Crypto Long & Short: What Changed My Mind About Bitcoin Narratives

One of the things I most enjoy about working in the crypto sector (apart from my awesome colleagues and the constant flow of fascinating change) is the level of debate.

I’m not being sarcastic. There are many takes I strongly disagree with, but when they are put forward by people with rational and inquisitive minds (which can be most of the time, depending on your Twitter filters), the engagement invariably ends up enriching my own opinion. And, sometimes, bouncing someone else’s conviction off yours opens your eyes to nuances you hadn’t seen. Who knows? Entertaining conflicting points might actually change minds.

Now, when you take two intelligent opinions that you don’t agree with, throw them together with yours and stir them up a bit, magic can do its uncomfortable thing. That happened to me this week.

You’re reading Crypto Long & Short, a newsletter that looks closely at the forces driving cryptocurrency markets. Authored by CoinDesk’s head of research, Noelle Acheson, it goes out every Sunday and offers a recap of the week – with insights and analysis – from a professional investor’s point of view. You can subscribe here.

Many of you will already have seen Bloomberg commentator Joe Weisenthal’s list of six reasons why bitcoin has not had a great year. To recap, they were a lack of new highs, its new correlation with the S&P 500, disappointingly resilient fiat currencies and inflation levels, and a new competitor for the volatility trade in the form of stocks.

Of course, there were many reactions. One of the best responses I’ve seen was from Nathaniel Whittemore, who stressed the progress made in institutional uptake, growth in emerging market demand and bitcoin’s endurance. Another was from Messari’s Ryan Selkis, who objected to Joe’s interpretation of bitcoin narratives and timeframes. I expand on some of my objections further down.

A different angle

The other analysis I disagreed with this week was from JPMorgan, although their take was almost the opposite of Joe’s.

A report shared with the investment bank’s clients and seen by CoinDesk boldly stated bitcoin has had a good year so far, highlighting that, even through the market turmoil in March, the cryptocurrency only briefly dipped below its cost of production. It also points out that liquidity in bitcoin markets was more resilient than in other more traditional markets. The analysis concludes that this points to a long and happy life for bitcoin, but more as a vehicle of speculation than as a store of value.

So, here we have Joe hinting bitcoin has had a disappointing first half because it didn’t have spectacular price moves relative to other asset groups, and JPMorgan inferring it’s had an unexpectedly good first half for the same reason.

In my opinion, they are both missing the point. But my disagreement with them changed my mind about something.

Common factors

Both JPMorgan and Joe seem to assume there is a clear narrative around bitcoin’s value.

JPMorgan equates bitcoin’s intrinsic value with its mining costs, although this is difficult to reliably calculate and reflects only a small part of the ecosystem. What’s more, mining costs could come down in line with lower energy prices, which does not mean bitcoin’s intrinsic value will come down if we rely on the “what an asset is worth” definition of the term. The analysts also infer that bitcoin’s current correlation with the S&P 500 represents the breakdown of its store of value potential, which overlooks the nature of backward-looking short-term calculations.

Joe understands bitcoin’s fundamental value is hard to quantify, and focuses on price as the principal metric that both shapes and is shaped by narratives. He assumes we have been waiting for specific triggers to drive up the price, that they have not materialized and therefore our narratives are wrong and bitcoin is not doing well.

Both Joe and JPMorgan seem to believe the overriding narrative for bitcoin today is that of speculative asset. This is a valid viewpoint, but not one that I share – for me, bitcoin is a technology play that will change the meaning of markets.

I also don’t buy into Joe’s focus on price, and his assumption the market as a whole expects sharp movements based on certain catalysts.

And I’m not convinced by JPMorgan’s conclusion that recent price action points to bitcoin’s continued use as a speculative asset – this week CoinDesk reported more than 60% of bitcoin held in wallets has not moved in over a year.

Thinking about why I disagreed, however, made me realize something I have been overlooking. I have always regarded bitcoin’s lack of a clear narrative as a strength. I was wrong – it is both a strength and a weakness.

The plus and the minus

It’s a strength in that the story is still unfolding. Bitcoin’s main use case is yet to be determined. Many see it as a store of value, in that it has no explicit economic drivers other than a limited supply. Others see it as a speculative asset that swings on sentiment and whose volatility can be harnessed to produce higher returns. For part of the world, it is a stable currency. For some, a venture investment.

