February 14, 2024

Insights and analysis for the professional investor

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Welcome to Crypto Long & Short!

This week, Jennifer Murphy, CEO of Runa Digital Assets, says systemic stressors like bank failures and cyber attacks help an "anti-fragile" asset like bitcoin.

Then, Todd Groth, head of research at CoinDesk Indices, looks at the historical impact of Bitcoin Halvings - reduction in block rewards that occur every four years - for asset prices and network dynamics.

As always, get the latest crypto news and data from CoinDeskMarkets.com.

– Benjamin Schiller, head of opinion and features at CoinDesk

From the Analyst

How Bitcoin Benefits From Global Stresses

Deficits - Inflation - War - Bank Failures - Cyber Attacks - De-dollarization.

These risks loom large as they threaten stock and bond returns for investors. Historically, U.S. Treasuries have been a "safe haven," providing some protection from crises, but from 2021 - 2023, Treasuries delivered -10%, their worst 3-year performance since at least the 1980s. Similarly, the 60/40 diversified portfolio suffered its worst performance period in 14 years with a return of -16% in 2022.

In an increasingly uncertain world, what's an investor to do?

In his book "Anti-Fragile," Nassim Taleb explores the unique characteristics of things that gain from disorder. The immune system, for example, is more effective after exposure to a cold. Laws are clarified by suits and appeals. Software is "battle hardened" by hackers who exploit flaws.

What if you could add a portfolio asset that may benefit from global stresses? That is improved by uncertainty and volatility?

Consider bitcoin. The Bitcoin network appears to thrive on stress. When the Chinese government banned bitcoin mining in 2021, ~50% of bitcoin mining capacity was forced to shut down or move. Within seven months, capacity had completely recovered, and it is now over 2x what it was prior to the Chinese shutdown. In the past 15 months, the world's second largest crypto exchange declared bankruptcy, and the largest exchange was sanctioned by the U.S. Department of Justice. Bitcoin network transactions were unaffected, and trading volumes are near all time highs.

As an asset, Bitcoin may be increasingly anti-fragile as well. When Silicon Valley Bank collapsed on March 10, 2023, fears of contagion sent stocks down by over -1% the next trading day, but bitcoin rose by 20%. This "safe haven" price response was a new phenomenon for bitcoin, and time will tell if it persists. But bitcoin is outperforming all other asset classes over the last 1, 3, 5, and 10 years, periods that include many stresses.

Research from Galaxy shows that a 1% allocation to bitcoin in a 55% S&P 500 / 35% Bloomberg U.S. Agg / 10% Bloomberg Commodity portfolio over 5 years from August 2018 - August 2023 would have resulted in higher returns and better risk adjusted returns, with virtually no impact on volatility or max drawdown:

Last week, Fidelity added bitcoin to its diversified ETF portfolios in Canada, with a 1% allocation for the Conservative ETF and a 3% allocation for the Growth ETF. With many bitcoin ETFs now available in the US, such as the low cost Franklin Templeton EZBC or iShares IBIT, it is easy for US investors to follow suit.

Little by little, your portfolio may gain a lot.

– Jennifer Murphy, founder and CEO of Runa Digital Assets

Institutional Outlook

How the 'Halving' Could Impact Bitcoin

The new entrants coming into Bitcoin via the recently launched ETF and prices bounce back up towards $50,000, it's a good time to dig a bit into the Bitcoin halving, as we're expected to go into another halving event in mid-April.

The Bitcoin halving cycle refers to the recurring event that reduces the blockchain rewards paid in bitcoin and given to miners for validating transactions and creating new blocks on the blockchain. This reduction occurs approximately every four years, specifically when the number of total blocks on the Bitcoin blockchain reaches a certain threshold, currently set at 210,000 blocks.

The halving event aims to maintain the scarcity of Bitcoin by gradually decreasing the rate at which new Bitcoins are introduced into circulation. Ultimately, this process will result in a total of 21 million Bitcoins being mined, with no more Bitcoins being generated after the final halving event.

The general consensus is that Bitcoin halving events are positive for the price of Bitcoin, and historically they have been. The event often generates optimism among crypto investors, leading to positive price action afterward. This positive price movement can be attributed to several factors. Firstly, the reduction in the supply issuance rate emphasizes Bitcoin's scarcity, which can drive up demand and consequently increase its price.

