Digital Assets Monthly Report | August

Cryptocurrency Monthly Report: Key Takeaways

• $1T crypto rally solidifies while macro flashes deep recession warning

• Ethereum September Merge certainty creates seismic shift

• What does Coinbase-BlackRock tie up mean for institutional crypto?

Macro Outlook

$1T market rally solidifies while macro flashes deep recession warning

After a bruising June for investors of all stripes, July offered some welcome respite. Equities bounced, with the S&P 500 returning 9.1% across the month, but it was crypto products that drastically outperformed every other asset class when even a hint of risk-on attitude returned. [1]

From the local bottom of 18 June 2022, Bitcoin climbed 36.9% to touch $24,000, while Ethereum reacted much more strongly, gaining 98% from its low of $897 to reach almost $1,800.[2] And crypto markets recaptured the psychologically important $1 trillion market cap in July, even while macro signals continued to flash warnings of a global growth slowdown and deep recessions across major economies. [3]

Further suggestion the crypto tide was turning as institutions added net $84m to Bitcoin-focused investment vehicles — such as ETC Group’s Physical Bitcoin (BTCE) — in the week to 29 July 2022.[4] That marks the fifth week of positive inflows in a row. Short Bitcoin products, that bet on the price of Bitcoin declining, also saw their first week of net outflows.

The US benchmark, the S&P 500, lost -20.6% of its value in the six months of 2022, marking its worst first-half performance since 1970 and plunging US equities into an official bear market. Wall Street expects more pain to come with Morgan Stanley strategists noting on 21 June 2022 that the S&P 500 could drop a further 23% in a worst-case scenario of unbridled global recession. Bloomberg’s Economics team are now modelling for the virtual certainty of a US recession this year, with the consensus that Federal Reserve rate hikes will peak in Q4 2022 and the central bank will reverse course to cut rates in Q1 2023. [4]

Markets are not out of the woods yet. The unprecedented nature of the economic times in which investors find themselves makes forward predictions exceedingly tricky.

Out there in the wider world, central banks are in a bind and according to some economists far too late in their hiking cycle.[5] Persistent inflation continues to rocket higher along with consumer prices. In July, the Bank of England raised interest rates by 50 basis points (bps), the largest such increase since 1995.[6] The European Central Bank also raised rates for the first time in more than a decade5, ending the era of negative rates dating back to the Greek debt crisis of 2012. [7]

The US Treasury 10 year/2-year yield curve, a highly watched macro metric, has now been negative for more than a month, and the spread continues to widen. [8]

By 9 August 2022 it stood at 44bps, far beyond the 16bps inversion that preceded the 2008-9 financial crisis, and approaching the largest negative spread on record, the 47bps of March 1989.[9] This suggests the world’s largest economy is entering an unprecedented period of crisis.

US yield curve inversion is worthy of note: firstly, because it happens so infrequently — just six times since 1978 — and secondly, because it suggests that the near-term economic outlook is riskier than the long-term. Inversions in this portion of the yield curve have preceded every recession since the 1970s, making this metric a key leading indicator.

Bitcoin was born in the wake of the 2008-9 financial crisis as a direct response to massive central bank quantitative easing, and over the last 13 years inflated money supply with currency devaluation has not abated.[10] Markets have yet to see how crypto will perform under such historic conditions, but one thing remains true. Bitcoin remains the only desirable asset in history whose supply schedule is deflationary and laid down in code in advance. [11]

Please remember that cryptocurrencies can be highly volatile, and your capital is at risk. Past performance is not indicative of future performance.

Ethereum September Merge certainty creates seismic shift

A specific date for a massive Ethereum software upgrade that will fundamentally change the character of the second-largest cryptoasset, has produced a huge rally in the blockchain’s native token ETH, along with its associated technologies Polygon and Uniswap. [12]

As noted above, since 18 June the price of Ethereum has rocketed more than 100%, while its critically-important layer two add-on Polygon jumped 164% and the Ethereum-based exchange token Uniswap soared by 142%.[13] On stock exchanges across Europe, ETC Group’s suite of physically-backed and centrally cleared exchange-traded products accurately track the prices of these assets. [14]

As a reminder, Ethereum is by far the largest blockchain ecosystem for decentralised apps and a key infrastructural building block for Web3. [15]

It introduced smart contracts — self-executing programs written on the blockchain — when it launched in 2015 and as a result created the vast new crypto verticals of decentralised lending and borrowing (DeFi) and NFTs. But it has been a victim of its own success: the millions of people and programs competing to use its services mean that fees have regularly soared to extortionately high levels and the processing speed of the network has suffered. [17]

Vitalik Buterin, the co-creator of Ethereum, originally scheduled the switch to Proof of Stake as early as mid-2016, making this perhaps the most overdue and highly-anticipated software upgrade in history. [18]

At the time, Buterin quoted Hofstadter’s Law, a somewhat joking adage often cited by programmers that describes the difficulty of accurately estimating how long it takes to implement tasks of substantial complexity. [19]

It goes: “It always takes longer than you expect, even when you take into account Hofstadter’s Law.” [20]

The Merge will now take place on 19 September 2022, according to Ethereum lead developer Tim Beiko.[21] Several testnets (testing environments that mimic the blockchain’s working without affecting it) have enacted Proof of Stake successfully. [22]

With Ethereum creating upwards of ten billion dollars of revenue per year through transaction fees for the thousands of apps vying to use its platform, the wholesale switch to a new consensus mechanism is a risky business, akin to rebuilding an aeroplane while it is still in flight. [23]

