Date: 08/16/2021
Author: Kent Moors, Ph.D.
There is something unusual developing in the crypto currency space. While the mainstay coins like bitcoin and ethereum continue to experience price volatility, the stocks representing the trading of such coins have been moving up.
The bellwether indicator here will be the earnings report from Coinbase Global (COIN) coming this week. Most analysts believe the report will be bullish, translating into a push up in COIN valuation by between 12 and 16 percent.
That the improvement is moving into the trading of crypto currency even as the coins themselves languish appears to support my contention in previous Classified Intelligence Brief entries that the genuine move in the digital sector is found in the middle.
While it is the trading of the coins that will improve this week, I still maintain that the essential opportunity is found in those companies providing support and access for connecting crypto and more conventional finance.
Now such a connection will require that crypto become more accepted in commercial and financial transactions. That is coming, but there are still some main impediments.
For one thing, the valuation of the currency remains suspect. A vehicle of exchange cannot accelerate simply on a desire for the exchange itself. Digital accounts cannot support a rising amount of exchange absent a broadening acceptance of the underlying valuation.
The recent significant change in ethereum – called the “London fork”—is the latest case in point. It has resulted in a transfer of interest to ether from the more dominant bitcoin. The algorithmic protocol transfer changes the way ethereum miners are paid.
Previously, users bid what they are willing to pay for a translation to be validated by a miner. The “fork” now sets up a set fee based upon how busy the ethereum network happens to be at any given time. Another major change involves “burning” a portion of each transaction fee, thereby serving to introduce more scarcity into the supply of the cryptocurrency and improving the value of those in circulation.
Bitcoin remains a currency having an absolute amount allowed in circulation. But the revision in ethereum tends to make ether a bit more valuable in any exchange.
It is still early to determine the genuine impact. But since the fork took effect, the ethereum current rolling week daily average (adding the most recent closing value, deleting the earliest) at close of market trade on Friday posted a rise of 21.95 percent in Ethereum-USD (ETH-USD). The equivalent for bitcoin, as measured by Bitcoin USD (BTC-USD), came in at a rise of 20.07 percent. End of week figures tend to be the more telling for crypto. They trade globally 24/7 but have a more subdued change in comparative performance as trade moves into a weekend.
There are also cross-trading trends among the dozens of liquid coins (where COIN makes its money). Usually, the primary coins take their bearings from what happens in the value of bitcoin. The “London fork,” and other similar moves anticipated in other coins, may begin to change that.
All of this occurs against a recent backdrop of major digital currency thefts, frauds, and questionable hedging moves. For crypto to be acceptable, what the market needs more than anything else is predictability.
And there are other matters rising to make this acceptance more problematic.
I no longer believe that crypto currencies are a passing fad. They will move into more general widespread use, especially since several central banks worldwide are intensifying drives to introduce their own digital coin presences. To the extent that these moves are successful, a greater crypto presence is assured.
But this may come at a price. Digital currency tied to a fiat currency (US dollars, for example) carry its own problems.
Much of this involves the rise of something I have previously identified as a concerning element in crypto. As I noted in an earlier CIB (“Why a Cryptocurrency Wrinkle Could Usher in the Next Asset Crisis,” Classified Intelligence Brief, #101, July 12, 2021):
This time, the problem area is rising in crypto currency. It is called stablecoin and it seeks to become a bridge between traditional asset valuations and digital currencies. A stablecoin is tied to a “real-world” asset (usually the US dollar), thereby providing a “stable” valuation, unlike better known crypto issuances like bitcoin or ethereum that have exhibited wide price volatility.
Tether, a stablecoin tied to the dollar has been accelerating fast and is now the third largest crypto coin by market value. And it has some analysts worried that it could become the source of the next subprime-like major asset bubble implosion.
Since it is tied to the dollar, tether should have a value that remains at $1. However, that has not always been the case, prompting some panic upon occasion among investors. Crypto traders will often use the tether to buy cryptocurrencies, rather than the dollar or other traditional fiat currency. Digital traders are increasingly preferring this approach to provide transaction safety via a more “stable” asset during times of sharp volatility in the crypto market.
