ALTERNATIVE MARKETS UPDATE - 2022 SUMMARY

​2022 was a year that tested the worldwide economy. The highest inflation in 40 years, unprecedented interest rate hikes, and the invasion of Russia into Ukraine were only some contributors to the hugely difficult year of 2022. In the US, inflation started soaring during 2021 and peaked in the summer of 2022 at 9.1%. Thanks to the central bank’s quick response, inflation has since continuously slowed down and is currently at 6.5%. Europe had significantly more issues handling the inflation crisis. The EU started the year at an inflation rate of slightly above 5.5% and it continued to soar until October 2022 when it reached its peak at 11.5%. The UK was similarly affected, despite the BoE being the fastest-acting central bank to raise interest rates. However, its inflation behaved like the EU’s and soared to its peak at 11.1% in October 2022. Both economies have not been able to reduce inflation below 10% so far. In contrast to the US, European countries were much more affected by the direct impact of the war between Russia and Ukraine. Soaring energy and food prices, for both of which Russia and Ukraine are crucial suppliers, were the main constituents causing the high inflation. Additionally, the ECB did not enjoy as much freedom as the Fed had when raising interest rates. This is in large part due to the high indebtedness of certain European countries that would have gone bankrupt if interest rates would have been raised as much as the US did. Other countries, such as Switzerland, Japan, and China stand out in this discussion, as those countries managed to keep their inflation relatively low. Switzerland managed to avoid such high inflation due to its strong currency, and a limited dependency on fossil fuels. Japan avoided high inflation through the continued quantitative easing by the BoJ. However, in contrast to the other countries, Japan’s inflation is still soaring and poses substantial issues to the country. China avoided high inflation through its rigorous Covid policies and its limited governmental support when Covid emerged. The source of this soaring inflation is a combination of the war but is largely based on unprecedented central bank intervention to save the economy during the early Covid days when large parts of the economy were completely unable to function. Figure 1 shows the inflation levels of the previously mentioned countries during 2022.

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RESEARCH PERSPECTIVE VOL. 196 January 2023 Alternative Markets Summary 2022 2022 was a year that tested the worldwide economy. The highest inflation in 40 years, unprecedented interest rate hikes, and the invasion of Russia into Ukraine were only some contributors to the hugely difficult year of 2022. In the US, inflation started soaring during 2021 and peaked in the summer of 2022 at 9.1%. Thanks to the central bank’s quick response, inflation has since continuously slowed down and is currently at 6.5%. Europe had significantly more issues handling the inflation crisis. The EU started the year at an inflation rate of slightly above 5.5% and it continued to soar until October 2022 when it reached its peak at 11.5%. The UK was similarly affected, despite the BoE being the fastest-acting central bank to raise interest rates. However, its inflation behaved like the EU’s and soared to its peak at 11.1% in October 2022. Both economies have not been able to reduce inflation below 10% so far. In contrast to the US, European countries were much more affected by the direct impact of the war between Russia and Ukraine. Soaring energy and food prices, for both of which Russia and Ukraine are crucial suppliers, were the main constituents causing the high inflation. Additionally, the ECB did not enjoy as much freedom as the Fed had when raising interest rates. This is in large part due to the high indebtedness of certain European countries that would have gone bankrupt if interest rates would have been raised as much as the US did. Other countries, such as Switzerland, Japan, and China stand out in this discussion, as those countries managed to keep their inflation relatively low. Switzerland managed to avoid such high inflation due to its strong currency, and a limited dependency on fossil fuels. Japan avoided high inflation through the continued quantitative easing by the BoJ. However, in contrast to the other countries, Japan’s inflation is still soaring and poses substantial issues to the country. China avoided high inflation through its rigorous Covid policies and its limited governmental support when Covid emerged. The source of this soaring inflation is a combination of the war but is largely based on unprecedented central bank intervention to save the economy during the early Covid days when large parts of the economy were completely unable to function. Figure 1 shows the inflation levels of the previously mentioned countries during 2022. Figure 1: Inflation Rates in Percentages in the US, UK, EU, Switzerland, Japan, and China During 2022, Sources: Stone Mountain Capital Research, Board of Governors of the Federal Reserve System, Eurostats, Office for National Statistics (UK), Swiss Federal Statistics Office, Ministry of Internal Affairs & Communication (JP), National Bureau of Statistics of China, January 2023 As mentioned in the previous paragraph, increasing interest rates was the go-to option for central banks to combat soaring inflation. The major economies in the West all started with negative interest rates before they started raising them. The Fed took the strongest actions by raising the federal fund rate from 0% to 4.25% in less than a year. In 2023, it is expected that rates will be raised further but only by small increments, and during the month of January 