RockDen Advisors

Wealth advisory & investment management

Market Updates

By

Bitcoin hashrate migrates to the US

Bitcoin hashrate migrates to the US with the share having doubled since April 2021 and reaching the #1 position globally. US share of bitcoin hashrate reached 34.5% in September, according to University of Cambridge because of China’s crypto mining ban. This geographic migration is important because US-based miners use far more renewable power than Chinese firms. The rising use of renewable energy should dent the “bitcoin is bad for the environment” attack vector. However, you should expect continued high energy prices to be a headwind for the bitcoin energy narrative. Governments continue to double down on their strategy to blame energy companies for spiking prices. It’ll be fascinating to watch the outcome of tightening investments further in carbon energy just as those prices head into unprecedented levels.

Bitcoin has rallied close to all-time highs due to speculation about the SEC approving a bitcoin ETF that is based on futures contracts. If true, will it be a genuinely positive catalyst or will it turn out to be over-hyped event signalling a market top? Will this speculation turn out to be accurate? Dispatch #33 has more thought below.

The full discussion subjects of The Dispatch #33 completed on October 15, 2021, follow:

  • US share of bitcoin hashpower reached #1, doubling to 34.5% from one quarter ago
  • Bitcoin ETF – genuine catalyst or macro-top indicator?
  • EU President doubles down to blame energy industry on high prices
  • “When you buy crypto you own nothing” + Jamie Dimon says bitcoin is worthless!
  • Former UK Finance Minister joins crypto firm
  • Property sales in China drop sharply in September

Bitcoin hashrate migrates to the US

The latest update by the respected Cambridge Bitcoin Electricity Consumption Index shows the US with #1 market share in bitcoin computing power (hashrate or hashpower). The share more than doubled from 16.8% in April to 34.5% in September 2021. Kazakhstan and Russia are the next largest share gainers, as bitcoin miners have left China (See Dispatch 21). This is a significant development, although wholly expected by The Dispatch, because it mitigates the  “bitcoin is bad for the environment” narrative. US-based bitcoin miners (who provide the hashpower) use a far higher percentage of renewable energy compared to China based miners.

To recap, over 60% of bitcoin hashpower (computing power securing the network) was previously located in China. This was a clear vulnerability for bitcoin because of China’s single party rule. Additionally, Chinese bitcoin miners used coal-based electricity during much of the dry season. The chart below shows the geographic evolution of hashrate until April 2021, which is when China stopped mining activity.  Since the last data points on the chart below, the US share has doubled. China’s share should be close to zero now.

Bitcoin hashrate migrates to the US – geographic hashrate share

Source: University of Cambridge

As The Dispatch has maintained, there’s no question that the bitcoin network uses energy. However, as the network moves increasingly to renewable sources of power that should dampen one of the key oppositions: that bitcoin harms the environment. The rate of change is startling as noted below.

Sustainable energy usage jumps as hashpower leaves China

The Bitcoin Mining Council, a forum of the largest bitcoin mining companies, published a 2Q survey that showed 67% of members’ power was from sustainable sources. The chart below from a Bitcoin Mining Council presentation shows the notable increase in sustainable energy use as China shutdown bitcoin mining, which was over 50% of bitcoin hashpower globally.

bitcoin network renewable energy use rises
Source: Bitcoin Mining Council

Source: Bitcoin Mining Council

The 10-slide presentation provides a positive spin on Bitcoin’s energy use, for anyone interested. This chart below is particularly provocative and not what’s highlighted by the media.

Source: Bitcoin Mining Council

The Dispatch looks forward to an independent entity like University of Cambridge publishing data on the Bitcoin network’s renewables usage.

“Sustainable” and “renewable” aren’t always what you might think they are

As this story about UK’s Drax wood pellet power plant illustrates, there’s plenty of wiggle room to become “renewable” and “sustainable.” The plant under discussion is a top-3 CO2 emitter in Europe and top-5 PM10 particulate matter emitter, but is deemed “sustainable” for burning wood pellets. This greenwashing risk is present in both national power grids and in bitcoin mining energy usage.

What does a bitcoin ETF launch mean?

Proshare bitcoin ETF launch

Bitcoin is experiencing renewed vigor as the market anticipates a bitcoin ETF launch as soon as next week. There are several ETF companies that have filed to launch futures-based bitcoin ETFs as discussed in this WSJ article. The more useful question is whether an ETF launch will signal a top or provide a positive catalyst. Close followers of crypto markets are aware that highly anticipated market events have turned out to be market-top signals. The CME futures launch in December 2017 and Coinbase IPO are two examples. Also, don’t forget that the SEC could object to these bitcoin ETFs next week.

What’s the difference between ETF approval vs. futures approval?

First, bitcoin is not at an all-time high and has not seen sharp price appreciation (by bitcoin standards) over the past several months. Instead, we’ve experienced volatility for sideways price movement. The price excitement in crypto assets has been in alt coins and not the more mature tokens. Second, an ETF is likely to increase consumer access to bitcoin. In contrast, CME futures started trading in 2017 when there was hardly any institutional participation. Futures are not a consumer offering, certainly not back in 2017. Here’s the WSJ’s take on what an ETF launch will mean for investors. Note, none of this is investment advice. Please speak to your advisor before investing.

