Why 72% of institutional investors believe that the value of crypto assets will rise during a recession
Macroeconomic analysis of cryptocurrency market
Crypto market is a part of a bigger global financial market and its price performance depends on fundamental factors of crypto ecosystem as well as global trends which will dominate on the market in the nearest future.
U.S. Dollar Index and cryptocurrency market sentiment
Dollar index is one of the most important indicators determining flows of capital on a macro scale. The U.S. Dollar Index (USDX, DXY, DX) is a measure of the value of the United States dollar relative to the U.S. trade partners’ currencies: Euro (57,6%), Japanese yen (13,6%), Pound sterling (11,9%), Canadian dollar (9,1%), Swedish krona (4.2%) and Swiss franc (3,6%). The Index goes up when the U.S. dollar gains “strength” (value) compared to other currencies.
According to the chart above, DXY was going south during all of 2017. Market was on a “risk on” mode from the beginning of 2017 until 2018 with capital flowing out from USD into risk assets classes such as emerging markets, crypto, junk bonds etc.
This time corresponds with crypto market bull rally. Speculative capital flowing out of USD partially came to the crypto market after a series of positive news, for example, Japan legalising Bitcoin in march 2017 and ICOs becoming new hot topic in retail investing, igniting wild rally which quickly transformed into hype.
It’s worth mentioning that the main driving force in the market was retail capital as institutional investors were not ready, nor able to participate. The reason behind this was insane volatility, lack of regulation and infrastructure: absence of custody services and regulated marketplaces with proper compliance.
Retail rally by its own nature is short-lived since participants’ capital is limited. The majority of the capital is in the hands of institutional players such as big banks (JP Morgan, Goldman Sachs), institutional money managers (Fidelity, Blackrock), pension funds, sovereign funds, endowments etc.
By the beginning of 2018 retail investors had finally run out of founds and gave up. Author can remember stories of a taxi driver talking about Telegram ICO and guys in a dealership center discussing Ripple back in december. When things reach the bottom of pyramid (retail investor pyramid in our case) it’s time to sell. Without institutional money following into the market the last participants of the bull run were left with bags which then quickly went underwater with nobody eager to buy them at higher prices.
The end of the rally corresponds nicely with DXY low of early 2018
The ongoing rising rates cycle by FED finally persuaded investors (especially smart money investors who bought early and made large gains) into considering USD as a “safe haven” asset for foreseeable future. As a result they started ditching risky assets such as emerging markets equity and corresponding currencies, e.g. lira, ruble, rand and real. Eventually, US markets broadly outperformed emerging markets in the first half of the year.
Crypto market is considered to be a risky asset class and that’s for a good reason. Insiders took advantage of hype fixing huge profits with Charlee Lee selling his Litecoin or Justin Sun — his Tron. This pushed exhausted market further south, together with a good amount of FUD: Tether insolvency rumors, Korean exchanges deposits ban, MtGox liquidation of remaining assets and US tax period.
Since the beginning of the year capital outflow in USD is really unprecedented
According to Commitment of Traders report (CoT) long positions of Large Speculators literally exploded to historical highs and currently is a 3 standard deviation (3 sigma) event. This situation is very rare for any market and by design it is posed to return to the mean.
In other words — the trade is so overcrowded that it is really hard to imagine anyone who have not bought into the USD yet. Its reminds us crypto market as of the end of 2017.
In our opinion there are several possible catalisis for market mood change.
1. China trade war;
2. US weaponizing the dollar with sanctions against Iran, Russia and unwillingness of other countries (EU in the first place) to follow US policy;
3. Dedollarization as a global phenomenon with Europe striving for economic independence through creation of alternative financial system (special purpose vehicle to trade with Iran);
4. Bloodbath on an equity and debt market;
6. EU Italy budget fight;
7. Khashoggi killing by Saudi Arabia and its consequences for global markets
According to J.P. Morgan Chase’s head quant, Marko Kolanovic, US dollar is at risk of losing its reserve currency status. In general, the theses of the quantum guru repeat those mentioned by us above.
His concern is shared by other sharks of the financial world:
- Stanley Druckenmiller: Next financial crisis could be bigger than last;
- Ken Griffin: there are at least 18-to-24 months left in the market rally, thanks to the “giant adrenaline shot” of the U.S. tax overhaul;
- Ray Dalio: the U.S. economy is about two years from a downturn, which will see the dollar plunge as the government prints money to fund a swelling deficit.
Thus, in the near future, we expect a turnaround of DXY index targeting 84 region which is support of the 10-year channel. And of course breaking that channel is also remaining an option depending on how quick dedollarization trend will proceed.
An outflow of capital from dollar will force investors to look for the next “safe haven” trade. In general, we can highlight gold, which CoT positions are no less extreme than dollar’s and Treasuries. And, of course, crypto market and Bitcoin in particular which volatility is at all time lows since june and looks quite comparable with volatility of some emerging fiat currencies.
In favor of the latter, the fact is that more and more professional participants are considering Bitcoin as a store of value, which, in particular, is indicated by recent investment by Yale University in a crypto fund.
In conditions of uncertainty and increasing volatility in traditional markets, the increased volatility of the crypto market will not be such a significant deterrent in the eyes of investors.
Again, since June, Bitcoin has been trading in a very narrow range, confidently holding the support level of $ 6,000, which was formed in early February (source). In our opinion, the stability in the crypto market suggests that there is a massive accumulation ongoing by institutional investors.