2023, market participants took a more optimistic stance that there will be fewer hikes than anticipated at the end of 2022. This also led to substantial gains in equity markets, as the S&P500 grew by more than 6% as of the time of writing. The ECB started the year at -0.5% and hiked in stronger increments after August 2022, when the Fed already upped the rate to 3%. Since then, the ECB raised its target rate to 2.5% and is committed to raising further. The committee intends to do two further 50bps hikes in February and March 2023 and will decide then if further hikes are necessary and their magnitudes. The BoE started the cycle of hiking earlier than any other major central bank. In contrast to the Fed, BoE hiked in smaller increments and is currently at 3.5%. Market participants expect that rates will be raised to 4% and remain at this level in the short term. Switzerland followed the development of other Western countries and raised interest rates from -0.75% to 1%. Similarly to the UK, it is expected that rates will be raised by 50bps in 2023, starting with a 25bps hike in March 2023. Unlike the Western countries, Japan and China barely changed their target rates in 2022, and it is not expected that much will change in 2023, as the threat of inflation only exists to a limited degree in those countries. Figure 2 summarizes the interest rates of the aforementioned countries. Figure 2: Interest Rates by the Central Banks of the US, EU, UK, Switzerland, Japan, and China, Source: Stone Mountain Capital Research, Federal Reserve, ECB, BoE, SNB, BoJ, PBoC, January 2023 A potential recession was another core topic in 2022. The “excess” money introduced by central banks during Covid-19 led to the currently high levels of inflation, which was further boosted by the shortages in food and energy caused by the war. Markets also faced a tough ecosystem, in which both of the major asset classes, bonds and equities, were correlating and losing value consistently. With the higher rates, bond prices declined substantially. For example, the BofA Merrill Lynch US Corporate Index lost 18% compared to the S&P500 which lost 19% in 2022. Both markets cannot necessarily expect much relief in 2023. Interest rates will be raised further, which leads to further declines in outstanding bonds. The high inflation, although declining, diminishes the attractivity of bonds, as it will still be difficult to obtain positive real returns. Equities face similar problems. High inflation leads to less consumer spending and therefore less revenue for the companies. Not only does that mean the companies have less capital to maneuver during a crisis, but it also declines their value. The already high interest rates, which likely go even higher, also reduce the value of companies. While this general outlook is not promising at all, it could get even worse, if a full-scale recession occurs or if the war in Ukraine is getting out of control, e.g. by series nuclear threats. Aside from the rather pessimistic outlook in general regarding an upcoming recession, there are further alarming indicators. Most financial institutions expect a recession in 2023 or possibly 2024 with a more or less consensus that Europe will slide into a recession in 2023 and the US at the end of 2023 or in early 2024. Many common recession indicators, such as a decline in real GDP, real income, and a decline in retail sales, are prominent in the current economic state. One of the most important indicators includes the yield curve. Especially in the US, the yield curve has inverted numerous times since Covid-19 hit. In most instances, it was present for a short period of time. However, currently, the yield curve has been inverted for the longest time in history as well as in the highest magnitude in history. Figure 3 shows the yield on 2- and 10-year US Treasuries and the magnitude of the historic inversion. The interest rate differential is currently around 0.6% and peaked in December 2022 when the difference exceeded 0.8%. While other countries do not face the same historical differential, most countries saw periodical inversions including Germany, the UK, and Switzerland. Figure 3: US Yield Curve Inversion of 2- and 10-Year Treasury Securities and Their Respective Interest Rates, Source: Stone Mountain Capital Research & FRED Economic Data, January 2023 While the general prospect is grim in general, there are some positive indicators as well. The production and supply chain issues are likely to recover, as China ended its zero-Covid policy and has reopened its economy which should also provide a boost to the worldwide economy. The likelihood of a recession may also be lower if the inflation in the affected countries can be brought down to around 2% by the end of 2023 with limited further interventions and possible interest rate declines late in 2023. Nonetheless, this prospect is not too likely to occur. Lastly, employment is still very strong and close to a record high in most countries across the globe. During 2022, the unemployment rate decreased steadily, and based on those numbers the economy is in a very healthy state, despite the recent news of mass layoffs in big tech. Figure 4 provides an overview of the unemployment rate in the US, UK, EU, Switzerland, Japan, and China. Figure 4: Unemployment Rates in the US, EU, UK, Switzerland, Japan, and China, Source: Stone Mountain Capital Research, US Bureau of Labor Statistics, Eurostat, Office for National Statistics (UK), State Secretariat for Economic Affairs (CH), Ministry of Internal Affairs & Communication (JP), National Bureau of Statistics of China, January 2023 Oil prices had a wild ride in 2022. WTI Crude started the year at $75 per barrel and Brent Crude at $78 per barrel. The year of oil prices can be summarized by strong gains in the