Tag: Cryptocurrency

The rise and fall of crypto assets over the preceding two years adds another chapter to the nascent narrative of the crypto industry. Many investors now believe that crypto markets are in the midst of a ‘crypto winter,’ a term used to describe long periods of underwhelming performance. The boom-and-bust nature of crypto assets is not exclusive to the current period, but there are several unique aspects of the recent decline including crypto’s shifting relationship to macro-factors and the specific market dynamics that influenced price action in the latest cycle.

Impact of the Grayscale Bitcoin Trust:

With the launch of Grayscale’s Bitcoin Trust (“GBTC”) in 2015, there was an easy way for investors to gain bitcoin exposure with regulatory compliance. Demand for public market vehicles afforded GBTC a significant premium to the Net Asset Value (“NAV”) of the underlying bitcoin (“BTC”) holdings in the latter part of 2020. To capture this premium, institutions subscribed to the trust by depositing bitcoin with the intention of selling GBTC after the six-month lockup. This crowded NAV-arbitrage trade was a source of buying pressure for BTC up until mid-2021. When the lockups ended and institutions took profit on the trade, the premium fell fast. Competition from a new bitcoin ETF in Canada also contributed to the collapse of the GBTC premium. Since GBTC has no near-term mechanism for shareholders to redeem its bitcoin holdings, nothing prevented GBTC from sliding to a significant discount to NAV. The biggest hope for those seeking to cash out at NAV was Grayscale’s push to convert the trust to an ETF. However, the SEC shut down their bid, sending the discount even lower (28.7% as of writing).

The GBTC phenomenon contributed to Bitcoin’s upward and subsequent downward price movement in the latest cycle, creating fragility among some crypto institutions who leveraged the arbitrage trade (perhaps underestimating the potential for a steep discount). Then the TerraUSD stablecoin collapsed.

Terra/ LUNA Breakdown

TerraUSD (“UST”) was an algorithmic stablecoin that maintained a U.S. dollar peg by being redeemable for $1 worth of the ecosystem token LUNA. This simply means that each UST token was supposed to be priced at 1 U.S. dollar at all times (or very close to it). If the UST price fell below $1, arbitrageurs could purchase UST at the lower price and trade it for $1 worth of LUNA, therefore profiting from the spread. Similarly, when UST traded above $1, arbitrageurs could exchange LUNA for UST. This mechanism kept the UST price very close to $1 for a while, but it only worked so long as investors believed it would work.

Algorithmic stablecoins have a long history of failed experiments with break downs in their economic assumptions. However, subsequent designs attempt to improve upon the shortcomings of previous iterations. Some thought Terra had solved the puzzle as LUNA quickly grew to a market capitalization of over $30 billion (a top-10 cryptocurrency by market capitalization). Still, others noticed red-flags and vulnerabilities.

The primary demand for UST was driven by Anchor, a decentralized lending platform which offered a whopping 19.5% annual return for depositing UST. In fact, of the $18 billion total supply of UST, $16 billion was deposited in Anchor— the first strong indicator that the system was fragile. Where was this yield coming from? Borrowers only paid around 10% APR on their loans, and they were scarce compared to depositors. Anchor’s cash inflow at the end of April was about $0.7 billion while its cash outflow for UST deposits was about $2.6 billion. Some more yield was sourced from transaction fees. Still, most of the difference had to be supplied by depleting Terra’s reserve funds. In other words, the yield was not sustainable without net inflows.

A 20% annual return for simply holding a US-dollars-equivalent would in principle attract any investor. It therefore isn’t surprising that this return proved to have associated risk. Yield in crypto usually comes from four sources: pooling tokens together to provide the market with liquidity, lending and borrowing, staking, or temporary reserves (as was the case with Terra). With DeFi, anyone can easily (and perhaps unwittingly) gain exposure to complex instruments and market activities such as arbitrage, market-making, and lending. Traditionally these activities are reserved for sophisticated firms within a regulatory framework^[1] (and even they can collapse when risk is not managed properly). While everything crypto carries significant risks at this stage, carefully examining the points-of-failure and being aware of the pitfalls of prior DeFi experiments can help evaluate the trade-offs and determine if capturing the risk-premia is worthwhile for a given tolerance.

