Hashdex Director of Marketing Chris Glendening recently sat down with International Head of Product Dramane Meite for a discussion on the current state of the crypto markets. Dramane shared his views on index investing in the current environment, institutional interest in crypto, and the global regulatory landscape.
Chris: The crypto markets experienced some big swings in August, after a period of relative calm in July. What were the catalysts driving the recent volatility?
Dramane: There’s a lot of factors at play regarding short-term market action, but the macro environment is certainly at the top of the list. Developed markets are facing the highest inflation levels in 40 years, growth is slowing, and recession risks are rising in the US. With this backdrop, investors reacted in mid-August to some unexpectedly hawkish minutes from the FOMC’s most recent meeting regarding the Fed’s intention to continue raising interest rates to combat high inflation. Crypto has not been immune to this macro landscape and sold off alongside the global equities markets.
There are crypto-specific events impacting recent volatility as well. Most notable is the long-awaited Ethereum merge, which will transition the network from a Proof-of-Work to Proof-of-Stake consensus mechanism. This transition is now imminent and will remove a huge uncertainty surrounding Ethereum’s future and its position as the dominant smart contract platform. But uncertainties around its impact remain, which has made some investors nervous.
Chris: Is the macro landscape or recent developments changing your views on the asset class?
Dramane: Despite these short-term headwinds, we are very bullish on crypto as an asset class over the long term. And this bear market has amplified some important strengths of crypto now compared to previous bear markets. For example, the overall ecosystem is healthier, as many non-viable projects and companies did not survive—or won’t survive.
The Merge could be a game changer for Ethereum and the crypto ecosystem as a whole. We believe this is not fully priced in by many investors, especially the potential price impact of a drastic (~90%) reduction in daily new tokens issuance after The Merge is completed in mid-September.
Interestingly, despite the bear market, institutional adoption of crypto remains strong and is even accelerating. VC investments in crypto in 2022 reached $18.3 billion at the end of July, nearly triple the amount invested in 2020 and on pace to exceed 2021's record haul of $32.4 billion.
There are also more traditional institutions making huge commitments to crypto and blockchain-based technologies. BlackRock, the largest asset manager in the world, announced it will be offering a bitcoin private fund to its institutional clients in the US and is partnering with Coinbase to enable access to investors via its Aladdin platform. These are massive steps in legitimizing bitcoin and crypto assets and will help make them easily accessible to large institutional investors and gatekeepers. We think many investors are too focused on short-term price action, and are not paying enough attention to these types of monumental events that strengthen crypto’s long-term investment case.
It’s also important to keep in mind we are still very early in crypto adoption. A recent Pew Research survey found that only 16% of US adults have ever invested in, traded, or used a cryptocurrency. In most European countries, less than 10% of the population is a cryptocurrency user. Many analysts draw parallels between where we are today in the crypto market and the internet in the mid-to-late 1990s, and we all remember the hyper-adoption phase that came right after. So, perspective here is important.
Chris: In this type of environment, what are the benefits or trade-offs of having broad crypto exposure versus investing strictly in single assets?
Dramane: It’s hard enough to pick winners and losers in traditional financial markets, let alone in an emerging technology and asset class like crypto. Broad exposure to crypto assets via a crypto basket is the most sensible approach to investing in this industry, instead of trying to time the market or select a single coin or token that will outperform all the others. As we shared in a recent research commentary, the case for a crypto basket—and for diversification—is stronger in this uncertain short term macro environment.
A broad market index such as the Nasdaq Crypto Index (NCI) or Nasdaq Crypto Index Europe (NCIE) provides exposure to the most mature and liquid tokens instead of having to pick just one or two; and we believe the NCI/NCIE should constitute the core allocation of a crypto portfolio. We co-developed these indices with Nasdaq to give investors access—via a single regulated product—to a basket that covers more than 60% of the eligible crypto universe.
One of the key features of the NCI indices is that they are dynamic and rebalanced quarterly. This allows the indices to get exposure to emerging crypto assets as they mature and gain relevance in the market. For instance, Uniswap was added to the NCIE in September and has proven to be one of the most successful decentralized applications (dApps) in crypto. Uniswap’s inclusion in the NCIE is exactly why it’s important to get broad crypto exposure through a dynamic index.
