By Brett Munster, Director of Research at Onramp
Welcome back to The Node Ahead, a cryptocurrency and digital asset resource for financial advisors. Every other week, we discuss the latest crypto news and the potential impacts it may have on you and your clients.
In this edition, we’ll cover the following:
- Crypto’s tailwinds
- Bitcoin’s falling correlation
- Gensler’s pivot away from crypto
- KPMG believes bitcoin is an ESG asset
The crypto market has some tailwinds again
Starting last year, the crypto industry went through a rocky 18-month period. 2022 saw prices crash back down as they do every cycle, and the first few months of 2023 were dominated by the SEC’s numerous enforcement actions. But over the last couple of months, winter has appeared to give way to spring in cryptoland. You can just see the tailwinds growing every week. Consider the following:
The regulatory landscape is shifting for the better:
- The judicial branch is reigning in an overzealous SEC. The judge in the SEC vs Ripple case ruled XRP was not a security, odds are that the SEC will lose its case to Grayscale, and Coinbase is motioning to dismiss the SEC’s lawsuit in its entirety.
- Gensler appears to now be downplaying the importance of crypto and shifting his focus to Artificial Intelligence (see our newsletter below).
- There are multiple bills proposed in both the House and Senate which would provide the regulatory clarity the industry has been asking for and would classify most (if not all) cryptoassets as commodities rather than securities.
Bitcoin is decoupling from traditional assets:
- Bitcoin’s correlation with stocks is back down to historical norms of near zero (see the newsletter below).
The supply and demand dynamics are bullish:
- A spot bitcoin ETF seems to be a matter of when, not if, which could make it much easier for tens (if not hundreds) of billions of dollars to flow into the space over the next few years. In addition, the SEC has indicated it is “ready” to consider ETH future ETFs for the first time.
- Larry Fink, the CEO of BlackRock, and David Rubenstein, the founder of Carlyle Group, have both recently publicly endorsed bitcoin.
- FASB accounting rules are likely to be changed by the end of the year which would remove one of the biggest hurdles for corporations to add bitcoin and cryptoassets to their balance sheets. Today, US public corporations alone currently have over $2 trillion of cash and cash equivalents on their balance sheets.
- The available supply of bitcoin to be traded is dwindling as more people are taking their coins off exchanges and holding bitcoin for the long term.
- The “Halving” is about 8 months away which further reduces the supply of new bitcoin issued per block and historically has put upward pressure on price.
The mainstream narrative about bitcoin’s environmental impact is changing for the better:
- KPMG, one of the world’s largest accounting firms, published a report arguing that bitcoin is an ESG asset (see our newsletter below).
- MIT researchers published a paper explaining the benefits of bitcoin mining on grid balancing and methane mitigation.
- A new peer-reviewed academic study finds that bitcoin mining is a potential contributor to renewable energy penetration and net decarbonization of the energy grid.
Prices are beginning to rebound from 2022.
- Bitcoin is up 75% since the start of the year.
- ETH is up 54% since the start of the year. Many tokens within the Ethereum ecosystem including layer 2 networks and staking services are up considerably as well.
- Solana is up 146% since the start of the year.
- Despite being sued by the SEC, Coinbase’s stock has more than doubled year to date (141%).
It’s been about 9 months since bitcoin’s price bottomed out. When bitcoin bottomed in 2015 and 2019, it rebounded to new highs within 24 months. Given the recent developments, there is good reason to believe history may repeat itself.
BTC’s Correlation with stocks is falling back to historical norms
One of the most compelling aspects of bitcoin as a financial asset has been the low historical correlation it has with other asset classes. Correlation is a statistical measurement from -1 to +1 that reveals how assets move in relation to each other. A positive correlation between two assets means every time one asset increases in value, the other asset also increases. The closer the correlation is to +1, the similar the magnitude of the change is. A negative correlation implies that when one asset increases in value, the other asset decreases in value. A correlation of 0 means there is no relationship between the two assets.
Correlation is often used in portfolio management to measure the amount of diversification among the various assets within a portfolio. But why does diversification between assets matter? Because the more diversified a portfolio is, the more it can be optimized for any given level of risk. If you could add an asset to a portfolio that increases diversification, you could expect a similar return with less overall risk in the portfolio (even if that asset itself is risky).
