Hi all!
This week we bring you big themes and small details, together weaving a portrait of change.
It’s not just the intensifying questions around the role and shape of money in economic stability and individual freedom. It’s not just the shifting fundamentals of crypto market infrastructure. And it’s not just the signs of growing adoption and emerging use cases.
It’s the fact that the quality, breadth and spread of the discussions is getting deeper and wider by the day.
Keeping up with it all, let alone making sense of it, is hard. We hope that this newsletter helps – every week, I focus on the more impactful developments, and try to distill why I think they’re important. If you find it useful, please share with your colleagues and friends (they can subscribe here). At the very least, you’ll have interesting conversations.
With that, read on.
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Bundle up
A handful of CoinDeskers are braving the Alpine winds this week, as we bring you insights from the World Economic Forum 2020 in Davos, Switzerland. (Check out our pop-up CoinDesk Confidential: Davos newsletter here.)
On her way to Davos, Leigh Cuen reported from St. Moritz on the global conversation around payments, how it seems to increasingly relate to crypto assets, and how this could impact geopolitical positioning. And that’s just for starters.
In one of this week’s must-reads, Michael Casey attempts to steer the Davos conversation to the problems caused by increasing centralization of both finance and information. Jill Carlson looks at the endurance of cash, and how that’s not a bad thing. And Jeremy Allaire has gone to Davos to talk about the potential role of crypto assets such as stablecoins in the new, emerging international monetary system.
Among the themes we will no doubt hear more about over the next few days are central bank digital currencies, bitcoin’s role as an investing safe haven, and the shifting balance of power in reserve currencies. On that last topic, The Economist (paywall) showed how the United States’ aggressive use of sanctions endangers the dollar’s reign. What will replace it?
Although we have been attending the Summit for a few years now, it is nevertheless astonishing how much crypto assets are now part of the global conversation.
Shuffle the board
The beginning of the year often brings a rebalancing of indices – especially in crypto, where assets move up and down the rankings with alacrity. A chart was shared on Twitter recently (h/t @nic__carter @ceterispar1bus) that shows that only 13 of 2018’s Top 20 are still there, and only six of 2017’s.
This is problematic for index fund managers: composition changes involve considerable costs, both overt (trading costs, communication) and hidden (non-representative price movements, tracking errors). It’s also not necessarily beneficial to investors: by the time they “buy in” to smaller up-and-coming assets, these have already enjoyed a large part of their potential run-up.
For instance, Bitwise last week revealed that they were adding the Chainlink token to their Bitwise 10 Large Cap Crypto Index, on which some investable products are based. This is after Chainlink was one of 2019’s top performing crypto assets, with an increase of over 350%.
What’s more, in a market as thinly traded as crypto assets, price moves can be sharp, whether or not manipulation is present. Shooting up into the Top 20 in terms of market volume or market capitalization is not necessarily a reflection of underlying value.
For now, index investing is not the norm in crypto. Given the youth of the market, and the volatility of both index compositions and the underlying assets, that’s a relief. But it is likely to grow in volume, as the market matures and the range of investable index products grows. While this could add concentration and risk (that’s for a different discussion), it could also make crypto investing more palatable and manageable for investors of all types.
What’s coming in?
Grayscale Investments* shared Q4 and 2019 figures for their crypto investment vehicles, which show that institutional interest continues to grow. 2019 new investment of almost $608 million surpassed the investment from 2013-2018 combined.
But before we trumpet this as proof of strong growth in institutional interest, let’s look a little deeper.
One thing that stands out is the skewed distribution of the inflows. Approximately 50% of the new investment in 2019 took place in two specific weeks, those beginning July 15 and October 21. We don’t know if these were from multiple investors, coincidentally grouped together, or from few.
Also, new clients accounted for less than a quarter of investment for the year. But we don’t know if these were few and large, or numerous and not so large.
And we don’t know how much of the Q4 inflows was “in kind,” with investors depositing crypto assets in exchange for fund shares. In Q3, 80% of new investment was in the form of crypto assets rather than fiat, up from 71% in Q2. If indeed the trend has continued to accelerate as investors seek the “premium trade” (planning to sell into the market post-lockup at the traded premium), then it could be that institutional interest is not growing at all.
Another takeaway is the consolidation of bitcoin as the institutional asset of choice. Almost 90% of Q4 investment was in the bitcoin trust, vs. almost 80% for the year as a whole.
This is curious, given that bitcoin’s “dominance” ratio does not seem to have noticeably increased over the past quarter – if anything, it has decreased slightly. Over the year, though, the increase has been notable.
(*Grayscale is owned by CoinDesk parent Digital Currency Group.)
