Crypto Long & Short: No, Bitcoin Is Not in a Bubble
 January 17, 2020  Weekly insights, news and analysis for the professional investor Sponsored By:  By Noelle Acheson Director of Research If you were forwarded this newsletter and would like to receive it, sign up here. PRICES (01/17/21 @ 12 p.m. UTC): BTC - $35,110.76 | ETH - $1,212.06
Hi everyone!
How's January going for you all? Anything out of the ordinary happening?
Seriously though, this year reminds me of film producer Jerry Bruckheimer's recipe for a successful blockbuster: "Start with an earthquake and build up from there."
Here's wishing you all a blockbuster year.
CoinDesk Research is delighted to welcome a new team member, Damanick Dantes, who will be contributing to this newsletter on a regular basis with his macro insights. I'm sure you'll find them illuminating, I know I do.
This is just one of the many changes we'll introduce this year on the newsletter front. Stay tuned!
– Noelle
P.S. Our latest Quarterly Review is out! In this report, we look back over Q4 and 2020, focusing on metrics that demonstrate the growth of institutional interest in bitcoin (BTC) and some of the drivers behind price increase of ether (ETH). You can download it here.
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The Briefing No, bitcoin is not in a bubble
To think that such a festive concept, one that evokes both sophistication and childlike wonder, could become so financially charged …
Last week, Bank of America Securities chief investment strategist Michael Hartnett said in a note that bitcoin looks like "the mother of all bubbles."
Harnett seems to be using the strength and speed of bitcoin's price rise as the base for his diagnosis, as if that is the main feature of a financial bubble. It isn't.
Continuing the misuse of the word, in a note quoted on Bloomberg this week, investment management firm Man Group said: "Every time a bitcoin bubble bursts, another grows back to replace it … This very frequency makes the bitcoin narrative somewhat atypical relative to the great bubbles of the past."
This is less irritating in that Man Group recognizes that bitcoin is "atypical" – but it also seems to believe that bitcoin is a bubble. It's not.
Words matter
To see why, let's pull out our financial dictionaries:
Investopedia: "During a bubble, assets typically trade at a price, or within a price range, that greatly exceeds the asset's intrinsic value (the price does not align with the fundamentals of the asset)."
Nasdaq: "A market phenomenon characterized by surges in asset prices to levels significantly above the fundamental value of that asset."
Wikipedia: "A situation in which asset prices appear to be based on implausible or inconsistent views about the future. It could also be described as [an asset that trades] at a price or price range that strongly exceeds the asset's intrinsic value."
Do you see the common thread? An asset is in a bubble when its price increase is unrelated to its intrinsic or fundamental value.
What is bitcoin's intrinsic value? Nobody yet knows. We're looking at a still young technology that is evolving alongside the demand for it. The technology's future use cases are still unclear, as is its place in the financial ecosystem. And bitcoin's unique investment characteristics and unfamiliar metrics make it impossible to apply traditional valuation techniques. Many have opinions as to its fundamental value, but you only need to look at the wide range to realize they are based on unestablished theories and untested logic.
So, anyone saying that bitcoin is in a "bubble" is making a judgement call on its intrinsic value. But they never (not that I've seen, anyway) share their calculations or even reveal the number that they're thinking of.
Social concepts
Maybe these analysts and commentators are using the term "bubble" in the social sense?
Economist Robert Schiller defines a speculative bubble as a "social epidemic whose contagion is mediated by price movements." Those of us that spend time on Twitter or YouTube may be nodding in recognition. But Schiller specifies "epidemic" (an unfortunate metaphor in 2020-21), which implies mainstream participation. The cacophony of bitcoin maximalists and altcoin enthusiasts is far from mainstream.
AQR Capital Management co-founder Cliff Asness gets it. In a 2014 paper written for the CFA Institute, he said: "The word 'bubble,' even if you are not an efficient market fan (if you are, it should never be uttered outside the tub), is very overused."
Suds aside, he goes on to add: "Whether a particular instance is a bubble will never be objective; we will always have disagreement ex ante and even ex post. But to have content, the term bubble should indicate a price that no reasonable future outcome can justify." (my emphasis)
Most professional investors allocating part of their portfolios to bitcoin are doing so to hedge against the scenario of currency debasement, which seems less and less unreasonable. How do you put a price on that?
