February 22, 2022

Insights and analysis for the professional investor

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Welcome to Crypto Long & Short!

This week, Glenn Williams Jr. examines what politicians are saying about crypto regulation in Washington, D.C.

Then, Jodie Gunzberg, managing director of CoinDesk Indices, talks about the crypto sectors that continue to thrive despite the regulatory crackdown.

- Nick Baker

From the Analyst

A Descent Into Partisanship for Digital Assets Won't Benefit Anyone

I took the time last week to tune into the Senate hearing on cryptocurrencies titled "Crypto Crash: Why Financial System Safeguards are Needed for Digital Assets." Quarterbacked by Democrat Sherrod Brown and Republican Tim Scott, it focused on the need for increased regulation within the digital asset space, punctuated by recent industry collapses.

At times I question the importance of even monitoring these events. It's getting to the point where if you've heard one, you've heard them all. One concern, however, is whether the regulation of digital assets is drifting more and more into partisan waters, which I think is negative for all involved.

If the discussion around cryptocurrencies devolves into a scenario where one's stance can be accurately predicted by which side of the aisle they sit on, it will have sunk to a level of simplistic discourse; a new technology like crypto deserves better than that. For that reason I often find political discussions around crypto as more akin to political theater.

But if you're going to operate within a sector, it makes sense to have an idea of which way the regulatory winds are blowing. It certainly makes sense to challenge your own ideas with ones that may be counter to your own. I would encourage all to watch it, even at 1.25x speed – which I may or may not have done.

CoinDesk Market Index Gains Despite Washington Scrutiny

Chairman Brown's testimony appeared to target cryptocurrencies in general. The overarching theme from my perspective is that the sector itself is not just vulnerable to fraud, but intrinsically emblematic of it. My guess is that if I sat down with him and discussed cryptocurrencies, it would largely revolve around its usage in criminal activity and the "greater fool theory" – the idea that the only value crypto has to the owner is being able to sell it to a bigger fool in the future at a higher price. It's worth noting, however, that his testimony concluded with a list of pre-existing financial regulatory methods. Examining where crypto fits within an already existing framework at least implies that a place is seen for it.
Ranking member Scott's testimony seemed to center around the failure of current regulators, with Securities and Exchange Commission Chairman Gary Gensler singled out specifically. An acknowledgement that financial innovation is an engine for growth was stated, along with an emphasis on the need for existing regulation to be conducted in a timely and appropriate manner. My guess is that if I sat down with him and discussed cryptocurrencies, he'd ask me if I knew where Gary Gensler was.
From there, testimony was provided by Lee Reiners of the Duke Financial Economics Center, Professor Linda Jeng of the Georgetown Institute of International Economic Law and Professor Yesha Yadav of the Vanderbilt University Law School. Each provided their views on cryptocurrencies, discussing the harnessing of innovation, development of a self-regulatory organization (SRO) and the banning of cryptocurrencies outright. I think some of their suggestions warrant consideration, while other suggestions seem openly hostile to the asset class itself.

Still, what was most encouraging about the witness testimony is that, agree or disagree, I'm not able to automatically determine their political affiliation based on their recommendations. I don't know if I can say the same for the people asking the questions, however.

There's a cadence that is beginning to present itself in these hearings that mirrors that of a tennis match – one where politicians alternate back and forth between pro-crypto and anti-crypto statements, directing the bulk of their questions to whichever witness aligns most with their political party's' decided stance.

I sincerely hope that this does not become the norm. Extreme partisanship would be detrimental to all parties involved, because it will likely remove the nuance necessary to allow for technical innovation, while protecting individual investors from bad actors.

Ultimately, investor protection, financial inclusion and innovation are all necessary elements for healthy growth within the digital asset space. As members of the U.S. Congress work to achieve these goals, I hope that they view them more from the lens of individuals than as members of a political party.

– Glenn C. Williams Jr., CMT

Cboe Digital is a U.S. regulated exchange and clearinghouse bringing trust and transparency to the crypto spot and derivatives markets. Cboe Digital honors a separation of duties and includes intermediaries as a key tenet in managing risk and avoiding conflicts of interest. Our unified spot and derivatives markets are underpinned by responsible innovation and enable collateral efficiency. www.cboedigital.com.