– Noelle Acheson
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BIG IDEAS
Deribit Insights published an illuminating deep dive into the market impact of the maker/taker fee structure. TAKEAWAY: It’s not just the profitability of one type of trading over another (takers pay more but often have more market information) – it’s also the influence of relatively high-cost maker strategies in the increasing centralization of crypto trading, which can generate some profitability through economies of scale.
Jeff Dorman, CIO of Arca Funds, points out that it’s not the percentage increase in a token’s asset price that’s worth looking at – it’s how resilient it is on the way down. TAKEAWAY: A lot of attention is paid to astonishing outlier performance, as if it were sustainable in spite of a long history of evidence to the contrary. Confirmation bias? FOMO? Not sure, but it has more to do with emotion than fundamentals.
MARKETS
Coinbase-backed crypto derivatives exchange Blade will be introducing zero-fee trading next month in a bid to gain market share from rivals. TAKEAWAY: Here come the zero-fee wars. Fees have been falling for some time on crypto exchanges, spreads have been narrowing on most, and the continuing squeeze is bound to trigger some sector reshuffling this year as some exchanges close and others merge.
Crypto exchange Kraken has acquired Bit Trade, one of Australia’s longest-running crypto asset exchanges. TAKEAWAY: We can expect to see a lot more M&A activity in crypto exchanges this year, as the sector struggles with compressing fees and rising compliance costs. Hopefully this is accompanied by greater oversight and economies of scale, which will make the sector as a whole more robust and less fragmented. We need to watch out for over-centralization, though.
TokenInsight shared its Cryptocurrency Spot Exchange Industry Annual Report, which looks at the evolution of crypto trading across several geographies. TAKEAWAY: The report presents a bleak outlook for centralized spot exchanges, due to shrinking volumes and growing compeititon from derivatives venues. But maybe the inevitable consolidation and restructuring (which we seem to mention quite often in today’s newsletter) will shake out some of the fragmentation and result in a more robust structure.
The Canadian Securities Administrators has said that an exchange that custodies users’ assets could be subject to securities legislation. TAKEAWAY: A logical step, following the QuadrigaCX fiasco. It does add texture, however, to the shifting exchange landscape as many are either offering or thinking of adding services (such as custody) in order to attract and retain clients in an increasingly competitive environment. One intriguing twist is the clarification that, unless a client actually takes delivery of purchased crypto assets, he or she is buying a derivative rather than the underlying (an extension of “not your keys, not your coins”).
Open interest in bitcoin futures listed on the CME has doubled so far this year. TAKEAWAY: The volume is still tiny compared to bitcoin perpetual exchanges such as BitMEX ($237 million vs $1.2 billion yesterday), but it is a sign of growing institutional interest in leveraged crypto products. The launch of various crypto options since the end of 2019 is likely to be encouraging investment in a range of derivatives, as investors become more comfortable with the growing maturation of the market.
Source: skew.com
Crypto analytics firm Elliptic has recommended at a hearing that the U.S. Congress call for more stringent anti-money laundering (AML) enforcement around exchanges facilitating the trade of privacy coins. TAKEAWAY: This could lead to some exchanges de-listing privacy coins due to the increased cost and the fear of retroactive regulatory action. In turn, this could affect liquidity and asset valuations, while adding fuel to the debate about the right to financial privacy.
London Stock Exchange-listed bitcoin mining firm Argo Blockchain generated £8.5 million (just over $11 million) in revenue, compared with £760,000 ($985,720) in 2018, according to the company. Q4 revenue dropped to £2.66 million from £3.63 million in Q3. TAKEAWAY: One main advantage of listed crypto-related shares is the insight they provide into the sector’s business economics. Argo listed in August 2018, so the audited statements expected in April will be the first that cover a full year of operations. They should be an interesting complement to the crescendo of Twitter-based analysis we will no doubt be fielding by then – the upcoming reward halving, expected in May, is shining a spotlight on mining profitability.
The Coinbase-led Crypto Ratings Council, which hopes to create a standard for assessing whether a crypto asset is a security under U.S. law, has added eToro, Radar and OKCoin US to its list of members. TAKEAWAY: Um, insight from ratings is potentially good, but I can’t help wondering about potential conflicts of interest. The group plans to reveal the framework later this year, which should boost transparency. But could the members objectively qualify a token as a security if they have been trading it as a non-security?
NEW PRODUCTS
Bitwise Asset Management withdrew its application for a bitcoin ETF, although it plans to resubmit the proposal “at an appropriate time.” TAKEAWAY: Apparently the SEC responded to the initial filing with 112 pages (!!!) of comments and questions, which Bitwise is working on answering. As with its thorough research determining fake volumes in response to previous SEC comments, the additional clarification will no doubt further push forward the sector’s understanding of its markets. We should all look forward to seeing the results.
