There has been an explosion of crypto legislation proposals from US politicians. The bogeyman of late has been sanctions evasion, even though the Treasury Department has repeatedly said that there’s no sign of evasion via crypto. Many of these proposals are unlikely to see the light of day in current form in our polarized political world. However, the bipartisan crypto legislation from Senators Lummis (R-WY) & Gillibrand (D-NY) may offer much needed regulatory clarity. The proposal doesn’t have a grand title and is currently at the discussion and research phase currently.
The macroeconomic outlook has become murkier since the last Dispatch. The yield curve has steepened (is a recession less likely?), diesel price has spiked, but container shipping rates are falling. Are shipping rates falling because Chinese factories are not producing (lockdowns) or because demand is slowing? These are questions to which we don’t yet have a firm answer. Our thinking remains that the Ukraine invasion has worsened commodity supply constraints, but we acknowledge there are rising risks to the demand side. The Strategic Petroleum Reserve release is easing the current price of crude oil, but it does not address the core under-investment issue plaguing supply. The market knows that the US will have to replace the current release in 2H22 and it would be ironic if US SPR purchases drove crude prices to a new high heading into midterm elections in November.
Dispatch #9, on 8th April, 2022, discusses the following items:
- Explosion of crypto legislation
- Rising uncertainty explained in a few charts
- $624m crypto hack
- Bitcoin futures margin composition change
- EU energy security and undervalued US gas reserves
- SEC Chair Gensler calls for collaboration
- Decomposing the last decade’s S&P 500 returns
- Crypto tax FAQ
Explosion of crypto legislation proposals
Crypto legislation has become a competitive sport for US politicians, some of it triggered by the Russian invasion. It should come as no surprise that crypto-skeptic Elizabeth Warren has proposed a “Sanctions Compliance Bill”. Not to be outdone, Brad Sherman, another reliable crypto skeptic, has proposed a companion House bill that matches the Warren proposals. There’s also the bipartisan Accountability for Cryptocurrency in El Salvador Act proposed by Senators Jim Risch (R-Idaho) and Bob Menendez (D-N.J.) This is some serious ink that’s been spilled as the legislature looks for free publicity, in the Dispatch’s view.
Much of the Russian sanction evasions fears were fanned by this poorly researched opinion journalism from the NY Times that quotes unnamed experts. Here are a few parts of the article with highlights added that illustrate the baseless statements littered throughout.
In reality, since this article was published, the State Department has stated that it’s very hard to evade sanctions via blockchains. Just this week, Janet Yellen told a House Financial Service Committee hearing that crypto hasn’t been used for significant Russian sanction evasion.
Lummis – Gillibrand effort holds promise
However, there is a serious bipartisan effort to work on regulatory framework for crypto spearheaded by Cynthia Lummis (R-WY), a well known crypto supporter, and Kirsten Gillibrand (D – NY). This legislation will not be rolled out quickly for self-marketing purpose, but it is likely to involve significant discussion and deliberation that’s needed for this new technology/asset class to evolve for everyone’s benefit. Here is Politico’s take on the effort. This last effort looks and feels legitimate and should be watched in the coming months.
Rising economic and market uncertainty in a few charts
The yield curve inverted briefly but has steepened since. We are talking about the yield between the 2yr and 10yr treasury securities.
Yield curve inversion has preceded most recessions, so has recession risk dropped because bond prices sold off recently? That is not our read. Instead, what we are seeing is a bond market that is merely following the Fed rather than acting independently.
This chart from macro strategist Jim Bianco (a must follow on macro) shows how expectations for 0.50% rate hikes for ALL Fed meetings in 2022 was near zero in early March. One month later, after much Fed officials’ jawboning, the expectations are well north of 50%.
After 15 years of QE and a 40-year bond bull market, market may have lost the predictive power and is merely following Fed guidance. And, the Fed, in our view, has proven rather inept at predicting economic trends and has swung the pendulum too far in favor of growth/full employment at the expense of the price stability mandate.
In the real world, despite lower crude oil prices following US SPR release, diesel price has spiked sharply. We don’t consume crude oil, so what matters for CPI is refined products like gasoline and diesel. The latter is far more important for broad economic activity through use in transportation and other commercial activity.
However, to muddy the water of the spike in diesel prices, global container shipping prices are gradually easing. It’s unclear if this is due to demand reduction as the economy cools or because factories in China are shut. Read this Twitter thread from a Shanghai resident to understand the draconian restrictions currently in place. We are amazed that China did not learn from the Rest of the World on how Covid can’t be avoided.
The charts above illustrate the conflicting global growth picture today.
Freddie Mac mortgage rates close to a 10-yr high
We’ll end with another cautionary data point, which is US mortgage rates that have spiked close to 10-year highs. This move has rapidly wiped out the low rates of the Covid Era. We are working on a long discussion on this subject.
Another crypto exploit, this time for $624m!
The Ronin Network is the unfortunate new leader atop the Rekt leaderboard of crypto hacks. The top-10 hacks have all taken place in the past year.
The Ronin hack was another failure of a cross-chain bridge, a network that moves value from one blockchain to another. This particular bridge connected Ethereum to the Ronin blockchain used by the decentralized game Axie Infinity, as this Blockworks article explains. The hacker targeted the multi-signature security system that signed off on the movement of assets between the two blockchains. They did not compromise the smart contract software code of the Ronin blockchain. This Medium article delves into the details of the security arrangement and how the hacker exploited the system.