first half and the second half in which the asset lost all its prior gains. Before the start of the war between Russia and Ukraine, oil already soared strongly. While geopolitical tensions and rising inflation were drivers, it was exacerbated by several other factors. The OPEC+ countries did not raise the amount of oil by a large amount, as they did in earlier crises. Oftentimes, the price of oil collapsed soon after, as there was so much supply available. In general, the demand was underestimated following the Covid pandemic. In addition, Western countries were not inclined to set on oil, due to the general trend of the energy transition. Lastly, some OPEC+ countries had shortages in oil extraction due to natural catastrophes. With all this in mind, the start of the war led to a skyrocketing price of oil. WTI Crude soared to $123 per barrel, while Brent Crude even reached $133 per barrel. While there was substantial volatility in the market during the early stages of the war, oil remained well above $100 per barrel. In the latter half of 2022, the steep fall of oil began. One major contributor to price declines in oil is the consequences of China´s Zero-Covid policy. China is a crucial economy for oil prices, as they accounted for around 16% of worldwide oil consumption in 2021. A looming recession also contributed to the decline in oil, as economies are likely to require less oil in difficult times. In addition, the EU put a cap on Russian oil into place to limit the price of Russian oil and its possibilities to finance the ongoing war. As of the time of writing, WTI Crude is trading at $81 per barrel and Brent Crude at $87 per barrel, only slightly higher than at the beginning of 2022. Figure 5 summarizes the development of the price of WTI crude oil. Figure 5: WTI Crude Oil Price from January 2022 to January 2023, Source: TradingEconomics, January 2023 Hedge Funds It is no secret that the hedge fund industry struggled in 2022. On an aggregate level, it is likely that 2022 will become the worst year for hedge funds in the past decade. Especially the first half of the year was brutal, while the latter half was largely positive and the industry could almost offset its losses incurred in the first half. Depending on the source, hedge funds are down between 2% and 5% in 2022. In particular, strategies that focus on fixed income and equities have contributed to the negative performance of the industry. Funds that focus on global macro, currency, and commodity strategies were very successful. For many of those strategies, 2022 will be one of their most successful years in history. Given the steep losses in most markets in 2022, hedge funds managed the crisis somewhat well with comparably small losses. While the results are not too appealing, the industry managed markets well since Covid-19, when they shielded investors from the large Covid drawdowns and profited from the bull run thereafter. Figures 6 to 10 summarize the performance of our SMC Strategy Indexes against appropriate benchmarks. Our equity strategies are down around 20% and are on par with the drawdown of the S&P500 in 2022. While other equity hedge fund benchmarks posted substantially lower losses, our strategies involve more risk than the average equity hedge fund. The difference is roughly the same in positive years. For example in 2020, when the average equity hedge fund was up 5%, our strategy benchmark achieved almost 25%. In the space of fixed income hedge funds, our funds managed to avoid large losses with an average loss of around 3.5% in 2022, compared to other fixed income benchmarks that lost around 10%. In particular, our Trade Finance Crypto strategy stood out with a return exceeding 11% in 2022 and not a single down month since its inception in 2017. Unsurprisingly, this year our global macro strategies delivered great results. Our strategy index is up almost 80% in 2022 compared to around 15% of most global macro hedge fund indices. This is in large part due to our Discretionary Global Macro strategy which gained almost 200% in 2022. On the other end of the spectrum, cryptocurrency hedge funds lost a substantial part of the gains of the two previous years. Our strategy index is down 73% compared to Bitcoin which is “only” down 64%. Again, this stems from the higher risk in investments in less established cryptocurrencies. The year of cryptocurrencies is addressed further below. Lastly, our fund of hedge funds strategies were able to avoid most of the drawbacks and returned 7% on average, compared to most other benchmarks that are down similarly to the total hedge fund industry. Figure 6: Performance of SMC Equity Strategy Index and Benchmarks in 2022, Source: Stone Mountain Capital Research, January 2023 Figure 7: Performance of SMC Fixed Income Strategy Index and Benchmarks in 2022, Source: Stone Mountain Capital Research, January 2023 Figure 8: Performance of SMC Global Macro Strategy Index and Benchmarks in 2022, Source: Stone Mountain Capital Research, January 2023 Figure 9: Performance of SMC Cryptocurrency Strategy Index and Benchmarks in 2022, Source: Stone Mountain Capital Research, January 2023 Figure 10: Performance of SMC FoHF Strategy Index and Benchmarks in 2022, Source: Stone Mountain Capital Research, January 2023 Despite the issues in the industry in 2022, hedge funds still remain close to their peak in AuM set in Q1 2022. In Q1 2022, the industry topped the $5tn mark for the first time. Over the next two quarters, the industry lost around $400bn, which is based on a combination of negative performance and seeing outflows. Figure 11 summarizes the development in AuM from 2019 to Q3 2022. The industry has done very well since Covid-19. When Covid hit, the industry fell below $3tn, as the industry was facing consistent outflows. After