An apt comparison to the TerraUSD de-pegging is what happened to supposedly safe money market mutual funds in 2008 when the Reserve Primary Fund broke its dollar peg. It became unable to meet redemption requests due to exposure to Lehman Brothers’ short-term loans as worried investors rushed to pull from the fund. Theoretically, this sort of risk is mitigated, because, as a decentralized platform, the cash flows of Anchor are executed automatically. The near-instant arbitrage capability of the cryptocurrency should also provide some stability. However, crypto-specific dynamics also created more risks. In practice, perfect arbitrage was limited by a percentage fee when redeeming LUNA for UST. This was typically set at 2 percent, but it was designed to increase exponentially when traders redeemed more LUNA than a set redemption capacity. The purpose of this mechanism was to encourage trading LUNA on secondary markets so there would be greater external liquidity. However, semi-reliance on these markets to round-out the arbitrage meant a reliance on their liquidity.

Liquidity fragmentation and opportunistic traders

In crypto, liquidity is fragmented across many centralized exchanges, networks, and decentralized automated market makers (“AMMs”). This enables relatively small capital to greatly influence price in certain situations. The liquidity is also publicly visible—everyone can see when it’s lacking. At the exact moment when the Terra team temporarily withdrew a significant amount of liquidity on Curve (the largest stablecoin AMM) to reallocate it to a new pool, a trader sold 85 million UST on the Curve pool. Along with 6 large wallets which followed (either selling UST or removing liquidity from the pool), this catalyst was enough to briefly break the peg. On-chain data suggests the trades were pre-planned, as huge amounts of UST were transferred from Terra to Ethereum compared to the daily average prior to the event; an increase led entirely by 10 large wallets.

Another 200 million UST was spontaneously sold on the Binance exchange. The dollar peg was only slightly broken at this point, but this sparked fear and uncertainty— UST was rapidly pulled from Anchor (9 billion of 14 billion was withdrawn in 48 hours) and LUNA’s price fell over 50%. If the LUNA market-cap fell below UST, UST could not hope to be redeemed for fair value. In an attempt to prevent this total-collapse threshold from being reached, the Terra organization sold over 80,000 reserve BTC, which contributed to a broader crypto-meltdown — but it wasn’t enough. To compound the issue, a free-fall LUNA price made it possible for malicious actors to abuse the proof-of-stake consensus mechanism and manipulate transactions as good-faith validators represented less capital in dollar terms (or fled the falling token). Therefore, Terra was forced to halt the chain entirely.

The contagion of the collapse led to a cascade of liquidations and margin calls that dried-up liquidity and made some firms insolvent— and segued into another de-peg that made matters even worse.

Staked Ethereum and GBTC Déjà vu

Lido’s stETH is a popular derivative of Ethereum (“ETH”), and the two historically maintained a 1:1 price ratio. With Terra’s collapse, insolvency and capital constraints depleted the available stETH liquidity. Meanwhile as people fled Terra’s ecosystem, large quantities of stETH that were deposited in Anchor were bridged back to the Ethereum network in a matter of days. Amidst general uncertainty and loss of Anchor’s yield incentive, selling pressure mounted on stETH (in excess of ordinary ETH). Because stETH cannot yet be directly redeemed for ETH, there was no arbitrage to defend the peg.

As stETH fell relative to ETH, leveraged traders who assumed stETH would remain roughly 1:1 with ETH were forced to liquidate their positions (creating a flywheel of sell-pressure).

This interconnected chain of events has exposed the overleveraged risk-taking of many of the largest centralized cryptocurrency institutions who now face insolvency (reminiscent of Lehman-brothers). And their retail customers may never get their funds back. In contrast, the blue-chip decentralized protocols like Aave, Compound, MakerDAO, and Uniswap have maintained flawless 24/7 functionality irrespective of market conditions— a testament to the reliability of the automated infrastructure.

The fact that much of the sell-pressure has been related to excess leverage could actually provide comfort to crypto bulls. Fundamental innovation and network effects remain intact, so perhaps the true demand is temporarily underrepresented in price. However, macro-concerns remain.

Crypto’s Shifting Relationship to Macro Factors

According to Shapeshift[2] founder Eric Voorhees, “this is the first crypto crash which is clearly… a result of macro factors.” However, the crypto-specific events described above certainly fueled the fire. According to the long running crypto hedge fund Pantera Capital— fundamentally “there really isn’t a reason that Bitcoin needs to be a risk asset correlated thing.” Recently, Bitcoin has performed more like a high-beta stock than ever before— a far cry from digital gold.