For example, the most common way to diversify a portfolio of stocks is to include bonds, as the two have historically had a relatively low degree of correlation with each other. Investors also often use commodities such as gold to increase diversification for the same reason. But now there is a better way to diversify a portfolio and that’s with bitcoin.
BTC has spent most of its existence uncorrelated to the stock market. From 2011 to 2019, bitcoin had a correlation with the S&P 500 of 0.03. That’s as close to zero as it gets. To put that in perspective, that’s significantly less correlation than bonds or gold have to stocks, meaning that during its first decade of existence, bitcoin provided greater diversification benefits to a portfolio than traditional assets. And the kicker of it is, during that time, bitcoin was the best-performing asset by a wide margin.
Source: Glassnode, Yahoo Finance
Source: Glassnode, Bloomberg
For any investor with a low time preference, bitcoin has historically provided incredibly high returns and essentially no correlation with traditional assets. That’s the dream investment for any portfolio manager. And this isn’t just theoretical. Studies done by Yale, Fidelity, Ark and others have all shown that because bitcoin has historically been uncorrelated with other asset classes, adding bitcoin to a diversified portfolio dramatically increases the expected returns without necessarily increasing the overall risk of the portfolio. Even Blackrock, the world’s largest asset manager, released a mathematical study on the impact of bitcoin in a portfolio in 2022. The results show that even for conservative investors, a 12.5% allocation to bitcoin statistically optimizes a portfolio. Another way of saying that is that any portfolio that doesn’t include bitcoin isn’t optimized on a risk-adjusted basis.
Like everything else in our world, the correlation between bitcoin and stocks changed in March 2020. When COVID hit, there was a sharp contraction in the economy and deep uncertainty about the virus’s severity and length. This caused a liquidity crisis in the market, which simply means there was a simultaneous lack of cash (or easily convertible-to-cash assets) across many businesses and financial institutions. As a result, investors and businesses began selling anything they could in order to generate liquidity. This, in turn, led to a sharp fall in not just the stock market but across all asset classes. Assets that typically have a low correlation with each other such as oil, gold, US treasuries and bitcoin, all fell simultaneously because investors suddenly needed cash. During a liquidity crisis, the correlation for all assets trends towards 1.
Fortunately, liquidity crises don’t last forever. For several months during 2020, bitcoin experienced a higher level of correlation with stocks and other assets but by the end of the year, that correlation had dropped back to historical norms.
Source: Glassnode, Bloomberg
Bitcoin’s correlation to stocks remained relatively low in 2021 but spiked again in 2022 when the correlation of all asset classes increased in lockstep just like in 2020. The reason this time wasn’t a liquidity crisis, but the drastic change in the Fed’s monetary policy in response to growing inflation. After a decade of near zero interest rates, the Fed gave its public forecasts in 2020 in which it told the market it wouldn’t raise interest rates until after 2023. However, starting in March 2022, the Fed raised interest rates 10 times. That drastic pivot to tighter monetary policy was the cause of the bank crisis earlier this year. It also led to just about every asset class falling in value as market participants had to adjust to the new reality. BTC fell alongside stocks, gold, and even bonds.
As a result, bitcoin’s correlation spiked once again starting in March 2022. Similar to 2020, bitcoin’s correlation remained high for several months but then slowly began to decouple from the stock market towards the end of the year. That decrease in correlation has continued throughout 2023 to the point where bitcoin’s correlation to stocks is now back close to 0.
Source: Glassnode, Bloomberg
Since the start of the year, BTC is up 75% compared to 16% for the S&P 500 and 4% for gold. All the while, bitcoin’s correlations to all other assets have fallen back to historical norms (BTC’s correlation with the S&P 500 last month was 0.08) making bitcoin once again a dream asset to add to any portfolio.
The data proves that over the long term, bitcoin has a very low correlation to traditional assets. Since 2011, BTC’s correlation to the S&P 500 is 0.12 and that’s including the two abnormal spikes in 2020 and 2022. The data also shows that during periods of financial stress, bitcoin’s correlation does have a tendency to rise. However, these periods are often short-lived and correspond with moments in time in which every other asset class also experienced an increase in correlations. For anyone with a time horizon longer than a few months, bitcoin is a valuable tool that can increase the diversification and returns to any portfolio.