Covid, when the drawdowns were managed well and funds strongly profited from the bull run afterward, the AuM of the industry surged. The substantial contributor there was the strong performance throughout 2021. These continuously strong results also led to steady inflows in the industry, which has been rarely the case in the past years. Hedge funds failed to maintain this trend of steady inflows after the industry came into critique again for its only decent handling of the drawdown of 2022. This led to outflows of around $110-$125bn in 2022, depending on the source. The industry started seeing inflows in Q3 2020 when market participants saw how hedge funds managed the crisis. This continued until Q4 2021 when the risk of a crisis heightened. Q2 and Q3 2022 can be characterized by historically large outflows given the unfavorable market conditions currently. Figure 12 shows the quarterly net flows from 2019 to Q3 2022. Figure 11: Hedge Fund AuM from Q1 2019 to Q3 2022, Source: BarclayHedge, January 2023 Figure 12: Quarterly Hedge Fund Asset Flows in Billion USD from Q1 2019 to Q3 2022, Source: Preqin, January 2023 Private Equity & Venture Capital As for most asset classes, 2022 has not been a great year. The soaring interest rates and high inflation had a dampening effect on the industry which performed great in the past years. The industry shares its struggles with public equities. These lost a substantial amount of value in 2022. The private equity industry could shield investors from most of the drawdown of public equities, but there is certainly more to come, as private markets lag behind public markets. Additionally, the underlying factors for the adjustment in share prices are evident and private equity won’t be able to escape them. High interest rates mean high financing costs, which has not been the case since the global financial crisis in 2008, and high inflation leads to customers being on tight budgets. In turn, companies will earn less, as customers have less capital to spend. While inflation is declining, a return to normal levels is unlikely to occur before the end of 2023. The same prospect applies to interest rates. Only optimistic market participants believe in rate cuts before the end of 2023, and the wide consensus plans for further rate increases in early 2023. The full extent to which private equity is affected by the drawdown of public equities and the unfavorable economic conditions will be visible throughout 2023, but 2023 will likely not be a significant improvement. While this ecosystem is already not great for private equity as a whole, the effects will be more severe for venture capital, given that it is the sub-category with the highest amount of risk involved. The risk of bankruptcy will rise given that for many companies the substantially higher financing costs combined with less income may come as a shock. The effect of the increased riskiness of venture capital is evident when addressing the performance as of Q3 2023. The US private equity index from Cambridge Associates is down 5.5% in 2022 compared to -15% for their venture capital benchmark. Despite a rather negative year in 2022, the industry is still growing – at a fast rate compared to other alternative asset classes. Preqin estimates that the private equity industry will be worth around $5tn once 2022 data is fully available. While the growth rate of the industry is likely to slow down in the short term, in the long term it is still expected that the industry will maintain its historically high growth rate. Additionally, in crisis, the reduced activity in the market tends to lead to very strong years thereafter. With a lower activity and reduced valuations, competition among funds is lower, and the low valuation leads to strong gains in the future. Although venture capital suffered more than private equity in 2022, the growth of the industry is still outpacing private equity. This is largely stemming from the extremely strong year in 2021 when the industry returned more than 50% in a single year. In the short-term, venture capital will be difficult to maneuver but the industry is expected to grow the most compared to any other alternative asset class. As with private equity, crisis years tend to be extremely valuable in the long term due to attractive valuations and limited competition. Figure 13: Actual and Forecasted AuM of the Private Equity Industry from 2010 to 2027, Source: Preqin, January 2023 Figure 14: Actual and Forecasted AuM of the Venture Capital Industry from 2010 to 2027, Source: Preqin, January 2023 Given the difficulties in the private equity industry, it is unsurprisingly that both deal volume and fundraising came down, especially when considering the record year of 2021. Bloomberg reports that the deal activity in the private equity market slid by $820bn in 2022 compared to its record year of 2021. In 2022, the industry invested $1.3tn. Despite the steep decline in deal volume this year, it remains the year with the second-highest deal activity. The deal activity in VC has dropped by around $300bn. In 2022, VC deal volume amounted to $0.5tn, part of which can be traced back to its hugely successful 2021. It is especially notable that these $500bn are almost doubled the activity the VC industry saw in years prior to 2021. Of this deal volume, a majority flows into Series A and B investments. 