Feature Stories | Jun 10 2022
Recent volatility in bitcoin and other cryptocurrencies has led the mainstream investment community to question the value of crypto as an alternative investment.
-Bitcoin has endured wild volatility since covid hit
-Crypto stablecoins prove to be not so stable
-Inflation hedge and safe haven arguments shot down
-Central banks have their own plans
By Greg Peel
Last month the value of crypto “stablecoin” TerraUSD crashed to US30c. Being linked to the US dollar, terra was supposed to always be worth one US dollar. The value in such a stablecoin lies in providing to investors and traders an option to store their assets in a cryptocurrency without the risk and volatility associated with typical cryptos, which are effectively conjured up out of thin air.
But terra was not directly linked to the US dollar. The terra currency was not backed by US dollar-denominated assets, rather it was redeemable for one dollar’s worth of another cryptocurrency, luna. A computer algorithm creates and destroys both terra and luna to bring the price back into equilibrium. This worked reasonably well in practice from inception until the recent crypto market plunge, when the downward pressure on terra was too much for the algorithm to keep up.
In early November, 2021, the price of bitcoin – the benchmark cryptocurrency – hit US$65,000. By mid-January this year it was back at US$36,000. Bitcoin wasn’t the only crypto to crash in value.
In September 2020 bitcoin was trading at US$11,000, so it took a little over a year to hit US$65,000. It was a classic speculative bubble, fuelled, it is suggested, mostly by bored millennials in lockdown.
The same scenario played out in early 2021 when said millennials turned their attention to the stock market for the first time. Spurred on by social media chat rooms and new zero-brokerage online platforms, young retail investors poured into the likes of US companies GameStop and AMC Entertainment, which at the time were both heavily shorted by hedge funds.
GameStop sells new and used video games and equipment, and was struggling in the face of streaming. AMC owns cinemas, and was struggling in the face of lockdowns (and streaming). GameStop was trading at US$17.25 at the beginning of January. By the end of January it was trading at US$500. As February opened the stock plunged to US$101.
Aside from being in bubbles that simply had to burst, bitcoin and the so-called “meme” stocks turned around sharply as Wall Street plunged on Fed rate hike fears, leading ultimately to popular speculative growth stocks crashing by up to -80%. Recent data suggested some 60% of bitcoin holders are “underwater”, that is sitting on bitcoin they bought at a higher level.
It is unlikely young retail traders will tempt such a fate once more, at least in the short term. But bitcoin lives on. While cryptocurrencies still boast a loyal band of followers, the mainstream investment community – which also decided at one point that if you can’t beat ‘em, join ‘em – is once again having its doubts.
What is the value of crypto? The exit has been swift.
Get Me Out
ETFGI, a leading independent research and consultancy firm covering trends in the global exchange-traded fund (ETF) ecosystem, reported late last month that crypto ETFs listed globally saw net outflows of -US$556m during April, bringing year to date net inflows to US$303m, down from US$2.69bn one year ago.
Total assets invested in crypto ETFs decreased by -18.8% from US$16.28bn at the end of March 2022 to US$13.21bn.
Bitcoin, the crypto pioneer, was born of the GFC, which saw over-leveraged banks send the global financial system into chaos and forced central banks into a race to devalue their currencies. Bitcoin offered a seamless, unregulated and anonymous means of domestic and cross-border transaction, and was seen as a store of value – the “new gold”, if you will.
From September 2020, bitcoin has traded at [all US$] 11,000, 59,000, 35,000, 65,000, and currently 30,000. In the same period, gold has traded in a range from US$1700 to US$2000/oz.
Over time, gold has proven to be a reliable hedge against inflation and a safe haven in times of market turmoil. On the former, nevertheless, once might ask why the gold price is not through the roof amidst the highest global inflation numbers seen since the seventies.
The reason is that gold does not provide a return, such as a dividend or coupon. Thus the value of gold as an investment is undermined when bond yields rise. However, as the reasonably tight range gold has traded in over the past couple of years suggests, it is still a sufficient store of value.
The same is evident during the market turmoil of 2022, in which the gold price has remained relatively stable.
It’s a little different for cryptos.
The latest crypto collapse — in large part driven by the poor design of the aforementioned “stablecoin” — highlights just one of the many reasons why cryptocurrency is a poor choice for long-term investors, according to global fund manager PGIM, which boasts US$1.4trn under management.
In PGIM’s latest Megatrends paper, dozens of investment professionals from across the fund manager’s fixed income, equity, real estate, private debt and alternatives businesses dissect the most common pro-cryptocurrency arguments and find that direct investment in cryptocurrencies offers little benefit to an institutional investor– while adding considerable volatility and risk.
