Crypto Correction - CHAINLETTER 51
Once again bitcoin has gone on sale. These are the moments to reflect on where this asset has come from and what it is capable of.
A year ago, bitcoin had just had a huge bounce and was trading at US$64,000. At US$84,000, following a large correction, the price is 31% higher than that today. Buying at US$64,000 felt a bit nuts back then, and it felt a lot worse when it fell back to touch US$50,000, but you’d be smiling now. That’s how this thing works.
At some point in the years ahead bitcoin will be multiples of where it is today, because it is uniquely qualified to become a globally recognised reserve asset and payments network in the next phase of the internet.
Lots to get stuck into…
?Technical
The first draft of this week’s letter was penned on Monday. It was long out of date by Tuesday afternoon as the weight of the Bybit hack and the cloud of memecoin disillusion fed through to bitcoin, which has fallen from the US$95-97k range to US$84k.
The main observation of the original draft was that something violent in one direction or the other was about to happen. I was wrong about the direction, but I’d never admit that in public.
So, let’s start again.
The flag pattern that had been developing since the start of the year broke to the downside. Obvious resistance is the level we are now trading at (~US$85,000, the top dashed line), with the risk that if that breaks we head back to US$75,000.
The experience is remarkably similar to the previous period of consolidation, although of late we’d been encouraged by the strength of buying that met sharp falls, which appeared to be trending higher.
Note that on the RSI measure (the lower chart) bitcoin is now as oversold as it was last August.
You want a view on where we go now? Short term: sideways. Long term (as ever) much higher.
My belief is that there are long term buyers in the market who are happy to keep accumulating. Whether the price is US$96,000 or US$84,000 is largely immaterial if you’re building a long-term cache. If it goes to US$75,000, so much the better.
One thing to watch is 30-day volatility (blue line, below), which was approaching levels that corresponded with decent buying opportunities in the last two years (vertical green lines). It hasn’t got there but I wouldn’t rule it out.
Volatility falling to those sorts of levels tends to suggest that punters have become bored and wandered off to find something else to play with. We probably have a bit more boredom to deal with and then off to races again in June/July.
As you can see below, periods of consolidation have lasted around 7 months, which also takes us to the July period.
That we are at an important moment is supported by the moving averages (above). A touch of the (green) 90-day Exponential Moving Average (EMA) has tended to signal the start of an accumulation period. A touch of the (red) 280-day has signalled lift-off. As shown above we are now betwixt the two, with US$81,000 suggested as strong support.
That means that if you understand the story, this is accumulation time.
Slow Flows
ETF fund flows have been a useful contrary indicator of late. This is because a sizeable proportion of investors treat bitcoin as a trading tool rather than a long-term investment. They trade with momentum and are therefore susceptible to selling when the price is weak and buying when the price is strong.
The chart below shows ETF holdings of BTC (orange) against the price (blue).
Longer term, fund flows look like noise. Short term you can discern that dips in the orange line coincide with soft price action, but I would contend it is the latter that typically leads the former. In the short term at least.
The suggestion is that only giant increases in fund holdings drive a price re-rating, rather than smaller short-term machinations. The history is so short it should be taken with a pinch of salt, but we have two clear “inflow” events that drove BTC to new levels..
So, the evidence says it is events which drive price and flows. The good news is that the holdings, once they have arrived, have so far been sticky.
So, what’s the next event? We can only speculate. To the upside it could be the announcement of a new category buyer (sovereign or mega-cap company) or a liquidity boost (QE, perhaps in June/July?), to the downside a system failure (collapse of a major exchange or custodian) or also an economic shock (debt default/currency crisis). Who knows? Size it according to risk tolerance.
Dominance Regained
Hope springs eternal in crypto. The main one is that there will be another “altcoin” season, during which coins and tokens of all shapes and sizes go parabolic, turning washers of dishes into washers of money.
This has happened twice before.
The observation here is that bull markets need a narrative, and in crypto’s case this has to be driven by a transformational innovation (or at least the idea of one). Crypto is more likely in future to be driven by “tech” cycles rather than “halving” cycles, the latter of which make little logical sense.
Thus, when crypto enthusiasts argue for another “altcoin season”, the question must be: why?
The one thing we can be pretty sure of is that the next crypto-tech cycle will not look like the previous one. It will consist of an entirely new set of drivers and projects. Coins and tokens that soared in the last bull market have no automatic claim to be the champions of the next.
Our belief is that it will happen, but the important feature is that it will stem from genuine use cases. It will come from projects that are visibly disrupting existing industries – or creating new ones - and are generating sustainable barriers to entry and network effects in the process. And they will be generating revenue and blurring the lines between Web2 and 3. New customers won’t be aware that they’re crypto customers.
