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Evergrande's Impact, Grayscale's Breakthrough, and the Crypto Landscape Shifts
September 22, 2023
August proved once again that in the world of cryptocurrencies, a month can feel like a year. With pivotal moments ranging from Evergrande's financial fiasco to SpaceX's Bitcoin divestiture, we break down the most influential events and their implications for the digital asset arena.
The broader crypto market weakened, with multiple catalysts such as the Evergrande bankruptcy, SpaceX’s divestiture of its bitcoin, and rising rates contributing to the weakness.
Correlations between cryptocurrencies and U.S. equities continue to trend downward from a recent peak reached in May of 2022.
US Court of Appeals vacated the SEC’s order on Grayscale’s proposal to convert its trust into an ETF, suggesting impending approvals for numerous spot Bitcoin ETF applications.
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The Bloomberg Galaxy Crypto Index (“BGCI”) fell -12.8% in the past month and is down -6.3% on an annual basis. Bitcoin is down -11.3% in the past month and is +20.1% on an annual basis. The recent weakness can be attributed to multiple catalysts, including the Evergrande bankruptcy, SpaceX’s divestiture of its bitcoin, and the rising rate environment.
The U.S. Treasury 10-year rate rose 28 basis points over the past month, translating to a -2.4% decline in 10-year prices. U.S. equities, U.S. High-Yield, U.S. Investment Grade, and gold fell -3.8%, -0.8%, -2.4%, and -1.9% over the last month, respectively. Short-term U.S. Treasuries notched a +0.5% monthly gain as short rates remained range bound.
Digital assets offer two important financial properties for investors – high returns and low correlations with traditional asset classes. The former enables digital assets to be an effective diversifier, reducing the overall risk of portfolios.
The broader digital asset space, as measured by the BGCI, exhibited elevated correlations with other asset classes, chiefly with US equities, in response to the monetary and fiscal response to the COVID-19 crisis. However, that correlation peaked in May 2022 and is currently in line with the historical average.
BGCI’s rolling 3-month correlation with US equities (as measured by the S&P500) as of August 24th, 2023 is 0.18, approximately 7 basis points lower than the long-term historical average (from August 2018).
On August 29th, 2023, the US Court of Appeals for the District of Columbia Circuit vacated a ruling by the Securities and Exchange Commission to block Grayscale’s proposal to convert its trust to an exchange-traded fund. While the SEC is reviewing the decision, the ruling is seen as a watershed moment for the industry and paves the way for potential spot Bitcoin ETF application approvals from institutions including, but not limited to: BlackRock, Bitwise, VanEck, Invesco, Fidelity, Valkyrie, WisdomTree, and ARK.
The appellate court’s ruling does not ensure Grayscale’s ETF application will be processed immediately or ahead of other issuers. The SEC can appeal the court’s decision; it may ask Grayscale to resubmit its application; or it may set a common launch date for all spot Bitcoin ETFs to avoid providing a first-mover advantage. The Team surmises the latter option to be the most likely scenario.
Bitcoin's price took a hit as China Evergrande filed for bankruptcy protection. The largest cryptocurrency dipped below $27,000 for the first time in two months. The Fed's focus on fighting inflation and uncertainty surrounding China's property developer Country Garden added to market turbulence.
Crypto firm Ledger has announced a new integration allowing U.S. customers to purchase cryptocurrencies using their PayPal accounts. Through Ledger's app, customers can buy crypto without verification if they have previously used PayPal for digital currency transactions. This collaboration aims to ensure secure and seamless transactions globally, simplifying the world of crypto. Both Ledger and PayPal have been expanding their interests in the crypto space, with PayPal launching a U.S. stablecoin (more below) and Ledger introducing a trading network for institutions. Founded in 2014, Ledger is one of Europe's leading crypto businesses.
PayPal has announced the launch of a stablecoin pegged to the US dollar in collaboration with Paxos. The digital token, called PayPal USD (PYUSD), will be backed by US dollar deposits and will be gradually introduced to PayPal customers in the US. Eligible customers will be able to make transfers and purchases using the stablecoin. PayPal aims to contribute to the growth of digital payments by providing a stable instrument that is easily connected to fiat currency. The issuance of the stablecoin on the Ethereum blockchain will also benefit the wider crypto community. Congressman Patrick McHenry expressed support for PayPal's initiative, highlighting the potential of stablecoins in the modern payments system.
Coinbase, the largest cryptocurrency exchange in the U.S., has received regulatory approval to offer crypto futures trading services to eligible U.S. customers. This milestone makes Coinbase the first crypto-native platform to provide regulated spot crypto trading alongside leveraged crypto futures. With the ability to trade on margin, customers gain leverage and access to the crypto market with less upfront investment. Coinbase's derivatives exchange, previously known as the Coinbase Derivatives Exchange, has established a significant liquidity pool, facilitating BTC and ETH futures trading. This approval further expands Coinbase's offerings for institutional clients.
This regulatory win opens up new revenue opportunities and validates the presence of crypto in the US. Coinbase believes this is a significant moment for regulated crypto products in the country. The approval also strengthens Coinbase's position and may provide a regulatory advantage compared to competitors. The expansion into derivatives further enhances Coinbase's upside potential.
Separately, Coinbase's Base mainnet has officially launched to the public, offering over 100 dapps and service providers. The Base ecosystem provides lower transaction fees and faster speeds compared to Ethereum. Base, developed on Optimism's software stack, operates as a rollup network. It is expected to become the default network for Coinbase's on-chain products. In conjunction with the mainnet rollout, Base is hosting an "onchain summer" event, promoting partner dapps in digital art, music, and gaming. Over $100 million in assets have already been transferred to the network.
Aptos Labs, the Layer 1 blockchain developed by former Meta employees, has partnered with Microsoft. The collaboration aims to explore innovative solutions in asset tokenization, digital payments, and central bank digital currencies. Aptos will also leverage Microsoft's Azure OpenAI Service to introduce Aptos Assistant, a secure digital assistant for answering questions about the Aptos blockchain. With the intersection of AI and blockchain being a compelling combination, this partnership looks to democratize blockchain usage and foster the development of decentralized applications using AI. Microsoft's previous investments in AI and crypto further demonstrate their commitment to advancing blockchain technology.
Amid recent weakness in the broader cryptocurrency market, the Investment Team remains constructive on the space and on overall risk assets. Steady economic growth, rapidly slowing inflation measures, and stable employment and wage growth suggests a “soft landing” is more probable than a “hard landing.” This view has led some market participants to forecast rate cuts in the second quarter of 2024.
The Team is cognizant of the time lagged effects of a 5.25-5.50% effective rate and quantitative tightening. Moreover, the Team is monitoring the possible pass-through of high input costs on operating margins and corporate profits. Downside surprises to profits will be destructive for equity valuations and credit, as defaults begin to rise.
Beyond the macro backdrop, the Team remains optimistic on the space given further adoption from traditional financial and technology companies, a possible spot Bitcoin ETF ruling, and technological-related events such as the Ethereum Cancun update.