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Crypto tax refresher as regulatory scrutiny spikes

Dispatch #25 – 2021

July 30th, 2021

This is a holiday-shortened edition of the Dispatch that provides a mid-year tax refresher for US readers. The key message is that YOU are responsible for keeping track of the cost basis and calculating gains/losses. There’s rising bipartisan support to crack down on crypto tax avoidance and the just-passed Infrastructure Bill assumes $28bn from better crypto tax enforcement. Full discussion line up follows:

  • Crypto tax refresher
  • Exchanges lower futures leverage available to clients
  • Debt service moratoriums ending
  • BITCOIN SCHOOL – short liquidation  

The Dispatch will be off next week

Crypto tax refresher

We are more than halfway through 2021, so let the headline below from this CNBC article incentivize collecting your crypto trading data. If you haven’t done this already, download the entire transaction history from your exchange account. Keep this backed up, as this will be your proof of cost basis.

To repeat the Dispatch’s key message: YOU are responsible for tracking and reporting capital gains/losses. This is particularly true if you move coins out of the exchange wallet for better security. Don’t you pay for gains and claim losses for your stock trades? Crypto should be no different, except that your exchange/custodian is unlikely to provide a 1099 form like your stock brokerage does.  

However, even though crypto exchanges haven’t historically provided 1099s to clients, the IRS is gathering transaction data from the exchanges. The IRS has ramped up “John Doe” warrants to gain access to records at Coinbase, Kraken and other exchanges as this legal newsletter lays out. A portion of the article is below with highlights by the Dispatch.

Crypto to fund the Infrastructure Bill!

This week’s Infrastructure Bill provides proof of the government’s focus on crypto taxes. The mainstream headline above from Fox is somewhat intimidating, but what this really means is stronger reporting rules on crypto exchanges. How that translates to an incremental $28bn in tax revenue is one of the wonders of Washington!

Source: Foxbusiness

The takeaway, once again, is pay your taxes just like you do with gains from any other asset. This Coindesk article has more details about the infrastructure bill.

FTX & Binance lower futures leverage to 20x

Two of the largest exchanges offering crypto derivatives have announced a substantial reduction in the leverage available to traders. Binance, the world’s largest crypto exchange, and FTX have said they are lowering max leverage to 20x from the 100x previously available. This Businessinsider story offers more details. The tweets below are from the respective leaders of Binance and FTX.

This is an encouraging trend, but 20x leverage on an asset that exhibits annualized volatility near 100% is the wrong combination. You typically want to leverage assets that have low volatility and steady appreciation. Think of your house with the typical 20% down mortgage, which is 4x leverage.

These leverage futures were only available to non US residents. However, just this week, Binance announced restrictions for residents of Germany, Italy and Netherlands.

Government debt service moratoriums set to end soon

The 1.75m mortgage borrowers currently in forbearance is the largest by dollar value. While that’s a small 3.5% of total mortgages, it’s large, relative to the current 1.37m house national inventory as this Fortune article explains. This program is set to expire at the end of September.  

At the same time, 30 million student loan borrowers will have to resume loan servicing at the end of September. The average payment is $400/month according to this Fortune article. Democrats in Congress are pushing to extend the moratorium again to 2022.

Finally, the eviction moratorium on renters expires today (Saturday) as Congress failed to extend protection. It’s not like Congress was surprised by the deadline, which they have known for months. This is estimated to place 12m families at eviction risk.

The government’s failure to extend the most pressing program — rental eviction for mostly lower income families ­— may suggests that the other program will also sunset as currently scheduled. All three of these programs have been extended three times from the original Cares Act schedule. Collectively, the end of these programs could become a short-term headwind for real estate markets and a longer-term headwind for consumption.

BITCOIN SCHOOL – Recent liquidation of bitcoin shorts  

The recent rally caused shorts to be liquidated

The Dispatch has previously highlighted how falling bitcoin price leads to long futures positions liquidation. The opposite can happen when prices rise, as it did this past week. The chart below shows the notable liquidation of bitcoin future shorts. In stock market paralance, this is essentially a “short squeeze”.

