Solana (SOL)- an Asymmetric Trade?
Unlocked from Pay Wall - "A Layer One Cryptocurrency with strong NFT links"
________________________________________________________________________
I’m releasing a former Pay Wall Article from mid April 2023. You can gauge the trade’s performance in hindsight which has indeed experienced a drawdown as the writing indicated it might. Note this is a non leverage, long duration trade with a small portfolio allocation, if any depending, on your risk tolerance / management.
I may do a couple of crypto related articles in the coming weeks as I feel global liquidity has turned a corner and with Sovereign Debt ever increasing this asset class offers something outside the conventional monetary system. Please give feedback in the comment section if this floats your boat or not or answer the Poll below.
________________________________________________________________________
This won’t be for everyone’s risk tolerance but I went down the Crypto rabbit hole in 2019 and pulled back in 2022 as it became obvious that the sector is like the wild west with a lot of bad actors. That said after the collapses of 3AC (June 2022), Terra Luna (June 2022), and FTX (Oct 2022) almost a year on there seems to have been a bottom formed in the sector.
Solana was very much the 3rd party token of choice of Sam Bankman Fried, and his FTX and Alameda platforms and it took a lot of punishment falling as low as $8.30 from highs of $260. However, as time has passed and the market has stabilized it makes sense to review Solana. What it is? Why its important for NFTs in particular? Does it offer a decent Risk/ Reward opportunity?
First thing is first, there are three major issues (“the trilemma”) with Cryptocurrencies from a network standpoint that everyone strives to beat, but you cannot have all three. They are 1. Security, 2. Scalability, and 3. Decentralization. For example, with Bitcoin, the network is decentralized and secure but it has low transactions per second so scaling is a challenge because the speed of the robust network is slow.
Full disclosure I have a position in SOL which has an approx. breakeven entry at $22. I started building up a position about 1 month ago. This was my investment research.
The speed / scalability of a blockchain in measured in Transactions per Second (“TPS”), not to be confused with the cult movie Office Space and its TPS Reports.
For context, in late 2022, Solana was running 500-600 TPS while Ethereum ran 20-30 TPS and Bitcoin only ran 7 TPS. So Solana is much faster than the average blockchain.
But What is Solana?
Solana was founded by Anatoly Yakovenko (ex-Qualcomm) and Raj Gokal in 2017 but only launched in 16th March 2020, so this is only a 3 year old live blockchain. Its network token is SOL which is traded on various centralized and decentralized exchanges (DEX).
Its a Proof of Staked Time also known as a Proof of History Blockchain as opposed to a Proof of Work (BTC) or Proof of Stake (ETH), which means it has a verifiable delay function. Ultimately it knows how long it takes to process information with current Chip Capacity and verifies on this basis so it can be faster but as mentioned above, more susceptible to security challenges.
What Use the Solana Blockchain?
Solana is targeting the consumer end of the blockchain world, as in it wants to cause a consumer breakout into Crypto.
NFT (“Non-Fungible Token”)
The fact that you are reading this and probably don’t know what is a NFT is testament to the fact that the market is in an extremely early phase. You’ll see below that Solana is second only to the market leader, Ethereum when it comes to usage in the NFT as the snapshot indicates.
NFT (Non-Fungible Token), is a digital representation of things ranging from art, music, gaming weapons or coins etc. They are “non-fungible” because they contain information that proves authority and ownership over the item and cannot be duplicated or mirrored.
Solana supports building NFT marketplaces where these NFTs can be listed for sale. These marketplaces generate 2.5% commission on each NFT sale so the platforms are extremely lucrative. Although this is not a major use case of Solana at the moment, the network is expected to be one of the top NFT platforms due to traffic and volume issues.
dApps
Like Ethereum, Solana is a smart-contracts blockchain platform. This means that it supports the development of decentralized applications (known as dApps), which have gained a wide range of use-cases. Any type of application can be built on smart-contract blockchains, ranging from simple web apps to complex decentralized finance (DeFi) apps; however, building DeFi and NFT app platforms has been Solana’s primary use cases as developers continue to explore cheaper and scalable platforms.
There has also been a decline in NFT activity. Aside from a few spikes, a consistent daily volume of around 30,000 new NFTs in January had fallen to under 10,000 by mid-April, according to Solscan.
DeFi activity is almost down by 60%. These are comparatively low numbers from peak but as the crypto market begins a slow incline these volumes along with new projects will kick on leading to more and more demand for the SOL Token. My take is that NFT activity will be high when consumer uses come more to the fore.
Mobile
There is also the development of the Solana Mobile whereby the actual hardware can store Web3 application built on the Solana and other blockchains and has the potential to operate as a hot and potentially a cold wallet via its Seed Vault encrypted service.
Reliability Concerns
The Solana blockchain did have to halt 7 times in a 12 month period which raises questions over security and centralization. This is Solana’s biggest challenge. At its peak Solana as operating at an average of 30 million transactions per day but it experience peaks as high as 65 million in a day.
