March 20, 2024

Insights and analysis for the professional investor

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Welcome to Crypto Long & Short!

This week, Gregory Mall, head of investment solutions at AMINA bank, says approval of bitcoin ETFs in the U.S. is a milestone event for crypto, opening up new innovations across the space.

Then, Todd Bendell from Amphibian Capital says we are seeing a gradual merging of digital assets with the existing global financial framework, promising more growth ahead.

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

– Benjamin Schiller, head of opinion and features at CoinDesk

From the Analyst

What's Next for Crypto?

After a staggering crypto rally, primarily led by Bitcoin, it is fair to say that the approval of spot bitcoin U.S. ETFs in January approval was a game-changer. Since January 10, crypto's total market cap has surged from $1.5 trillion to $2.4 trillion, a 60% increase. Nonetheless, crypto remains a nascent and niche asset class – its size is only a fraction of gold (10%) and smaller than Microsoft ($3.1 trillion).

Many naysayers predicted that the ETF approval would be a classic buy-the-rumor-sell-the-fact situation. But, given the massive price rally, this could not have been further from the truth.

The burning question now is: What's next?

ETFs and Supply/Demand Imbalances

U.S. ETFs alone have attracted inflows of around $19 billion. Including all ETPs, the year-to-date figure is significantly higher. The Blackrock IBIT ETF is the fastest ETF to reach $10 billion in assets. In only two months, the ETF has amassed more bitcoin than Microstrategy since 2020.

These large inflows have created a supply/demand imbalance, thereby increasing the price of the underlying asset. Bitcoin ETFs in the U.S. alone account for ~4% of all Bitcoins in circulation. Add to this the fact that ~29% of all Bitcoin supply has not been touched for over five years, or might be lost forever, these ETFs now represent a significant source of demand.

The current demand-supply dynamics are likely to exacerbate once the Bitcoin halving takes place mid-April. Like a pre-announced corporate action in the traditional world, the event should not have any price impact. However, if the past is any guidance, halving cycles have acted as a psychological catalyst for price increases, kicking off a rally not only in Bitcoin but also in the altcoin market.

'Crypto Is a Solution in Search of a Problem'

A large bulk of the flows into the ETFs has come from institutional investors, while retail investors have preferred buying coins directly. And this may be a key reason as to why this rally may still have legs. Unlike retail investors, institutional investors tend to have a longer-term investment horizon and are unlikely to sell all their ETF holdings as markets correct. While they do systematically rebalance from time to time, they are less susceptible to the day-to-day fluctuations compared to retail investors.

In that sense, the arrival of institutions may overall decrease the volatility of the asset class, making the asset class more embedded into the traditional financial system. This is still going to be a slow and gradual process, and while Bitcoin ETFs are certainly one catalyst, it is simply not enough for an entire asset class to become mainstream.

Although the crypto ecosystem is rich with applications ranging from use cases in payments, settlement, market-making, lending/borrowing, gaming, metaverse, logistics, art, copyright enforcement, and so on, it seems that most of these use cases are still either early-stage or focussed on a niche target group. For crypto to become mainstream, more real-world uses need to emerge and impact not just a tech savvy problem or user group, but offer tangible innovations to our everyday lives.

Where are we in the cycle and how to participate?

Looking at Google Trends, search results for terms such as "crypto" or "Bitcoin" have increased in recent weeks but remain a far cry from their peaks in the previous bull-market of 2021. Furthermore, the recent rally has been primarily led by Bitcoin and Ethereum. Altcoins have not had their big moment yet and most of them trade at a fraction of their all-time highs of November 2021. BTC dominance still hovers around 50%. Generally, altcoins tend to outperform Bitcoin and ETH in the later stages of the cycle. Given the favorable macroeconomic conditions, it seems like this rally could still have some room to go.

Figure 1 – Bitcoin Dominance and Halving

From a risk/return perspective, it appears as if cryptocurrencies may be compared to early-stage VC investing. Given that there are more than 9,000 cryptocurrencies in the world, it is probably safe to assume that a relatively small number of those will have a profound economic impact in our daily lives and thus would justify a long-term investment.

In Figure 1 below, we show how many of the top-100 tokens in June 2019 have maintained their place within the leaderboard over time. The numbers are sobering. In a similar way, the dotcom bubble showed how difficult it is to pick winners. Who would have thought that Amazon and Google would become the dominant companies within their industry back in the late-90s?

Figure 2 – How many of the Top 100 Coins in June 2019 Remain in Top 100 Over Time?

One way to avoid over-concentrated bets and refrain from chasing myopic trends, is to invest long-term in a broadly diversified buy-and-hold index. Having spent a considerable amount of time on index-engineering, we can see that a mix of quantitative and qualitative inclusion criteria, coupled with a smart-beta weighting methodology, provide the best results over an entire market cycle.

In the same way that there are not a lot of growth-equity stock pickers still around who outperformed the Nasdaq index since the late-90s, it is hard to imagine a world where individual coin pickers or discretionary market timers will outperform a rigorously designed index over the long run.

