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Tom Rodgers
Tom Rodgers Head of Research
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ETC Group Crypto Minutes Week #34

There are opportunities galore for crypto investors with an eye on the macro, but we ask whether Crypto Winter is really over; ETC Group debuts a new institutional data series looking at fund flows across crypto, blockchain stocks and Metaverse ETFs; and OFAC sanctions on Tornado Cash casts a chilling pall over US cryptoasset innovation.

Macro Outlook 2022: Opportunities everywhere but is Crypto Winter over?

Time and tide wait for no man, and as investors barrel towards Q3 2022 there remain myriad opportunities in crypto for those nimble participants who have kept capital on hand during the downturn.

There has been a strong rally in risk-on assets since the start of August, with the NASDAQ 100 gaining around 6%. Historically, Bitcoin has outperformed this tech index, but undershot with a 3% gain in August.

Amid the underperformance, BTC's much-discussed correlation to risk equities has turned back to near-annual low levels of 0.52. A correlation of 1 would mean BTC and stocks were moving perfectly in tandem. After spending practically all of April, May and June in historically high correlation with the NASDAQ, Russell 2000 and S&P 500, Bitcoin is diverging.

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Elsewhere in US equities, hedge funds are piling up $125bn in bets against the S&P 500's summer rally, and suggestions proliferate that the uptick could become a bear market trap for the unwary.

Credit conditions remain fragile, according to S&P Global's This Week in Credit research. And its analysts note that

some central banks are no longer providing forward guidance, so markets should expect increased volatility.

A negative tone to credit pricing can undermine market sentiment, broadly.

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When macro analysts consider the most closely-watched part of the US Treasury yield curve, the 2y/10y spread, they look at two factors: depth and duration. The 2y/10y has now been inverted for 46 days.

The longer dated 10-year US government bonds should offer more yield to investors than the shorter-dated 2-year bonds, to pay investors for the opportunity cost of locking up their funds for longer. Negative spreads indicate all is not well and have preceded every US recession since the 1970s.

What was near-record 47 basis points (bps) is, as of 23 August 2022, only 27bps. This is still a heavy negative bias but the state of play is perhaps less bad than it was a few weeks ago.

Markets are now pricing in the possibility of higher central bank interest rates for longer: what does that mean for crypto? Certainly, the fundamentals remain unchanged.

With €500bn of assets under management, the Swiss institution Julius Bär is one of the most prominent private banks in Europe. In a recent opinion piece, Chief Investment Officer Yves Bonzon noting that the case for blockchain disruption

is far from dead…with viable commercial applications emerging.
Incoming legislation on both sides of the Atlantic speaks for itself - regulators do not expect the digital asset ecosystem to fade into obscurity - neither do we, Bonzon wrote.
[We] believe emphasis should be put on a diversified, carefully selected exposure,

concluded Yves Bonzon, sounding the clarion call for institutional cryptoasset allocation.

So, where are we heading for the rest of 2022? Bitcoin remains acutely sensitive to central bank interest rate moves, and there is no doubt that looser monetary policy, expected in early 2023, would aid crypto markets on their way northwards.

The resumption of a more bullish and optimistic picture for Bitcoin and crypto markets would come with BTC recapturing $28k to $30k. At around $21k, Bitcoin remains in a long-term value position in terms of its two-year moving average multiplier, and in terms of Net Unrealised Profit and Loss, which gives us a cost basis for every Bitcoin investor in the market.

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That is for Bitcoin only, of course. The pantheon of investable assets in crypto is very broad, with Ethereum's Merge rally to $2k softening as its possible Proof of Work fork approaches, and Web3-critical assets like Cosmos (ATOM) and Polygon (MATIC) continuing their upward charge, the message could not be more clear: diversification and prudent position sizing in cryptoassets should be top of investment managers' minds.

Citibank research published on 22 August now suggests that UK consumer prices inflation will peak at 18% in the first quarter of 2023, much higher than forecasters originally modelled.

That puts the Bank of England even further on the back foot as regards when it may be able to cut rates, and perhaps extends the possibility that rates could increase out into Q2 2023, further than markets expected before a turnaround in policy.

Chief UK economist at Citi Benjamin Nabarro said disinflationary measures had moved

somewhat further down the pecking order

in terms of government priorities, replaced by tax cuts and lower energy bills for consumers.

With US inflation coming in under expectations at 8.5% for July, markets enjoyed a rebound rally after the worst first half of a year for equities in half a century. Hopes that slightly cooler inflation readings would push the Fed to slow its rate hikes have not been borne out, with a poll of economists by Reuters suggesting the risks were skewed towards another 75bps hike in September.

Again: caution should be the watchword for the foreseeable, but investors who can move more quickly than most will likely pick up the best bargains of this investment cycle.

ETC Group Digital Asset Tracker explains institutional crypto, Metaverse

In a new data series, ETC Group is analysing not just how institutions are approaching individual cryptoassets like Bitcoin and Ethereum, but also how the largest asset managers feel about blockchain, digital assets and Metaverse ETFs.

