Letter to Investors: Bitcoin in the Era of a More Inflationary Fed
In August, the Federal Reserve made a landmark change in its inflation policy, and what that means for cryptocurrencies.
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Cryptocurrencies in the Post-Jackson Hole Era
The Jackson Hole Global Central Bank Annual Meeting originated in 1982. Volcker, then chairman of the Federal Reserve, attended the economic policy seminar held in Jackson Hole that year, and spoke at the meeting, saying that prices should be stabilized and inflation rates should be reduced. Then take measures to restore economic growth and reduce unemployment.
Fundamental changes in how the Fed conducts monetary policy are extremely rare. While economic historians debate the details, many point to two major changes in the Fed's policy approach over the past 50 years:
In 1977, the Federal Reserve Reform Act officially introduced the bank's dual goals of low inflation and maximum employment;
In 2008, the Fed began quantitative easing, overseeing an unprecedented increase in the size and types of assets held on its balance sheet.
These two shifts mark the beginning of a generational opportunity:
Act of 1977 for Federal Reserve Chairman Paul Volcker from 1979 to 1981"Break the Shadow of Inflation"Conditions were created to raise interest rates to 19%, which in turn sparked a 40-year bull market over the ensuing 40 years as rates fell from these highs; • A policy shift in 2008 rewarded equity investors in favor , by approaching zero interest rates and buying diversified assets, flooded the market with liquidity, triggered general inflation of many assets, and gave birth to the longest bull market in history.
On August 27, 2020, Federal Reserve Chairman Jerome Powell delivered a landmark speech at the Jackson Hole Economic Policy Symposium, announcing what some consider to be the third major shift in Fed policy.
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What is the new policy framework and why is it important?
Central to the new policy framework is a significantly more accommodative and flexible approach to managing inflation. This shift is packaged as a small semantic change with big implications.
Before Powell spoke, the Fed's policy objective was to keep inflation trending toward 2% a year. Now, the Fed will aim to achieve an average inflation rate of 2% over time, with the flexibility to go above or below 2% in any given year.
It might sound like a modest change, but in the world of Fed policy, it's huge. This means that if inflation runs below 2% for several years, the Fed will let it run at a higher level for a while. There is no clear formula for how the average inflation rate is calculated, giving the Fed new flexibility to adjust inflation results based on feel, both to meet inflation targets and to achieve macroeconomic goals.
What does this mean for investors?
One of the best pieces of investment advice is the old line of Marty Zweig:"Don't fight the Fed". In this case, if the Fed is willing to do whatever it takes to see inflation rise even higher, it is fair to assume that it will end up doing as it pleases...and possibly higher than it claims to be. Reflecting on the new policy, legendary investor Stanley Druckenmiller predicts that we could easily see inflation between 5% and 10% over the next four to five years. Others -- including former Fed chairs Alan Greenspan and Ray Dalio -- are also concerned about inflation.
At Bitwise, we hear concerns about inflation directly in our conversations with our clients every day.
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Why Bitcoin and not Gold?
When investors worry about inflation and want to adjust accordingly, the traditional safe haven is of course gold. In fact, so far this year, investors have allocated more than $29 billion in gold ETFs alone.
However, there is a practical challenge when relying solely on gold to hedge a portfolio: in order for gold to have a meaningful impact on overall performance -- to actually protect you in the worst-case scenario -- you have to be heavily allocated to gold, so you Must exit from most other assets.
The prospect of doing so unnerved many people. There are many factors to consider before making such a drastic change: Inflation is an issue, yes, but not guaranteed; gold is not an income-generating asset; stocks may have more room to perform; and, as gold nears all-time highs , some worry that it doesn't have much upside left (and maybe even a downside in the future).
It is from this perspective that many people see Bitcoin as a godsend.
Like gold, Bitcoin has low correlations with other asset classes and is highly liquid. An important difference from gold, though, lies in plain sight. Bitcoin is more volatile and less accepted, and its market cap is only 2% of gold today.
