Market View
Crypto market volatility has picked up over the last two weeks due to a combination of factors. Those include investor concerns over more supply coming on the market as well as a more restrictive macro environment, as the Federal Reserve has pushed a higher for longer narrative. (US CPI data for February will be released on March 14, with a median Bloomberg survey forecast of 6.0% YoY compared to a Cleveland Fed nowcast of 6.2%.) Meanwhile, open interest on futures across all tokens has fallen by around US$6.4B (to $30.6B as of March 10) in the first week of March, reflected in mixed action on the spot-futures basis for BTC and ETH. The lack of clear directionality has left more cash sidelined for the time being.
Silvergate. Headline risks like the announcement from crypto-friendly bank Silvergate that it intends to "wind down operations and voluntarily liquidate the bank" haven’t helped either, particularly given fears of contagion (like Silicon Valley Bank). We previously discussed the insolvency concerns surrounding Silvergate amid the delayed filing of its annual report to the US Securities and Exchange Commission (SEC). Many of its issues were connected to the collapse of FTX late last year, but not because the bank was holding bad assets. Rather, Silvergate was forced to liquidate its US Treasury, mortgage bond, and municipal bond holdings amid a run on the bank in 4Q22, and those assets had declined in value because of the Fed’s tightening cycle. (The assets that banks buy tend to have a longer duration than the deposits they receive, i.e. a classic maturity mismatch.) This led Silvergate to realize a $949M loss last quarter ($886M from its bond portfolio). The issue for the industry now is that many crypto firms will need to find alternative onramps for the asset class.
Grayscale. Separately, Grayscale’s bitcoin trust (GBTC) got more interesting as levels breached above the 200 day moving average. GBTC's discount to its net asset value narrowed sharply from 46% on March 1 to 34% as of March 8, the lowest discount level going back to late October 2022. The move follows some favorable initial progress in Grayscale Investments' court case against the SEC regarding its petition to convert the trust into a spot exchange traded fund (ETF). For example, one of the judges in the hearing (Judge Neomi Rao) questioned the nature of the SEC’s distinction between bitcoin spot and futures, when “they move together 99.9% of the time.” A conclusion in the case is still likely to take a few months. (See the “Exchange & CES Insights” section below for more details on our expectations for price action in relation to this event risk.)
Mt. Gox. Finally, the Mt. Gox rehabilitation trust announced that it has delayed the registration deadline for the disbursement of bitcoin and other funds until April 6 (rather than March 10). The distribution of assets is now slated to begin on October 31, rather than September 30. The process should distribute up to 141,686 BTC to creditors whose funds were lost by the defunct exchange, though we believe this process could potentially be dragged out. The notification from Mt. Gox in July 2022 stipulated that any movement of creditors’ funds will be restricted “until all or part of the repayments made as initial repayments is completed.” That suggests that not all the repayments will be distributed at once. For more details, see our latest research report published March 9.
Web3
The crypto mixing service Tornado Cash was sanctioned by the US Treasury Department's Office of Foreign Asset Control (OFAC) in August 2022 in response to North Korean hackers using the Ethereum-based protocol to launder illicit funds. According to a recent report from Chainalysis, inflows to Tornado Cash decreased by 68% in the 30 days following the sanctions, but the usage of mixing services has not ceased entirely.
Ameen Soleimani, an early contributor to the Tornado Cash protocol, recently unveiled a new and improved version of the sanctioned service. Privacy Pools is a fork of Tornado Cash that has been deployed on Optimism, an Ethereum layer-2 (L2), and aims to foster an environment where legitimate users can leverage the privacy afforded by the service, while also allowing authorities to more effectively identify bad actors.
Privacy Pools implements zero-knowledge (ZK) proof technology to allow users to opt-out of anonymity sets that contain illicit funds and provably disassociate their transactions from illicit activity, while preserving their own privacy. In theory, as users increasingly opt-out of those tainted anonymity sets, it becomes more difficult for bad actors to use the service as the liquidity available for accounts linked to illicit activity decreases. It is worth noting that the protocol is still in its early stages of development and the code has not yet been audited. Nevertheless, the project could represent an innovative approach to self-regulation in crypto as well as the potential of ZK technology.
Coinbase Exchange & CES Insights
Volumes on exchange have held steady the past couple weeks, as have the mix of assets being traded. Positioning now seems much more neutral or even short in some tokens. While basis and perp funding rates are still marginally positive, we’d expect to see higher funding costs if the market was positioned long as cash rates are 5% or more.
GBTC has been in focus after Grayscale’s legal argument was well received by the DC Circuit judges. If Grayscale were allowed to convert to an ETF it’s hard to say exactly how that would affect the spot market. It should be medium and long term positive because anyone with a brokerage account would be able to allocate to BTC. But initially it could pressure the spot market if GBTC holders look to redeem. Price action will hinge on who holds GBTC. If it’s unhedged institutional event driven traders we could see significant redemptions. If it is mostly retail we’d expect selling pressure to be less severe.
As expected, our flows changed drastically from last week. Traditional hedge funds, traditional financial institutions, and crypto native hedge funds are now net sellers. And while we have seen consistent derisking from these client segments we do expect both BTC and ETH to find support near their 200 day moving averages.
View From Around the World
Asia
Thailand is offering a tax break for companies that issue digital tokens for investment. The tax break includes waiving the corporation and value-added tax, a form of sales tax, for companies that raise capital by issuing digital tokens rather than by more traditional ways. (Reuters)
Europe
“The French National Assembly has voted in favor of legislating stricter licensing rules for new cryptocurrency firms … If passed, the new law would require France-based cryptocurrency service providers to comply with stricter anti-money laundering rules,” according to CoinTelegraph. This includes proving that customer funds are segregated, adhere to new guidelines on reporting to regulators and “provide more detailed risk and conflict of interest disclosures.” The bill would not apply to the 60 crypto firms registered with the Financial Markets Authority (AMF), the nation’s financial regulator. Instead, they will comply with the AMF’s rules until the passing of the EU's MiCA bill. (CoinTelegraph)
