The end of the beginning
Why did crypto underperform in Q4 and what comes next?
If you’re reading this, you likely already know that Q4 was tough for crypto – its second worst quarterly return since 2022. This comes against a backdrop of growing corporate adoption, increasing regulatory clarity, and a favorable macro set up that carried stocks and metals to new all-time highs. Whereas those assets tracked global M2 (money supply) as usual, BTC diverged.
The total market cap of crypto is still up 30% since November 2024, but Bitcoin ended the year flat while ETH and SOL are down several points and many alts are off 50% or more. So what happened? Was this a fundamental regime shift, or a sharp but typical correction within a longer-term bull trend? A few factors to consider:
1. Long-term holders took profit at unprecedented rates: Reasons are unclear, but on-chain data shows BTC held by ‘long-term holders’ was an outsized portion of selling pressure. The psychology of the $100K price level and the so-called “4 year cycle” likely played a role, as well as percolating concerns in the Bitcoin community regarding quantum. There’s also the increasing institutionalization of the asset – which is at odds with the libertarian ideology of many long-term holders.
2. The DAT (Digital Asset Treasury) trade fell apart faster than expected: Last quarter, we wrote that DATs were “zero-sum financial engineering” and a waste of time and capital. That looks prescient now, with nearly all DATs trading at a discount to NAV. Most of the Michael Saylor copycats never really got off the ground with Strategy itself down 50% in 2025. Despite being a short-term headwind, this is healthy for long-term stability.
3. Something broke on October 10: Markets experienced an unprecedented flash crash – even by crypto standards – resulting in $20B of liquidations and some tokens nosediving 50%+ in a matter of minutes. Ironically, this occurred after decreasing volatility for most of the year, leading many to suspect the crash was tied to a major blowup of an exchange or market maker. Prices recovered in the short-term, but then ranged lower into year-end. Alts have been hit especially hard, along with sentiment.
Market outlook
The combination of decoupling and 10/10 has challenged existing mental models and investor fortitude. However, we still view Q4 as more idiosyncratic than trend-setting. The rapid ascent to new all-time highs came faster than we expected, and the subsequent drawdown was equally surprising and unusually violent. But with leverage and sentiment now fully reset, we think the market is more likely to grind higher in 2026 than slide into an extended bear market.
Some of these pressures may persist, but they don’t invalidate the underlying adoption story. Institutional accumulation has not slowed. The administration remains focused on growth, and key appointments like SEC chair Paul Atkins signal regulatory acceptance. The Clarity Act is making its way through congress. Fed policy coupled with White House pressure appears supportive. All the tentpoles of progress remain in place despite price action to the contrary.
As always, it’s important to remember that “crypto” is really two different asset classes. Bitcoin is a known macro commodity with robust TradFi vehicles (ETFs have $60B in net in-flows) and an established holder base. Altcoins are still plagued by regulatory uncertainty, but will end up looking more akin to equity in early-stage or growth tech. Some correlation will persist, but we expect these assets to perform differently moving forward.
Crypto’s crisis of conscience
While the adoption of blockchains is real, the cypherpunk future many hoped would accompany it has not materialized. Institutional players are leading the demand for Bitcoin and holding tokens in regulated entities (e.g. ETFs, QCs). Financial markets are still dominated by corporate incumbents, many of whom are now building their own blockchain infrastructure instead of using existing networks. Use cases that once held promise – gaming, social, DAOs – look more like interesting experiments than avenues of adoption. After all, they have only yielded ~50m MAUs on chain. Future cohorts are much more likely to arrive via distribution channels people already use.
This has led to extensive – and in some cases existential – reflection on what crypto has built and where we go from here. To summarize the post from Dougie Deluca (though it’s quite good and worth reading): the time has come for blockchain technology to dissolve into mainstream applications so normal people can benefit without needing to adopt crypto culture or even know they’re using crypto.
While we appreciate how this can feel like a failure to OGs (and share the sentiment to an extent), we have always approached the space pragmatically. Adoption was always going to require integration with incumbents, which inevitably implies trade-offs against the early crypto ethos. To borrow another framework from Dougie, crypto is now in its post-imagination era:
If you zoom out, it’s easy to see that blockchains are better, faster and cheaper financial infrastructure. But if you zoom in, it’s also clear that much of what exists today are remnants of an idealistic, speculative regime that is unlikely to return. Meme coins may rebound in the short-term, but they are never going to lead a market that prioritizes revenue growth. Some L1s may win market share from Ethereum and Solana, but there is no good reason to believe that dozens of chains can support multi-billion dollar valuations on de minimis fee revenue. And no amount of returning bullish sentiment can compensate for the overwhelming supply of locked tokens venture investors still have to sell. It’s becoming more obvious that these valuations were a function of a bygone fundraising environment that has more in common with multi-level marketing than actual investing. But now is when the actual investing starts.
