August 23, 2023

Insights and analysis for the professional investor

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Welcome to Crypto Long & Short!

This week, CoinDesk Indices' Todd Groth travels (rhetorically speaking) to Argentina and Turkey.

Then, Jeff Park of Bitwise Asset Management thinks about physics and what it means for crypto.

As always, get the latest crypto news and data from CoinDeskMarkets.com.

– Nick Baker

From the Analyst

Bitcoin Dreams Are Coming True in Argentina and Turkey

Right before the volatility in digital assets late last week and the breakout of bitcoin (BTC) to the downside due to rising interest rates and low market liquidity, Javier Milei made global news by unexpectedly winning the Argentinean primary election.

A libertarian candidate and member of the "La Libertad Avanza" party, Milei is a Bitcoin advocate, saying it "represents the return of money to its original creator, the private sector." He also calls for the abolition of the country's central bank, which, he says, "is a scam, a mechanism by which politicians cheat the good people with inflationary tax." While it's unsurprising that a candidate in a country infamous for inflation (currently estimated above about 100% annualized) would have a critical view of the central bank, it does raise questions more broadly about the global experience for cryptocurrency holders.

When we hear that "Bitcoin is too risky," as citizens of the U.S. and as holders of dollars we must remember that this simple statement comes from a position of substantial privilege, specifically "exorbitant privilege." First termed by French Finance Minister Valéry Giscard d'Estaing in the 1960s, exorbitant privilege refers to the unique benefits that the U.S. enjoys due to the widespread use of the dollar in international trade, finance and as a global reserve currency. Some of the benefits from the global ubiquity and near-insatiable demand for dollars are the U.S. government's ability to print dollars with minimal consequence and to borrow at lower interest rates than other countries, many with checkered financial pasts (like Argentina). Global reserve status also simplifies monetary policy decisions for the U.S., as the Federal Reserve is the de facto global central bank, setting the tone for other central banks to follow similar rate policies to defend their exchange rates. Or, as John Connally, President Richard Nixon's Treasury Secretary, bluntly put it to a group of European finance ministers: "The dollar is our currency, but it's your problem."

So, how has the bitcoin investment experience been for global holders outside of the local dollar system? Over the past five years, most bitcoin holders outside of the U.S. experienced greater gains in bitcoin (see Figure 1 below), due to the depreciation of their local currencies relative to the dollar as a consequence of the U.S. interest rates going up in addition to the 31% return of bitcoin relative to the dollar (see orange bar for bitcoin vs. USD return for comparison). Bitcoin over the past five-year period has been stronger than a stronger dollar.

Figure 1: Average five-year return of bitcoin holders by foreign currency. Source: CoinDesk Indices Research, FactSet.

Notable outliers over the period include Argentina (providing context for Milei's primary election success) and Turkey (whose leader recently came around to reinstating traditional economic theories after a foray into "Erdoyanomics" in pursuit of the stimulative effects of lower interest rates). With five-year realized inflation for Argentina and Turkey at 60% and 33%, respectively, BTC holders in Argentina and Turkey have been able to preserve their purchasing power and mostly weather the political and economic conditions within their countries by leveraging a decentralized and digital store of value.

Pretty neat, huh?

— Todd Groth, CFA, head of index research at CoinDesk Indices

A message from Messari

Come build with us and register for Mainnet 2023, the premiere crypto event of the year!

Hosted by Messari, Mainnet returns to Pier 36 NYC from Sept 20-22. Mainnet unites together the leading voices in crypto and will spotlight the true innovations propelling crypto forward, with programming focusing on regulation & policy, real-world finance & DeFi, operators & builders, AI's native currency, and a wide variety of other topics. This year, Mainnet will feature 100+ in-person speakers from across the crypto and TradFi landscapes, including Coinbase's Brian Armstrong, Circle's Jeremy Allaire, Ripple's Brad Garlinghouse, Stellar's Denelle Dixon, EY's Paul Brody, PayPal's Jose Fernandez da Ponte, Onyx by J.P. Morgan's Tyrone Lobban, and many more.

Institutional Outlook

The Thermodynamics of Crypto Investing

The first law of thermodynamics states that energy can neither be created nor destroyed, only altered in form. The same law can be appreciated in investing, where risk and return are never created or destroyed, just transformed through an investing cycle. You may also have heard the popular crypto meme, "Everyone buys bitcoin at the price that they deserve." These two statements are saying the same thing, just in slightly different vernacular: As the various structural risks of crypto investing change over time, the opportunities for returns change, too.

