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What’s China’s Role in the Crypto Rally?

Jeff Dorman, CFA
Oct 28, 2019
What happened this week in the Crypto markets?
An Unexpected, Rip-Your-Face Off Rally
The crypto market was headed toward another week of greater than 10% declines, and just about every crypto fund and market maker had finally capitulated.  Midway through the week, it was difficult to find anyone that was excited about owning crypto risk, with most investors either heavily weighted to cash, or outright short.  
Then on Friday, the crypto market jumped 40% in less than 12 hours. This was the largest percentage increase since April 2013, and the 20th largest daily move of all time.  As it turns out, mostly dead is still slightly alive.
Many will point to comments out of China (see below) as the spark for this rally, but this sharp and unexpected move higher was likely more due to positioning than any one specific catalyst.  As we’ve discussed in past weeks, the macro backdrop for crypto has been improving even while prices sank -- and this disconnect can only happen for so long before price catches up with fundamentals.  That said, without patient money invested in crypto, not everyone can afford to wait it out.  
This was the recipe for a “rip-your-face-off” explosive rally:
  • The Fear and greed index revisited all time lows
  • Funds and dealers were positioned short or underweight, as indicated by the Bitmex Funding
  • Rate turning negative (shorts paying longs for perpetual swaps)
  • Key indicators turning bullish - like Bitcoin moving below the 2-year Moving Average
  • Miners turning bullish again, after spending much of August / September buying puts
  • Options expiry and month-end -- as risk rolls off, the market was prone to jumping higher with little resistance
  • Everyone eyeing 7200 as a buy level -- and when consensus is reached, you generally don’t ever get there. 
The max pain theory suggests that the market will go whichever way hurts the most people, and Friday was no exception.  This asset class is still tiny relative to the size of some of the largest groups and organizations who are trading crypto, and they can, and often do, push the market whichever way they see fit. 
As a result, the market is now right back to where it was in August.

China / Macro

What's China's role in the crypto rally? Friday’s rally is being credited to comments on Thursday from China's President Xi Jinping saying that the country's communist party should regard blockchain as a core technology for important innovative breakthroughs and commit to accelerating the development of the technology.  This is President Xi's first public statements on blockchain. Xi stressed the need for China to "take the leading position in the emerging field of blockchain." He also said China would promote the integration of blockchain technology with the real-world economy and solve problems in the existing banking and financial systems.   While Bitcoin stole the headlines, many tokens with exposure to (or associated with) China rallied the most last week - with some gaining over 50%.
The ongoing tense US / China relationship is the largest factor currently affecting the global macro backdrop.  There is quite a juxtaposition between President Xi’s positive comments compared with the 6-hour clown show in Washington where Congressmen grilled Mark Zuckerberg over its proposed Libra project, focusing more on Facebook as a bad actor than on the technology or innovation itself.  No matter how this ends, it is certain that Blockchain and digital assets are now directly in the middle of this global power showdown … and China is embracing this important technology while the USD seems set on stifling it.
Meanwhile, China reported that its economy grew a below-forecast 6.0% in the third quarter, marking its slowest growth pace since 1992. And US equities rose week-over-week despite pretty poor earnings, including whiffs from bellwethers like Amazon, Boeing and Caterpillar. 
Looking ahead, the Brexit trainwreck continues, the Fed continues to pump more and more money into the system, and we should see another rate cut this week.  Needless to say, the bullish narrative for crypto will continue regardless of how price responds.
These are not normal times.
As US Equities Rose, What’s China’s Role in the Crypto Rally?Crypto Digital Assets Will Continue Regardless Of How Price Responds

When Will We See Digital Asset Class Rotations Into Crypto?