What is the "fundamental value" of a good that does not fall in value along with the underlying currency, that does not suffer the consequences of a weak economy, and that cannot be co-opted to provide profit for a select and powerful few? What is the "intrinsic value" of a technology that also allows for the auditable, immutable and censorship-resistant sharing of information? How do you assign a baseline price level to a cryptographic token that embodies all of this, and can also be used as a payment innovation as well as a seizure-resistant emergent store of value?
For bitcoin to be in a bubble, its price movements need to be unrelated to its underlying value. Given the astonishing increase in the global supply of dollars at a time of stagnating demand due to widespread pandemic-induced recessions, and the likely emergence of recovery-fueled inflation which will be difficult to control, it could be argued that bitcoin's underlying value as a potential offset to the ensuing economic chaos is rapidly increasing. It could be argued that bitcoin's price movements are catching up to its underlying value.
The anti-bubble
It could also be argued that bitcoin is the anti-bubble, that its price is going up because of bubbles elsewhere in the economy. Many investors are buying bitcoin in response to what they see as a massive sovereign bond bubble, which they believe the government will try to deflate by printing money.
And as for equities, the blistering market valuations of tech companies are to a large degree dependent on low interest rates which could head up fast should the bond bubble burst. This would make "alternatives" such as bitcoin even more attractive.
To get a feel for bitcoin's anti-bubble nature, try to imagine what its "fundamental value" would be if we had central banks that did not print money, governments that kept balanced accounts and no fear at all of MMT, financial repression or any kind of populist uprisings. In this scenario, demand and price would be much lower than they are today.
So, before we accuse bitcoin of being in a bubble, before we imply that its current price in no way reflects its potential utility in a chaotic and increasingly uncertain world, let's ask ourselves where we think the drivers of bitcoin's utility are heading.
None of this means that bitcoin's price won't fall – it might, and if it does, it might do so quickly. The likelihood of that is for each investor to decide.
It does mean, however, that we need to examine more than just recent price movements. A strong return does not automatically deserve "bubble" designation. Bubbles are not about prices – they're about price relative to value.
Labels matter, and what's coming is going to be confusing enough without charged words misrepresenting new concepts.
Macro currents
When institutional investors praise the current macro environment as being "perfect" for bitcoin, we listen. After all, low rates, a declining dollar, and inflation fears cause investors to deploy low-yielding cash into higher-yielding assets such as gold and bitcoin.
But do these investors go back to the drawing board when BTC plunges more than 20% just as the 10-year Treasury yield breaches 1%? I'm starting to question if the macro narrative of ongoing Fed support suppressing yields and boosting market speculation still holds.
Just like the Fed, investment managers care more about real yields (adjusted to remove the effects of inflation) rather than nominal yields. The fact that real yields are still negative means the inflation outlook is muted. The Fed will continue monetary easing until it sees a meaningful pickup in growth and inflation, which supports the base case for bitcoin as a speculative asset.
And what about bitcoin as a hedge against inflation?
Some might say there's no evidence of inflation running wild just yet. But market participants would disagree as they position ahead of economic data. We can see this in breakeven rates (a market-based measure of inflation expectations) which exceeded 2% this week.  Source: Federal Reserve Bank of St. Louis
(The above chart shows the US 10-year real yield struggling to chase inflation expectations higher, which should keep the Fed active - supporting the macro case for bitcoin. )
To be fair, volatility metrics such as Treasury swaption premiums show no hedging bias for a significant move higher or lower in rates. This means volatility in the rates market remains very low, suggesting that investors are not yet demanding greater reward for rising interest rate (or inflation) risk.
So, where can investors find such a reward? Bitcoin. The cryptocurrency is attracting greater institutional flows because it yields high returns compared to traditional assets. Bitcoin's high relative return compensates investors for volatility and inflation risk.  As long as the Fed keeps the punchbowl flowing, the speculative quest for high returns will continue. It's a goldilocks environment for bitcoin as an asset class.
– Damanick
 CoinDesk Quarterly Review 2020 Q4
If Q1 2020 was the quarter of market turmoil, Q2 the bitcoin halving and Q3 the explosion of stablecoins and decentralized finance applications, Q4 was the quarter of institutional FOMO for bitcoin and of Ethereum launching the first phase of its ambitious migration to a proof-of-stake blockchain.
The latest CoinDesk Quarterly Review looks at the performance of bitcoin and ether compared to macro assets and other crypto assets, and at their progress, milestones and value drivers over the past three months. Download the free report.
