Think Twice About Catching This Knife

Date: 9/18/2022
Author: Mr. X


There’s an old saying in trading: “Don’t try to catch a falling knife.” Just because a stock’s price is historically low doesn’t necessarily mean it’s going to increase. Stocks can go to zero. Companies do go bust.

FedEx (FDX) CEO Raj Subramaniam recently said that we are “going into a worldwide recession.” Some might call that alarmist, but traders clearly believed him, considering last week’s decline in the overall markets and FDX’s drop of more than 23% last week.

There are some dividend stocks and value plays that are shaping up, but some stocks may be entering a protracted decline. The Federal Reserve will raise rates by at least 0.75% this week, and we can’t rule out a full point increase. This is going to have a disproportionate impact on tech stocks and growth stocks.

This is a knife that investors should be extremely cautious about trying to catch. Yes, it is historically cheap. But there are plenty of reasons to think we haven’t hit bottom.

This is the bearish case for Coinbase (COIN).

COIN was going for $342 a share in April 2021. On April 14, 2021, Jim Cramer infamously tweeted: “We like Coinbase to $475.” Coinbase looked poised to become the point of entry for the swelling cryptocurrency marketplace. Unfortunately for Coinbase, the bottom fell out for cryptocurrency over the last year.

  • Bitcoin (BTC) is down almost 60%
  • Ethereum (ETC) is down more than 60%
  • Cardano (ADA) is down almost 91%
  • Monero is down more than 48%

Matt Damon’s “Fortune Favors The Brave” ad for Crypto.com, which compared investing in crypto to the Age of Exploration, has practically become a meme because of the way crypto tanked almost immediately afterward. Even South Park got in on the action, with Cartman’s mother explaining, “Matt Damon told me fortune favors the brave and I lost all my f***ing money.”

Part of the reason this is happening is because the government is circling the cryptocurrency market like a hungry shark. In July, the Securities and Exchange Commission brought insider trading charges against a Coinbase product manager along with two others. Coinbase is currently involved in a legal battle against the Treasury Department regarding that body’s actions against Tornado Cash. CEO Brian Armstrong said that while a hard stance against unlawful behavior is justified, “[I]n this case, Treasury went much further and took the unprecedented step of sanctioning an entire technology instead of specific individuals.”


Move Fast. Keep Winning.


This also must be considered against the background of SEC Gary Gensler’s concerns about cryptocurrency in general. “This asset class is rife with fraud, scams, and abuse in certain applications,” he has said. “We need additional congressional authorities [new powers] to prevent transactions, products, and platforms from falling between regulatory cracks.” In March, the SEC said any public company that holds crypto assets for clients, including large investment banks such as JP Morgan Chase or Goldman Sachs, must list them as liabilities. In May, the SEC bragged that it had nearly doubled the size of its “Crypto Assets and Cyber Unit.”

There’s also the absolutely fundamental question of whether a cryptocurrency is a currency or a security. All the way back in December 2020, I wrote about the SEC’s lawsuit against Ripple Labs, which issues XRP. Is XRP a currency or a token, or is it simply a security or a kind of share from Ripple Labs? If it’s the latter, it clearly falls under the SEC’s jurisdiction.

I wrote then:

The SEC’s action against XRP, which had been on a tear before the suit, seems like a shot across the bow of the entire industry. XRP was far from fringe and the entire sector is clearly shocked. However, the SEC’s suit doesn’t really clarify the situation. Instead, it just makes it more confusing. The combined assets tracked by Coinbase were down by more than 3.75 percent Wednesday, with XRP losing almost 40 percent. The situation is going to become even more chaotic because Coinbase itself has filed to become a publicly traded company.

Cryptocurrency shook off this off in early 2021, but the uncertainty clearly remains for this industry. The wheels of justice turn slowly; there’s still been no resolution. In fact, just days ago, the SEC and Ripple Labs finally agreed on one thing – this has gone on long enough. Both have filed motions for summary judgment in New York’s southern District court. Judge Analisa Torres (a Barack Obama appointee) may issue a truly historic judgment very soon. The implications could be massive. If cryptocurrencies are securities and not tokens or currencies, the regulation will intensify.

Our dear friend the late Dr. Kent Moors warned all the way back in July 2021 that the issue of stablecoins could also have massive implications. Stablecoins are tokens linked to the dollar’s value which are needed to underlie most cryptocurrency exchanges. If you are investing in cryptocurrency for speculative purposes, the whole system doesn’t work unless stablecoins have enough backing in fiat currency and other assets. Some people have questioned whether certain coins have that backing.

Dr. Moors wrote then:

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.