Note the uptick in the R-squared^[3] of Bitcoin and the Nasdaq 100 Index (QQQ):

Historically, bitcoin’s correlation with stocks is elevated during major S&P 500 downturns. However, this time the relationship is much stronger and has persisted for longer than usual.

Key factors contribute to making this period unique (from the downturns of 2014, 2018, and 2020):

• The type of investor is different – According to Mike Boroughs, founder of the blockchain investment fund Fortis Digital: “Now you’ve got guys who are across the whole span of risk assets. So when they’re getting hit over there, it’s impacting their psychology.” This extends to the uptick in institutional players whose other exposures and responsibilities can influence their allocation.
• Federal reserve policy – The viewpoint of Bitcoin as a sponge for excess liquidity has been vindicated thus far. Many anticipate that a tighter monetary environment could be here for a while. To what extent is the thus-far stellar performance of bitcoin dependent on an accommodative monetary policy? There is little historical precedent for guidance.

If federal reserve policy induces a period of lower growth for traditional assets, it could be an opportunity for crypto to prove its value as a counter-cyclical forward-looking investment opportunity. Or are the current correlations more of a lasting trend?

[1] See our previous blog post “Developments in the US Regulatory Environment for Cryptocurrencies”

[2] ShapeShift is a non-custodial cryptocurrency exchange founded in 2014 that open sourced all code and fully dissolved its corporate structure in 2021, transitioning to a decentralized community-owned and governed platform.

[3] R–squared is a statistical measure that, in this case, represents the proportion of the variance of BTC’s returns that is explained by QQQ returns. The value can range from 0 to 1 with higher values indicating a stronger relationship.

 

The views expressed represent the opinion of Passage Global Capital Management, LLC. The views are subject to change and are not intended as a forecast or guarantee of future results. This material is for informational purposes only. It does not constitute as investment advice and is not intended as an endorsement of any specific investment. Stated information is derived from proprietary and nonproprietary sources that have not been independently verified for accuracy or completeness. While Passage Global Capital Management, LLC believes the information to be accurate and reliable, we do not claim or have responsibility for its completeness, accuracy, or reliability. Statements of future expectations, estimates, projections, and other forward-looking statements are based on available information and Passage Global Capital Management, LLC’s views as of the time of these statements. Accordingly, such statements are inherently speculative as they are based on assumption that may involve known and unknown risks and uncertainties. Actual results, performance or events may differ materially from those expressed or implied in such statements.

 

 

Regulation is coming to digital assets after a flurry of catalysts, including:

• The total collapse of the UST algorithmic stablecoin and associated token Luna (which had a market cap of over $40 billion; among the top 10 cryptocurrencies by market cap).
• Very visible influencers marketing what many argue amount to scams.
• Abuse of informational advantages (or insider trading) at exchanges. For instance, the DOJ is currently bringing its first NFT insider trading case against a former OpenSea employee.^[1]
• The general explosion in cryptocurrency interest and related applications in the last few years; and the accompanying ~$40B lost in exploits.
• And the overall market downturn.

On March 9, President Joe Biden issued the “Executive Order on Ensuring Responsible Development of Digital Assets.” The executive order named the following areas of focus:

• Consumer and investor protection
• Financial stability and systemic risk
• The prevention of illicit finance
• U.S. leadership and competitiveness
• Financial inclusion
• Responsible innovation

And spurs action from the following regulatory bodies:

• the Securities Exchange Commission (SEC)
• Commodity Futures Trading Commission (CFTC)
• the Treasury Department (OFAC)
• Financial Stability Oversight Council (FSOC)
• Commerce Department
• and the Federal Reserve

Each of these parties treats cryptocurrencies differently, and their overlapping regulatory authority has been an ongoing conflict.

 

Securities or Commodities?

SEC chair Gary Gensler has repeatedly sought to bring digital assets under the SEC’s jurisdiction as securities; sometimes clashing with the CFTC (who seek to classify cryptocurrencies as commodities). In a recent interview, Gensler separated Bitcoin as the only cryptocurrency he was prepared to publicly label a commodity, although his statement still leaves the door open for others. “Crypto financial assets have the key attributes of a security,” Gensler said recently, noting that there is almost always a centralized entity that directs projects and stands to profit the most.