In other words, bitcoin is not a one-trick pony – the demand growth from any one of its many narratives could be enough to push up its value.

Having many threads to pull on is also a weakness, however, because investors like clear narratives. Professional managers generally need to justify their allocation decisions, and bitcoin’s story is confusing. Even Paul Tudor Jones expressed skepticism at the success of his preferred narrative, that of digital gold, but invested anyway based on probabilities and price.

Bitcoin’s lack of a clear value and a diluted understanding of its fundamentals lead many smart people such as Joe to focus on price performance as a barometer for success. It’s there, easy to watch, easy to track. And in a markets-centric world, that’s good enough for some.

Value, on the other hand, depends partly on fundamentals, which in the case of cryptocurrencies are still poorly understood. It also depends on sentiment, which is the result of stories and expectations, not just of cryptocurrencies but also of environments and influencing factors. You think bitcoin has confusing narratives? Let’s talk about tech stocks, oil, the dollar, take your pick.

So while I still believe rapidly evolving narratives around bitcoin are an opportunity, and that the fundamental value drivers of the cryptocurrency will become better understood with time and patience, I also accept now that a lack of clarity around what those are makes the price an understandable value proxy for many.

The formula

However, recent market trends have shown us price is increasingly disassociated from value, not just in cryptocurrencies. In today’s stock, bond and even currency markets, price is often totally out of whack with the underlying potential. It doesn’t mean that price is not important; it just means that it’s not something that should be taken as a proxy for value – or for success – as we look forward.

As an industry, we need to work on honing our understanding of the many narratives, and how they can influence value. We all need to learn to ask deeper questions, to entertain conflicting ideas and to accept that we just don’t know what the winning story – if there is one – will be. We’re getting better at metrics, a broader range of people are participating and our collective understanding is moving forward every day. But stories evolve, as they must to survive. We need to work on giving the stories scrutiny, as well as a broader vocabulary and set of tools that can enhance their telling.

Anyone know what's going on yet?

Talk about conflicting signals: Stocks seem to be pricing in a booming economy, bonds are forecasting a protracted downturn in spite of heavy government and central bank buying, and currencies are all over the place. Given the momentum, investors seem to be accepting this conflict – the worry is that it becomes the new normal.

Signs of a COVID-19 resurgence, though, are causing some jitters – but even so, the reality of the economic damage does not seem to have sunk in, in spite of even the Chairman of the Federal Reserve warning of hardship ahead.

Bitcoin has had a lackluster month so far, underperforming most other asset groups while maintaining its newfound correlation with the S&P 500.

Chain links

WisdomTree Trust has filed for an ETF that may invest up to 5% of its net assets in the Chicago Mercantile Exchange’s (CME) bitcoin futures contracts. If approved, the rest of the fund would be invested in traditional commodities. TAKEAWAY: Early last year Reality Shares filed an exchange-traded fund proposal that included a partial investment in bitcoin futures, but the application was withdrawn at the SEC’s request. It’s possible the market and regulatory sentiment have evolved over the past 16 months such that this filing will meet a different fate – to start, there are differentiating technicalities between this filing and last year’s, and the bitcoin futures market has grown considerably. But we shouldn’t hold our breath. If it does get approved, it will not have the same market impact as a straightforward bitcoin ETF, given the fund’s limited exposure and focus on the futures markets.

Asset manager Wilshire Phoenixhas filed to launch a bitcoin investment trust. TAKEAWAY: Like the Grayscale* bitcoin trust, if approved this will list on an OTC market and have fixed redemptions. Grayscale’s GBTC bitcoin trust is often criticized for the high premium retail investors have to pay to buy shares on the secondary market. If approved, this trust could add competition and reduce the premiums. Or, in the absence of a bitcoin ETF, demand could grow such that we’ll have two sets of high premiums. (*Grayscale is owned by DCG, the parent of CoinDesk.)

Mason Privatbank Liechtenstein AG has become the latest private bank to offer digital asset custody through a partnership with Hong Kong-based Hex Trust. TAKEAWAY: News about European private banks offering crypto services seems to be gracing our headlinesmore frequently these days. These banks tend to be small by U.S. standards, but they focus on institutional clients and high-net-worth individuals, so their potential reach when it comes to crypto services is significant. And the range of services they are offering is similar to full prime brokerage, with trading, custody, lending and banking services rolled into one. We will most likely see more announcements like this in the remainder of the year, each of which provide new onramps to satisfy the growing interest they expect to see.