2023 will interesting to monitor whether both industries can hold onto current deal- and fundraising values amid a difficult ecosystem and no longer benefit from the hype in 2021. Figures 15 and 16 provide a breakdown of the deal activity volume in private equity and venture capital. Figure 15: Private Equity and Venture Capital Deal Volume from 2018 to 2022, Source: Bloomberg Law, January 2023 Figure 16: VC Deal Volume Across All Series from 2018 to 2022, Source: Bloomberg Law, January 2023 As mentioned previously, fundraising also decline significantly in 2022. There are several issues that led to this decline. Not only is the current performance declining, but the prospect of the industry in the short term also is not great either. With the strong correction in the public equity market, institutional investors also face the problem that they may now be over-allocated to private equity, as its valuations have been resilient so far. This is further exacerbated, as private funds tend to mark down their investments less frequently and to lesser amounts than public vehicles. According to an analysis from Bloomberg, mutual funds marked down 70% of their private holdings by 35% on average compared to private funds that have marked down investments by only 10%. The private equity industry reached a new high in fundraising in 2021 with around $550bn, slightly more than before the pandemic. Fundraising in 2022 is expected to be on par with 2020 when Covid started and the reaction to the new working environment was slow. Preqin expects that fundraising will remain low (relative to current years) until 2025 when the crisis hopefully has subsided. VC was able to manage the drawdown of 2022 better and is on track to outperform its previous fundraising record of 2021. Unlike private equity, Preqin estimates that fundraising in the VC space will continuously grow throughout 2027. Figures 17 and 18 provide information on current and future fundraising in the private equity and VC industries. Figure 17: Fundraising of the Private Equity Industry Across Strategy and Geography from 2010 to 2027 (Forecasted), Source: Preqin, January 2023 Figure 18: Fundraising of the Venture Capital Industry Across Strategy and Geography from 2010 to 2027 (Forecasted), Source: Preqin, January 2023 Cryptocurrencies / Blockchain The cryptocurrency market has faced substantial issues during 2022. The industry started the year at a market capitalization of way above $2tn. Even this is down quite a bit from its 2021 high of around $2.9tn. Bitcoin (BTC) started the year at $47k, while Ethereum (ETH) started at $3.8k. Their respective highs in 2021 were $68k and $4.6k. Despite the substantial drawdowns of the industry, many tech-focused equities lost similar amounts of value. Even some of the very established companies, such as Tesla, Meta, and PayPal lost more than BTC in 2022. In the first few months, the industry behaved very volatile until April 2022. The market capitalization of the industry varied from $1.5tn to $2.5tn during that time with another surge starting in mid-March 2022 when Ray Dalio’s Bridgewater Associates announced that the hedge fund will invest in digital assets. However, at the beginning of May 2022, the industry crashed by half a trillion. This decline was caused by the collapse of TerraUSD (UST) and its governance coin LUNA. This was especially notable as this was a stablecoin that should be pegged one-to-one to the US-Dollar. The company used an algorithm to achieve this peg. UST was in high demand, due to its DeFi protocol, Anchor, which is essentially a high-yield (up to 20% annualized) savings account. However, the platform had much more lenders than borrowers and its yield is dependent on the reserve. With this, the reserve increased substantially and led to yields dropping to 5% and further anticipation that the yield would drop to 1.5% in April 2022. At the end of April 2022, 72% of UST was locked in Anchor, and UST holders began to leave with lower expected yields. Then, over the weekend, $2.3bn of UST was withdrawn from Anchor and exchanged (there is essentially no need for UST other than Anchor). The two exit mechanisms were burning UST and minting LUNA with it (limited volume due to gas fees), and exiting through Curve Finance (liquidity pool with a discount for undervalued coins). With this wave of redemptions, the peg dropped to $0.98. This de-pegging caused further redemptions, which widened the gap to $0.32. The Luna Foundations attempted to rescue the stablecoin with an injection of $216m. This was not substantial enough and the coins eventually collapsed. In the end, LUNA collapsed. At the time, the coin was among the top 10 tokens in terms of market capitalization. The collapse of UST and LUNA led to a chain reaction in the crypto space. The most notable defaults from the UST bankruptcy were Three Arrows Capital and Voyager, which filed for bankruptcy around one month later. Celsius (CEL) was the next prominent crypto company that went bankrupt in July 2022. The company provided an all-in-one platform for buying, borrowing, swapping, and earning. In mid-June, the company announced that withdrawals are paused. Following the announcement, the coin tanked by more than 70%. It certainly did not help that company executives withdrew $17m in assets from the platform. Then, it seemed the industry was through the worst. In particular, as Sam Bankman-Fried (SBF) (ex-CEO of now-defunct FTX) stepped in and announced that he and FTX has a few billion to rescue crypto companies. They then bailed out BlockFi, which was hit strongly by the bankruptcy of Three Arrows Capital. With the successful completion of “the Merge”, in which ETH 1.0 and 2.0 were merged into ETH 2.0. This was one of the most important events in crypto history, as the second largest cryptocurrency ETH is now fully using the Proof-of-Stake (PoS) instead of Proof-of-Work (PoW) consensus algorithm. This should reduce the energy consumption of ETH by more than 99.9%. Ultimately, the latter two events only provided a brief relief for the industry. The collapse of FTX in November 2022 surpassed the previous negative events substantially. FTX became one of the most powerful exchanges around