Additionally, the halving event brings attention to the crypto space, attracting new investors and contributing to increased trading activity. However, it's important to note that while the halving historically has led to price increases, the magnitude of these increases may diminish with each subsequent halvings.

To look more closely into the effects Bitcoin halving periods have had on distribution of returns, we looked back from July 2010 to February 2024 utilizing the CoinDesk Indices Bitcoin XBX Price Index, and compare the distribution of weekly returns of each halving period as bitcoin increased in value from 0.1 to recent levels of 50k USD per BTC.

(Source: CoinDesk Indices, Investing.com)

July 2010 - October 2014 period utilizes BTCUSD pricing from Investing.com; Return outliers of 0.5% and 99.5% were removed for sake of distribution illustrative purposes.

(Source: CoinDesk Indices, Investing.com)

From the overlay of these distributions, and comparison of annual return and volatility, we can see that as the distribution of returns has narrowed as the bitcoin market has matured from a crypto enthusiast hobby to a real asset with institutional interest. This evolution can also be seen in the decrease in both returns and volatility over each subsequent halving, while Return per Volatility has held more constant after the first halving. This evolution suggests that investors should not expect similar performance gains in Bitcoin that were experienced when the market was in its early stages prior to 2012.

One area of the market that is directly affected by the halving event is the Bitcoin miners, via an immediate halving of block rewards for new blocks. This reduction in mining rewards can impact miners' revenue and profitability, as miners could face increased competition and higher operational costs, potentially leading to consolidation within the mining sector. Smaller miners may struggle to remain profitable, while larger players with greater resources, cheaper sources of electricity and economies of scale may dominate the industry.

Looking beyond the halving events, the future of Bitcoin mining will eventually transition to relying solely on transaction fees once all 21 million Bitcoins have been mined. This shift will occur approximately 31 years after Bitcoin's inception. Miners will need to adapt to this change towards relying solely on transaction fees, although this will be a gradual change from each halving.

Innovations in the crypto space, such as additional protocols and tokens that coexist alongside Bitcoin (e.g. Ordinals), may provide opportunities for miners to diversify and optimize their mining operations to maintain revenue beyond Bitcoin block rewards.

We've come a long way in the evolution of Bitcoin from a cypherpunk and cryptography enthusiast hobby to a digitally-scarce store of value with its own spot ETFs and regulated derivative markets. That said, through market cycles, and increases in market capitalization, the volatility of the asset has decreased. So we should taper our expectations when analyzing historical halving cycles, as Bitcoin holders today are very different from holders in 2010.

– Todd Groth, Head of Index Research at CoinDesk Indices

Takeaways

From CoinDesk Deputy Editor-in-Chief Nick Baker, here is some news worth reading:

BITCOIN 50K: Look, we all know round number milestones don't really matter in markets. The Dow gets to X0,000, someone's market cap tops $1 trillion – who cares? They make good journalists' fodder, an excuse to tell a story. (I'm plenty guilty of that.) This week, bitcoin surpassed $50,000 for the first time since 2021. Stories were written. And I won't argue $50,000 matters, intrinsically, but I will say this: Can you believe how close BTC is to the record high near $70,000? For all that the industry has gone through, the angst, the arrests and the anger, the original cryptocurrency is not far from an all-time high. That's unreal. Can it last? Will bitcoin ETFs provide a steady stream of buying interest for infinity years? Will the Bitcoin halving in April catapult bitcoin above the record? Is crypto a fad that'll pass? The fact that the industry has survived 15 years for us to even ask those questions is a feat of its own.
COME IN AND REGISTER: On the one hand, the U.S. Securities and Exchange Commission has said crypto exchanges and other services need to play by the rules of securities regulation. They need to come in and register, as the colloquialism goes. On the other hand, folks in crypto say new laws are required to meet their industry's modern needs. But there's Prometheum, which came in and registered. This yet-to-launch trading platform just picked Ethereum's ether (ETH) as its first cryptocurrency. As CoinDesk's Jesse Hamilton wrote : "The stakes aren't just high for Prometheum and the rest of the industry, but also for the government agency that has claimed for years that there's a proper way for crypto firms to 'come in and register' to do business in the U.S.; Prometheum came in and registered but what happens next is unclear. And while it tests these murky waters, it may also help establish whether the SEC intends to view ETH as a security."

Want more? For the latest news affecting the crypto markets, listen to CoinDesk's Markets Daily podcast.

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