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“That’s Our Two Satoshis”—  Analyzing Incremental Buyers of Crypto Compared to Equities/Fixed Income

Jeff Dorman, CFA
Nov 5, 2018
What happened this week in the Crypto markets?
 
A slow week for crypto
The crypto market appeared to be heading towards a rough week, as yet another rapid decline on light volume pushed crypto prices down by 5% in early Monday trading. But the market proved its resilience once again, bouncing back throughout the week to end down just 1–2% week-over-week. Crypto assets remain highly uncorrelated to global equity markets, which recovered to the tune of 3–5% gains.
 
In the absence of any tangible market-moving news (unless you count the “ Bitcoin will cause Global Warming ” narrative as news), and a constant decrease in crypto trading volumes and volatility , we thought it made sense to discuss a few reasons why this asset class may be slowing down.
 
There are a lot more incremental buyers in equities and fixed income, compared to crypto
In order to understand crypto investing, it’s important to compare this new asset class to traditional asset classes like equities and fixed income. Both have an ecosystem filled with exchanges, market makers, asset managers and traders looking to realize profits by buying low and selling high. And both see the number of investable assets grow via new supply in the form of issuance, either by companies themselves raising money, or in the new world, decentralized projects looking to raise capital to build and grow a network.
 
As such, there are a few shared attributes by both traditional and crypto markets that influence the direction of prices and size of the market:
 
  • New issue supply
  • Enthusiasm / momentum / sentiment
  • Liquidity
  • An increase in capital flowing into the space
But the similarities largely end there. And one of the reasons the overall size of the crypto market has failed to grow this year is a lack of players OUTSIDE of the capital markets who keep markets in check, offer an “end game”, and ultimately influence price. Meaning, while the crypto asset class only has issuers and investors, the equity and fixed income markets also contain a variety of other outside forces that come and go periodically based on attractive or unattractive valuations. These include:
 
  • Buybacks: Companies buying back their own stock/bonds.
  • M&A: Both from competitors looking to boost ROI through acquisition, and from Private Equity companies who feel they can extract value by increasing leverage or selling assets.
  • Secondary sales of stocks/bonds: Testing demand and thus validating existing trading levels.
  • “Value” investors: Those that rigorously defend price by buying when values fall below certain time-tested and largely agreed upon fundamental valuation metrics .
  • Income: in the form of dividends and coupons.
As it stands today, few to none of these outside forces exist in crypto. So when current market participants tire of the market, or become fully invested, there just isn’t much out there to move markets.
 
But these additional market participants are coming. In fact, we’ve already seen flashes:
 
  • Buybacks: Binance Coin (BNB) — Binance buys back and burns BNB using up to 20% of quarterly profits
  • M&A: Blockchain related companies without cryptocurrencies have merged or acquired other companies this year, like Coinbase acquiring Earn.com, Circle acquiring Poloniex, and Tron acquiring BitTorrent. While none of these acquisitions involved assuming a digital token, it’s only a matter of time before this happens.
  • Secondary sales of stocks/bonds: The early days of Tokenomics has largely precluded this from happening due to restricting and capping the supply of tokens at initial issuance, but this practice may be more detrimental than helpful to investors. The ability for companies/projects to take advantage of new demand not only helps these companies/projects grow, but also introduces valuation metrics (i.e. at what valuation will new investors want to receive more tokens). Ripple’s continuous and scheduled sale of XRP tokens from its own treasury is a good example of this practice.
  • “Value” investors: While Graham & Dodd are no longer with us, new fundamental valuation techniques are being built, tested, and discovered. From the original MV = PQ analysis , to NVT , to Metcalf’s Law … teams of smart crypto analysts (including our own internal team at Arca) are developing new methodologies to value cryptoassets. As these metrics become accepted and universal, price floors based on fundamentals will be set.
  • Income: Secondary lending and prime brokerage services are already here, and a new wave of asset-backed security tokens expected in 2019 will come with dividends/coupons to attract investors.
Once these influences on price develop further, valuation ranges for cryptos will become more predictable. This is a much-needed piece of the puzzle. Until then, crypto investing is largely a zero-sum game between traders.
 
