HODLers Stand Firm, Pension Funds, and More Dominoes FallThe Node Ahead #4
November 9, 2021
In traditional finance, investors analyze financial data and use a host of metrics to value assets when making investment decisions. Contrary to popular belief, the same principles can be applied to cryptoassets. In many ways, there is far more and much richer data for most cryptoassets than in traditional finance because every transaction is recorded on the blockchain and visible to anyone. Rather than getting a quarterly report, imagine having a real-time data feed for every transaction on Amazon and using that to analyze the stock price. That is essentially what we can do with cryptoassets. This research strategy is what is known as “on-chain analytics,” a rapidly growing field within the crypto community.
One of the leading on-chain data providers in the space is a company called Glassnode. The charts used in previous editions of our newsletter, as well as those seen below, came from Glassnode. If you would like to have access to the data yourself, we highly encourage you to sign up for Glassnode through the link below and start playing around with some of the amazing charts they have.
With that, let's jump in.
HODLer's Are Not Satisfied with New All-Time Highs
Before we get into where we are today, it's helpful to revisit what has happened thus far in 2021. Bitcoin started the year off on a tear, rising from $29k to over $63k by mid-April. As per usual during bull runs, the price increase attracted new entrants looking to get in on the wave. Then, in early May, two big headlines (China banning mining and Tesla no longer accepting bitcoin as payment) led to a panic sell-off by many of those same new market entrants. The veterans in the space knew these headlines were unrelated to the fundamentals of the network (China bans bitcoin every year, and Elon's rationale for removing bitcoin as a payment method was factually inaccurate). The smart money calmly watched as the price fell and began scooping up coins at a steep discount. That accumulation phase continued into October to the point where we started the month with the largest supply shock in bitcoin's history.
How do we know all of this? The on-chain data lays it out as clear as day. The vast majority of coins sold between May and October were coins that were just recently acquired. Below is a chart of the supply held by addresses that bought or sold within the last five months, starting in September of 2020.
Here is what the experienced, smart money was doing during that same period.
In other words, we saw a large number of coins transferred from short-term market participants to long-term holders between May and October. These long-term holders have a propensity to sit on their coins and not sell (hence the name). Instead, they take them off of the exchanges and put them in cold storage for safekeeping. This led to the largest supply shock in bitcoin's history that we affectionately referred to as “Shocktober” in the first Node Ahead newsletter. So, it should be no surprise to any of us to see bitcoin back above $60k. When demand is high and supply is low, the price naturally rises.
The question then becomes, now that we are at or near all-time highs, what does the structure of the network look like today, and where are we likely headed?
Let's start with one of the original, most reliable on-chain metrics; MVRV. First introduced by Murad Mahmudov and David Puell, Market Value to Realized Value is a ratio that can be used to get a sense of when the price of a cryptoasset is above or below its “fair value.” Market Value (the numerator) is simply another name for market cap. We calculate this portion of the ratio the same way we calculate it for stocks, simply multiplying the number of outstanding coins by the current market price. This gives us the current valuation of the network as determined by the market.
Realized Value (the denominator) is an alternative method for measuring the value of the network and was first introduced by Nic Carter and Antoine Le Calvez of Coinmetrics in 2018. Rather than treating the value of every coin as equal, Realized Value calculates the value of the network using the price at which each individual coin (or fraction of a coin) was last moved. Thus, Realized Cap is a gross approximation of the network's aggregate cost basis.
MVRV has historically been a great on-chain indicator of market tops and bottoms. A high ratio indicates that the price has appreciated to a point at which holders are sitting on a lot of unrealized gains and may look to sell in the near future. As MVRV rises, the odds that we are nearing a market top increase. An MVRV of greater than 3.7 has historically correlated with a market top for bitcoin. The reverse is true as well; the few times that MVRV has dropped below one have historically been some of the best times to buy bitcoin.
So, where are we today? MVRV is still relatively low, sitting at around 2.7. The last time MVRV rose to its current level in a market where bitcoin price was rising was back in December 2020, when its price was $21,000. Between December 2020 and April 2021, the price of bitcoin tripled.