Chris: Beyond NCI-based products, Hashdex has also been a leader in providing investors with sector-specific or thematic products. Are there particular areas that are generating more attention from investors these days?
Dramane: Thematic strategies can offer investors a great opportunity to express their views on specific areas of the crypto ecosystem. While exposure to the NCI/NCIE can serve as a core crypto allocation, a thematic strategy can allow investors to get exposure to one area of crypto that is still diversified at the sector level.
I mentioned Uniswap earlier, and it’s hard not to talk about DeFI given how it has performed in the recent environment. We recently wrote a more detailed client piece on this topic, but if you look at the liquidity and market stresses the crypto market has faced this year, one thing is true: DeFi worked while CeFi—centralized finance platforms—failed.
CeFi projects (e.g., 3AC, Celsius) lost investors' funds, while DeFi lending protocols (e.g., Aave, Compound) worked and are still standing. This performance has vindicated the value of “Code is Law” as well as the importance of DeFi protocol transparency. In addition, centralized exchanges (CeXs) halted customers’ withdrawals many times but decentralized exchanges (DEXs) such as Uniswap were up and running the whole time—even during periods of heightened volatility.
DeFi works at scale and is gaining market share against centralized platforms. In fact, as of June this year, Uniswap’s trading volumes rivaled Coinbase volumes, one of the leading crypto centralized exchanges.
DeFi protocols tend to generate revenues, something different from most crypto projects. This serves as a useful anchor for traditional investors to validate that indeed these projects create a valuable service that users are willing to pay for. In 2021, Uniswap collected a total of $1.5 billion in fees from trades executed and it has an annualized run rate of $755 million for 2022. One interesting development at Uniswap is a proposal to activate a “fee switch” that would return some revenue to the protocols and token holders. These types of monetization initiatives are important factors making the DeFi sector particularly attractive to investors.
Chris: Let’s wrap up by shifting gears to the regulatory landscape. European crypto regulation has been front and center recently, especially in light of EU policymakers seeking to cap banks' crypto exposure. What should investors be watching for in the current regulatory environment?
Dramane: The EU Parliament’s proposal, which would apply a punitive capital treatment and impose caps on banks' balance sheet exposures to crypto assets, is not surprising. It’s in line with the Basel Committee on Banking Supervision’s recommendations in June and consistent with how bank regulators approach capital requirements for risky assets.
What is interesting is that the proposal delineates between 1) crypto assets such as regulated stablecoins and securities using distributed ledger technology, and 2) all the other crypto assets—including bitcoin and ether—they consider more volatile and risky. The first group is deemed less risky and under the proposal would have more flexible capital requirements with no cap. The second group is subject to the cap and the punitive capital requirement. The nuance between these two classifications will be a huge plus for large financial institutions to fully engage with crypto assets.
The proposal is still in its early days and would need support from other lawmakers in the European parliament. A vote is expected in December, so we anticipate full engagement from the crypto community as this proposal advances.
The most important piece of crypto regulation is MiCA, the recently enacted Markets in Crypto Assets law. MiCA could become a global reference, as the first comprehensive set of rules applying to crypto issuers and services providers. There are two important developments resulting from MiCA:
First, it creates a unique regulatory framework—instead of the patchwork of different countries’ policies—that helps service providers build and scale across the European Union. As an ETP issuer, we rely on these service providers. The more effective regulation placed on these entities will help benefit issuers and end investors as well.
Second, MiCA gives regulatory clarity to institutional investors, private and retail banks, and distribution platforms. These important participants can now develop a crypto strategy and how they will partner with issuers like Hashdex and others. This clarity also helps them to confidently support their clients' crypto journey. Large financial institutions and their gatekeepers are key to getting onboard to move the large pools of capital off the sidelines. And these institutions can’t afford to be idle, not when their clients are demanding crypto products that some of their more aggressive peers are offering.
Ultimately, we believe Europe remains the best market for crypto ETPs. There are a lot of innovative products that are accessible to retail investors, and a very supportive regulatory environment. With MiCA, Europe is positioning itself as a global leader in crypto regulation and providing a blueprint that we hope guides other regulators. More regulatory clarity is a net positive for crypto adoption in Europe, and we are bullish on the European crypto ETP and investment products landscape.