the world. It all started with a news article from Coindesk, which raised concerns about FTX and Alameda Research (an ex-crypto hedge fund transformed into a crypto VC fund). Alameda held mostly FTT tokens and FTX itself used these tokens as collateral in their balance sheet. Amid those concerns, Binance announced it will liquidate its FTT tokens valued at around $530m. This led investors to liquidate their FTT tokens, and investors became concerned with the liquidity of FTX. The total redemptions amounted to more than $6bn. FTX paused withdrawals thereafter. Binance then announced a potential take-over offer for FTX. However, Binance discarded this offer a few days later, as FTX failed their due diligence process, in which they specifically mentioned the misuse of customers’ funds and a potential US investigation. Following that, FTX and all its affiliates filed for bankruptcy on 11th November 2022. Currently, FTX and ex-CEO SBF are on trial in the US. While the collapse of FTX shook the crypto market and it had a major impact in the short term, the market was stable until the year 2022 ended. In mid-January 2023, BTC managed to reclaim the $20k mark for the first time since the FTX collapse. It is largely assumed that the positive development in January 2023 is based on a more optimistic outlook for 2023 in terms of interest rate policy in the US. Figure 19 highlights the development of the total crypto market capitalization throughout 2022. In spite of the specular collapse of one of the most used stablecoins UST, stablecoins are still hugely important for the industry. Stablecoins fulfill an important bridge in the current crypto markets, as they facilitate crypto-to-crypto transactions, but are essentially denominated in fiat currency. Many exchanges only support crypto transactions or offer better rates than for fiat currencies. Stablecoins can be directly exchanged for fiat currency for a fixed amount. The importance of these types of coins has continuously risen, despite issues with individual stablecoins. Figure 20 summarizes the total volume of the most important stablecoins in the crypto market. In addition, the industry is also seeing continuous inflows from established players in financial markets. For example, JPMorgan executed its first DeFi-trade on a public blockchain in 2022. BlackRock partnered with Coinbase to grant investors access to digital assets, while Fidelity allows investors to buy BTC in their 401k accounts and launched a crypto service for its investors. Governments also started to approve policies and executive orders to regulate and embrace crypto. Central banks are also moving into the crypto space by experimenting with blockchain-based central bank digital currencies (CBDCs). Figure 19: Total Cryptocurrency Market Capitalization from January 2022 to January 2023, Source: CoinMarketCap, January 2023 Figure 20: U.S.-Dollar Stablecoins On-Chain Volumes from January 2019 to December 2022 in Billion USD, Source: CoinMetrics, January 2023 While the industry experienced several major bankruptcies, and crypto lost a lot of its appeal compared to its prior bull cycle, crypto is still functioning as it is supposed to. Many if not all collapses of crypto companies can be traced to flawed risk management. The credit market in the crypto space was extremely risk-seeking. Many platforms yielded huge returns, especially for lending activities, which are theoretically backed by collateral. Some protocols did not require collateral at all or did not require adjustments in collateral even if its value dropped substantially. That such protocols blow up is not the fault of crypto, but rather from the company itself that does not enforce risk management. Similarly, centralized applications, in particular exchanges, build on the premise of decentralization in crypto, but are not decentralized themselves and require trust from investors, as established exchanges do. If risk management is not strictly enforced, the exchange can get into trouble and halt redemption and default, as was observed in 2022. While many exchanges, even well-functioning ones, stopped trading activity from time to time (e.g. when a coin crashed heavily in a short time), (at least the established) decentralized exchanges (DEXs) did not face any issues during the year. As DEXs are based on code (which comes with its own risks), trading activities and, importantly, risk management is set in stone and cannot be changed or tweaked. This is a simple comparison of the premise of decentralization of crypto and what it can do as well as its resilience compared to companies that build on this premise, but think they can do it better or for more negative intentions. In the longer term, centralized exchanges will face more competition from DEXs. The collapse of FTX highlights the imperfections of centralized exchanges and has led to a temporary increase in DEX volume. DEXs are still in their infancy and are cumbersome to use for most investors. In addition, the fees are high, due to the high gas fees. However, there has been substantial development in this sector, as Layer-2 protocols are more established. Layer-2 protocols are based on an underlying coin, e.g. ETH, and help scale the number of transactions by creating side chains on which transactions are validated. In January 2023, the transaction volume of Layer-2 protocols on ETH surpassed the transaction volume on the ETH-main chain for the first time. This leads to substantially lower transaction costs. Once those fees become very low and DEXs are easily usable by any investors, centralized exchanges will face difficulties to compete with them. Venture investments in crypto tanked in 2022 but are still at comparatively high levels. In H1 2022, funding remained strong, as the private market