Bitcoin short futures liquidation

Source: The Block Crypto

However, as the chart below illustrates the recent short liquidation was small compared to the long liquidations in May.

Bitcoin all futures liquidations

Source: The Block Crypto

Stay safe, enjoy the summer and do reach out if you have any questions or comments about the material in this Dispatch.

Asi

Important Disclosures

This is not an offer or solicitation for the purchase or sale of any security or asset. While the information presented herein is believed to be reliable, no representation or warranty is made concerning its accuracy. The views expressed are those of RockDen Advisors LLC and are subject to change at any time based on market and other conditions. Past performance may not be indicative of future results.

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Tether reserve risks are serious & more stablecoin regulation is coming

Dispatch #24 – 2021

July 23rd, 2021

This week The Dispatch looks at the stablecoin market and the risks posed by a lack of reserve audit at Tether, the largest stablecoin. Additionally, there’s clear evidence of US authorities desire to impose additional oversight of stablecoins, which could well be a positive. It is ironic that decentralized digital assets like bitcoin might be negatively impacted by a lack of trust (loss of confidence) in a centralized stablecoin. It is disappointing that crypto trading firms that utilize Tether don’t speak out more forcefully. The full discussion lineup follows:

  • Tether, opaque reserves = elevated risk
  • Stablecoin regulatory oversight will rise
  • Bipartisan crypto legislation proposed
  • Blockfi troubles with States – would national regulations help?
  • Musk, Dorsey & Woods provides insightful discussion
  • Crypto adoption: JP Morgan private clients, Amazon & Saquan Barkley
  • Venture flows into crypto/blockchain accelerated in 2Q

** Note The Dispatch will not publish the next two weeks **

Tether – What’s the reserve backing and risks to wider ecosystem

Tether is the largest stablecoin with a circulating value of $62bn. A stablecoin is a blockchain-based digital currency that’s designed to hold a 1:1 value to the pegged fiat currency. Most stablecoins are US$-backed. Tether is neither regulated by a national authority nor has reserves undergone an audit by a reputable third party. In addition, Tether was sued and settled with the NY Attorney General (see Dispatch #16), as well the company founders have colorful backgrounds.

Rapid rise in Tether in circulation

Tether has seen a meteoric rise over the past 12 to 18 months. There was $4.2billion Tether in circulation at the start of 2020. We are now at $62bn. The 2nd largest stablecoin, USD Coin (USDC) has also grown rapidly from just over $500m at the start of 2020 to now over $26bn.

Tether in Circulation

Source: CoinGecko

As concern over Tether’s reserves have increased lately, we’ve seen USDC’s growth rate accelerate relative to Tether. Over the past 90 days, USDC in circulation has more than doubled to $26.7bn whereas Tether has risen just 26% to $62.1bn.

Tether dominates crypto trading

As the chart below from The Block illustrates. Note USDT = Tether.

The bear thesis is documented in the sources listed below, if you’d like to investigate further.

  1. This Grant Williams podcast with Bennett Tomlin. https://ttmygh.podbean.com/e/gwp_0013/ . To be clear, Tomlin, Williams & Noble (other guest) are Tether skeptics.
  2. Bennett Tomlin tweet thread. This has a copious amount of information on the many allegations, and founders’ backgrounds.  https://twitter.com/BennettTomlin/status/1188096974840647680?s=20

Dispatch readers based in the US do not have direct Tether risk because it is not listed at most large exchanges here. Instead, alternatives like USDC, Gemini USD (GUSD) and Paxos are available. However, if uncertainty over reserve backing leads to a run on the Tether, that could have notable short-term impact on the wider crypto ecosystem. If, on the other hand, you have invested a small percentage of your wealth in bitcoin with a 3-5 year view, then the short-term issues are less of a concern.