The case for a long-short crypto portfolio
We’ve said for quite some time that actual KPIs are all that really matter, and our portfolio reflects two concurrent realities:
There are a handful of tokens attached to winning projects that will increase in value in line with adoption and fundamentals
Most tokens are attached to failed startups which benefitted from speculative imagination, but will inevitably approach an intrinsic value near zero
Most of what is investable is on-chain finance, as has been the case for several quarters now. We still view borrow-and-lend protocols as the most obvious beneficiary of stablecoin growth. We still view perps as a superior instrument for leverage trading, and see another leg of growth coming from on-chain equities and commodities. We still believe more assets will be issued on chain, and the venues that facilitate their issuance and exchange will grow. Despite recent price action to the contrary, our thesis remains the same. We are betting on a handful of high-conviction alts to outperform benchmarks on a longer time frame.
1k(x) released its Onchain Revenue Report in October, which illustrates the growing divergence in fee revenue generated by apps and infrastructure. Historically, most fee revenue (and mindshare) was captured by L1s. In the last 12 months that has shifted. Finance apps alone now earn 73% of fees, and yet the relative market caps haven’t budged. Owning the “app store” (i.e. Ethereum, Solana) is an easy pitch for casual investors, but doesn’t hold water if the apps actually capture the value.
We might not go so far as to call it the “pair trade of the decade”, but we are on the same side. A re-rating should occur that drives the price of L1s down relative to apps. History tells us that whoever owns the user will own the economics as fee capture moves up the stack. It’s not overly surprising to see this divergence now; L1s still dominate mindshare and have been aided by ETF flows. But in the long-term, the financial gravity of earnings should overwhelm outdated value accrual narratives.
The value of shorts
If you accept that we are entering a post-imagination era, it’s obvious how winners benefit. What happens to the losers should be equally obvious. Historically, excess VC capital kept private valuations high and retail speculation sustained many overvalued public tokens. But now, speculative mania has moved to AI and early investors are left to sell these tokens into a relatively bidless market in order to return DPI. Who is the marginal buyer for tokens that don’t accrue value? We do not believe there are many.
We continue to see evidence that price tracks fundamentals. Below is a view of selected L1 ecosystem tokens of varying age and traction. As you can see, the projects that grew activity and revenue last year – namely Hyperliquid and Binance Smart Chain – outperformed BTC while laggards bled 50-90%.
We expect exceptions to the rule in the short-term, but there is no escaping the long-term reality. We believe liquid funds have an opportunity to combine core long-term holdings with tactical but fundamental short exposure to improve returns and decrease portfolio volatility. This assumes appropriate sizing to withstand volatility and incremental exposure to mitigate timing risk. Our short positions have allowed us to harvest cash during this downtrend, which can be re-deployed lower. We expect to give up gains during pumps, but have an opportunity to collect funding, harvest tax losses, and enter higher. Plus, we will always be net long.
We sometimes wonder why more crypto funds don’t short. We often hear that investment mandates don’t allow, or that liquidity is an issue (certainly true for larger funds). Presumably some that do would rather not talk about it. Most of the people we talk to simply choose not to. They are squeamish about upside volatility in an asset class they are ideologically long and has traded irrationally in the past. Fair enough, but if we have actually reached an inflection point from irrational imagination to rational fundamental investing, we see an opportunity to outperform.
We use a basket approach to diversify single-name blowup risk. We’ve seen enough short squeezes to know that any individual token can pump 50% for no good reason. But a basket of structurally impaired tokens is less likely to squeeze simultaneously. We generally look for two or more of the following conditions:
Declining traction, as measured by fee revenue, developer activity, mindshare, etc
Significant unlocking supply, either in the form of emissions or early investor/team allocations
Poor economic design, indicating a lack of value even with regulatory clarity
$TRUMP has been our biggest position to date, falling from $15 to $5 in 6 months with more tokens unlocking every month – over $400m in January alone. There are plenty of others to choose from though. Our short exposure increased to roughly 15% in Q4 and we expect to remain at that level or above on an ongoing basis.
A productive, post-imagination future
In our view, there are two mistakes people can make here. The first would be to give up on an industry that is finally coming into its own as frontier technology, even if it looks more like fintech than futarchy. The second would be to assume that the future will look like the past, and a rising tide will lift all boats and tokens. We have called for a cyclical rotation to alts for some time now – and still believe quality alts can outperform – but winners will be fewer and farther between. The market is telling us that durability matters more than novelty with most flows going into majors.
The imagination phase may be over, but we are now beginning to see the reality of companies that use blockchain and stablecoins to improve their business and create value for customers. That is still the opportunity we are most interested in.
Portfolio Allocation
87% long | 16% short
71% net exposure | 103% gross exposure
42% majors (BTC, SOL, ETH) | 40% internet finance | 13% cash | 5% other