Insight
September 23, 2022
Last Friday morning, the White House released a framework for the Responsible Development of Digital Assets, which follows the March 9th executive order on the same topic. The framework outlines recommendations in several key areas, including consumer and investor protection, financial stability, illicit finance, U.S. financial market leadership, financial inclusion, and technical innovation. The framework comes after consultation with various agencies and departments that resulted in the production of nine reports on digital assets from departments such as Treasury, Commerce, Justice, and the White House Office of Science Technology Policy.
Much of what is prescribed in the framework are activities agencies and regulators are already engaged in - enforcement actions, monitoring customer complaints, data sharing, public education, and global coordination - and so are less incremental, in our opinion. The incremental recommendations in the framework, from our vantage point, include the adoption of FedNow instant payment systems, tracking the environmental impact of proof-of-work mining, creating a federal framework to regulate non-bank payment providers, and amending the Bank Secrecy Act to apply to digital asset service providers. The most important outcome of the framework was the urging that the US continues to pursue a Central Bank Digital Currency (CBDC) based on the US dollar.
With the bulk of the deliverables requested by the Executive Order produced and distributed and a framework put forth by the White House, it might be tempting to think that regulatory efforts are complete. The reality, however, is that several bills that are winding their way through the law-making process may result in a more comprehensive regulatory framework for digital assets. The two most important pieces of legislation to watch, in our opinion, are the bipartisan stablecoin legislation, which is coming out of the efforts of the US House Committee on Financial Services (comments from Congresswoman Maxine Waters, Chair of the committee) and the US Senate Committee on Agriculture, Nutrition, and Forestry bill on Digital Commodities (overview and full text of legislation). The Ag Committee bill clearly designates the CFTC as the main regulator of digital commodities, which explicitly includes bitcoin and ether. While it might take some time for either bill to be signed into law, we urge investors to focus on the developments of both bills, and we will continue to provide updates as they progress. We feel the Ag Committee bill, in particular, would be welcomed by the investors, supporting our prior analysis in our report Quantifying the Benefits of Regulatory Clarity that regulation has been beneficial to prices.
Over the past few months, we have seen numerous attempts by the media and by investment research to explain the movement of financial markets. One of the investment trends that has perplexed investors has been the poor performance of traditional inflation hedges, such as gold, amidst the highest inflation levels the US has seen in 40 years. While attempts have been made to blame everything from investor mindshare loss to bitcoin to the strong dollar, the reality is that these narratives expose a misunderstanding of what has been driving the returns for gold over recent years.
Gold has had two distinct eras since it began to float freely against the dollar: the stagflation era of the 1970s and the post dot-com era. During the stagflation era, gold performance was driven by rising inflation, helped by its uncoupling from the dollar. This era, coupled with gold’s longstanding societal function as a store of value, is perhaps why the asset is best known by investors today as an inflation hedge. But since the early 2000s, gold returns have been driven not only by inflation but also by real interest rates. Notably, since the advent of Bitcoin, changes in real interest rates, measured by the year-over-year change in the yield on 10y TIPS, have been the most influential factor on the price outcomes for gold. Importantly, this has been an inverse relationship - as real interest rates have risen, gold prices have fallen, and vice versa. Factors that have driven gold prices in previous eras, such as changes in inflation, have not influenced gold prices at all lately. Other factors, such as changes in the money supply or the US dollar index have proven much less important than real rates. Given this relationship between real rates and gold prices, it should come as no surprise that gold has struggled in the recent environment of increasing real rates.
What does that mean for bitcoin? Some of the same factors are at play with bitcoin as with gold but are less impactful. For example, the R-Squared of changes in real rates drops from 53.8% with gold to 12.6% with bitcoin, meaning much less of bitcoin’s price movement is explained by changes in real rates. Other factors, such as changes in the US dollar or the money supply (M2), have even lower R-Squared measures. This is a positive for bitcoin investors as it means that despite all the talk of macro drivers and asset correlations, bitcoin is likely driven by unique factors to the asset itself, such as adoption, usage, and user growth.
Earlier this week, we published a report looking at the history, development, and developers of Bitcoin. It chronicles the growth of Bitcoin from an idea circulated on a mailing list to an open-source monetary system recognized around the world. The report contains a full in-depth historical accounting of the development of Bitcoin as well as never seen before measures of developer activity and contributions. We hope this piece becomes part of the educational journey for those seeking to gain insight and a greater appreciation of the technical side of Bitcoin.
Financial assets struggled again this week as there was little hiding from the Fed’s campaign to fight inflation via higher interest rates. Bitcoin dropped 2.4% on the week with pronounced volatility around the FOMC rate decision. Equity markets were down on the week as well, with the S&P 500 down 3.7% and the Nasdaq Composite down 4.2%. Gold, while holding up better than most asset classes on a year-to-date basis, was down 1.0% on the week. Bonds continue to struggle amidst the higher interest rates, with Investment Grade Corporate Bonds down 2.1%, High Yield Corporate Bonds down 1.2%, and Long-Term US Treasuries down 2.5%. Real interest rates rose on the week while inflation expectations fell.
Companies:
MicroStrategy Acquires $6M Worth of Bitcoin at and Average Price of $19,851 - SEC
Coinbase Tested Group to Speculate on Crypto - WSJ
In Response to the Wall Street Journal - Coinbase
OTC Trader Wintermute Hacked for $160M Worth of Defi Tokens - Twitter
Poolin Issues $238M of IOU Tokens to Mining Pool Participants - Twitter
Investing:
Nasdaq Is Preparing to Launch an Institutional Crypto Custody Service - The Block
Icebreaker Launches Defi Pool with $300M in Capacity to Issue Loans to Miners - Maple Finance
LN.capital Releases Report on Lightning - Twitter
Regulation and Taxation:
Sparkster to Pay $35M to Harmed Investor Fund for Unregistered Crypto Asset Offering - SEC
SEC Brings Case Against Individual in Connection with Sparkster Offering - SEC
Colorado Becomes First Us State to Accept Bitcoin as Payment for Taxes - Bitcoin Magazine
September 30th – CME bitcoin futures and options expiry
October 7th – United States Non-Farm Payrolls
October 13th – Consumer Price Index
Nov 2nd – Next FOMC rate decision
Thanks for joining us again this week. Please reach out with any questions or comments.
Sincerely,
The NYDIG Team
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