Crypto Long & Short: The Battle of the Yields

“Cash is trash” has a nice rhyme to it, and in some inflation-ravaged paper-based economies it’s literally true. But as an investment mantra, it bears some scrutiny, especially in light of what it says about bitcoin. 

When a multi-asset manager such as Ray Dalio uses that phrase, as he did in Davos earlier this year, we can assume he means that cash is not as attractive for portfolios as other assets. He expanded further on this in a question-and-answer session on Reddit earlier this month, pointing out its “costly negative return.”

You’re reading Crypto Long & Short, a newsletter that looks closely at the forces driving cryptocurrency markets. Authored by CoinDesk’s head of research, Noelle Acheson, it goes out every Sunday and offers a recap of the week – with insights and analysis – from a professional investor’s point of view. You can subscribe here.

This warrants further clarification, as the actual yield on cash is a complex subject. The cash under your mattress does not earn any interest and has a theoretical storage cost. (Even if there’s no direct outlay, there’s the cost of a lack of solid rest due to bumpy sleep surfaces.) And there’s the opportunity cost – just think of all the potential returns you’re forgoing by not investing in stocks or bonds (oh wait…). 

The cash in your bank account is also unlikely to produce meaningful income. And we now have the very real possibility that banks will start to apply negative rates to cash holdings, as part of a mandated strategy to stimulate spending. 

(Note that I’m not saying I agree with this rationale, just that it’s often trotted out. There’s an opportunity cost to not having cash around, as well. And many renowned investors are flush with cash, preferring to have “dry powder” for when opportunities arise.)

A bigger-picture way to look at cash returns is the real yield, which incorporates inflation. We are already seeing a dip in inflation as spending plummets due to lockdowns, but once economies re-open and the stimulus checks are used to purchase everyday items made relatively scarce by supply chain constraints, inflation is likely to edge or even surge upwards. 

This will push real yields on cash well into negative territory. Then, cash will indeed be “trash.” But at least its negative territory will be stable. 

Let’s look at the yield outlook for government bonds. Even before the Fed abruptly cut its benchmark rate to 0% last month, U.S. bond yields were heading down across all maturities. Other government debt either carries a negative return or default and currency risk.

Corporate bonds offer higher yields, but a wave of defaults is more likely now than at any time in recent history. They don’t call it a risk premium for nothing.

Stock yields, which have recently been even higher than bonds, are likely to head sharply down as dividends are cut across the board. 

Two assets that aren’t looking at lower yields? Gold and bitcoin.

Both are “real assets” in that they don’t have any income. Which means that there’s no income to cut. Their value may go down as well as up, but it will do so because of consensus market forces, not political interference or centralized decisions.

This adds a new nuance to the use of the word “real.” Both gold and bitcoin can be influenced by political priorities and economic measures, but their intrinsic value cannot. And both gold and bitcoin are relatively liquid instruments with sophisticated derivatives markets. 

True, both are held in multi-asset portfolios valued in fiat currencies, and both largely depend on fiat currencies for their utility, for now. But of the two, only bitcoin can operate efficiently outside the fiat rails. Only bitcoin can be exchanged for other assets without going through a fiat conversion.

For now, this feature is limited to crypto exchanges that let you buy other crypto assets with bitcoin. It’s a start, and as traditional and crypto capital markets gingerly approach each other, it’s likely to spread.

Admittedly, that will take time, but meanwhile, the point is this: unlike cash and securities, bitcoin is not vulnerable to centralized decisions on asset yields; and it can be used in a way similar to cash in asset purchases. It is the only quasi-cash equivalent that is resilient to the likely politicization of finance that results from the current ructions in markets and the broader economy. 

Cash may be dissed by some who believe that yields should be a fundamental investment consideration; but everything in the investment world is relative. We could see attention start to coalesce around a potential alternative – not to cash itself, but to the role it plays in asset allocations. Bitcoin is by no means a cash substitute, at least not yet. It will, however, become an increasingly intriguing alternative for some of cash’s applications. 

