Crypto Long & Short: Crypto Needs More Than VC Interest

Weekly insights, news and analysis for the professional investor

By Galen Moore, Director of Data & Indexes

July 18, 2021

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Hi all!

So inflation finally showed up in the consumer price index this week. And it came in hot, with year-over-year inflation in the U.S. clocking in at 5.4%, well beyond the Federal Reserve's 2% target. It also marks a 13-year high (FYI – that was 2008, not exactly a great economic year). The kicker? Professional investors didn't seem to care.

The 10-year Treasury bond yield, which is the benchmark for setting the borrowing costs of mortgage rates and corporate debt in America, initially fell. Expectations of higher inflation and economic growth tend to boost, not dampen, government-issued bond yields. While the 10-year eventually ticked upwards, the initial reaction was surprising.

Quick programming note: While Galen Moore, CoinDesk's director of Data and Indexes and the usual author of Crypto Long & Short, is away for the next few weeks, the Research team will be pitching in to write the newsletter. I wrote last week's issue with some findings from our 2021 Q2 Quarterly Review, and I have the pleasure of writing again this week.

With the markets in mind, I wanted to use the Briefing this week to talk about the supposed lack of institutional interest in bitcoin these days. (Hint: it's apparent that it's not lacking.) I also wanted to outline why I think the industry is positioned to see another burst of institutional interest for cryptocurrencies as a result of Circle's upcoming public listing in Q4 2021.

– George Kaloudis, Research Associate

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THE BRIEFING

Institutions Supposedly Don't Care About Crypto

(Note: We use Bitcoin with uppercase for the blockchain and bitcoin with lowercase, or BTC, for the asset.)

BlackRock CEO Larry Fink's comments on CNBC's "Squawk Box" made headlines this past week after he asserted there was "very little demand" for crypto assets. "In the past you've asked me about crypto and bitcoin. Again, in my last two weeks of business travel not one question has been asked about that," Fink said.

Granted, Fink was referring to retirement investing and how registered investment advisors, pension funds and insurance companies should construct portfolios on behalf of their clients over a long-term horizon. He wasn't speaking to institutional investment strategies by hedge funds, venture capital firms or large corporations.

So while I don't think Fink was suggesting institutional interest in general for crypto assets is small, I do want to latch on to the misguided takeaway from his comments that institutions don't care about crypto. This is something that people have asked me questions about ever since the bitcoin price started to fall from its all-time high of $64,888.99, and since anecdotal evidence like Fink's statements began to suggest that the smart money was no longer in the crypto space.

Crypto Direct Investments and VC Funds
We haven't seen the glut of companies buying bitcoin to put on their balance sheets in Q2 like we did in Q1. What we have seen instead is an immense amount of capital pouring into crypto companies through venture capital funds or direct investment. There has been more deal activity for blockchain-focused companies in the first half of 2021 than there was in all of 2020. VC funding globally across all industries is at record highs so far this year, but even so the share of deal activity going into crypto and blockchain startups is also on the rise, increasing from 0.89% to 5.97% from H2 2020 to H1 2021.

The timeline below outlines some of the biggest deal activity and fund raises in the past four months. The VC funds themselves have also been raking in record amounts of capital this past quarter. On June 24, Andreessen Horowitz (a16z) announced it had created the largest crypto-related fund to date, raising $2.2 billion for its Crypto Fund III.

VC investment in crypto companies does not indicate that all types of institutions are deeply interested in crypto right now. To some, VC bets are 1-out-of-100 long shots in search of the next Coinbase (so goes the cynic). One upcoming event I think will bring about broader institutional interest in crypto is the public listing of crypto financial services firm Circle.

On July 8, Circle announced it is planning to go public by way of a merger with a special purpose acquisition corporation, Concord Acquisition Corp (NYSE: CND). It's innocuous because in the grand scheme of capital markets $4.5 billion is peanuts, but the butterfly effects of Circle going public may have far-reaching consequences for the crypto markets by way of bringing greater regulatory clarity in the U.S. for stablecoins.

The Advent of a Regulatory-Compliant Stablecoin
A stablecoin is a cryptocurrency that is pegged to the value of a fiat currency. In 2018, Circle, in collaboration with cryptocurrency exchange Coinbase, created a dollar-pegged stablecoin called USDC. USDC is fully backed 1:1 by an audited reserve and governed by Centre, a membership-based consortium that sets technical, policy and financial standards for stablecoins. USDC isn't the only dollar-pegged stablecoin, but it's one of the largest next to tether (USDT).

Stablecoins are important to the health of crypto markets because they solve the issue of high volatility and convertibility between fiat and crypto. When banking relationships were difficult for crypto exchanges to come by, stablecoins were critical for market growth.

Circle going public may be a critical step for gaining regulatory clarity and acceptance around stablecoins in the U.S. Circle co-founder Jeremy Allaire said as much when he stressed on CoinDesk TV that Circle's intention for going public was to bring "greater reserves transparency" with auditors and the U.S. Securities and Exchange Commission (SEC). Allaire also said he welcomes working with regulators to see "adjustments to various forms of banking and payments regulations to adapt to some of the nuances and characteristics of stablecoins."

