Monochrome Digest | October 2023 - November 2023

Pressure of lawsuits weigh on U.S. spot Bitcoin ETF applications

In a report, JPMorgan analysts outlined the legal ramifications for applicants if the SEC chooses to deny the approval of the many spot bitcoin ETF applications, which are due to be reviewed. In a statement from JPMorgan analysts, “Any rejection could trigger lawsuits against the SEC creating more legal troubles for the agency.” Bloomberg analysts have stated there is a 90% chance that a spot bitcoin ETF is approved by the January deadline, which supports JPMorgan’s prediction that a rejection is unlikely. Whatever the outcome in January, it is expected that applicants are prepared for legal action, however another legal battle may not be ideal for the SEC especially after Grayscale’s recent successful lawsuit against the agency.

After Grayscale’s legal victory against the SEC in August, the SEC must now review Grayscale’s application to convert its Grayscale Bitcoin Trust (GBTC) into an ETF. Grayscale's recent legal victory against the SEC has not only created significant momentum in favour of applicants, but also set a precedent in challenging regulatory decisions within the digital asset industry.

Additionally, Bitwise has submitted its revised application with the SEC, which implemented feedback from the SEC. According to James Seyffart, the revised application now meets expectations after responding to comments made by the SEC. The changes made are also reflected in many other applications, which demonstrates the progress applicants are making with the SEC.

Nonetheless, the market reaction of a spot bitcoin ETF approval was momentarily tested after it was falsely reported that BlackRock had received the green light for its spot bitcoin ETF application, which was reported by Bloomberg and Reuters. While the application has yet to be approved, the BlackRock's iShares Bitcoin Trust has now been listed on the Depository Trust and Clearing Corporation (DTCC) with the ticker IBTC. While this is not an approval, which many had believed, it indicates that BlackRock’s confidence that the application will be approved. From this news, bitcoin prices surged by 10% within hours, which shows how the market may react to an approval.

Anthony Scaramucci, an investor in BlackRock’s bitcoin trust product, through his firm SkyBridge Capital, has anticipated the approval will occur in the first half of 2024 and predicts institutional investment of over US$100bn once the product trades. In support of this statement, Scaramucci explained,

“There will be an army of people, sales people, financial consultants, financial advisors, private bankers that will have digital assets as part of their long-term tactical capital allocation portfolios,” adding, “Think of the magnitude of that, if there’s $100 billion that flows in bitcoin … that could have an 11-times factor in terms of valuation. So you could see bitcoin go from a $600 billion asset to a $600 trillion asset.”

BlackRock uses JPMorgan blockchain settlement system

The world’s largest asset manager, BlackRock, continued to add to headlines within the digital asset industry, after the financial giant used JPMorgan’s blockchain settlement system. After being formed in 2020, JPMorgan’s Onyx is a bank-led ether-based blockchain platform that facilitates transaction orders using smart contracts.

BlackRock tokenised shares in one of its money market funds and demonstrated a near-instant collateralised transfer to London-based Barclays through an over-the-counter (OTC) trade. If this collateralised transaction used existing settlement solutions, it would be expected to take a day, which highlights the potential speed of blockchain transactions. Additionally, the collateralisation of assets using tokenisation can assist in the freeing of locked up capital and improve efficiency within markets.

This transaction involved three of the largest traditional financial institutions, which demonstrates the emergence of existing firms within digital asset markets. Alongside JPMorgan, Citigroup also launched a similar offering, Citi Token services, which is a blockchain based payment solution to be used across borders. This service involves smart contracts and tokenised deposits to achieve real time settlement.

Many analysts see the entrance and involvement of the traditional financial industry within digital asset markets to be a catalyst for growth. For instance, George Tung stated, “Forbes is predicting BlackRock and JPMorgan, they will drive the next bull run.”

He further emphasised their impact by adding,

“I do think that institutions will definitely play a big role in this cycle, in the cycle top, and that could be a good thing. We’re talking about trillions, upon trillions, upon trillions coming into the space led by the likes of BlackRock, and Fidelity, and Vanguard, and even Grayscale and others.”

Institutional adoption of digital assets remains to be a key driver of digital asset markets, where demand for assets weighs on the supply.

Warren Buffet’s best performing asset year to date is a crypto friendly bank

World renown investor and businessman, Warren Buffet, has often been vocal on, and critical of, bitcoin over recent years. Despite these comments, analysis of Buffet’s Berkshire Hathaway investment portfolio has shown the best performing stock this year is Nubank.

Nubank is a crypto-friendly bank that allows its customers to trade digital assets, including bitcoin, through its platform. Nubank also launched its own token, ‘Nucoin’, as part of a loyalty program that rewards the user for their participation within the platform. The token was distributed as part of an airdrop providing users with the token free of charge.

