Hi all! We have several big announcements:
Our first CoinDesk Quarterly Review is out! In this 35-chart presentation, put together by my colleagues Galen Moore and Christine Kim, we look at metrics that could hint at emerging use cases for crypto assets. Data in this sector is fragmented and often tough to interpret, but we want to start the conversation about which charts matter, and what they are telling us. You can download the full report here.
Interested in finding out more? Join us for a live WEBINAR on Tuesday, February 4 at 2pmET. Galen and Christine will go through their main takeaways, answer some of your questions and probably go off on a tangent or two. You can sign up for free HERE.
The last announcement for today is that we’ve launched our own Twitter account! Follow CoinDesk Research at @coindeskdata. We’ll keep you abreast of our investigations, output and internal debates, and we’ll share interesting insight from around the sector.
With that, please download, sign up, click that follow button and read on…
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Halls of power
In spite of a few connection hiccups, our team made it back safely from the snowy mountains of Davos, with tales to tell of central bankers pontificating about digital currencies while politicians avoided answering questions about bitcoin.
One outcome from the event is the creation of a WEF-backed international consortium comprising financial institutions, technical experts, academics and legislators, to design a governance framework for cryptocurrencies. Consortiums are plentiful in the crypto space, and yet few have (so far) made a far-reaching impact. This one, however, aims to focus on “solutions for a fragmented regulatory system” – a daunting task, but if it can make even a little bit of progress, that will be a good thing for clarity, funding and technological support.
Central bank digital currencies (CBDCs) seem to be dominating conversations in the halls of power elsewhere as well. Last week, the central banks of Sweden, Canada, Switzerland, the U.K. and Japan, as well as the European Central Bank, announced a working group with the Bank of International Settlements (BIS) to delve into potential CBDC use cases.
Speaking of the BIS, last week it released its annual CBDC survey which showed that 80% of central banks are working on digital currencies, up from 70% in 2018. Nearly 40% have moved to experiments and proof of concepts, and 10% are developing pilot projects.
And politicians from Japan’s ruling Liberal Democratic Party plan to propose that the nation issue its own digital currency, to counter the approaching launches of Libra and China's digital currency.
Why does this matter for investors? Because it indicates that a conversation about blockchain technology transforming monetary policy has finally made it onto the agendas of people who can make change happen. This has happened in just over 10 years, which is but a mere blip on the timeline of financial evolution. It gives us an inkling of what giant steps could be made over the next 10 years. We should all start thinking about the potential implications for capital markets, interest rates, purchasing power and monetary flows.
Insurance funds
Binance issued a report that explains the insurance funds of derivative exchanges. This concept is worth spending some time on, as it not only has a material impact on the potential return of derivative positions; it is also a fundamental feature of infrastructure risk.
Crypto assets are more volatile than most others, and the high leverage offered by some derivative platforms (100x or more) makes a business based on crypto derivatives especially vulnerable to market swings. The implosion of a large platform, taking with it investors’ capital, would not be at all good.
Insurance funds absorb any margin remaining after a trader’s position has been liquidated due to adverse market movements. In any derivatives trade, there is a “winner” and “loser.” Liquidation usually happens at a price below the “bankruptcy price,” at which the loser’s margin would not be enough to cover the winner’s profits. Occasionally the market moves so fast that liquidation does not happen below the bankruptcy price, and the margin is not enough – here’s where the insurance fund steps in, to ensure the winners are always made whole, even if the margin is wiped out.
This sounds wholesome, but can be misconstrued. BitMEX’s insurance fund, for example, has for some time now attracted attention for its sheer size. It currently holds almost 34,000 BTC, worth over $300 million at today’s BTC price. This is about 25% of BitMEX’s total open interest. Is such a large cushion necessary? Is it good for the market?
Some have pointed out that the existence and policy of the fund is bullish, given that it steadily drains bitcoin from circulation as margin deposits get absorbed. Yet the funds are not exactly “locked up” and would in theory find their way back into the system in the event of extreme volatility – not exactly a stabilizing factor.
Others have questioned the true purpose of the insurance – is it for traders, or could it be used to protect the company (and presumably its shareholders) against any eventuality?
An insurance fund is certainly preferable to the “forced clawback” from traders’ profits that OKEx had to do a couple of years ago when a large trade went spectacularly wrong. But the overhang of the BitMEX fund, and what it says about market resilience, will most likely be a source of much contention over the coming months.
In the end, as long as traders feel that they can overall make a good return, they probably don’t care very much about their preferred exchange’s insurance fund practices. Trading opportunities are what matter, and if an exchange is going to get rich while providing those, then fine. But if traders start to feel cheated, we could see migration to other platforms, as competition in the sector heats up.
The concept gets especially intriguing when you start to think about what else can be done with these funds. A policy of rebates, paid from the fund, for volume or good behavior, could attract more traders and liquidity to a venue. And how about tokenizing an insurance fund? Derivatives exchange FTX socializes gains from the insurance fund through its FTT token.
