Blockforce June Digital Asset Commentary

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Key Highlights

• Bitcoin continues its outperformance of major asset classes and other top cryptocurrencies, up 26.2% for the month of June, after posting a 62% gain in May. It continued to significantly outpace other major asset classes June returns, with gold gaining 8%, the S&P 500 gaining 6.9%, the ACWI All-World Index gaining 6.5%, and two-year Treasuries declining by 8.7%.
• On June 18th, Facebook unveiled details of its long-rumored cryptocurrency initiative, Libra. Libra will be backed by a basket of global currencies and sovereign debt instruments, but it is not without regulatory uncertainty.
• The current multi-month rally in digital assets is different than 2017, with altcoins trailing in relative performance, CME futures volume surging and a relative lag in retail interest, all pointing toward the increasing institutionalization of the asset class.
• While Google Trend search results for the words “bitcoin” and “crypto” were 4x higher in December 2017 than they were the last week of June 2019, the search trends have still shown significant month-over month growth in four of the first six months of 2019, including 100% increases in both May and June.
• Despite the overall lack of retail participation compared to the 2017 mania, interest appears to be growing. Unique visits to both the Coinbase and Binance websites may still be down more than 70% from their respective peaks in December 2017, but both have seen over 120% growth since the end of 2018.
• Bitcoin’s dominance — calculated as the market capitalization of bitcoin compared to the total cryptocurrency market — hit 62.7% at the end of June, the highest it has been since mid-September 2017 (with the recent low of 36% in August 2018), furthering the theory that institutions are behind the recent rally as they allocate to the flagship asset.
• Bitcoin is significantly outperforming most of the top cryptocurrencies by market cap, up 165% since the rally began on April 1st, with XRP (Ripple), EOS, Stellar, Tron, and Cardano all trailing bitcoin by more than 100% — quite a different picture than the retail-led altcoin mania of 2017.
• Bitcoin’s volatility was painfully low throughout the first quarter of 2019, but it has gradually increased throughout the second quarter, peaking on June 30th with a six-month volatility reading closing at 95.28%, the highest it has been since April 2018.
• Sharpe ratios fell for all of the top 10 digital assets, despite the monthly uptrend due to the increased risk (volatility) that the assets exhibited. Historically, bitcoin has had an elevated risk-reward ratio compared to other top digital assets, a trend that continues to ring true through the first half of 2019.

Market Overview

Over the past few months, there has been a considerable amount of news and volatility surrounding digital assets, with the trajectory of hype and excitement continuing higher in June. Bitcoin continued to dominate most digital assets in terms of performance, propelled by a large number of macroeconomic factors building up the cryptocurrency ecosystem. Most notably, Facebook announced Project Libra, the cryptocurrency project it has been developing (in conjunction with a consortium of large corporate partners) to work both within Facebook’s ecosystem as well as throughout the internet, backed by a basket of top global currencies. We’ll get into the similarities and differences of Libra versus bitcoin later, but with 2.4 billion users on the Facebook platform alone, this could be an incredible propellant for the mainstream use and adoption of cryptocurrencies. The Libra announcement is not without negatives for the asset class, but only time will tell if the negative aspects of a centralized corporate blockchain can be outweighed by the visibility and legitimacy Libra will bring to the blockchain ecosystem.

The second major news to break toward the end of the month relates to LedgerX, a derivatives and futures contract provider. LedgerX received CFTC approval to operate as a Designated Contract Market (DCM), which allows them to now offer physically delivered futures to US customers. LedgerX is now the second company to receive such a designation in the United States, and other companies such as ICE’s Bakkt, SeedCX, and ErisX are waiting in the wings to compete in this marketplace. Up to this point, LedgerX had their Swap Execution Facility (SEF) and Derivatives Clearing Organization (DCO) licenses, which allowed them to provide institutional parties exposure to the market via swap and options contracts on bitcoin. [UPDATE: the CFTC granted ErisX a DCO license on July 1st]

These two recent developments –- along with Binance’s announcement that they will offer a regulated US exchange toward the end of summer –- will continue to fuel the institutionalization of the digital asset environment. The use of cryptocurrencies is not one size fits all, and we are still in the midst of a massive multi-year macroeconomic experiment that is just getting its legs underneath it.

In terms of performance for the month, Bitcoin continued its performance streak, up 26.2% for the month of June after posting a 62% gain in May. It continued to significantly outpace other major asset classes with gold gaining 8% for the month, the S&P 500 gaining 6.9%, the ACWI All-World Index gaining 6.5%, and two-year Treasuries declining by 8.7% (check out our interactive tool here).

