its base of 1.5B active Windows and MS Office users, it will most likely

move into the C2C and C2B markets

Judging by its launch of 7 new products including its Horizon platforms,

Meta appears to also want to be in all 4 markets. See our Meta case study

3 The Risks

Because NFTs are priced in cryptocurrencies, known to be volatile, they are exposed to an exchange rate risk (as of May 12th, 2022, we've been witnessing

a simultaneous 50% decrease in both NFT and cryptocurrency prices)

There are 2 types of cryptocurrency price risk, depending on whether the

exchange rate to the dollar is fixed or variable:

Fixed Exchange Rate Cryptocurrencies The exchange rate of Roblox's Robux

cryptocurrency is set by the firm at a fixed annual rate, at $4.99 for 450 Robux coins for 2022, an increase of 10% compared to 2021. Players buy digital objects and pay their subscription fees in Robux coins. Developers' proceeds from the

sale of digital objects and the subscription fees on their games posted on Roblox

are paid out in Robux coins, which they can convert back to dollars at the

fixed annual rate of $4.99 (after deducting Roblox's 30% cut). Rates being quite stable, there is no cryptocurrency-related price risk. See also our NFT case study

on the 5 types of price risk NFTs are generally exposed to

Variable Exchange Rate Cryptocurrencies The exchange rate of Decentraland's

Mana cryptocurrency is freely set by the market, on a cryptocurrency exchange.

Like bitcoin and ethereum (ether), the 2 most popular cryptocurrencies, Mana's

exchange rate to the dollar has witnessed significant fluctuations, increasing by

7275% from $0.08 per coin in January 2021 to $5.90 in November 2021, then

plunged by 72% to $1.60 per coin end April 2022. Rates being highly unstable,

there is significant currency risk.

4 Hedging - The Prerequisites

There are 2 factors one usually takes into account in any hedging strategy:

Short or Long Position If as an asset holder, you are short on cryptocurrencies, expecting them to depreciate in the future, the best strategy may be the one followed by the artist Beeple. "Spooked" as he said by the volatility of cryptocurrencies, the artist Beeple quickly converted the $53M worth of

ethereum (ETH) cryptocurrencies he pocketed from the sale of his 5000 days digital collage to US dollars. On the other hand, had Beeple been long,

he could have waited 7 more months, until November 2021, before converting

the $53M at $4500 per ethereum instead of at $1650 per ethereum in March

2021, at the time of the sale. He would have pocketed $144M instead of $53M.

This said, ethereum is today at $2765 as we speak. (as a liability holder, you

would have done the opposite. It's better to reason in gross positions, as here)

Market Liquidity In contrast to the major so-called fiat currencies (dollars,

euros), out of some 19000 cryptocurrencies, only 2 generate most of the

volume and are therefore highly liquid, bitcoin and the preferred crypto-

currency of NFTs, ethereum. Beeple was lucky to have billed in ethereum.

Had he billed in say Decentraland's Mana, he may not have been able to

convert his proceeds to dollars. Like what we learned in school, it was the skyrocketing demand for NFTs (from less then $100M in Q4 2020 to $40B

of revenue beginning May 2022) which may well have led to the exponential

surge in the demand for ethereum and therefeore its price, which increased

from $112 in 2018 to $4500 in Nov 2021 and today to $2765. (Ethereum

is a blockchain platform used by most NFTs because of its digital signature/

smart contract feature, and its highly traded and highly liquid cryptocurrency,

the ether)

1 The Value Chain

As shown on the table below, both product families fit into a broader

Metaverse Value Chain

Products Beginning in the mid 2000s, the traditional ITC companies (IBM, Microsoft, Oracle, SAP, Adobe, Salesforce,..), along with a few of the  

FAANGs (Amazon, Google), threw their weight into the game, coming up

with a slew of Cloud Platform and Metaverse Platform products of their

own

Platforms & Apps Very young entrepreneurs (Bezos, Page and Brin,

Zuckerberg) seized the opportunity provided by 4G and more interactive

languages (C, Javascript) to launch the first eCommerce, Search and Social

Media platforms. On their heels, user apps began to go Mobile and to shift

from Enterprise ERPs to customer- facing apps, such as Martech and Fintech.

All platforms, today in 2D, will be in 3D

Channels & Markets 4G cellular networks shifted the market from home PCs

to wireless mobile. The big winners were: i) the telecom operators who had a lock-in on both the Mobile and Internet markets, ii) Google and Facebook

who built up the Web Advertising market with their Search and Social Media websites, iii) Amazon of course who created the eCommerce market, iv) the

TV broadcasters and TV Cable companies who took control of a new Digital

TV market in the making, v) Snap and Tik Tok who carved out the Instant Messaging market. All channels, today running on a highly centralized 5G network, will need to run on a more decentralized 6G network. As

we describe in more detail on our Meta case study page, we see the Metaverse

as an additional marketing channel, which will create a distinct Metaverse

market, with its own value chain as shown on the following table in red:

The Internet Value Chain With New Metaverse Channel

Cloud

Products

Metaverse

Products

Digital

Content,

aka Digital Assets

(original collectible items)

The Network

Website (Domain Name)

Geolocation (PoP)

Data Traffic (Router)

Device (IP Address)

The Equipment

Servers

Devices

Telecom Equipment

Data Storage

Software (Kubernetes)

The People

Developer

Data Analyst

Designer

The Technologies

Application Software

Web Services Software

Hardware & Rel. Software

Open Source Software

see page

ERP

Martech

Fintech

Metaverse

Apps

The ITC

Industry

Cloud Infrastructure

(hardware)

The Training

Computer

Science

Electronic  & Telecom

Engineering

Metaverse Platforms (business operations)

Cloud Platforms (IT operations)

eCommerce

Search

Social Media

Metaverse

Platform

Cloud Platforms

(software)

Addressable

Market

75B IoT devices

Meta's

Target Markets

Social,

Business,

Retail,

Smart Home,

Smart TV,

Gaming,

Fintech

Product

Channels

App

Products

Platform

Products

Generic

Product

Markets

NFT Trading VOlume

Ethereum Trading Volume

Price of Ethereum

(May-Nov 2021)

The NFT & Ethereum Markets in Sync

Stock

Market

Crypto

Market

NFT

Market

Regulatory protection Dodd-Frank

Asset Bubble-Like Price Changes (a)

Asset Bubble-Like Price Changes (a)

a) The Asset Bubble Question An asset bubble is when the price of an asset, such as stocks, real estate, and in our case cryptocurrencies, rises at a rapid pace without underlying fundamentals

Bubbles Always Burst Because of this lack of a link to economic and business fundamentals, the bubble always bursts

The Bubble We can say that there has been a bubble with cryptocurrencies, judging by the rise of the price of bitcoin from $3189 in Dec 2019 to $29792 in July 2021 to $66098 in Nov 2021, then a sudden fall to $28011 in May 2022. Correspondingly, the market value of bitcoin has gone from $69B in Dec 2019 to a high of $1.3T in Nov 2021 only to plunge to a low of $625B in May 2022

The Undoing Judging by the recent $700B market value drop in Q1 2022, the cryptocurrency bubble has effectively burst

Regulatory Protection Unlike the mistake they made back in

2008 with derivatvies, regulators have prevented this time around cryptocurrencies from spilling over and ultimately derailing the

capital markets

Channel

Market

FUNDAMENTALS

real economic process,

factual narrative,

reporting transparency

NO FUNDAMENTALS

no economic process,

false narrative (blockchain,...),

no reporting transparency