Crypto’s Coming of Age
May Commentary on the Financial and Crypto Markets
Since the release of the 2008 Bitcoin White Paper, crypto has gone through many iterations. It was originally billed as a new electronic peer-to-peer cash system, a new currency, and a new asset that would not be debased by the inflationary leanings of central bankers. Fourteen years later and the world is seeing the return of a global inflation hitting G7 economies with a vengeance and a war in Ukraine that has only further accentuated an already hot global recovery. The US alone has seen inflation spike to a 40-year high of 8.3%. Although there are many drivers of inflation, COVID and the massive increase in monetary policy to address the pandemic are clearly factors as G7 balance sheets surged by upwards of 8 trillion since March 2020.
True crypto aficionados see Bitcoin as a way of avoiding the inflationary tendencies of central banks. The concept is that Bitcoin value cannot be inflated away by money printing as the number of Bitcoins in circulation is capped at 21 million. This is a key selling point for almost all crypto coins and is why bitcoin is commonly referred to as “Digital Gold” by investors.
So how is crypto performing in a world where inflation is hitting 40-year highs around the world? The answer is: not great. Bitcoin is down 30% over the past 12 months. What have we missed? When we look at the effects of quantitative easing by the major central banks, we saw money pile into everything from real estate to wine as the world become flush with cash. Crypto seems to be one of the key beneficiaries of this trend with the total value locked (TVL) hitting just over 257 Bio in Nov of 2021. As inflation spiked, we have seen central banks reining in loose monetary policies and hiking rates. This has caused stratospheric valuations to come back down to earth. As of this past week, TVL in crypto was 113 Bio, falling 56% off its high in Nov and down 40% year to date.
Did the inflation hedge work? No – in fact, it would appear the opposite is happening. Correlation between risky assets and crypto is moving higher so as tech shares fall, so too do crypto currencies. In other words, if you are looking for an inflation hedge, crypto is not something that appears to offer diversification. Over time this could change but for now crypto appears to have a high correlation with risky assets.
What has been driving the moves in crypto and what has changed?
If we go back to March of 2020, Bitcoin was at $8,500 per coin and the pandemic was just beginning. It was in April and May of 2020 when central banks around the world began to aggressively flood the market with liquidity and governments started to implement fiscal measures to support both consumers and businesses. By January 2021, Bitcoin hit a new high of $40,000 per coin and finally peaking in Nov 2021 at over $64,000 per coin. By January 2022, US CPI was over 7% and it was clear that inflation was not transitory. We saw treasuries sell-off with yields rising across the curve. Assets which tend to be seen as riskier (tech stocks, etc.) saw one of their worst starts to the year falling 9% by the end of Q1 and falling further as it became clear that the Fed had a lot more hikes in the works. The NASDAQ is down 29% for 2022 as we write this.
Bond markets also saw large losses as the market re-prices the yield curve. Traditionally, bonds can be seen as a diversifier for stocks (as stocks drop, the Fed has eased liquidity giving support to bonds). This time, however, the market is more concerned about inflation. This means a fear of additional rate hikes, so consequently, bonds have also been falling. Is this the beginning of the end for crypto?
Is this the beginning of the end for crypto?
Our sense is that crypto is here to stay but with some caveats. Bitcoin has become a risk on / risk off asset that has liquidity 24 hours a day, 7 days a week. When bad news comes out, asset managers cannot always transact in equity markets, but crypto is available to trade around the clock. Its value is an important driver for the overall crypto market but there is a lot more to crypto and defi than simply the coin prices.
Much like the evolution of the internet, we saw a lot of focus on exorbitant valuations early on, though over time the benefits of internet technology became apparent. Many industries were completely changed as technology removed the need to do business in person. As we look to the future of crypto, we believe that we will see a similar transition from speculating on coin and token values, to crypto and decentralized finance changing the way we pay, we borrow and, in some cases, how we invest. Blockchain technology is already changing how payments can be made. Countries like El Salvador have made Bitcoin legal tender meaning that those without bank accounts can have a digital account on their phone or computer. In addition, remittances which makes up much of El Salvador’s income can be made without going through a middleman, reducing the costs of sending these funds.
Today’s payment technology was mostly developed 50+ years ago and much of it is now outdated. These systems can be slow, expensive and difficult to integrate with modern payment systems. The blockchain allows payments to be made utilizing tech such as smart contracts in a cheaper, faster and more automated way. Although legislation is still being written for some of these new systems and payment technologies, it is clear that over time, crypto and defi will become the building blocks of the next generation of payment systems.
Crypto is not perfect and hacks are not uncommon, but we believe we will see more and more blockchain technology become mainstream. The value will not be in the price of a coin but rather in the utility of the process. As the technology is adopted, we expect to see credit card fees and other payment charges to come under pressure. We would also expect to see greater use of payments made by phone technology.
For investors who are feeling the pain of falling prices, it is hard to say if a recovery is on the way, but we believe that the underlying technology is here to stay and the coming years will bring a number of changes in this space.
