Hi all!
Plans are progressing for our virtual Consensus, which we are calling Consensus: Distributed (geddit?). Although we would rather have seen you all in person, we’re getting excited about this new format, which is likely to give us a ton of ideas (and experience) for other types of events as the year unfolds. If ever there was a time to talk to each other and learn and learn about the evolving role of crypto in this weird environment, this is it. Our new sign-up page and agenda will be available soon, so watch this space.
Since we seem to be getting used to this OMG environment, I’m going back to the comforting format of these newsletters, separating out analysis from big ideas and adoption news. You’re welcome.
Below in THE BRIEFING I talk about how general market turmoil is highlighting how crypto markets are immune to structural manipulation, for better or worse. And as always, a long and yet engrossing list of links and takeaways.
Read on…
- Noelle Acheson
(The song in this week’s subline.)
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Keep it flowing
Shuttered shops. Empty streets. Scant traffic. The world’s financial centers are increasingly looking like ghost cities. The world’s financial markets, on the other hand, are a frenzy of activity, as dealers and traders try to ride the wild swings each headline and sentiment shift brings.
Yet, even though almost all trading is electronic these days, conducted behind sanitary screens, there is talk of shutting down markets for health reasons. The health in question is not just that of the traders and support staff involved.
Wild seesaws like we have been seeing this month in both traditional and crypto markets destroy wealth more often than they create it. At times, the destruction can be truly threatening – at time of writing, the S&P 500 has lost over $3 trillion in value so far this month. And, as we saw in 2008, market losses can trigger a widespread economic meltdown that impacts the lives of people that had no idea they were inadvertent market participants.
It takes on a new meaning, however, when the threat is more than economic. As most of us retreat to safety (with a huge shout-out of appreciation for those who can’t), markets need to keep running.
Yet sending market makers to work from home is not as simple as it sounds. Regulations require certain levels of supervision, time stamping, data privacy procedures and voice recording that cannot be replicated in a home office. And market surveillance and audits are not quite as reliable via a saturated home Wi-Fi. The CFTC, SEC and FINRA have issued no-action relief notices exempting market operators from these rules while the pandemic lasts, but the full functioning of markets will not be “business as usual.” Market makers that are out of their comfort zone, either because of unstable infrastructure or unclear rules, may have less appetite to offer liquidity.
Preventive measures
So, for health and safety, of people and prices, should markets close?
Some notable financial influencers have argued in favor of doing so. CNBC’s Jim Cramer believes that closing until the virus peaks would stop company valuations from collapsing unnecessarily. Tech entrepreneur Max Levchin argues that doing so would allow everyone to focus on staying safe, without the distraction of collapsing 401(k)s. Even Treasury Secretary Steven Mnuchin has confirmed that there have been talks about reducing opening hours.
Bloomberg’s John Authers, one of the more insightful and sober economists that I follow, presents the case for closure as a data issue: there’s not much point in letting markets absorb and trade on data when the data that matters (the spread of the virus and its economic impact) is incomplete and unreliable.
Less drastic but similar measures are being implemented already. Several countries, including France, Italy, Spain and South Korea, have instituted full or partial short-selling bans. Some support the move as an acceptable compromise to more stringent measures. Others point out that banning short selling distorts price discovery and limits investors’ hedging opportunities. A 2012 paper by researchers at the Federal Reserve Bank of New York showed that stocks subject to short-selling restrictions performed worse than those without.
What’s more, almost all traditional markets have an inbuilt closure mechanism anyway, in the form of circuit breakers. In the U.S., for instance, if a market falls more than 7% before 3:25pm, trading is halted for 15 minutes; a fall of 20% will halt trading for the rest of the day. Since implementation in 1987, they have only been triggered five times in the U.S.: once in 1997, and four times so far this month.
These circuit breakers give traders a chance to gather their wits and strategize, rather than just try to catch the proverbial falling knife. They are seen as a breather that restores common sense, and that might help panic sellers to see the error of their ways.
Keep them open
Fortunately, none of the arguments for full closure are as yet being seriously considered. The closure of the world’s principal trading venues would suspend price discovery, which is a fundamental mechanism of trade beyond stocks and bonds. And the blow to investor confidence in liquid markets from a prolonged shutdown would be severe and long-lasting.
But even more urgently, many investors will most likely need to sell shares or bonds for cash over the coming weeks to cover living expenses.