Before the rally on Friday, we were asking ourselves who will be the buyer of last resort in crypto when prices are free-falling for no real reason?  Even after the rally, it was still evident that the buying was coming from existing pools of crypto liquidity and short-covering rather than new money or new entrants.
In traditional markets, there are always buyers of last resort.  Distressed investors will step in when equity or real estate markets are broken, and companies will step in to buy back depressed shares.  Activist investors will step in when corporate debt markets are broken, as will value investors. Essentially, other asset classes are more efficient, and there will always be a new, “atypical” investor from another asset class ready to step into broken markets.  The buyer of last resort comes from somewhere outside the ecosystem.  
But crypto doesn’t seem to be part of this natural “asset rotation” quite yet.  For a variety of reasons (some more legit than others), we just aren’t seeing a large cross-over between the traditional world and crypto, even when prices are extremely cheap or rich.
While crypto investors are of course watching and reacting to every Bitcoin price tick, those not in the market full-time can (and should) be cherry-picking.  Ark Invest, who famously became the first public fund to invest in Bitcoin, seems to be doing just that.  A quick look at their latest filing shows they bought at the market lows in December 2018, and sold at the peak of the market in June 2019.
Why aren’t more investors doing this? 
Ark Investments In Bitcoin Digital Assets
When you aren’t focused on the equity markets every day, you can see one or two data points and think pretty clearly and objectively if something doesn’t make sense.  For example, Q3 earnings don’t seem to be that strong, leading us to wonder about stock prices and the validity of multiple expansions amid slowing global growth. 
Conversely if you’re not focused every day on digital assets, and were presented with just the facts right now, you might conclude that the macro environment is creating the perfect storm for owning digital assets.
But none of this matters if crypto continues to be an isolated, completely separate, and oft-ignored, section of the financial ecosystem.  Perhaps the Bitcoin carry trade (similar to the Yen carry trade in 2013), will be one catalyst that brings in new players.
Regardless of how it happens, this will be the next step before digital assets can truly take off.
Notable Movers and Shakers
While it is easy to gloss over the rest of the market with Bitcoin rallying at the end of the week to finish +16%, there was news to be had that led to individual opportunities in the space:  
  • Neo (NEO) was the beneficiary of a statement that Chinese President Xi Jinping gave at a Politburo meeting of the Communist Party of China’s Central Committee on Thursday, urging the country to focus on accelerating the development of blockchain technology into the fabric of Chinese innovation. Neo, the self-prescribed “Ethereum of China”, is recognized as the country’s de-facto blockchain platform for dApp development. As such, the market reacted to the news and the price of NEO gained heavily into the weekend, finishing up 56%.
  • Ethereum (ETH) set a target date (December 4th) for its long awaited Istanbul Mainnet update during the core developer call on Friday. This is the first step for the eventual transition from the Proof-of-Work (PoW) system to the Proof-of-Stake (PoS) model that Ethereum core developers have been working towards. With Bitcoin rallying hard into week-end, ETH never really gained significant traction from the news, finishing the week up 5%. 
What We’re Reading this Week
The headline news last week was all about Mark Zuckerberg’s testimony in front of Congress. The hearing which was mainly called in response to the launch of Facebook’s Libra project resulted in an opportunity for the House  Financial Services Committee to probe Zuck on all the missteps Facebook has made in recent years. However, Zuckerberg’s testimony also revealed much of Libra’s strategy including how it is planning to position itself. If you’re looking for a recap of all the action we like this one from Nathaniel Whitmore
As congressional members were grilling Zuckerberg on the Hill, China has been making headway with blockchain adoption. Right after last week’s testimony, China’s President Xi Jinping held a study session on blockchain technology. At the session, he stressed the need for China to pursue blockchain technology so China can “take the leading position in the emerging field of blockchain.”  China’s Central Bank Digital Currency project has been underway for quite some time now, with expectations of its launch coming “soon”, but this recent news out of China indicates that the government could be looking at applications beyond payments.
Speaking at a Vanity Fair event last week, Coinbase CEO Brian Armstrong stated that Coinbase has turned a profit over the last three years including during 2018’s bear market. The company has also earned $2b in transaction revenue since launching in 2012, an amount that is greater than all the venture capital funding it has received ($550m reported). With recent private market valuations (WeWork, Lyft, Uber, Juul) considered over-valued, it is refreshing to see a VC-backed company that is making profits and earning its valuation ($8b).
Last week The Chainsmokers, an EDM-pop duo, announced they were investing in YellowHeart, a blockchain-based ticketing platform for secondary ticket sales. YellowHeart’s platform is designed to cut out middlemen or scalpers who purchase tickets and resell them at a higher price point. The platform will allow artists to set the secondary sales prices for tickets and ensure the authenticity of tickets. Ticketing is yet another industry that would benefit from the application of blockchain technology with the sky high resale costs on ticketed events and the potential for massive fraud. 
Here in the US we may not feel the daily need to transact in Bitcoin, but that is not the case for countries suffering from serious economic crises such as Venezuela. Venezuela has experienced massive inflation and currency devaluation over the last few years has become one of the more active markets for Bitcoin with platforms such as LocalBitcoins exploding in popularity. In this story, the writer describes his experience being paid in Bitcoin which he then used to pay for the clinic where his son was delivered last month. He describes that despite the 20% drawdown in BTC price in September, he would rather have his money in a volatile asset than in local currency.

And That’s Our Two Satoshis! 
Thanks for reading everyone!   
Questions or comments, just let us know.  
The Arca Portfolio Management Team
Jeff Dorman, CFA - Chief Investment Officer
Katie Talati - Head of Research
Hassan Bassiri, CFA - PM / Analyst
Sasha Fleyshman -  Trader  
Wes Hansen -  Head of Trading & Operations
To learn more or talk to us about investing in digital assets and cryptocurrency
call us now at (424) 289-8068.

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