5MF(WEEK 41): CPI COMES IN HIGH, ETH DEFLATIONARY, Q3 VC BLOCKCHAIN INVESTMENTS
The 5-minute newsletter on the important stuff in finance — explaining what’s going on, and why.
Let’s see what’s going on this week:
- What Does the Latest 8.2% CPI Tell Us?
- SEC Probes Yuga Labs: Should the Industry be Concerned?
- BTC Down 68% from Nov ATH, but Hash Rate is Up
- ETH Goes Deflationary, but Price Drops 7%
- Q3 2022 Blockchain VC Investing Breakdown
Market Volatility Amid Latest CPI Drop
- US CPI Prints 8.2% for September, is Peak Inflation Over? (link)
PCE vs. CPI: They Tell the Same Hiking Story
Since we entered the period of 40-year high inflation, a new monthly percentage is as anticipated as a hot album. For September, the inflation-measuring Consumer Price Index (CPI) hit 8.2%, a 0.1% increase than the expected forecast of 8.1%. However, CPI is at its lowest level since February 2022, when it came in at 7.9%.
The less volatile lighter red, core CPI (CPI less food and energy), is at 6.6%, having increased by +0.3% from August, vs. the expected +0.2%. Image credit: U.S. Bureau of Labor Statistics
With the steaming hot inflation number dropped, it is now market interpretation-reaction time. So, how does the Federal Reserve interpret the number?
Well, the Fed’s official dual mandate is to stabilize prices, alongside keeping unemployment low. Will the Fed continue to suppress asset prices to drive down consumer demand, which can lead to a recession as a means of cooling inflation?
To answer that is to see which indicator the Fed tends to utilize more. While the central bank takes note of CPI, its preferred inflation gauge is the core Personal Consumption Expenditure (PCE). Let’s clarify the differences:
- CPI: Average change in consumer prices in urban areas. Based on household surveys.
- PCE: Measures consumer spending and is based on prices from all households, corporations, governments, and GDP. Stems from surveys of businesses.
- There’s both ‘core CPI’ and ‘core PCE’ which do not include food and energy expenditures.
So why is there a ‘core’ aspect? Because there’s a lag in enacting monetary policy and its measurable effect. The core PCE excludes items that tend to fluctuate wildly in the short-term, such as food and energy, making it a less volatile indicator. And importantly, core PCE is made out of business surveys, while CPI is made out of household surveys.
This means that PCE includes goods and services bought on behalf of customers. For this reason, it captures a wider price trend, resulting in lower rates than with either CPI or core CPI. In turn, this creates an odd dynamic in which the public (markets) respond to CPI, while the Fed typically measures inflation through core PCE.
However, whether it is core CPI (+6.6% YoY) or core PCE (+4.9% for August), the Fed’s blue funding rate has to be over the red inflation rate to make a deflationary dent. Reminder, the Fed’s target PCE is still at 2%.
Since the 1950s, the Fed funds rate had to top core CPI to successfully stabilize prices. Image credit: fred.stlouisfed.org
For this reason, consecutive +75 bps hikes are expected for both November and December, at 98.2%% and 64.2% respective probabilities. This would bring the funds rate to 4.75%, still under the core PCE of 4.9% (September’s report will be released on October 28th).
As other central banks struggle to keep up with tightened dollar liquidity, a lot can happen in that time to affect the Fed’s course. But judging from the market’s reaction — a quick drop and subsequent rally within a few hours — the hikes appear to already be priced in.
SEC Probes Yuga Labs: Cause for Concern?
- Are NFTs Securities? SEC Begins Probe Into Yuga Labs (link)
- Bored Ape Yacht Club Trade Volume up 80%+ After SEC’s Yuga Probe Revealed (link)
What Exactly is the SEC Targeting? NFTs? APEcoin?
Since Gary Gensler was confirmed as the SEC chief, he has been using legislative crypto void to carve out de-facto regulation of digital assets. First in his sights were yield-bearing crypto products. After slapping BlockFi with a $100 million fine, and stopping Coinbase’s Lend program, next in line could be non-fungible tokens (NFTs).
Unlike fungible cryptocurrencies, the value of NFTs is in the eyes of the beholder, similar to gallery art pieces. Yuga Labs climbed to the top of the NFT food chain with the Bored Ape Yacht Club (BAYC) collection, having turned $2.4 billion in total sales.
The highest priced BAYC NFTs last sold in ETH cryptocurrency (1 ETH = ~$1,327). Image credit: OpenSea.
This is not including Yuga Labs’ adjacent projects Mutant Ape Yacht Club ($1.7b), Bored Ape Kennel Club ($351m) and Otherdeed ($1b). While the SEC hasn’t accused Yuga Labs of any wrongdoing, the probe is exploring the grounds for defining NFTs as securities.