Tether’s attestation statement

This is the extent of Tether’s reserve information. This is an unacceptably low transparency of the one of the most critical components of today’s digital asset market.

Source: Tether release

Furthermore, this attestation statement was only published as required by the settlement with the NY Attorney General.

Ideally you would want the USD backing to be with cash at a bank or at least in short term treasuries. However, given Tether’s unregulated status, if they had $60bn sitting in a global bank, it could (probably would) be seized by US authorities. All US dollars flow through the NY Fed. We can see why Tether have opted for short term securities, mostly commercial paper. This is very similar to how a money market fund operates, except that money market funds in the US are registered with the SEC.

Lack of reserve leads to social media speculation

Now there’s social media speculation that Tether’s reserves have been invested in commercial paper issued by beleaguered China property company Evergrande. Evergrande default fears have rise, and the tweet below captures the speculation connecting the two entities. Reddit discussions have also picked up the speculation.

Source: Twitter

This tweet provides more evidence that Tether needs to release a proper audit. Until then, speculation of this nature will persist, as they can’t be dismissed. It’s unfortunate that the largest crypto trading firms that utilize Tether haven’t pushed the company for more transparency.

Additional stablecoin regulation in the US is likely

With the rapid growth of stablecoins, global regulators are increasingly focused on the financial stability risks posed by these lightly regulated money alternatives. Just this week the Presidential Working Group announced they are working on new regulations. More details in this Reuters article.

This WSJ article provides deeper background on stablecoin usage in crypto trading and how some of the regulators’ fears are based on private money in the 1800s. The Dispatch finds it ironic that decentralized digital assets like bitcoin could be impacted by a centralized stablecoin.

Stablecoin financial stability risk is similar to issues with money market funds of 2008 and 2020. The Fed had to backstop money funds. There is no lender of last resort for stablecoins.

The tweets highlighted below offer texture to the multi-faceted stablecoins issues.

Caitlin Long is the Founder of Avanti Bank and the single best the authority on the connectivity between crypto and traditional financial plumbing, in the Dispatches view.  Kevin Werbach is a Wharton professor. This tweet thread is the source for Werbach’s tweets.  This is the reserch paper he referenced in the thread, if you’d like to nerd out!

The following podcasts with Caitlin Long as a guest offers an in-depth view on stablecoins, financial stability and traditional financial plumbing.

  1. https://stephanlivera.com/episode/291/
  2. https://www.rollcall.com/podcasts/fintech-beat/dan-tarullo-and-caitlin-long-on-capital-rules-for-crypto/

Bipartisan Securities Clarity Act introduce in Congress

House Reps Tom Emmer (R-MN), Darren Soto (FD-L) and Ro Khanna (D-CA) collectively introduced the Securities Clarity Act. As this Financial Advisor Magazine article says, the Act will aim to provide clarity to crypto assets being commodities and not securities. This Block Crypto article provides a summary.

Blockfi runs into trouble with States: Would Federal legislation have prevented this?

Blockfi’s core business is a crypto lending account, which allow you to lend out your crypto and receive interest. Blockfi is the most conservative of the operators that offer crypto interest, in the Dispatch’s opinion. Three states have issued cease and desist letters, as this Coindesk article notes. The Dispatch is no legal expert, but wonders if Federal legislation would prevent a messy state-by-state fight. The crypto yield accounts offer high yields by taking advantage of the unique supply/demand and arbitrage opportunities available in crypto. Yes, the risks are far different than FDIC guaranteed bank deposits, but a suitably regulated product is good for consumer choice in our yield-starved world.

Jack Dorsey, Cathie Woods and Elon Musk discussion at the B Word conference  

Here is an insightful 45 minute discussion (https://www.youtube.com/watch?v=Zwx_7XAJ3p0) between Dorsey (Founder of Twitter & Square), Musk (Tesla) and Woods (Ark Invest).