“As long-term investors and fiduciaries on behalf of our clients, three things need to be true for us to add an asset class into a portfolio: the asset needs a clear regulatory framework, it needs to be an effective store of value, and it needs to have a predictable correlation with other asset classes,” says PGIM CEO David Hunt. “Cryptocurrency currently meets none of these three criteria. It’s much more of a speculation than an investment.”
“Cryptocurrency may be a heroic quest to build a viable, decentralized peer-to-peer payment system, but its pricing is based on speculative behaviour, rather than a fundamental thesis around its value or utility,” says PGIM Head of Thematic Research Shehriyar Antia. “Furthermore, with little evidence to support it as an effective inflation hedge or safe-haven asset, we see no reason for cryptocurrencies to be a part of institutional portfolios.”
PGIM goes on to “bust” the three main cryptocurrency “myths”.
Firstly, when the global inflation scare became very apparent in 2021, beginning from March, bitcoin fell from US$59,000 to US$35,000 by June. Fans might argue this is true, but it then rallied to US$65,000 by March 2021, as the inflation scare turned into a full-blown catastrophe.
But it has since fallen back to US$30,000. Where’s the hedge?
Secondly, see above – from US$65,000 to US$30,000 at the time the fear of Fed rate hikes has turned stock markets into bear markets and bond prices down sharply (rising yields). Safe haven?
The third argument is in regards to crypto’s ESG credentials, or lack thereof.
Last year a young analyst from “new world” investment specialist ARK Innovation had eyes rolling when he laughably suggested crypto mining was actually good for the environment, because it incentivised investment in renewable energy capacity.
PGIM pointed out in its recent report that one single transaction on the bitcoin blockchain is equivalent to two million transactions on the Visa network, or roughly the same energy needed to power the average American home for over two months. Last year China banned crypto mining altogether, given its draw on an already undersupplied Chinese energy market.
What the young lad from ARK failed to acknowledge was that the world is already in dire need of increased renewable energy capacity and that capacity takes time to build. If crypto mining sucks up any new capacity, even if it that capacity is incentivised by crypto mining (which is a ridiculous argument anyway), where does that leave a climate change-beset world?
It leaves a handful of computer nerds with an asset that could be worth either a fortune or very little in a short space of time.
The other ESG issue relates to the G, being governance. As PGIM notes, the anonymity and difficulty in tracing the identity of crypto owners makes it a preferred medium of exchange in illicit activity – and most recently offers the potential for skirting sanctions in the wake of Russia’s invasion of Ukraine.
Baby and Bathwater
While cryptocurrencies might be scorned and dismissed by many, there is little disagreement in the value of the underlying blockchain technology that provides for their existence. Blockchain does not exist simply to support cryptocurrencies.
“Cryptocurrency gets all the breathless hype, but it’s the underlying technology where we find the most interesting investment opportunities,” says Taimur Hyat, chief operating officer for PGIM. “Firms that enable real-world blockchain applications like clearing and settling transactions, preventing fraud, and tokenizing real assets offer significantly greater creation of value over the next decade. The old axiom applies — when there’s a gold rush, invest in shovels and pickaxes.”
Distributed ledger technology (blockchain) and smart contracts can revolutionise elements of financial services, logistics, and supply chain management, as they eliminate the need for counterparty and trade verification as well as transaction and record reconciliation, says PGIM.
The tokenisation of real estate and infrastructure assets could substantially reduce costs from transactions and servicing, increase liquidity, simplify transactions, enhance price transparency, and allow more granular portfolio construction.
Blockchain also supports the Ether platform, which focuses on decentralised finance (de-fi). The related cryptocurrency, ether, is the second most popular after bitcoin.
The platform is (supposedly) in the process of switching from a proof-of-work verification model (mining via algorithms) to a proof-of-stake model (in which verification, and thus coin creation, requires the verifier to put their holding of ether up as collateral), which would alleviate the need for excessive energy consumption.
Blockchain technology is being embraced, developed and implemented by everyone from corporations to central banks. The latter development is another warning bell for crypto.
While China’s excuse for banning crypto mining was deemed environmental, the other reason is China’s central bank has developed and is currently trialling its own digital currency on a blockchain platform. The assumption is Beijing wants to crush a currency alternative that is out of its own control.
Central banks across the globe, including in the US, Europe and Australia, are also exploring the introduction of their own digital currencies. They might argue such a move makes sense in today’s fintech world, but presumably there is an underlying goal of backdoor-regulating digital currency by squeezing out cryptos.
The concept of a central bank digital currency is anathema to the reason cryptos exist in the first place – to bypass the omniscient control of financial markets by central banks. But given the clash, the jury is out on whether CBDCs will signal the death of bitcoin and its crypto peers.
For an extensive explanation of cryptocurrencies, blockchain, stablecoins, de-fi, CBDCs and more, go to FNArena's Special Report section (https://www.fnarena.com/index.php/analysis-data/special-reports/) to find Bitcoin And Cryptos, An Introduction in PDF format.
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