Also, market closures would not necessarily stop trading from happening – it would just move off-exchange to unregulated “back rooms” with no investor protection. As with nature, markets always find a way.
Even the concept of temporary circuit breakers is criticized as a market distortion. To mitigate the damage from technology glitches, fine, but why shouldn’t prices plummet in response to new information, if they reflect investors’ opinions (however mistaken) on fair value?
What’s more, circuit breakers do have an ideological bias – notice that there are no market-wide circuit breakers when markets move up, even though rapidly ascending indices can also encourage traders and investors to take foolish positions.
Business as usual
And then we have the crypto markets.
These never close. Ever. Crypto assets can be traded 24/7 – even if one exchange is down (which often happens), there is another one somewhere that can pick up the action.
Even if it were agreed that temporary closure is a good idea, there is no central authority to enforce that. Even if all the large exchanges agreed (work with me here), there would be many smaller exchanges happy to help traders express their market opinions. Heck, you don’t even need an exchange to sell your crypto assets – you and I could agree to trade via email if we wanted.
Investors in crypto assets, especially those that believe in the true purpose of markets, must take some comfort from the knowledge that there is no way their intentions could be thwarted by a centralized decision.
Proposals have been made to introduce circuit breakers in crypto, arguing that the steep drop of over 15% in the space of 30 minutes on three different occasions on March 12-13 limits the usefulness of the technology. Some insist it is enough to scare many investors away. Others point out that were it not for an inadvertent circuit breaker in the form of a technical halt to trading on leading derivatives exchange BitMEX, allegedly due to a DDOS attack, the imbalance of bids vs. positions to liquidate on the platform could have pushed bitcoin’s price down to $0.
While the desire to protect the market is understandable, it flies against the very essence of crypto assets – they are decentralized stores of value that can be transferred from one party to another without going through a centralized authority.
An effective circuit breaker plan would require total centralization. First, who makes that decision? Consensus amongst all trading platforms? Not likely, especially as any holdout would reap rewards as trading flowed its way.
Second, when would the circuit breakers be triggered? And who decides that? Again, consensus is unlikely, as is efficient implementation. Who would be responsible for making sure that all platforms complied? How would this be enforced?
The bigger question
This is a fascinating conversation for market nerds like me, as it goes down to the root of what markets are for. Are they for allocating resources and messaging value? Or are they for protecting capital and preserving wealth? Are they there to crowdsource opinions as to economic outlook? Or are they there to boost investing confidence?
Much is uncertain about the environment and the outlook of the crisis we are going through. One thing is sure, though: we have not seen the last of wild swings. The temptation of many to use markets as a political tool in troubled times will run up against those that understand that markets are about more than making money.
Those working in crypto markets are well aware of this. They have no central authority to manipulate their platforms to influence investors – in that sense, the market is “free.” Yet with freedom comes risk.
In the case of crypto markets, that risk has the form of disjointed oversight, sometimes lax security, relatively low investor assurances and occasional volatile swings with enough ferocity to make even crypto enthusiasts occasionally wonder if total centralization of rules isn’t such a bad idea after all. Mercifully, those bruised lapses in focus tend to be fleeting.
As with much about the current crisis, deep questions about what we want from crypto markets are being asked. Conversations are flowing, information is ample and meaningful answers are emerging.
Disclosure: Nothing in this newsletter should be taken as investment advice. The author is a long-term holder of a small amount of bitcoin and ether. Her opinions are her own and do not necessarily reflect those of CoinDesk.
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BIG IDEAS
Given the turmoil in currencies, market structures and the concept of capitalism, it’s not surprising that this week saw a slew of articles hypothesizing about the emergence of a new financial order, and bitcoin’s potential role. Here are some really good ones from outside CoinDesk. Podcasts, too – in this one I debate our Chief Content Officer Michael Casey on the role of inflation and the ideology whiplash we’re seeing in market management today. TAKEAWAY: Even those of us who have been studying this sector for a while don’t know what bitcoin’s eventual role will be, but the fractures emerging in the system are not a surprise to us. Things are ugly out there, and they’re going to get worse before they get better – what that “better” looks like, and how we implement the lessons learned in an environment that was showing profound change even before the pandemic hit, is worth thinking about.