Institutional Outlook

Bitcoin, DeFi and Computing Thrive Amid Crypto Crackdown

After bitcoin's (BTC) best January since 2015, it has retreated because the U.S. Securities and Exchange Commission is cracking down on crypto, and inflation was slightly hotter than expected. Despite these challenges, crypto continues to dramatically outperform traditional asset classes.

The CoinDesk Market Index (CMI), the broad measure of crypto returns, surged 6.5% in February through Feb. 16. Stocks haven't done nearly as well, with the S&P 500 up only 0.5%. The Bloomberg U.S. Aggregate Bond Index fell 2.2%, while the Bloomberg Commodity Index lost 3.9%.

A key reason why crypto is doing so well: Bitcoin is on a tear because the Ordinals Protocol essentially brings non-fungible tokens (NFT) to that blockchain. "This has demonstrated a new, high-value use case for the longest-running cryptocurrency chain," CoinDesk Chief Content Officer Michael J. Casey recently wrote.

Source: CoinDesk Indices. Bloomberg. Data ending 2/16/2023

The big gain in the CoinDesk Bitcoin Price Index (XBX) shows the enthusiasm. But many other digital assets performed even better. There are 158 total digital assets in the CMI, and 109 of them did better than bitcoin. These outperforming assets were concentrated in the CoinDesk Digital Asset Classification Standard's (DACS) DeFi and Computing sectors.

Although they make up only 2% and 1.4%, respectively, of the CMI's weight, their gains stand out. Month to date, Computing is up 23.5%, giving it a gain of 91.5% so far this year. DeFi is up 12.4% in February and nearly 66% in 2023. Computing has been driven by excitement over artificial intelligence (AI), with ChatGPT and Bing dominating the conversation. DeFi is the sector many are looking to for greater security and infrastructure.

Although Computing and DeFi are relatively small by market cap, there are many constituents in each sector: Computing has 23 assets and DeFi has 39. So opportunities for big gains (alpha, for you pros) are plentiful.

Source: CoinDesk Indices. Data ending 2/16/2023

However, bitcoin is still in high demand as the most established, largest, most-liquid asset with the longest track record and deepest derivatives market. So, in order to mix bitcoin with some of these potentially high performers, some market participants prefer the CoinDesk Large Cap Select Index (DLCS), which is similar in concept to other market-cap-weighted flagship indexes to measure various asset classes.

Still, the digital asset market is in its early days, so the concentration is high currently with five assets (which are in two sectors) accounting for 70% of the index's market capitalization. Therefore, some prefer a broader sector exposure through the CoinDesk Market Select Index (CMIS) that spans five sectors with at least five market-cap-weighted assets from each sector.

– Jodie Gunzberg, CFA, managing director of CoinDesk Indices

Takeaways

From CoinDesk's Nick Baker, here's some recent news worth reading:

MT. GOX: Once upon a time, in the early days of crypto, there was an exchange called Mt. Gox (which stood for Magic: The Gathering Online eXchange, just to clue you into the vibe). The business collapsed spectacularly because of a 2014 hack. The ensuing bankruptcy process has dragged on and on, but there was important news last week that may signal the end is in sight: The two largest creditors picked the repayment option that could allay fears the restructuring will tank the price of bitcoin (BTC).
CANADIAN CRACKDOWN: Canada is close to boosting requirements on crypto exchanges, putting it toward the front of the pack in terms of tangible action in the aftermath of FTX's collapse. Surely, it will not be the last to do something, though.
SHANGHAI VOLATILITY: The Ethereum Merge didin't stir up ETH prices much back in September. But there's reason to believe that Shanghai, the Ethereum upgrade that will allow staked ETH to be unstaked, could generate volatility.
JUMP CRYPTO: Last week the SEC didn't identify the company that made more than $1 billion from the terraUSD/LUNA ecosystem before it collapsed. (The unnamed company wasn't accused of wrongdoing.) But sources told CoinDesk that it's Jump Crypto, which declined to comment.
BRAGGING: CoinDesk journalists won one of the biggest prizes in journalism, a George Polk Award, for the scoop that led to FTX's collapse and two explosive followups.

To hear more analysis, click here or here for CoinDesk's "Markets Daily Crypto Roundup" podcast.

Over the past few months, CoinDesk has been developing a reward system for Consensus 2023 attendees to bring long-term value. We've partnered with Art Blocks Engine, TokenProof and Passage Protocol to launch the Consensus Multi-Year, Multi-Tiered NFT Ticket, coming on March 2. Learn more.