lagged behind public markets. The true impact of the decline in 2022 occurred in H2 2022 when funding dropped by more than 50%. However, investments in crypto won’t fall much lower, as crypto winters in the past led to a substantial transformation of the industry. This is largely the case, the new companies are not pushing as much to raise capital through tokens to profit from the wave and crypto winters tend to provide a good overview of what is working in the industry as well as what the industry is lacking. Figure 21 provides a breakdown of VC-backed investments in crypto from Q1 2021 to Q4 2022. The last cycle saw a strong rise in DAOs (decentralized autonomous organizations) and consumer crypto, while the current cycle is dominated by DeFi, gaming, NFTs, and the web3 economy. Figure 21: Global Funding for VC-Backed Crypto Startups from Q1 2021 to Q4 2022, Source: Pantera Capital & Crunchbase, January 2023 Fintech The year has not been easy for the fintech industry. The industry suffered from the decline in public equity markets and reduced activity in the private sector. The current economic prospect also does not help the industry, as is the case for the private equity industry. Whether the industry is doing well or is struggling is largely dependent on its sub-sectors. While the “classic” fintech sector is still on track to disrupt the financial industry, 2022 had a severe impact on the space. Fintech companies have achieved continuous new record highs in growth and fundraising. This decade-long growth came to an abrupt end in 2022. For example, in the UK, 21 out of 44 unicorns are fintech companies, but in 2023 there will be a substantial correction. Data from Finch Capital reveals that the industry raised 25% less in 2022, compared to its $19bn in 2021. Even more alarming is the number of firms founded, which is down 85% since 2020. The market is also continuing its strong consolidation trend which spiked in H1 2022. In 2022, AgTech, which includes robotics and smart field equipment, as well as FoodTech took the spotlight following the food shortages from the war. A second sector that is of huge interest is RegTech, which rose to prominence during and after the pandemic. As business was mostly conducted online, of which a large part is here to stay, the risk in the digital space became evident. These include fraud risk, cybercrime, money laundering, and market manipulations. Data analytics firm SteelEye conducted a survey, in which nearly half of the interviewed companies are intending to commit resources to the RegTech solution to protect the company from such threats. Although 2022 was difficult for most sectors in the industry, valuations still remain at high levels. Figure 22 shows a pre-money valuation index for fintech companies from 2020 to the end of 2022. While there is a decent chance that valuations will continue to slow down in 2023 and beyond (also dependent on whether there will be a recession), valuations are still up substantially. Since the beginning of 2020, the current pre-money valuations are still more than doubled. In particular, Series A and B valuations remain very high. Series A valuations have grown by 140% and Series B valuations even increased by 270%. They are no longer at their peak but have not lost much so far. Seed rounds are almost doubled what they used to be in 2020 but they never grew to the same extent as Series A and B. Nonetheless, compared to those rounds, they also lost very little from their peak in mid-2022. Series C and beyond achieved almost a $1bn pre-money valuation peak in the middle of 2021 and again in 2022. Nonetheless, since then it dropped below $750m, marking the steepest drop from all rounds. Figure 22: US Fintech Trailing 180-Day Pre-Money Valuation Index, Source: Pitchbook & Silicon Valley Bank Analysis, January 2023 Private Debt The ecosystem for private debt in 2022 was not great but will become substantially better in the short term, especially if the interest rates hike can push down inflation to acceptable low levels. With mediocre interest rates in 2022 on average and exceptionally high inflation, the industry suffered given that most strategies yield negative real returns or only slightly positive real returns. While this seems bad, it was quite a good asset class to hold given that most conventional asset classes are significantly down, even without considering inflation. 2023 and beyond will be very attractive years, as inflation is likely to come down and settle at the acceptable 2% rate, which might be reached at the end of 2023 for the case of the US and delayed for European countries. With low inflation then, central banks will start lower interest rates again, as they have to balance inflation and the high chance of a recession in the coming years. Although lower rates translate to lower yields for private debt, interest rates will remain high compared to the recent past. The strategy will become very attractive, as the industry will achieve high real returns, which will be difficult to obtain for most other strategies. Direct lending strategies returned around 4% as of Q3 2022, whereas distressed-focus strategies lost in the single-digit area. Preqin sees the most upside potential in direct lending strategies that largely benefit from mostly using floating rates that will pay off strongly in the coming years. It is expected that the strategy grew by almost 15% annually until 2027 on an AuM basis. If true, the industry would hit the $1.2tn mark by the end of 2027. Distressed debt is on the other end of the spectrum, as the strategy saw a substantial decline in fundraising, and this trend is expected to continue. Preqin estimates that fundraising for the strategy will drop from $44bn in 2021 to only $20bn by the end of 2027. Despite the suboptimal 