When Ethereum first launched in 2014, the Ethereum Foundation held this type of centralized role. However, by 2018, Ethereum had reached “sufficient decentralization” according to then-SEC Director for the Division of Corporation Finance William Hinman, and therefore ought to be classified as a commodity. It’s possible that Gensler was hesitant to confirm this classification for Ethereum because it may hurt the SEC’s ongoing case against Ripple for failing to register their XRP token as a security– Ripple’s defense would of course attempt comparison with Ethereum. The SEC is also currently probing whether Binance (the most popular crypto exchange) should have registered its token BNB (currently 5th ranked crypto market cap) as a security in its initial coin offering (ICO) back in 2017. According to the report, “one of the SEC’s focuses is on whether Binance.US is wholly independent of the global exchange and whether employees may be involved in insider trading.” Gensler and the SEC have doubled the size of its crypto enforcement unit and are also reportedly planning greater regulation of exchanges– requiring them to register with the SEC and segregate custody and market-making functions.

On June 7, senators Cynthia Lummis (R-Wyo.) and Kirsten Gillibrand (D-N.Y.) proposed the Responsible Financial Innovation Act on June 7, which seeks to assign regulatory authority over digital assets to the Commodity Futures Trading Commission (CFTC) rather than the Securities Exchange Commission (SEC). If passed, many believe cryptocurrency could see a less strict and more accommodative regulatory environment. Advocates argue that regulations surrounding securities are too strict and too tailored for the well-developed traditional equities market.

At the June 23rd U.S. Congressional Committee hearing, Representative Austin Scott posed that neither the SEC nor the CFTC have the requisite manpower, saying “it’s not possible to regulate all these currencies.” Technology founder Charles Hoskinson agreed, arguing for a “public-private partnership” where compliance should be left to the software developers. “It’s not the SEC or CFTC going out there doing KYC/AML; it’s banks. They are the ones on the front line.” Because digital assets can store and transmit meta-data, they could perform much of the regulatory function automatically. Hoskinson also argued that because digital assets are “more fundamental than a particular category (like a currency or a commodity),” regulatory bodies should avoid binary classification and instead refocus broadly on “what things … we want to guard against.”

While the federal government is still working on its approach, state legislatures have moved forward with their approaches to the industry.  Lobbying from the crypto-industry has seen a large uptick, contributing to a notably accommodative trend across most state legislatures as they seek to attract the industry. The biggest exception is New York, whose regulatory provisions remain among the strictest.  States like Colorado, Wyoming, Florida, and North Carolina have even legislated securities and consumer protection exemptions for crypto-companies– which some consumer-protection advocates argue is going too far.

Irrespective of the final regulatory outcomes, perhaps most important is that we are now much closer to finding regulatory clarity in what has historically been very murky. Institutions can then feel more comfortable moving forward with cryptocurrency-related endeavors with lessened fear of regulatory risk. Indeed, the timing of these landmark regulatory developments coincides with prominent US financial institutions wanting to enter the fray. Goldman Sachs is considering a venture into derivatives in a deal with the FTX crypto exchange; while Citadel, Charles Schwab, and Fidelity are reportedly partnering to build a cryptocurrency trading platform.

 

^[1] Presumably because NFTs are not clearly securities, the DOJ has not charged standard violation of Section 10(b) of the Securities Exchange Act here. Instead, it charged wire fraud under 18 USC 1343. This could set an important precedent.

 

 

The views expressed represent the opinion of Passage Global Capital Management, LLC. The views are subject to change and are not intended as a forecast or guarantee of future results. This material is for informational purposes only. It does not constitute as investment advice and is not intended as an endorsement of any specific investment. Stated information is derived from proprietary and nonproprietary sources that have not been independently verified for accuracy or completeness. While Passage Global Capital Management, LLC believes the information to be accurate and reliable, we do not claim or have responsibility for its completeness, accuracy, or reliability. Statements of future expectations, estimates, projections, and other forward-looking statements are based on available information and Passage Global Capital Management, LLC’s views as of the time of these statements. Accordingly, such statements are inherently speculative as they are based on assumption that may involve known and unknown risks and uncertainties. Actual results, performance or events may differ materially from those expressed or implied in such statements.