Traditional markets got a boost from comments by Federal Reserve Chairman Jerome Powell at the beginning of the month, stating the Fed’s commitment to sustaining economic growth in the US. On June 19th, the Fed held interests rates steady, but indicated that rates may be cut multiple times throughout the remainder of the year. The market looks to be pricing in a near 100% probability that the Fed will cut rates in mid-July. The Fed’s actions and Chairman Powell’s comments, coupled with President Trump dropping Mexican tariff threats and meeting with China’s President Xi Jinping at the G20 summit, were viewed favorably by market participants, with the Dow Jones Industrial Average and the S&P 500 posting their best month of the year.

The Libra Initiative

• Value: Libra is backed by physical assets (cash reserves and sovereign debt) and should hold to parity versus the underlying assets, whereas bitcoin’s price is based on market forces, such as supply and demand.
• Centralization: The Libra blockchain is more centralized than Bitcoin. Originally developed by Facebook, its decentralization will include the Libra Association members (target of 100) supporting the network, meaning a handful of selected (mainly corporate) partners will support the network and run the network nodes; whereas Bitcoin is fully decentralized, as any person with a computer can add to and support the network and/or run a network node. This is a big differentiator, as the decentralized nature of Bitcoin prevents the blockchain from being altered, as the computing power to overtake the network (a 51% attack) would require 3x the computing power of the largest supercomputer in the world. Whereas the Libra blockchain could theoretically be altered by a majority of the consortium members.
• Privacy: Bitcoin transactions are pseudo-anonymous, meaning asset transfer can be tracked on the blockchain, but it can be difficult for governments to track a wallet ownership back to a user. Libra is controlled by a handful of organizations, and it is near certain that Libra wallets will have an identity attached to satisfy anti-money laundering and know-your-customer regulations. This data could potentially be extremely valuable to Libra partners — as usage increases these corporations may have access to the entire spending history. Additionally, this means that the organizations that make up the Libra Association will have the ability to exclude individuals and entities from utilizing the network, unlike the Bitcoin network, through which it is impossible to exclude anyone.
• Regulation: As bitcoin is decentralized, it is very difficult for governments to regulate. China has banned cryptocurrencies, but due to bitcoin’s decentralized nature it is fairly easy for individuals or corporations to still buy, own, or transact in the cryptocurrency. Libra is already facing regulatory scrutiny from a handful of governments, and as a result of its centralization it will be easier for governments to subject Libra to regulations. In fact, the U.S. House Committee on Financial Services has already sent Facebook a letter, asking them to halt their cryptocurrency initiatives until regulators and Congress have an opportunity to examine the issues surrounding their issuance of a cryptocurrency.

An Institutional State of Mind

As we noted in last month’s commentary, we continue to believe that this multi-month rally has been and will continue to be different than the retail-backed altcoin craze from 2017. It appears that institutions are getting involved this time around, carrying considerable monetary firepower that has the ability to significantly change the digital asset landscape. There are a number of factors that support this theory, including the explosion in CME futures volume, the performance lag of altcoins versus bitcoin, and the standstill of retail app usage, among others. While we generally believe the recent rally is mainly from institutional investors, public interest in cryptocurrencies has also grown considerably over the past few months as a result of both price action and the increased media coverage.

Digital Asset Portfolio Allocation

Bitcoin’s 1,000% run-up in 2017, 80% drawdown in 2018, and 177% return through the first half of 2019 has set a new bar for volatility in a speculative asset. Even with multiple 80%+ peak-to-trough drawdowns over the last 10 years, bitcoin has outperformed every other asset class in all but two years since 2010. While it would not be appropriate to make digital assets a core holding of a portfolio, small allocations to the space have had tremendous benefits to a portfolio’s risk/reward ratio. For example, a portfolio comprised of 59% SPY, 40% AGG, and 1% bitcoin performs almost as well as a 100% SPY portfolio over the last nine and a half years. Additionally, having a small allocation to digital assets considerably increases a portfolio’s Sharpe Ratio, with a 1% bitcoin allocation portfolio boasting a Sharpe of 1.36, versus 1.02 for a 60/40 split, and 0.87 for 100% S&P500. The portfolio drawdown for the portfolio with 1% bitcoin increases by one-tenth of a percent versus the 60/40 portfolio allocation.

Even with bitcoin’s cyclical boom and bust nature, the fact that it is uncorrelated to any other global asset boosts the blended portfolio’s Sharpe ratio. When comparing a portfolio’s performance since the beginning of 2018, a year in which bitcoin had an 80% drawdown, a 59/40/1 portfolio offers an enhanced return versus a 60/40 portfolio, and a higher Sharpe with lower risk and drawdown than a 100% equity portfolio.