For those enjoying the current price action, do keep in mind there are plenty of headwinds on the horizon. The White House is contemplating executive orders for crypto oversight, Bloomberg claims, which is most likely to target stablecoins. Updated FinCEN rules on crypto are expected before year end. Lastly, The Dispatch has repeatedly flagged the idiosyncratic risks posed by Tether reserve ambiguity. These are risks to the price short term. Taking a five-year view on this emerging asset should capture the upside provided by this highly volatile asset.   

EU doubles down on current policy despite price spike

European politicians are trying to spin the current energy price surge and blame producers. The tweet below from Ursula Van der Layen, the President of the EU Commission, is an excellent example. Economics 101 says that when you cut capital investment in a capital-intensive industry, supply will drop. When prices rise, it’ll take years for supply to rise, but even then, Van der Layen’s instinct is to vilify the industry and press on the renewables pedal cloaked behind “energy independence.” The transition will take decades because it takes time to deploy renewable generation and because renewable sources are less energy dense compared to fossil fuels. Her tweet feels somewhat like asking society that’s struggling to afford bread to eat cake!

Source: via Twitter

The tweet includes a 1-minute video clip that’s worth a listen but think critically of her words. Von der Leyen compares gas volumes not increasing to renewable prices not rising. Apples to oranges. The cost of producing gas hasn’t risen either. European energy companies have been coerced into not investing and now Europe is overly dependent on Russian gas. As for surging electricity prices, renewables will benefit from the same higher price if they are exposed to the spot market. It’s quite likely that much of the renewable energy is sold on long-term contracts where the price would not rise. This is just spin focused on fooling the population to cover up for policy decisions that led to the current energy price surge.

Political decisions are starting to shutdown energy funding

These political words carry over into the real world as this WSJ article lays out the scarce funding for energy projects now. The paragraph shown below highlights conditions.

Source: WSJ

Labor Department to change ERISA rule to comply with Biden executive order

For further evidence, this Department of Labor (DOL) action, illustrates how executive prose and action trickles into tangible actions. The DOL, which regulates employee retirement plans, proposed revisions to plan administrators to allow ESG factors in investing. The ERISA Act required a fiduciary duty from plan administration to focus on retirees’ financial wellbeing. On the surface, the DOL’s proposed changes appear sensible. Unfortunately, the politicization of these rules is well underway, having started during the Trump Administration, as this article explains. We are probably in the middle innings of this policy trend and prices will have to get much worse before there’s a change to the current thinking. They may well be decided at the ballot box with US mid-term elections thirteen months away.

Private equity flows into energy dry up

The chart below from the Private Equity Propels the Climate Crisis report by Private Equity Stakeholder Project illustrates the dramatic swing in energy deals. To be fair, the Kyoto Protocol was ratified in 2005, yet there was no change in capital allocation for many years, as the chart shows. However, the chart also shows how funding has tipped over in the past 2-3 years.

Source: Private Equity Propels the Climate Crisis

The chart also highlights how the same data can be used for different narratives. The Dispatch looks at the data and sees a worsening energy crisis. The report, on the other hand, is pushing the view that private equity is causing global warming. Both views have a point: private capital should have reallocated to renewable energy faster, but the aggressive shift today may cause higher prices in the future. This is just a simple view. In reality, solar and wind projects did not present attractive returns a decade ago due to higher costs and efficiency.

Falling capital flows into traditional energy is likely to lend momentum to sustained high energy prices. Yes, shutting off capital to carbon energy sources certainly slows the rate of increase in atmospheric carbon dioxide, but that may come with a growth slowdown as energy price impact everything we do.

Could political winds on energy flip quickly?

Despite all that’s highlighted above, the Politico headline shown below from a few days ago caught our attention.

Politicians are driven to stay in power. The view here remains that the headline is a set up to tell the voters that rising prices are the industry’s fault, Just as the EU tweet highlighted earlier. However, speech writing will only obfuscate voters for a short period of time and won’t overcome sustained high energy prices.

When you buy cryptocurrency you own nothing

This article was the top read last week on the wealth advisory industry site, Advisor Perspectives. This goes to show how many in the wealth advisory business dismiss digital assets. You’d expect a more nuanced and detailed presentation of facts by authors publishing on industry sites. Instead, you get this ending paragraph.  

The same can be said for a Picasso or a gold bar. All monetary assets rests on societal acceptance: it doesn’t matter if it’s real or digital. In fact, digital monetary assets have superior divisibility, portability & fungibility properties to gold. Also, what about the finance applications being built on blockchains like Ethereum or Polkadot? Isn’t that real value? The prevalence of these bearish views from mainstream finance illustrates that we are still early in the adoption of digital assets.  

Jamie Dimon thinks bitcoin is worthless

Staying on the subject of worthless bitcoin….JP Morgan CEO Jamie Dimon on Monday said, to paraphase “I personally think bitcoin is worthless… but if clients want access we’ll provide it”. Here’s a 21 second video of Dimon at the Institute of International Finance conference.

