April 17, 2024

Insights and analysis for the professional investor

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Welcome to Crypto Long & Short!

This week, Nadine Chakar, Global Head of Digital Assets at DTCC, explains how tokenization can revolutionize institutional finance and that the opportunity is now.

Then, Dan Weiskopf, at Tidal Financial Group, argues that the Halving will spur another uptick in the price of Bitcoin, but that the benefits will fall unequally on miners depending how well they've prepared for the event.

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

– Benjamin Schiller, head of opinion and features at CoinDesk

From the Analyst

Ready or Not: Time to Take the Reins on Tokenization, or Risk Missing Out

The arrival of the first bitcoin ETFs in the U.S. in January was a turning point for the convergence of traditional and digital assets. For the first time, investors were granted exposure to bitcoin through their traditional brokerage account.

The core technology associated with bitcoin, cryptography, is not new but it has re-emerged with blockchain and smart contract technology, which supports tokenization. A token is a unit of value that can be transferred, stored, and traded on the blockchain and is a digital representation of potentially many different kinds of assets, such as ownership rights for cryptocurrencies as well as real-world assets like stock shares, real estate or even art. For some, the SEC's approval of Bitcoin ETFs helped boost the legitimacy of this technology, and now we're seeing more firms and retail investors exploring the many benefits of tokenization.

With tokenization, firms could be more capital-efficient, create new business models and more easily expand product offerings and distribution channels. Firms could unlock new efficiencies and uncover ways to streamline existing processes while finding new markets and ways of unlocking liquidity – and they can likely do it cheaper and faster.

At the same time, tokenization could revolutionize the way transactions are processed. Take securities lending for example. With tokenization, collateral could be exchanged in real time, enabling firms to lower the risk of their existing processes. Managing a securities lending pool using smart contracts, or transactions that automatically execute when certain conditions are met, could also unlock efficiencies by embedding compliance within tokens, paving the way to 24/7 trading – without the need for a network of trading desks around the world.

These benefits, however, are just the tip of the iceberg. The real promise of blockchain technology lies in the assets themselves. Consider how assets operate today. Various systems are needed to run vital processes such as pricing an asset, distributing interest and dividends, and communicating with investors. With tokenization, we could incorporate these processes into the asset itself. Given a tokenized asset is capable of executing automated processes on its own, we could eliminate the need for potentially dozens of systems working behind the scenes.

If the benefits are so tangible, why haven't we seen more widespread adoption in the financial services industry? Mainly because we are somewhat still in the infancy stage around this technology, and policymakers are still assessing the landscape and considering the appropriate legal and regulatory frameworks.

There are also concerns about counterparty risk, finality of settlement, and control locations, not to mention a lack of standards and taxonomy. More philosophically, digital asset owners want to ensure that their ownership rights will be preserved in the absence of a tangible asset they can hold in their hand.

At the same time, the industry's approach to innovation continues in siloes and represents another roadblock to adoption. In 2023, nearly three out of four projects involving distributed ledger technology (DLT) had fewer than seven participants, according to a study from the International Securities Services Association (ISSA). Of course, it's encouraging to see firms dive in and explore DLT. However, if innovation continues in silos, one of the core promises offered by tokenization will be missed: creating broad efficiencies across the industry.

The answer here is simple: let's work together. Experiments should have a shared infrastructure. There should be many participants representing the financial industry's wide range of stakeholders. There's mutual benefit to be found here. Together, we can lay the foundation for successful experimentation in sandboxes with initiatives that expand upon each other incrementally and create an ecosystem that's scalable and works for all counterparties.

Collaboration would also help ensure digital assets thrive within a well-regulated framework, with standardized governance that reduces risks and costs. In addition, collaboration could facilitate connectivity by improving optionality and the choice of platforms, ultimately improving the way digital assets interact with traditional securities and payment infrastructures.

But before all of this, firms must look inward to realize the full potential of tokenization. There's no one size-fits-all approach, and every organization has its own, unique business model. More and more firms from across the industry are sitting down and thinking through what tokenization means for them. How can it revolutionize their business and the way it serves their clients?

In the end, the value of tokenization is directly correlated to the strength of a firm's imagination. We are only limited by our creativity in the way we're able to reimagine business and operating models, and the way tokenization could unlock new opportunities.

