America is a country made up of people of all cultures and, as such, we have a potpourri of traditions. One derived from the Pennsylvania Dutch involves turning to animals or, more specifically, a groundhog to determine if we are going to have a long winter or not. Of course, I’m referring to the tradition of Groundhog Day.
This Feb 2, as is the case every February, the venerable groundhog, Punxsutawney Phil, poked his head out to search for his shadow which, obviously, prognosticates whether we are going to have an additional six weeks of winter. This year, Phil looked out and saw his shadow which, if you follow legend, implies that more winter is in front of us.
Maybe our Bullbearen saw his shadow too. As distinguished last blog a Bullbearen (close relative to a Turducken) refers to a little bear stuffed inside a bull. This is our current perception of the markets; that we have a short-term bear inside a larger bull that has yet to run its full course. Shadow or not, with regards to the markets, it sure seems that we have a little more winter in front of us before the next bull leg returns. I’ll not rehash our case for this at this point. I will note that with the Fed’s stance, impeding war on the horizon between Russia and Ukraine, and unfavorable macro winds blowing, that discomfort remains in markets across the board. Given this, it would not surprise us to have a little more of this sideways progression before the next leg is upon us. Six more weeks of winter, as it were.
Having said all that, Punxsutawney Phil has only a 40% accuracy rating, so rather than base predictions on shadow viewing, I think it’s best to look at what’s currently happening in the world of crypto assets while the macro environment sorts itself out. We see this as the best indicator available to show the long-term potential of these markets, and there were a lot of positive factors this past month.
We Need a Bigger Pool
Starting with perhaps the biggest news of the month, BlackRock, the world’s largest asset manager ($10T AUM) is set to offer crypto trading. Folks, if there was any question about the legitimacy and forward movement of these markets this simple announcement should quash it all. Blackrock would never do this in a market that doesn’t have massive potential, after all, with this action they are providing exposure to crypto assets to their 1,500 institutional clients. What is even more interesting is that they will also allow lending against crypto assets, and they have also filed for a spot ETF. The biggest kid on the playground just jumped into the pool in a very big way. Everyone tends to follow this kid. I think we are going to need a bigger pool.
Regulators, Ride!
One of the acknowledged barriers to entry for the institutional players is regulatory clarity. Regulation – the appropriate amount mind you – will provide the guard rails that will facilitate much larger participation in these already booming markets. To that end there are a couple of big cases that came to light this month that will shed some insight into this world.
BlockFi, one of the earliest and most well-known DeFi companies, is a platform that allows users to generate interest on deposited crypto assets which could be in the form of BTC, ETH, USDT and many others. What is amazing is that this interest was substantial and could reach in some cases up to 9%. This, unsurprisingly, caught the attention of the SEC and has led to a months-long entanglement over whether this was proper. Well, the good news is the two groups recently reached a settlement, which resulted in the ruling that BlockFi can provide this service. The asterisk is that such lending instruments are considered a security, must be registered with the SEC, and BlockFi needs to pay a $100M fine for this privilege. (Peanuts ultimately.)
This isn’t particularly surprising as the US regulatory agencies are vying for crypto control. Now, the SEC has one more feather in their cap; they want this type of transaction regulated by them, so they have more control of this nascent industry. While I don’t love the fact these interest-bearing instruments are considered securities, the net-net of this is that, once the proper filings are done, US citizens will be able to deposit principle and earn significant interest. This also opens the door wide open to all other vendors who provide these services and, ultimately, is a watershed moment for crypto. The services are legal and legitimate. We have regulatory guidance. That’s a win-win if you ask me. It promotes further growth of the DeFi space and crypto in general and clears the way for institutional investors to now participate in the world of yield-farming.
Meanwhile, the IRS is now being taken to task. Some blockchains allow staking, which is pledging that the blockchain’s token will be stable on the network. In return, the blockchain returns rewards of additional tokens. It seems that a couple of taxpayers, the Jarretts, reported their staking returns as income and paid the expected tax. In a “didn’t see that coming” move, the IRS stated no, you don’t need to do this, staking is not considered income and returned funds to the Jarrets. Yes, you read that correctly. The IRS sent money back.
The interesting wrinkle here is that the Jarretts did not cash the check – instead, they are suing the IRS to prove their point in court. If this seems counterintuitive consider that by doing so they are making the IRS back their position in what would become case law and, assuming this goes the direction the IRS has already indicated, this would mean that assets earned via staking are not subject to taxation. It will be very interesting to see how this turns out but, if it does become case law, it lends further clarity into the world of crypto assets and their nature which will in turn be foundational for determining future law. Simple summary: Pay your taxes. Sometimes it works out really, really well.
The Joy of Pseudonymity
One of the biggest comments I get from those skeptical is the assertion that crypto is primarily used for illicit activity. Let’s be honest, crypto gets a bad rap because of this despite the fact that it’s just not true. Certainly, it’s used for some illegal activities in the same way that the $100 bill is. The actual percentage of activity is miniscule in the amount of dollars however, and may be as little as 0.1% in 2021 ($14B in illicit transactions vs $15T in legitimate transactions) according to Chainanalysis. Even if they are an order of magnitude off it’s still a small percentage. Will it continued to be used by bad guys? Of course! As long as there are humans there will be those that subvert the system, and they’ll use any means to do so. This does not mean that crypto is inherently evil.
An important detractor to illicit activity is the debunking of the myth that crypto transactions are anonymous. They aren’t. They are pseudonymous. This means only partly anonymous. Remember that blockchains are transparent, which allows all transactions to be “seen” by everyone at any time. Wallets may not necessarily have a name and social security number attached to them as identifying data, which is what yields the argument that it’s anonymous. But guess what? Ultimately bitcoin, in order to be redeemed for anything, must end up somewhere, be it a store, a human, or an exchange (which requires full informational data on account holders for any transaction of size). We now see this in action because two individuals were just arrested for a 2016 hack which resulted in $45 billion in bitcoin being stolen from the exchange BitFinex. While it took a little time, the authorities were ultimately able to trace the transactions to two individuals Ilya Lichtenstein and his wife, Heather Morgan, who are now accused of multiple counts of money laundering. What was the deciding clue? Some of the flow was eventually traced to a – wait for it – Walmart gift card.
The fact that a blockchain is immutable means that transactions are visible forever which is a deterrent to would-be-wrong doers and, importantly, a boon to law enforcement. Worth mentioning, $36 billion of the $45 billion stolen has been recovered. Crime doesn’t pay. On the blockchain, counterintuitively, it may pay even less.
In Closing
I just touched on a very few items here but I’m already long winded so I’ll wind it up. Maybe it will be 6 more weeks of winter. Heck, maybe it’ll be 12. But you know what happens after winter? Spring. With BlackRock going big, regulation clarity moving forward and do-badders on notice, our little blockchain world (with market cap of $1.7 trillion) certainly has plenty of forward movement. This is why we believe we’re just at the very beginning of a long wave boom cycle – the Age of Autonomy – that will be unlike anything we’ve seen in generations. As always, I encourage our readers to keep their eye on the long view, not on their shadows.
Lastly, on the speaking circuit front, for those of you in New York City, Jake and I will be speaking at Hedgeweek on Feb 24 – we hope to see you there!
Until next month take care, be safe, and I’ll be sure to keep Decrypting:Crypto for you!