RockDen Advisors

Wealth advisory & investment management

Defi

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

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.