Crypto bridges have been a frequent target of hacks
Many of the largest recent hacks have targetted bridges between different blockchains. We previously highlighted the $320m Wormhole hack, which attacked the bridge that connected Ethereum and Solana. If you can’t easily and reliably move value from one network to another, then we may have walled-garden blockchains that slow overall adoption. The Dispatch believes in a multi-chain future, but these hacks may call for a reevaluating the adoption trajectory. The quick takeaway from the proliferation of cross-chain bridge hacks is that dominant chains like Ethereum should benefit if consumers are reluctant to move value out of incumbent chains due to weakness in bridges.
Finally, this Chopping Block YouTube pod offers a broad-ranging discussion of the Ronin hack, general bridge risks and the overall sloppiness of coding/security even at large projects.
Falling exposure of bitcoin margined BTC perpetual futures
This is a long-term trend (nearly 10 months) that should lower price volatility in the digital asset universe. As the chart below shows, before May 2021, nearly 70% of bitcoin futures open interest (O/I) was margined with bitcoin. This meant that a drop in the bitcoin price led to the collateral also dropping in value at the same pace. Since the May 2021 price peak, futures collateralization has moved rapidly to stablecoins. The benefit here is that as bitcoin drops, the stablecoin collateral does not drop leading to a smaller margin call and, therefore, lower liquidation risk.
It’s also worth noting that futures funding rates remain low in 2022, indicating low levels of speculation.
EU Energy Security and the upside to US natural gas
The current Ukraine conflict has laid bare Europe’s need for energy security. Russia supplied almost 40% of Europe’s gas, which is now leads to heroic promises by EU politicians. One such promise is that they can slash Russian gas imports by two thirds in 2022 and end imports entirely before 2030. The first question that jumps out is why would the EU wait until 2030 to end dependency if they can reduce dependency by two-thirds in nine months? Additional announcement, like the headline below, followed.
Don’t buy the headline hype. This Reuters article lays out the true picture of Europe’s energy dependence. In 2021, Russia exported 18.3 billion cubic feet/ day (bcfd) to Europe. In contrast, total US LNG production running at full capacity today is 12.7bcfd. Most of this production has already sold via long-term contracts to mostly Asia power utilities. In the short term, it’s not possible for US LNG to replace Russian gas to Europe.
A few cargoes (each shipment is called a cargo) have been diverted to Europe to take advantage of the much higher European prices relative to those in Asia. A warmer Asian winter has lowered gas demand, therefore owners of long-term contracts to receive LNG in Asia have been happy to sell cargoes into higher European prices.
LNG crucial to reducing reliance on Russian energy
Reducing Russian gas dependency means replacing piped gas with LNG (liquified natural gas). In the short term, the world does not have excess LNG supplies. Over the long term, say five+ years, the world can build more liquefaction plants to convert natural gas to LNG. The US is an abundant and secure source of natural gas for Europe. The US needs to commit to building additional liquefaction plants on the Gulf Coast and allow more pipelines capacity to move gas from the fracking areas to the coast. Given the pricing difference between natural gas in the US and the rest of the world, The Dispatch sees US price moving higher over a multi-year period.
We are sharpening our pencils on undervalued natural gas assets. Europe is also trying to get Qatar, already a large LNG producer, to expand production, as this WSJ article explains. However, any new Qatari plants could easily take more than five years to come online, just like new US production. In the near term, for all the political promises of more US gas to Europe, inventories are dangerously low in the US. This should put upward pressure on US Henry Hub gas prices. Longer term, this should incentivize higher gas production.
And let’s end this discussion with another one of Elizabeth Warren’s populist proposals.
This headline was released on February 4, 2022. Energy is a reliable populist clutch, but economic and geopolitical realities win the day.
SEC’s Gensler calls for collaboration
SEC Chair Gensler is the consummate Washington insider who’s been focused on the crypto land grab as this Bloomberg article mentions. Crypto assets are currently overseen by a single regulator, and both the SEC and CFTC have been pushing to grab that roll. There has been little talk of collaboration from Gensler until now. We find it hard to imagine he’ll be looking to collaborate if the undercurrents in Washington were in favor of the SEC regulating digital assets. It’s quite possible that the CFTC is gaing momentum in the race to regulate crypto. That’s when collaboration becomes attractive for the likes of Gensler.
Decomposing S&P 500 returns for the past decade
The key forward-looking question is if the expansion of the light blue earnings per share area is a sustainable trend or merely a pull-forward of earnings. We know the plight of the most prominent Covid beneficiaries like Peloton. However, what matters is earnings trends for the largest index components. Rising rates should crimp the buybacks trend even if it doesn’t go back to 2013-15 levels.
Crypto Taxes – Are you ready to file?
Coinbase has a glossary on crypto taxes to get you rolling before the April 18th deadline. It is both succinct and comprehensive. Can you use FIFO, LIFO or HIFO for your crypto taxes? Click on the link above and check. If you don’t know what these acronyms mean, definitely speak to a tax advisor. Are staking rewards or cyrpto yields taxable? Again, the glossary points you in the right direction.
Stay safe and do reach out if you have any questions or comments about the material in this Dispatch.
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