If the SEC is successful, the $4b valued Yuga Labs could be charged for selling unregistered securities. In the absence of crypto legislation, the SEC still operates under the 1946 U.S. Supreme Court case of Howey, which identifies securities as:
- Represented financial investments into a common enterprise, where:
- The enterprise is expected to yield profits from the investment, including from the efforts of third parties.
From its NFT projects, Yuga Labs earns a 2.5% royalty fee on each sale. The common enterprise would be its upcoming metaverse/gaming platform Otherside, monetized by ApeCoin (APE) cryptocurrency, also in SEC’s probing sights. However, although the coin is integral to the Yuga Labs ecosystem, it is managed by the Ape Foundation, not Yuga Labs.
Additionally, the Ape Foundation uses a decentralized autonomous organization (DAO) to deploy APE funds. This means that all APE tokenholders can vote and direct the common enterprise, which could go against the foundation. For instance, when the Ape Foundation proposed to host Otherside on its own blockchain instead of staying on Ethereum, the community voted with 3.8 million APE against it, vs. the 3.3 million APE coins in favor.
In other words, that’s a lot of complexity and dilution of governance for the SEC to pin down, using rules from the pre-computer era. Nonetheless, after the news broke out on Tuesday, APE had a bad time, going down over the week by -11%.
ApeCoin (APE) price over the week. Image credit: Trading View
At the same time, BAYC sales went up by 21.20%, at $7.3 million over the week. Yet, despite the speculative spike, the BAYC floor price remains flat at 73 ETH, far away from its May peak of 153 ETH.
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BTC is Now Down -68% from November ATH: What Happens From Here?
- Bitcoin Perp. Open Interest Hits 500,000 as Price Remains Range Bound, is a Squeeze Upcoming? (link)
Bitcoin Resists Market Stress
When the Federal Reserve opened a $4.5 trillion liquidity gate in 2020 and 2021 to pour money into and lubricate the dry American economy, funds poured into both stocks and cryptocurrencies. As the crypto vanguard, in November 2021, Bitcoin reached its all-time price peak of $68,789. The inflation rate, measured as CPI was 6.8% at that time, reaching the 40-year high range.
Since then, Bitcoin went down -68%, to ~$20k. Yet, this is not Bitcoin’s first major drawdown rodeo.
For years, the prevailing narrative painted Bitcoin as an inflation hedge. Once it became clear that the Fed is serious about interest rate hike rates, this long-standing narrative collapsed. Instead, as the Dollar Strength Index (DXY) grew, it became clear that Bitcoin is — at least currently — functioning as a hedge against currency debasement.
Since the top, Bitcoin’s strength waned as the dollar’s strength ballooned. Image credit: Trading View
However, with foreign central banks falling into liquidity traps, Bitcoin has remained remarkably stable at this bottom. Bitcoin’s perpetual futures contracts (perps) support this with nearly neutral funding rates.
For that to happen, favorable longs and hostile shorts against BTC would have to clash. Moreover, Arcane’s research report noted the highest open interest rate relative to Bitcoin’s market cap. What does this mean for Bitcoin moving forward?
On a fundamental level, Bitcoin is still a platform for human signals. Specifically, how investors interpret macroeconomic conditions. On one hand, Bitcoin expanded its user base to over 300 million in a span of 13.8 years. If this growth rate continues, Bitcoin could reach the milestone of 1 billion users in three years, covering 12% of the world’s population.
Anticipating this growth, Bitcoin mining software is undergoing a major overhaul, streamlining it further. On the other hand, Bitcoin could face problems in the short run. The network’s hash rate power reached an all-time high on Monday, which means that it is more secure than ever.
The total amount of Bitcoin mining power, expressed in quintillion hash rate per second (EH/s). Image credit: CoinWarz.com
But, this is a double-edged sword because the network difficulty is also higher, demanding more energy for mining transaction blocks.
It takes two weeks for hash difficulty to re-adjust, leaving miners to deal with the high energy prices in a bear market with a bottomed BTC price (side note: Binance is launching a $500 million project to provide loans to BTC miners at 5% — 10% interest rates to help with this). This dynamic may be the likely culprit we are seeing such a high open interest at this time.
Ethereum Just Went Deflationary, but Nothing Happened. Why?
- Ethereum Turns Deflationary but Drops 7% as Market Stays Uncertain (link)
Ethereum Goes Deflationary in a Bear Market
Many investors are confused at the inflationary dynamic between Ethereum and Bitcoin. The latter has a total supply which is limited to 21 million BTC, while Ethereum has a potentially infinite supply of ETH. Yet, after the Merge transitioned Ethereum to a proof-of-stake blockchain, fewer ETH are issued into circulation than bitcoins.