However, crypto is not regulated. Most banks balk at working with digital currencies, citing the increased risk involved. That is different from MBS [mortgage-backed securities that ushered in the 2009 crash] paper where, initially at least, the injection of dollar-denominated assets provided the semblance of some risk protection. This is the reason why tether has caught on inside the crypto trading market so quickly and is now poised to have a wider impact.
With the MBS crisis paper, the problem was suspect asset valuation. In that case, the face value of the mortgages buried within a wider asset class never had the dollar value the consolidated mortgages conveyed. The amount represented by subprime borrowers reflected a false valuation. The dollar amount reflected was never the true (more discounted) value of the underlying asset. That asset, in turn, was not the market value of the real estate but the payment value of the mortgage on that property.
The same problem may emerge with tether. Only this time, it will play out in a still unregulated market yet serve as a transaction base for a widening collateralization of other dollar-denominated assets.
Two months ago, Tether (the company) broke down the reserves for its stablecoin. The firm revealed that only 2.9 percent of its holdings were in cash, while the vast majority was in commercial paper, that is, unsecured, short-term debt. That would still put the company in the top 10 biggest holders of commercial paper in the world. Some analysts have compared Tether to a traditional money-market funds — but without any regulation.
With more than $60 billion worth of tokens in circulation, Tether has more deposits than that of many US banks (see, https://www.bloomberg.com/news/articles/2021-05-01/crypto-s-shadow-currency-surges-past-deposits-of-most-u-s-banks).
In addition, there have been concerns expressed that tether has already been used to manipulate crypto prices, a point strongly made in one well-done academic review of a 2017 bitcoin value surge (see https://papers.ssrn.cm/sol3/ papers.cfm?abstract_id=3195066).
As CNBC reported in 2018 in an article entitled, “Much of bitcoin’s 2017 boom was market manipulation, research says,” University of Texas finance professor John Griffin, who has a 10-year track record of spotting financial fraud, and graduate student Amin Shams examined millions of transactions on cryptocurrency exchange Bitfinex. They found that tether was used to “stabilize and manipulate” bitcoin’s price.
Griffin suggested that this was creating “price support” for bitcoin and had “huge price effects.” Even just one percent of heavy tether trading could explain as much as half of the rise of bitcoin and even a greater percentage when it comes to other cryptocurrencies.
This is hardly an encouraging foundation upon which to base a tether usage in broader dollar-denominated asset categories. An unregulated use of a stablecoin looks a lot like the latest version of an MBS clone. Not the development to put much trust into the securitizing of assets. Unless, of course, you really enjoyed that subprime mess.
All of this may be welcome to the crypto currency purists who view the coins as an alternative to fiat or paper currency and a way to lessen the impact of central governments in regulating exchange. Yet this “maverick” nature will gravitate against acceptance in traditional exchange.
Then there is the danger of inbred valuation, as a myriad of new minor coins are created with no way to ascertain a genuine independent value apart from what they may extract from the more established coins. Despite what adherents would have you believe, there is not enough game to go around.
Once again, the seminal example of dogecoin is illustrative. That those who created the coin as a parody of the crypto sector now find their joke being considered serious, and even being accepted in some very limited circumstances, is a significant statement on the space as a whole. The whole issue isn’t helped by noted entrepreneur and investor March Cuban declaring on Friday that dogecoin is now the “strongest” crypto currency as a medium of exchange.
I am aware of nobody in my network of traditional capital and financial folks who would agree.
Solidifying the middle ground in the digital space is essential for crypto to gain greater acceptance. Increasing valuation of Coinbase Global will serve as a first step. But, unless the development moves into a wider group of genuine exchange service providers having more direct access to the traditional financial universe, it will remain a trading among crypto afficionados rather than an introduction to a new age. It will be a digital currency version of Peter borrowing under the table to pay Paul.
Dr. Kent Moors
This is an installment of Classified Intelligence Brief, your guide to what’s really happening behind the headlines… and how to profit from it. Dr. Kent Moors served the United States for 30 years as one of the most highly decorated intelligence operatives alive today (including THREE Presidential commendations).
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