Before discovering cryptocurrencies in 2013, my partner Daniel Masters and I were involved in commodity trading for almost three decades.
At that time, one of the features of bitcoin that appealed to us was the limited issuance, as only 21 million bitcoin will ever be issued. This made it feel quite similar to gold or silver.
The longer I am in this space, the more I see similar patterns emerge.
First: One of the successful themes we employed in our Global Advisors Commodity Investment Fund during the period 2002–2007 was the “Three Ds” of Demand, Depletion and the Dollar. In some ways, these same elements are present in the digital asset ecosystem today:
- Demand in the form of increased utility for digital assets beyond financial speculation —* as we’ll highlight later, institutional interest, while increasing in our experience, is untethered from demand for the underlying
- Depletion in the form of the periodic halving of bitcoin’s block mining reward.
- The Dollar in the form of reduced confidence in fiat currencies following the 2008 Global Financial Crisis, use of policies such as Quantitative Easing, and the current mini-currency war between the U.S. & China.
So at the very least, we are getting a similar setup here…
Second: Between the mid-1990s and the cycle peak in 2008, commodities developed from a market of professionals & industry participants into a more widely recognized asset class. By the end of 2008 there was more than $250 billion in commodity index funds (up from $20 billion in 2002) and the gross market value of commodity derivatives had risen by a factor of 25 times to $2.13 trillion between June 2003 and June 2008.
This expansion was obviously assisted by the advent of a broader range of low-friction, non-physical exchange-traded products, as no one wanted to buy actual barrels of oil and take delivery, etc, and rather preferred to speculate on the price of the underlying via synthetic instruments. The growth of the gold market and oil market, as evidenced below, was primarily driven by futures and products that were independent of the underlying physical asset in every way except for price.
Note for a moment here that when I am talking about institutional money flowing into the commodities space, reducing friction was an important driver in facilitating market growth. This growth happened via synthetic, or non-physical, means. At first slowly, then rapidly.
There is a similar tension today, behind the idea of “institutional capital” entering the digital asset market. It is highly unlikely that a large institutional buyer will want to buy and take digital settlement of bitcoin. It is much more likely that these institutional investors will take synthetic exposure that provides them with the price volatility of digital assets without all of the underlying execution risk and operational risk.
For years, there has been a quiet flow into the underlying asset (in this case bitcoin) and a slow pick-up as other lower friction ways to invest (such as futures and exchange-traded products) have hit the market. I let you infer from history what would follow, cycle-wise.
Third: I’ve definitely heard the “blockchain, not bitcoin” line before…or said differently, I’ve seen investors conflate exposure types early in an asset class before.
Back in the early 2000s many institutional investors simply weren’t convinced they needed to access commodities themselves, with commodity exposure available through investment in mining & oil equities. My response to this is yes, and no.
Let’s take the example of a company like BP — they are exposed to oil & gas prices, yes. But they are also exposed to refinery margins, operational risks as the Deepwater Horizon disaster demonstrated, and environmental policies and new regulation that impact demand, so no. In this case, for an investor wanting exposure to oil prices, buying BP is not the same as buying oil prices. They are buying other risks and other potential upside as well.
Likewise, so-called “Junior Mining” stocks might feel like options on the price of the commodity, but — even having made a discovery — it can take many years to obtain the necessary permits & build a mine. For the uninitiated, a junior mining company is an exploration company in search of new deposits of gold, silver, uranium or other precious metals. Many junior miners are penny stocks, and highly speculative, high risk investments that investors hope to buy into before a company hits the mother lode.
As a consequence, equity indices like OSX (PHLX Oil Services Sector) or GDM (NYSE Arca Gold Miners) do track oil & gold prices, but imperfectly. The ebb and flow in the relationship between the value of the equity & the underlying asset is driven by many factors.
We see a similar, bi-polar investing (and liquidity) spectrum emerging in the digital asset space.
Certainly, with the lion’s share of liquidity and name recognition, bitcoin has tended to lead the market and be the ‘flagship investment’ if you will. Though during much of bitcoin’s 2017 rally — the ‘pro money’ was often looking elsewhere as the ICO phenomenon fuelled buying of ETH.
At the other end of the liquidity spectrum we have the long tail of “alt coins” which includes more than a few scams as reported in the press and, in our opinion, very optimistic “business plans”, but also covers some very interesting and innovative technologies.
These tokens behave more like the equity market’s junior mining or exploration stocks: a brief surge of excitement on some news which may inflate the price, but until there’s some real evidence of traction, or in my ‘Three Ds,’ demand (Minimum Viable Product delivered, or ideally some people actually using the technology) nothing much happens. My partner Meltem Demirors further expanded token investing on using onshore shale gas development as an analogy. Did I mention we are commodities people?
Gartner Group describes this period of their Hype Cycle as the “Trough of Disillusionment.” Without question, 2018 was a Trough of Disillusionment for digital assets. Many alt-coins were down more than 90% from late 2017 / early 2018 all-time highs (some still are see here, sort by % down from ATH”), with bitcoin also falling more than 80% from a high of over $19,000 in December 2017 to below $3,500 in December 2018.
But, I think the real truth is that at some point in the (likely not-too-distant ) future, nobody will care if a technology is “powered by blockchain” any more than anyone cares today that the internet is powered by TCP/IP & HTTPS.
When the hype fades, consumers and businesses only care that stuff works.And that is the most important lesson of all.
Crypto projects — whether at the protocol layer via some token or the application layer via a product or service — need to deploy technology that works and that people want to use because it’s better than what’s already available. We’re starting to see some of that tech finally emerge in 2019 and we expect it to accelerate into 2020 and beyond.
At CoinShares, we are believers in this shift from legacy capital markets to digitized, blockchain-based financial markets. This is history continuing to do what it has done before, and as my partner Ryan Radloff has pointed out prior, this is a natural evolution, not revolution.
*see for reference: What Explains the Growth in Commodity Derivatives? Parantap Basu and William T. Gavin Federal Reserve Bank of St. Louis Review, January/February 2011, 93(1), pp. 37–48
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