There’s good material about Bitcoin energy usage, positive social impact of cheap international money transfer and how Bitcoin could accelerate the move to renewables. International money transfer, for example, is estimated at US$700bn annually with merchants charging 8%-30% of the value transferred. With regard to Musk and bitcoin, it’s now clear to the Dispatch that he is on a journey of crypto discovery, and is doing so publicly along with his 50m twitter followers!

Crypto adoption news

  1. JP Morgan allows private clients to buy listed crypto funds like GBTC. This is not as notable as Morgan Stanley offering wealth management clients Bitcoin mutual funds. Business Insider story.
  2. Saquon Barkely of the NY Giants to take endorsement revenue in bitcoin: Barkely will convert his endorsement money into bitcoin. More details on this Bitcoin.com article.
  3. Amazon hiring for blockchain. The company has posted a Digital Currency Blockchain Product Lead to work in the payments acceptance team. Fortune article.

Venture flows into crypto accelerated in 2Q


Source: The Block

This is another manifestation of the liquidity created by global Central Banks. Perhaps some of these ventures become home runs, but many are likely to falter by the wayside, at a higher percentage than in traditional commerce. There’s a winner-takes-all network effect in blockchains, and blockchains’ inherent efficiency could eliminate anti-trust concerns of a single winner.

BITCOIN SCHOOL – Continued summer break!

Enjoy the summer, watch out for Delta and do reach out if you have any questions or comments about the material in this Dispatch.

Asi

Important Disclosures

This is not an offer or solicitation for the purchase or sale of any security or asset. While the information presented herein is believed to be reliable, no representation or warranty is made concerning its accuracy. The views expressed are those of RockDen Advisors LLC and are subject to change at any time based on market and other conditions. Past performance may not be indicative of future results.

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Inflation stays high as home prices feed into rent survey

Dispatch #23 – 2021

July 16th, 2021

This week’s Dispatch is going to focus on Inflation. We’ll look at the composition of the CPI basket, what items are most heavily weighted and how price data is diverging from reality. Housing, the largest weight at 42%, is most distorted as the government’s Owners’ Equivalent Rent (OER) Index has not kept pace with house prices. Despite the housing index only rising 2.6% year-over-year (YoY) in June, the headline CPI index came in hot, rising 5.4% YoY. In contrast, median home price data from the National Association of Realtors (NAR) jumped a record 23.6% YoY in May. Evidence points to an 18-month lag between housing prices and OER. Therefore, we should see rising OER keeping inflation high in the coming months, even as transitory items like used car prices (2.75% weight) ease. Longer term, though, the OER just hasn’t kept up with surging home prices, and it’s an ongoing distortion between real costs and government manufactured economic data. Here are this week’s discussion items:         

  • Inflation: June CPI came in hot, despite housing component remaining subdued
  • Rising rents should keep inflation high as transitory items fade
  • Elizabeth Warren’s letter to the SEC Chairman warns of crypto
  • Super Mario cartridge sells for $1.5m – another investment asset!
  • Bitcoin adoption news: Marshal Wace, BofA & Capital Group

Inflation: what CPI captures, what’s most important and the divergence

June headline CPI came in higher than expected at +5.4% year over year (YoY). This despite housing, the largest component with a 42% weight, rising a relatively modest 2.6% YoY. Let’s dig further into how the CPI index is calculated, as Fed officials continue to sing a transitory tune on inflation.  Just note that Fed sets policy based on Personal Consumption Expenditure (PCE) index, but the CPI and PCE have a tight correlation.  The Dispatch will focus on the more broadly followed CPI.  

Housing is the dominant component of CPI

The chart above from Advisor Perspectives illustrates the importance of housing, which is 42.4% of the CPI basket. Housing is further divided into several components as the table below shows. Within “housing”, the largest component by far is “Owner’s equivalent rent..”, or OER. To calculate the OER index, the Bureau of Labor Statistics (BLS) takes the rent data from rental units and then massages to data to extrapolate the effective rent cost for the much larger number of owner occupied households. This BLS OER factsheet provides some color for anyone interested in more details. The Dispatch finds this Federal Reserve paper measuring rent inflation offers a clearer explanation.

