Crypto is off to one of its strongest starts on record. Bitcoin (BTC) had the best January in about ten years (+40%) while the Nasdaq Crypto Index (NCI) went up by a similar figure (+38%) in its third-best performing month since inception. At Hashdex, we’re always cautious to read too much into price performance, but with such a strong start for 2023, it makes us think whether or not the crypto bottom is in, and if we’re off to the races for a new bull market.
On Wednesday, Samir Kerbage, Chief Technology and Product Officer at Hashdex, and David Lawant, Head of Research at FalconX, joined Hashdex’s Head of Global Content, Gerry O’Shea, to make sense of the most recent developments in the crypto space, not only about what happened in January, but going back to 2022 and how the events of last year will impact crypto in 2023. With the ultimate goal of separating signal from noise, here are the key takeaways of this great discussion you can watch on YouTube and LinkedIn.
January is a reflection of a better macro outlook and diminishing contagion fears
The first month of 2023 was positive for risk assets in general, with crypto being a highlight among all asset classes. This was a consequence of two factors: (i) the fear of contagion from FTX and other bankrupt centralized crypto players has been diminishing over the last several weeks, and (ii) there’s a much better macroeconomic outlook, with the market pricing in that inflation will likely recede to something around 2% about a year from now, together with the expectation of a reduction in the pace of interest rate increases by the Fed, which has already materialized in the last meeting in January. If there’s no recession or if a mild recession takes place, risk assets can benefit a lot, with crypto leading the way. In particular, going back to right before the FTX fallout in early November, crypto has actually outperformed most benchmarks for other broader risk asset classes, such as the S&P 500 and the Nasdaq 100. This is definitely surprising, given that one of the world’s biggest crypto exchanges has proved to be a fraud, carrying together a number of other important players in this space.
More crypto, more regulation, more jail time
The FTX issue had and will continue to have a number of repercussions. It was an important milestone for the industry in order to raise awareness to issues related to regulation and market structure, that crypto investors, and institutional investors in particular, will start paying a lot more attention to. In the long run the crypto investment case remains intact, and it’s very clear that the FTX issue was a self-contained problem, a fraud issue in the crypto space, not an indictment on crypto as a whole. In that regard, three things are very much necessary for an asset class to evolve and become mainstream in the portfolio of institutional investors: (i) regulation—having more clarity around how individuals and institutions can invest, all the risks involved and desired protections; (ii) education—understanding how to differentiate between good and bad players; and (iii) jail time—bad actors and fraudsters need to be properly penalized. These three things have been happening recently.
Better infrastructure and a generational shift will bring crypto’s broadband phase
A fair question coming from institutional investors worldwide is what is the actual usage of crypto. Similar to other digital revolutions, like personal computers in the 80’s and the internet in the 90’s, it’s naturally very hard to see the implications of new technologies in advance. Back then, one could describe the potential of the internet and how live-streaming a webcast for hundreds of people sounded like a good idea, but if one wanted to listen to a song, they needed to spend twelve hours downloading an MP3 and, by the way, that was piracy. That’s the same question in crypto today. There’s a lot of discussion around BTC as a store of value, Ethereum as a major platform for Web 3.0, non-fungible tokens (NFTs), decentralized finance (DeFi), tokenization, etc. But if we try to use these today, it’s still really hard.
Going back a couple of decades, two things had to happen for the internet to become a mainstream utility: (i) infrastructure had to evolve and (ii) a generational shift needed to occur. The infrastructure evolution of the internet happened in the early 2000’s, during the so-called broadband phase. For crypto, it’s happening right now, with Ethereum and its scalability solutions, and the Lightning Network on Bitcoin. Once this is in place, what will determine crypto adoption is a generational shift, which takes many years. For the internet, a new workforce had to come to the market, kids that grew up doing their homework using Google and Yahoo. That generational shift is very important because the adoption of new technologies doesn’t come from the older generations. They weren’t responsible for widespread internet adoption, and the old generations of today won’t be responsible for crypto adoption.
Crypto is no longer a promise
One huge difference between the stage we're at today and previous bear markets is that the crypto applications now are a lot more tangible. Back in 2018, DeFi was just a theoretical concept, stablecoins were extremely incipient, and NFTs existed only in some very distant corners of the crypto community. Of course there was Bitcoin’s investment thesis as, rather than an inflation hedge, a protection against monetary mismanagement, but that was it all. Today, DeFi has tens of billions of capital allocated. It was battle-tested in a way that it hadn’t been before, and it worked way better than most centralized players in crypto. NFTs are a new and firm vertical that, even with all the hype around them, are a very interesting vessel for a handful of tokenization ideas. Stablecoins are perhaps the biggest application in crypto right now. Finally, there’s also a lot of new and exciting applications which will be much more feasible in a higher scalability blockchain world, such as decentralized social networks and decentralized physical infrastructure. All in all, as we go into crypto’s broadband phase, there are several established applications and a set of new ones that will work better or even give rise to completely new things that weren’t possible before.