Market metrics

Markets were all over the place this week, with bitcoin dropping 8 percent between Monday and Thursday, only to rebound by almost 9 percent by Friday. 

The S&P 500 was also volatile, clocking in a second weekly gain in a row for the first time since February, in spite of yet another staggering jump in unemployment claims, the worst retail sales data since 1992, the worst New York state manufacturing data since WWII and a relentless climb in COVID casualties. Maybe expectations are just so bad that the actual news comes as a relief? Or maybe reality doesn’t matter anymore. I don’t know.

Not to be left out, gold is also doing weird things, with the spread between the spot and futures price widening to its highest level in 40 years. The spot price reached its highest point in seven years, which is confusing given the strong performance of the main equity index. I really need to dig deeper into what the problem is, if any, with physical delivery.

Digital currencies

It was an intense week for significant (albeit unsurprising) developments in global stablecoins. The Facebook-backed Libra project has pivoted from a multi-currency-backed global token to a wallet and blockchain for single currency stablecoins as well as a multi-currency stablecoin-backed stablecoin (not a typo). 

The idea of a “digital dollar” to facilitate stimulus payments has been reintroduced in the latest stimulus bill. 

And my colleagues Wolfie Zhao and David Pan went deep into the Chinese national blockchain platform with global ambitions that could significantly impact the digital currency plans of central banks around the world. 

Our chief content officer, Michael Casey, has launched a newsletter focused on the impact of these and other developments on our financial system. It’s called “Money Reimagined,” and it comes out on Fridays – you can subscribe here, and read the latest issue here.

(Nothing in this newsletter should be considered investment advice. The author holds a small amount of bitcoin and ether.)

CHAIN LINKS

Renaissance Technologies’ flagship Medallion fund is considering adding cash-settled bitcoin futures to its holdings, according to a recent filing. TAKEAWAY: On the surface this may seem like a big deal: one of the world’s largest and best-known hedge funds (the Medallion fund has nearly $10 billion AUM and is up 24 percent so far this year) believes bitcoin is worthy of investment. But, digging a bit deeper, it’s not that at all. Renaissance is a quant firm, which means that it does not pay attention to underlying stories. It cares about correlations. Bitcoin exposure does not mean the managers see bitcoin as a revolutionary idea worth betting on; it’s a number. Still, we should keep an eye on bitcoin futures volumes on the CME.  

Silicon Valley venture firm Andreessen Horowitz is aiming to raise $450 million for a second cryptocurrency fund, according to the Financial Times. Its first crypto fund raised $350 million in 2018. TAKEAWAY: This is a pretty sizeable vote of confidence in the sector’s potential, and not just through venture support for promising crypto-related companies. The investment may end up having an impact on the market itself – last year the firm registered all employees as financial advisers, enabling the fund to invest directly in crypto assets.  

(You also might want to check out their explanation of how crypto business models are different from web business models. TL;DR: It’s not just the network effect that gives value, it’s also the ability to reward participation and redistribute economic value to participants in the network, creating a virtuous circle of increasing participation and value.)

Researchers at the Kansas City Federal Reserve published a paper about bitcoin’s correlation with bonds and equities, with some unexpected results. TAKEAWAY: This study is particularly interesting in that it differs from studies that look at overall correlations over time. This one isolates times of financial stress, when you arguably most need a safe haven, and it finds that, during these times, bitcoin acts more like a risk asset and has positive (yes, positive) correlations with the S&P 500.

Marcel Burger gives us a good overview of the evolution and current state of the crypto derivatives market, and explains why settling in BTC while quoting in USD turns the P&L from linear to non-linear. TAKEAWAY: Yet another peculiarity of trading in the crypto market. Outside of the FX markets, most traders won’t be used to this risk shift. This could be one of the reasons that BitMEX’s liquidation engine gets so much exercise. (For more detail, see also our “Crypto Derivatives” report.) 