Crypto lobbying boost

Former UK Finance Minister – Chancellor of the Exchequer for any British readers here – has joined Custody firm Copper as an advisor. The Dispatch likes to flag this steady rise in the crypto industry’s lobbying capacity. This Decrypto article provides more details.

China property sales drop sharply in September

Source: WSJ

The sharp slowdown is worth following as it could have global implications down the road. President Xi is clearly working on changing the heavy reliance property to generate growth (See Dispatch 31), but it’s a tricky balancing act.

Once confidence is dented, it won’t be easy to recover. The Dispatch anticipates Chinese property prices staying soft in the coming months, increasing the chances of the government resorting to monetary stimulus to re-inject confidence into the sector. However, a notable easing is likely to lead to Chinese currency weakness, which won’t be accepted by Western trading partners in the current environment. This should be a slowly evolving stream of events worth following for its global implications.

Stay safe, enjoy fall 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

Energy Policy and Future Supply Crunch

This week’s focus is energy policy and how it contributes to energy supply crunch. Simply put, we are attempting the clean energy transition by vilifying traditional sources of energy. This is leading to underinvestment that is likely to cause sustained higher prices to consumers. Despite The Dispatch wanting a cleaner, lower carbon future, it has placed significant bets on higher energy price in client portfolios. This includes nuclear, carbon reduction/credits and, where valuations make sense, renewable energy.

Digital asset markets are buoyant once again, and the media has several narratives to fit the price action. These include SEC possibly approving a bitcoin ETF based on futures contracts, speculation that bitcoin will become legal tender in Brazil and Bank of America publishing a report titled “Only the First Inning”.  

Discussion subjects of Dispatch #32 on 8 October 2021 follow:

  • Energy policy and structurally higher prices
  • Used car prices hit new all-time high. CPI moderation over?
  • Another software bug leads to $60m crypto value loss
  • Crypto exchanges restrict access to Chinese residents
  • Bitcoin/crypto disrupting global money transfer market
  • Bank of America Digital Asset Primer – “Too large to ignore”
  • Tether allegations recycled on Bloomberg Businessweek cover story

Unrealistic energy policy and future energy supply crunch

The misguided policies are illustrated by President Biden’s statement that the US power sector will be free of carbon by 2025.

Interestingly, the video clip is no longer available on The Hill tweet, but The Dispatch did watch it several times (when the video was first released) and heard the President say “power sector will be free of carbon.” Even a 5th grader shown the current total energy mix will realize that carbon free by 2025 is merely a dream. The EIA estimates that 60% of electricity is generated from fossil fuel sources, less than the total energy mix shown below, but still very high.

Source: EIA 2021 outlook

The government’s Energy Information Administration (EIA) projects that we’ll consume more carbon energy and much more renewable energy in the future. For a more detailed discussion about how current energy policy is likely to exacerbate prices read this post by respected commodity investors Goehring & Rozencwajg.

An aggressive switch to renewables may require lower energy consumption & lower growth to avoid energy supply crunch

We could sharply lower the consumption of carbon energy, but that’ll come with slower growth, which no politician is willing to accept. Instead, all we ever hear is the demand to stimulate consumption at all costs. Monetary policy via the Fed is pushed to print money and the federal government increase spending and transfers to boost aggregate demand. More consumption = more energy use. We have no other growth model than higher consumption driving higher GDP. The world needs to have an honest discussion about the trade off, but we won’t do so as partisan politics dominate. 

Energy transition needs to be balanced and well planned

Germany and England are good examples of sharply higher energy costs from a faster transition to renewables. Both countries rely on renewables for a larger portion of their electricity needs and that has led to sharply higher energy prices. The intermittence of renewable power generation and energy density are two factors that need to be considered.

The two charts below from this WSJ story illustrate the long-term wholesale electricity price in each of those two countries. They are up by a factor or 2-3x before the most recent surge.

The electricity price spike is partly driven by gas prices that have surged multiples more, as seen in this chart below.

Source: WSJ

US energy prices are also spiking

The US hasn’t experienced as severe a price spike, but winter heating bills should be notably higher this year following higher energy prices.  Here’s a chart of the US natural gas prices from this recent WSJ article

The Dispatch is a supporter of the switch to greener energy, but our politicians need to highlight the potential consequences of this acceleration. The burden of higher energy costs is greatest on the lower 50% of income earners.

Betting on sustained high prices as energy supply crunch worsens

The Dispatch remain notably skewed to higher energy prices in client portfolio. This does not mean purely oil and gas value chain. There’s ignored-for-decades nuclear, the carbon reduction/credit value chain and a handful of alternative energy assets that aren’t valued like SaaS companies like Adobe or Salesforce. This is NOT investment advice.

Shortages are widespread in physical commodities, not just energy

The diversified Bloomberg Commodity Index is hitting all time highs because the same dynamics of underinvestment in energy was also a feature in most commodities. This is going to be a substantial source of future inflationary pressure, even though governments and policy makers ignore food and energy costs when setting monetary policy. Politicians will act once the voters are unhappy. Watch activity in Europe to see if/how the debate changes.  