We can as always look to derivatives markets to see how institutional traders are pricing the effects of the Merge. Crypto derivatives have become an important part of market structure in Europe and beyond, with, for example, ETC Group’s Bitcoin product BTCE providing the underlying for the first regulated market in Bitcoin derivatives in Europe. [24]

Ever since crypto derivatives became widely offered in 2020, the open interest in options contracts for Ethereum (ETH) has never exceeded that of Bitcoin (BTC). That curve flipped in July, with ETH options interest rocketing 32% higher than BTC. And so for the first time ever in early August, ETH options open interest at $6.6bn exceeded BTC at $4.8bn. [25]

Bullish call options on Ethereum outweigh protective put options by a factor of three to one, the latest data show, with significant interest out to $5,000, suggesting that traders are betting big on the Merge sending Ethereum prices flying higher. [26]

There remains much discussion over what The Merge will and will not do for Ethereum. It will certainly move the platform from the Bitcoin-favoured Proof of Work to the newer technology of Proof of Stake, becoming 99.95% less energy intensive in the process. [27]

Overcoming performance bottlenecks in the Ethereum ecosystem is already a multi-billion-dollar business, hence the dramatic rise of Polygon. But for NFT and DeFi users to see lower fees, they will have to wait for the sharding upgrade that comes in 2023, which will split Ethereum’s network compute load horizontally, and won’t be affected by the Merge. [28]

What does Coinbase-BlackRock tie up mean for institutional crypto?

With some $8.5 trillion of assets under management, BlackRock is the world’s largest asset manager. [29]

Despite this, the financial services giant has not been immune to the worst first half-year performance for equities in 50 years.[30] Indeed, between the end of 2021 and mid-July 2022, its AUM dropped 11%. CEO Larry Fink said H1 2022 had brought an investment environment “not seen in decades”. [31]

So, it was perhaps little surprise to see it announce a tie-up with digital asset exchange Coinbase on 4 August 2022.[32] The move will provide BlackRock clients more seamless access to crypto markets via its investment platform Aladdin.

As Financial Times journalists explained, the move “marks a victory for Coinbase, which has come under intense pressure since its direct listing last year as a result of tumbling crypto prices and falling trading volumes. It also shows how, despite the turbulence in crypto markets this year, some institutional investors are more actively considering allocations in digital tokens.” [33]

There remains a marked gulf between US, Asian and European institutional investment in cryptoassets.

As Joshua Oliver noted for the same news outlet on 20 June 2022, some active fund managers are still wary of investing in cryptoassets.[34] And “while smaller players have been quick to serve retail investors’ ravenous demand for crypto funds, major players like BlackRock, which runs the iShares funds empire, have held back — put off by volatility, regulatory worries, and the daunting logistics of running crypto investment products.” [35]

“For wealth management firms, digital assets are a $54bn revenue opportunity — that most are ignoring,” says Accenture’s Asia-focused study.[36] “Among firms’’ barriers to action are a lack of belief in (and understanding of) digital assets, a wait-and-see mindset, and giving that launching a digital asset proposition is operationally complex — choosing to prioritize other initiatives.” [37]

And the recent price crash notwithstanding, recent analyses have found some jurisdictions far in advance of others across Europe.

Switzerland for example, is broadly the tail wagging the dog in Europe in terms of institutional cryptoasset adoption, according to a 2022 wealth management report from Accenture. [38]

“In terms of digital assets, Switzerland is probably at the forefront with its Crypto Valley,” its analysts write. [39]

The regulation gap in almost every major jurisdiction remains one major barrier to entry. However, changes are expected soon with the results of President Biden’s Executive Order on Crypto hotly anticipated, and the UK moving quickly to secure a legal definition for cryptoassets, as we saw from the Law Commission on 28 July 2022. [40]

Crypto remains a nascent asset class, and despite recent data, regulated exchange traded products like the $400m AUM Bitcoin ETP (BTCE) and $63m AUM Ethereum ETP (ZETH) have not always moved in 1:1 in tune with the Nasdaq or equities at large.

That extended potential to outperform stocks and bonds, to provide dramatic upside to otherwise small market rallies, and for the underlying technology to provide a technological basis for the next iteration of the internet leaves institutional investors still intrigued as to what level of cryptoasset exposure they should allocate.

However, even amid the chaos consuming all asset classes, we believe it has become increasingly clear that investors with capital to deploy are adding significantly at these levels.

Digital Assets Performance (As of 31.07.2022)

Please note that all performance figures are showing net data. Source: Bloomberg / HANetf. Data as of 31/07/2022 Performance before inception is based on back tested data. Back testing is the process of evaluating an investment strategy by applying it to historical data to simulate what the performance of such strategy would have been. Back tested data does not represent actual performance and should not be interpreted as an indication of actual or future performance. Past performance for the index is in USD. Past performance is not an indicator for future results and should not be the sole factor of consideration when selecting a product. Investors should read the prospectus of the Issuer (“Prospectus”) before investing and should refer to the section of the Prospectus entitled ‘Risk Factors’ for further details of risks associated with an investment in this product.

Learn more about our crypto products:

BTCetc – ETC Group Physical Bitcoin

ETHetc - ETC Group Physical Ethereum

ETC Group Digital Assets and Blockchain Equity UCITS ETF

ETC Group Global Metaverse UCITS ETF