We already see the seeds of this, but it is often happening a long way down the capitalisation scale. It is where our research is focussed and why we remain very excited about some of the digital assets we can accumulate through this tough period.
Meanwhile, it wouldn't be surprising to see bitcoin’s dominance of the industry continue to climb. I can see it between 70-75% before we have a meaningful altcoin run again.
On-Chain
Activity on the Bitcoin Network is subdued. In momentum terms there’s very little to like. Of our five internal momentum signals, only one is positive.
The only consolation here is that the last time the signals moved from 2/5 to 1/5 was on 10th August last year, when the price closed at US$55,130. That was pretty close to the bottom of the last consolidation period.
Value transacted in BTC terms is muddling along at low levels.
There has also been no recovery in the number of onchain transactions.
On a more positive note, we observe that longer term holders have stopped selling, as shown in the uptick of the orange line in both charts below.
Macro
We published a thought-provoking piece on Monday by Ewan Markson-Brown, who argues that we are heading into a new era of “sound money”.
This is something I have been wrestling with for a while. In a sound money environment, where you get a return on cash higher than the inflation rate, an asset bearing no return – like gold or bitcoin – should underperform.
Additionally, the appetite for highly speculative assets (like altcoins) is likely to diminish, because the cost of capital has gone up.
The recent history of real interest rates
The blue line in the chart below shows US real interest rates (defined by yields on 10-year treasuries minus CPI) since the early 1980s, over 40 years ago.
You can see that until the global financial crisis in 2007/8 (vertical green line), real interest rates were above 2% (marked by the horizontal maroon line). In fact, 2% formed a floor, signalling a good moment to move heavily into equities. Spikes in real interest rates frequently signalled a moment to be cautious about stock markets.
Ever since the GFC, real interest rates have been below 2%. This is an era defined by bank bailouts and a massive increase in global debt. The 2% level has almost always been stopped in its tracks by a stock market correction.
The ability of real interest rates to return to the pre-GFC sounder money era is key asset allocation decision at this point. Will real interest rates move back above 2% on a structural basis?
Has anything changed?
My answer would be that something has changed, but it’s not enough to fundamentally alter this construct. It would be extremely surprising to see the 2% level breached to any meaningful extent in the foreseeable future, and that’s good news for gold and bitcoin.
The thing that has changed is that the new Republican party have understood the scale of the problem. In cutting back Federal spending (via DOGE) they will make inroads to reducing the Federal deficit. The shift of resources away from the public sector and into the private sector should be a further boost for productive growth.
However, this is being accompanied by policies that are inherently inflationary, in a year when 30% of US government debt needs refinancing. It’s quite the tightrope for Scott Bessent to be walking, because the one thing he wants to avoid is a stock market crash.
This is not simply because of the dreadful optics of a market crash for a vainglorious President, but it’s also because in the US the stock market tail wags the economy dog. A buoyant stock market is the critical underpinning to government tax revenues.
This explains why real rates are more likely to fall than to rise, whatever the intentions of the new administration. Bond yields are already coming down, while inflation expectations are going up, as shown below, where 10-year bond yields are compared to 1-year inflation expectations.
This should work out well for bitcoin, and we can draw confidence from the continued resilience of gold.
This view suggests that Bitcoin is currently being pulled down by issues with the crypto world at large. I have little doubt it will re-assert itself as the dust settles.
Liquidity update
Michael Howell provides an updated liquidity chart. I shamelessly copy it.
But it’s another data point to make the case that this is a correction in a long term trend rather than...THE END…
Institutional buying
I’ve previously written about this turning into the institutional cycle for bitcoin, so it’s good see evidence of that turning into reality.
The latest buyer to emerge is the Mubadala Investment Company, otherwise known as the Abu Dhabi sovereign wealth fund. They’ve acquired US$437m worth of BTC via the Blackrock ETF. This sounds large until you consider it’s only around 0.14% of AUM.
What happens when they start taking it seriously?
The Structural Case for Crypto
A bullish piece on crypto here from someone I honestly didn’t think would make a case for crypto. But the perspective from a less developed nation clearly changes the view…
Cryptoverse
Thanks Donald. No, really…
The world of crypto is thoroughly deflated by the damage wrought by Donald Trump and his TRUMP memecoin. It was a cynical move and will have served to affirm many sceptics’ view of the asset class as a den of speculation, chicanery and uselessness. We often have similar concerns and we run a crypto fund.
Combined with the release of the LIBRA coin and its association with Argentine libertarian revolutionary Javier Milei, and a whopping US$1.5bn heist from Bybit, it’s been a few weeks to forget for the space, despite the latter being crisis-managed extremely effectively.
While billions have been wiped off the value of crypto (Donald Trump has done a much better job than Gary Gensler in demoralising the space), my view is that ultimately crypto will be thankful.
