Crypto’s shift from fringe to mainstream–and what that means for investors.
KEY TAKEAWAYS
Bitcoin hits an all-time high amid lower rate expectations and institutional adoption
Bullish IPO surges 84% on debut despite heavy competition and unclear scalability
Crypto now trades like a mainstream high-beta risk asset correlated to the Nasdaq
Fixed supply and surging demand drive Bitcoin’s record-breaking rally
Risk and volatility rise for smaller altcoins; service providers may be safer plays
MY HOT TAKES
Bitcoin’s rise has little to do with its utility and everything to do with market risk appetite
Institutional adoption has made Bitcoin behave like a growth stock, not a hedge
Bullish IPO shows there’s still appetite for crypto plays without owning crypto directly
Valuations in the crypto service space can be wildly optimistic relative to fundamentals
Correlation to equities could erode crypto’s diversification benefit
You can quote me: “I am sure that I am insulting the crypto ‘splainer, religious zeolites out there, but the currency’s rise has less to do with its utility and more to do with the market’s treating it as a speculative risk asset.”
As if by magic. My regulars know that I go out of my way each morning, on my way to my office, to pass the New York Stock Exchange. For those of you who have been there, you know that, especially during peak vacation times, that it is no easy task. Tourists line the narrow sidewalks to get a selfie with the exchange’s iconic pediment in the background. Also dotting the streets are gaggles of tourists following guides holding up strange flags and hanging plush toys. Throw in the guy who sits on the curb and sings 90s pop tunes on the top of his lungs (literally) and you start to get the picture of what one must do to negotiate the historic location. Now, I am quite sure that most of my real-life Wall Street colleagues do their best to avoid the traffic, but for me, it’s worth it. Yesterday, I walked by to see the front of the exchange draped with a banner of the company Bullish, which IPOed on the NYSE.
Bullish, indeed. The company raised $1.1 billion yesterday, closing almost 84% above its offer price, but it traded even higher before settling in that impressive gain. What, you haven’t heard of Bullish? It’s OK, most of us haven’t. You may have heard of CoinDesk, a media outlet that has been around since 2013–which is like an old-timer in the crypto world that doesn’t seem to want to go away, despite its predicted demise for many years. Beyond its ownership of the “known” entity, the company boasts former New York Stock Exchange Tom Farley as its CEO. As to what the company actually does, that gets a bit more complicated. According to its filing, the company offers crypto and derivatives trading focused on institutional investors. The company was founded just a few years ago and claims to be in a position to take advantage of the “digital revolution.” Cool–I guess.
It claims to have earned $109 million in income in the first half of the year. Looking closely at its offering documents you might note that the revenues come from its purchases and sale of digital assets, and a positive mark-to-market on some of its held digital and financial, as well as $32.8 million in certain “other revenues,” which are likely to come from CoinDesk. All this makes sense as the company is in the “exchange” business. While there are so many questions as to scalability and competition by larger, more well-established competitors. Namely, Coinbase, Robinhood, Binance, Kraken, Gemini, and many others. Now, I know that it claims to have unique technology and focuses on institutions, but is that enough to justify a $9.2 billion market cap? That puts it in a group that includes companies like Ally Financial, Texas Roadhouse, Unum Group, Albermarle, Abercrombie & Fitch, and Invesco. The company is expecting to be profitable and to experience rapid earnings growth. It would seem that investors are putting a lot of hope into what could be.
Revolution, indeed. It would seem that investors simply cannot get enough of all-things crypto these days. Bitcoin, the poster child and most well-known crypto asset, closed at its all-time high of $123,000. Are you surprised? I am sure you are not. The President had made it clear during his campaign that he would prioritize mainstreaming of crypto and he has made good on that promise. Companies that were being sued and restrained under the Biden Administration are now being welcomed in the oak-lined chambers of Washington.
Is that the reason that Bitcoin–the mother of all cryptos is up by over 30% year-to-date and other-fav Ethereum is up by some 42%! For some reference, the S&P 500 is up by only around 10% this year. Those YTD numbers are more in line with the likes of NVIDIA, up by 35% year-to-date. So, what is it that is driving Bitcoin? Well, first of all, it is really important to understand that Bitcoin is not a company! It does not earn any money or hold any assets. It is a fiat currency, but it is not backed by any sovereign. The US Dollar is a fiat currency, but it is backed by the US Government, which–relatively speaking–means something. So, really, Bitcoin itself is worthless. There are no fundamentals associated with it. No multiples or ratios and no dividends. So, the question still begs: what is causing its rise?
