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Four lessons from the Bitcoin debacle

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Update time : 2022-12-01

Cryptocurrencies aren’t dead yet, but their core tenet is life support right now. The illusion that bitcoin is an inflation fighter is gone. The first serious inflation since the 1970s has coincided with a 60% drop in the price of bitcoin over the past year. Gone is the notion that bitcoin is “digital gold,” a precious metal that has far outperformed bitcoin, stocks and bonds this year, falling just 6%.

But it would be wrong to interpret Bitcoin’s woes as a false argument for the entire cryptocurrency industry. Etherum, the second-largest blockchain, just underwent a major upgrade that could fuel a resurgence in encryption activity. Companies backing other blockchains remain committed to building new systems for financial products, payments and digital assets.

Just as the Internet survived the demise of Pets.com, the cryptocurrency crash is not an epitaph for blockchain technology. In fact, scratch away the junk and what’s left is an industry worth revisiting. “In previous cryptocurrency cycles, you’ve had less engagement. In this new cycle, more people will use digital assets and build on top of blockchain, “said Alkesh Shah, cryptocurrency strategist at Bank of America.

Investors still need to be wary. Dogecoin, an “influencer” token that started as a joke, still retains a market value of $8 billion, close to the market cap of companies like American Airlines Group (AAL). Even though the token market has lost $2 trillion in value, plenty of bubbles remain. “The durability of crypto assets is questionable,” said Cornell professor Eswar Prasad, a leading expert on digital assets, “but the technology does seem to have some durability.”

If you’re considering investing in cryptocurrencies, here are four lessons for you.

Bitcoin is still finding its raison d ‘etre

Bitcoin’s backers have spent a decade promoting its use as a currency free of government control, digital gold and an inflation hedge whose limited supply would protect the price. But Bitcoin hasn’t lived up to those promises.

Moreover, there is little agreement on what Bitcoin really is: just another set of software rules, a truly revolutionary technology like the Internet, or a quasi-currency that could one day be worth $500,000 each (as some bulls believe), well above the current $20,000.

“It reminds me of the fable of the blind man and the elephant,” said Madeline Hume, a senior analyst at Morningstar. No one can figure out what an elephant really is, because everyone can only sense a single attribute like ivory or elephant skin. “We are slowly understanding what Bitcoin is,” she said. .

Bitcoin’s role as an alternative asset remains questionable. The price collapse shattered the belief that the cryptocurrency market could withstand the macroeconomic pressures that have pushed the Nasdaq Composite index down 29 percent this year. The correlation between bitcoin and Nasdaq hit a record high in September and has averaged 0.66 over the past six months, suggesting that bitcoin and tech stocks tend to move in tandem.

Despite these drawbacks, proponents like Shah argue that bitcoin and other cryptocurrencies are still viable long-term investments. “People are realising that digital assets are becoming an Internet operating system, like a high-growth sector of the economy,” he says.

The mere influx of big money is not an endorsement

Before the crisis, a big selling point for cryptocurrencies was that they attracted institutional capital from pension funds and venture capital firms. Why are these established foundations putting their savings and investments into cryptocurrency companies built on fragile promises of revenue and profits? The prevailing thinking at the time was that they would not. So that creates a selling point for attracting more money from retail investors.

But, like many small investors, large sums of money were wiped out when the market crashed. Take the crypto lending company Celsius Network, which has attracted more than $20 billion in customer deposits, in part because of the 18 percent yield it pays. Celsius is now operating under bankruptcy protection, its chief executive has resigned and thousands of investors are trying to recover their savings.

However, eight months before Celsius halted customer withdrawals in June, it raised $400m in a funding round that included Savings and Investments Quebecois, Canada’s second-largest pension fund. Alex Mashinsky, former chief executive of Celsius, said in a live video broadcast a few days after the funding announcement: “No one would have put so much money into Celsius if they were very concerned that we were not doing it legally and following all the rules.”

The pension fund has since reduced the amount it invests in Celsius. Charles Emond, the head of the C $392 billion (US $288 billion) fund, said at a press conference in August that the losses were “not even a rounding error of our returns.” Despite his remarks, according to the Montreal Gazette, He is considering legal action after writing off $150 million of the fund’s investments. Celsius did not respond to requests for comment.

Andreessen Horowitz, the venture capital firm, could also be affected. Mr Horowitz is the biggest backer of Silicon Valley’s crypto start-ups. The company has invested more than $7 billion in crypto start-ups, including a $314 million token offering from Solana Labs. Solana’s token surged to $259 in November but is now trading at just $33 amid concerns about cyber security and the ability to scale. Both Anderson and the Solana Foundation declined to comment.