This is because there isn’t a great deal of value in memecoins. It was destined to end this way, so the sooner the better. Memecoin trading has been great fun and very profitable for the exchanges, but it won’t last. Pseudo intellectual efforts are constantly being made to justify their existence, but from a professional’s perspective they are completely uninvestable. Many will end up being worthless.
The sooner this is acknowledged and priced in, the better. The release of the TRUMP coin has brought into focus the absurdity of the memecoin. I don’t begrudge anyone having a punt – spend your money as you wish – but if memecoin trading is the best that this new technology can offer, we might as well pack up and go home now.
The removal of memecoins from the field of play clears space for the next narrative to lead the way.
The next narrative will be real
Our view is that the next crypto narrative will revolve around real use cases, the ability to erect barriers to entry and generate revenue. This will come from the smaller cap parts of the market, and we have a number of names that we’re happy to hold in small size as we wait for this to unfold. There are disrupters emerging in a variety of areas. They are valued in their millions rather than their billions and are aligning coin and token holders properly to other stakeholders in the project.
It will be a fascinating period. Having poured cold water on the ridiculous parts of the market we can start to focus on what will really matter.
Thanks, Donald. Honestly.
SEC drops lawsuits against Coinbase and Binance
It’s not all bad. This is all happening against a backdrop of more accommodative regulation. In an important move, and an implicit acknowledgement of the regulatory chokehold being imposed by the previous administration, the SEC has dropped lawsuits against both Coinbase and Binance.
This paves the way for more constructive regulation, which again will have a disciplining effect on the industry, as it will facilitate the entrance of more discerning money. I’m relatively sure new institutional investors will not be memecoin traders (although, to be fair, their algorithms might).
Ethos
Crypto’s fight against the Three Mutant Capitalisms
I would recommend anyone have a good scan around the speeches made at the ARC conference in London last week. There are a host of 15-20 minute gems on YouTube. ARC stands for the Alliance for Responsible Citizenship, by the way.
One that I’ve picked out for you here, though, is Paul Marshall’s superb speech a year ago.
His point is that free market capitalisation is “the greatest instrument of poverty relief that the world has ever seen”, but that it has deep flaws which need to be addressed. It is not working for everyone. In fact, in its current form, it is failing many.
The challenge is to explain that it is not free market capitalism that is failing. Rather, it is the corruption of free market capitalism that is the issue. Marshall argues that the root cause is a breakdown of Virtue.
He identifies three “mutant” capitalisms:
The relevance to bitcoin and crypto is that the corrosion in the free market system, as described by Marshall, really starts in the last 40 years, as the system of fiat money was abused. Decentralised ledger technology offers a system of value exchange that mechanistically protects against that abuse, since bitcoin has a finite supply of 21 million coins.
My interpretation is that the breakdown of virtue is itself largely caused by the corruption of money.
The greatness of Britain was built on the back of the high standards that individuals demanded of each other. The pillars that held this together were family, communities, constitution and Church. In this regard the elected government was largely a bystander.
These standards covered morality (honour/virtue/trust), manners, skills and so on. It is no coincidence that the most splendid house in many an English village is the Old Rectory! The local vicar had status he can only dream about today.
Most importantly, the system was self-regulating. As recently as the early 1980s, the City of London operated under a code of “My Word Is My Bond”. The importance was that everyone knew if you broke your word. You were personally tainted, and became a liability to the other partners in your firm. There were massive financial and social consequences. This was a massive disincentive to behave dishonestly. It was the foundation on which the City of London’s global pre-eminence as a financial centre was built.
This all changed when the City was “de-regulated” by Mrs Thatcher in the 1980s. De-regulation is something of a misnomer since there’s been nothing but regulation and compliance since. But it brought in the American financiers and their way of doing things. This included using other people’s money to speculate. The banks were content to do this in the expectation that – following the example set after the rescue of LTCM in 1998 - they would be bailed out by the state.
Sure enough, when this model broke in the GFC, the losses were socialised. The State can only bail out a financial system to this degree if it has free rein over the supply of money. The bankers were rewarded for their behaviour. Ordinary taxpayers have had to pick up the bill.
Among many contenders, it is the greatest scandal of our generation.
A loss of virtue is hardly surprising in this context. It is also a desperately hard thing to win back, unless the system of money is altered.
One of the foundations for decentalised ledger technology is the idea of trustlessness. It is the idea that we don’t have to trust someone, or a company, to do our financial bidding. We can reduce our reliance on the middleman, clipping the ticket on all our financial transactions. Smart contracts will do this for us, faster and more efficiently.
In an age when there is a major trust deficit, this is an important tool in the financial, and moral, toolbox.
People buy gold because, in the end, it won’t let you down. Bitcoin is the same.
It doesn’t need Virtue to succeed.