One of the fun things about jigsaw puzzles, for those of you that haven’t tried them, is the satisfying snap of pieces fitting together to reveal part of a picture. Another is watching the whole picture emerge as more pieces are joined.
In July of last year, the U.S. Office of the Comptroller of the Currency (OCC) said national banks could custody crypto assets. That was a pretty big deal because, should national banks start to offer this service, investors could in theory ask their habitual institution to custody all their holdings, be they stocks, bonds or crypto. So much easier. A major barrier to crypto investment removed.
In September, the OCC said banks could provide services to stablecoin issuers, such as holding reserves. Banks had been doing this for some time, but in an uncertain regulatory environment. Now they had official approval to do so. Stablecoins backed one-to-one by fiat held in bank reserves are not deemed a risk in one of the most regulated industries in the U.S.
And then this week the federal banking regulator published an interpretive letter saying that national banks and federal savings associations can use public blockchains to store and validate payments. It effectively awards blockchains the status of “payment network.”
Do you see the picture emerging? It’s not just about expanding the range of products banks can offer clients. It’s not just about offering better payment services. It’s about the convergence between traditional and crypto markets. It’s also about the role of the dollar in the economies of tomorrow.
Let’s look at why this emerging picture is worth your attention:
- It is good news for crypto markets: a nudge to traditional banks to offer support for blockchain infrastructure and even facilitate crypto transactions. This makes crypto investments easier for traditional investors, which will bring more money into the industry, which will encourage more infrastructure development, and so on in a virtuous circle that will end up offering opportunity to an ever-wider user base. If investors can pay for crypto assets with stablecoins issued by their bank, through their bank and have the assets automatically dropped into their bank custody account, then why not put part of your portfolio in a systemic hedge instrument? Barriers are removed.
- It is good for traditional markets because it is likely to encourage the emergence of a new type of lower-cost and more transparent settlement system. In spite of substantial improvement over the past decade or so, traditional settlement is still hampered by reconciliation needs. Using stablecoins does not necessarily fix this (the issues are more legal than technological), but it does open the door to an alternative process that may be worth deeper investigation and which may tie in with a future market of tokenized traditional assets, new types of assets that we have not yet even begun to design and everything in between.
- It is good for the banking sector, potentially opening the door to new types of financial products as well as payment and collateral services. With banking margins squeezed by ever-onerous compliance costs and low interest rates that are unlikely to increase any time soon, the need to diversify revenue streams and extract more value from existing clients is becoming increasingly imperative for a systemically important part of our economy.
- It is good for financial innovation. Banks can use stablecoins but they can also issue them, potentially with bells and whistles and functionalities attached. JPM Coin, issued by investment bank JPMorgan, is now live and used to make global wholesale payments. Others will follow, each with its own functionality and target customer base. And if they become interoperable, we’ll have a swarm of programmable tokens that can boost liquidity in previously overlooked economic segments while lowering costs for, as well as encouraging, new types of transactions.
- It is good for liquidity. Apart from the potential diversity within and use cases for programmable stablecoins mentioned above, more crypto dollars sloshing around a system that allows for interchangeable settlement tokens is likely to allow for better optimization of capital.
- It is good for the global economy. More efficient cross-border settlements will be good for trade, lowering the costs of documentation and compliance and maybe finally giving blockchain supply chain and trade finance apps the transactional piece they’ve been missing. Better payment systems boost economic activity.
- It is good for the U.S. dollar. With the U.S. leading the charge on this, it is likely that dollar-backed stablecoins will become the de facto global settlement token, further consolidating the dollar’s hegemony. More dependence on the dollar could make the global economy more vulnerable, especially with a limitless supply of the currency flooding the market. But blockchain-based systems allow for the rapid iteration of payment token innovation, and human ingenuity is likely to find a way to compensate for weaknesses and vulnerabilities when necessary.
A quiet transformation
The jigsaw puzzle metaphor I introduced at the beginning reminds me of one of my favorite philosophies: “Just when you think you have life’s puzzle all figured out, someone hands you another piece.”
