BLACKROCK REDUCES REPUTATIONAL RISK & PRESSURES SEC
BLACKROCK REDUCES REPUTATIONAL RISK
BlackRock's application for a spot Bitcoin ETF has sparked a sharp bitcoin price increase from $25K above $30K as investor’s assess the probability of improved institutional access in the US. Perhaps the world’s largest asset manager is able to shift the SEC’s notably negative stance under Gary Gensler. Either way, Blackrock’s decision lowers the reputational risk of other institutions making a foray into crypto. While Larry Fink and co. are engaging with the tech, Genler’s SEC has taken off the gloves, charging the world’s largest exchanges. We expect Congressional backlash heading into the 2024 Presidential elections as the ramifications of Gensler’s crusade become obvious. While we anticipate higher prices in the second half of 2023, we must remain cautious of excessive euphoria and focus on fundamentals rather than SEC speculation.TLDR: Bitcoin shrugs off external attack as Blackrock confirms institutional adoption trend.
Conclusions
Spot bitcoin ETF would improve trad-fi access
Blackrock application does not imply SEC success
Blackrock’s stance reduces the reputational risk for crypto allocations
We continue to expect higher prices in H2 2023
Caution against excessive euphoria
Improving Trad-FI Access
Currently, the United States only offers features-based Bitcoin ETFs, which are expensive, inefficient, and unpopular. The introduction of a spot Bitcoin ETF would likely be more accessible and gain greater popularity among investors.
Eventually, the SEC will have to relent to a spot bitcoin ETF
Although BlackRock's application is a significant milestone, it does not guarantee approval by the U.S. Securities and Exchange Commission (SEC). It is worth noting that BlackRock, being the world's largest asset manager, has had only one ETF application rejected by the SEC in the past. However, the SEC, under Gary Gensler's leadership, has displayed scepticism towards the crypto industry. Blackrock’s application has the best chance of success and eventually the SEC will need to relent to the will of the market but it would be foolhardy to be confident of success in 2023.
BlackRock's Endorsement REDUCES Reputational Risk
Regardless of the application's fate, BlackRock's decision to file for an ETF is a vote of confidence in both the technology and the asset class. In a November 2022 CNBC interview, BlackRock CEO Larry Fink expressed positivity for the technology. While minor, Blackrock had skin in the game through small indirect exposure to FTX in 2022. The losses showed Blackrock that centralized financial infrastructure poses risks, yet decentralized financial applications like bitcoin and ethereum were resilient through the crisis. Fink even stated that tokenization is the future of securities markets, highlighting his conviction in this transformative technology. BlackRock's interest in cryptocurrencies helps alleviate the reputational risk associated with the asset class, positively influencing other asset managers' allocation decisions.
Tempering Expectations
Although this development is exciting, it is essential to temper expectations. We should refrain from making premature assumptions about the acceptance of the application and the potential inflows that may follow a positive announcement. Comparatively, the largest gold ETF, GLD, is valued at approximately $59 billion, representing only about 10% of Bitcoin's market capitalization. While positive flows from an ETF approval could impact the price positively, they are not guaranteed and would likely occur over time rather than in a single day.
Focus on market dynamics over ETF speculation
The sharp price reaction to the news suggests that the market was under-allocated. Depressed sentiment clearly caught some participants offside and serves as another reminder that sentiment is a bad way to make investment decisions - unless you counter-trade sentiment.
This news does not fundamentally alter our perception of the market. We anticipate continued adoption and allocation in the coming years as decentralized financial technology demonstrates its value amidst uncertainties surrounding traditional financial infrastructure, loose Federal Reserve policies, and demand for alternatives to the USD reserve currency system. We still expect $35-40K prices as a realistic possibility in H2 2023.
While we remain optimistic about Bitcoin's potential, current market conditions do not suggest an immediate sustained run to new record highs in 2023. Long-term holders have been realizing profits relative to short-term holders, and the next halving cycle is still ten months away. Therefore, we consider the likelihood of new record highs and aggressive bull-market conditions to be higher in 2024, than 2023. If euphoric sentiment emerges in H2 2023, prompting investors to shift aggressively into high beta portions of the market, adopting a more defensive stance would be prudent.
SEC TAKES OFF GLOVES, TARGETS CENTRALISED EXCHANGES
Gary Gensler’s SEC has thrown off the gloves but bare-knuckle boxing with crypto is not going particularly well. Trading activity is outside the US and stablecoin volumes are shifting to tether, defeating the goals of the US government - which raises the prospects of Congressional action. The SEC case introduces FTX fears at Binance, but offshore investors do not seem to care, for now. The Coinbase allegations could bring some much-needed clarity regarding securities regulation, but this could take time to emerge.