- Gregory Mall, head of investment solutions, AMINA bank

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Institutional Outlook

The Institutional Era of Crypto Brings Fresh Innovation

In the wake of Binance's $4.3 billion settlement with U.S. regulators last November, a shift is underway in the institutional adoption of digital assets. We are now in a fresh market cycle and we're seeing innovative custody solutions and many market opportunities.

The collaboration between Binance and Sygnum to introduce a tri-party agreement for off-exchange custody exemplifies this shift. This arrangement, by decoupling custody and trading, helps mitigate exchange risk and opens accessibility and security for institutional investors venturing into the domain of digital assets. (Under the agreement, larger traders on Binance can now custody their assets at third-party institutions like banks.)

The essence of this transformation lies in innovation — both in the technological infrastructure supporting digital assets and in the financial strategies that institutions can now employ. Crypto quant funds, once the domain of a few, are becoming increasingly mainstream, accessible, and attractive to institutions. This is because diversifying portfolios and engaging with proven financial technology in a new market environment through crypto quantitative hedge funds works. These innovations offer institutional allocators the ability to gain diversified digital asset exposure with one investment.

Amphibian Capital offers USD, BTC, and ETH denominated funds giving investors the opportunity to maintain long exposure to crypto with disciplined and resilient risk management measures in place.

The rise in exchange volumes across digital assets signifies growing interest and growing confidence in the infrastructure and regulatory frameworks surrounding digital assets. Institutions, once wary of the nascent and unregulated nature of digital assets, are now stepping into this space, encouraged by clearer regulatory guidance and more sophisticated financial instruments.

Just as institutional quant hedge funds carved out strategies that generated hundreds of billions in traditional equity markets, we are seeing a paradigm shift in crypto. The complexity and volatility inherent in digital assets markets, far from deterring institutional investors, present unique opportunities for quant strategies that thrive on such conditions. These strategies, powered by advanced algorithms, comprehensive data analytics and machine learning, are beginning to unlock the potential for methodical returns in crypto, much as they did in traditional equity markets.

The evolution of custody and trading practices reflects a broader industry trend towards integrating technological innovations to address the financial sector's complex challenges. The collaboration between legacy financial institutions and digital assets platforms in such initiatives highlights the gradual merging of digital assets with the global financial framework.

The introduction of a tri-party custodial solution by Binance and Sygnum signifies a pivotal development in the institutional embrace of digital assets. It tackles fundamental concerns around security and risk management, making digital assets a more enticing option for institutional investors.

With the advent of crypto quant funds and enhanced custodial services, the digital asset market is becoming increasingly accessible and appealing for institutional investment, heralding a significant period of growth and integration of digital assets into mainstream financial portfolios.

- Todd Bendell, co-founder and managing general partner, Amphibian Capital

Takeaways

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

BIG ETHEREUM SHIFT: I assume many readers of "Crypto Long & Short" are broadly familiar with investing in cryptocurrencies, but not as much about the technical underpinnings of blockchains and whatnot. A key concept for anyone exploring this space is the difference between layer-1 and layer-2 blockchains. The most famous blockchains are layer 1s: Bitcoin and Ethereum. These are broad ecosystems that do some things well but others not so much. Layer-2 blockchains built atop layer 1s have been introduced in recent years to address those shortcomings, most famously in the Ethereum realm where transactions have historically been slow and expensive. Transactions can be sent to layer-2 blockchains like Polygon, Arbitrum and Optimism for faster and cheaper processing. But Ethereum remained relatively expensive versus, say, other layer 1s like Solana. Last week's Dencun upgrade to Ethereum was designed to make Ethereum layer 2s even cheaper and more competitive. In the early days of the shift, it appears to be working. Ethereum layer 2s are cheaper. Sharpen those analysis pencils because Ethereum layer-2 bulls just got a reason to be more optimistic.
A FLASH CRASH: A leading writing strategy is to make your words personal. And so, after this week's bitcoin flash crash, I'll just say that flash crashes have had a sometimes prominent spot in my life for about 14 years. One of the themes I've explored is circuit breakers and whether crypto exchanges could introduce these (and other) safeguards seen at traditional exchanges. Crypto is famously (by design!) decentralized, so there's no central authority saying, "You must have guardrails." And so, these safeguards (which either prevent prices from accidentally moving really fast in one direction or another really quickly, or fully pause trading when prices fall off a cliff) are mostly lacking in crypto. Does anyone care? In this week's case, bitcoin crashed to about $8,900 on BitMEX and almost immediately recovered. But what if prices had been frozen at $8,900 for a while due to a circuit breaker? Would that be even more worrisome than what actually happened: an immediate snapback as arbs and other traders spotted an amazing opportunity to buy BTC at a price it hasn't traded at for years? It seems unlikely anything will change anytime soon – or ever. So, keep those eyes open for dislocations! They may not last long.