Chain Links Investors talking:
· "We have been watching it for a longish time, and our judgement is that it is a unique beast as an emerging store of value, blending some of the benefits of technology and gold. Yes, it is a seemingly non-sensical asset – but one that makes absolute sense for how we see the world." – excerpt from a beautifully written and thoughtful investor letter from Jonathan Ruffer, chairman of Ruffer Investment Company
· "Every time a Bitcoin bubble bursts, another grows back to replace it … This very frequency makes the Bitcoin narrative somewhat atypical relative to the great bubbles of the past." – Man Group investment note
· "In our view, given their high volatility and the size of their past drawdowns, cryptocurrencies might be attractive to speculative investors, but they are neither a suitable alternative to safe-haven assets nor do they necessarily contribute to portfolio diversification." – strategists at UBS Asset Management
· "I don't even know enough to say this with confidence, but I will still say that I'm somewhat cynical that someone is going to come up with a really good valuation model for what the right price." – Cliff Asness, co-founder of AQR Capital Management, in a Bloomberg interview
· Speaking on CNBC's The Coin Rush on Tuesday, Goldman Sachs' global head of commodities research, Jeff Currie, said the cryptocurrency market "is becoming more mature" but still has a way to go, and that he thought that approximately 1% of the current bitcoin market cap was attributable to institutional investors.
In his latest investor memo, Oak Tree Capital founder Howard Marks reveals that his son "thankfully owns a meaningful amount for our family." He goes on to say: "In the case of cryptocurrencies, I probably allowed my pattern recognition around financial innovation and speculative market behavior – along with my natural conservatism – to produce my skeptical position. … Thus, I've concluded (with Andrew's help) that I'm not yet informed enough to form a firm view on cryptocurrencies. In the spirit of open-mindedness, I'm striving to learn."
Takeaways:
According to sources, Goldman Sachs is considering launching a crypto custody service. TAKEAWAY: I remember back in the early days, we used to say that Goldman Sachs getting into the crypto business would be the tipping point for institutions. Years later, even with other significant legacy institutions already offering digital asset services, it would still be a very big deal, as it would be the strongest signal yet that Wall Street is interested. It would also trigger a scramble to catch up from other traditional financial institutions, and would incentivize professional fund managers to at least get better informed.
This week, Reuters reported that the incoming Biden administration is expected to name Gary Gensler, a Washington and Wall Street veteran who has closely studied the cryptocurrency field, as chairman of the U.S. Securities and Exchange Commission. TAKEAWAY: This is very good news for the crypto industry. Gensler has experience in capital markets, academia and public administration. He served as chairman of the U.S. Commodity Futures Trading Commission (CFTC), as a key financial regulator for former President Obama, and in the Treasury Department during the Clinton administration. More recently, he taught a blockchain and crypto assets course at MIT, has spoken at several crypto conferences, and even penned an op-ed for us in 2019. Gensler sees blockchain as a "catalyst for change," and seems to have a nuanced understanding of how crypto assets work and the impact they can have on capital markets. This nomination is likely to rekindle the market's expectation that a bitcoin ETF will get approved this year. (See former CFTC official Jeff Bandman's take on the reported nomination here.)
Crypto custodian Anchorage has secured conditional approval for a national trust charter from the U.S. Office of the Comptroller of the Currency (OCC), making it the first national "digital asset bank" in the U.S. TAKEAWAY: The U.S. now has three crypto-native banks, up from precisely zero just a few months ago (crypto exchange Kraken was awarded a special purpose depository institution – SPDI – charter by the state of Wyoming last September, and crypto bank Avanti got one a month later). There are notable differences between the three that are worth pointing out. As a national trust, Anchorage cannot accept deposits, which means that it does not automatically get access to the Fed discount window and payment system. It does, however, make Anchorage a Qualified Custodian under U.S. Securities and Exchange Commission (SEC) rules, and adds another crypto piece to the regulated financial institution puzzle. The more "authorized" financial companies there are in the crypto industry, the greater the level of institutional trust.
New York-based crypto exchange Bakkt, backed by NYSE parent ICE, will become a publicly listed company via a merger with a special purpose acquisition company (SPAC) sponsored by Victory Park Capital. TAKEAWAY: The expected valuation is $2.1 billion, for a pre-product, pre-revenue business. According to a presentation by the Bakkt team to the SEC, the firm expects the size of the cryptocurrency market to reach $3 trillion in 2025 – in other words, it will more than triple in five years.