The crypto markets are like that. Just when you think you understand the potential impact of bitcoin and other decentralized value tokens, you find out that this story is not just about a new type of market. It’s also about traditional markets and how they evolve.
While there are many hurdles yet to overcome, and many more pieces of legislation and regulatory guidance needed, we are getting a glimpse of what the finance of tomorrow could look like. And blockchains and crypto assets play a meaningful role in the emerging picture, which depicts so much more than rising prices and portfolio allocations. It sketches a new way of transacting, something that eventually will affect all of us.
Anyone know what's going on yet?
Everyone knows that all bubbles pop when a needle appears on the scene. It’s hard to imagine anything as messy and noisy as an insurrection being compared to something as small and sharp as a needle, so let’s mix metaphors and go with the sudden appearance of a “bump in the road.”
But that didn’t happen – the main U.S. stock markets continued to go up, and call options saw their fourth-highest volume day on record. So, either traditional U.S. markets are not in a bubble or we have not yet had that bump.
Yet, if it’s not 10-year yields edging over 1% for the first time since March … If it’s not a greater likelihood of corporate tax increases or antitrust legislation … If it’s not, heck, the realization that political polarization has pushed faith in the democratic process to a generational low, then what will that bump look like? I shudder to think.
The optimist in me likes to think that the strength of the market in the face of greater political turmoil than I’ve ever seen, demonstrates unbending trust that the U.S. democratic institutions will hold, no matter what. That’s touching. But it doesn’t feel true.
To confuse things further, crypto assets also had an extraordinary week, with BTC and ETH throwing up returns of over 34% and 60%, respectively.
(Yes, I know that all three columns in the above chart are the same – it’s the way the dates worked out. This coincidence is just yet another detail that makes this week particularly weird.)
What makes this confusing from a traditional investment point of view is that bitcoin is a good hedge against “crazy,” and things were definitely crazy this week. But the stock market is telling us that everything is fine.
And it’s not that crypto assets and stocks are becoming more correlated. The 30-day correlation (not useful from an investment point of view, but a handy narrative device) between BTC and the S&P 500 has turned negative for the first time since last February.
As I type, the BTC price is again flirting with $40,000, double what it was three weeks ago. Could this also be a bubble?
The difference between the movements in BTC and ETH is that they have strong fundamental drivers behind them. These include the multiple “bumps in the road” that we referred to above, and the growing awareness from institutional investors that these assets were designed to operate separately from the traditional economy, with different incentives and accounting mechanisms.
That said, a short-term correction from these levels would not be surprising (although demand may be such that it doesn’t happen). And if traditional markets crash, it is likely we will see crypto assets head down as well in the rush to liquidity. But, looking further ahead, the underlying fundamentals have never been stronger.
(Now is a good time to remind you that nothing in this newsletter is ever investment advice.)
· The Stone Ridge investor letter is a must-read – one of the most eloquent and insightful (not to mention amusing and moving) pieces I’ve read in a long time, on the nature of money and why bitcoin matters.
· Investor Bill Miller, whose flagship mutual fund in 2020 beat the S&P 500 Index for the straight second year, said he believes bitcoin could replace cash and markets are underpricing inflation risk. And then there’s this: “Warren Buffett famously called bitcoin rat poison. He may well be right. Bitcoin could be rat poison, and the rat could be cash.”
· He also pointed out, in a separate interview, that bitcoin “gets less risky the higher it goes.”
· Skybridge Capital, the hedge-fund investing firm headed by Anthony Scaramucci, confirmed its launch of a new bitcoin fund Monday and said its exposure to bitcoin has already reached $310 million.
· According to Michael Sonnenshein, former managing director and now CEO of digital asset manager Grayscale Investments (owned by DCG, also the parent of CoinDesk), a broader range of institutional investors, including pensions and endowments, is starting to participate in the company’s crypto asset funds.