Source: via Twitter

Energy accounts for 30% of the above index weight, grains ~23%, industrial metal ~15% and precious metals 19%. Full details here.

Another Crypto software hiccup leads to value dilution

Compound, one of the largest Defi venues, gave away $80m worth of compound tokens to users due to a software flaw, as Coindesk explains. This is a loss to all the other holders of the Compound token as it dilutes their interest, just like a company issuing new shares. It is not the typical crypto hack where value is stolen directly from individuals by sophisticated software programmers. The initial flaw in the protocol software gave out too many tokens to some users. Since the discovery of the initial bug, additional flaws have been reported. This second heist appears to be actioned by sophisticated programmers. It is eye opening that one of the largest Defi protocols had a software bug. This is another data point guiding The Dispatch on digital asset allocation: The largest positions are matched to the most secure protocols, all else equal.

Used car prices reversed to record high

In July’s Dispatch #23, we articulated that inflation is likely to stays elevated over the long-term, as surging house price feed through into the CPI’s “shelter index”.  We did see the possibility of inflation easing in the short term as transitory items like used car and airfare prices ease. The short-term view is likely to be fleeting as used car prices have hit a new all-time high after a brief decline. With the worst of the Delta variant behind, lodging and airfare could also rise. The Dispatch now does not anticipate easing inflation in the next one or two quarters and sees high inflation challenging the Fed’s transitory narrative.

Source: Manheim

Crypto exchange starts offboarding Chinese users

This story follows up on China’s more comprehensive anti-crypto measures announced a few weeks ago (see Dispatch #31). Many exchanges have started restricting new Chinese users and plan to offboard existing Mainland clients. US users are familiar with such restrictions as most offshore exchanges restrict them. Chinese users are now feeling those same restrictions, but without having access to any onshore services. The most sophisticated of Chinese users could trade on Defi venues where there is no centralized authority stopping Chinese users. Using Defi venues will require working around the China firewall. Let’s be clear, though, excluding the Chinese population from crypto assets is a negative to the sector. These articles from  Coindesk and WSJ discuss the measures announced by exchanges.

Bitcoin starts to disruption global money transfer industry

Bitcoin/crypto’s ability to disrupt the global money transfer industry might be coming to fruition. The World Bank World Bank estimates 2020 global remittances of $700bn, and it is an industry littered with high fees.

Until now, the efficiency of the bitcoin value transfer technology hasn’t been well advertised, because all the attention has been on bitcoin the asset. That is changing with El Salvador adopting bitcoin and rolling out a national bitcoin wallet.  The country received ~ $6bn from remittances in 2020, which is nearly 25% of GDP this CNBC article explains.

Rapid Chivo wallet adoption and rising financial inclusion

This first tweets from President Bukele illustrates the explosive adoption and rising financial inclusion. That’s a one third of the population using the wallet!

Source: via Twitter

The tweet below highlights the disruptive pace. At $2m/day that’s in the vicinity of $600m/yr (assuming just 300 days), which is a 10% of 2020’s transfers into El Salvador. And, this is just one month post the launch of the Chivo wallet, which was marred by technical glitches.

Source: via Twitter

Money transfer companies take anywhere from 5-10% of transfer amount are most at risk. Just to be clear, the lightning payment system is merely using bitcoin’s payment mechanism to move US$.  The participants don’t have to take bitcoin price volatility, as the founder of Strike explains in this CNBC interview.

Money transfer company shares may be pricing in the crypto risk

The chart below of Western Union stock shows the weak performance since bitcoin became legal tender in El Salvador. A one-year stock price chart does not provide definite conclusions in the Dispatch’s view, but it’s worth following. Thank you to reader Frank D for flagging the WU move.

Source: Tradingview

Tether allegations make Bloomberg Businessweek cover story

Regular readers of The Dispatch know that we see this stablecoin as the most serious risks to the crypto ecosystem. On July 23rd Dispatch #24 laid out the allegations and the risks of Tether. There’s nothing new in this Bloomberg article that has not been alleged many months previously. It is, however, a well packaged summary of all the allegation with the Bloomberg’s substantial reach. It’s good that a wider audience is aware of the allegation. @BennettTomlin on twitter remains the authority on Tether allegations, in The Dispatch’s view. Follow Mr. Tomlin as he’ll flag any new worries while the Bloomberg reporter would have moved onto the next story in a few weeks.

BofA on digital assets – “only in the first inning” and “too large to ignore”

Despite the headline, the report is not a digital asset primer at all. Instead, it just provides a summary of digital asset exposure of legacy stocks under BofA coverage. The Dispatch, with several decades of institutional equities insights, is skeptical of banks’ digital asset research. They are helmed by overworked analyst trying get up to speed on a new technology and asset in months, which is reach. This report is evidence of the effort to purely drive value into their legacy stock coverage. There’s hardly a dusting of digital asset insights. It’s laughable to see these FOMO research efforts from banks that bashed digital assets for years. FOMO = Fear of Missing Out.