Nubank is a Brazilian neobank and the largest fintech company in Latin America, which was valued at over $45bn in its June 2021 IPO. Before this IPO, Buffet invested $500m into Nubank and a further $250m during the IPO, which is now worth over $840m.

The adoption of cryptocurrencies, particularly through a rewards based system, has been a driving force behind the valuation of Nubank. Consequently, Nubank has outperformed other major positions held by Buffet, including Coca-Cola, Bank of America, Apple and Amazon among others.

Despite investing into crypto-exposed businesses, Buffet and his right-hand man, Charlie Munger, have been critical of the use case for digital assets, labelling them as tools for criminals. Sequoia Capital is expected to be an influence on Buffet’s decision, as the firm provided seed funding to Nubank in 2013 and currently owns 13% of the company through its funds. Additionally, Nubank CEO, David Vélez, is a former Sequoia partner and Munger has previously hailed Sequoia’s previous successes.

While Buffet’s investment thesis on digital assets contradicts his position in Nubank, the performance benefits of exposure to digital assets, even through equity proxies, have shown in one of the world’s largest portfolios.

Bitcoin rallied over 100% this year

Many investors believe the approaching deadline for spot bitcoin ETF applications and the growing confidence that these applications will be approved has provided tailwinds for bitcoin throughout 2023. While the bridging of traditional financial markets with digital assets has been a contributing factor, there are also other market dynamics that may have led to the surge in price.

While traditional financial institutions are entering the digital asset landscape, October 31 marks 15 years since the Bitcoin white paper was released. During this time, extreme stresses were placed on the banking system in the GFC. For some, the Bitcoin white paper posed an alternative, peer to peer banking solution despite it not explicitly being stated. Ironically, much of the dialogue within bitcoin communities is about the entrance of wall street giants into a market created to run them out of business.

Within the current macroeconomic environment, political tensions and conflict have led to uncertainty within markets. As a result, investors have ‘flown to safety’ by investing in safe-haven assets. This may have benefited bitcoin as investors may increasingly recognise its pre-programmed monetary policy. Amidst the devaluation of fiat currencies around the world from reserve bank money printing and government spending, while the supply of bitcoin has remained consistent, asset managers around the world appear to be reallocating investment exposures. Alongside these macroeconomic factors, increased volatility in equity and fixed income markets is compounding these effects.

Chief Investment Officer of Arca, Jeff Dorman, explained the transition,

"After 2022 tricked so many into thinking that digital assets are correlated to stocks and bonds, many are left scratching their heads at the 'new' old normal." He added "A debt spiral leads to a loss of confidence in banks and governments and a repricing of risk-free rates amidst record supply, which is bad for bonds and equity valuation models, but good for alternative forms of wealth and money creation."

The underperformance of the classic 60/40 portfolio has shown the diversification benefits of allocating a small portion of an investor’s portfolio. While a 40% allocation to fixed income previously offered income generation and risk mitigation, the addition of bitcoin within a portfolio has provided insurance-like qualities in uncertain market conditions.

Analysts also believe the collapse of banking institutions in the United States over the last year and the recent Chinese shadow banking crisis have led to the surge in bitcoin. After real estate firms, Evergrande and Sunac filed for bankruptcy, the People’s Bank of China (PBOC) provided $100bn to lending facilities, to assist the liquidity of the bank system. In 2020, PBOC lowered the deposit reserve ratio for financial institutions, which is the percentage of deposits that must be held in cash. After requiring a lower ratio equivalent to a $115bn injection into the economy, bitcoin surged by 13% and addresses rose by 48%.

There have been many factors driving the price of bitcoin this year, including geopolitical tensions, an uncertain macroeconomic outlook and fragility in traditional financial systems. While these tailwinds continue alongside the upcoming SEC decisions for spot bitcoin ETF applications and the halving expected in the first half of 2024, investors may benefit by appropriately allocating to bitcoin within a diversified portfolio.

The content, presentations and discussion topics covered in this material are intended for licensed financial advisers and institutional clients only and are not intended for use by retail clients. No representation, warranty or undertaking is given or made in relation to the accuracy or completeness of the information presented. Except for any liability which cannot be excluded, Monochrome, its directors, officers, employees and agents disclaim all liability for any error or inaccuracy in this material or any loss or damage suffered by any person as a consequence of relying upon it. Monochrome advises that the views expressed in this material are not necessarily those of Monochrome or of any organisation Monochrome is associated with. Monochrome does not purport to provide legal or other expert advice in this material and if any such advice is required, you should obtain the services of a suitably qualified professional.