Most people know that cryptocurrency is a decentralized, digital form of money that can be used for transactions, but what about the technology behind it? Blockchain technology was adopted in 2009 by Satoshi Nakamoto, the anonymous creator of Bitcoin, in order to support its function. However, not many people are aware of what exactly blockchain technology is, or about its many uses for cryptocurrency and beyond. With thousands of cryptocurrencies in existence, and with Bitcoin reaching an all-time high price of above $68,000 this November, they continue to rise in popularity and their influence is becoming more dominant. These digital currencies are likely here to stay and can no longer be overlooked, so now, it is more important than ever to be informed on cryptocurrency and its technology.

Popularized with the original Bitcoin whitepaper, blockchain is now the primary technology behind thousands of other cryptocurrencies. Blockchain is a type of distributed ledger technology; essentially, it is a database that acts as a public ledger to record digital transactions across a peer-to-peer network in a way that cannot be altered. Before diving deeper into how blockchain works, it is important to note some key characteristics of this technology. First, blockchain is a decentralized, peer-to-peer network where no single person or entity controls any of the data. This means that transactions occur directly from one party to the other without any third-party intermediary such as a bank, and there is no government involvement. Every transaction on the blockchain is verified through the peer-to-peer network, a process known as mining, which we will get more into later. Mining is completed through the proof-of-work framework, and this helps alleviate concerns of tampering, hacking, and fraud. Additionally, blockchain technology is distributed, meaning that everyone participating on the network has access to the entire database for full transparency. Anyone is allowed to join the network, and once they do, all transactions will be visible to that participant. The participants on the network are anonymous, and all transactions are secured and linked together through cryptography. As a result, no transaction can be altered once it is in the database, and every transaction is time-stamped to ensure there is no way to “double-spend.” The blockchain algorithms confirm that every transaction is permanent and in chronological order. Blockchain is also time efficient, as it is open 24 hours, 7 days a week. There were many attempts to create digital money before Bitcoin, but blockchain technology solved the issues that prior attempts ran into, making it an extreme success.

Blockchain can be thought of as an operating system that has different applications running on it, which are the cryptocurrencies like Bitcoin. These cryptocurrencies are built with blockchain technology, and each cryptocurrency has their own, separate blockchain. To better understand how blockchain technology works, it is important to know its three primary components: blocks, miners, and nodes. Generally speaking, the blocks are what collect all of  the information on the blockchain. There are four main elements within these blocks which are the data, the nonce, the hash, and the previous hash. The data being held in the blocks depends on the type of blockchain. For example, the Bitcoin blockchain stores all of the data regarding transactions, such as the amount, sender, and receiver. Essentially, these blocks act like boxes of receipts, and once the storage capacity of one block is filled, it is closed and will be linked to the previous block. The nonce, also referred to as a “number used only once”, is a 32-bit number that is randomly generated. This value is essential for the proof-of-work algorithm and is the number that crypto miners are searching for in order to be rewarded with cryptocurrency. The hash is a 256-bit number unique to each block, like a fingerprint. The block also includes the hash of the previous block which creates this immutable, unbreakable chain of blocks. This also helps with security, because in the event of someone tampering with a block, all following blocks will be changed and invalid. The only block that does not have the hash of the previous block is the initial block on the chain, known as the Genesis block. The second component of blockchain is the miners. Through mining, their goal is to find the “golden nonce” value, and when found, a new block is created on the chain. They will receive a reward of cryptocurrency for their work, and for some cryptocurrencies such as Bitcoin, this is the only way new “tokens” are entered into circulation. The third component of blockchain is the nodes, which are a critical part of blockchain’s infrastructure. Nodes are any electronic device, such as a computer, that allow for  a blockchain’s data to be accessible. In-essence, a blockchain exists on nodes. Additionally, nodes are needed in the mining process. When a miner attempts to add a block to the chain, all nodes will be notified, and they will either accept or reject the block based on the legitimacy of those transactions in that block.

Cryptocurrency is the primary reason for blockchain’s existence; however, more applications are beginning to be discovered beyond this. Businesses can use a private, or public, blockchain to track supply chains, store health care records, implement smart contracts, and more. Smart contracts are digital contracts on a blockchain that are automatically executed when certain conditions are met. Ethereum is the largest blockchain supporter of smart contracts, and it has extensive utility such as for automatic payments, crowdfunding, or registering a vehicle. Currently, companies including The Home Depot have implemented smart contracts to help resolve issues with vendors. Pharma Portal, a blockchain platform powered by IBM, tracks temperature-controlled pharmaceuticals through the supply chain to provide trusted data. These are only a few of the thousands of new blockchain uses being discovered and tested. In addition, more companies are beginning to accept cryptocurrency as a form of payment, showing its growing stance in society. Despite blockchain’s tremendous potential, the negative environmental impact that comes with blockchain technology and mining is raising concerns.