Here’s BLS’ simple formula for calculating OER!

Leave it to the government to obfuscate with complexity. To their credit, the BLS publishes all of their methods. Many countries would not.

Source: BLS OER factsheet

OER accounts for nearly one quarter of the CPI basket, and it is an even higher weight in the core CPI Index that excludes food and energy prices. The Fed uses core pricing data to guide policy.

Components of the Housing Index

Source: BLS

The scatter plot below of the May CPI data from research firm Variant Perception shows the outsized importance of OER relatively to the other large categories.

Source: Variant Perception

There is an 18-month lag between house prices and OER

Variant Perception also notes, as the charts below illustrate, that there’s an 18-month lag between OER and home prices. If this correlation persists, we should see inflation staying high even as used car prices and air fares ease. Used car prices have a 2.75% weight and airline fares just 0.63%. Rising OER could have an even larger impact on core CPI, which supposed to drive Fed policy.

Source: Variant Perception

Rents have lagged surging home prices over the longer term

Despite the Variant Perception observation above, OER has diverged over the longer term from rising home prices, as the chart below illustrates. The two data series is indexed to 100 at the end of 1982. One can ask who the heck is the BLS surveying? Or is this possibly what happens in an increasingly financialized world, where asset prices rally with structurally lower cashflow returns/yields. Zero percent interest rates will reduce the return homeowners seek. This is a good example of why interest rates can’t rise because it they will likely crush home prices as stagnant median wages won’t support rents rising. The Dispatch wish people would realize the low inflation mirage created by government CPI data. The housing market is exhibit 1 in that disconnect.  

Source: St Louis Federal Reserve

This is what the nominal dollar chart of median home sale prices reported to the Fed looks like

Source: Federal Reserve

NAR Home price data is rising even faster

The snippet below is from the NAR’s most recent data release that shows home prices in May 2021 rose at a record 23.6% YoY pace. The highlights are by The Dispatch.

Source: NAR

Housing affordability is dropping, which is no surprise

Evidence of sustained money printing that is justified by unrealistic inflation calculations are visible in many markets today. Housing is the most visible since it’s a basic human need and the largest household expenditure. The headline below from US News sums up the Fed-created condition on the ground. Many politicians continue to thank him for printing money to support consumption, but they fail to realize the negative consequences.

Source: US News

National Association of Realtors’ affordability index hit new low in May (low is less affordable)

Despite these notable signs of housing inflation, the “shelter” component of the CPI was up just 2.6% YoY in June 2021. The table below shows what components that contributed to the jump in June inflation.

June Inflation report by major component

Source: BLS June 2021 release

In conclusion, there’s a strong chance that inflation will remain elevated in the coming months as OER starts to pick up. However, the data above also shows that OER structurally understates the cost housing for homeowners, as the gap between home prices and OER widens. It’s one more example of how an economic measure, the CPI, is supressed to justify our current economic model of supporting growth at any cost.

This excellent historical perspective, from current Yale Professor and former Morgan Stanley and Fed economist Stephen Roach, talks about how the Fed botched tackling inflation in the 1970s and how it pushed to ignore food and energy by creating core-CPI concept. Of course, the core-CPI is even more heavily dominated by the rents. So, could the Fed, like they did in the 1970s, just ignore rent prices? Well, here’s a St Louis Fed article that argues just that!  

What can consumers, investors or retirees do in the face of these distortions?

The Dispatch models higher inflation into retirement saving assumptions than what is frequently used by industry Monte Carlo Simulation models. We routinely see 2% inflation assumptions in models, whereas a more conservative rate for the next decade might be more than double that. The gap makes a significant difference in your retirement outcomes. Yes, demographics and technology are sources of structural deflation, but that does not preclude an extended period of high inflation as our money printing monetary policy experience continues apace. ESG too,is constraining capital allocation into energy intensive sectors, just as a new energy future requires more resources.  