Once upon a time, when bitcoin (BTC) came to life, there were many risks. One of the first primordial ones was "existential risk." Back in 2014, it was not clear if bitcoin was going to make it, especially after the Mt. Gox hack. This was the baffling "funny money" era, when an unsuspecting pizza lover spent 10,000 BTC (now worth about $300 million) for a pair of pies. As the market eventually reduced its assessment of existential risk, the value of bitcoin rose, finding a new price equilibrium for new investors who no longer needed to worry about that particular risk.

Then there was "financial/funding risk," i.e., whether enough capital would be mobilized into this asset class to lead the imagined technological revolution. This risk was ultimately reduced by massive inflows of venture capital, which reached over $50 billion in 2021 to 2022. As another dimension of crypto's multivariable risk calculus was removed, the price jumped once more. In 2023, we would argue that regulatory risk is the next domino to fall. While, at times, progress may be shrouded in fog, we believe that crypto will work through this risk (as we've already seen outside the U.S.) and usher in the next transformation of risk.

Many risks still remain, of course, which is why investors still have the chance for outsized returns – though as each risk falls, returns become incrementally smaller.

So, if this risk-return energy is not destroyed, what does it become? As regulatory risk takes center stage, we see a continually transforming landscape for digital alpha investing. Consider:

Offshore market makers are decreasing volume, which affects quantitative market-making and high-frequency arbitrage trading strategies.
Government lawsuits that target altcoins as potential unregistered securities affect the viable universe of token selection alpha for fundamental investors.
Rules around qualified custody affect all on-chain strategies, where today's cutting edge of financial engineering and market structure innovation live.

In other words, while each incremental return opportunity for crypto beta is less significant than the prior, the opposite is happening for crypto alpha: The reduction of these later-stage risks is paving the way for extraordinary financialization and institutional adoption. Yet, this transformation creates an "allocator's dilemma." You can't just offhandedly invest with the largest funds as a sure-fire path to success. Instead, we are currently in an exceptional era for capacity-constrained smaller funds, which have a unique opportunity to outperform. But, of course, that won't last forever as the thermodynamics of crypto investing continue to transform. Astute institutional investors would be well-served to consider what kind of stake they want to have in this moment of transition.

– Jeff Park, head of alpha strategies at Bitwise Asset Management

Takeaways

From CoinDesk Deputy Editor-in-Chief Nick Baker, here is some news worth reading:

BUFFETT RULE: Berkshire Hathaway Chair Warren Buffett, describing his firm's investment objective, said nearly four decades ago: "We simply attempt to be fearful when others are greedy and to be greedy only when others are fearful." With the obvious caveat that this is not investment advice: There sure is a lot of fear out there in crypto. Bitcoin (BTC) just somewhat mysteriously (no, it probably wasn't Elon Musk's doing) plunged the other day. It's left the market in the most oversold condition since the Covid crash in early 2020. A buying opportunity? You tell me!
COINCIRCLE: While PayPal is no Mastercard or Visa, it's also no slouch in payments. A major potential use case for stablecoins is paying for stuff. So, PayPal's experience in the paying-for-stuff business is highly relevant as the company enters the stablecoins game, creating a real risk for the big incumbents USDT (from Tether) and USDC (which has been overseen by both Circle Internet Financial and Coinbase – until now). News broke this week via CoinDesk that Circle and Coinbase are dissolving the partnership that had governed USDC; Circle is bringing USDC fully in-house, with Coinbase remaining associated by getting (apparently by paying no cash, per the CoinDesk story) a minority equity stake in Circle. Coinbase downplayed any fears of PayPal. "I really do believe PayPal grows the pie for us," a Coinbase executive told CoinDesk's Ian Allison, who broke the news. I guess we should watch the stablecoin market cap leaderboard.
HOPE SPRINGS ETERNAL: Despite the massive gains this year in bitcoin and other digital assets, it's hard to argue these are wonderful, comfortable times for crypto. The blow-ups of last year continue to weigh on the space, regulators are on the prowl, etc. Nevertheless, there is a pretty clear sign of optimism: People keep launching new blockchains. What this actually means or will amount to is really hard to say. One of them – Sei – is built for low-latency applications such as trading … just like Solana, Sui and Aptos before it. None of those have exactly upended how Wall Street works.

Want more? For the latest news affecting the crypto markets, listen to CoinDesk's Markets Daily podcast.

State of Crypto: Policy & Regulation

It is now more important than ever to set industry standards and align on practical short-term and long-term objectives through pointed conversations with the best legal minds and Washington D.C.'s most important decision makers.

Join us at State of Crypto: Policy and Regulation on October 24 in Washington D.C. for an unprecedented opportunity to evaluate, dissect and ultimately shape crypto regulatory frameworks that support a vibrant, secure and healthy future for the digital economy.