Source: Blockforce Capital Research, Bloomberg period ending 06/28/2019

CME Futures

CME futures contracts exploded this month in terms of both volume and open interest. Volume surged toward the month-end expiration, and more than $1.7 billion exchanged hands on June 26th, dwarfing May’s historic high of $543.2 million. Open interest peaked on June 24th at $309 million, 24% higher than the high set on May 31st.

The continued record-setting futures volume — on the only regulated derivatives exchange offering bitcoin futures to US investors — proves that institutions are taking notice of the asset class and allocating to it accordingly. The June 24th Commitment of Traders Report from the CFTC stated that 52% of the open interest is short — made up primarily by large institutional accounts. We believe that the amount of short interest in these contracts contributed to bitcoin’s high-velocity move in the early morning of June 26th, which saw bitcoin’s price rise from $12,500 to $13,800 in a matter of hours. Such a move appear to have been created by large asset managers covering short positions. Additionally, following the close of the US equity markets at 4PM EST, CME volume dried up, and the price of bitcoin fell 10% over the next two hours adding further credence to the theory of a short squeeze.

Retail Crypto App Usage

On June 28th, Bloomberg released an article titled “Crypto Apps See Zero Growth as Bitcoin Price Triples This Year”, which sourced research from App Annie, an application analytics platform. The report showed that downloads for crypto-related phone applications were stagnant when compared to the first half of 2018. While we agree that usage has flatlined when comparing the two six-month periods, it’s also important to remember that the first half of 2018 bitcoin was coming off its all-time high and still buzzing with significant retail interest. Bitcoin was basically dead in the water for the first quarter of 2019, so it will be interesting to see how these stats play out for the remainder of the year. We generally view this in a more positive light for retail interest than the article suggests, but we do not believe retail is the driving force behind this rally like it was in 2017.

Retail Participation

Google Trend search results for the words “bitcoin” and “crypto” were 4x higher in December 2017 than they were the last week of June 2019, however they have shown significant month-over month growth in four of the first six months of 2019, including a 100% increase in both May and June.

While the results are a far cry from their December 2017 peak, it’s important to note that interest has been increasing with the retail public, and unique website visitors to both Coinbase and Binance has increased over the last few months. In fact, although both sites’ unique monthly visitor stats are down more than 70% from their respective peaks in December 2017, both have seen over 120% growth since the end of 2018.

In addition to more unique visitors as of late, both Coinbase and Binance have seen increases in the duration of customer visits. While Binance’s visits per user are going to be longer because of the vast amount of assets available on their site, in general, both sites have experienced positive momentum in regard to this metric, as Binance’s average visit length increased by 40% since December 2018 and Coinbase’s increased by 17%. Notably, over the past four months, both sites have averaged the same time metric as they did during the parabolic rally in the last four months of 2017.

Coinbase also released a recent blog post highlighting the growing retail awareness of bitcoin, and stated that 58% of Americans have heard of bitcoin, and “upwards of 15% of Americans are ‘somewhat’ or ‘very’ likely to buy bitcoin or some other cryptocurrency in the near future.” Statistics vary between different surveys, as Blockchain Capital’s recent blog post cited that 89% of people have heard of bitcoin in the Spring of 2019, versus 77% of people in the Fall of 2017. The Blockchain Capital post also highlights that 9% of the population owns bitcoin, with that number jumping to 18% for the 18–34 age group (aka Millennials). A Fidelity research report from the beginning of May showed institutional ownership is actually greater than retail, with 22% of institutional investors surveyed stating that they have exposure to digital assets. The key notation is that awareness of digital assets has been rising even with bitcoin’s price at approximately half of its 2017 peak.

Source: Blockchain Capital

Bitcoin Dominance

Bitcoin’s dominance, calculated as the market capitalization of bitcoin compared to the total cryptocurrency market, hit 62.7% at the end of June, the highest it has been since mid-September 2017 (recent low of 36% in August 2018). It is our view that this recent uptick supports the theory that new entrants are establishing cryptocurrency exposure by mostly, if not entirely, allocating to bitcoin.

Altcoins are Trailing

One of our favorite metrics to keep an eye on is the relative performance of top cryptocurrencies versus that of bitcoin. Astoundingly, all of the top 10 cryptocurrencies are trailing bitcoin since the current rally began on April 1st. Bitcoin Cash was outperforming bitcoin by about 54% at the beginning of the month, the only cryptocurrency to do so between April 1st and May 31st, but closed the month trailing bitcoin’s return by 27%.