Crypto custodian Anchorage has launched a trading platform for institutional investors, and acquired the data analysis firm Merkle Data. TAKEAWAY: Service diversification in crypto custodians should intensify this year as the sector struggles to offset growing competition and declining custody fees. While this should on the whole be good news for clients, it could distract both investors and companies from the main objective: asset safekeeping. Bells, whistles, low fees and nifty research reports are fun until they become the main reason a custodian is chosen over others.
SFOX has launched a “Separately Managed Account Solution” that enables fund managers to design and administer personalized crypto trading strategies for clients. TAKEAWAY: This is a well-known traditional asset management service which allows investors to benefit from fund manager expertise without having to pool investment in a mutual fund. It is unlikely to provoke an immediate uptick in investment, but any crypto investment tool that is familiar to traditional fund managers should soften some of the investment barriers.
New York-based crypto exchange Gemini has created its own insurance company to protect clients against the potential loss of coins from its offline vaults, with a $200 million coverage limit. TAKEAWAY: Insurance is hard to come by in crypto custody, largely because of the unfamiliar nature of crypto assets and the outsize risk (the theft of digitized securities is not really a thing in traditional markets). Building it yourself sounds like a practical solution for custodians, and clients will be comforted by the coveted protection, provided the funding of the insurance company is totally separate from that of the custody service (in other words, the counterparty risk is insulated – if the latter folds because of a serious hack, the insurance can still pay out).
BTCX, one of the oldest cryptocurrency exchanges in Scandinavia, is planning an IPO before the end of Q3 2020. TAKEAWAY: This effectively gives the market a listed vehicle through which to invest in the health of the crypto asset ecosystem, although adding business-specific risks on top of broader market ones.
CRUNCHING NUMBERS
According to The Block, bitcoin miners generated an estimated $5 billion in revenue in 2019, mainly from block rewards, with approximately 2% coming from transaction fees. TAKEAWAY: With the block reward set to reduce by 50% in Q2, 2020 revenue could see a significant slump unless the bitcoin price increases by at least a corresponding amount. Since miner revenue is one of the main sources of network security, this is worth keeping an eye on.
According to @ceterispar1bus, using data from skew.com, June bitcoin options pricing shows a 32% probability that the BTC price will be greater than $10,000. TAKEAWAY: Glass half-full, glass half-empty – the market seems to think there's a 68% probability it won’t be. But the bitcoin options markets are still young and it’s not clear how much information about broad market expectation is embedded in the prices.
Source: skew.com
ADOPTION
Alyssa Hertig reviews some of the main players in the development of the lightning network, which should enable fast and cheap bitcoin payments as well as help bitcoin scale. TAKEAWAY: Progress on lightning is worth keeping an eye on, as it could kickstart an overlooked use case. Last week, BitMEX released a report concluding that lightning network usage is higher than expected.
Conner Brown wrote about how the lightning network can transform bitcoin into a smart contracts protocol. TAKEAWAY: The lightning network could solve the scalability problem; but it’s not clear that it would be a notable improvement on what other smart contract protocols such as ethereum already offer.
The value of tokens held on DeFi platforms has shot up since the beginning of the year, and it’s not just because of the spike in the value of ETH – it’s also because of increased use of DeFi loans to take advantage of market movements. TAKEAWAY: As my colleague Brady Dale points out, the market is still small and the technology is still relatively new. But the innate demand for leverage in crypto markets will boost usage… and risk.
Electric Coin Company, the entity behind the development of privacy coin Zcash, has released a software development kit that will facilitate shielded payments on mobile devices. TAKEAWAY: This could open up a host of new use cases for transactions with embedded privacy. The asset price is up over 25% since the day before the announcement was made (vs. bitcoin’s 1.6% increase over the same time period), which could hint at a correlation decoupling. But, as we saw above (in Markets), the threat of regulation-inspired delistings of privacy coins complicates fundamental analysis.
The Bitcoin/Zcash correlation chart, from Coin Metrics:
Australia's financial regulator has given the green light to the first bitcoin fund aimed at retail investors, launched by micro-investment app provider Raiz Invest Australia. TAKEAWAY: With the crypto market apparently no longer holding its breath for SEC approval of a bitcoin ETF, steps like this remind us that it will happen, but probably gradually. This step is a small one, as the Raiz app allows anyone to invest small change left over from everyday purchases in listed ETFs, with only 5% going to bitcoin.
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As I mentioned above, CoinDesk sent a team to the snowy mountains of Davos this week to bring you first-hand coverage of the themes, discussions and events that global finance is thinking about. Subscribe to our pop-up newsletter to get updates and insight right in your inbox – just for this week!
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Previous newsletters: 55, 56, 57, 58, 59, 60, 61, 62, 63, 64, 65, 66
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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 - mountains, valleys and slippery slopes