By size, the BitMEX fund is larger than the market cap of all but the top 31 coins. As market leader, it doesn’t have an obvious incentive to change what works. But innovation from competitors is likely to make infrastructure business model evolution fascinating to watch over the coming months.
Something for everyone
Messari’s Ryan Selkis and DTC Capital’s Spencer Noon got into a Twitter squabble about what institutional investors are more interested in – is it just BTC and maybe a couple of the other large ones? Or are they tired of the “digital gold” narrative and see in decentralized finance (DeFi) parallels to the emergence of the legacy financial system?
Both. Neither. We all tend to talk about “institutional investors” as if they were a uniform group with similar priorities. This is not so. There is almost as much variety within the “institutional investor” category as there is within crypto investment opportunities.
In my experience, the “general” institutional investors that I talk to at our events and in individual chats, are looking for a broad introduction into crypto investing. They want to get comfortable with the basic concepts before digging into specific assets. They tend to be skeptical (as they should be), and are more often than not looking for reasons to stay away (it’s easier, let’s face it) than for the necessary conviction to dive in.
But many are doing that. Ryan’s right, most will do so through BTC – it’s the only one liquid enough (for now) to handle orders large enough to potentially give the return that would justify the hassle, and the only one with a sophisticated enough regulated derivatives pool to provide the necessary hedging and leverage opportunities.
Spencer’s also right – DeFi is a fascinating experiment to watch, and it does feel like a rebirth of financial markets, which markets nerds like myself are fascinated by. But the field is, for now, too niche for most traditional funds to justify investing in. Some are, sure, but not in significant volume.
Many are (and should be) following DeFi closely – but that’s not the same as investing. Putting clients’ capital in a nascent concept, no matter how compelling, is a step that few traditional investors will take. Large private investors and perhaps some crypto funds that have fewer limitations and explanations to give are a much more likely target market for the returns and products that are emerging from this supremely innovative segment.
– Noelle Acheson
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BIG IDEAS
Parker Lewis of Unchained Capital (his pieces are generally worth reading) goes deep into the philosophy of money and shows how bitcoin is a better version than its fiat competitors. TAKEAWAY: One intriguing insight is that knowing how bitcoin works and understanding its complexity is not necessary for everyone to converge on it as the “best” money. Bitcoin becomes an A/B test, and it’s not just about the hard cap and reliably predictable supply schedule.
 (Source: Unchained Capital)
The latest overview from fund manager ARK Invest takes us through the grand tech innovations shaping the investment opportunities of today, and sees bitcoin in a good position to win the global battle among monetary systems. TAKEAWAY: The team does more than pontificate about regime change, it actually does its homework and puts numbers on the potential use cases – bitcoin as a potential medium of exchange and catalyst for currency demonetization could be worth $1.1 trillion in five years, bitcoin as digital gold $800 billion, and bitcoin as insurance against asset seizure could be worth $46 trillion.
Paul Brodsky, partner at crypto fund Pantera, presents a case for the role of crypto assets in portfolio diversification, given monetary policy tensions and their likely impact on U.S. dollar-denominated wealth. TAKEAWAY: Bitcoin and peers are not vulnerable to central bank strategies, which tend to be short-term and protectionist by necessity. Although the market is still relatively young, its sophistication does support the accumulation of strategic positions for portfolios that seek low correlations.
In my op-ed on CoinDesk last week, I look at how crypto custodians are starting to wield significant influence on crypto asset markets by acting as gatekeepers for certain types of assets. TAKEAWAY: Custody is important – but should the service providers have enough power to affect asset values?
Max Boonen of crypto OTC firm B2C2 continues his deep dive into the world of HFT, and looks at how it can affect crypto market microstructures. TAKEAWAY: There’s a lot to unpack in here, including adverse selection and the move to HFT, as well as its impact on exchange structure and on prices. My favorite quote: “Being informed nowadays means being fast.”
Daniel Goldman published a summary of the main arguments against ethereum, and how most of them are factually incorrect. TAKEAWAY: A degree of skepticism is healthy (especially in a sector so low on actual fundamentals), and portfolio allocations need to be done with care and conviction. But total dismissal without a deeper understanding not only limits investment performance – it’s also a less interesting way to embrace the universal truth that things change, and new technologies are an intrinsic part of that.
MARKETS
Fidelity Digital Assets published an in-depth look at crypto custody models, specifically omnibus accounts. TAKEAWAY: The report debunks common myths surrounding omnibus accounts, such as 1) they are not necessarily one wallet that holds all clients’ assets, and 2) they can be more secure, flexible and private than segregated accounts. The report also discusses “proof of solvency” as a way to verify a custodian’s capital ratios.
