Sifting Through the Wreckage
The first half of the year punched above its weight in terms of global macro and market events. War, COVID-19 surges and record inflation to hit the highlights. The negative impact across global markets was pervasive, with only the inflation sensitive and supply constrained energy sector (Brent Crude, +47%) being a clear exception.
Global equities entered a bear market, (S&P 500 and the MSCI World Index were down -21% YTD through June) with no offset from traditional safe havens. Both gold, and the U.S. 10Y treasury, posted losses in the first half of 2022, -1% and -13% respectively.
Pulling up the rear in terms of YTD performance through June was Crypto, evidenced by bitcoin’s -60% and Ethereum’s -73% decline. In today’s publication, we provide tools to help gauge the risk reward from these historically depressed levels.
Crypto Price Decline as Opportunity
Source: 3iQ Research. Data sourced from Messari as of July 7, 2022.
As shared in June’s Baby’s Out with the Bathwater publication, we remain constructive on both assets (BTC and ETH), as forced selling across a host of leveraged platforms likely accentuated the degree of price declines. The combination of market and industry risks combinedto push BTC below its 200 week Moving Average (200W MA), a unique and previously profitable entry point based on the only two instances on record in 2015 and 2020, table below.
Source: 3iQ Research. Data sourced from Messari as of July 7, 2022.
The BTC Beachball Bounces Higher
Our assertion that BTC trading below its 200W MA was like a beachball underwater was based on;
- Historically, buying BTC under its 200-week moving average has led to positive 3, 6, and 12-month returns. Today’s breach of the 200W MA is only the third time in the protocol’s history.
- The continued performance of the Bitcoin protocol as evidenced by hash rate, block prints and traffic.
- June’s substantive loss of -41% (BTC’s WORST MONTHLY LOSS ever as per 2010~ price discovery), in our opinion, will force bitcoin’s bounce back.
The acceleration in BTC loss during the second quarter was attended by a period of forced selling, first by the Luna Foundation Guard (LFG) in May and then the lending platforms such as Celsius and Voyager. With fewer reports of new forced unwinds in July, we are not surprised to see a clear shift in its performance, +15% MTD through July 7th, posting 5 up days in the past 7, the most since Q1 2022.
While the macro market still holds uncertainties as discussed here, BTC and ETH have been hit harder than traditional assets for technical, not fundamental, issues. Therefore, we are monitoring on-chain data to confirm proper functioning of the protocols. See previous publications for more detail on the market impact from the LFG sale of BTC and the driver of forced selling by CeFi lending platforms.
Beyond Price: Not Your Keys…Not Your Cheese1.
Traditional Assets are often purchased and then viewed periodically from an ever-improving user interface by a regulated entity. Digital Assets are different, as June’s events demonstrated.
Last month, the combination of unregulated players executing high risk schemes with ‘bearer’ assets, resulted in loss of ownership and potential value impairment. For these reasons, proper custody of digital assets gets pushed to the top of the risk factor list…even ahead of price. June’s failure of several CeFI (Centralized Finance) platforms that separated asset owners from their assets, underscores this point, as the 15% and 22% MTD gains for BTC and ETH respectively through July 7th means little without title to the asset.
1A play on the Catchphrase, ‘Not your Keys, Not your coins’, in support of bitcoin self-custody.
Custody and Transparency: Satoshi set the Standard.
Satoshi’s white paper had many qualities. Solving the double spend gets most of the attention, as it should. However, the paper’s simplicity and clarity are equal accomplishments. Making the concepts accessible to laypeople set the tone for the promise of the Bitcoin protocol and others that followed. Its value comes from solid architecture and broad adoption. No fancy words or promise of riches.
Following up on last week’s Bulletin, Language Matters, we build on the distinctions made between CeFi and DeFi (Decentralized Finance) platforms to underscore the primacy of custody and transparency in the Digital Asset investment process. For those not quite ready to take self-custody of assets, choosing a regulated entity, engaging in business lines that are transparent and not reliant on excessive leverage may be a good alternative. Now that we have addressed the issue of secure ownership, we can discuss price.