Did Gensler Just Pivot Away From Crypto?
SEC chair Gary Gensler has had a tough stretch over the past two months. Multiple crypto specific bills from both the House and the Senate have been voted on and passed by various committees. Just the existence of these bills undermines Gensler’s stance that no new crypto regulation is needed and should any of these bills become law, it would significantly limit the SEC’s jurisdiction and authority over the crypto industry. In July, the judge in the SEC’s lawsuit against Ripple ruled that XRP is not a security thus directly contradicting Gensler’s public rhetoric that all cryptoassets other than bitcoin are securities. It’s also becoming increasingly likely the SEC will lose its case against Grayscale and Coinbase is seeking a dismissal of the SEC’s case due to the agency violating due process, abusing its discretion, and abandoning its own earlier interpretation of the securities laws. Wyoming Senator Cynthia Lummis filed an amicus brief supporting Coinbase’s dismissal motion against SEC stating that the SEC is attempting to “circumvent the political process” by establishing itself as the main authority on crypto. There was also an Amicus Brief in support of Coinbase by six securities law scholars that dismantles the SEC’s “investment contract” theory. If that wasn’t enough, numerous congressmen from both sides of the aisle have called for investigations into the SEC for the agency’s approach to the crypto industry. Warren Davidson even went so far as to propose a full restructuring of the agency and to have Gensler fired.
With the SEC’s legal arguments being questioned by the courts and mounting political pressure, Gensler now appears to be changing tactics. In response, Gensler agreed to an interview with Bloomberg in which he claims to be pivoting his focus away from crypto and towards artificial intelligence. According to Gensler, artificial intelligence (AI) is a much bigger potential threat than cryptoassets or NFTs. “[AI] is the most transformative technology of this generation. There’s a ‘there’ there—we can get to crypto later.”
I haven’t seen anyone backpedal that fast since the Tour de France ended. Gensler just spent years going after anyone he could in the crypto industry and now, all of a sudden, he has decided that crypto isn’t that important and that he really should be focusing on AI. Funny how those comments were made after his legal standing has been questioned by the courts.
The SEC was designed to be a disclosure-based regulator, meaning the agency is tasked with establishing frameworks for issuers to divulge pertinent information to investors, but its mandate requires it to be technology neutral. Instead, under Gary Gensler, the SEC has behaved like a merit-based regulator that sees itself as the arbiter of which technologies should exist in the U.S. Rather than providing market guidance and rooting out bad actors (an important and vital role), the SEC has taken advantage of regulatory gaps due to a lack of any Congressional bills in order to increase the agency’s power and jurisdiction. At first, Gensler was able to bully smaller companies into settlements because they did not have the resources to fight back. But once the SEC started taking on companies that were willing and able to stand up to Gensler (Ripple, Grayscale, and Coinbase), the SEC’s tactics began to fall apart. Gensler appears to now be shifting his focus to another industry where it might be easier for him to run his playbook.
The good news for the crypto industry is that this Bloomberg article appears to signify a change in focus which suggests we might see fewer regulatory actions from the SEC against the crypto industry moving forward. If true, it’s yet another sign that the regulatory landscape is changing for the better in the U.S.
KPMG Thinks BTC is ESG
In March we laid out the argument that bitcoin, perhaps more so than any other asset in existence, closely aligns with all three aspects of ESG investing. With regards to the environment (the “E” in ESG), bitcoin mining is curbing methane emissions, improving the economics of operating clean energy production, and stabilizing our current grid infrastructure by buying excess demand. As a result, over half of the Bitcoin network is already powered by clean energy sources compared to only 36% of the current electrical grid and is becoming less dependent on fossil fuels at a faster rate than any other major industry in the U.S.
But the environment is only one of three components. Bitcoin is having social impacts (the “S” in ESG) by improving cross-border payments, making humanitarian aid easier and more transparent, providing an economic lifeline to those living under oppressive regimes, and enabling those experiencing hyperinflation to store their wealth in an asset that can’t be debased. Bitcoin is far more inclusive than the traditional financial system, can’t be manipulated by any single entity, and operates by a set of rules that everyone must abide by making its governance (the “G” in ESG) the fairest of any monetary network to ever exist.