· This is the best quote I’ve seen on why even skeptics should be investing in bitcoin, via Lionel Laurent and Mark Gilbert in Bloomberg: “Bitcoin is the perfect vehicle for exploiting mankind’s infinite stupidity," says Julian Rimmer, a sales trader at Investec Plc. “A small percentage of one’s portfolio must be held in this ‘asset’ because gullibility never goes out of fashion.”
· JPMorgan’s Global Markets Strategy team has published a note that puts a long-term theoretical price target on BTC of $146,000, assuming BTC’s volatility converges to that of gold.
· Merryn Somerset Webb, editor-in-chief of MoneyWeek, said in an op-ed for the Financial Times that she will put some money into bitcoin, but confesses that her “go-to inflation hedge will remain gold for the simple reason that it isn’t new.”
The CFA Institute Research Foundation, part of the global association for investment professionals, has published a 64-page guide to crypto asset investing. “Cryptoassets: The Guide to Bitcoin, Blockchain, and Cryptocurrency for Investment Professionals” was written by Matt Hougan and David Lawant, respectively CIO and analyst at crypto fund manager Bitwise. TAKEAWAY: This publication is significant since the CFA Institute is a respected source of continuing fund management education. Their promotion of a guide not only validates cryptocurrencies and tokens as worth considering for portfolios; it also puts a well-written and thorough information document in front of the association’s almost 200,000 members.
Cryptocurrency exchange Bakkt, backed by NYSE parent Intercontinental Exchange (ICE), is in advanced talks to go public via a merger with special purpose acquisition company (SPAC) VPC Impact Acquisition Holdings, according to Bloomberg. TAKEAWAY: That the first large crypto SPAC is an infrastructure play highlights the difference between now and 2017. Back then it was about shiny new tokens and “decentralized protocols.” Now infrastructure dominates new funding.
The Chicago Mercantile Exchange (CME) is now the largest bitcoin futures exchange in terms of open interest in the world. TAKEAWAY: This is indicative of the growth of institutional interest in crypto markets – the CME is one of the few U.S.-regulated crypto derivatives exchanges, and is therefore the venue for most U.S. institutional activity in bitcoin futures. The growth is spectacular, given that the exchange started Q4 in fifth place (see our Quarterly Review for more on this.)
Bitwise Asset Management revealed that its AUM has increased five-fold to $500 million, up from $100 million reported in late Octobers. TAKEAWAY: More evidence, if any was needed, of growing institutional interest. Most of the increase came from the multi-asset fund, which shows that investors are starting to think beyond bitcoin.
Crypto custodian BitGo has expanded its Wrapped Bitcoin (WBTC) project, which converts bitcoin into an Ethereum-based token, to the Tron network. Previously only available on the Ethereum network, WBTC converts bitcoin into a bitcoin-backed token on a different blockchain. BitGo has also enabled Wrapped Ether (WETH) on Tron. TAKEAWAY: This expands the yield potential of BTC, as well as its potential attractiveness to professional investors. WBTC tracks the value of BTC, but can also be used in decentralized finance applications, some of which offer yields of over 10%.
The ban announced in October by the U.K’s Financial Conduct Authority (FCA) on the sale of derivatives and exchange-traded notes (ETNs) to retail investors went into effect this week. TAKEAWAY: This is unlikely to have a material impact initially as professional investors can still access these products, and retail investors can still buy crypto assets. It is a clear indication, however, of how much investment independence the FCA thinks retail investors should have, even with ample information.
The spread between the six-month implied volatility for ETH and BTC has risen to a record high of 46%. TAKEAWAY: This tells us that the market is expecting higher volatility for ETH relative to BTC, which in a bull market implies higher returns.
You might have seen that CoinDesk (yes, us) has acquired TradeBlock, the industry’s leading crypto index provider. TAKEAWAY: This gives us access to deeper data sets on market movements, as well as robust indices for crypto asset prices. It will also allow us to better serve the professional investor audience, combining information, insight and data.