Back to the Price Action
BTC has now traded under its 200-week moving average (200W MA) for the past 21 days. The last time we saw this extend a period below the 200W MA was back in 2015, when the industry was still emerging and quite fragmented. While there were a few podcasts and conferences, there was not a Presidential Executive order, investable ETF, or mobile apps from regulated exchanges to trade your digital assets.
It is for these and other reasons, we suggest that the price is declining and business failures may give way to a continuation of the maturity of BTC and the digital asset ecosystem. The growing adoption rates coupled with the recent failure of CeFi platforms has only accelerated a now coordinated regulatory effort in Washington that we believe, will advance the prospects of institutional ownership.
The Bitcoin block reward halves every 210,000 blocks, or approximately every four years. The last three halvings took place in 2012, 2016 and 2020. The first Bitcoin halving was in 2012, when the reward for mining a new block was halved from 50 to 25 BTC. These halving events are what makes bitcoin disinflationary and scarce by nature, essentially halving its inflation rate every 210,000 blocks.
The halving event in 2016 reduced rewards to 12.5 BTC for each block mined, and beginning May 11, 2020, each newly minted block generated 6.25 new BTC. In 2024, the block reward will again be halved to just 3.125 new BTC.
When looking at BTC price through this lens, it appears that investors may be influenced by these halving cycles. As we can see in the chart below, the impact of increased ‘scarcity’ from a decrease in the supply of coins from a ‘halving’ was not “priced in” – in fact, when they occur, the cycle begins again, and we can see prices quickly reacting to the upside.
The question is “why” has bitcoin rallied after these halving events? It’s likely a combination of things, not limited to and including: a reduction in technological execution risk, less newly minted supply available to be sold by miners, and an increase in monetary integrity in the face of fiat debasement.
In Medias Res
When you find yourself in a tough situation, context can explain how you got there. Rolling the proverbial tape to see what transpired to bring about your current state.
In film and literature, it is termed, in medias res, or in the middle of things. This conceit dates as far back as the Iliad and is still used today in films. We see it in dramas like Pulp Fiction, Batman Begins and Slumdog Millionaire, but it can also have dramatic effect in Comedies.
In the opening scene of The Hangover, a clearly disheveled Bradley Cooper, calls from the side of the road in the Nevada desert to alert the bride-to-be that the groomsmen ‘lost Doug’, the groom. The audience is then walked through the night’s events to help resolve the issue.
Today, the markets are in similar disarray as previously mentioned in our opening paragraph. In keeping with the in medias res theme, we are flashing back in time, to help explain the issues…the softness in BTC price and increased co-movement with rates.
Instead of a lost groom, BTC appears to have lost direction as it sits below its 200W MA after posting its worst monthly loss. So how did we get here, and how do we get out of here? The graph below, aptly named the Timechain2 may provide some direction.
The Timechain incorporates a heat map into a BTC price chart to color code the number of days to the next block reward halving, aka, the halving 3. Red indicates a halving just occurred, so ~ 1400 days until the next one, while violet indicates an imminent reduction in the block reward. Green, somewhere in the middle. This Green period is neither supported by the reduced supply of a recent cut nor close enough to the next and its guarantee of another decline in supply.
3Block Reward – Block rewards are the units of cryptocurrency earned by miners (proof-of-work) or stakers (proof-of-stake) for their work on a blockchain.
Like the pull-to-par dynamic in fixed income, where the maturity overwhelms any market factors, we see the halving as a structural support to the price of BTC. Click here for more on the declining BTC supply as adoption grows from our Demand go Up Bulletin.
There are two observations from the Timescale graph worth sharing. First, the overall amplitude of BTC during this cycle appears lower than previous cycles. Second, and related, the trajectory of price during this mid-cycle phase is clearly lower. Gone is the blowoff-top between 700-1000 days of the next halving (Yellow -> Green), in its place an uncharacteristic sideways chop.
