Rope-a-Dope

A Week of Table-Turning Developments

ETF Summer

Over the last five years, there have been numerous calls for traditional financial institutions to enter the crypto industry. Once total crypto market cap surpassed the $1 trillion mark for the first time, the industry’s investors, developers, and followers began to discuss how crypto had transformed into an investable asset class and projected a significant influx of institutional investors.

Until recently, several signs suggested that institutions were showing interest, and by some measures, one could argue that they had already begun to penetrate the industry. Major banks are now starting to cover crypto and offer ancillary services related to this domain. However, this past week, we witnessed the most significant foray by a major traditional finance player into crypto since the industry’s inception.

On June 15th, BlackRock, the world’s largest asset manager, filed for a spot Bitcoin exchange-traded fund (ETF) with the Securities and Exchange Commission (SEC). This move by BlackRock has had a profound impact on market sentiment, prompting other institutions to take action. Following the BlackRock filing, WisdomTree, Invesco, Valkyrie, and Bitwise have all followed suit. Each of these applicants has made previous unsuccessful attempts to get a spot BTC ETF approved.

This was a momentous event for several reasons:

1. Not Their First Rodeo – BlackRock doesn’t merely “throw things at the wall and hope something sticks.” As the world’s largest asset manager, they have a proven track record in fund applications. Indeed, in its storied history, BlackRock has a 575 – 1 record in getting ETFs approved, with the only loss being an application for a “non-transparent” ETF.
2. Politics – The most bearish interpretation of this filing is that this is a politically-motivated gesture towards the SEC. While it is no secret that those within crypto are disgruntled with the SEC’s approach, many outside of crypto also perceive the SEC as overly ambitious in its regulatory pursuits. It’s possible that this act signals to those in political power that economic heavyweights want the SEC to shift its stance on crypto and possibly markets overall.
3. Grayscale Decision Imminent – This point isn’t entirely independent of those listed above, but it is crucial to remember that we are still awaiting a court decision on Grayscale’s lawsuit against the SEC for disapproving its spot ETF. While it’s not a given that Grayscale will prevail, preliminary oral arguments seem to have tilted in Grayscale’s favor. If this case’s outcome undermines the SEC’s current argument against a spot-based Bitcoin ETF, it could pave the way for BlackRock and others to get the go-ahead.

For a while now, we have viewed being long GBTC and ETHE as a long-term play reserved for one’s retirement account, since that’s the place where you invest with a more indefinite time horizon. However, given the potential of near-term ETF news (from either the Grayscale or BlackRock front), we think that this is a good risk-adjusted place to take advantage of the persistent discount to NAV of the GBTC and ETHE grayscale trusts. As of market close on Wednesday (6/21/23), GBTC and ETHE were trading at 34.95% and 47.86% discounts to NAV, respectively.

TradFi Swooping In to Provide Centralized Infrastructure

In the aftermath of the FTX debacle, our high-level perspective on the event’s repercussions was that it would undoubtedly hasten the demand for regulatory clarity. However, we believed it would not significantly impact the core thesis behind crypto because the principal problem revolved around commonplace fraud. We also saw it as a chance for traditional finance institutions to participate in serving the crypto market.

Fast forward to Tuesday and the launch of EDX Markets, a novel crypto exchange backed by large financial institutions such as Citadel Securities, Fidelity Investments, and Charles Schwab. The platform aims to lure industry leaders by adopting best practices from traditional finance, providing benefits such as liquidity, competitive quotes, and safeguarding of assets.

Currently, EDX supports trading of BTC, ETH, LTC, and BCH. In the forthcoming months, it plans to launch a clearinghouse for settling trades, offering enhanced price competition and operational efficiencies. EDX recently wrapped up a funding round to further develop its platform and consolidate its market position.

Naturally, the coins that received Ken Griffin’s blessing to be listed performed quite well over the past week.

Capitol Hill Advancing Key Initiatives

The US House Financial Services Committee is set to vote on two key pieces of legislation concerning digital assets in July. These proposed laws aim to (1) establish a clearer transition process for digital assets from being securities to commodities and (2) create a comprehensive regulatory framework for stablecoins.

Committee Chair Patrick McHenry, alongside Rep. Glenn ‘GT’ Thompson, initiated the drafting of these laws, which seek to reduce reporting and regulatory requirements by distinguishing digital assets as commodities rather than securities. However, to become law, these proposed legislations require support from Senate Democrats and President Joe Biden’s approval.

Moreover, a separate bill focused on the regulation of stablecoins, mainly authored by McHenry and Rep. French Hill, will also be discussed. This July session will provide the committee members an opportunity to suggest amendments to the bill’s text. The final version of the legislation will be put to a vote, determining if it will progress from the committee to the full House of Representatives for further voting.