Bitcoin is significantly outperforming most of the top cryptocurrencies by market cap, up 165% since the rally began on April 1st, with XRP (Ripple), EOS, Stellar, Tron, and Cardano all trailing bitcoin by more than 100% — quite a different picture than the retail-led altcoin mania of 2017. Many top altcoins outperformed bitcoin by thousands of a percent during that time — a testament to the retail appreciation for the new projects. It is our belief that this bitcoin-led rally is due to new institutional entrants getting exposure to cryptocurrency through bitcoin. It’s apparent that many of these altcoins are out of favor with investors, as Steller (XLM) is basically flat, and XRP, EOS, Tron (TRX) and Cardano (ADA) are up less than 50% since April 1st, compared to bitcoin’s 165% return.

Volatility

Coming out of the January rally, bitcoin volatility was painfully low throughout the first quarter of 2019 but gradually increased throughout the second quarter, peaking on June 30th with a six-month volatility reading closing at 95.28%, the highest it had been since April 2018. Bitcoin’s volatility was on full display throughout the month, as the asset rallied 62% from the beginning of the month through June 26th, only to fall 24% in just over 24 hours.

Long term volatility averages are declining, as to be expected with any emerging asset but there are going to be periods of elevated volatility. Today, bitcoin is still more than eight times as volatile as the S&P 500, and its 500-day average is hovering around 100%. While it is likely that we will see periods of elevated short-term volatility as bitcoin emerges as an institutional asset, it’s unlikely to be the type of volatility that was on display over 2014 and 2015. This is due, in part, to shifting market dynamics caused by increased participation and wider audiences with significant amounts of capital to inject in the marketplace.

Risk/Reward Review

As reported last month, Binance Coin (BNB) was the only top altcoin in May to provide a better risk-adjusted return year to date than bitcoin. The trend continued in June with BNB’s year-to-date (as of June 30) Sharpe ratio of 4.11 versus bitcoin at 3.41. Sharpe ratios fell for all top 10 digital assets despite the monthly uptrend due to the increased risk (volatility) that the assets exhibited. Historically, bitcoin has had an elevated risk-reward ratio compared to other top digital assets, a trend that continues to ring true through the first half of 2019.

Correlations

Given bitcoin’s dominant surge as of late, it’s natural that correlations to bitcoin would fall as other assets fail to keep pace with its resurgence. Accordingly, over the last two months, correlations have generally fallen against bitcoin. Binance Coin continues to remain the sole asset in the top 10 that consistently remains statistically uncorrelated to bitcoin. However, Tron’s correlation has been gradually fading all year and is now statistically uncorrelated to bitcoin as well. If you are interested in tracking correlations, check out our daily correlation matrix or our rolling historical correlation heatmap.

More often than not, market cycles dictate that assets are generally less correlated in an upward trending environment and more correlated in a bear market. Thus far, the same has rung true for cryptocurrency, as the average correlation of top altcoins to bitcoin was 0.65 in June and has been fading since it peaked at 0.83 in January 2019. We expect this trend to continue as projects fall in and out of favor.

Looking forward to next month

After significantly outpacing many other top coins, Bitcoin sold off into month-end, exhibiting significant volatility after nearly a year of below-average volatility. Institutional interest should dampen volatility over the long term, but while these assets are still emerging the speculative nature of cryptocurrencies is ripe for a heightened risk environment.

What we’ll be watching in July:

• Facebook’s ongoing saga with lawmakers on the status and regulation surrounding their proposed initiatives;
• Binance’s US regulatory initiatives and US exchange rollout;
• Whether altcoin’s performance lag will continue, or see a resurgence after a big run in bitcoin;
• Continued follow-through in CME futures contracts and adoption of LedgerX and ErisX’s institutional platforms; and
• Retail follow-through on slow but continued growth throughout the year.

Tracking all the developments and market moves in June only leave us more excited to see how the rest of this month and upcoming months play out as well. If you would like to receive our monthly market commentary again next month please sign up here.

The opinions and data presented herein are for informational purposes only and should not serve as the basis of any investment decision. Information is given in a summary form and does not purport to be complete. Information and data have been obtained or derived from sources believed by Blockforce Capital to be reliable, however, Blockforce Capital does not make any representation or warranty as to its accuracy or completeness. The sole purpose of this material is to inform, and in no way is intended to be an offer or solicitation to purchase or sell any security, other investment or services, or to attract any funds or deposits. Past performance does not guarantee future results.

DISCLOSURE: Blockforce Capital manages investment vehicles that invest in and hold digital assets, including the digital assets discussed in this article.