Crypto Long & Short: Cryptocurrency Markets May Be Decentralized but They’re Still Accountable

Markets

14 June 2020

One underappreciated feature of crypto markets is the lack of centralization. I mean, people know crypto assets are decentralized and trade on exchanges all over the world. But what’s often overlooked is the relative ease with which people can change the venues they buy and sell their holdings on.

If, for instance, Jeff Sprecher (chairman of the New York Stock Exchange) says something that upsets you, you couldn’t exactly stop trading on the NYSE without liquidating a good percentage of your portfolio because for many stocks it is the only trading venue.

However, if a crypto exchange does something you fundamentally disagree with, you can trade your crypto assets elsewhere. There is no shortage of options.

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.

Coinbase earlier this week revealed that it has initiated procurement deals with a number of U.S. agencies, including the Drug Enforcement Administration (DEA) and the Internal Revenue Service (IRS), for a tool called “Coinbase Analytics.” The firm insists that the tool will not draw on customer information – but crypto folks are not, in general, a trusting lot.

According to data from blockchain analytics firm Glassnode, bitcoin held on Coinbase has plummeted.

glassnode-studio_bitcoin-coinbase-balance-1 — Source: Glassnode

Now, Coinbase uses a different address-reuse policy than most exchanges, so this might be the exchange moving coins from one address to another that has not yet been labeled. Or, it could be one very large holder moving his or her bitcoins to another wallet, either on or off Coinbase.

While we can’t yet draw firm conclusions, there are two intriguing takeaways from this speculation:

1) Crypto asset movements are trackable. We usually don’t know who is sending or receiving, but we can see the movements happen, and large exchange addresses are usually known – some services automatically send alerts when a significant shift happens between exchanges and either users or other exchanges. Imagine being able to track movements of stock or bond holdings.

2) Crypto exchanges can easily lose business if users feel certain values are not being upheld. Many crypto investors have strong feelings about privacy and government collusion, and, judging from Twitter comments, many are moving their business elsewhere.

In the non-crypto world, we have often seen businesses suffering the consequences of actions – but not significant market infrastructure players. They often have a quasi-monopoly over certain parts of capital markets. On the other hand, they are heavily regulated, so their leeway to anger customers is limited.

Crypto market infrastructure participants are not so constrained. They are, however, subject to public scrutiny, by a cohort with a megaphone, that cares deeply about certain issues and business practices. In early 2019, Coinbase bought cybersecurity firm Neutrino, which had close links to a team that had helped authoritarian governments spy on their citizens. The resulting public outcry and the #DeleteCoinbase campaign that got started on Twitter was enough for Coinbase to backpedal and fire Neutrino’s founders. This puts a new twist on the notion of businesses being accountable to their users.

It highlights the role that trust plays in markets. In traditional markets, that trust is enforced by regulations. However, regulations are enacted by governments, which in these tumultuous times are losing trust across the board, according to the latest Edelman Trust Barometer (not that we needed a study to tell us that).

Here we have an emergent capital market that does not need oversight to enforce good market behavior. The crypto market itself seems to be doing a pretty good job of that.

This raises questions about the value of transparency, the power of choice and the connection with community. And I’d be very surprised if traditional capital markets players weren’t watching all this with interest.

Out of my way

Fidelity Digital Assets, the crypto asset arm of financial giant Fidelity Investments, released a survey of over 770 institutional investors in the U.S. and Europe, which revealed that 36% own cryptocurrencies or related derivatives. Last year, Fidelity Digital Assets surveyed 441 institutions in the U.S., 22% of which had invested crypto assets at the time.

Beyond those headline figures, which show encouraging growth, there are some significant takeaways from the result.

The data I find especially intriguing are the barriers to investment, the main concerns that hold institutional investors back from investing in crypto assets. The highest-ranking worry is price volatility, which bothered over half of the respondents. Yet, compared to the 2019 survey, the worry quotient fell by 13 points, more than any other factor.

Good news perhaps? But take a look at the dates during which the survey was carried out: November 2019 – March 2020.

