Adapted from our March 2019 Macro Research Report
Global Macroeconomics are Favorable for Cryptoassets
Over the past decade, global macroeconomic conditions have set the stage for Bitcoin (and cryptocurrencies at large) to achieve outsized gains in the mid to long-term. We don’t believe we could have asked for a better global environment for the success of Bitcoin than what we are seeing today. While cryptocurrencies do not require the failure of fiat currencies, weakness in fiat will likely expedite crypto adoption and demand.
The global political climate is fractured.
We’re witnessing a renewed sense of nationalism and political extremism as citizens grow disenchanted with their governments. The UK is attempting to ‘Brexit,’ France has seen mass protests (Gilets Jaunes), and Germany (the last truly productive nation in the EU) is on the edge of recession.
These actions and behaviors are a symptom of fundamental underlying issues with the global economy. Demand for violent or extreme change to the political status quo generally begins with widespread financial stress leading to scape-goating. Often times the economic issues are not evident until after the political change is demanded and effectuated.
Non-Sovereign Money is More Important Than Ever
Hidden risks in the global financial system are manifesting.
Irresponsible economic policies (MMT) are gaining popularity, while sovereign fiat (non-backed) currencies are collapsing (Venezuela). Global debt is on the rise and faith in central banking is at an all time low. Central banks are racing toward negative interest rates and are in a position where they can not stop balance sheet asset purchases in an effort to prop up economies.
Negative interest rates are a sign of impending trouble (and are long term unsustainable).
Borrowers are being paid to issue debt and investors who hold those bonds to maturity are guaranteed to realize a loss. The US bond market sticks out like a sore thumb, begging the question of when hidden inflation will begin to manifest in the US.
Negative swap spreads indicate structural economic faults.
The 30-year swap spread turned negative in 2008 and has remained in negative territory since. The 10-year swap spread also fell into negative territory in late 2015 for over a year and turned negative again in March 2019.
Negative spreads seem to suggest that markets view government bonds as risky assets due to the bailouts of private banks and the Treasury bond selloffs that occurred in the aftermath of 2008. In an effort to prop up the US economy, the Federal Reserve has continuously purchased treasuries and other assets on the open market (adding to the Fed balance sheet). In February, the Fed folded to market demands and indicated a willingness to continue purchases indefinitely. This phenomenon is not unique to the US as central banks globally are playing a game of chicken - each inflating their balance sheets and money supply with the goal of propping
up their own economies. This game can’t last forever.
Runaway Sovereign Debt Will Lead to Further Currency Devaluation
United States federal debt to GDP ratio is the highest since World War II.
United States history indicates a connection between the debasement (or devaluing) of its native currency (USD) and irresponsible borrowing at the federal level. Eradication of the gold standard and movement to a pure fiat system set up the environment for unrestricted no-consequence borrowing.
US Federal debt to GDP ratio has reached the highest level since World War II - exceeding 100% (i.e. more debt than annual economic output), generally a “point of no return” as future GDP growth will need to outpace US Treasury interest rates. Interest rates are low today but can not persist at these levels indefinitely. Because there are no simple ways out of this debt problem, further debasement of the US Dollar seems inevitable (and is already being priced in by the global bond market, where USD denominated corporate bonds trade at discount to Euro or Swiss denominated).
Bitcoin is the Hedge to These Structural Global Economic Faults
Bitcoin is currently misclassified as a risk asset due to its history as a speculative asset.
Historically, disruptive high upside asset classes draw in wild monetary speculation before real world uses are adopted. Cryptoassets are probably the highest upside asset class we have seen in history. Disruption to global money, the banking industry, governance, identity, and corporate entities are all in play. Some of these categories are at higher risk of disruption than others, but in aggregate the potential value accrual is staggering (tens of trillions of dollars). Maturation of the asset class and better overall understanding of the differentiating properties of Bitcoin and cryptoassets will eventually lead to proper classification.
At its core, Bitcoin was developed as a response to the irresponsible behavior of central bankers in 2008. Through quantitative and other monetary easing actions, central banks have inflated the total money supply and decreased the value of fiat currencies. Bitcoin solves this fault of fiat currencies through a fixed monetary policy, creating inherent scarcity in the asset. Bitcoin is both fungible (generally each Bitcoin, or fraction thereof, is the same as any other) and non-sovereign (it is not able to be controlled by or at risk of failure due to any sovereign entity). Further, Bitcoin is a bearer asset (control of private keys is all that is required to control its value) and permissionless (can be transacted by anybody, anywhere, and across any border).
Bitcoin improves on the properties of gold, making it an ideal global store of value candidate.
The above listed attributes were once limited to precious metals and gemstones, however cryptoassets are now in a position to absorb a significant portion, if not all, of the value currently ascribed to precious metals and gemstones.