Elizabeth Warren warns of crypto and asks SEC for a response

This is the start to Senator Warren’s 5-page letter to the SEC Chair, which illustrates her aims. This Reuters article has more details.

Many politicians continue attack digital assets as they are a threat to the Fed’s ability to print money. Digital assets are a risk because those printed dollars will leak into scarce assets like bitcoin or ether that offers more utility. Government sanctioned money is a recent phenomenon in the fullness of history, which is a longer discussion for another time.

Super Mario 64 game sells for $1.5m

Central Bank manufactured liquidity is making assets out of formerly mundane items. As the Dispatch is fond of saying, most things are going up in fiat currency terms. This is just the latest, and there will be many other formerly mundane items reaching serious values. This BBC article provides more details of this auction.

Bitcoin and crypto adoption news

  1. Marshal Wace, the $50bn London based hedge fund, is expanding into digital asset investing. Read more on Blockworks.
  2.  Bank of America established crypto research group within the research division. Read these articles from Coindesk and Bloomberg.
  3. Capital Group that manages funds worth $2.3tn reported a 12.2% stake in Microstrategy (MSTR) via Capital’s private equity arm. Microstrategy has invested heavily in bitcoin. The Dispatch wonders if the investment is for partners and employee capital.  Nasdaq article has more details.

BITCOIN SCHOOL – Still on summer break  

Stay safe and do reach out if you have any questions or comments about the material in this Dispatch.

Asi

Important Disclosures

This is not an offer or solicitation for the purchase or sale of any security or asset. While the information presented herein is believed to be reliable, no representation or warranty is made concerning its accuracy. The views expressed are those of RockDen Advisors LLC and are subject to change at any time based on market and other conditions. Past performance may not be indicative of future results.

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Elevated equity inflows and bitcoin price update

Dispatch #22 – 2021

July 9th, 2021

I hope everyone enjoyed a relaxing Independence Day weekend. The Dispatch was in South Florida and got a glimpse of a property market even hotter than the DC suburbs. The continued strength of residential real estate goes against the long-term trends of lackluster median income growth and high unemployment. It’s a good example of how ample liquidity can smooth over fundamental realities for an extended period. There is no dominant theme this week, but there’s ample evidence of market frothiness in several of the stories that follow.              

  • Money flows into stocks look elevated
  • Pfizer vaccine and the Delta variant
  • An update on the bitcoin price since 3rd halving vs earlier cycles
  • The average bitcoin wallet holding has fallen to 0.25 btc
  • Sotheby’s to accept bitcoin and ether
  • Not-yet-launched crypto exchange valued at $9bn
  • Crypto comes to 401k plans
  • BITCOIN SCHOOL – Still on summer break!  

Money flow and positioning in equities (stocks)

As the data below from Topdown charts illustrates, equity sentiment is elevated. The AAII captures individual investor sentiment.

Pfizer vaccine and the Delta variant

The Dispatch reads the WSJ headline and interprets that mRNA vaccines are providing strong protection against the Delta variant. However, our media world is driven to draw eyeballs and the headlines often frame the data with a negative skew. For example, could the WSJ headline have read “Pfizer vaccine highly effective against Delta variant”, since 94% of recipients are protected from severe illness? Isn’t that 94% a remarkably effective vaccine protection judged against all vaccines we consume as a society?

The section above from this CNN article should provide confidence that the Pfizer mRNA vaccine does indeed offer strong protection again the latest Covid variant. This news of rising infections in Israel was partly attributed to the stock market weakness last week.