Well, it would appear that there are, indeed, some key drivers at work here, aside from the more crypto-friendly environment installed by the administration. First, it is important to note that Bitcoin has been trading like a traditional “risk” asset for some time. If we simply changed its name to something implying high-tech, AI, and semiconductors, you would probably accept it as a traditional, high-beta, growth stock. I am sure that I am insulting the crypto ‘splainer, religious zeolites out there, but the currency’s rise has less to do with its utility and more to do with the market’s treating it as a speculative risk asset.
That said, it is subject to the same gravitational forces that are faced by public fertilizer, garbage removal, railroad, and pest control companies. All those companies’ stocks, despite having real fundamentals, revenues, and assets, are subject to the laws of supply and demand. There is an old snarky Wall Street answer to the oft-questioned “why is so-and-so stock trading up?” The answer is simple: “more buyers than sellers!” That’s right, good old supply and demand.
Bitcoin, you see, is intentionally scarce in supply. Mining has gotten harder and harder and it will get harder yet. It is not unlike gold in that way. When demand surges and supply is limited, it goes up in value. So, it is clear that demand has surged and has caused its price to jump to record highs. We still haven’t answered the question, though. What is causing that demand to rise?
Well, in case you haven’t noticed, institutions have entered the fray. Bitcoin is no longer a retail, hobby investment. It is held by mainstream investment companies, non-investment companies, and hybrids like Microstrategy. There has also been a surge of demand from ETFs and now, 401(k)s.
Folks, it is now like any other risk asset in the mainstream, can you see that? So, stepping back, we need to examine what is driving traditional risk assets to new highs. Well, this week, that driver is certainly the increased expectation for rate cuts. In the most traditional sense, lower rates make risk assets look more appetizing, because you gotta earn money somehow. You all know that there is also a financial explanation for lower rates causing asset value to rise, but I won’t get into that today, BECAUSE ITS DOESN’T APPLY to Bitcoin which has no cash flows. So, generally speaking, more volatile assets rally when interest rates are expected to go lower, and Bitcoin has now been accepted into that club by the mainstream. Check out this chart, really quickly and then follow me to the close.
I know that this is a super-busy chart, but bear with me. Focus on the bottom two panels. Those show Bitcoin’s correlation to the Nasdaq Composite. The middle panel shows 90-day correlation. You can see how there is an increased positive correlation which has generally persisted since late last year. The bottom panel is a shorter term (20-days) correlation which shows that the two get more highly correlated during risk-on periods. This is the classic finger print of a risk asset. If I extended the left side of the chart you would see that there was an even closer tie between the two in the 2020-2022 timeframe–Bitcoin’s coming of age as a mainstream risk asset. It should be clear that the current administration’s embrace of digital assets has cemented Bitcoin’s acceptance as another risk-on proxy.
Can this be extended beyond Bitcoin to the other mainstream digital assets like Ethereum,Tether, Solana, Cardano, Dogecoin, or Litecoin? What about the 10,000 or so others listed in other private exchange sites? Well, today at least, I think that the answers to those questions would be “possibly” and “it’s too early to tell.”
Look, there is a clear demand for alternative risk assets. Bitcoin’s acceptance as a mainstream risk asset is a positive and negative for it. Investors like to find uncorrelated assets for diversification, and if Bitcoin behaves like any other growth stock, it loses some of its utility as a diversified portfolio asset. But it is important to go back to our earlier discussion that there is no real value underlying the currency as a growth asset. That makes trading in the more obscure alternative coins more risky yet. More risk, indeed means higher expected returns… but also greater potential losses. The message there is: be careful.
I hope that it is clear why Bitcoin is trading at its all-time high given the current macro environment and the broader equity market risk-on regime. So, what if you believe that crypto will have legs going forward but you still can’t wrap your mind around investing in something without any real assets? That is where the stock Bullish comes in. Its competitors have shown the ability to make real revenue by providing services to folks who ARE willing to dabble in the asset-less crypto currencies. They all have fundamentals to justify (or not) their share prices. Those may prove to be a safer crypto play for non-believers. Bullish–the company–has big designs on this new world (post-”digital revolution), as a service provider. Today, unfortunately, their projections are backed by mostly air. Going back to those un-sexy industrial companies, Air Products & Chemicals (APD) sells… um, air, and it had an income of $655 million in Q2. That’s not bad. It is trading at a forward P/E of 24 times. I am not sure if we could even calculate what the forward PE of Bullish might be. Even if we agree with management’s growth assessment, it is likely to be pretty high, that is, if we are applying mainstream risk-asset math. This story will continue to unfold for years to come, and, I suspect, some new math will be one of the results. Be safe out there, there are wild bulls running on the narrow streets of lower Manhattan.
YESTERDAY’S MARKETS
Stocks rallied yesterday in the vacuum of no economic data and rising hopes of Fed interest rate cuts. It was risk-on for crypto as Bitcoin hit another all-time high. Bond yields slipped with gaining bets of rate cuts.
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