How to avoid staying irrelevant
For those of us who have dedicated our lives and careers to advancing blockchain and crypto as an asset class, we can be both undoubtedly bullish while also remaining realistic. Many in the token space make grandiose statements claiming that crypto-securities will be the next financial revolution, but this is going to take time. We think this statement from Jesus Rodriguez via HackerNoon sums it up perfectly, and draws on our own vast experience in the High Yield and Distressed debt markets:
If history give [sic] us a lesson in financial markets, it is that many promising products have stayed irrelevant for decades until a viable application was found. An analogy I like to use a lot in this space is high-yield debt or junk bonds. Originally a product of the 1970s, junk bonds remained largely irrelevant until people like Michael Milken and the team at Drexel Burnham Lambert figured out how to use them to finance leveraged buyouts [in the mid-1980s]. In that context, security tokens need a “Milken moment”.
Stay tuned — Milken had a lot of lawyers and financial engineers, but nothing like the firepower of intellectual capital flocking to crypto.
 
Notable Movers and Shakers
The overall market continues to trade sideways — only 9 of the Top 100 tokens by market cap moved +/- 10% last week. And while crypto remains unaffected by global equity and rates volatility, there have been individual token outperformers driven by “real news” (partnership announcements, acquisitions, exchange listings and in some cases software upgrades). Business transactions like acquisitions also signify that this market is maturing and consolidating, as real winners emerge from the noise.
 
What We’re Reading this Week
 
For those that are more technically minded, Joseph Bonneau, an assistant professor at NYU, details some of the specifics of Bitcoin’s original design. He lays out clearly all the technical hurdles Bitcoin still needs to overcome and some mistakes that were made in the ten-year-old design.
 
Tether announced late last week that they have established a new banking relationship with Deltec out of the Bahamas. Tether also published a letter from Deltec stating that Tether’s account had a cash value of $1,831,322,828 — enough to cover its market cap. Only time will tell if Tether can overcome the recent hurdles to maintain its market dominance. Recall, Arca talked about the binary outcome in October’s “ That’s Our Two Satoshis ”.
 
Move over Crypto-enthusiasts, Wall Street will take it from here. This clever, albeit snarky article, discusses how typical Wall Street tactics are now taking over crypto. It’s hard to ignore at this point. Every major financial institution is slowly finding their way into the space. With Bakkt gearing up to launch next month, some groups like JP Morgan are able to enter the digital asset space, since Bakkt “provides a clear and clean regulatory construct to engage with Bitcoin”. JP Morgan is not alone asGoldman Sachs is onboarding clients into their crypto derivative product, and Morgan Stanley’s global banking division released a report this week covering Bitcoin over the last six months . Meanwhile, Blackrock’s CEO, Larry Fink, says they won’t be offering an ETF product until the industry is “legitimate” .
 
Venezuela has had a rough go the last several years: hyperinflation and economic sanctions have crippled the economy and left its citizens starving. President Maduro came up with the idea of the Petro Coin, a cryptocurrency backed by reserves of oil. The coin has come under heavy criticism: the offering circumvents international sanctions, there is no transparency into the oil reserves backing the crypto, and it was alleged that whole sections of the DASH White Paper were lifted for its own white paper. The world is now watching to see what happens as the first government-backed crypto will be used to replace local fiat currency.
 
Why are Millennials flocking to crypto? Edelman explores some of the sentiments of affluent millennials towards finance and financial products, most importantly that they feel the entire process is confusing and difficult. Some notable highlights:
 
  • 61% believe financial services companies do not use data and technology to customize their customer experience.
  • 70% believe financial services companies make the purchasing process unnecessarily confusing/frustrating.
  • 77% believe that it is just a matter of time before the bad behavior of the financial industry leads us into another global financial crisis.
Arca in the Press & on the Streets
This week, Arca’s executive team is hitting New York City. If you’d like to meet with CEO, Rayne Steinberg, or Portfolio Manager, Jeff Dorman, please reach out to info@ar.ca .
Not in the NYC area? That’s ok… follow us on Twitter for our views on;

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 — Portfolio Manager
Katie Talati — Director of Research
Hassan Bassiri , CFA — Junior PM / Analyst

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©2018 by Arca Funds Past performance is not indicative of future results. Investors should carefully consider the investment objectives, risks, charges and expenses of Arca "(The "Funds"). This ad other important information about the Funds are in the respective Fund's offering documents which can be obtained by entering Arca Private Investor Portal. All of the offering documents should be read carefully before investing. Disclaimer: This commentary is provided as general information only and is in no way intended as investment advice, investment research, a research report or a recommendation. Any decision to invest or take any other action with respect to the securities discussed in this commentary may involve risks not discussed herein and such decisions should not be based solely on the information contained in this document.