After two years of development, Komainu – a joint venture between Nomura Holdings, CoinShares and Ledger – has launched to offer crypto asset custody to institutional investors. TAKEAWAY: The entity is based in the U.K.’s Jersey Channel Islands, and will provide custody, compliance and insurance services. The pedigree of the partners is interesting: Nomura is one of Japan’s largest investment banks (yes, a legacy bank investing in crypto custody!), and Ledger is one of the sector’s original custodians. CoinShares is one of the sector’s longest-running asset managers (as well as manager of a handful of listed crypto funds), and now also provides trading services, index management and tokenized assets. With the addition of custody, could CoinShares be angling to break into the crypto prime brokerage business?

Codefi, backed by Ethereum development group ConsenSys, is working on an Eth 2.0 staking API, which aims to help large exchanges, wallet providers, custodians and funds earn income from a portion of their crypto asset holdings. TAKEAWAY: As the launch of the transition to Ethereum’s new blockchain nears*, interest in staking seems to be growing. This could pick up steam as demand is fueled by the record-low yields on other traditional asset groups, and as service providers become more robust and user-friendly. (*TEASER: We will soon be publishing a report on what this transition means for Ethereum and for investors.)

Chinese bitcoin miner manufacturer Ebang estimates it incurred a net loss of $2.5 million on a revenue of $6.4 million for Q1 2020. This disclosure was posted this week in an update to the firm’s IPO prospectus filed with the SEC. TAKEAWAY: A Chinese loss-making company trying to raise shares in a U.S. listing? In these crazy markets, it could do very well. However, the listing may be denied due to a lack of inspected audits – or for a lack of revenue, or a number of other reasons. (For a detailed breakdown of the Ebang filing, see our report “Ebang IPO: Dude, where’s my revenue?”)

According to data from crypto analytics firm Glassnode, over 60% of all bitcoins have not moved in at least a year. TAKEAWAY: Contrary to some analyses (see THE BRIEFING above), this indicates that the buy-and-hold strategy is gaining ground. True, a chunk of these coins may be in wallets with lost keys, but the overall trend indicates that holders are still holding. The number of bitcoin that hasn’t moved in 2-3 years grew by over 25%.

Jeff Dorman of Arca Funds compares the crypto asset universe to the bond market, arguing that the two asset groups have much in common in terms of investor specialization and arcane math. TAKEAWAY: Great insight into how valuation models are still evolving, and have a way to go still.

The Financial Services Commission of Mauritiushas created a regulatory regime for a full-fledged security token ecosystem. TAKEAWAY: This is interesting given that the island state was one of the early sovereign nations to embrace the potential of becoming a blockchain hub, and is pretty far along in setting up legal frameworks for a wide range of crypto-related businesses. Combine that with its status as a tax haven that has attracted a growing base of high-net-worth individuals, and the imminent likely blacklisting by Europe as a “high-risk third country,” and you can start to catch a glimpse of where fully functioning crypto financial system could flex its resilience, even if it’s at a small scale. Worth watching.

Over a recent 30-day period, the total open interest for CME bitcoin options increased more than tenfold to over $370 million, making it the second largest bitcoin options market in the industry, behind Deribit. TAKEAWAY: Open interest for Deribit has also reached all-time highs, almost double the 2019 high reached almost exactly a year ago. This growth indicates a solid maturation of the crypto markets overall, and could unleash increasingly aggressive trading strategies as risk-takers feel more comfortable with the hedging tools available.

Podcasts worth listening to:

• Bitcoin Is More Than an Inflation Hedge – The Breakdown, Nathaniel Whittemore
• Sorry, Bloomberg: Here Are 6 Reasons Why 2020 Is a Great Year for Bitcoin – The Breakdown, Nathaniel Whittemore
• From Moral Hazard to Business as Usual, Feat. Jesse Felder – The Breakdown, Nathaniel Whittemore
• Lord Mervyn King On The Wrong Use Of Monetary Policy In A Radically Uncertain World – Macro Hive, Bilal Hafeez
• ‘Stonks,’ the Rise of Retail Bros, & Powell’s Money Printer | Tony Greer – Hidden Forces, Demetri Kofinas