For context, stablecoin reserve transparency has been a hot-button issue for the dominant dollar-pegged stablecoin, tether, which only a few months ago settled a legal battle with the New York Attorney General's office for allegedly trying to cover up the loss of $850 million in customer and corporate funds.

USDT is a pain point for institutional investors. Investors don't like falling out of favor with lawmakers and they don't like losing money. The lack of transparency for USDT represented the possibility of both of those things happening; possibly to the same catalyst (imagine if tether went to zero).

If USDC continues to rise in market capitalization to outrank tether while also becoming a regulatory-compliant stablecoin, this may open the door to institutional investors who were once fearful of the regulatory risk of cryptocurrencies, specifically when it comes to trading and crypto off-ramps.

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CHAIN LINKS

The U.S. State Department's Rewards for Justice (RFJ) program, which provides sources up to $10 million for information on cybercriminals, is offering reward payments in cryptocurrency for the first time ever. The announcement is part of a larger effort to crack down on ransomware attacks, which have become increasingly prevalent in the U.S. alongside the use of cryptocurrencies to facilitate anonymous/pseudonymous transfers of value. TAKEAWAY: The State Dept. is fighting fire with fire by offering payouts in crypto for information about cybercriminals paid in crypto, which will likely incentivize the use of crypto, or at least a deeper understanding of it, for the parties involved.

$2 trillion dollar asset manager Capital Group acquired a 12.2% stake in MicroStrategy's common stock. TAKEAWAY: The purchase is likely a long-term bet on bitcoin, which makes up a large portion of MicroStrategy's corporate balance sheet. Capital Group is now the third-biggest shareholder in MicroStrategy, with the largest shareholder being MicroStrategy Chief Executive Michael Saylor, followed by BlackRock Inc.

In efforts to expand its crypto product offerings, Fidelity Digital Assets is in the process of increasing headcount by about 70%, or roughly 100 workers. TAKEAWAY: Fidelity Digital may be looking into expanding its custody and trading services beyond bitcoin into ether. Fidelity Digital Assets President Tom Jessop explained that one of the main reasons behind the company's growth in headcount was to get ahead of rising demand and interest in ether.

The largest deal that made up the majority of VC funding in blockchain this quarter was a $10 billion investment in May from blockchain software company Block.one in cryptocurrency exchange Bullish Global. Bullish is now set to go public through a special purpose acquisition company (SPAC) deal led by a former president of the New York Stock Exchange, Thomas Farley. TAKEAWAY: Farley will take over as CEO of Bullish post-merger, bringing on his experience from leading the world's largest stock exchange.

Investment firm J.C. Flowers, headed by J. Christopher Flowers, agreed to buy 30% of LMAX Group, a forex and crypto exchange operator, for $300 million in cash. TAKEAWAY: Although characterizing J.C. Flowers as a crypto evangelist would be a step too far, cryptocurrencies account for 30% of LMAX's revenue, marking an important and sizable investment into the crypto industry by an established private equity player.

U.S. media giant Warner Bros and non-fungible token (NFT) trading platform Niftys.com will launch a series of NFTs named "Space Jam: A New Legacy." TAKEAWAY: The collection demonstrates the continued proliferation of NFTs for mainstream audiences by major sports and entertainment companies. While monthly NFT trade volume dropped 77% from May to June, it's expected to rebound from roughly $60 million to $153 million by the end of July, based on daily average trade volume so far this month.

A message from CoinDesk

The CoinDesk Quarterly Review 2021 Q2

After two consecutive quarters of strong price gains for most of the top crypto assets, Q2 2021 finally brought an end to market euphoria with a resounding crash. Most CoinDesk 20 assets, which constitute 99% of the crypto market by verifiable volume, ended the quarter with negative returns.

Meanwhile, protocol development for the world's largest cryptocurrencies by market capitalization, Bitcoin and Ethereum, reached new milestones.

CoinDesk Research's latest Quarterly Review dives into the trends, developments and technological progress that shaped the crypto markets from April to June 2021.

The full report is now available from the CoinDesk Research Hub.

Podcast episodes worth listening to:

Federal Reserve Vice Chair: 'We Do Not Need to Fear Stablecoins' – Nathaniel Whittemore, "The Breakdown."
Hashflow: Building the Ultimate DeFi Exchange – Jason Choi, "Blockcrunch"
Security is about maximizing the minimum set of colluding miners – Richard Yan, "The Blockchain Debate Podcast."
Women Scaling Blockchains: The Vision Behind Ethereum Layer 2 Solution Metis – Christine Kim and Ben Edgington, "Mapping Out Eth 2.0."

A message from Coindesk

The Investor's Perspective on the Bitcoin Taproot Upgrade

Taproot is a bundle of three upgrades to Bitcoin aimed at improving network security, privacy and scalability. At the same time, it poses some potential drawbacks to Bitcoin including risks of low adoption, unintended privacy shortcomings and Bitcoin community disappointment and fracturing.

CoinDesk Research's newest report dives into the economic impact and investment implications of the Taproot upgrade.

Download the full report.

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