While gold can be transported freely without intermediaries (to the extent not restricted by sovereign border control), it is difficult and expensive to physically transport in large quantities while Bitcoin can be transferred inexpensively, digitally, and in a borderless manner. Further, Bitcoin’s mathematically-secured supply schedule can not be inflated while precious metal supply is at risk of increased mining capabilities (terrestrially or extraterrestrial). Bitcoin’s use of an underlying blockchain allows users to maintain pseudo-privacy while enabling (selective) proof of reserve holdings, a highly desirable attribute in any banking use.
Bitcoin’s Linear Chart Improperly Exaggerates Long Term Price Extremes
Bitcoin’s history has shown a pattern of repeated boom and bust cycles. This is likely a factor of Bitcoin’s (and cryptocurrencies in general) immense potential and the momentarily inflated expectations of these currencies - resulting in near term over exuberance and long term return to the mean. A linear price chart overweights nominal price action (as opposed to percentage growth), overweighting recent exponential price moves and giving the view that each of Bitcoin’s previous booms and busts might be the last.
Evaluating Bitcoin Logarithmically Normalizes Long Term Price Growth
In 2014, multiple analysts began to proliferate the theory that Bitcoin would follow a logarithmic growth curve due to its high growth potential and strong network effects. Five years of additional market data have generally confirmed the trend.
Bitcoin’s price, like other datasets which span large ranges, is best viewed through a logarithmic chart. A logarithmic chart scales based on orders of magnitude (where the y-axis represents percentage change as opposed to fixed value change). This perspective better represents the growth of the asset as we are interested in tracking percentage change as opposed to fixed dollar change.
When viewed from this perspective (and displayed in the chart above), the volatility in Bitcoin’s price becomes easier to anticipate and begins to form a more predictable long-term trend, with identifiable over-exuberant “bubble” periods.
As of December 2018, Bitcoin has returned to its baseline growth channel.
Hyperbolic Growth Curves Are Not Exclusive to Bitcoin & Appear in Traditional Assets Too
Hyperbolic growth curves on logarithmic charts also appear over large time frames in traditional equities. While there are many examples available, we've highlighted a traditional consumer product company (Johnson & Johnson) and a consumer technology company (Apple, Inc.), both displaying exponential growth curves in linear view (inset) and hyperbolic growth rates in logarithmic view.
Bitcoin’s Technology Stack is Stronger Than Ever
2018 was an extremely positive year for the development of Bitcoin’s underlying infrastructure - including the adoption of two new technologies to increase transaction throughput and reduce transaction fees in the Bitcoin ecosystem, paving the way for the next generation of use cases and adoption.
Segregated Witness (SegWit)
In August 2017, an optional Bitcoin update known as SegWit was released. The update was designed to increase network capacity by modifying the manner in which digital signatures of transactions are handled, which account for approximately 60% of a transaction’s size. Nodes running SegWit can process twice as many transactions per second compared to legacy nodes. Currently the SegWit update has been adopted by over 45% of the Bitcoin network.
Lightning Network
Additionally, Bitcoin’s Lightning Network, a new ‘layer 2' scaling solution has brought near instant transactions to Bitcoin, while also helping to decrease network congestion by creating a pipeline to facilitate lower value transactions. Currently the Lightning Network’s capacity has grown to approximately $4.2MM USD in its first year.
Blockchain 3.0 Delivers on Early Promises
2018 brought with it the next generation of blockchain (3.0) platforms, with more developer friendly features, fast and free transactions, and higher overall throughput.
In July 2015, Ethereum, the original ‘blockchain 2.0’ smart contract platform went live. Ethereum’s ecosystem ballooned over the next 4 years, amassing a repository of over 2,400 dApps. However, Despite the platforms early success, the network has experienced a decrease in both new monthly dApps and daily active users (now 20k). These decreases are most likely attributed to the emergence of newer ‘blockchain 3.0’ platforms.
In June of 2018, the first ‘blockchain 3.0’ network, EOS, was launched. The blockchain delivered on the promises of fast transactions (300x faster than Ethereum), high throughput (48x more transaction volume than Ethereum), and no transaction fees — while simultaneously offering more tools to developers. There are currently only 230+ dApps on EOS, however the network has gained 90k daily active dApp users (4.5x more DAU’s than Ethereum).
In July 2018, a similar blockchain 3.0 project, TRON launched their network. Tron delivers on all the same benefits as EOS and has amassed 220+ dApps and 44k daily active users. In 2018, the Tron Foundation acquired BitTorrent for $140MM USD. BitTorrent created the Torrent protocol, made infamous by the rise and fall of Napster.
Novel Decentralized Use Cases Emerge
Applications and use cases of “programmable money” began to take shape throughout 2018 and are poised to continue to grow through the rest of 2019.
Ethereum Pivots From dApps to Decentralized Finance (DeFi).