Bitcoin price update since the 3rd halving

This is an updated Ecoinometric chart that illustrates the bitcoin price since the 3rd halving (May 2020) versus the two prior halving cycles. Given the recent price action, it should come as no surprise that the price trajectory has dropped below the earlier cycles. The top of the blue shaded area is the price move in 2013 and the bottom is the 2017 cycle. Note this is a log scale chart. The current debate centers over the question of whether we have seen a price peak for this third cycle. Since the Dispatch advocates a small allocation with a minimum five-year view, that debate is somewhat academic.

Evolution of number of bitcoin held by the average wallet

The tweet below from well-regarded block-chain analyst Willy Woo shows how the average bitcoin owner’s position size has evolved. While ownership has become more widespread, it’s worth noting that 1000 bitcoin in 2009 was worth $1 whereas 0.25 bitcoin is worth roughly $8,500 today.

Note that when you take into account exchange wallets that commingle thousands of individuals’ coins into a single address, the estimated average holding drops from 0.69 btc to 0.25 btc.

Sotheby’s to accept bitcoin and ether

This continues the gradual penetration of the digital asset acceptance for large-ticket transactions. Potential bidders who want to use crypto will now be able to transfer digital value directly to the auction house rather than trade the tokens at an exchange for fiat, move fiat currency to a bank and finally move that to Sotheby’s. This Market Watch article provides more details of the auction.

SPAC deal values not-yet-launched crypto trading firm at $9bn!

This is a SPAC (Special Purpose Acquisition Company) deal valued at $9bn for a yet-to-be-launched crypto exchange! Seriously, this is another sign of the crazy times we live in. Sure, the backers are blue chip entities like Peter Thiel and Blackrock, but this still makes the Dispatch shudder. Coinbase has a $53bn market cap as a mature (by crypto standards) business model and this newbie gets a $9bn valuation. It is more evidence of market frothiness that has been generated by the Fed liquidity spigot, in the Dispatch’s view. More details in this Reuters story and Blockworks article.

Crypto comes to 401K plans

We end by highlighting this June WSJ article about a small 401(k) plan administrator named ForUsAll Inc that is bringing digital assets to savers. ForUsAll only has $1.7bn in in plan assets, a tiny fraction of the $22trillion retirement market. This scrappy upstart is innovating with a smart plan will limit crypto exposure to 5% to start, and plan participants will get reminders to rebalance once crypto exposure goes above 5%.

BITCOIN SCHOOL – Still on summer break!  

Enjoy life returning to normal. Stay safe and do reach out if you have any questions or comments about the material in this Dispatch.

Asi

Important Disclosures

This is not an offer or solicitation for the purchase or sale of any security or asset. While the information presented herein is believed to be reliable, no representation or warranty is made concerning its accuracy. The views expressed are those of RockDen Advisors LLC and are subject to change at any time based on market and other conditions. Past performance may not be indicative of future results.

By

Bitcoin absorbs China’s “crypto crackdown” body-blow

Dispatch #21 -2021

July 2nd, 2021

This week, the Dispatch will focus on China’s “crypto ban” body-blow that Bitcoin absorbed, and how it kept on chugging. China’s “crypto crackdown,” which included stopping bitcoin mining ahead of the Communist Party’s 100th anniversary celebrations, was a significant stress test of the Bitcoin network. Despite a more than 50% drop in computing power securing the network, the protocol operated smoothly, just as it was designed. Yes, price did drop initially, but it never fell below recent lows. We may not be out of the woods yet as miner-selling could accelerate in the coming months, but the de-risking of Bitcoin has accelerated because of China’s action. Hash power moving out of China should reduce Bitcoin’s carbon footprint in the coming years. Furthermore, having 65% of hash power in China was a geographic/national risk, which will also be alleviated.  

  • China stops Bitcoin mining & cracks down on crypto
  • China crackdown will aid decentralization & carbon foot print reduction
  • BITCOIN SCHOOL – We are off this week!  

China’s “crypto crackdown”

As usual the Dispatch turns to Twitter for insights on what took place in China. First off, China “banning crypto” is not a new theme, as the below media headlines from 2013, 2017 and 2021 highlight.