2022 with high inflation, the industry grew in terms of AuM. While the beginning of 2022 was difficult with high inflation and low rates, the latter half of 2022 began to show the benefits of private debt strategies with high interest rates and declining inflation. This trend will continue in 2023 and beyond, which only increases the attractiveness of private debt. This is in particular the case if a recession truly hits and other asset classes face more turbulence than they have before. Direct lending will then provide a steady source of income, although the default risk of individual companies will rise, which may affect performance. Distressed debt will provide a multitude of opportunities in that case. Preqin estimates that the AuM of the industry will rise to around $1.4tn once the 2022 data are fully available and reach close to $1.5tn by the end of 2023. Figure 23 summarizes the historical increase in assets of the private debt industry and the gains through a promising outlook for the years to come. Figure 23: Actual and Forecast AuM of the Private Debt Industry Across Strategies, Source: Preqin, January 2023 In contrast to private equity, fundraising in private debt strategies remains strong in 2022, which is set to break its record level of 2021. As discussed above, direct lending is well positioned now and in the coming years and is responsible for the surging interest in private debt funding. Distressed debt will be less interesting relative to the total amount in the industry. Nonetheless, this could shift tremendously if there is a genuine recession and the sector can profit from many arising opportunities. In 2021, the industry raised $70bn, while Preqin expects that the $80bn mark will be hit with the full 2022 data. By 2027, it is expected that this will rise to around $120bn largely on the back of direct lending strategies. Figure 24 summarizes these findings. Figure 24: Actual and Forecasted Fundraising in the Private Debt Industry Across Strategies, Source: Preqin, January 2023 Real Estate Ever since Covid-19, the real estate industry is under pressure. During Covid-19, office and leisure real estate have suffered tremendously, as companies scaled back their office, due to the trend of working from home (and at times the only way to do business) and traveling became impossible. In 2022, most of the issues prevalent during the Covid-19 times have persisted somewhat and are unlikely to change. For example, working from home and online meetings have proven to be effective, which require less time in the office and are an alternative to traveling. The opposite was the case for residential real estate and industrial real estate. With more working from home, a nice home becomes more important and people are investing more in it. Industrial real estate gained substantially from the boom in online shopping which is also here to stay. With it, logistics become much more important to provide a smooth management of the shipping process. While the general trends in these markets have not changed dramatically over the past two years, the current macroeconomic foundation does not favor real estate. Real estate as an asset class is intriguing, as they provide a steady income stream from the rents of tenants. With the currently high inflation, the steady income is low (if it exists) on a real basis. As mentioned in private debt, close to no losses on a real basis is attractive in the current markets but it does not necessarily attract many investments. While the declining inflation will certainly help the industry, it is offset by the huge increase in costs for mortgages. Despite these challenges, the industry managed to grow in 2022. For the year 2022, the AuM of the industry is estimated at around $1.4tn. In particular the growth of the industry since Covid-19 is remarkable, given the numerous difficulties. At the end of 2019, the AuM just hit the $1tn mark. It is estimated that the AuM of the industry will or less stay flat in 2023 and start to grow again in 2024 and beyond. Preqin estimates that the industry will hit the $2tn AuM mark by the end of 2027. Figure 25: Actual and Forecasted AuM in the Real Estate Industry Across Strategies, Source: Preqin, January 2023 The current difficulties are stronger reflected in the fundraising of the industry. In 2021, the industry managed to set another record high with around $200bn, which is almost $60bn higher than in 2020, when the industry was shaken by the pandemic and its impact. Currently, the US is the dominant market with around two-thirds of capital coming from there. According to estimates, this is unlikely to change in the near future. Fundraising in 2022 is on par with 2020 and is the worst year since 2016. The rather bleak outlook also contributes to lower expected capital raises in the future. For example, Preqin estimates fundraising to reach the $200bn mark again by 2027 but not before. Figure 26 provides a breakdown of current and future fundraising across strategy and geography. Figure 26: Actual and Forecasted Fundraising in the Real Estate Industry Across Strategy and Geography, Source: Preqin, January 2023 STONE MOUNTAIN CAPITAL Stone Mountain Capital is an advisory boutique established in 2012 and headquartered in London with offices Pfaeffikon in Switzerland, Dubai and Umm Al Quwain in United Arab Emirates. We are advising 30+ best in class single hedge fund and multi-strategy managers across equity, credit, and tactical trading (global macro, CTAs and volatility). In private assets, we advise 10+ sponsors and general partners across private equity, venture capital, private credit, real estate, capital relief trades (CRT) by structuring funding vehicles, rating advisory and private placements. 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