We can take a more historical view of MVRV as well. In 2013, the bull market had a “double pump” in which it went from $13 at the start of 2013 to $230 by April. There was then a pullback down to around $90 during the summer, until the price ran up to over $1,000 in December (hint: this scenario should sound awfully similar to this year). Glassnode analyst TXMC pointed out that if we isolate the long-term holders only (the cohort we care most about tracking closely), MVRV looks familiar with what is playing out today. If 2013 were to repeat itself, we would be looking at a top of around $300k sometime early next year. By no means are we claiming that bitcoin is going to hit $300k in Q1; we are merely pointing out that the current dynamics in the market leave a lot of room for price appreciation over the next few months.
Although we are sitting near all-time highs in price, the trading activity is still pretty quiet, which is also an extremely bullish indicator. Normally, we start to see coins coming out of cold storage and onto exchanges when prices rise, as investors look to lock in some gains. However, over the last several months, we have seen the opposite. The number of bitcoins on exchanges has been decreasing (i.e., less available supply to be traded) and now sits at the lowest level since September of 2018. In other words, the market expects bitcoin to go higher, and investors aren't ready to realize their gains even as we sit at all-time highs.
There is one more metric we'd like to showcase that indicates the market is nowhere near a fever pitch, and that is Coin Days Destroyed (CDD). Every day a coin sits idle, it accumulates one “coin day.” So, if one coin sits idle for two days since last acquired and another coin sits idle for five days since it was acquired, the cumulative coin days between the two is 7. When those coins are traded, the accumulated coin days are reset to zero or “destroyed.” CDD measures the aggregated number of days destroyed across the network.
CDD is an important metric because coins held in cold storage as a long-term store of value are considered economically important and hence have a high number of accumulated coin days. When those high-value coins are spent, it serves as a strong signal in the change in long-term holder behavior. To smooth out any outliers, it helps to apply a rolling average over a period of time which gives us a clearer signal. Below is the 90-day CDD metric over bitcoin's history.
As the price rises, we typically see CDD start to elevate as long-term holders start to sell their coins. However, something very interesting has happened since late July. The price of BTC has risen from $30k to over $60k, and yet CDD has continued to decrease. This means the only ones selling right now are holders of younger and younger coins. Long-term holders are standing firm, which means we have not reached prices at which they are willing to sell yet.
So, what does this mean? Long-term holders are likely waiting for higher prices before they start to liquidate, which is another indication of just how strong the holding behavior currently is. Long-term holders seem to be completely uninterested in liquidating at $60k and have yet to do so in any significant way. Let me put it this way; we have never in the history of bitcoin seen a market top when liquid supply, CDD, MVRV, and percent balance on exchanges is this low (let alone all four simultaneously). This is an extremely bullish signal for the future price of bitcoin, and the crypto markets in general, for the coming months.
As hard as it is to believe, the behavior of the market suggests that $55-60k isn't just a new high – it may soon be the new floor.
Why this matters to RIAs – Understanding the market structure of crypto, just like understanding the market structure for stocks or bonds, is critical in order for RIAs to make informed decisions on behalf of their clients. Advisers should have a baseline comprehension of the vast amounts of data that the cryptoasset markets provide and how it can be used to power their research.
Here Come the Pension Funds
Retail investors have been investing in bitcoin for years, but Wall Street, hedge funds, and endowments have recently started moving into crypto. Corporations have begun adding bitcoin to their balance sheets. Governments are buying and mining bitcoin. One of the few holdouts has always been pension funds. Well, that dam appears to be breaking now too.
In late October, The Houston Firefighters' Relief and Retirement Fund (HFRRF) announced that it had invested $25 million in bitcoin and ether.
This isn't the first pension fund to invest in the crypto industry – three pension funds have done so to date. Two public pension funds in Virginia invested in crypto funds managed by Mark Yusko's Morgan Creek Capital. The Municipal Employees Retirement System of Michigan was allocated to Dan Tapiero's 10T Holdings growth equity fund.
However, each of these three public pension funds invested in venture capital-style funds rather than holding cryptoassets themselves. What is unique about HFRRF is that they appear to be the first pension fund to invest in and hold cryptoassets directly.
Why did the HFRRF decide to invest in crypto? Because they realized it was too risky not to. Ajit Singh, the Chief Investment Officer for the fund, said he “sees this as another tool to manage my risk. It has a positive expected return, and it manages my risk. It has a low correlation to every other asset class.”