If an investor wants to put all their money in one asset, these features may not sound appealing. But in the case of investors trying to hedge their portfolios, these features mean you can reap substantial gains. (Refer to the previous article"It's Time to Put Bitcoin in Your Portfolio"）
ReportReportYears of performance are also impressive, as shown.
Bitcoin was not recognized by everyone at the beginning, and it also carries a lot of risks. But it also means that Bitcoin still has a lot of room to run, which makes its potential great. Of course, there is also a growing belief that a digital version of gold - with its confiscation resistance, ease of transfer, ease of storage, always open markets and privacy - is an essential part of the future.
Jerome Powell's landmark new inflation policy has many investors now thinking about how to allocate assets when inflation comes. Bitcoin is doing better and better when we look at the options available to hedge against this risk.
As Paul Tudor Jones recently wrote about his fund’s allocation to Bitcoin:"I am not a hard moneyist, nor am I a crypto fanatic. I'm not a Millennial...I'm a Baby Boomer and I want to seize opportunities while protecting my assets in a changing environment."
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Fund and index rebalancing in August 2020
Bitwise's research and portfolio management teams continuously monitor the cryptocurrency ecosystem to ensure that Bitwise Indices and Bitwise Funds capture all opportunities available to investors in each market, while minimizing uncompensated risk.
As part of this process, we updated our analysis of each cryptoasset's five-year planned issuance; reassessed the eligibility of all major coins based on trading volume and potential risk; and procedurally recalculated market capitalization rankings to ensure we capture to the most valuable items on the market. We also conduct regular reviews of our index methodology to ensure that it reflects current institutional performance in the cryptocurrency investment market.
The results of the August 2020 rebalancing are as follows:
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Crypto asset prices in August
The Bitwise 10 Large Cap Crypto Index (BITX) had another good month this month, rising 7.6%. 8 out of 10 coins have achieved positive returns. From the beginning of the year to August 31, the index rose 79.6%.
The best-performing coin in August was Chainlink (LINK), which posted a staggering 112.3% gain for the third month in a row. As highlighted in its July investor letter, LINK is one of the major beneficiaries of the DeFi trend that is taking the cryptocurrency industry by storm. The development of the asset has also been fueled by Chainlink’s acquisition of DECO technology, which came from Cornell University. The creator of DECO is a well-respected computer scientist who shaped some of the key concepts used in the cryptocurrency industry and joined Chainlink as Chief Scientist.
The second best performer on the index was ether (ETH), up 27.1%. Ether, the second largest currency on Bitwise 10, is the backbone of the DeFi economy.
On the other hand, Cardano (ADA) and Bitcoin Cash (BCH) had negative returns for the month, falling 9.8% and 7.8%, respectively. After a very strong year-to-date performance, ADA appears to be slowing down; even after its poor performance in August, it is the second-best performing coin in the Bitwise 10 index year-to-date. BCH is one of the worst-performing assets in the index this year.
The current dispersion between the best and worst performing Bitwise 10 coins widened to 122.0 percentage points in August. This is the largest dispersion over the past 12 months, with an average of 56.4 percentage points over the period and a low of 23.0 percentage points in March 2020.
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Bitwise 10 Offshore Index Fund
Key developments in August
As usual, the past month has seen many exciting offerings in the cryptocurrency industry, including the DeFi market continuing to experience record growth.
Stablecoin adoption continues to climb. The circulation of two stablecoins (Tether and USDC) broke the $15 billion mark in August and approached the $18 billion mark in September. The market is now more than three times larger than it was at the start of 2020, and the trend shows no signs of abating. The majority of stablecoins (64%) are issued on the Ethereum blockchain, which represents Ethereum’s continuation as the platform of choice.