Vc funds expect most of their bets to fail and hope that one of them will be the next Facebook(META). David Nage, a portfolio manager at cryptocurrency investment firm Arca, said retail investors shouldn’t take comfort from the fact that VCS are investing with them. “If the fund is large and the cheque is small, the bandwidth and support for the project is quite low,” he said. .

Separate the blockchain infrastructure from the tokens

Many big companies are betting that blockchain technology will exist long after pure token speculation is gone. The idea was that block chain and related digital assets provides a way to enter a new market ー ー whether video games, financial products based on it, or repackage for homogeneity tokens, art, music and video products, new iteration or NFT.

These plans range from the trivial to the extremely significant. On the one hand, Starbucks (SBUX) said last month that it would introduce “digital collector stamps” to give its most loyal customers “an immersive coffee experience,” but that’s unlikely to lift a company to $33 billion in sales this year.

In a separate development, Swift, the interbank messaging system that handles trillions of dollars in global transactions, is testing a system that would allow messages to be transferred directly by token. If this works, banks could start moving money via blockchain to methods already used to move traditional money.

“We’re in a cryptocurrency winter, but we’re certainly not in an infrastructure winter,” says Will Peck, head of digital assets at ETF provider WisdomTree Investments (WETF). “People are still talking about building blockchain-based infrastructure.” Wisdom Tree itself is launching a short-term Treasury fund that trades using blockchain – the Short-term Treasury Digital Fund. Wisdom Tree said the fund could provide faster clearing and settlement speeds.

Investing in companies that serve the crypto industry is less risky than buying tokens. A prominent example is Silvergate Capital (SI), a bank that is developing services for cryptocurrency brokers, finance firms, and others in the industry. Silvergate managed to expand its crypto customer base through the collapse in Bitcoin’s price. The company’s net profit is expected to grow 72 percent to $277 million in 2023.

The stock trades at two times book value, well above the banking sector average. But Wall Street still likes it: The average price target is $129, which would represent a 63% gain from the current price of around $79.

Other crypto-related stocks include Signature Bank (SBNY), PayPal Holdings (PYPL), Block (SQ) and Coinbase Global (COIN). With the exception of Coinbase, a large digital asset exchange, these companies are developing encryption services outside their core business.

To be sure, crypto stocks have been terrible performers. The Amplify Transformational Data Share ETF (BLOK), the largest ETF for crypto-related companies, is down 50%. That’s a victory over rivals like the Global X Blockchain exchange-Traded Fund (BKCH), whose shares are down 70%.

Shah said investors should look at cryptocurrencies as a way for large corporations to prove that their earnings can hold their value. “The existing players that embrace this technology and engage in mentoring or market education are likely to do well over the next five to 10 years,” he says.

Regulation really helps

While other banks are also experimenting with cryptocurrencies, most have been sitting on the sidelines. A recent report by the Basel Committee found that large banks hold just 9.4 billion euros ($9.2 billion) worth of cryptocurrency exposure on their books, a small fraction of total assets.

A big reason behind this is that big institutions won’t jump in without clear regulations, but it could happen. Regulators are currently working on rules that would allow financial institutions to own cryptocurrencies and offer cryptocurrency-related services to their customers. The Senate legislation, for example, would direct federal agencies to place much of the cryptocurrency market under the jurisdiction of the Commodity Futures Trading Commission. Other bills address whether the Securities and Exchange Commission should regulate exchanges, or whether cryptocurrency banks should have access to core Federal Reserve services.

Most companies won’t touch cryptocurrencies without more regulatory certainty. Charley Cooper, managing director of R3, a blockchain software company, said that if an executive tried to get approval to launch a legally ambiguous encryption product these days, lawyers inside the company “would choke to death at breakfast.”

Regulations that have bipartisan support in the Senate have a good chance of passing next year. The proposals also appear to be consistent with the Biden administration’s recently announced regulatory framework for the industry.

Creating a level playing field between cryptocurrency upstarts and banking firms would be a win for Wall Street. It could trigger a wave of investment as institutions and consumers adapt to legal protections.

“If there were a CFTC-regulated market, the price of bitcoin could double,” Rostin Behnam, the CFTC’s chairman, said in September. Does that sound good? But even doubling would still leave bitcoin 40% below its peak price

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