Our current view is that the probability of any market structure bill making it through Congress is rather low given its partisan nature, but anecdotally, it seems that the stablecoin bill has some legs to it given the logical desire for the US government to regulate the dissemination of the US dollar.

Americans are Bidding

Given the deluge of positive developments out of the US, it should be no secret that bitcoin reversed its recent trend and surged during US market hours.

We believe this could signify a couple of things:

1. The positive headlines from the US have alleviated much of the perceived regulatory risk. As a result, we can expect crypto to play a bit of a “catch-up” trade with equities considering the current market state. The historically strong relationship between crypto and US liquidity conditions should reestablish itself.
2. Institutions are placing bids. We have touched on this theory in earlier notes, but we propose that strong Bitcoin price performance during US market hours often indicates the type of players entering the market. Funds that operate during US market hours to seek the best liquidity tend to buy during these hours. When price performance is more evenly distributed globally, it might suggest periods when retail investors are more active, making trades in the morning and after the US equity market closes.

Catch-Up Trade?

As we discussed last week, capital has been flowing back into the banking system through the draining of the Reverse Repurchase Agreement (RRP) facility, creating favorable conditions for asset prices.

The chart below features US Net Liquidity (Fed Assets – TGA balance – RRP balance) vs the SPX

For most of the past month, Bitcoin has not benefited from these conditions due to regulatory concerns. However, recent headlines suggest a change in this trend.

We believe Bitcoin is experiencing a “catch-up trade,” aligning to where it would have been without the regulatory pressures. We think it’s possible that sidelined capital that missed the bulk of the AI trade in Q2 might find BTC to be the vehicle of choice to make up for lost time.

The chart below features US Net Liquidity (Fed Assets – TGA balance – RRP balance) vs BTC

Persistent Macro Tailwinds

We have recently discussed several major macro themes helping to support risk assets (excluding crypto): (1) capital movement out of the RRP, as mentioned above, (2) an expected continuation of stimulative monetary policy from the PBOC and BOJ, and (3) a declining US dollar index.

The recent decline in the US dollar index has continued this week, providing another reason to view liquidity-sensitive assets like Bitcoin positively. Our clients know well the long-term inverse relationship between Bitcoin and the DXY, which we expect to continue for the foreseeable future.

Moreover, the draining of the RRP facility has sustained, with its balance dropping below $2 trillion for the first time in over a year. While a minor rebound in the RRP balance is expected as funds deleverage towards the quarter-end, it seems that the observed draining will result in an average RRP balance for June significantly lower than previous months. We anticipate this trend will continue as short-term rates compete with the overnight rate and inflationary pressures continue to diminish.

Rope-A-Dope

Last week, we titled our note, “Against the Ropes.” The casual observer might have read that title and thought of a boxer standing with his back pinned against the corner of the ring, absorbing punches from his opponent as his body swells and blood pours out of his mouth. The crowd rises to its feet in expectation of the referee waving his hands to call the fight in favor of the aggressor.

However, our intended use of the phrase actually emanates from a different allegory. Muhammad Ali, “The Greatest,” was a paragon of poise and power, an Olympic gold medalist who reigned as the world heavyweight boxing champion three times. He was strong, but what separated his prowess from the rest was arguably his athleticism and tactical genius.

Ali was famous for employing the “Rope-a-Dope” strategy against his stronger opponents, wherein he would lean against the ropes and cover up, letting his opponent throw numerous punches. He would allow some punches to land, but using his positioning and guard, he would mitigate a lot of the damage from these strikes. This approach allowed Ali to conserve energy while his opponent exhausted themselves. Then, with his opponent tired, Ali would unleash a flurry of counterattacks to seize victory.

In our view, this is a fitting analogy for what we’ve seen in the crypto industry over the past 18 months. Fraud, political jostling, regulatory threats, and often outright misinformation have buffeted the industry and its longtime proponents. Yet, we perceive crypto not as a bloody victim in the corner of the ring but as an Ali-esque, antifragile technology. It is built from the ground up, and every attempt to dismantle it only fortifies its strength and positions it more favorably as the next layer of money, the internet, and finance. Once it steps out from its corner, its weary opponents will have nothing left in their reserve, leading to an inevitable capitulation.

While the ride to the top will not be a straight line, the worst of the blows are behind us, our opponents are tired, and the next round will look a whole lot different than the last.

Core Strategy

Peak of regulatory uncertainty, symbolized by the Coinbase lawsuit, appears to have passed. Blackrock’s entry into the field has been a game-changer, significantly altering the landscape. Given this, it’s prudent to remain primarily allocated to the majors, with minor allocations to alts that serve as call options on regulatory wins. We foresee macro tailwinds for BTC and ETH due to the near-term decline in the dollar, the continued drain of the RRP, and the ongoing monetary easing from global central banks.

Tickers in this report: BTC, ETH, SOL, RPL, GBTC -0.15% , ETHE -1.83% , BCH -0.13%