At 65 million transactions in one day that is higher than all the other layer 1 blockchains combined with room to spare. The issue is that it can be prone to an attack from high GB Bots, particularly around NFT minting auctions. Ultimately if there was a high volume of 5 - 10 million packages per second being sent to a validator and there was maybe an issue with the validator, once 1/3 of the validators lost capacity, the network would shut down until “manually” restarted.
Alternatively the network could receive a lot of spam but not enough to topple validators, but enough to slow the network down for its real users.
Outages / Hacks Reported on Wikipedia
On 14 September, 2021, the Solana blockchain went offline after a surge of transactions caused the network to fork, and different validators had different views of the state of the network. The network was brought back online the next day on 15 September, 2021. The outage lasted a total of about 17 hours.
The Solana blockchain again went offline on 1 May 2022, with the outage lasting roughly seven hours due to it being taken offline by bots. The blockchain went offline again on 31 May, 2022, due to a bug in how the blockchain processes offline transactions. This outage lasted about four and a half hours.
On 1 October, 2022, the Solana network went down for 6 hours due to a consensus bug in the validator client allowing a misconfigured node to publish multiple valid but different blocks.
Why did Solana take a beating post FTX/Alameda collapse?
As well as the market activity shrinking another factor was that Serum became defunct due to the collapse of FTX and Alameda. This was necessary because FTX held the upgrade authority for Serum, putting its security at risk. This is a critical issue because Serum was a key on-chain Central Limit Order Book (“CLOB”) piece of infrastructure on which Solana is built.
To ensure their security, other protocols started to move to new infrastructure, like OpenBook, that forked (copied and branched off) from Serum. Despite this, Serum still had more usage than OpenBook by the end of FY2022, indicating that most protocols have not completed their migrations yet. OpenBook is now expected to overtake Serum as Solana and other protocols reduce their reliance on Serum.
Where does Solana Rank against it’s Peers?
As of 12th April 2023, Solana is ranked at #10 just inside the Top 10 Cryptocurrencies.
The circulating supply is 391.6m and market cap is $9.23 billion against 120.4m ETH with a market cap of $225.6 billion
How does it Trade?
SOL/USD has experienced a huge decline from November 2021 at $260 to a low of $8.30, a 96.8% decline in price. Usually speaking this type of price action is what kills things. That said, Solana is still alive and has bounced back over $23.
Looking at the weekly chart above we can see targets above past this challenging channel are $48 then $75 then $110 then $137 which also more or less tie into some Fib levels (not shown in the chart). Nothing goes up in a start line and all these levels will be tested and retested and sometimes fail those retests and cause drawdowns from unrealized profit gains and losses.
Looking at a Crypto Pair SOL/ETH you’ll see a trendline (perhaps better trending on a candle chart) from Nov 2022 to present and it appears that SOL is breaking out of the trend and could outperform ETH. I.e. the further down the risk curve you go the higher the alpha.
Why I like a 1%-5% allocation (no leverage)
I certainly wouldn’t be betting the farm on crypto or altcoins in particular but this seems to be a low level historically speaking and the wider market appears to have started a recovery, if not a full flung bull market.
Given the asymmetric upside and obvious risk / reward benefits I would say a 1% allocation could cause that allocation to rise to as much as 10% from actual profitability as opposed to new capital deployed or you could lose 0.5%+ of your portfolio if the lowest local lows are retested.
Maybe it would be worth position sizing in 4 measures and average into a 1% allocation to safeguard any volatile drop in price. However, should this token progress outside its current VPVR zones there is a lot of head room towards $40, whereby you could take 50% of the total position off being your original investment and have a free carry with the rest.
You should look a sizing your positioning and entering in small tranche sizes to avail of a potential better blended base cost by averaging in over the next 3-4 months.
Conclusion
This is an extremely volatile and high risk asset, but as a result it has significant asymmetric upside. Solana’s faster speeds but obvious security issues represents something that neither Bitcoin or Ethereum can be. At these low levels, (caveat which could go lower before they go higher) this seems like a higher beta opportunity in the space with a real life use case.
Should this asset achieve its prior all time high of $260 and the entry is $24, there is a 10x upside to the trade. Should it achieve a higher all time high, obviously you can run the math. The price action will be extremely volatile and based on possible hacks and macro tail winds and you should expect but perhaps not enjoy short term drawdowns (3-6 months). Timeline for this investment should be 24-30 months and is a zero leverage trade due to the associated volatility.
NB: This is not financial advice and you should manage your own risk and discuss any investments with your own independent financial advisor before deploying your hard earned capital into these particularly volatile markets.
Additional news post mid April
Metaplex, which is Solana’s leading NFT infrastructure provider, introduced usage fees which was unexpected by market participations, particularly since it had raised $46m recently enough. Given Solana Open Source approach the introduction of fees seem prohibitive but my take is that it prices value. If the application adds value it deserves a premium. This is a developing story.