Conclusions
· SEC’s Binance case raises FTX fears but existing investors appear unperturbed
· Coinbase case may create clarity on the application of securities law in crypto
· Both cases will probably take many years to conclude
· SEC’s actions are pushing activity outside the US, towards less regulated entities
· Congressional backlash increases with each anti-crypto SEC case
Binance faces far more severe charges than Coinbase
It is important to distinguish between the two cases as Binance faces more serious allegations than Coinbase. Both organizations have been charged as unregistered exchanges, brokers, and clearing agencies. While there is some overlap regarding unregistered securities charges, the gravity of the remaining allegations weighs heavily on Binance.
Coinbase believes they have strictly adhered to the letter of the law. It is worth noting that Coinbase underwent extensive due diligence from the SEC before its direct listing on the Nasdaq in April 2021, just prior to Gary Gensler assuming leadership of the SEC. The outcome of the Coinbase case could potentially provide much-needed clarity on the application of securities law in the crypto industry.
Regarding the Binance case, it may also bring about clarity in the long run, but in the short term, numerous uncertainties and a prolonged resolution process are expected. The SEC alleges that Binance's BNB token is an unregistered security. The most damning accusations against Binance include misleading investors, potential misrepresentation of consistent overcollateralization, and the possibility of using client funds to secure debt. These allegations, coupled with concerns reminiscent of the FTX scandal, could generate fear within the market.
As the world's largest exchange, Binance holds a substantial amount of Bitcoin, approximately 3.6% of its circulating supply, the most among any exchange. Should evidence of commingling at Binance surface and FTX-style fears escalate, there could be a rush for liquidity, making this a situation that requires close monitoring. So far, Binance customers appear relatively unaffected by the allegations, with Bitcoin balances remaining largely unchanged.
Gary Gensler’s time at the SEC is running out
That the SEC has charged both exchanges simultaneously is probably not coincidental. The SEC under Gary Gensler wants to create the perception that crypto companies lack credibility. Binance lawyers allege that Gary Gensler offered to act as an advisor to Binance before he took up the position at the SEC, which casts further dispersion over his credibility. This does not necessarily imply innocence on Binance's part. It merely seems clear that Gary Gensler has ulterior motives and is not necessarily acting in the interests of the American consumer. This raises the possibility of backlash from Congress.
Market participants may need to consider the possibility that President Joe Biden may not remain in office in 2024 and that Gary Gensler could lose his position as SEC Chair. If crypto becomes a significant topic in the election campaign, Gensler's job could be at stake, regardless of the election outcome.
As anticipated, the regulatory crackdown on crypto in the United States is driving activity offshore, into the hands of less regulated entities. This contradicts the goals of the SEC and the US government. In the past six months, there has been a substantial divergence in supply activity between the US and Asia, while Tether's market share growing sharply compared to USDC.
Both cases involving Binance and Coinbase are expected to take several years to reach a resolution, so immediate changes are unlikely. However, a significant shift in Binance balances would raise concerns similar to those surrounding FTX and should be closely monitored. While these concerns carry some weight, they do not appear to be as severe as the FTX situation. Ideally, the SEC's case against Binance will encourage the adoption of more transparent business practices.
NOTABLE ALTCOIN UNDERPERFORMANCE VS BITCOIN
One notable implication of the SEC’s charges is the underperformance of altcoins relative to bitcoin. We have long taken a cautious stance at Sound Money Capital, focusing primarily on bitcoin ethereum and stablecoins. The longer history and proven use cases have always been important for us. A smaller but non-negligible component of the decision-making was the greater risk of certain crypto assets being deemed securities. We feel somewhat vindicated by these actions from the SEC. Not because we agree with their stance, but because we assessed this securities risk premium to be material. Currently, the market is largely reviewing the situation through our lense.
Investment process trumps SEC speculation
The unfolding events in these cases are of great interest, but similarly to the Blackrock news mentioned earlier, we prefer to focus on our investment process rather than attempting to predict regulatory outcomes.
One notable aspect throughout these challenges is the resilience demonstrated by Bitcoin in the face of external attacks on centralized crypto exchanges. As Larry Fink highlighted in the aforementioned interview, centralized institutions pose numerous risks such as fraud, negligence, and regulatory vulnerabilities. In contrast, truly decentralized protocols like Bitcoin and Ethereum are not subject to the same level of risks, which contributes to their widespread appeal.