Here’s the volatility chart for BTC for the 18 months leading up to the end of the survey period:

But we all know what happened in March – prices in almost everything crashed, and bitcoin’s volatility shot up.

btc-vol — Source: Coin Metrics, CoinDesk Research

Does this mean that volatility has now become more of a barrier than during the survey period? Perhaps, but volatility has shot up in more traditional markets, too:

sp500-vol-60d — Source: FactSet, CoinDesk Research

Moving on to the other main concerns – the lack of market surveillance (47% of respondents see this as a barrier) and the lack of valuation fundamentals (45%) – we see two very encouraging developments.

Market surveillance is less of a worry now than it was a year ago – the proportion of respondents citing this as a barrier dropped 6 points, pushing it to below half. This is likely to continue to trend lower, as both startups and incumbents are constantly fine-tuning the technology used to flag bad actors.

And as for the understandable bewilderment as to how to value crypto assets when they have no solid backing and no cash flows, the shift there is especially exciting, and one that I expect to see significantly accelerate over the next 12 months. Crypto data platforms are improving their depth and breadth at an astonishing rate, and many new ones are springing up. And CoinDesk Research is currently working on a series of projects aimed at putting more crypto asset data in front of our users, as well as explaining this data in more detail. (Stay tuned.)

But even more important, the survey result indicates a significant mindset shift. The supposed non-existence of crypto fundamentals has not changed. The assets still have the same properties as a year ago. What has changed is that a greater number of investors are accepting that they can’t view crypto assets through the same lens as more traditional holdings. They can’t expect to be able to value them in the same way. More are coming around to the idea that crypto assets require a new framework of understanding, based on new types of data and new value drivers. It’s a significant step towards more demand for education and deeper interest in the data. And where one group of open-minded innovative thinkers go, others will follow, if only to not miss out on potential returns. These are the necessary precursors to a broader acceptance of this asset class. Next year’s survey should be even more interesting.

Anyone know what's going on yet?

While it’s never good to see value lost, the end-of-week rout feels like a breather in the oppressive rise of stocks in the face of dire economic outlook that had not been priced in. Strong swings are commonplace these days, however, so by the time you read this, the confidence in the perpetual bailout could have overcome frightened animal spirits. Or not.

The alarming 20% drop in U.K. GDP month-on-month in April was a tragic accent to renewed Brexit tensions. And contagion rebounds in the face of much-welcome lockdown easing are a blow to fragile spirits, no matter how expected they were.

As I write this on Friday morning, U.S. and European stocks are resting from their worst one-day falls since March, and signs point to markets opening further down. This seems like a sadly fitting end to a week that began with mainstream financial media using words like “fervid” in headlines. And, if indeed markets continue down, it will be oddly comforting to professional investors around the world to see confirmation of the adage that the top is called by retail investors pouring in.

Even after the fall, the S&P 500 is still higher than at the end of February, when the economic outlook was not nearly as dire. Whether that means more declines are in store for next week, is anybody’s guess.

performance-chart-061220-wide — Source: CoinDesk Research, FactSet

Gold has continued to trend up, rebel that it is. Bitcoin suffered a sharp fall on Thursday, and looks to end the week down, strengthening its new-found correlation with stock market indices.

bitcoincorrelationwithgoldandstocks_coindeskresearch_june12

While BTC is still ahead of other major indicators in terms of year-to-date performance, the long bond index is catching up fast, with what looks like momentum.

Chain links

Oops. Someone sent a $130 transaction on ethereum with a $2.6 million transaction fee. And then he or she did it again. And then another user made a transaction with a $500,000 fee. TAKEAWAY: This is an extraordinary story for many reasons. One is the mystery: who is sending transactions with such whopping fees, and why? Some think it could be money laundering, others suggest blackmail, or it could just be a series of genuine mistakes. Another compelling aspect is what this says about the vulnerabilities of trustless transactions – if this were traditional finance, the financial middleman would notice and hopefully fix the error. In crypto, however, what’s done is done. The miners who receive the outsized fees can decide to return the funds, but they don’t have to, and they may not even be able to trace the sender. This highlights how removing the need to trust the middleman merely surfaces vulnerabilities elsewhere.