The CFTC has clarified what “delivery” of a crypto asset means: it’s when a buyer has complete control over the asset by the end of 28 days after the transaction. TAKEAWAY: The idea of “delivery” is relatively simple when it comes to physical commodities – much less so with financial ones. And the matter has legal importance as it affects custody, and could impact how crypto platforms structure their business models. If an exchange holds your bitcoin, for example, and can move it around its internal wallets, have you taken delivery? Does that mean the exchange has fulfilled its contract with you? I have a feeling this CFTC clarification will lead to even more questions.
Su Zhu of Deribit Insights explains why cash-settled crypto derivatives are much more liquid than asset-settled. TAKEAWAY: It’s partly because cash-settled is easier for non-professional investors – you can go away and forget about it, cash will be deposited in your account on expiry. It’s also about trading costs on spot exchanges – do you roll your asset-settled derivative over, or do you incur spot trading costs to close it out?
Marcelo M. Prates, a lawyer with Brazil’s central bank, argues that a public/private cryptocurrency collaboration is more likely to succeed than one that is all one or the other. TAKEAWAY: Marcelo points out that cryptocurrencies are an “elitist” type of money, not accessible to all. And many central banks face a trust problem. Both issues will be extremely difficult to overcome, and would require a structural and social overhaul of expectations. Times of turmoil are the most likely catalyst for the conversations that could actually lead to those sort of changes.
MARKETS
After the stress and uncertainty in crypto markets earlier this month, BitMEX – one of the sector’s largest derivatives exchanges, and a protagonist in the sharp drops March 12-13 – felt compelled to remind us all of how its liquidations and insurance fund work. TAKEAWAY: A welcome reminder, but more useful would have been a detailed and frank diagnosis of what happened and why it might happen again.
Silvergate Bank, which counts 804 cryptocurrency businesses among its clients, was unable to process wire transfers for a while on the morning of Friday 20th, citing an outage resulting from an attempted cyberattack at bank payments processor Finastra. TAKEAWAY: This is a reminder that crypto exchanges and funds rely on several layers of payment handlers, and analysis of a system’s health has to go several layers deep. While it is true that the more complex a system the more likely it is that something could go wrong, we should remember that complex systems generally have failsafes, and an outage in one layer doesn’t mean the other layers collapse – with simple systems, there may be a lower likelihood that things go wrong, but when they do, the results can be catastrophic.
The shortage in gold markets has raised questions about the resilience of gold-backed crypto tokens such as PAXG and XAUT. TAKEAWAY: These tokens are seeing strong inflows, although they could soon come up against requests for proof of backing assets, especially given reports about problems with the gold supply chains.
The depreciation of the Russian ruble relative to the dollar has helped the bottom line of the country’s bitcoin miners, even with the price slump. TAKEAWAY: This highlights how bitcoin could be seen as a currency play by investors outside the U.S. – as a currency depreciates, bitcoin (quoted in U.S. dollars) appreciates, all else being equal. Currency depreciation and lower energy prices will also lower miners’ costs.
Digital Farms, a California-based cryptocurrency mining company, is putting its operations on hold due to the recent decline in bitcoin's (BTC) price. TAKEAWAY: It won’t be the only one – the sharp fall this month will no doubt spook many producers and push some into losses, exacerbated by the uncertain business environment. Not all miners make losses at current levels, however, and bitcoin’s protocol does have a self-correcting mechanism for a decline in overall processing power.
Speaking of which, bitcoin’s difficulty – a programmed target that influences how likely it is any given miner will be able to process a transaction block and receive the bitcoin subsidy – was adjusted downward this week in the second-largest decline in the network’s history. TAKEAWAY: The difficulty level adjusts automatically to reflect the amount of computing power contributing to network maintenance – when there is a lot, the difficulty rises. The drop signals that miners have been dropping out of the network, unsurprising given the sharp drop in price earlier this month. It also means that bitcoin will require less resources to mine for now, which could entice some back in.
Bain Capital, Polychain Capital, BitMEX-owner HDR Global Trading and others have invested in the $3 million Series A round of Mumbai-based exchange CoinDCX, just weeks after the Supreme Court overruled a prohibition imposed by the country’s central bank on banking services for crypto companies. TAKEAWAY: While much is yet to be ironed out regarding limitations on cryptocurrency trading by retail investors in India, this is starting to feel like the awakening of a potentially significant marketplace.