The information contained herein (“Information”) may not be reproduced or redistributed in whole or in part, in any format, without the express written approval of Hashdex Asset Management Ltd. (“Hashdex”) and its affiliates and subsidiaries (“Hashdex Group”). By accepting this document, you acknowledge and agree that all of the Information contained in this document is proprietary to Hashdex Group. While not explicitly referenced within this piece, Hashdex Group includer investment vehicles focused on digital assets which invests in digital tokens (collectively the “Products” and each a “Product”). The Information is not an offer to buy or sell, nor is it a solicitation of an offer to buy or sell, interests in the Products or any advisory services or any other security or to participate in any advisory services or trading strategy. If any offer and sale of securities is made, it will be pursuant to the confidential offering documents of the Product (the Offering Documents). Any decision to make an investment in the Products should be made after reviewing the relevant Offering Documents, conducting such investigations as the investor deems necessary and consulting the investor’s own investment, legal, accounting and tax advisors in order to make an independent determination of the suitability and consequences of an investment.
Each Product seeks to track a relevant index. The performance of each Product will vary from the performance of the relevant index that it seeks to track. The Information is being provided to you solely for discussion purposes and may not be used or relied on for any purpose (including, without limitation, as legal, tax or investment advice) without the express written approval of Hashdex Group. Certain statements reflect Hashdex Group’s views, estimates, opinions or predictions (which may be based on proprietary models and assumptions, including, in particular, Hashdex Group’s views on the current and future market for digital assets), and there is no guarantee that these views, estimates, opinions or predictions are currently accurate or that they will be ultimately realized. To the extent these assumptions or models are not correct or circumstances change, the actual performance of Hashdex Group and the Products may vary substantially from, and be less than, the estimated performance. None of Hashdex Group, the Products nor any of their respective affiliates, shareholders, partners, members, directors, officers, management, employees or representatives makes any representation or warranty, express or implied, as to the accuracy or completeness of any of the Information or any other information (whether communicated in written or oral form) transmitted or made available to you.
Each of the aforementioned parties expressly disclaims any and all liability relating to or resulting from the use of the Information or such other information. Except where otherwise indicated, the Information is based on matters as they exist as of the date of preparation and not as of any future date and will not be updated or otherwise revised to reflect information that subsequently becomes available, or circumstances existing or changes occurring after the date hereof. Investing in financial markets, the Products and digital assets, including Bitcoin, DeFi tokens, and Ethereum, involves a substantial degree of risk. There can be no assurance that the investment objectives described herein will be achieved. Any investment in the Products may result in a loss of the entire amount invested. Investment losses may occur, and investors could lose some or all of their investment. No guarantee or representation is made that Hashdex’s investment strategy, including, without limitation, its business and investment objectives, diversification strategies or risk monitoring goals, will be successful, and investment results may vary substantially over time. Nothing herein is intended to imply that the Hashdex Group’s investment methodology or that investing any of the protocols or tokens listed in the Information or the Products may be considered “conservative,” “safe,” “risk free,” or “risk averse.” Neither historical returns nor economic, market or other performance is an indication of future results. Certain information contained herein (including financial information) has been obtained from published and non-published sources. Such information has not been independently verified by Hashdex Group, and Hashdex Group does not assume responsibility for the accuracy of such information. Hashdex Group does not provide tax, accounting or legal advice. Certain information contained herein constitutes forward-looking statements, which can be identified by the use of terms such as “may,” “will,” “should,” “expect,” “anticipate,” “project,” “estimate,” “intend,” “continue” or “believe” (or the negatives thereof) or other variations thereof. Due to various risks and uncertainties, including those discussed above, actual events or results, the ultimate business or activities of Hashdex Group or the Products or the actual performance of Hashdex Group, the Products, or digital tokens may differ materially from those reflected or contemplated in such forward-looking statements. As a result, investors should not rely on such forward-looking statements in making their investment decisions. None of the Information has been filed with the U.S. Securities and Exchange Commission, any securities administrator under any state securities laws or any other governmental or self-regulatory authority. No governmental authority has opined on the merits of the offering of any securities by the Products or Hashdex, or the adequacy of the information contained herein.