My colleague Ian Allison reviews recent developments in the crypto custody industry. TAKEAWAY: The hectic building and acquisition activity seen recently reveals a scramble to define the business model for crypto market infrastructure going forward. While some are trying to adapt traditional structures for crypto markets, on the grounds that investors expect a certain level of service and reassurance, others are working to break the centralized mold and create systems that in theory are more robust. The interesting split is the differentiation between service and technology: can they go together, or will investors have to choose?

London-based investment firm ETC Group plans to list a bitcoin-backed security, called the Bitcoin Exchange Traded Crypto (BTCE), on the German electronic trading market later this month. TAKEAWAY: This is actually quite a big deal. Xetra is a very significant exchange, one of Europe’s largest – more than 90% of German share trading volume and 30% of all European ETF volume pass through the platform. And now it will have a bitcoin-backed product, centrally cleared and accessible to all types of investors, which makes it easier to include in diversified portfolios of any size. Investors won’t need to master new processes and open up new accounts, which should move the needle on access to convenient bitcoin investing.

The trading arm of crypto investment house Galaxy Digital and regulated bitcoin derivatives exchange Bakkt are partnering to offer institutional investors a high-touch trading and custody service. TAKEAWAY: This adds to the intensifying push towards full prime brokerage services in the crypto asset markets. Over the past few weeks we have seen crypto lender and OTC desk Genesis* launch prime brokerage services, crypto custodian BitGo get into the space, and crypto exchange Coinbase buy prime broker Tagomi. Other startups and incumbents are also maneuvering to get what all see as building institutional demand. Bakkt and Galaxy add some blue-chip names (by crypto standards) to the list, and also represent the growing consolidation in investor services. (*Genesis is owned by DCG, parent of CoinDesk.)

On Wednesday, Coinbasereleased a list of 19 crypto assets that it is considering listing. As of Thursday, these assets had increased in price by an average of 17%. TAKEAWAY: I find this bewildering. You announce you’re thinking of listing certain assets on your exchange, and the prices of those assets shoot up on other exchanges, presumably in anticipation of the additional liquidity and investor interest that listing on your exchange will bring. This is totally okay, and not at all against the rules. True, there is no overt market manipulation going on, because we can’t assume that Coinbase or its employees are benefitting from the announcement and the subsequent pump. But why announce, why not just list? I’m not saying it’s manipulation, because it’s not clear that the insiders benefit – but releasing sensitive information that can move prices before any actual decision is made feels like manipulation.

Binance, the largest crypto exchange in the world in terms of volume, has introduced physically settled bitcoin futures with quarterly expiration dates, to complement its perpetual swaps. TAKEAWAY: Binance has been growing fast in the derivatives market – it has come from nowhere in late 2019 to being the fifth largest bitcoin futures platform in terms of open interest. The introduction of a new product that has seen traction elsewhere could kick that growth up a notch. What’s more, a broader range of derivative formats is good news for the crypto markets. Not only do investors, traders, miners, exchanges and other crypto-related business have a wider range of choices when it comes to risk management; us market watchers also get another data point to scratch our heads over.

skew_btc_futures__aggregated_open_interest-3-2 — Source: Skew

Hut 8 Mining, one of the largest publicly traded miners in the world (it is listed on the Toronto Stock Exchange under the symbol HUT), is looking to raise at least C$7.5 million (US $5.6 million) to upgrade its fleet of BlockBox bitcoin miners. It’s targeting an asking price of C$1.45 per common share, substantially above the stock’s price at time of writing ($1.31 on 6/12/20). TAKEAWAY: In his recent in-depth report on Hut 8, my colleague Matt Yamamoto predicted they would need additional funding in order to upgrade to more efficient miners. He also, however, pointed out that a successful raise would be difficult in the current macro environment, especially given the recent departure of the CEO, who was pivotal in previous funding rounds.

The percentage of bitcoin’s circulating supply in profit is currently hovering at 87% – according to blockchain analytics firm Glassnode, levels this high have historically marked bull markets. TAKEAWAY: This is an interesting metric, but its application is confusing at times. I have seen a high in-profit ratio used as a bull indicator, and I have also seen it used as a bearish indicator (because holders could be tempted to take profits).