DeFi smart contracts continue to attract capital and develop new use cases. The remarkable growth in the DeFi space discussed in the July investor letter continued apace in August. At the time of writing this letter, according to DeFi Pulse, there are now 8 DeFi applications with more than $500 million locked in assets, and 4 applications with more than $1 billion locked.
An important driver of demand in this area is the"liquidity gain", this process is to lock the encrypted asset investment in the DeFI agreement as a way to earn interest (similar to depositing money in a bank to earn interest). Liquidity yields have attracted multiple multi-billion dollar assets over the past few months.
Building on this trend, a new technology called Yearn.Finance achieved a market cap of about $1 billion in August, just 1.5 months after its token launch. Yearn is an app that allows its users to deposit digital assets (including ETH) and deploy assets on a lucrative DeFi lending platform. One aspect of what gets investors excited about Yearn is that its creators have opted for a more decentralized launch process than other DeFi assets.
Uniswap has the most trading volume on Coinbase. Another interesting aspect over the past few months is that the most used applications have expanded from decentralized lending to other decentralized services such as exchanges and asset issuance. In an incredible result, decentralized exchange and automated market maker Uniswap recently surpassed $1 billion in daily trading volume, an increase of more than 10 times from the previous month and more than that of Coinbase, the largest cryptocurrency exchange in the United States. The transaction volume monitored by Pro is 50% higher, and Uniswap is currently the leader in the amount of locked assets in the DeFi field, reaching 1.8 billion US dollars.
Ethereum transaction fees hit an all-time high. Transaction processing fees on the Ethereum network reached an all-time high in August as rising activity on the network led to increased demand for processing power. Ethereum developers are working on upgrades to increase the processing power of the network, but this is a challenging problem (more on this below). The graph below shows the fees paid in the Ethereum network (drawn on a logarithmic scale to make the highest points easier to identify).
In terms of store of value, this month the first public company uses bitcoin for some of its cash reserves.
MicroStrategy, a $1.4 billion Nasdaq-listed business intelligence and software company, has adopted bitcoin as its primary reserve asset: the company bought a total of 21,454 bitcoins (approximately $250 million at current prices) in an effort to make Its reserves are diversified.
Co-founder and CEO Michael Saylor believes the company settled on bitcoin after considering potential investments in various asset classes.
"We found that for those looking for a long-term store of value, Bitcoin's global acceptance, brand recognition, ecosystem dynamism, network strengths, architectural resilience, technical utility, and community ethos make Bitcoin a viable alternative. This superior asset class is very convincing. Bitcoin is digital gold - harder, stronger, faster and smarter than any currency before it. We expect its value to accrue as technology advances, adoption expands, and the network effects that have fueled the rise of many of the killer products of the modern era."
MicroStrategy didn't stop there. On Sept. 14, the company bought another $175 million worth of bitcoin, thus expanding its total purchases to $425 million.
M&A activity in the cryptocurrency market remains lively, including deals involving the largest U.S. financial institutions.
JPMorgan Chase sells blockchain division to Ethereum infrastructure provider Consensys while making strategic investment. The two companies have been working together since 2016, when JPMorgan launched Quorum, an Ethereum-based blockchain. As part of the deal, JP Morgan will invest $20 million in ConsenSys.
At the same time, the central banks of various countries are continuing to embrace digital currencies.
The Federal Reserve Bank of Boston and the Massachusetts Institute of Technology have partnered on a central bank digital currency (CBDC) research project. According to Federal Reserve Board member Lael Brainard, the two institutions are working together"Build and test a digital currency for central bank use". The bank is expected to announce the results of this collaboration and make its software code publicly available.
China expands pilot cities for digital currency. According to the Wall Street Journal, China is expanding its digital currency pilot program to include several of its most economically prosperous regions, including Beijing. The policy design related to media reports should be completed before the end of the year. The People's Bank of China launched a digital currency pilot earlier this year that included four major cities as part of Beijing's preparations for the 2022 Winter Olympics.