Gemini Trust, the cryptocurrency exchange and custodian founded by twins Tyler and Cameron Winklevoss, could soon go public, according to a Bloomberg report. TAKEAWAY: It looks like 2020 will see a number of crypto market infrastructure companies go public. There's Bakkt mentioned above, and other rumored possibilities are Coinbase, BlockFi, eToro, and I'm probably missing a couple. This is great news for us analysts, as we're excited about getting a look at detailed financials for some of the largest platforms in the industry. It's also good news for the industry, as these listings are likely to attract mainstream investor attention, as well as give investors an alternative path to cryptocurrency exposure.
Over $3 billion flowed into the products of crypto asset manager Grayscale in Q4 2020, according to its latest report (Grayscale is owned by DCG, also the parent of CoinDesk). Over 90% of this came from institutional investors, mainly asset managers. TAKEAWAY: The report also showed that the Q4 inflows accounted for almost 60% of the year's total, in spite of most of its funds being closed to new investment for the last 10 days of the year, which highlights the acceleration of institutional interest in crypto assets. Furthermore, the weight of institutional inflow in the mix was notably higher in Q4 vs. the year as a whole. Almost 90% of inflows went into the firm's bitcoin trust GBTC.  Source: Grayscale
Grayscale has reopened some of the funds it closed to new investment in December of last year, including the bitcoin trust (GBTC) and the digital large cap fund (GDLC). TAKEAWAY: Since Grayscale was responsible for much of the bitcoin purchases in the fourth quarter last year, the reopening could be taken as good news for the market – a buyer that had temporarily left is coming back in.  Source: skew.com
A prospectus for a new bitcoin exchange-traded fund (ETF) has been filed by Arxnovum Investments Inc. with the Ontario Securities Commission (OSC) in Canada. TAKEAWAY: With renewed attention on a potential bitcoin ETF approval in the U.S., the OSC's actions here could set a precedent – a bitcoin ETF trading on a neighbouring stock exchange could kindle the competitive spirit and help the SEC realize that other jurisdictions are leading the way in financial innovation; on the other hand, a rejection by the OSC could send a signal to the SEC that there's no hurry.
3iq Corp's bitcoin fund, listed as QBTC.U on the Toronto Stock Exchange, has reached over CA$1 billion (US$785 million) in market capitalization. TAKEAWAY: This level of growth in an exchange-trade fund that was originally listed in Toronto in April of last year, and on the Gibraltar Stock Exchange in September, underscores the demand for listed bitcoin vehicles.
The bitcoin exchange-traded product BTCE, which started trading on Deutsche Börse's Xetra exchange in June 2020, now also trades on Swiss stock exchange SIX. TAKEAWAY: The Financial Times reported this week that, BTCE's daily trading volumes on Xetra averaged €57 million in the first 11 days of January, up from a daily average in December of €15.5 million, which points to surging demand in Europe for listed bitcoin products. The SIX listing takes the number of ETPs trading on the Swiss exchange up to 34, and, according to the exchange, turnover in cryptocurrency products reached CHF 1.1 billion ($1.24 billion) in 2020. This is still tiny in the overall picture (the exchange reported 2020 turnover of over CHF 1.7 trillion, or almost $2 trillion), but if BTCE's trend on Xetra is anything to go by, that figure is likely to substantially higher in 2021.
The number of financial advisers allocating crypto to client portfolios reached almost 10% in 2020, an increase of almost 50% compared to 2019. TAKEAWAY: This is according to a recent survey carried out by crypto fund manager Bitwise and financial media site ETF Trends (you can see the full report on our Research Hub), which got input from almost 1,000 registered financial advisers. 81% of whom reported that they had received a question from a client about crypto in the past 12 months. This highlights the imperative for financial advisers to at least be able to answer questions about crypto assets – they are doing a disservice to their clients if they can't, and dismissing something because it's not easy to understand goes against the ethics of the profession.
Crypto trading platform CrossTower is launching a capital markets desk for institutional clients. TAKEAWAY: This encapsulates two trends we've been seeing build up over the past year: 1) the emergence of institutional-grade crypto market services, which widens choice and deepens the comfort level of institutional investors in the crypto markets, and 2) the bundling of crypto-related services and the gradual consolidation of the industry into a few firms that do many things, prime broker-style. Expanding from its spot exchange and over-the-counter (OTC) trading desk, CrossTower now offers digital asset lending, trade financing, structured products and trade execution across multiple venues.