Stay safe, enjoy cooler temperatures 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

China Crypto Ban & Policy Change Hits Evergrande

China’s crypto ban (again) and Chinese policy changes driving the Evergrande crisis are this week’s focus. When the world’s second largest economy bans an asset class and the largest token (bitcoin) only drops ~5%, does that not seem like a source of strength? Yes, the volatility is unpleasant, but that’s why The Dispatch believes appropriate position size and a long-term view are essential tools for this volatile asset class.  

In traditional markets, most investors were blissfully unaware of Chinese property company Evergrande until worries about the company’s debt load led to a global stock selloff this week. The Dispatch is quite familiar with Evergrande from the past life and is most focused on possible changes to accommodative real estate policy in China. Such a change could have material long term impact on many commodities. It’s probably wise to avoid commodities that rely on Chinese investment for substantial demand as we might be seeing a notable change in Chinese real estate (RE) policy.

Dispatch #31 discussion items on 24th September 2021 are listed below.  

  • Evergrande, China RE policy and commodities
  • China “bans” cryptocurrencies again!

Evergrande and Chinese policy change

Worries about contagion from an Evergrande default led to a global equity selloff earlier this week. Evergrande is a company that The Dispatch knew well in the past life as an emerging markets investor. The company’s debt levels have been steadily rising for many years, but new policies from Beijing led to the current cashflow problems. The new policy, widely called Three Red Lines, restricted companies from issuing new debt based on financial thresholds, as shown below. Needless to say, Evergrande was in the red on all three of the

Three Red Lines

Source: UBS Asset Management

This is a notable change from many decades of official policy that supported higher property price and real estate companies.  For most financial market observers, what’s happening today is purely a capital misallocation issue. However, the Dispatch takes the view that there’s a larger socio-economic driver behind the Chinese Communist Party’s (CCP) policy changes. This story in the Guardian  provides a glimpse into the delicate balance between property affordability, gender imbalance, falling marriage rates/birth rates and male eligibility to name a few factors. Underlying all this is potential popular discontent with the CCP, which drives most party decisions.

If you do want to peel back the Evergrande onion, it’s crucial to understand how the RE sector fits within the wider Chinese economy and what Beijing’s policy changes aimed to achieve.  This essay What Does Evergrande Meltdown Mean for China? by Beijing-based Professor Michael Pettis provides exactly that. The paragraph below from his essay is instructive of the delicate balance facing Beijing policy makers.

Source: Michael Pettis

Property affordability is worst in the world

At a sector level, this Tweet thread by the founder of Exante Data explains the excesses in the Chinese real estate market. One of those tweets shown below illustrates how property is outrageously unaffordable in China relative to incomes.

Source: Exante Data

Chinese real estate firms have excess debt levels

If you’d like to dig deeper into the capital misallocation of Evergrande and contagion within China RE companies, this is an excellent Tweet thread. The chart below illustrates the dominance of Chinese RE companies in the list of the world’s largest interest payers.  

Source: Journalist at The Economist via Twitter

Chinese policy making has seen a structural break

To conclude, when we combine Beijing’s 2021 action against the large tech firms, demolishing the after-school education sector, crypto ban (see next story) and now Evergrade/ RE, it’s best to assume that there’s a notable change underway in how the Central Government is driving growth. It’s different to the growth-at -all-cost model of the past several decades.

These tweet from Prof. Pettis on September 23rd speculates how the Evergrande situation might resolve.

 

Source: Michael Pettis via Twitter

Implications for commodity demand

The Dispatch is focused on the implications for commodity sectors as there are global macro drivers that suggests a tight demand/supply environment for many commodities. The changes in China point to avoiding commodities that are heavily dependent on Chinese investment for end demand. From that macro view, the seaborne iron ore and coking coal sectors are two that might be impacted by the potential changes to Chinese RE.

China crypto ban… again!

That’s right, the country is “banning” crypto activity again. This time 10 government agencies are coordinating the action. China has not banned ownership of crypto assets but it has banned any trading in crypto tokens. This Coindesk article notes that this week’s announced is a notable tightening of regulations. It would be wise to assume that we’ll see high profile conviction/arrests of crypto personalities in the coming months to drive home these tighter regulations.  Such an action would be no different that the SEC’s threat to sue Coinbase over the Coinbase Lend cypto interest product. It’s high profile signalling to the industry.

We have seen this before

Nevertheless, The Dispatch would be remiss if it didn’t point out that we’ve seen “crypto ban” statements from China before. The stories below, that go back to 2013, are reminders.

Source: via Twitter

The chart below from Grayscale also shows how bitcoin has performed since earlier “China bans”.

Source: Grayscale Market Bytes email 9/24/2021

As a long-term investor in the emerging digital asset space, The Dispatch is less troubled by the regular announcements by China. Governments will NOT easily give up their monopoly to issue an effective currency. Genuinely decentralized, trusted, scarce private digital currencies will challenge the effectiveness of government money. As a result, we should continue to expect policy measures against some or all of digital currencies. Domicile your investment activity in a jurisdiction with robust private property rights/legal system to minimize these regulatory measures. In The Dispatch’s biased view, the US still offers the best regulatory regime in spite of all the debate surrounding regulation.