As briefly mentioned earlier, cryptocurrency mining is the process where miners compete against each other to be the first one to solve a complicated computational math problem. They are attempting to find the correct nonce value that will generate a hash. The solution is completely found by guesswork and chance, like a gamble, where the miner’s system will spit out random numbers until the nonce value is found. Once it is solved, that miner has validated transactions through proof-of-work and has added a new block to the blockchain. Mining is essentially a way that network participants complete the proof-of-work algorithm on blockchain, or verify the legitimacy of transactions, and it allows for more “tokens” to enter circulation. Currently, the reward for being the first miner to complete this process for Bitcoin is 6.25 Bitcoins, and the reward rate is cut in half about every four years. In order to mine for cryptocurrency, you need access to a substantial amount of energy, mining hardware that is either an “application-specific integrated circuit” or a “graphics processing unit,” and mining software to join a network. Although the price of hardware can be costly, the amount of money spent on energy will greatly exceed that. Despite crypto mining being a very expensive venture with a high probability for failure, people still find this process appealing. However, mining is causing severe damage to the environment. As explained, mining requires an immense amount of energy, and major sources of electricity are coal and fossil fuels. Burning coal contributes to the negative effects on the climate, and according to CNBC, Bitcoin mining accounts for about 35.95 million tons of carbon dioxide emissions which is the same as New Zealand. China, where mining rigs utilized energy from burning coal, recently banned all crypto activity due to environmental concerns. Many participants in Texas, a popular place for crypto mining, are using wind power. Others across the U.S. are converting abandoned factories into mining facilities using renewable energy. However, these places draw up millions of gallons of water a day through pipes to cool the plant which harms the wildlife. Even with the use of clean energy, electronic waste remains a problem. Since all of the participating miners compete against one another, they all want the most efficient hardware. This means that their old systems are constantly being discarded and ending up in dangerous landfills. These devices contain hazardous chemicals that harm the environment and the health of others. Although this is a negative side of the new world of blockchain, it still holds immense promise for the future.

 

The views expressed represent the opinion of Passage Global Capital Management, LLC. The views are subject to change and are not intended as a forecast or guarantee of future results. This material is for informational purposes only. It does not constitute as investment advice and is not intended as an endorsement of any specific investment. Stated information is derived from proprietary and nonproprietary sources that have not been independently verified for accuracy or completeness. While Passage Global Capital Management, LLC believes the information to be accurate and reliable, we do not claim or have responsibility for its completeness, accuracy, or reliability. Statements of future expectations, estimates, projections, and other forward-looking statements are based on available information and Passage Global Capital Management, LLC’s views as of the time of these statements. Accordingly, such statements are inherently speculative as they are based on assumption that may involve known and unknown risks and uncertainties. Actual results, performance or events may differ materially from those expressed or implied in such statements.

 

In recent years, there has been an influx of interest in cryptocurrencies. The investor base is diverse: tech-savvy traders, aggressive speculators, hedgers prophesizing the doom of fiat currencies, Elon Musk fans, and even large institutions seeking to supplement their investments in alternative assets. This list is not all-inclusive nor is it mutually exclusive.  The insatiable demand for cryptocurrencies has wrought massive price increases. The price of Bitcoin, for example, skyrocketed to well over $60,000 earlier this year before paring some of the gains. The volatility associated with cryptocurrency can cause the value to drop precipitously; yet many people like the idea that it is not controlled by a government or financial institution.

Despite the strong appreciation for decentralized currencies, Chinese regulators have continuously attempted to ban them. In 2013, the Chinese government defined Bitcoin as a virtual commodity rather than legal tender. Later that year, China banned banks from providing any bitcoin-related services. Four years later, in 2017, China banned initial coin offerings and cryptocurrency exchanges. However, investors found many ways to get around this through offshore exchanges and over-the-counter platforms. China’s numerous attempts to ban cryptocurrency have shown the immense technological challenges of regulation due to crypto’s decentralized design.  Still, on September 24^th of 2021, China once again launched a crackdown on cryptocurrency, and this is their most powerful attempt yet.

