By John Sarson, Sarson Funds
What a terrible time to be a cryptocurrency investor. The bellwether of the crypto industry, bitcoin, is down over 65% for the year and most cryptocurrencies have fared worse. Some much worse. It can be said with certainty now that bitcoin has failed to live up to its one-time vision as a hedge against inflation. Turns out leveraged investments (like bitcoin) need to work through a deleveraging process before their fundamentals can matter to the market. The cryptocurrency markets, unlike the equity markets, were running at nearly 100% leverage rates leading into bitcoin’s all time high of $69,000 achieved last November.
The global “risk-off” trade that started with Russia’s invasion of Ukraine (before turning to focus on an aggressive FED) prompted speculators worldwide to raise cash and reduce leverage. This meant selling crypto holdings. Bitcoin had to work through excess leverage before finally finding an equilibrium price, which is did manage to do about three months ago of around $20,000. It spent a few months at this level and was actually demonstrating less volatility than the equity market, right up until the still-unfolding fiasco of crypto exchange FTX’s bankruptcy last week which was more than enough impetus to again cause crypto prices to fall.
The bankruptcy of FTX took down with it at least 130 cryptocurrency companies associated with the firm with more distressed assets still emerging. Adding to the problem, one day after declaring bankruptcy a mysterious group of hackers which may or may not have been FX insiders, seem to have absconded with $700 million of customer assets. What a mess.
There is of course, as with any disaster, an opportunity and maybe even a silver lining to what has happened. This is the third time now that retail investors have been on the receiving end of a cryptocurrency exchange or centralized lender going bankrupt. Regulators have dropped the ball, clearly. And this time, since Tom Brady and Giselle are involved, the stakes have been raised. And regulators seem to know it. Most other major developed economies already have cryptocurrency laws in place designed to protect investors and to safeguard exchanges, but not here in the United States. The SEC’s highest profile regulatory event for the year? A fine for Kim Kardashian for promoting a crypto project. Thanks Gary Gensler, please go back to academia.
The silver lining is that we will get crypto regulation sooner than we were expecting. Last week if asked we would have said that we were not expecting to see meaningful progress on regulation until the new year. However, with the midterms now behind us and the carnage so prominent, we may have just moved cryptocurrency regulation up on the legislative agenda.
Currently, there are some very easy bills that can be passed by Congress. One of these is the “Stablecoin transparency act”. This piece of legislation has bipartisan support, and it will require stablecoins to be regulated similar to the way money market funds are regulated. There’s a more comprehensive bill in front of Congress called the “Lummis bill” offered by senator Cynthia Lummis. This will make important steps in regulating exchanges and digital asset service providers. I suspect at this point we will see both pieces of legislation passed this year.
If this happens will we look back on 2022 as a good year for crypto because we finally got regulation? I highly doubt that, but it is good to get this regulation because institutions preparing. They are adding blockchain employees and adjusting business structures so as to take advantage and to gain market share in this new emerging category. They will not, however, make significant progress without a clear regulatory framework, which is what we will hopefully start the new year with.
Institutions are large allocators representing about $25 trillion of investable assets. This is about the same size as the retail intermediary advised category of assets, also at around $25 trillion. Neither category has meaningful exposure to crypto at the moment with crypto/blockchain representing less than 1% of total assets for each. We believe that in the future digital assets and cryptocurrencies will need to represent between 3% – 5% of portfolio holdings when the asset class is finally normalized. This should translate into an additional $2 or $3 trillion of fresh capital coming into the sector. For a market with a total market cap of just $1 trillion, this should translate into a very very good year (or years) for asset prices.
For bitcoin, big down years and big up years are very normal. Considering that we have just lived through a big down year, at Sarson Funds we remain optimistic for what is to come next. Yes, there’s been a lot of growing pains in the industry. The industry is certainly learning a lot in what seems to be the hardest way possible. However, do not concede any ground to the naysayers who say that maybe crypto is going away. It’s not. At its core, crypto represents a “better, faster and cheaper” solution for businesses and, “better, faster and cheaper” will eventually find a way in our capitalistic society.
Yes, there’s more to crypto and then just its superior technology. Crypto can also bring its users an expansion of personal freedom and liberty when used correctly. The jury remains out on whether those value propositions will be fully realized or regulated out of existence. Heavy-handed regulation will be a very real threat to crypto achieving this part of its world bettering potential, lets encourage our lawmakers to regulate with discretion and to continue to nurture this emerging industry.