This is an important milestone because it proves that bitcoin and cryptoassets are maturing to a point at which public pension funds, along with financial institutions and corporations, are comfortable holding the assets directly. The infrastructure is finally at a point where even the most conservative institutions are beginning to become comfortable with custody, insurance, and compliance in this asset class. Furthermore, there is a growing realization that adding a non-correlated asset that allows an investor to make a small allocation and still have an outsized impact on the portfolio could be one of the most prudent financial decisions they can make.
While the infrastructure has matured immensely in recent years, we are still very early in terms of adoption and price appreciation. There is still a lot of education that needs to be done as an industry in order to get more public pension funds, their investment teams, and their investment committees up to speed on the benefits of allocating to this asset class. Nonetheless, we are making progress, and that is exciting to see. Congratulations to the Houston Firefighters Pension Fund. Something tells us that their courage to evaluate the current environment and think from first principles will be immensely rewarded over the next decade.
Why this matters to RIAs – If pension funds, which have historically been some of the most conservative asset allocators out there, are now comfortable with investing and holding cryptoassets directly, there is no reason not to be educated on this space.
Lord Fusitu'a is a Bitcoiner
In the first Node Ahead, we highlighted a popular theory within the bitcoin community that once a sovereign nation publicly adopted bitcoin, it would lead to many other governments following suit out of self-interest. It was a big risk to be first but, because there is a finite amount of bitcoin, it would be an even bigger risk to be last. So, when El Salvador made bitcoin legal tender earlier this year, several people within the crypto community started eagerly waiting to see whether this theory would turn out to be true.
Not only is it playing out as predicted, but one could argue that it's happening faster than anyone previously anticipated. More citizens in El Salvador now have bitcoin wallets than bank accounts, and the purchasing power of the country has increased by 30% since the law went into effect.
The success of El Salvador is opening its eyes throughout the world. After El Salvador, Panama recognized bitcoin as a legal payment method, Ukraine legalized bitcoin, Cuba legally recognized cryptocurrencies, and, a couple of weeks ago, Brazil announced its intention to recognize bitcoin as a legal form of tender. All that has happened in only five months!
Now we can add Tonga to that list. Tonga's parliament is now planning to draft a bill to make Bitcoin legal tender in the Pacific Islands nation. The leader driving this initiative is the Lord Member of Parliament for the Niuas, Lord Fusitu'a, who believes he has the support of 12 of the 14 Legislative Assembly members he needs to pass the bill.
Believe us when we say that this isn't a publicity stunt. Lord Fusitu'a has an impressive level of understanding of bitcoin and the potential impact it could have on Tonga's economy. Similar to El Salvador, 38% of Tonga's income comes from remittances, and services such as Western Union can take 30-50% in fees. According to Lord Fusitu'a, adopting bitcoin could increase the income of the people of Tonga by as much as 30%.
The game theory appears to be playing out just as predicted. Expect to see more countries adopting bitcoin as legal tender in the coming months and years as this generation's version of the arms race is just starting to heat up.
Why this matters to RIAs – More and more countries are adopting bitcoin as legal tender, thus further reducing the risk of the asset class and propelling the industry towards a state of mass adoption.
The Mayor Race No One Saw Coming
No, we aren't not talking about a political race. We're talking about mayors trying to out-compete each other for who can embrace bitcoin the fastest. It all started with an announcement last week from Miami Mayor Francis Suarez, who pledged to take his next paycheck entirely in bitcoin, making him the first U.S. politician to do so. Not to be outdone, the next day, NYC mayor Eric Adams promised to take his first three paychecks in bitcoin. Then the mayor of Jackson, Tennessee, got in on the action and promised to convert his entire next paycheck to bitcoin. Not wanting to be left behind, Jane Castor from Tampa, FL, announced she would be accepting her paycheck in bitcoin.
This all happened over the course of a few days; it seems as though everyone wants to be portrayed as bitcoin-friendly. Why? This could be positive for their local economy (just ask Texas). Not to mention, bitcoiners are a growing demographic and political force. So, while we've talked about game theory playing out on an international level, apparently, we should have applied that same theory to mayors across the U.S. Go figure…
Why this matters to RIAs – The biggest concern that most people have when it comes to cryptoassets is in regard to the future of regulation. The more policymakers who adopt crypto, the more likely that risk decreases over time.