- Nadine Chakar, Managing Director, Global Head of DTCC Digital Assets

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Institutional Outlook

Bitcoin Miners Are Set for a Coiled Spring Rally

Source: Ycharts https://tinyurl.com/3996xvba

Since around 2017, our team has been researching the infrastructure opportunities available to investors in the public markets. I am pleased to see close-to-record highs in daily revenues as we approach the fourth halving, predicted around April 19. Pleased because it reflects the business success of an industry that presently is running close to a $26.1 billion run rate (365 times daily revenues of $71.6 million). As one of the most substantial investors in the space, with almost $100 million allocated in our portfolio, the outcome of how this business is financed and valued is important to us.

Despite the optimism expressed by investors, we can understand why miners and investors are facing the halving with trepidation. We would also like to point out that 1st quarter profitable financials results expected by some of the miners seem more than discounted at current levels. Many mining stocks could be looking at forward-EV/EBITDA multiples in the very low single digits versus 2024 and 2025.

Of course, any single digit multiple assumed on valuation metrics must assume a Bitcoin price of between $70,000 to $100,000 which we would argue is reasonable given the current momentum in the price of Bitcoin. Conversely, given that these are technology companies, we would have to admit that execution risk at scale has proven a high hurdle to achieve.

How we view the industry:

Bucket 1: Accelerators: CLSK, MARA and RIOT

A few companies like Cleanspark, Marathon Digital and RIOT Platforms have positioned themselves as large scale miners aggressively raising capital through At-The Market Offerings (ATMs). These companies are expected to show accelerating growth in revenues due from higher Bitcoin price and significant beta from exahash expansion.

As such, they have drawn a competitive advantage from an increase in trading activity, ample financial liquidity and or a war chest to capitalize on acquisition opportunities. People who are disappointed by the recent failure of the mining stocks to keep up with the price of bitcoin are missing the fact that this correlation is sustainable but frequently behaves like a coiled spring> The question is timing and the near term direction of bitcoin at $60K or $100K. All bets are off at $500K.

Bucket #2: HPC-AI Group (IREN, CORE, BTBT, HIVE, HUT)

Pragmatic oriented companies such as Core Scientific (CORZ), Iris Energy (IREN), Bit Digital (BTBT) or Hut8 (HUT) are led by managers who are executing under the pretext that traditional financial metrics matter in the context of measuring discipline. To be clear, these are definitely growth companies.

The issue is that their Bitcoin mining segment may not be their sole source of growth. HPC-AI is a compelling business model and in demand. AI computing, of course, is in high demand these days. AI compute centers are more predictable as a business than self-mining. But of course it also has less optionality than that $500,000 bitcoin price.

Bucket #3: Distressed/Value Plays

For the record, you don't want to be in this category since this presumes a company is boxed into raising capital and in a potentially distressed situation as a small-cap publicly traded company. We would rather not tag any company as a distressed situation, but note that there are some 15-20 companies that are micro-cap in size. Distressed, of course, does not mean that some of these companies won't survive or even grow through acquisitions or consolidation to come out on top.

- Dan Weiskopf, Portfolio Manager, Tidal Financial Group

Takeaways

From Benjamin Schiller, here is some news worth reading:

THE WEEKEND: TradFi takes a lot of breaks. The cash equities market is just open weekdays from the morning through early evening in the U.S. The associated S&P 500 futures market goes from Sunday evening through Friday night, with some short pauses mixed in there. Even the massive, global foreign exchange market is a weekday business. So what's a macro trader with an itchy trigger finger to do if big news breaks over the weekend? Trade crypto, of course, since that market never sleeps. Iran attacking Israel this past weekend was one such moment. Bitcoin (BTC) sank in the aftermath, challenging its image as a haven asset like gold or the U.S. dollar at a moment of geopolitical stress. Crypto also gave a clue about what an ancient haven, gold, would do once traditional markets opened on Monday. PAX Gold (PAXG), a token backed by the precious metal, surged over the weekend. Gold itself followed suit soon after. Fears that crypto would turn every traders' life into a 24/7/365 buying and selling nightmare haven't exactly come to pass. Thankfully, disasters like one country attacking another are rare enough that macro-minded speculators can mostly tune out on the weekend. But the past few days illustrated that crypto is always there, for better or worse.
BITCOIN HALVING: The Bitcoin halving should take place late Friday or early Saturday UTC time, cutting payouts to miners who create new BTC by 50%. Much has been written about how this might shake up the mining industry, forcing them to rely more on transaction fees, rather than mining rewards, for their profits. Here is a fun story from CoinDesk's Jamie Crawley about how, now that Ordinals – effectively NFTs on the Bitcoin blockchain – are a thing, the first post-halving "sat," or smallest bitcoin denomination, will be a collectible item, something that could be worth a lot. "It's kind of a lottery ticket," said an executive of the crypto mining firm Marathon Digital.