TokenInsight published its annual Cryptocurrency Derivatives Exchange Industry Report, with a ton of statistics, charts and insight. TAKEAWAY: One interesting prediction is that futures volumes will surpass those of spot by a factor of 2x. If so, that would imply phenomenal growth, and would signal a greater depth of market maturity. Would this be enough to tempt more institutional investors to take a closer look at crypto assets? The report worries that current trading fees on the large exchanges have been designed with retail traders in mind – this could be a barrier.
The Block produced the report of a survey carried out in conjunction with the Blockchain Association that looked into blockchain employment. TAKEAWAY: The report managed to highlight the importance of local regulations in the concentration of blockchain activity – almost 40% of all 2019 token launches were based in Singapore, and over 90% of firms believe that regulatory uncertainty is a barrier to setting up operations in the U.S.
(Source: The Block)
CryptoCompare shared its latest Exchange Report, which showed that trading volumes were down across the board in December (almost 50% off the July peak), but still more than double those of December 2018. TAKEAWAY: One chart that caught my eye was the three-month bitcoin trading volumes chart. If you squint, turn your head sideways and look very closely, you’ll see that bitcoin trading into USDC (the stablecoin run by Coinbase and Circle’s CENTRE coalition) increased slightly in December, amid a general volume decline. Expect to see more of this as stablecoin use in crypto markets continues to grow, and institutional investors feel more comfortable with an audited, US-backed version.
(Source: CryptoCompare)
Avi Felman shared an explanation of the bitcoin futures forward curve, and why it sees large swings. TAKEAWAY: It’s because of demand for long leverage and the unpredictability of the funding rate, the opportunity cost of not holding actual bitcoin and operational cost (the potential yield is not worth the risk).
According to Norwegian cryptocurrency research firm Arcane Research, searches on Google for “bitcoin halving” have almost doubled this month. TAKEAWAY: Even though fundamentals may not be enough to justify a bitcoin price rise in the run-up to the 50% reduction in the miners’ block reward, expected in May, the public attention the event could draw might change the balance. The assumption that the supply inflow reduction is already priced in does not take into account new demand.
The Grayscale* Bitcoin Trust has become the first digital currency investment vehicle to register with the SEC. TAKEAWAY: One of the most interesting changes here is the shortening of the lock-up, the time accredited private placement investors have to wait before they can sell their shares on public OTC markets, from 12 months to six. It will be worth watching what happens to both inflows and to the public market price premium vs the price of BTC (currently over 10%).
(*Grayscale Investments is owned by DCG, also CoinDesk’s parent.)
NEW PRODUCTS
Digital asset issuer Amun has launched an “inverse ETP” called the 21Shares Short Bitcoin ETP (SBTC) on the Swiss Stock Exchange, which will track bitcoin’s price movements inversely. TAKEAWAY: While it is certainly possible to take negative positions in BTC by playing the derivatives market or even selling BTC short, they can be cumbersome processes for many investors – a traded ETP that fits neatly into existing portfolio structures and administration systems could provide funds with an easier way to express a bearish view.
Stablecoin issuer Tether has launched a new token, XAUt, which represents one troy fine ounce of physical gold stored in a Swiss vault. TAKEAWAY: The idea is interesting, but will they be able to verify the reserves with enough frequency and reliability to satisfy investors, given their choppy record on verifying their U.S. dollar-backed stablecoin reserves?
CRUNCHING NUMBERS
Nic Carter shares some graphs that show that the transaction velocity of stablecoins is significantly higher than that of cryptocurrencies. TAKEAWAY: This may seem obvious – stablecoins are designed to be transacted, whereas the main use case of most major cryptocurrencies is still up in the air – but it is interesting to see a growing focus on non-speculative uses of blockchain-based tokens.
(Source: Nic Carter via Twitter)
Alex Krüger picks apart reaction times and correlations to explore if bitcoin may be trading like a risk-on or a risk-off asset. TAKEAWAY: An illuminating thread that points out that bitcoin has been consistently uncorrelated with traditional assets, until the Iran missile strikes in early January when they turned negative. Could this mean that bitcoin is becoming more of a macro hedge?
ADOPTION
Work on “Taproot,” a privacy and scalability upgrade for the bitcoin network, is one step closer to being implemented. TAKEAWAY: Apart from the potential impact of improved scalability and privacy features, two oft-cited barriers to broader adoption, the progress of this upgrade – proposed by Bitcoin Core contributor Peter Wuille – is an intriguing example of how development can move forward in a leaderless system.
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As you saw above, our first CoinDesk Quarterly Review is out, and invite you to join us for a LIVE WEBINAR in which we will discuss the charts, conclusions and lingering questions. Sign up for free here – it’s on Tuesday, February 4 at 2:00pm ET. Come along, share your questions and tell us what you want to hear more about – we’ll be doing more of these, and your opinion matters.
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Previous newsletters: 56, 57, 58, 59, 60, 61, 62, 63, 64, 65, 66, 67
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CoinDesk is not an investment advisor. This newsletter is for informational purposes only, and any comments here do not constitute investment advice. |
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Institutional Crypto - Investment focus, insurance funds and what the powerful are talking about