Crypto market in deflationary environment
Another scenario we are questioning ourselves — what will happen to Bitcoin and crypto market in case of a severe correction on equity markets?
By its nature correction is a very deflationary event with traders liquidating their portfolios in cash in panic disregarding of an asset class. This type of behaviour is market psychology 101 when things starts to look really bad.
And only after going cash people start to look for the next “safe haven”. The best example here is gold back in 2008. When financial crisis started in september 2008 gold dropped from $936 to $681 (about 30%) in a matter of a single month. However, after first knee jerk reaction traders realized that in a new reality gold is a “safe haven” asset and quickly bought it back, igniting a new multi-year bull trend which catapulted gold to a new ATH.
So, in theory for a while a severe market correction can drag down all asset classes including Bitcoin. However, it’s not the case in our opinion. There are several reasons for that.
First — unlike gold in 2008, Bitcoin is barely a position in portfolio of any professional money manager. Institutions are simply not yet in crypto, so in case of a dump they will not be selling for the simple reason — no exposure to Bitcoin in their portfolios.
Second — if first is true, only a limited group of retail traders can be selling crypto. However taking into account that we are in a correction for 10 months now, its safe to assume that all weak hands had already sold their positions with mostly a strong hands remaining. Bitcoin is holding a $6.000 support nicely from february which in our opinion is indicating that a strong accumulation by big institutional players is ongoing (Bakkt, Fidelity, VanEch are about those candidates). In case of a (limited) retail dump our whales would easily buy it. Our worst case scenario — $5.500 for Bitcoin if this plays out.
Third — quite opposite to the above mentioned can happen with people quickly realizing Bitcoin is a “safe haven” bid as it is an asset outside of a banking system (as well as gold) but unlike gold it`s not simply an asset, it’s a full scale financial system operating flawlessly 24/7 for the last 10 years.
To summarize it all, we believe that global uncertainty, geopolitical instability and increasing expectations of a recession will have a positive impact on the crypto market. According to a recent study by Fundstrat Global Advisors, 72% of institutional investors believe that the value of crypto assets will rise during a recession.
Fundamental assessment of the current crypto-ecosystem state
When assessing the state of a crypto-ecosystem, two types of factors should be considered:
1. Technical development of the industry and its progress since the beginning of the year;
2. Development of associated traditional market infrastructure and regulation.
As for the first factor, it cannot be described in a separate article due to the global nature of the ecosystem. It can be noted that state of technology of the crypto ecosystem, is several light years away from the end of 2017, when the crypto market was ATH:
- lightning network;
- atomic swaps;
- private smart contracts crucial for any financial applications;
- launch of the legal security tokens that open the way to asset tokenization;
- tokenization of major messengers, such as LINE and Telegram;
- integration of private blockchain solutions by the largest banks in the world;
- first implementation of scalable and interoperable protocols;
- emergence of the first Proof-of-stake systems and on-chain governance;
- first platforms for security tokens
- stable coins “explosion”
The second factor (development of associated traditional market infrastructure and regulation) seems to be much easier to analyse in terms of its impact on the price of crypto assets in the nearest future.
For a long time, the attention of investors’ community was focused on the launch of the first bitcoin ETF and its endorsement by the SEC, as this event in market`s opinion, was supposed to open up an access to institutional investors and start the next wave of growth.
In our opinion it’s a very narrow point of view as it’s only one piece of a puzzle that allows institutional players to seamlessly invest in crypto assets. The second piece is the presence of professional custodian solutions on the market offered by proven traditional participants.
In this part, the crypto ecosystem achieved its goal since giants such as Bank of New York Mellon, Northern Trust, Fidelity and Coinbase obtained licenses to provide custodian services. From that point, this is no longer an obstacle for institutional players to enter the market.
However, focusing on the launch of the ETF, the market underestimates another very important event — December launch of ICE and Microsoft joint project — Bakkt. This marketplace, launched by the world’s largest stock exchange operator ICE (a corporation with assets worth 42 billion dollars, which is the parent company of the NYSE) will allow institutional players to buy bitcoin with full compliance.
The main product of Bakkt platform is one-day bitcoin futures with physical delivery and it’s very different from CME and CBOE futures. Those trading at CME and CBOE represents contract for difference (CFD) nominated in US dollars and are not creating a demand for the underlying asset (Bitcoin). Bakkt’s one-day physical bitcoin futures traded in pairs with USD, EUR and GBP provide delivery of Bitcoin to the buyer’s account by the end of the day. Thus, this will create a strong demand for the underlying asset and could serve as a catalyst for the next crypto rally.
Finally, with Fidelity announcing its services lately and Nasdaq said to start its own at the beginning of 2019 situation reminds us of a race among big players in the field of traditional finance.
And the most recent news came out VanEck, CBOE and SolidX meeting with SEC commissioner Elad Roisman, significantly increasing chances of ETF`s approval.
After all ……. Bakkt, Fidelity, Nasdaq, TD Ameritrade, NYSE, BlackRock, Northern Trust, BNY Mellon, Goldman, JP Morgan, VanEck, CME and CBOE, Yale endowment, top VC`s and tech`s …… do you really think they are investing in the market with $200bln in mind? They know it’s very temporary with Trillion(s) market coming very soon! Stay tuned!