The crypto barbell market structure
The bad things that happened in crypto in 2022 were clearly related to market structure, not to the asset class itself. This is very important because people from outside the industry may mix things and dismiss the fact that 2022 was in fact great for the fundamentals and the development of blockchain technology. The market structure for this asset class is certainly still flawed, mainly due to a lack of regulation, which especially after FTX should accelerate worldwide. Last year’s events might actually lead to a market structure forming a barbell of sorts: on one end, highly regulated and safe centralized players, and on the other end, DeFi, with perhaps nothing inbetween. For centralized players, things like an exchange probably not running a hedge fund on the side are pretty obvious. Other things are less straightforward and unlikely to happen overnight, like separating exchange, broker, and custodian activities, as well as requiring tri-party agreements. But the industry is certainly walking and trending toward that direction.
Bitcoin’s cyclicality and its macro thesis is on the cards
Bitcoin has historically behaved as a pendulum between fear and greed, following an interesting pattern that seems to be repeating across different macro environments and adoption levels: (i) there’s a bull phase (~12 months) from the prior all-time-high (ATH) until the next one, followed by (ii) a bear phase (~13 months) where BTC goes down from its last ATH to a low at the maximum drawdown for that cycle, and finally (iii) a recovery phase (~22 months) in which BTC goes from its cycle low to its prior ATH. It seems like we are in the beginning of the next recovery phase, where it’s fair to expect BTC to still have high volatility and price uncertainty, but not too much optimism or pessimism, with a big anchor being the Bitcoin halving, which occurs around May of next year. Furthermore, a bit of the Bitcoin macro thesis is playing out. There have been pretty frenetic changes on monetary policy, going from record flexible financial conditions to record fast tightening. Central banks are changing very quickly, there are geopolitical issues, and the market is talking about a potential Bretton Woods III or a new monetary type of system. Over the long term, there are important changes happening at the very core of the global monetary order and Bitcoin could have a big role to play, not in the coming weeks or months, but over many years in the future.
The stakes are getting higher and regulation needs to be in place
Regulation has been an increasingly front and center topic as the crypto industry becomes more relevant. In the US, there’s much more awareness across regulators and lawmakers about crypto to the point that there is a fair number of them that are very pro-crypto and that understand this industry extremely deeply, even though US legislation still lags very much behind Europe and Latin America. Three major topics in crypto regulation in the near future are:
1. Stablecoins: the least controversial one, with some sort of US regulation likely coming in 2023;
2. SEC vs CFTC: security status of crypto assets and something related to market structure in the early innings of discussion;
3. Republican House vs Democratic Senate: the US Congress is currently divided, with the politicians with jurisdiction over crypto having pretty opposing views: on one end there’s serious industry champions, on the other, there’s some big industry critics.
Another challenge is how to regulate decentralized finance, since the whole ecosystem is built atop smart contracts, that is, code that doesn’t have a controller and is self-executed on a public blockchain.
Crypto assets and Central Bank Digital Currencies (CBDCs) are fundamentally different
When CBDCs become available, the concept of digital assets being part of the daily life of people will become the norm. That can actually be a catalyst for the adoption and the usability of crypto assets. And while CBDCs may be this big normalization factor for the general public to get used to dealing with wallets and private keys, they are fundamentally different from crypto and don’t compete directly with it. Especially when it comes to public blockchains, like Bitcoin, these technologies are a lot more about a non-sovereign monetary system with a fixed monetary base, giving more user privacy and resilience, whereas CBDCs enable factors linked to discretionary control of the monetary base and surveillance mechanisms. At the end of the day, CBDCs can help onboard hundreds of millions of users to crypto, while blockchain technologies such as stablecoins may be leveraged by central banks in their design of a CBDC, something that is already being considered by some countries worldwide.
Institutional investors know that mass crypto adoption is a matter of “when” not “if”
Institutional interest in crypto arrived in 2020, and it hasn’t slowed down significantly in 2022 or after the FTX issue. These allocators underwrite much longer investment theses and they have due diligence and investment committee processes that are much longer than what a typical retail investor would do. It doesn’t seem like these decisions have stopped but they could maybe not be as in a rush as they were six or twelve months ago. While in late 2018 or even early 2020, institutional clients used to ask if crypto was over, now they want to know if the bottom is in and if we are off to a recovery phase. As such, it’s fair to say that institutional players are seeing that mass crypto adoption is no longer a matter of “if” but “when.” And even though institutional clients still request a proper valuation framework for crypto assets, their increasing interest in crypto shows a clear sign of maturation for the asset class, which over the long haul will likely behave much more alike traditional assets.
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