Could Crypto be the Unexpected Beneficiary of Present Challenges?

Could Crypto be the Unexpected Beneficiary of Present Challenges?

Patrick Tan 27/04/2022
Could Crypto be the Unexpected Beneficiary of Present Challenges?

While it may seem counterintuitive, cryptocurrencies could be the unexpected beneficiary of an increasingly challenging investment landscape.

Ask your average Mom-and-Pop investor as to the role that cryptocurrencies play in a standard investment portfolio and the likely answer is “none.”

Given how complex and volatile cryptocurrencies are, it would be entirely expected if traditional investors were to shun the digital asset class as “uninvestable.”

Yet a recent Bitwise / ETF Trends survey of financial advisers, found that 16% had allocated cryptocurrencies to client portfolios in 2021, up 9% from 2020 and more Mom-and-Pop as well as professional investors are getting in on the action.

Part of the reason for this increase in cryptocurrency allocations has of course been the rising availability of options.

Unlike in 2018, there are more regulated pathways to invest in cryptocurrencies than at any time in the past — from opening a basic cryptocurrency trading account at listed exchanges such as Coinbase Global, to simply tacking on to a Robinhood Markets account.

And somewhat ironically, there are more ways for retail investors to participate in cryptocurrencies than there are for institutional investors, who need to contend with oftentimes conservative and restrictive mandates and are limited to regulated vehicles, whereas retail investors can deal with loosely-regulated exchanges and self-service decentralized forums.

Last year, a slew of Bitcoin-linked ETFs hit the market and saw record inflows — the ProShares Bitcoin Strategy ETF raised a record US$1 billion in just 2 days of listing.

That demand for cryptocurrency products in a hard institutional shells has been so great that some of Wall Street’s most storied names are throwing their hat in the ring.

Recently, the world’s largest asset manager, the US$10 trillion BlackRock and brokerage Charles Schwab filed to register funds that track the cryptocurrency economy, while other providers continue to lobby regulators to approve more products.

What Are We Betting on?

Trying to guess where cryptocurrencies will head next is akin to having predicted the path of the internet in the early 1990s — there are strong parallels, but many unknown unknowns.

In 1998, American economist Paul Krugman infamously noted,

“The growth of the Internet will slow drastically, as the flaw in ‘Metcalfe’s law’ — which states that the number of potential connections in a network is proportional to the square of the number of participants — becomes apparent — most people have nothing to say to each other!

By 2005 or so, it will become clear that the Internet’s impact on the economy has been no greater than the fax machine’s.”

Although Krugman’s observations about the internet have not aged well, it also reflects the difficulty in predicting the future when it comes to new technology.

Bearing in mind, when Krugman made his forecast on the future of the internet, the few people who were online had at best a dial-up internet connection and few companies (in particular Sears) saw the merit in an online presence.

Fast forward to our current epoch, and even JPMorgan Chase, whose CEO Jamie Dimon once declared that, “cryptocurrency has no intrinsic value” finds his bank not only has a presence in the Metaverse, but has his portrait hanging on the walls of his literally, digital bank branch.

While the internet represented a new way to distribute information that could have major consequences, moving from that early observation to predicting one day people would use smartphones to rent out a stranger’s house instead of staying at a hotel is a different leap altogether.

Which is why so many investors and analysts will inevitably get it wrong on cryptocurrencies, especially the seasoned and scholarly ones.

Rifling Through the Couch Cushions for Investments

In a week that has seen both stocks and bonds routed as the U.S. Federal Reserve doubled down on its inflation-fighting rhetoric, spooking markets that are now preparing for a 50 basis-point rate hike in May, investors are clamoring for cover in an investment landscape that appears to be providing limited respite.

And while investors may be lamenting the 2.8% hit to the S&P 500 this past week, that damage remains but a flesh wound when held up to measures of valuation — a sign that more losses could be on the cards.

At 22-times earnings and just shy of 3 times sales, the S&P 500 is still valued at a whopping 60% more than U.S. gross domestic product, higher than at any point in time before the pandemic.

