Crypto at a Crossroads

Store of value, or speculative asset?

Number of the Week: $31 billion (explanation below)

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Crypto at a Crossroads

It’s been an instructive—albeit, for some, painful—week, reminding the world that the price of Bitcoin can actually go down, about 26% over the past seven days.

The precipitous drop came ironically as the mainstream embrace of Bitcoin continued at a feverish pace; Blackrock, Square, and Tesla all announced new or increased Bitcoin investments in recent days. And the mainstream embrace is not merely at the institutional level; in the UK, the financial tool Money Dashboard announced this week that it will allow its 600,000 customers to access their crypto assets along with their other financial holdings. US companies are clearly eyeing similar integrations; this week Dan Carroll, co-founder and Chief Strategy Officer at Wealthfront, told FIN “it's more a matter of when, not if” his roboadvisory firm starts offering crypto tracking and trading alongside its other wealth management tools.

All of the new attention should be an accelerant for Bitcoin and other cryptocurrencies. Last year, Chris Dixon and Eddy Lazzarin from Andreessen Horowitz argued that crypto has gone through three cycles which follow a rough pattern: price rises lead to more interest and more social media posts; which in turn spawn new ideas and new startups and projects; which then fuel the next cycle.

But it’s also true that increased attention to cryptocurrency reveals a lot of unsavory activity that makes traditionally-minded investors anxious. This week, New York State Attorney General Letitia James announced an $18.5 million settlement with Bitfinex and Tether, charging that the companies misled the market about the money that was supposed to be backing the Tether “stablecoin,” and moved money around to hide substantial losses.

While the companies technically admitted to no wrongdoing, the facts in the settlement are quite damning. Bitfinex and Tether lost Wells Fargo as their banking partner in 2017 and couldn’t find any legitimate bank that would work with them. They ended up in bed with a payments firm called Crypto Capital, ostensibly based in Panama but also in trouble with Polish authorities over money-laundering allegations. That company was indicted by the US Attorney for New York’s Southern District in 2019 for bank fraud and conspiracy to run an unlicensed money transmitting business.

From the Bitcoin ecosystem’s perspective, arguably more damning than Bitfine/Tether’s alliance with sleazy financiers is the Attorney General’s insistence that for a substantial period, Tether was creating millions, perhaps billions, of Tether coins that weren’t actually backed 1-to-1 by US dollars held in reserve, as Tether consistently told investors it was doing.

There have been credible allegations in the past that the firms used these untethered Tethers to manipulate the Bitcoin market; the companies have obviously denied that, but even the possibility points to the liquidity issues that dog Bitcoin, even as it grows ever bigger. A similar red flag emerged this week when the S-1 for Coinbase was made public. (Note to paying subscribers: FIN will issue an in-depth examination of Coinbase’s going public in the coming week.) Among the risk factors Coinbase listed is that its business could be harmed by “the identification of Satoshi Nakamoto, the pseudonymous person or persons who developed Bitcoin.” Name another legal industry that would be damaged by naming the person who invented it!

And that brings us back to some nagging, fundamental questions about what exactly Bitcoin and crypto are supposed to be. CNBC.com’s reporter Taylor Locke recently asked a bunch of questions that got me thinking about Bitcoin as a “store of value,” which many Bitcoin investors claim is a key motivation for their purchases. There’s a lot of doubt about whether collectively that’s what Bitcoin investors are doing.

In 2018, two economists then affiliated with Yale published a multiyear study of Bitcoin, Ethereum, and Ripple. They focused on, among other things, cryptocurrency as a store of value. They reasoned that if investors treated cryptocurrencies as a store of value, then the currencies should behave similarly to more time-honored stores of value, such as gold, platinum and silver. Their study found that, with the exception of Ethereum’s exposure to gold, there was no statistically significant correlation between cryptocurrencies and the three precious metals.

This point was further developed in a blog post last month from Ray Dalio and four of his colleagues at Bridgewater. Bridgewater examined in great detail the Bitcoin traits that make it a theoretical store of value:

Certainly, Bitcoin has merit: similar to gold, it cannot be devalued by central bank printing and its total supply is limited. Further, it is easily portable and exchangeable globally, especially for individuals. It also has the potential to provide diversification…

But in practice, the Bridgewater analysts point out, that’s not really how investors have treated Bitcoin in its ten-year history. There are many ways to measure that; an especially telling one is to look at Bitcoin’s average daily turnover, as a percentage of the amount outstanding, in comparison to gold:

A market in which half of all Bitcoin is trading hands in a single day is an environment for speculation, not for storing longterm value. The Bridgewater analysts are careful to point out that Bitcoin and crypto markets are still in their infancy, and that as they mature their potential to act as a store of value may become less theoretical. They conclude that Bitcoin at present “feels more like an option—it remains a highly volatile and speculative asset.” Even investments like Square’s and Tesla’s don’t change the fundamental issues, they note, because “a large share still appears to be using Bitcoin for shorter-term speculative trading, rather than as an actual longer-term savings vehicle.” And as long as there’s a market that dips 26% in a week, a lot of institutional players will remain on the sidelines.

FINvestments

🦈Number of the Week: CNBC.com reported this week that Buy Now, Pay Later giant Klarna is about to close a $1 billion (!) fundraising round that will value the Stockholm-based company at $31 billion. That would make it Europe’s largest tech unicorn, although these days that title seems to change every few weeks.

🦈The Information reported that Brex, which provides credit cards and financial management tools to startups, is raising money that values the firm at $8 billion, more than 3 times what it was ostensibly worth when it raised in 2019. This is especially interesting because when COVID hit a year ago, it looked like Brex’s customer base was about to crater.

🦈US regulators have repeatedly declined to authorize a Bitcoin ETF. But in late February, two Bitcoin ETFs began trading on the Toronto Stock Exchange, attracting collectively more than a billion dollars in assets right out of the gate.

Photo by André François McKenzie on Unsplash