Given bitcoin’s close alignment with all three aspects of the ESG initiative and its outsized historical financial performance, we argued that bitcoin must be considered one of the greatest ESG investments of all time. And apparently, KPMG agrees.
KPMG is one of the largest consultancy and accounting firms in the world. In fact, there are four accounting firms that dominate the US market (collectively known as the “Big Four”) of which KPMG is one. And they just released a paper arguing that bitcoin checks the box on all three aspects and should be considered an ESG asset.
Let’s start with the environment because that’s the first aspect most people think of. KPMG starts off by comparing bitcoin mining to electric vehicles in that they don’t emit direct emissions. They also acknowledge that bitcoin’s energy use is relatively small and equivalent to tumble dryers.
Source: KPMG
But most importantly, KPMG highlighted four ways in which bitcoin is actively helping to reduce carbon footprints. The first is that bitcoin incentivizes the production of hydro, wind and solar power because of miners’ ability to dynamically flex their power consumption making the buildout of additional renewable energy more economical. Second, KPMG calls out the ability to help balance current electrical grid infrastructure due to bitcoin mining’s ability to quickly curtail its energy use during periods of high demand and thus balance out electrical grids. Third is the ability to recycle the heat generated from miners for other purposes such as heating homes, commercial buildings, greenhouses and even swimming pools. Finally, bitcoin is reducing methane emissions from oil and gas sites as well as landfills.
But the report didn’t stop there. The report highlights bitcoin’s superiority over Western Union and MoneyGram for cross-border payments, its role in improving humanitarian aid, its ability to help citizens escape authoritative governments and how bitcoin mining is helping spur investments to bring electricity in rural Africa. The report then concludes by saying bitcoin’s governance system “cannot be abused or misused by those in power or even individuals with ulterior motives due to its decentralization.”
This report by KPMG doesn’t break any new ground. All the aspects discussed in the report have been covered in this newsletter and other publications. But that’s not the point. The reason this report is important is because it comes from one of the largest consulting firms in the world. KPMG wields considerable influence. And keep in mind accountants and auditors tend to be a conservative bunch. They wouldn’t take the risk of publishing a report like this unless there is substantial evidence backing it up. This was a deep, and well-researched endorsement of the utility of bitcoin and bitcoin mining. KPMG’s conclusion wasn’t just that bitcoin isn’t bad, the conclusion was that bitcoin is a net positive ESG asset. That’s going to change a lot of people’s perception about bitcoin.
In other news
Richard Heart is being sued by the SEC for alleged violations related to his work on the controversial crypto projects HEX, PulseChain and PulseX.
Binance was awarded an operational license in Dubai, taking another step towards becoming fully regulated in the desert city-state.
Franklin Templeton plans to expand its blockchain money market funds to Avalanche, Aptos, and Arbitrum.
The IRS says staking rewards are taxable income in their latest ruling.
FTX could be restarted for some non-U.S. users.
Crypto’s regulatory winter gives way to a bipartisan spring.
Binance user base surges to 150 million despite US regulatory lawsuits
Ethereum futures become the latest ETF craze as applications tumble in.
Coinbase Q2 earnings exceed estimates, signaling potential market recovery.
Cathie Wood and Mike Novogratz are both bullish on spot bitcoin ETF approvals.
Traditional asset tokenization may reach $16 trillion, which will transform infrastructure and markets over the next 5-15 years, according to BAML.
Billionaire private equity titan David Rubenstein believes bitcoin is here to stay.SEC is likely to approve several spot ETFs, sparking the next bitcoin rally.
Disclaimer: This is not investment advice. The content is for informational purposes only, you should not construe any such information or other material as legal, tax, investment, financial, or other advice. Nothing contained constitutes a solicitation, recommendation, endorsement, or offer to buy or sell any securities or other financial instruments in this or in any other jurisdiction in which such solicitation or offer would be unlawful under the securities laws of such jurisdiction. All Content is information of a general nature and does not address the circumstances of any particular individual or entity. Opinions expressed are solely my own and do not express the views or opinions of Blockforce Capital or Onramp Invest.