Recently, The Wall Street Journal made similar accusations and raised similar questions about Tether. About two weeks ago, Tether forcefully responded against the “disinformation” published by the Wall Street Journal, arguing that it has sufficient reserves and defending the credibility of BDO Italia. Its detailed reply is worth reading in full, but the key excerpt was:

The article seeks to discredit the work that Tether has put into transparent and honest communication to the public. BDO, a very reputable and independent Top 5 audit firm, is not a “Tether accounting firm”, as erroneously written by the WSJ. BDO will continue to have unrestricted access to any relevant  information to perform their work and Tether will continue to share its attestations, despite continuous attempts by the media to disparage its reputation and that of top-ranking firms like BDO that are working with digital asset companies.

“Tether is committed to maintaining its role as the leading stablecoin in the market and we will continue to demonstrate our transparency, regardless of naysayers,” it added.

An audit is reportedly still forthcoming so only time will tell. However, if the stablecoin doesn’t have sufficient reserves, it would be a massive blow to the cryptocurrency trading market.

Coinbase is a company that facilitates trading in assets that are supposed to be alternatives to the dollar. Yet it is facing similar problems to the Federal Reserve. The Fed is trying to limit inflation with interest rate hikes. Unfortunately, there are countless circumstances completely out of its control, not least the supply chain disruptions caused by the war in Ukraine and China’s occasional production halts in response to COVID-19 outbreaks. Coinbase has the same problems. The company itself may have solid practices and deep credibility, no small thing in the cryptocurrency sector. Unfortunately, Coinbase’s fate (much like Robinhood’s [HOOD]) is deeply linked to the underlying value of these tokens. And Coinbase can’t do much to solve the underlying challenges to those values.

Every investor and analyst has an underlying bias. Here’s mine – every economy, even “free markets,” has a certain element of central planning. It’s simply a fact that the federal government is studying the feasibility of a central bank backed digital currency. This necessarily means moving rivals out of the way.

In March, the Biden Administration issued an executive order on regulating cryptocurrencies, emphasizing that “we must take strong steps to reduce the risks that digital assets could pose to consumers, investors, and business protections; financial stability and financial system integrity; combating and preventing crime and illicit finance; national security; the ability to exercise human rights; financial inclusion and equity; and climate change and pollution.”

That last part is an almost direct shot at bitcoin, which relies on an increasingly intensive “Proof of Work” protocol in order to exist. Ethereum has successfully transferred to more climate-friendly “Proof of Stake” model; but it hasn’t done much to increase the price.

Axios reports that the federal government “is prioritizing speeding up domestic and international payment,” which “includes readying the way for a potential U.S. central bank digital currency (CBDC). (Emphasis in original.)

China is far ahead of the United States in its own efforts to develop a central bank backed digital currency, and Russia, China, Iran and other powers would be glad to ditch the dollar-dominated international payment system. That will be much harder to do if a digital dollar emerges. Of course, a digital dollar might remove a lot of the appeal of BTC, ETH, and other cryptocurrencies. We’re already seeing the consequences of those fears as a digital dollar nears reality.

For all those reasons, I wouldn’t attempt to catch the falling knife that is Coinbase (COIN). There are simply too many unknowns. Depending on one judge’s ruling, we could see it surge or collapse in the coming days.

If you’re in a gambling mood, feel free to take your shot but have no illusions. Coinbase is trapped by circumstances out of its control.

Where does this leave bitcoin and ethereum? BTC is still the undisputed international alternative to fiat currencies outside precious metals. While it has had a rough year, long-term investors have made spectacular gains. (It’s up almost 350% over the last five years). The Ethereum network’s successful “Merge” also opens the door to an entire new marketplace, and it’s going to be tremendously exciting to see the apps, games, and programs that are developed.

However, none of that may drive ethereum’s price up in the short-term (Note: capital letters designate the network, lowercase designates the currency). I would consider stacking BTC and ETH as alternatives to the dollar as the Fed scrambles to control inflation. Yet this should be an investment that is considered in terms of years, not months. Short-term, the dollar is likely to be strengthened by the Fed’s interest-rate hikes. The American government’s fiscal position is obviously unsustainable, but that doesn’t mean it’s going to “collapse” anytime soon. Rather than COIN, safer refuges might be gold, silver, and mining stocks, especially those that pay a dividend. RID Daily will be getting some analysis of specific companies going forward.

It’s a tremendously volatile time. COIN may look incredibly lucrative even 48 hours from now, depending on what a judge rules or what the SEC says. However, as we start the week, this isn’t a time where “fortune favors the bold.” Instead, as inflation surges, it’s time to conserve one’s existing fortune from the bull market of the last few years. Stay liquid and prepare for a better time to strike.

Mr. X is an investment analyst working in the Washington DC area who specializes in the intersection of business and public policy. After fifteen years working in politics, he writes on a classified basis for RogueInvesting.com to bring you news on what those with power are debating, planning, and doing.

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