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China crypto ban

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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.

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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.

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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.