Crypto in 2019: where do we go from here?
As is customary at this time of the year, we would like to share our parting thoughts on 2018 and outlook for 2019. 2018 turned out to be a lot tougher than most people expected. This applied not just to the crypto market but across most asset classes. The combination of rising interest rates, the threat of a major trade war and rich valuations posed a serious headwind for risk assets. The crypto market had to deal with a deflating ICO bubble and a regulatory crackdown from the U.S. SEC. Many crypto startups that had no/poor treasury management were caught overexposed to Ether prices and its sharp correction has seriously compromised these projects. Similarly, many funds with poor risk management overexposed themselves to falling Ether prices via ICOs. Most of these funds are either down significantly, stuck in illiquid assets or both. The challenging environment notwithstanding, there are still some industry excesses that need to be worked through. Even the good teams are now starting to make the hard decision to restructure in order to navigate the current environment.
We expect the news headlines to remain negative in the first half of 2019. However, we believe there are reasons to be optimistic. Many teams are still hard at work. The first of the scaling projects (where so much capital was channeled into in late 2017-early 2018) should be launched in 1H2019 and based on preliminary testnet results, we are optimistic that the debate about blockchains’ ability to scale will largely be resolved favorably when some of these projects come into fruition. In addition, many have doubted the usefulness of cryptocurrency as mediums of transactions due to their volatility. A number of stablecoins were launched in the past three months including USD Coin (USDC), Gemini Dollar (GUSD), TrueUSD (TUSD), Paxos Standard Token (PAX), Stronghold USD (SUSD), all of which have held their pegs well despite the bear market. So, while Basis has given up and other stablecoins have failed, there are today more than 10 stablecoins that are functioning as intended, and there are others that will be launched in 2019 including Facebook’s own stablecoin. Besides these, we expect to see the first interoperability projects launch in 2019 including those from Polkadot, Cosmos and Wanchain. So bottomline, there is a lot of developmental work to look forward to that will contribute to making cryptocurrencies and blockchains more useful and disruptive than they have been so far.
Alongside that, we also expect to see more institutional participation in the space. In our previous newsletters, we have highlighted the activities of several large financial institutions such as the World Bank, Intercontinental Exchange (ICE) via its subsidiary BAKKT, Fidelity Investments, Yale Endowment Fund, PNC Bank and others in the crypto space. There are many others that are involved but have not publicly made any announcements. We can expect these to come in 2019.
One factor that has hindered the growth and legitimacy of the cryptocurrency space is the lack of a consistent regulatory framework. Some governments have opted for a light touch regulatory approach to foster innovation (e.g. Switzerland, Singapore, Japan). Others have adopted a more hardline approach by banning or heavily restricting all crypto related activities (e.g. China, India). Yet others haven taken a more proactive stance by enacting regulations that are favorable to crypto startups (e.g. Malta, Gibraltar). The 800-pound gorilla in the room, the U.S. SEC, has largely relied on existing securities regulations to govern the cryptocurrency market. In the past few months, the SEC has been taking enforcement actions against numerous projects for failing to register their offerings with the SEC or operating unlicensed exchanges. A pair of U.S. lawmakers are now looking to bridge the gap between the crypto community and fuzzy regulation. Rep. Warren Davidson of Ohio and Darren Soto of Florida have introduced the “Token Taxonomy Act,” which would essentially remove cryptocurrencies from the securities discussion. The bill, if it becomes law, would likely exclude most digital currencies from the SEC’s definition of what constitutes a security. The SEC’s current definition of a security, based on the Howey Test, goes back more than 70 years, with no provisions for the decentralized assets which currently circulate in the crypto markets. Whatever the outcome of this bill, one thing is clear: there should be greater regulatory clarity in 2019. In the meantime, founders are turning to Securities Token Offerings (STOs) to access funding. STOs are, by design, more compliant and less disruptive than ICOs.
So where do we go from here? Are we yet at the market bottom? Based on my experience with financial markets, calling market bottoms is always tricky as markets have a way of surprising us. Nonetheless, as discussed earlier, based on current industry conditions, valuation parameters and technical indicators, we believe a market bottom is near, if the 15 December Bitcoin price low of $3,180 wasn’t already the bottom. Having said that, we believe the market is likely to consolidate near the lows over the next 6–9 months before we get a more sustained recovery. While we expect the first half of 2019 will be tough, we believe the narrative will start to change as we get into the second half of the year. This will partly be a function of the positive development buzz we will get as some of the new innovations discussed above come to market. The entry of more institutional players will also add to this buzz. The regulatory side is where things might surprise both ways with enforcement actions against more high-profile projects being the key risk, while success with the proposed new bill would be the upside scenario. Any Bitcoin ETF approval would also be a major catalyst.
As we approach the second half of 2019, the Bitcoin Halving narrative will also come into play. The incremental supply of Bitcoin is algorithmically programmed to halve every four years. That is, miners who provide hashing power to secure the Bitcoin network will see their block reward cut in half at that point. Miners are currently earning 12.5 Bitcoins per block, or approximately 1,800 Bitcoins per day. Although some miners hold a portion of their mined coins, most sell the coins immediately at market price to cover electricity costs and to lock in their profit. The next halving occurs in May 2020, after which miners will only earn 900 Bitcoins per day, reducing the daily Bitcoin supply on the market drastically. The last 2 halving events (November 2012 and July 2016) coincided with the early stages of a multi-year rally in Bitcoin prices. Now, the Halving event itself is not a guarantee of a price rally, as incremental demand for Bitcoin still needs to exceed incremental supply for prices to move higher, but assuming demand growth is somewhat steady, the halving of new Bitcoin supply does provide upside impetus to Bitcoin prices.
