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Crypto assets were supposed to be a hedge. The last few months have shown that it is a pretty ineffective one.

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Good Evening [%first_name |Dear Reader%],

Welcome to this week’s edition of Tokenised.

Opposition to governments bailing out banks and printing money after the 2008 financial crisis was supposedly at the core of why crypto-assets were created. The idea was to establish hedges—starting with one—that wouldn’t be affected by central bank activities such as quantitative easing. 

But reality hasn’t really played out that way. The strongest inflationary environment we’ve seen in a few years has provoked central banks across the world to roll up their sleeves, and the adolescent crypto market has been shaken to its core. With prices in sharp retreat and sectoral business prospects appearing shaky, a winter might just be setting in.

Let’s jump right in.

The dollar upcycle has the crypto wagon losing its wheels

Yesterday, Coinbase—the only publicly traded crypto exchange in the world—revealed its quarterly earnings after markets closed in the United States.

The exchange reported that its trading volumes had dropped 44% as compared to the previous quarter and that its overall revenue was down 27% compared to last year. All told, the exchange reported a net loss of US$430 million in the first quarter of 2022. 

The sobering earnings report from Coinbase comes against the larger backdrop of a broad market rout for crypto assets over the past couple of months. While overall market capitalisation for tokens stood at US$2.9 trillion in November 2021, it currently stands at roughly US$1.7 trillion, according to data provider CoinGecko. 

But I think the drop in prices isn’t as interesting as the timing of it. 

The foundational idea behind building a hedge with crypto assets was to shield participating money from inflationary risk and central bank actions. But they seem to be quickly losing value just as inflation (and inflation-control measures) ramps up across the world. 

Bitcoin alone has lost about 17% of its value since the US Federal Reserve announced rate hikes last week aimed at slowing the pace of inflation. The immediate spillover of central bank actions into crypto markets can be partially explained by the heavy involvement of institutional investors in the sector. 

So, instead of working as a hedge against stocks sensitive to inflation, the involvement of financial whales in the crypto sector has actually led to a strong coupling effect arising between the two asset classes. 

The hedge hypothesis for crypto seems to have clearly faltered. And a rotation away from risk—partly driven by rising yields for US government debt (a global benchmark)—could very well have more pain in store for crypto assets.

It was perhaps in expectation of such pain that Coinbase slipped this new disclosure into its quarterly filings. 

Because custodially held crypto assets may be considered to be the property of a bankruptcy estate, in the event of a bankruptcy, the crypto assets we hold in custody on behalf of our customers could be subject to bankruptcy proceedings and such customers could be treated as our general unsecured creditors.

In other words, if Coinbase goes broke, customer assets held with the exchange aren’t likely to be returned. 

With that, let’s turn to some other things that happened in crypto this week. 

Crispy bytes

  • Meta (formerly Facebook) is rolling out non-fungible tokens on Instagram. [Meta]
  • Crypto exchange KuCoin has raised a US$150 million funding round at a US$10 billion valuation. [TechCrunch]
  • Binance has received regulatory approval to offer digital asset services in France. [CNBC]
  • Indian tax authorities could end up imposing an additional 28% tax on crypto transactions. If approved, the cumulative tax burden on such assets would be 59%. [Economic Times]
  • Nvidia has agreed to pay a US$5.5 million fine to the US markets regulator due to insufficient disclosures of crypto mining’s impact on its business. [Al Jazeera]
  • Binance is among the coterie of investors put together by Elon Musk to support his acquisition of Twitter. [Bloomberg]
  • Argentina’s central bank has banned private banks in the country from offering crypto asset services. [Central Bank of Argentina]
  • Jamaica is likely to launch its central bank digital currency this summer. [Blockworks]

Deeper dives

About 90% of the central banks surveyed by the Bank of International Settlements (BIS)—an umbrella group of global central banks—are currently exploring issuing central bank digital currencies (CBDC). It seems the spurt in popularity for crypto assets, including stablecoins, has pushed nations to come up with alternatives of their own.

Among the stated priorities of doing so, financial inclusion and increasing domestic payments efficiency rank the highest, according to a recent paper released by BIS. Most countries currently researching CBDCs are likely to involve the private sector in its issuance and might even end up integrating the digital version of their currency into existing payment systems.

While only a few countries like Nigeria, China, and the Bahamas have actually launched CBDCs, the BIS report notes that that group might become sizable soon. [Link]

What caught my eye this week

TerraUSD Price between 8 May and 11 May, [Source: CoinMarketCap]

The algorithmic buck appears to have broken. 

Without getting too deep into the weeds on this, TerraUSD is an algorithmic stablecoin that’s supposed to maintain its link (par value) to the US dollar via game theory-driven software mechanics. This allows one token of TerraUSD to be continuously redeemed for US$1. Kind of like a casino chip, but with the caveat that the casino chip isn’t backed by US dollars but by a set of volatile assets. 

Now, as long as there is ‘faith’ in those volatile assets, things work out fine. But if that faith is shaken, the buck breaks. Put simply, breaking the buck refers to a situation where the net asset value (NAV) of a fund that invests in short-term, safe financial securities falls below the US$1 mark—at which point, from an investor’s standpoint, the value of the investment is now lower than the principal amount invested.

That’s pretty much what is going on with TerraUSD. It first dropped from US$1 for each token to 70 cents yesterday, briefly recovered to 84 cents, and was down to 48 cents as of 3 PM today. Just to reiterate, it was supposed to stay constant at US$1 through an algorithmic process. 

There’s really no way I can go into all the complexities of how this worked and how TerraUSD recovered within the confines of this section (maybe we’ll get into it in more detail in one of our future editions), but suffice to say that saving a ‘decentralised’ stablecoin required the deployment of capital by an entity central to it. While some of the capital came out of selling bitcoin reserves backing the token, the firm behind the stablecoin is also in the market trying to raise US$1 billion to keep the token afloat, as reported by The Block

That’s all for this week’s edition. If you have any overarching thoughts (or even nitpicky ones) about this newsletter, please do write to me at [email protected].

I’ll see you again next week. Take care!

Regards,

Jaspreet Kalra

This newsletter has been discontinued. But you can read The Stack which includes our newsletters around cleantech, fintech, personal finance and e-commerce in India!