Evidence of resilience?

Furthermore, if a young asset like bitcoin only drops ~5% after the world’s second largest economy bans the asset class, doesn’t it further reinforce the resiliency of that asset?  We often hear that China is cracking down on crypto because they want the Digital Yuan to flourish. With these unilateral announcements/decisions by China, no one in their right mind should store wealth in the Digital Yuan.  

Stay safe, enjoy the cooler days 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

52% of Institutional Investors Own Crypto

52% of institutional investors own crypto assets, according to Fidelity’s 2021 Digital Asset Study, a robust survey of 1,100 global institutions. 71% of Asian institutions in the sample have already allocated to crypto, 56% in Europe and only 33% in the US. The Dispatch is not surprised that US institutions’ adoption trails offshore peers because the regulatory discourse here has been rather adversarial. The SEC’s threat to sue Coinbase over a new product is a good example of high-profile signalling. This is a structural disadvantage for US pensioners and retirees who are represented by institutional investors. Additionally, the New Jersey action featured below is evidence of US regulators enforcing outdated laws that limit consumers’ choice and their ability to maintain purchasing power by investing in an emerging technology. Unfortunately, there is little media attention on the currently regulatory approach to digital assets and how it hinders real returns for consumers and retirement savings.   

The follow are Dispatch 30 discussion items on September 17th, 2021:

  • 52% of institutional investors own crypto
  • Solana blockchain network failure
  • Regulators target additional crypto interest account providers
  • Stablecoin regulations forthcoming
  • S&P 500 sees 54 record closes thus in 2021
  • Congress may pass wash sale rule for crypto assets
  • COIN SCHOOL – Taking a week off!

52% of global institutional investors own crypto assets according to Fidelity’s 2021 digital asset study

The 2021 Digital Asset Study by Fidelity Digital Assets showed a notable jump in institutional investor adoption of crypto assets. 52% of the 1,100 investors sampled have already invested in digital assets with Asian institutions leading the way with 77% adoption. 56% of European institutions have allocated with US institutions only 33% allocated. The Dispatch posits that many of the US institutions already allocated to crypto are family offices rather than more conservative pensions plans, which are the institutions facing the largest funding holes.

It’s a robust survey of 1,100 global institutions conducted by financial services survey firm Coalition Greenwich between December 2, 2020 and April 2, 2021.

Institutional Investors crypto asset purchase intent is higher still

What jumps out in future intentions is that 60% of US institutional investors hope to allocate to digital assets, which is nearly double the 33% who have allocated already.

The US money management market is the largest in the world. This BCG report on the global asset management industry estimates US investment funds at $49tn in 2020 with 53% in institutional mandates and the rest in retail/high net worth accounts. This probably does not capture family offices that often invest directly instead of using asset managers. The impact of 60% of US institutional investors allocating to crypto yields a back-of-the-envelope $7tn change in the pool investing in digital assets. One percent of that US$7tn potential change yields ~ US$70bn, which is a notable amount compared to the US$2tn value of the entire digital asset market today. It’s probably fair to assume that these institutions will only adopt the highest quality digital assets with the longest track record.

This Blockworks article provides a good summary of the survey. The well laid out and informative study can be downloaded directly from the Fidelity site.

Solana instability – another example of the inherently higher risk of Digital

The lead story in Dispatch 28 was the brief Ethereum chain fork a few weeks ago, which received scant attention. This week, we had high-flying layer-1 protocol Solana go offline for 17 hours. Luckily, we are in a bull market, and the Solana token only dropped 10% despite a pretty serious hiccup that stopped all services built on Solana. If blockchains are to become mainstream by gaining a substantial share of today’s centralized service, reliability will need to improve dramatically. When things go wrong in decentralized networks there is nobody there to help. You simply do not want networks to fail in the fashion that Solana did this week. You can read more about the issue on Coindesk and Bitcoin.com. The tweet below from Solana wallet Phantom, illustrates the seriousness, when you can’t access the funds in your wallet.

However, just like with the Ethereum fork, there has been limited detailed follow up on the hiccup by crypto media outlets. Eyeballs have moved elsewhere without a deeper evaluation of the implications of the stoppage. What does the issue say about the challenges of higher transaction throughput vs. network stability and centralization?

Regulatory scrutiny of crypto interest accounts expands

On September 17th, New Jersey’s securities regulator issued a cease and desist order against Celsius Network, as this Blockcrypto article explains. This follows NJ’s earlier action against Blockfi (see Dispatch 24) and the SEC’s Wells Notice against Coinbase’s Lend product (see Dispatch 29). This action highlights the urgent need to pass updated investment laws to bring them into the 21st century. Trying to fit securities law issued in 1933 or a 1946 Supreme Court Ruling (Howey Test) to new technologies like digital assets is a disservice to consumers.