Ethereum’s Merge milestone changed its tokenomics dynamic. Image credit: Ultrasound.money
That’s because Ethereum’s staking consensus reduced ETH issuance by -90%, alongside reducing the network’s energy consumption by ~99.95%. In the meantime, Bitcoin’s issuance is still governed by its 4-year halving mechanism, scheduled to cease with BTC issuance as rewards (the releasing of BTC into circulating supply) in 2140.
Ethereum is now drastically deflationary compared to Bitcoin, having its ETH token supply growth decreased by -0.22% over the week. This past week, we saw the first ever deflationary day for the Ethereum network.
Ethereum’s ETH supply growth decrease over 7 days. Image credit: Ultrasound.money
Yet, the Ethereum price barely budged in that time, increasing by +0.41% vs. Bitcoin’s +2% increase. Isn’t deflationary pressure supposed to appreciate the value of each coin, similar to the Fed’s efforts with its quantitative tightening to the dollar?
Well, it turns out, much of the deflationary pressure on Ethereum stemmed from the launch of a single project this past week. Out of 15,720 ETH burned as base fees, nearly a third of that came from minting recently launched XEN tokens, spearheading the novel proof-of-participation.
ETH gas fees poured into XEN token minting. Image credit: CoinTool.app
Not only did XEN spike ETH gas fees, but the project crashed by -89% shortly after. A clever hacker exploited XEN’s gas loophole on the FTX exchange, having minted 100 million XEN.
Suffice to say, the good news was overshadowed by the bad news.
Follow the Money: Q3 2022 Blockchain VC Investing
- VC Funding for Crypto Startups Down 37% in Q3 (link)
VC Investing Down, But Still Substantial
In a bear market, it’s common to see the phrase “smart money” pop up. With so much anxiety going on, there is misguidance left and right. But what about people whose job it is to seek out investing opportunities with a calculated mindset?
Typically, these wealth seekers are found in venture capital (VC) firms, so it bears noticing where their money flows — at least in terms of the different sectors of an industry.
Expectedly, VC crypto funding declined 37% in Q3 compared to the same period last year, according to PitchBook data.
Image credit: The Block
Out of that $4.44 billion VC investment flow, nearly half ($2b) went into NFTs/gaming. This is a consistent trend as play-to-earn (P2E) gaming is expected to displace traditional gaming in which in-game resources are account-locked.
In contrast, blockchain games have tradable resources, both in terms of tokens and playable NFTs, allowing for viable gaming incomes. Coupled with a steady rise in average gaming hours played per week, blockchain gaming investments become a popular trend.
Of course, blockchain gaming has to be supported by blockchain infrastructure, so VCs allocated almost as much, at $1.8 billion. The winners were Tatum at $42 million, and SettleMint at $15.65 million. The Czech Tatum is resolving the fragmented nature of the blockchain ecosystem, holding dozens of networks.
The Tatum team, headquartered in both London and Miami, is developing tools and frameworks to unify dApp development for over 40 different blockchain protocols. This way, dApps could be built faster by reducing time spent on the particularities of each individual blockchain.
Interestingly, VCs allocated funds to crypto financial services and DeFi almost equally, at half a billion each. In Q1, the interest for these sectors was over 3x higher, at $3.6 billion. This suggests a hiatus due to uncertainties on how the regulation of digital assets will ultimately look like.
Just this Thursday, Senator Hickenlooper of Colorado wrote a letter to the SEC, asking the agency to recognize that “existing laws and regulations were not designed to deal with how digital assets are being used in the market”.
The senator joined his colleague, Representative Tom Emmer, who carries a similar sentiment.
Tweets of the Week
As rising interest rates and volatile markets signal growing financial stability risks, our global stress test for banks indicates that some lenders in emerging markets may not have sufficient capital.
The S&P 500, Gold, Bitcoin and EURUSD after the CPI Print:
The US Strategic Petroleum Reserve moved down for the 57th consecutive week, now at its lowest level since 1984. The 31% decline in reserves this year is the largest on record by a wide margin.
Charting via @ycharts
At the height of panic-buying today, more than 45% of all NYSE securities traded on an uptick.
That’s the 2nd-highest amount in at least 25 years on the day after the S&P 500 set a 52-week low (suggesting short-covering).
The Polygon ecosystem roadmap is looking insane
- POS mainnet
- Polygon Supernets
- Polygon Avail
- Polygon Zero, Miden & zkEVM
- Polygon Nightfall
A simple breakdown of these different scaling solutions and why they are groundbreaking for the space
1/25
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