December 6, 2023

Insights and analysis for the professional investor

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Welcome to Crypto Long & Short!

This week, Delphi Digital's Kevin Kelly takes you to history class, and if you're a bitcoin bull, you'll like what he says.

Then, ETC Group's André Dragosch explores the enthusiasm about bitcoin ETFs.

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

– Nick Baker

From the Analyst

Bitcoin and the Predictability of Crypto Market Cycles

The crypto market may seem like a foreign world to many, with no real rhyme or reason for how it trades.

Just like traditional markets, though, crypto goes through its own cycles – and these price cycles are remarkably consistent, including their timing between peak-to-trough bottoms, price recoveries and subsequent rallies to new cycle highs.

We believe we're in the early stages of a new cycle. Using bitcoin (BTC) as our benchmark, here's the typical structure of a crypto market cycle:

BTC's price peaks at a new all-time high.
BTC then suffers a painful 80% or so drawdown.
The price eventually bottoms almost exactly one year after the prior cycle's high.
BTC starts to recover and takes about two years to reach a new all-time high.
BTC continues to rally for another year before topping out at its next cycle high.
Then the cycle repeats.

The last few cycles have followed this playbook to a T.

The consistency of these cycles isn't by coincidence. It's driven by bigger, more powerful macro trends – and one that lies at the very heart of bitcoin's value proposition.

Bitcoin is not an inflation hedge in the way many believe it to be. Bitcoin is not a hedge on the Consumer Price Index, or CPI. It's a hedge against currency debasement.

That distinction is important because currency debasement is driven by monetary inflation and the expansion of central bank balance sheets. In essence, BTC is of the most leveraged bets on an expansionary liquidity environment.

Bitcoin halvings aren't the primary catalyst for BTC bull markets – liquidity cycle uptrends are. It just so happens that each halving has lined up with an expansionary liquidity environment. The next halving is expected to occur in April 2024, which once again looks to be right on cue.

That's not to say the Halving isn't important – it's a strong narrative that can certainly pour fuel on a bullish uptrend, especially if we see a spot BTC ETF approved ahead of time given liquidity upcycles tend to turbocharge fund flows.

BTC's Promising Path Ahead

Bitcoin's price bottomed in November 2022 – almost exactly one year after its last cycle peak. If BTC follows its historical playbook, that would imply a new all-time high by the fourth quarter of 2024 – and its next cycle peak roughly a year after that.

We noted back in the fourth quarter of 2022 that last year's downtrend in global liquidity appeared to be bottoming, putting BTC's price bottom in the rearview. The subsequent rebound in central bank liquidity has been a key support for the recovery in risk assets this year – especially crypto.

And we expect these trends to continue. Looking out over the next 12 to 18 months, we expect central bank balance sheets to continue expanding – largely because they'll have to.

Many of the world's largest economies are saddled with huge debt burdens – and here in the U.S., fiscal deficits are only expected to get worse (and that's without a recession). Larger deficits mean more debt issuance, which eventually means more Federal Reserve support.

That is unless the relationship in this chart – which shows total U.S. public debt versus Fed total assets – decouples drastically.

And if we are in the early innings of a new global liquidity uptrend, BTC and crypto assets should outperform considerably over the next 12 to 18 months.

– Kevin Kelly, CFA, Co-founder and Head of Research, Delphi Digital

Institutional Outlook

Why Are Pros Craving a Spot Bitcoin ETF?

Gradually, then suddenly, as they say, bitcoin (BTC) is becoming mainstream. The biggest asset managers in the world like BlackRock and Fidelity have lined up to launch a spot bitcoin ETF in the U.S. Based on the Grayscale Bitcoin Trust's NAV discount, which has narrowed dramatically, the market assigns a probability of around 90% that the Securities and Exchange Commission will approve such a vehicle.

But why is there such a big need for a spot bitcoin ETF in the first place, especially since there are already futures-based bitcoin ETFs?

As a starter, BTC futures ETFs have many drawbacks compared to a spot-based product, including high roll costs that can eat up to 30 percentage points (!) of the annual performance if the bitcoin futures curve exhibits a steep contango.