Consumer protection at the expense of consumer choice and return suppression is a terrible regulatory regime

Ironically, much of the regulatory action is done in the name of consumer protection. Yes, we need better consumer protection in crypto, but that does not include preventing consumers from earnings a real yield from their digital asset holdings. Banks, in contrast, provide near zero interest on your US$s despite inflation staying above 5%. The Dispatch has a fiduciary duty (laid out in another old law – The Investment Advisor Act of 1940) to maintain and grow clients’ purchasing power. Bank deposits and fixed income today destroy purchasing power, so our regulators and politicians aren’t protecting consumers by preventing access to assets that offer real yields (yields that are higher than inflation) and higher potential returns. Go ahead and provide the rules for crypto firms to operate in an environment that provides consumer protection, but don’t throw an old rule book to bury these new products and return streams. The centralized crypto interest accounts have thus far operated without consumer loss, to the Dispatch’s knowledge. Defi interest products have been exploited with permanent capital loss to investors, but Defi is hard to regulate.

More Stablecoin regulation coming?

Staying on the theme of rising regulatory action, this Bloomberg story says that new stablecoin regulations are possibly weeks away. The focus on maintaining good liquidity into stablecoins, illustrated in the paragraph below, is encouraging.

However, part of the story has more adversarial undertones as the picture below (highlights by The Dispatch) illustrate.

The Dispatch is in favor of more centralized stablecoin oversight. The reserves that ensure 1-to-1 stable peg between the stablecoin and the US$ should be more transparent than what’s available today. The regulation hopefully coincide with better access for crypto firms into the Federal Reserve payment system, so liquidity can flow reliably between the two markets. The flow of US$s into crypto markets is a bottleneck today and a source of risk because very few traditional banks service the crypto industry.

S&P has had 54 record closes in 2021

Traditional assets like stocks are also in full-on bull phase. We have yet to close out the 3rd quarter, but the S&P has already recorded 54 all-time high closes in 2021. The chart below puts that trend into historical context. This WSJ article provides more details including the chart below. `

Congress may pass a wash sale rule for crypto to obtain more tax revenue

Since crypto currencies have been categorized as property (not securities) by the IRS, wash sale rule applicable to securities like stocks and bonds, don’t impact digital assets. Investopedia explains what a wash sale is. Even though wash sale rule does not apply to property, Congress is looking to introduce a wash sale rule specifically for crypto. This Blockcrypto article provides more detail on our politician’s patchwork approach to regulation instead of passing more comprehensive regulations on this new technology. This Forbes article provides examples of wash sales in action. The Dispatch will be watching this space as it could further trip up digital asset investors’ tax obligations.

Stay safe, enjoy the waning days of 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.

By

Social Security Insolvency is Looming

Dispatch #29 – 2021

September 10th, 2021

Looming Social Security insolvency, highlighted in the 2021 Trustees Report, is the lead story this week. The retirement Trust Fund (called old-age insurance) is set to run out in 2033 and the Medicare Trust Fund will be empty even earlier in 2026. How’s that for just around the corner! We barely hear a peep about either of these near insolvent programs, though, as our polarized political systems focus on spending more to stay/regain power. The glass half-full observation is that the numbers weren’t that much better in years past, they’ve just got slightly worse.

This multi-trillion dollar financial deficit will have to be tackled in our lifetime, and the most obvious outcome is to print more money to cover benefits. As a society we have shown no desire to raise taxes or cut spending, which is why the money-print option is most likely.

The Dispatch hopes readers think about the broader repercussions of how printing money to cover this funding gap will impact their other assets and cost of living. We analyze more below, but this subject is best discussed 1-on-1, as individual circumstances are different.  

Following are this week’s discussion subjects:

  • Social Security Insolvency: Trust Fund to run dry after 2033 and Medicare Fund after 2026!
  • NFTs and Metaverse: What’s the Metaverse?
  • SEC threatens to sue Coinbase, right after warning Uniswap
  • Sotheby’s Bored Ape auction clears at $24.4m!
  • COIN SCHOOL – $10m+ bitcoin transactions rise–> Institutional adoption?  

Social Security insolvency: Trust fund to deplete by 2033 & Medicare fund by 2026!

The main retirement fund (Old-age and survivor insurance trust fund) will deplete after 2033, which is one year earlier than previous projections.  After that, payroll taxes will only cover 76% of schedule benefits according to the Trustees report. There’s also the Social Security Disability Insurance Trust Fund. This will deplete after 2057, which is a full 8 years earlier than previous projections. One bullet point of the report is shown below. The full 276 page report is here, but we recommend this summary of the Trustees report. This WSJ article provides a good synthesis as well.

The Hospital Insurance Trust Fund, which supports Medicare Part A, will deplete after 2026, the report states. After that, the fund will be able to cover 91% of scheduled benefits.

Knowing about Social Security insolvency, what do you do?

At the most conservative end, one can assume zero social security payments if retiring after 2034, plus having to pay for healthcare. Unfortunately, your future income will not suddenly rise just because these two Trust Funds are near empty. Therefore, lowering expenses is the only viable option to make up for lower or lack of retirement/health benefits.