TradeStation is now offering crypto trading via an agreement with institutional-grade crypto exchange ErisX. TAKEAWAY: This in itself isn’t really news – TradeStation has been offering crypto trading for almost a year now, through its subsidiary TradeStation Crypto. What is surprising is that the legacy financial firm (founded in 1982) is continuing to invest in crypto market infrastructure, even after the disruptions of March. Just being offered on TradeStation is not enough to boost investor interest in crypto assets – many investors will still be wary of the volatility and relative lack of liquidity. But the additional exposure, getting in front of its sizable client base, won’t hurt. The platform is even promoting crypto asset trading on its home page. 

According to analytics firm Glassnode, the amount of bitcoin held on exchanges is at its lowest level since June 2019. TAKEAWAY: This could imply that investors are moving their holdings off-exchange into custody, a sign that selling pressure might be easing up. In theory, you hold your bitcoins on an exchange if you are likely to want to trade them. If you’re planning on holding them for a while, you’ll probably move them to a safer storage.

Grayscale Investments* released their Q1 figures, revealing over $500 million in new investment, with almost 90 percent coming from institutional investors. TAKEAWAY: The growth is impressive, but it is unclear how much of the increase comes from contributions in kind – a popular trade amongst professional investors is to exchange bitcoin for shares in the Bitcoin Trust and sell after the lockup period, pocketing the premium the trust traditionally commands in the market. The relative reliability of this return means that not all of the inflow growth is from institutional investors excited by the potential of the cryptocurrency market.

*Grayscale Investments is a wholly owned subsidiary of CoinDesk’s parent DCG.

Greenidge Generation, an Upstate New York power plant using proprietary facilities to mine bitcoin, has sold up to 30 percent of its computing power to institutional buyers. TAKEAWAY: This came out last week after I had finished the newsletter, but is worth flagging anyway since I am convinced we will see more traditional companies adapting their current installations to generate additional income through cryptocurrency mining. Keep an eye on other electricity generators and also on the oil and gas industry, where a lot of energy currently goes to waste and could be monetized through mining rigs. This would be very good news for the sector, as it would further decentralize the infrastructure and embed cryptocurrency in more mainstream business settings.

Shares of cryptocurrency mining firm Hut 8 Mining Corp. (HUT) rose 32 percent on the Toronto Stock Exchange on Friday, on volume nearly eight times the daily average. TAKEAWAY: I don’t know what’s going on, but for perspective, the shares are now back to where they were a month ago. The few listed shares with strong crypto exposure are worth keeping a close eye on not just as investment opportunities but also for what they teach us about sector economics. Mining companies are vulnerable to a sharp drop in revenue post-halving, but also stand to benefit from price upside.

Leah Callon-Butler describes how COVID highlights a potential crypto-shaped lifeline for citizens of the Philippines, and how traditional finance organizations are getting involved. TAKEAWAY: For much of the world, the potential of bitcoin is not as an investment asset – it’s as a payment method. This duality should produce some intriguing growth patterns over the coming years as both narratives move forward. 

After the spike resulting from the mid-March crash, the volatility of the S&P 500 has stayed high, while that of bitcoin has fallen. TAKEAWAY: This is true of the 30-day volatility, but even so, bitcoin’s volatility is still higher than that of the S&P; and longer-term, the difference is even more apparent.

Open interest in bitcoin futures on the CME have rebounded since the March crash. TAKEAWAY: The levels are still low, and are not yet accompanied by noticeably higher trading volumes. They do, however, indicate a gentle recovery of investor confidence that the sharp volatility of mid-March is unlikely to return in the short term. 

Google searches for “Bitcoin halving” are shooting up. TAKEAWAY: Not a surprise, but it is indicative of an uptick in mainstream interest in bitcoin, and since we’re still a few weeks away, is likely to trend much higher (going by what happened in the last halving in 2016).

Crypto Long & Short is CoinDesk’s weekly newsletter with insights, news and analysis tailored for the professional investor. Subscribe here.