Digital asset manager NYDIG – which earlier this week announced the acquisition of crypto data firm Digital Assets Data – is partnering with banking technology provider Moven to offer plugins for banks that want to launch bitcoin products. TAKEAWAY: This is yet another indication that traditional financial institutions are gearing up to enter the crypto asset market, either through custody services, trading platforms, payments or a combination thereof. In an online survey of more than 2,000 U.S. consumers shared exclusively with CoinDesk, NYDIG found that 80% of bitcoin holders would move their crypto to a bank if it had secure storage. Of those same holders, 71% would switch their primary bank account if a bank offered bitcoin-related products and 81% would be interested in buying bitcoin through their bank.
Asset management firm Arca has closed a $10 million Series A round of funding led by RRE Ventures. TAKEAWAY: Arca is one of the more innovative crypto fund managers in the industry. Not only does it manage its crypto fund, but it is also pushing the envelope in terms of financial products and fund management. In 2019, it filed a prospectus with the Securities and Exchange Commission (SEC) Friday for a bond fund whose shares would be tokenized on the ethereum blockchain. In 2020, it championed the concept of "tokenholder activism," pushing decentralized exchange and prediction market platform Gnosis to stick to its original mission or return funds to investors. It will be interesting to see what it does with the funds raised in the latest round.
This report by Bloomberg on the Arctic's first bitcoin mining facility not only has gorgeous photos; it also reminds us that bitcoin does not just exist in cyberspace, and it is not a pure technology play. It has an industrial side, too. TAKEAWAY: The report also reminds us that the heavy power consumption of bitcoin mining is not an industry-killer, as many early critics insisted it would be.
Speaking of mining, Minnesota-based Compute North and New York-based Foundry Digital (owned by DCG, also the parent of CoinDesk) have partnered to provide a "turnkey" hosted mining solution which allows investors to purchase hosted machines through either company. TAKEAWAY: This is a step towards turning bitcoin mining into an investment option with fewer barriers (such as finding a location, buying the machines, etc.). It could also serve as the basis for other types of financial products, such as mining-based collateral and hedging derivatives. Crypto investing is not just about buying an asset and watching the price move.
Babel Finance is letting bitcoin mining firms put up their machines as loan collateral in exchange for significantly better lending terms than those offered for crypto asset collateral. TAKEAWAY: This offers a glimpse at the growing sophistication of the mining industry in China, and the emergence of leveraged operations. On the one hand, more leverage means more risk. On the other hand, leverage will allow for faster industry growth, which leads to even more secure blockchain networks, which leads to more financial inflows, and so on in a virtuous circle.
The venture arm of U.S. cryptocurrency exchange Coinbase participated in the seed round of mining software and services company Titan, which in December announced what will reportedly be the first enterprise-grade bitcoin mining pool in North America. TAKEAWAY: This echoes the trend mentioned above of crypto mining facilities being packaged as investment opportunities, and Coinbase's endorsement of the potential makes it an even more intriguing area to watch.
Las Vegas-based bitcoin mining company Marathon Patent Group (MARA) has entered into a securities purchase agreement with institutional investors for the registered offering of 12.5 million shares of common stock at $20 per share, to raise $250 million. TAKEAWAY: CEO Merrick Okamoto told CoinDesk in an email he intends to use the funds to, among other things, purchase more mining machines and expand facilities amid the ongoing "arms race" as manufacturers struggle to keep pace with demand. The increased activity in "mining as a business" is largely attributable to the rising bitcoin price, which directly affects mining profitability. It also has to do with the growing sophistication we mentioned above, with advances in mining technology that are impacting the economics, and with the growing global competition, which is good for the industry as a whole.
Panama-based crypto derivatives exchange Deribit, the largest options exchange in the industry, has already recorded approximately 25% of last year's entire bitcoin options trading volume. TAKEAWAY: This is astonishing growth that underlines the market's growing maturity. The growth is not limited to Deribit, although it is consolidating its position as segment leader. Open interest (OI) across all crypto options exchanges has exploded from just over $520 million a year ago (16% of the OI of bitcoin futures) to over $8.3 billion (66% of the OI of bitcoin futures!) today.  Source: skew.com
Bitcoin miners selling their holdings is a popular trope to explain market dips, and this week was no different – but the data doesn't support that theory. TAKEAWAY: The transparency of on-chain data allows us to track outflows from known bitcoin miner addresses to known exchange addresses. This shows that miner outflows to exchanges have been trending down. True, this doesn't catch off-exchange activity, and the overall balance at mining addresses is down to early 2020 levels, according to the data. But accounts from mining pools support the conclusion that miners are more likely to be selling fewer BTC into the rally, rather than dumping and causing the price to fall. 
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