At the other end, assume that the US will print its way out of this shortfall, just like the Covid response, and nominal payments will remain as promised. The Dispatch leans to the latter view as no sitting politician will be able to go back on promised retirement benefits. We have not shown a desire to cut spending/benefits or raise taxes as a society. Now that we have discovered the ability to print money to cover shortfalls, it’s hard to imagine politicians won’t embrace this approach. The NY Times headline below illustrates the narrative that downplays the grave financial condition by leaving out the year when insolvency is reached.

What does monetizing Social Security insolvency mean for other assets and cost of living?

The more important question to ponder is if the government monetizes social security liability (just a fancy term for printing money to make up the hole), what impact will that have on your other assets and cost of living? This is a complicated subject with multiple permutations, and one that requires a longer discussion. However, The Dispatch considers the potential range of outcomes when making client asset allocations.

This is also where digital assets may play a role with their exponential adoption-led growth. The network effect/adoption expansion has already led to exponential returns from leading digital assets. There have been plenty of flameout projects, which is rarely discussed due to our survivorship bias. Historic returns are no guarantee of future returns!

Digital Assets offer exponential adoption

However, we continue to see exponential adoption of decentralized services that have only been around for 2-3 years. For example, NFTs weren’t a thing 12 months ago, and now it’s likely that artists adopt this new use of blockchains. Decentralized Finance (Defi) was just emerging 12 months ago, and total value lock (TVL) in Defi has grown from $6bn a year ago to $164bn now. This is what exponential growth looks like. TVL is a measure of money deposited to earn an interest on your crypto holdings.

Source: Defi Llama on 11th September, 2021

Futhermore, expansionary Central Bank monetary policy should continue to drive adoption of scarce assets like bitcoin. In the traditional asset world, Apple shares are scarce assets too.

NFTs and the Metaverse. What the heck is the Metaverse?

Dispatch 28 highlighted the startling NFT price action recently. While we question the sustainability of prices near term, the Dispatch believes NFTs are here to stay. They provide creators – artists, musicians, athletes – a new channel to market and sell their craft. Plus, some NFTs offer status in a world where we spend increasing amounts of time in the digital world. Covid has accelerated that trend.

For a deeper, more philosophical dive into the digital world, it’s important to understand the Metaverse. The Metaverse is essentially the digital world we occupy, and it will have far-reaching socioeconomic consequences, not just Cryptopunks replacing Rolexes. This Bankless essay, The Metaverse Emerges, provides a solid exploration of the Metaverse as we can imagine it today. It takes time to absorb the subject if you aren’t someone deeply in the space. If you prefer, here’s a 30 minute Youtube reading of the article.

SEC threatens to sue Coinbase, right after Uniswap probe

The SEC has threatened to sue Coinbase if the company goes ahead with its Coinbase Lend product. Coinbase Lend would pay 4% interest on USDC stablecoin balances, like offering from Blockfi, Crypto.com, Celsius and others. Dispatch 24 highlighted the US States’ cease-and-desist orders on Blockfi, which are still pending as discussions progress between Blockfi at State Attorney Generals.

The WSJ covers the story well. Coinbase CEO Brian Armstrong called the SEC action “sketchy” in this Tweet thread. The action against Coinbase follows SEC launching an investigating of Uniswap Laps, the developer of Uniswap, the largest Decentralized exchange.

The issue at stake is whether Coinbase’s interest account is a security. If a crypto interest-bearing account offered by an exchange is a securities, then it needs to be registered with the SEC. The main problem is that our securities law was written in 1933! The definition of a security is very broad, as the American Bar Association website description shows below.

US regulations are in desperate need of updating to catch up with technology advances. There are several proposals floating in Congress to provide clarity on Digital Assets, specifically to lay out when a digital asset will be deemed a security. Until then American consumers will be shut out of the some of the wealth being created in the digital asset ecosystem.

The SEC action, in the guise of consumer protection, will remove Americans’ ability to earn a yield on their crypto holdings. US consumers are already ineligible to receive crypto token distributions by blockchain service companies. Just this week, dYdX, one of the fastest growing Defi services, distributed $100m worth of tokens to users, but US residents were ineligible because of SEC regulatory fears. How is the free distribution of tokens to community users a risk to consumer protection? Similarly, developers are likely to locate outside the US to avoid the uncertainty and threat of prosecution that Uniswap Labs may face. If you’d like to dive deeper into the issues, this is a blog post with a skeptical view of decentralized services.

Remember the Sotheby’s auction of Bored Ape NFTs?

Highlighted last week in Dispatch 28, the auction closed at $24.4m, well above the $12-18m Sotheby’s estimate. Only time will illustrate if this particular set of JPEGs were good value, fools gold or something in between. This Forbes article has more details.

COIN SCHOOL – Rising $10m+ transactions on the Bitcoin network

Does this point to institutional adoption?

This chart from Glassnode provides their interpretation of blockchain data, which shows a notable jump in transfers larger than $10m. The ratio has risen from ~10% of transfers in October 2020 to near 30% today. It’s fair to assume that a $10m plus movement of bitcoin value is mostly institutions and not individual whales trading more actively.

Bitcoin Relative Transfer Volume Breakdown by Size (entity adjusted, 30d moving avg)

Source: Glassnode

Stay safe, enjoy the waning days of 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.