The cryptocurrency industry has come under scrutiny for various reasons including money laundering, energy consumption, and the safety of peoples’ assets.  China’s new ban restricts cryptocurrency transactions and mining, making all crypto-related activities illegal in China. One reason for this ban is to allow China to reach their goal to become carbon neutral by 2060. The cryptocurrency mining process uses highly sophisticated hardware and a substantial amount of energy. Often, miners spend more money on electricity costs than what they mine is even worth. Since China is home to many crypto miners, China believes this has contributed to the power crisis that has interfered with their carbon goals. This electricity shortage has caused energy prices to increase along with blackouts across many of China’s provinces. However, some researchers suggest that most of the coins that are mined in China are generated by green energy. Proponents argue that Bitcoin mining incentivizes renewables due to the high energy costs. However, this is still somewhat controversial.

Some of the world’s largest cryptocurrency exchanges such as Huobi and Binance have already made drastic changes. Huobi is retiring all existing accounts of mainland Chinese users and will end account registrations for new users in mainland China by midnight of December 31^st, 2021. Huobi announced that this is to protect the current users’ assets, and they will continue to announce more details of these changes in the future. This resulted in the token price of Huobi to slide down to an 8-month low. Binance has also complied with these new regulations and has blocked all account registrations with mainland Chinese phone numbers. A spokesperson from Binance explained that they take their compliance obligations seriously, and will follow regulatory requirements wherever they have operations.

While Chinese agencies are working together to make this ban successful, in the U.S., the Fed is considering its own digital currency. It is important to note that this is not the same as cryptocurrency. Cryptocurrencies are decentralized whereas a digital currency would fall under the control of the Fed. During the same week of China’s crackdown, the Fed made several comments about a potential digital currency. These comments are not new, however, since the Fed has been talking about creating a digital currency for quite some time. Chairman of the Federal Reserve, Jerome Powell, explained that the Fed is moving forward with their research into implementing their own digital currency and will soon release a whitepaper on the topic. There has been no final decision announced on this as the Fed officials want to ensure they make an informed decision and “do it right the first time.”

Some of the benefits, the Fed claims, of issuing its own digital currency would be to provide services to people who do not use banks and to quickly get payments to people, especially in times of crisis. For example, digital currency could allow for a faster and cheaper way to issue stimulus checks compared to the paper stimulus checks issued by the U.S. government during the COVID-19 pandemic. Opponents argue that the Fed creating a digital currency could have serious repercussions for the financial system. Banks may see a digital currency as a source of competition. Furthermore, since this is digital, there are chances of hackers and fraud. If the government does not protect the digital currency from major cyber attacks, people will begin to lose trust in the “lender of last resort.”

Although the Fed has been considering this for a while, many people believe they have fallen behind in a “global race for digital currency.” However, Powell does not agree as he states, “I think it’s more important to do this right than to do it fast.” It seems that the US was once a leader in technological innovation but now may be lagging. Places around the world are beginning to realize the importance of digital integration. The Bahamas have integrated a digital Sand Dollar, and other countries such as Australia and Malaysia are in the process of creating a cross-border central bank digital currency exchange program. El Salvador just recently became the first country to accept Bitcoin as legal tender, and even China has created a digital version of its paper currency called e-RMB. The world is experiencing technological improvements every day, and countries are starting to change aspects of their economies. The US establishing a digital currency could allow for easier banking while also keeping their technological edge and influence.

 

Disclaimer

The views expressed represent the opinion of Passage Global Capital Management, LLC. The views are subject to change and are not intended as a forecast or guarantee of future results. This material is for informational purposes only. It does not constitute investment advice and is not intended as an endorsement of any specific investment. Stated information is derived from proprietary and nonproprietary sources that have not been independently verified for accuracy or completeness. While Passage Global Capital Management, LLC believes the information to be accurate and reliable, we do not claim or have responsibility for its completeness, accuracy, or reliability. Statements of future expectations, estimates, projections, and other forward-looking statements are based on available information and Passage Global Capital Management, LLC’s views as of the time of these statements. Accordingly, such statements are inherently speculative as they are based on assumptions that may involve known and unknown risks and uncertainties. Actual results, performance, or events may differ materially from those expressed or implied in such statements.