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“That’s Our Two Satoshis” —  When Bad News is Already Priced In

Jeff Dorman, CFA
Jan 28, 2019
What happened this week in the Crypto markets?

A tale of two uncorrelated markets
The equity markets don’t necessarily behave rationally, but at least they are consistent. Take January’s rally thus far, which has pushed small caps up 10% in just 3+ weeks even though forward EPS estimates are coming down, economic data has been largely negative, and the IMF recently lowered its 2019 global growth forecast to 3.5% from 3.7% (October) and 3.9% (July). Last week, stock indexes almost overcame early-week losses again, but came up just short of notching their fifth straight weekly gain. Similarly, the credit markets have thawed with over $7 billion of drive-by high yield issuance last week, following a strong 5% rally to start the year. As we mentioned last week, bad news is good news until the Fed stops reacting to every hiccup.
We bring this up in the context of crypto because the lack of correlation between crypto and equities remains a key theme, as the rolling correlations are fast approaching zero. Following an abysmal 2018 campaign, crypto markets rose for the first nine days of January as well, but unlike equities, have traded sideways, to lower, ever since, culminating in another large selloff over the weekend which has brought January MTD returns close to -10%. The crypto markets don’t behave rationally or consistently, but they do offer real diversification to equity and bond markets.
Source: Data from General Risk Advisors
Of course, diversification doesn’t mean much when you are diversifying away from gains and into losses. And over the last 6 months, losses are all the crypto markets have generated. But signs of health continue to emerge, even if the prices of assets are a lagging indicator. Every week we analyze the macro factors influencing crypto, and our list this month has had many more positives than negatives:
Of the above, the market’s recent willingness to shrug off bad news and the low market sentiment are two of the most encouraging signs of renewed health. As investors in any asset class will tell you, when all bad news is priced in because expectations are so low, it’s usually a good time to buy, even if the bad news isn’t over yet. Those buying the equity markets right now are doing just that — assuming all of the negative catalysts we mentioned in our opening paragraph are well known and already priced in. Time will tell of course for both equities and crypto, as new information can trigger more negative news that isn’t priced in yet. And a lack of volatility often leads to bad outcomes, as traders get bored and look for ways to push markets in their favor (especially in crypto, given the immaturity of the crypto landscape and the lack of institutional players, anything can happen in the short-term including the negative price action seen over the weekend). But for the time being, it does seem as if price is lagging reality.
Betting on a recovery — with a form of activism
Mike Novogratz’s Galaxy Digital is reportedly set to raise a $250M fund to help needy crypto firms. At first glance, our reaction was, “why give a lifeline to project owners who burned through their cash and produced little with it?”. But upon further reflection, this is a very novel idea. In essence, this is a form of soft activism.
Many famous investors use the full capital structures of companies in order to increase the ROI of their investments — for instance, Carl Icahn and Warren Buffett often famously buy up all of the debt of a distressed company before announcing an equity injection, thereby sending the price of the debt skyrocketing upon the equity announcement, causing the gains on the debt investment to basically pay for the equity investment.
What Galaxy is doing may be a similar form of loose activism. Many crypto tokens behave similarly to options — whereby time is a crucial component of the Black-Scholes model. By lending crypto companies money and keeping the tokens as collateral, Galaxy is essentially increasing the optionality of these tokens by increasing the time it has to complete the project. As a result, the token price will go higher, which means Galaxy’s loan becomes over-collateralized and the loan-to-value ratio drops. Moreover, there is a good chance Galaxy is also buying the tokens ahead of issuing the loan, betting on a recovery of the tokens if they have cash to finish building the project. Savvy financial moves like this are exciting, brand new, and unique to crypto given token cap structures are largely new and untested.
We anticipate a lot more activism in the months to come.
Notable Movers and Shakers
Signs of health are emerging, as prices are reacting to real news.
What We’re Reading this Week
Last week, the CBOE withdrew their proposed rule change for the SolidX VanEck Bitcoin Trust. The SEC deadline to provide comments on the Bitcoin ETF was scheduled for February 27, a date that many worried would not be kept with the government shutdown. Technically, if no comments were made by the SEC, the ETF could have gone into effect by default. Many crypto enthusiasts have lauded a Bitcoin ETF to pave the way for institutional adoption and the next bull run, simply because it fits better into the workflows of financial advisors. Further, after a series of setbacks, the market has basically priced in no ETF this year… so any positive outcome would likely send BTC much higher.
Controversial title, but Lou Kerner makes some excellent points about how the US Dollar has evolved over the years. The government’s method of issuing debt combined with the move away from a gold-pegged value has placed the dollar in a precarious position. Although gold is a preferred and stable store of value against which currencies are backed by, it may soon be eclipsed by Bitcoin.
Nasdaq Making Headlines
Nasdaq’s CEO, Adena Friedman, published a post last week relaying that “crypto could still be a global currency of the future”, discussing the invention cycle cryptocurrencies have traced. Indeed, the firm seems to be putting its money where its mouth is. After investing in ErisX late last year, Nasdaq Ventures is now leading a Series B financing round for blockchain startup,, which aims to integrate blockchain technology into capital markets. Citi Ventures and Galaxy Digital Holdings also participated in the financing round.
A new bill introduced in Wyoming proposes to categorize cryptoassets into three categories: digital securities, digital assets, and virtual currencies. In addition, the bill could pave the way for banks to offer custody of cryptocurrencies and give virtual currencies the same protections as legal tender.
IBM, who is no stranger to blockchain, is partnering with healthcare giants Aetna, Anthem, Health Care Service Corporation, and PNC Bank to create a blockchain healthcare network. Healthcare has long been one of the industries that blockchain is poised to disrupt, however, legacy systems and regulations have stymied attempts by smaller players. A project that includes these large healthcare giants is far more likely to have a lasting impact.
In their 2018 review, Circle Research reviews performance and statistics across the crypto industry. Most interesting is the data on DApps, which shows steady growth in 2018, something that will be continued with open finance applications in 2019.
Arca in the Press & on the Street
  • Arca’s Portfolio Manager, Jeff Dorman, was published last week by CoinDesk highlighting feedback we’ve received from hundreds of meetings with institutional investors regarding crypto investing
  • Arca’s Head of Strategic Relations, David Nage, hosted Spencer Noon on his Base Layer podcast late last week. They talked Constantinople, Serenity, the future innovations in Ethereum and much more.
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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