Last month, we sent out our first Digital Asset Bulletin, which is our new research newsletter focused on providing institutional colour on the macro environment. Going forward, you should expect regular market commentary and thought leadership in the digital asset space coming from the 3iQ research team. I’d like to introduce our new head of research, Mark Connors, who is joining us with over 30 years of investment experience, most recently with Credit Suisse where he was Global Head of Portfolio & Risk Advisory.
The focus on integrity in today’s Digital Asset Bulletin – Code is Law, is keeping with the motivation for starting 3iQ over 10 years ago, to provide innovative investments of institutional quality. Please feel free to reach out to the team at research@3iq.ca to discuss.
Fred Pye, CEO & Chairman of 3iQ Digital Asset Management
When code is law defines monetary policy, integrity follows. However, based on the market’s reaction, these past six months have demonstrated that current central bank policy is not codified, and, by definition lacks integrity*.
BTC new supply declines while Consumer Price Index (CPI), M2 (a broad measure of money supply– not shown) increases:
Source: 3iQ Research. Data sourced from Bloomberg as of May 6, 2022. Note: USA and Canada CPI (inflation rate) is calculated month-over-month (MoM), while BTC inflation rate is calculated daily.
*Integrity – Performing to expectation over time and regardless of circumstance.
Defining integrity as the ability to perform to expectation over time, regardless of circumstance, we see a central banking system that is failing in terms of its price stability mandate. COVID-19 was the circumstance, but mounting knock-on effects including supply chain issues, consumer behavior and political dynamics (Ukraine, China) suggest performance will continue to be tested. Market price action after Wednesday’s Fed hike being the most recent evidence.
Where April’s market carnage has already cost investors, or users of the fiat system, trillions of dollars as assets posted historic moves, May price action suggests more of the same.
– The UST10Y treasury’s three-month decline of -9.8%, was the worst since 1987.
– A spike in the MOVE, an index of US interest rate volatility to 140, ranked in the 96th percentile on data going back to 1988. See the Market Reboot bulletin for more details.
– Last Wednesday’s 50 basis point hike by the Fed was the largest in over 20 years.
Life in Reaction
The record hike by the Fed was a catch up move to the market. Where the Fed met and deliberated over the past several months, market participants didn’t wait to act, increasing the UST 2Y by over 200 basis points over the course of 2022. However, the Fed policy alone is not to blame.
The growing US money supply (M2) discussed in our April 25th Bulletin, The Monetary Ratchet, contributed to the growing and destabilizing chasm between US GDP and US equity market capitalization.
Where both the US GDP and the Wilshire 5000 were ~ $16.5 Trillion in 2012, by the end of 2021, US GDP was $23 Trillion while the Wilshire 5000 grew to over $47 Trillion. Not unexpected as M2 has grown by over 40% in the last two years alone.
Why the focus on US rate policy? Because like the market move in the UST2Y noted above, we assert that the market move into BTC in terms of growing adoption, owes in great part to the degree of certainty that the Bitcoin network provides.
Where central bankers and treasury officials reacted to the COVID-19 circumstance with an expansion of M2, the Bitcoin protocol reduced its rate of supply of new coins from approximately ~5% to just ~ 2.5% at the May 2020 halving.
Playing the Long Game
The time series above shows the disinflationary character of BTC as the capped supply of 21 million coins are reduced every four years, commonly termed a ‘halving’. Zooming out, the graph below illustrates the scope of BTC’s disinflation. This reduction in supply from 45% to just 2.5% per year may also explain the decrease in BTC volatility from 100% to ~50%, shared in last week’s bulletin.
Using volatility as a proxy for uncertainty, it is not surprising to see BTC adoption increase in a time of otherwise growing uncertainty. Instead of reacting to circumstance, the Bitcoin protocol offers adopters certainty of supply, a unique quality that supports network integrity.
Source: 3iQ Research. Data sourced from Bloomberg as of May 6, 2022. Note: USA and Canada CPI (inflation rate) is calculated month-over-month (MoM), while BTC inflation rate is calculated daily.
Bitcoin enjoyed a higher dominance throughout much of its recent history; however, the immense growth of competing Layer-1 and Layer-2 networks will continue to add greater size to the total industry market cap over time. As shown by the table below, BTC dominance has shrunk to 43% today compared to its historical 6-year average of 59%.
Source: 3iQ Research. Data sourced from Coin.Dance, Etherscan.io as at May 6, 2022.
ETH dominance has continued to rise of late, especially over the last two years. ETH dominance of 21% is elevated, relative to its historical average at 13%. Where BTC adopters are attracted to the stability of the Bitcoin protocol, ETH adoption can be attributed to the evolving ecosystem built with smart contracts. As such, the ETH/BTC ratio is often cited as a proxy for risk appetite in the digital asset arena.
Source: 3iQ Research. Data sourced from Coin.Dance, Etherscan.io as of May 6, 2022.
Growing market size typically comes with growing network usage, as the supply of most digital assets are constrained by their code. As seen in the graph below, Bitcoin regularly enjoys greater transaction throughput than smaller networks by market cap.
Source: 3iQ Research. Data sourced from Messari as of May 6, 2022. Figures expressed in USD unless otherwise stated. Note: Some on-chain data has been estimated.
As a supplement, we have included the categories noted above and added some context for clarity:
Price
Sources of price discovery for digital assets include centralized cryptocurrency exchanges, decentralized cryptocurrency exchanges, over-the-counter (OTC) trading desks, peer-to-peer (P2P) markets, futures markets, perpetual swap markets, and other contracts-for-difference (CFD) markets. These burgeoning market structures help inform the clearing price for digital assets.
Supply
The supply of a digital asset is typically derived from its respective blockchain. For example, BTC is the native token of the Bitcoin blockchain, while ETH is the native token of the Ethereum blockchain.
Some digital assets have a capped-supply, or “maximum”, while others are theoretically uncapped. Each digital asset typically has its own supply schedule, or inflation rate. Inflation rate can vary depending on the blockchain protocol.
Market Cap
The market capitalization for a given digital asset is a function of its current supply and current market price. By multiplying the supply and price figures together, we can derive a digital assets’ market capitalization, similar to a stock.
Active Addresses
The active addresses of digital assets are the total count of unique wallet addresses that were active in its network, generally as either a recipient or originator of a transaction or ledger change.
Individual addresses are not double-counted, and therefore unique. This typically indicates how active a network is among all its unique participants.
The number of wallets with greater than 0.001 native units is one of many metrics to show growth in adoption. By counting wallets with non-zero balances, we can derive how many wallets are holding that digital asset. Note that any person or entity can have any number of digital asset wallets.
Transfer Value
The daily transfer value shows the US-dollar adjusted value of transactions on the digital asset’s blockchain. This metric helps gauge the current dollar amounts being transacted with the digital asset to show its daily activity.
The number of daily transfers shows how many total transactions occurred on a blockchain ledger on any given day. Note that some digital assets may include consensus messages as part of this transaction count, possibly inflating numbers over the actual number of value transfers.
BTC Returns
The table below shows historical returns of BTC in several global currencies, including ETH. In the face of US Fed tightening and USD strength, people trapped in the Japanese fiat system would have been better served than folks in the US over the last three months.
Shifting our attention laterally into the crypto-universe, we see that BTC is down versus ETH over most timeframes – potentially owing to the latest promise of proof-of-stake (PoS), non-fungible tokens (NFTs), yield farming, and evolving layer-2s.
Source: 3iQ Research. Data sourced from Bloomberg as of May 6, 2022.
