Bear Markets are for Building
The S&P 500 fell around 4% since market close last week in response to a hotter-than-anticipated inflation print. Inflation clocked in at 8.3% for the month of August, exceeding the consensus estimate of 8.1%. Similar to the Jackson Hole about face, markets retreated sharply, having their worst day since June 2020. Expectations for the upcoming FOMC meeting meaningfully worsened with economists taking a 50 bps hike off the table and placing a strong possibility of a 100 bps rate hike in its stead.
With our weekly pulse check on the Fed out of the way, let’s shift focus to one of the recurring themes that we have already covered in spades. I am talking about nothing less than the hot topic of institutional adoption, something that to the behest of many of crypto’s most vocal proponents is yet to arrive en masse. I believe that in hindsight the somewhat lethargic response by institutions to the prior bull run will make sense when we are in the back half of the next four-year cycle. The reasons that many institutions lacked follow-through this time around are as follows:
A distinct lack of regulatory clarity
Poor rails to make interaction with the asset class seamless for portfolio managers and retail alike
Institutional and political understanding of the asset class remained underdeveloped
We are poised for meaningful improvements in all three of these facets. With the U.S. government beginning to prioritize crypto regulation many concerns over the staying power of the asset class are apt to be eliminated.
With BlackRock making their foray into crypto last month and Brevan Howard raising a $1 billion hedge fund, the rails to interact with crypto for institutions are also rapidly improving. In another major step forward this week, Fidelity, Charles Schwab, and Citadel refused to be outdone and teamed up to launch a cryptocurrency exchange. As for retail, Fidelity recently allowed investors to allocate to Bitcoin in their 401(k) plans.
Lastly, the research arms of major banks and institutional investment firms have been pumping out quality reports for a couple of years, raising their overall level of understanding of the asset class. With politicians asking increasingly better questions regarding crypto, we are beginning to move away from crypto’s era of blind fear and distrust.
Another core institutional narrative advanced this week with the Ethereum merge taking place Wednesday night/Thursday morning. After years of delays, the Ethereum network completed its long-awaited transition to Proof-of-Stake. This departure from the consensus mechanism used by Bitcoin is lauded by some who believe that the pervasive ESG narratives may now work their way into crypto with Ethereum’s energy consumption falling by over 99%. Instead of dedicating computing power, transactions on Ethereum are now approved by selecting validators based on their ownership of the overall network. This paves the way for future increases in the overall throughput of the network as Ethereum strives to be the world’s decentralized computational layer. This contrasts with Bitcoin which currently serves more as a global settlement layer and creates an even sharper divide between the two assets value propositions. Ethereum’s preference for speed over security clearly bifurcates the use cases for the two assets and creates room for institutional participation as multiple investment themes are now actively at play.
In Other News
In a recently published report, JPMorgan estimates that the Total Addressable Market for the metaverse in China is around $4 Trillion and revenues for their online gaming market could potentially triple from $44 to $131 billion.
The United Kingdom’s newest inflation print of 9.9% provides a tiny bit of respite from the pervasive slew of bad news the country has faced. This report checked in lower than the 10.1% in July and came in under the consensus estimate of 10.2%.
Zooming out, Euro Area inflation climbed to 9.1% in August, up from 8.9% in July. The recent report highlights that the peak has not yet been reached and there is more pain to come.
The European Union General Court upheld an antitrust ruling against Alphabet (Google), fining the company 4.125 billion Euros. Fun fact: As of 6/30/2022 they had about $125 billion of cash and short-term investments on their balance sheet, meaning this massive fine is under 4% of their most liquid assets.
To make the ongoing situation between OFAC and Tornado Cash more confusing, the US Treasury tried to clarify that using crypto mixing service Tornado Cash under certain provisions would not be in violation of recent OFAC sanctions. Take this with a grain of salt as the developer of the protocol was recently arrested with the only obvious cause being his involvement in creating the inherently neutral mixing service.
Mining Metrics
Bitcoin Price: ~$19,600
Hashrate (amount of computing power used by the Bitcoin network): 235EH/s
Hashprice (expected value of 1 TH/s of mining power per day): ~$0.078
ASIC Prices (the computing machines used to mine BTC): $33.41/TH
And then there was one.
With Ethereum’s transition to Proof-of-Stake now complete, Bitcoin is now the only cryptocurrency utilizing Proof-of-Work with over $10 billion in market capitalization. While other assets such as Litecoin and Bitcoin Cash also engage in Proof-of-Work, their relative computation is a trifle in comparison to BTC & ETH.
Iris Energy is the primary public crypto miner whose core operating model is to sell all of the Bitcoin they mine. Their operating model is the polar opposite of most of their peers who hold as much of the mined Bitcoin as possible. Across the entire spectrum of operators, Iris Energy has navigated the present market downturn more effectively by capitalizing on Bitcoin’s upside late last year when margins were around 90%. In light of this, research firm Compass Point elevated their stock to a Buy rating with around a 50% upside from current prices due to their positive outlook and recent performance, suggesting their stock could end up trading at a premium relative to other small-cap miners.
Hashrate Index’s newest blog post showed that the top public miners have around 17 EH on order through the remainder of 2022. Despite the continued margin compression for Bitcoin miners, Hashrate Index estimates that the year-end hashrate could still reach 270-280 EH. If this occurs without price appreciation, we will see mining profitability dip to new lows in the coming quarter. The one caveat to this outcome is that some miners may end up swapping their older hardware for newer models instead of purely adding to their overall hashrate. It is likely that some miners will go this route to maintain profitability amid a margin squeeze, putting additional downward pressure on second tier ASIC prices.
Until next week,
Artem