In plain English: If bitcoin futures are priced significantly higher than today's spot price, bitcoin futures investors surrender a large chunk of their performance. Hence, the full performance benefits of holding bitcoin do not come to fruition when investing into a futures-based product.

Broadening investment access to bitcoin and other crypto assets can open up a whole new universe of potential portfolio allocations that were not possible before.

In portfolio managers' parlance: Investments into bitcoin significantly enlarge the so-called "efficient frontier" of possible multi-asset portfolios.

The efficient frontier represents all the potential portfolios displayed in a return-risk diagram based on varying weights of the different asset classes. For instance, one dot represents a portfolio that invests X% into equities, Y% into bonds and the rest into bitcoin.

Portfolio managers want to be at the very edge of that frontier since they receive the highest possible return for the lowest possible risk.

For illustrative purposes only. Source: ETC Group.

The black cloud of dots represents the universe of potential portfolios based on traditional asset classes only. The green cloud represents the whole new universe of potential portfolios when adding bitcoin. As you can see, the addition of crypto assets like bitcoin greatly expands things.

Thus, it is not surprising that including bitcoin in a classic 60/40 stock-bond multi-asset portfolio has led to a significant increase in risk-adjusted returns ("Sharpe Ratio") in the past with only a minor increase in portfolio drawdowns.

For illustrative purposes only. Source: ETC Group.

When these spot bitcoin ETF applications will ultimately be approved is still uncertain, although the consensus expects a batch approval most likely in January.

These prospective bitcoin ETF issues have a significant amount of assets under management (we estimate around $16 trillion), so they could have a huge impact on crypto. If only a small percentage of that amount gets invested into bitcoin, the effect would most likely be very significant because, currently, bitcoin exchange-traded products only amount to $38.8 billion of assets, based on our calculations (including Grayscale's trust).

But this capital won't be invested overnight. It will probably take many months before investors start replacing parts of their traditional asset allocations with bitcoin.

Gradually, then suddenly, as they say.

– André Dragosch, head of research at ETC Group

Takeaways

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

THIS FEELS DIFFERENT: About two years ago, crypto prices topped out. Bitcoin (BTC) almost got to $70,000. And then things got bad, and then they got worse and then they got cataclysmic. You probably remember! BTC sank toward $15,000 a year ago after FTX blew up. Prices have rebounded for most of 2023, but these felt like hard-won gains – rallies were quickly followed by setbacks. By mid-October, bitcoin was around $27,000. And then the market caught fire, fueled by optimism over bitcoin ETFs and sinking interest rates. As I write this Tuesday evening, bitcoin just hit $45,000 on Coinbase. It only managed to surpass $40,000 a few days ago. A crypto-skeptic friend texted me a few hours ago saying he was about to buy more bitcoin. Will this last? To the disappointment of my father, who has asked me for market forecasts during my entire two-decade career covering finance, I have no idea. But I know it's been two years since the mood in crypto markets felt this ebullient – before the collapses of Celsius, Voyager, Three Arrows Capital, FTX, Genesis …
A ROCKY DEBUT: After FTX fell apart, many folks wondered if something bad was going to happen to its bigger rival, Binance. U.S. regulators and law enforcement seemed to be circling. We got our answer recently: The crypto exchange agreed to pay $4.3 billion to settle several U.S. investigations. Changpeng "CZ" Zhao stepped down as CEO. For all the angst in the run-up to this, though, the industry has taken it in stride. Anyway, CZ's replacement, Richard Teng, just had his first big public interview, and it was not a smooth debut, according to CoinDesk's Helene Braun. He came across as evasive. The company never says where it's based, and Teng was opaque about that and other issues. The question is whether this matters. Maybe traders don't care if the world's biggest crypto exchange is evasive?
CRYPTO'S BEST CORRELATION: It's become a cliché: Elon Musk says or does something, and it moves the price of dogecoin (DOGE), the meme coin he's long loved. It just happened again. A regulatory filing shows he's trying to raise $1 billion for his AI efforts. DOGE immediately surged. One of the strangest correlations in markets persists.

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

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