Turf Wars Brewing
Historically, the biggest challenge with regulation in the crypto industry has not been harmful or poor regulation; it's been a lack of clarity from U.S. regulatory bodies. Regardless of what the headlines might lead you to believe, the few formal laws that have been introduced by U.S. lawmakers and agencies have had a positive inclination to the use of Bitcoin and other cryptoassets. However, the explosive growth of the industry over the last couple of years and that lack of clarity is now leading to a power grab among various regulatory agencies.
The challenge facing regulators is that cryptoassets are not a monolithic asset class. Some assets resemble securities, some behave more like currencies, and others are best characterized as commodities. Then there are assets that have features of some if not all the above. As a result, every regulatory body believes they have jurisdiction over this asset class.
Let's start with the SEC, whose chairman has publicly stated in the past that he believes most cryptoassets other than bitcoin and ether are securities. Many have interpreted this to mean that the SEC believes that any cryptoasset not “sufficiently decentralized” should fall under their jurisdiction (though, again, what qualifies as sufficiently decentralized has not been made clear by the SEC). Gensler recently said his agency would “be very active in trying to bring this market into what I'd call the investor protection framework.” Gensler has even gone so far as to say that this includes stablecoins. His argument is that stablecoins should be considered stable-value funds, a framework that the SEC already claims jurisdiction over.
Next, we have the CFTC, which is in charge of regulating commodities. Yes, you guessed it – their acting chair Rostin Behnam believes the majority of cryptoassets fall under his jurisdiction. In fact, the day after Gensler said he believed most cryptoassets are securities, Behnam said he believes 60% of cryptoassets are commodities and that the CFTC should be the primary regulator of the crypto markets. Behnam is currently pushing for a broader mandate to give the CFTC more authority over the crypto markets.
Then, there is the FDIC and OCC, who recently proposed new oversight of stablecoins by suggesting Congress should bring stablecoin issuers into the U.S. federal deposit insurance system, making them very close equivalents to traditional banks. If a token is considered a banknote, then it will be exempted from regulation as a security (which won't make Gensler very happy). The OCC previously set the stage for this by issuing guidance that banks are allowed to use stablecoins as part of their normal business and that they can hold reserves for stablecoins. While this new proposal represents a welcome acknowledgment of the validity of stablecoins as a useful financial and technological innovation, this legislative focus feels like a backdoor route to disguise what is really a regulatory power grab.
At a high level, all this recent regulatory development is a sign that the crypto industry is here to stay. Two years ago, the crypto industry was largely ignored by regulators, and now every one of them are fighting amongst themselves to get as big of a slice as they can. We don't know who will win, what legislation they will enact, or even who should be in charge of regulating this industry. What we do know is that we need clarity. The single greatest thing any regulator could do is simply provide a clear framework that would eliminate a lot of the uncertainty surrounding the crypto markets. Hopefully, we will get that sooner rather than later.
Why this matters to RIAs – For many financial advisers, the ambiguous future of crypto regulation is a major deterrent from the asset class. It is important to stay up to date on what is happening from a regulatory perspective, how cryptoassets are treated, and who has oversight on the industry – especially when developments within the space are as fast and as frequent as they have been recently. By remaining well informed, advisers ensure that they are well-positioned to answer any questions that come their way.
In Other News
All-Pro Quarterback Aaron Rodgers joins a growing list of professional athletes now taking a portion of their salary in bitcoin.
U.S. regulators are exploring how banks could hold cryptoassets, according to the FDIC Chairman.
The long-awaited FATF crypto guidance is not as bad as it could have been, but it's still flawed.
Crypto trade associations reported an unprecedented third quarter for lobbying spending.
How Lobster NFTs and a DAO helped the crypto industry's lobbying efforts.
Coinbase hits the number 1 spot on Apple's U.S. App Store.
Square's Cash App generated $1.8B in bitcoin revenue in Q3.
Bank of America COO says that offering loans against crypto assets could be a possibility in the future.
Bitcoin miners score their second-highest month of revenue ever with $1.72 billion in October.
Energy providers will have improved economics from the existence of bitcoin mining as an additional source of offtake.
Quentin Tarantino to offer seven uncut scenes from ‘Pulp Fiction' as NFTs.
Someone took out a $1.4 million loan with an NFT as collateral.