Crypto data provider Coin Metrics (you’ll see their name often mentioned as a source for the charts we include in these newsletters) has closed a $6 million Series A round, backed by Fidelity, Coinbase and others. TAKEAWAY: It’s always interesting to watch what types of businesses are getting VC funding. I have heard some investors say that the most investable sectors now are data and trading platforms. Both have investor-focused functions, which speaks volumes as to the current use case in the eyes of investors: that of investable asset.
Cryptocurrency startups are reporting increased demand for estate-planning services as the coronavirus outbreak motivates users to make sure their coins are passed on to heirs. TAKEAWAY: This is actually a fascinating insight into the complexities of crypto custody and KYC. You can leave your crypto in an exchange vault, but your heirs won’t pass the various tests these services have implemented to make sure that you’re you (because they’re not you). And your lawyer is probably not going to be comfortable holding your private keys to give to your heirs when you pass – they don’t want to be responsible for any slip or oversight that could lose the holding. Services that plan for the eventual handover will most likely make long-term holders more comfortable with their positions and strategies.
NEW PRODUCTS
Crypto fund manager Bitwise is working to list shares of its Bitwise 10 Index Fund on alternative trading system OTCQX, which would allow retail investors and advisors to trade the fund on brokerage services such as Charles Schwab and TD Ameritrade. If approved by FINRA, trading could commence in H2 2020. TAKEAWAY: As evidenced by the high premium to spot for traded shares of bitcoin fund GBTC, there is demand from retail investors for a regulated way to invest in crypto assets without actually holding the currency. Perhaps this fund is not the answer (it could depend on structural considerations such as lock-up and fees), but it is a step forward in broadening the options available.
Dante Federighi, a nominee for a CME director role, believes the Chicago-based exchange should issue its own tokens and mine bitcoin with renewable energy. TAKEAWAY: What??? I mean, sure, I don’t see why not, but I just need to check what decade we’re in.
CRUNCHING NUMBERS
Bitcoin’s 21-day miners’ rolling inventory (MRI) figure stayed above 100 during the recent price recovery from lows below $4,000, which implies that miners are selling more than they mine and running down inventory. TAKEAWAY: The encouraging interpretation is that, given that bitcoin’s price has rallied a bit and is now (at time of writing) holding steady, there is enough buying demand in the market to absorb the miners’ selling. When (if) the selling eases, this could lend support to further upward price movements.
Crypto market data provider Kaiko shows how order books reacted in the March 12-13 sell-off in bitcoin markets. TAKEAWAY: It is fascinating to see how fast liquidity dried up. This is not surprising in a young and volatile market, and points to continued volatility as market uncertainty gives traders of all types the jitters. With so much volatility, it will be interesting to keep an eye on the evolution of the derivatives market.
Data analytics firm Coin Metrics looks at the impact the March 12-13 crash had on spreads. It’s logical that in market turmoil, spreads widen. However, in previous sharp drops (such as that of Sept. 24, 2019), spreads soon returned to their normal levels. That has not happened this time. TAKEAWAY: Coin Metrics posits that it could be because of increased volatility overall, and possibly because some participants have left the market, reducing liquidity. This makes sense, yet even if true, it is likely to be temporary. The drop on Sept. 24 was just over 15%. BTC fell over 50% from its high to its low on March 12-13. That colossal a crash is bound to leave the market limping for some time, until the pain fades and confidence returns. Investors in search of value and traders in search of arbitrage opportunities are not afraid of volatility – they’re afraid of unmanaged volatility.
(Source: Coin Metrics Market Data Feed)
ADOPTION
The retail payment portal of crypto exchange Coinbase has processed more than $200 million in transactions, from approximately 8,000 retailers. TAKEAWAY: This is surprising, given the generally accepted dogma that bitcoin has failed as a payment mechanism and is now more an investment asset. Part of the growth comes from stablecoin transactions, but bitcoin is still the cryptocurrency of choice for transactions, according to Coinbase Commerce’s product lead John Zettler. |
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| We’ve been working hard this month on producing a report on the upcoming bitcoin halving. It’s an explainer that also offers insight into potential market consequences. It has some history, some outlook, a good dose of miner testimony and a lot of charts.
It will be published on Tuesday of next week, so please keep an eye out!
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Previous newsletters: 65, 66, 67, 68, 69, 70, 71, 72, 73, 74, 75, 76
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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 - River runs deep