Maker is a decentralized lending platform built on the Ethereum network that allows borrowers to post collateral (currently only in the form of Ether) for the right to borrow or draw a USD-pegged token called Dai. Because Maker’s system doesn’t rely on legacy banking infrastructure, it allows users to maintain stable wealth in a crypto-native platform entirely outside of existing financial systems as well as interact with Ethereum dApps using a less volatile asset than the native Ether. To date, users have deposited over 2.2 million Ether (roughly 2% of Ethereum’s supply and worth approximately $300MM USD).
Compound launched an open-source decentralized peer-to-peer lending platform allowing users to trustlessly (without counterparty risk) borrow and lend assets to one another. Compound takes advantage of a shared liquidity pool to dynamically adjust interest rates based on supply and demand. There are currently $25MM USD worth of digital assets being lent on the platform.
Uniswap is a protocol for the decentralized exchange of tokens that doesn’t utilize a standard order book model. Rather the protocol controls order matching and market making, utilizing a dynamic pricing algorithm that determines price based on liquidity. Users provide liquidity by depositing their assets into the platform to earn fees (similar to trading fees earned by traditional asset exchange platforms).
Uniswap is the first of a new generation of application which has no token or ownership representation but rather incentivizes certain behaviors based on native rewards and behavioral dynamics. There are currently $7MM USD worth of digital assets deposited in the platform’s liquidity pools.
Institutions Have Entered The Arena
Recognizing the transformative nature of the technology, large, multi-national corporations are rapidly incorporating crypto-native technologies in their products and services - accelerating the proliferation of cryptocurrencies and blockchain technology.
Perhaps the biggest news regarding potential mass adoption of cryptoassets is the release of Samsung’s flagship phone, the Galaxy S10, which supports a native crypto-wallet and blockchain based games, along with their tradable non-fungible in-game assets.
Simultaneously, HTC released their Exodus 1 blockchain-native phone which includes a secure hardware crypto-wallet and supports Nodle's p2p mesh network, a revolutionary technology that pays users to passively transfers IoT data between devices.
JP Morgan announced efforts to develop their own token-enabled public blockchain aimed at providing more rapid and efficient international value transfer amongst international banks.
Meanwhile, rumors surrounding Facebook are suggesting that the company is pursuing a mobile cryptocurrency solution for their southeast-Asian WhatsApp users, allowing them to easily remit value from one user to another.
Bitcoin's Market Cycles Follow Fundamentals
While the market has historically followed an emotional boom and bust cycle, there are several identifiable fundamental factors which drive the larger cyclical trends. Here are some of the factors we’re paying attention to:
“The Halving” refers to Bitcoin’s supply schedule, where roughly every 4 years Bitcoin’s inflation rate (the rewards paid to Bitcoin miners) is reduced by 50% (until 21 million Bitcoin have been mined, when no new supply will be issued). The reduction in supply schedule historically begins to be anticipated by the market approximately 12-15 months prior to the next ‘halving’ and has historically signified the very beginning of the next bull cycle. The next halving is expected to occur late May 2020 (14 months from now).
Bitcoin’s price has been found to follow a stock-to-flow model, which predicts price based on outstanding supply versus the new supply introduced annually. We see that price generally follows the resulting stepwise-function model. This follows logically, because if we assume steady (or increasing) demand for the asset with decreasing new available supply, the result will be upward price pressure. It’s important to note that speculation in the price of the asset causes extremes on both ends - over-exuberance in bull markets and over-gloominess in bear markets - where we are in a period of over-gloominess.
When the price of Bitcoin falls, mining becomes less profitable, or unprofitable, for certain miners. In response, these inefficient miners cease operations, which manifests as a rapid decrease in mining computing power (or “hash power") supporting the network. Bitcoin’s software automatically decreases mining difficulty in response to the decrease in hash power (signifying the “miner capitulation”).
We have seen miner capitulations three times in Bitcoin’s history. The first two coincided with market cycle bottoms and the most recent occurred between October and December 2018, setting the stage for the next cycle to begin.
Money Flow is an Early Indicator of Price
On Balance Volume (OBV) has been a dependable bottom signal.
OBV is a technical indicator that approximates money flows into and out of an asset. Rising OBV reflects increasing buy volume which may reflect hidden buy pressure that may lead to higher prices, while falling OBV reflects increasing sell volume pressure that may foreshadow lower prices. Our analysis of the indicator operates on the notion that volume precedes price movement, making it a leading indicator of future price action.
When analyzing OBV in relation to a long term down trend, we witnessed OBV continually set lower lows through the bear market and capitulation. It is only after OBV begins setting higher lows and breaks the long term OBV trend line while also (almost simultaneously) breaking the long term downward price trend that we see the mark of the end of the bear market.
Looking at 2018 and 2019, OBV appears to be setting higher lows and has broken both relevant trend lines — signaling the end of the bear market.
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