Not helping matters, central banks are aggressively raising interest rates, Russia’s invasion of Ukraine is jacking up commodity prices and the return of the coronavirus to China may shutter the world’s factory.

Last week, the sharp selloff in bonds took so-called 10-year real yields, U.S. Treasury yields with inflation stripped out, into positive territory for the first time since 2020 — which sent riskier assets from all corners of the investing world plummeting.

All of which has forced investors to search for alternatives outside of the stock and bond markets.

Commodities appear attractive, given their soaring prices, but they will be the first to suffer should supply issues be ironed out and inflation kept in check by soaring interest rates.

And contrary to popular belief, the bulk of movement in commodity prices is driven by traders speculating on the direction of the market, rather than purely demand-driven price pressures, which do not make for strong long-term fundamentals.

Floating rates of private credit and yields from public fixed income look tempting as well, but the best deals are often beyond the reach of retail investors, as is venture capital and recession-related risks have already been baked into returns.

Real estate is sensitive to interest rate hikes and should wages not keep up with inflation, serve as a potential headwind for a sector that has only seen prices go up since the 2008 Financial Crisis.

Emerging market assets look alluring as the dollar strengthens, but geopolitics are raising risks and reducing liquidity as the world becomes increasingly polarized.

So where does that leave investors?

Virtually every other asset class has well-established valuation matrices and long histories with deep data troves for analysis.

Cryptocurrencies and their attendant blockchains however, represent potential that the world has yet to fully understand or grasp making them ripe for both extremes of optimism and pessimism.

To dismiss cryptocurrencies as purely a technology play is to ignore the fact that they sit at the nexus of finance, technology, game theory, behavioral economics and monetary systems — portable power.

The same way the internet had limited value when it consisted of just a handful of terminals connected over the ARPANET, when Bitcoin was being transferred between a clutch of early adopters, 10,000 Bitcoin could only be exchanged for two pizzas at Papa Johns.

Today, Bitcoin serves as legal tender alongside the dollar in El Salvador and Mexico is mulling a similar move.

When Western sanctions were leveled against Russia for its unprovoked invasion of Ukraine, ordinary Russians looking to protect the value of their assets sent ruble-crypto trading pairs soaring overnight, with between 8 to 16 times the typical volume.

And when Ukraine desperately needed financial and military aid to combat the invaders, a portion of that aid came in the form of cryptocurrency donations, requiring no financial intermediary to effect the assistance to buy everything from flak jackets to ammunition.

In 2018, few (if any) governments took the threat of cryptocurrencies seriously, whether as a challenge to the supremacy of fiat currencies or as a means by which to circumvent taxation and sanctions.

Fast forward to our present time and the Biden administration is actively moving towards developing a comprehensive policy approach to cryptocurrencies and the European Central Bank is mulling the issuance of its own digital currency, while China has already had one for some time.

Whereas the internet needed advances in the actual hardware that was necessary to advance the disruptive and transformative effect of the World Wide Web as we know it today, cryptocurrencies are solving hard problems with software solutions meaning that their development and application expansion will be faster (no fiber optic cables to lay down here).

Take the allegation that cryptocurrency mining is a wasteful use of electricity for instance — later this year, the world’s second most valuable blockchain by market cap, Ethereum, will be attempting a significant shift from the energy-intensive proof-of-work method to secure the blockchain to a far more energy- efficient proof-of-stake mechanism.

Other blockchains such as Solana, Cardano and Algorand already utilize proof-of-stake, although they’re not as popular or as widely used as Ethereum.

Unlike traditional assets, cryptocurrencies don’t lend themselves well to typical valuation metrics, because it’s not possible to value a blockchain on the basis of profits or sales.

Yet cryptocurrencies themselves can have far more value than equity in many ways, as they allow stakeholders to have a vote that can determine the development of their respective blockchains, including on matters such as fees and distribution plans.