Down but not Out
This reduced amplitude as noted above is also evident in the below graph, where Bitcoin’s codified disinflationary rate of supply is attending a steady decline in the rolling 63D volatility of BTC’s price. Given this relationship, lower amplitude may be the pro-forma pattern. The lower trajectory is another matter, and one we think will NOT endure.
The less desirable price trajectory owes to both the macro backdrop discussed here and the flush out of CeFi businesses we are currently experiencing. As the market digests these events, we believe the structural integrity of the Bitcoin protocol will continue to attract new uses and with it, more adoption.
Price aside, the Bitcoin network continues to set new all-time highs in hash rate, a proxy for its security profile. Despite declining BTC prices and increasing energy costs for miners, the network continues to attract new mining participants with greater scale and efficacy. An increasing hash rate, in our view, is a strong signal that the Bitcoin network is maintaining protocol integrity and with it, Satoshi’s promise of the first trustless monetary network.
For those willing to go into the weeds of mining, FoundryUSA recently sent a note about the geographic makeup of miners. As the largest mining pool over the past year, we took note when they stated that Western interests are beginning to surpass Chinese interests, which when combined, still dominate the Bitcoin mining pool industry today.
We wonder if the recent uptick in U.S. regulatory efforts reflects an awareness around the source of hash rates. Specifically, is Washington linking Bitcoin network security to U.S. security, as China continues to find ways to participate in mining even after their May 2021 government ban.
BTC Utility is Growing, Despite Price Decline
Year-to-date, there has been growth of over 21% on the Bitcoin Lightning Network. There are now over 4,000 BTC across all lightning channels. While this may seem low on a dollar-basis, growth here is typically organic and spurred by power-users, cypherpunks, and those more familiar with the Bitcoin protocol.
Through the end of 2021 and into this year, an increasing number of cryptocurrency exchanges have made concerted efforts to bring this technology to the mass market. These exchanges are now offering the ability for clients to utilize this emerging transactional channel, which is collapsing both transaction time and fees relative to traditional options.
Piecing it all Together
Like the characters in the Hangover, where some grow up, others, don’t, we are seeing that not all crypto players will make it to the next phase of digital asset adoption. Where macro volatility spilling over into crypto waters has revealed unsustainable CeFi business models, it is also an opportunity for those investors entering the action only now, in medias res. For you, we hope this bulletin helps catch you up on Bitcoin’s backstory and information on its uninterrupted utility, adoption and potential to resume its longer run pattern of price appreciation.
Source: 3iQ Research. Data sourced from CoinMetrics as of July 7, 2022.
Digital Asset Universe
The total crypto market capitalization still remains below $1 trillion USD, with BTC and ETH dominance unchanged from our previous bulletin.
Source: 3iQ Research. Data sourced from Coin.Dance, Etherscan.io as of July 7, 2022.
Source: 3iQ Research. Data sourced from Messari as of July 7, 2022. Figures expressed in USD unless otherwise stated. Past performance is not indicative of future results.
Source: 3iQ Research. Data sourced from Bloomberg as of July 7, 2022. Past performance is not indicative of future results.
The majority of risk assets have recovered a portion of June’s losses. The 5D gains in July by BTC and ETH lead all other assets and is to be expected as they led losers in June, down 41% and 48% respectively. This pattern is reminiscent of the mid may price action after the Terra Luna declines, when the stagflation theme re-emerged and BTC/ ETH posted 5D gains, while other risk assets were flattish.
We revisit this point given the dominance of the macro landscape and the potential for recession, as suggested by the Atlanta Fed’s GDPNow estimate of -1.2%. If this estimate comes to fruition, the U.S. will be in technical recession on July 28th. This does not prevent the Fed from continuing with its market-disrupting hikes, but it does give them cover to stop, especially if housing, employment and most important, inflation data co-operates.
As our April 25th call to action states, Blockchain enabled technologies are a solve for the remedy of structurally lower growth, ergo, its outperformance when the low growth narrative reasserts.
Source: 3iQ Research. Data sourced from Bloomberg as of July 7, 2022. You cannot invest directly in an index. Past performance is not indicative of future results.