Source: Ark Invest crypto analyst via Twitter

China reiterated existing rules

As with prior “crack downs”, this episode also included the PBOC, China’s central bank, issuing guidance to tighten currency flows into crypto markets.  This Coindesk opinion article provides a good background to the machination in China. The author goes through the many theories of why China might have stopped Bitcoin mining at this particular time.

China’s various actions on crypto in 2nd quarter of 2021 are shown in this Galaxy Digital Research timeline.  This was a slow, evolving “crackdown”. If China wanted to more severely restrict or disrupt crypto, it could have banned crypto currencies outright. China has not done so despite repeatedly tightening rules on moving domestic currency into crypto trading venues.  This is not a surprise to the Dispatch as some of the wealthy that have been utilizing crypto to move money out of China are likely members of the CCP!

The Bitcoin network adjusts smoothly to a precipitous drop in hashrate

Regardless of China’s motivations, it is a fact that 65% of Bitcoin network hashrate (hashrate is the computing power securing the network) was in China. The chart below is from Cambridge Centre for Alternative Finance, which is seen is the most reputable authority on the Bitcoin network and energy usage.

Most of this hash power has gone offline, which can be seen in the hashrate chart from blockchain.com. It’s worth asking, would any other industrial system absorb an interruption of this magnitude with minimal impact on the network operation? 

Despite the underlying stress on the network, the average bitcoin user may have only noticed that it took longer than usual to confirm a transaction last week. With the hashrate down sharply, but difficult yet to adjust, the network had the slowest ever block confirmation.

The tweets above from this thread shows the outlier nature of the 23-minute block confirmation. The thread also provides a good summary of block times, and the difficult adjustment mechanism that’s a core function of the network.  It is well worth a read if you are unfamiliar with how the protocol is designed to operate. That design was tested last week and it came through with flying colors.  Several additional tweets from the Twitter-thread provided useful insights.

The China crypto crackdown will aid decentralization & reduce carbon footprint          

The dominance of China based computers securing the network has been seen as a risk to Bitcoin. The slide below is from RockDen Advisor’s September 2020 “The Investment Case for Bitcoin” presentation. China related risk featured prominently.

Computer power securing Bitcoin, aka bitcoin miners, is leaving China. These mining machines will seek homes in other geographies with better regulatory regimes and cheap, stranded energy. The Bitcoin network will become more decentralized in the coming months as a result. It’s unlikely that these miners will return to China, a location where an autocratic government shut down their business overnight. The tweet below from this thread by the CEO of SBI Crypto provides a glimpse of the speed of change.

Conclusion

While much of the traditional media narrative has highlighted the risks to Bitcoin exposed last week, the Dispatch believes the “China crackdown” is a notable de-risking moment. It showed the resiliency of the Bitcoin network in the face of a Nation State-mandated deterrence of the network. In the coming months and years, Bitcoin will become more decentralized (better security) and lower its carbon footprint as miners leave China. The Dispatch previously viewed the environmental narrative as the biggest risk to continued bitcoin adoption. The Dispatch now believes this concern will be alleviated thanks to China’s actions last week.

What, then, is the most notable risk to Bitcoin? It’s probably a systemic issue emanating from the Tether stable currency, which has come to dominate bitcoin and crypto trading. That’s a discussion for another Dispatch. Dispatch #6 and  Dispatch #16 touched on the Tether issues, which were related to a lack of audited reserves.  

BITCOIN SCHOOL – We are off this week!   

Stay safe, but do enjoy life returning to normal. Do reach out if you have any questions or comments about the material in this Dispatch.

Asi

Important Disclosures

This is not an offer or solicitation for the purchase or sale of any security or asset. While the information presented herein is believed to be reliable, no representation or warranty is made concerning its accuracy. The views expressed are those of RockDen Advisors LLC and are subject to change at any time based on market and other conditions. Past performance may not be indicative of future results.