Imagine if a minority stake in Apple enabled shareholders to have a meaningful say in the company’s privacy policies or the remuneration of its top executives — while ordinary stock can’t necessarily facilitate such actions, cryptocurrencies can enable and empower the exercise of such rights.

While it’s easy to take for granted our current ability to transfer vast amounts of information across the internet today, not so long ago, this would have been the stuff of science fiction.

Now imagine if our economic lives could be borderless as well — if we could transfer value whenever we needed to whoever needed it, execute a contract without ever having met our counterparty, and effect a trade without ever going through a broker.

Because we’re only just beginning to explore what’s possible with cryptocurrencies and the blockchain is also why they’re so difficult to value.

Markets Know the Price of Everything But the Value of Nothing

Given how any meaningful engagement with cryptocurrencies is multidisciplinary, converging expertise in computer science, behavioral economics and financial services, predicting their transformative value and development potential is not a simple task, let alone price discovery.

And that’s also the reason why cryptocurrencies are so often simultaneously under and overvalued.

By most traditional measures, Bitcoin, and the rest of the US$2 trillion cryptocurrency sector should have crashed by now, that they haven’t isn’t necessarily testimony to their resilience, but the lack of leverage lingering in the cryptocurrency markets at this moment.

Raising interest rates to combat inflation also means that the risk-free rate of return rises, and so more investors won’t necessarily be as desperate for yield, which makes risk assets, including cryptocurrencies less attractive — or so goes the argument.

While leverage is prevalent with traditional financial assets, it has actually decreased in recent months when it’s come to cryptocurrencies — too many traders got burned in the great crypto deleveraging episodes throughout 2021.

But because Bitcoin is now increasingly viewed by professional investors as a component of the speculative class, it is not immune to central bank hawkishness and even though other cryptocurrencies bring different value propositions to Bitcoin, can’t rise against a receding tide.

Given the myriad challenges facing asset markets, nothing is doing well.

From the Russian invasion of Ukraine, to central bank policy tightening, China’s insistence on zero-Covid lockdowns and soaring inflation — regardless of the asset concerned, there is some reason to be bearish.

Tech stocks have been hammered while bond yields have soared (yields rise inversely to bond prices).

Crude oil stumbled on concerns over Chinese demand while gold, typically regarded as a inflation haven asset, fell as yields soared — the precious metal after all is a non-yielding asset and if investors believe that central banks will keep raising rates to combat inflation, there’s little incentive to justify holding on to the precious metal.

Against this bearish backdrop, investors need to ask themselves which assets will fair well when our current troubles are eventually resolved.

And while there’s no guarantee that cryptocurrencies will be that asset to plug forward — there are at least enough reasons that will become apparent with the benefit of hindsight.

 

Disclaimer: The information disclosed on this article is for informational purposes. This is not an investment advice. You should not make any financial, trading or investment decision without consulting a professional financial adviser. 

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Patrick Tan

Crypto Expert

Patrick is an innovative entrepreneur and a lawyer passionate about cryptocurrencies and the business world. He is the CEO of Novum Global Technologies, a cryptocurrency quantitative trading firm. He understands the business concerns of founders and business people helping them to utilise the legal framework to structure their companies to take advantage of emerging technologies such as the blockchain in order to reach greater heights. His passion for travel, marketing and brand building has led him across careers and continents. He read law at the National University of Singapore and graduated with Honors in the Upper Division and joined one of Singapore’s top law firms, Allen & Gledhill where he was called to the Singapore Bar as an Advocate & Solicitor in 2005. He created Purer Skin, a skincare and inner beauty company which melds the traditional wisdom of ancient Asian ingredients such as Bird's Nest with modern technology. In 2010, his partner and himself successfully raised $589,000 from the National Research Foundation of Singapore under the Prime Minister’s Office. He has played a key role in the growth of Purer Skin from 11 retail points in Singapore to over 755 retail points in Singapore and 2 overseas in less than a year. He taught himself graphic design, coding, website design and video editing to create the Purer Skin brand and finished his training at a leading Digital Media Company. 

 

   

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