Charting the levels of ETP and ETF inflows and outflows provides the strongest indications of how asset managers and institutions in North America and Europe are treating cryptoassets. And yet the data to support these conclusions remains highly concentrated around a few key players, and in many cases, locked behind paywalls.

For example, in the week to 12 August investors piled net $198m into Bitcoin investment products in North America and Europe. Over the same period, net $280m flowed into Ethereum investment products, some 42.7% more than Bitcoin. This suggests that certainty over a 15 September 2022 date for Ethereum's software upgrade (called the Merge) contributed to wide-scale bullishness among institutional asset managers.

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Sources: Bloomberg, ETC Group. Data correct as of 12 August 2022

However, in the week to 19 August 2022, both Bitcoin and Ethereum ETPs and ETFs gave up these substantial gains, suggesting a choppier picture moving forwards.

Intriguingly enough, Metaverse ETFs continue to outperform Bitcoin and Ethereum on a year-to-date percentage growth basis. While in the last three months to 23 August Bitcoin ETPs have shed on average 23% of their value, Metaverse ETFs have climbed more than 32%.

Become a free subscriber at etc-group.com to read these insights, or follow ETC Group on Medium.

US Tornado Cash ban has chilling effect on Web3 innovation

Participants with vested interests in the realm of blockchain are all mulling the same question: are US regulators on a war footing?

The dispute between Coinbase and the SEC over alleged securities fraud brought this question back to the fore. Recent steps taken by The Office of Financial Asset Control (OFAC) against decentralised Web3 protocols have crystallised it.

OFAC sanctioned virtual currency mixer Tornado Cash on 8 August. It estimates that the Ethereum-based platform has been leveraged to launder more than $7 billion since its creation in 2019.

A virtual currency mixer is a tool that facilities anonymous transactions by obscuring their origin and destination – severing the link between sender and receiver.

Blender.io became the first virtual currency mixer to be blacklisted in the US in May. This was used by the North Korean hacking outfit Lazarus Group to wash illicit proceeds procured from the $620 million hack of Ronin Bridge earlier this year.

In a similar vein, OFAC has pointed to Tornado Cash's failure to deter malicious actors away from its platform as the reason to block it.

Tornado Cash had previously made attempts to comply with regulators by censoring wallet addresses that had been red-flagged by the US government. But maintaining an embargo against its nameless users was always going to be a challenge when users can generate new wallet addresses at will.

The original creators gave up their ability to change the rules that make Tornado Cash tick. Its open-source software will exist as long as Ethereum continues to run; available to anybody looking to download or refashion it.

Much of the reforms demanded of Tornado Cash by US regulators are beyond its capacity, given its inherently decentralised and permissionless nature. Even with sanctions on the table, Tornado Cash can still be accessed to send and receive cryptoassets.

One anonymous user publicly illustrated how the weight of US sanctions lose their force in the decentralised universe on 13 August. The user sent Ethereum to over 600 addresses based in the US via Tornado Cash. Because on-chain transactions cannot be rejected, recipient addresses had to involuntarily interact with the sanctioned software as government agencies were reduced to onlookers.

Nevertheless, the outright ban on Tornado Cash has still cast a shadow on the future of blockchain privacy – and the platforms that have made it their raison d'être – as some protocol developers jump to comply with US sanctions.

The decentralised exchange Uniswap has banned a raft of addresses linked to Tornado Cash and the stablecoin issuer Circle has frozen 75,000 USDC belonging to users associated with the virtual currency mixer.

Regulators threaten to cast out any entity that prioritises financial privacy software above financial compliance. In doing so, they are demonising innovation and infringing the privacy of citizens – perhaps unconstitutionally.

By this measure, the blockchain think tank Coin Centre has argued that applying sanctions to smart contract code instead of people is beyond the authority of the US government.

The debate over financial privacy is a symptom of US lawmakers' inability to come together on the larger issue of broad regulation. On this front, the US is well behind the EU, which brought its Markets in Crypto Assets (MiCA) law into play this summer.

The US is in desperate need of a comprehensive cryptoasset framework that settles questions related to privacy, finance, taxation, and digital ownership if it seriously intends to incubate blockchain technology.

Markets

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The market rally that began in July has come to a halt on the back of fears of more hawkish rhetoric from the Federal Reserve, and fears that inflation and higher rates could persist for longer in major economies.

The most recent FOMC meeting signalled that the US central bank is determined to raise interest rates aggressively until it can substantially dent inflation figures at a 40-year high.

The total cryptoasset market cap remains ahead of the psychologically important $1 trillion dollar line but the news comes as a blow to hitherto bullish investors now pricing in the possibility of another 75 basis points hike in September.

Bitcoin's price briefly hit a two-month high on 15 August when its price reached $25,000 but has since returned to the $21,000 resistance zone in a bearish lean.

Ethereum has retracted by 7% over the last two weeks but has consolidated most of the gains it saw in July and earlier this month. Its value is gravitating between $1,500 and $1,600 as investors prepare for the Merge in September.

Cosmos (ATOM) has been the strongest performer, retracing only 0.2% over the last fortnight. This is in contrast to other Web3 infrastructure onramps like Avalanche (AVAX) and Polkadot (DOT) that have shed almost 20% of their market value in the same period.

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