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Crypto’s In The Upside Down

Like the Netflix hit sci-fi series “Stranger Things” where governmental test labs inadvertently create a new volatile dimension called the “Upside Down” so, too, have crypto markets taken on paranormal proportions to become their own “Upside Down.”

In a recent article for The “Wall Street Journal” on Thanksgiving Day entitled “How Crypto’s Collapse May Have Done the Economy a Favor” Greg Ip chronicles the side-by-side worlds of the traditional financial systems and the new crypto world destined to replace it. Here is his scorecard after the failure of FXT and a crash of almost every variety of crypto in the Upside Down:

“While bankruptcy filings aren’t entirely clear, they describe many of the largest creditors as customers or other crypto-related companies. Crypto companies, in other words, operate in a closed loop, deeply interconnected within that loop but with few apparent connections of significance to traditional finance. This explains how an asset class once worth roughly $3 trillion could lose 72% of its value, and prominent intermediaries could go bust, with no discernible spillovers to the financial system.”

This reminds me of 2008 where speculation in every derivative of a mortgage almost wiped out the world’s Bretton Woods financial system and all the commercial banks in its international spiderweb. Here in 2022 the contagion was largely isolated to meme stocks, crypto and the central banks’ own balance sheets.

As the commercial banking systems all over the world change their roles to being distributors of money created by central banks, credit risk and asset losses have been shifted to and “monetized” by central banks. Unlike 2008 when central banks intervened in markets all over the world by buying assets like General Motors at bargain prices, this time central banks have bought assets with little chance of ever recovering value. A new concept of “monetization” now suggests central banks can isolate upside down asset classes on their balance sheets with the objective of simply writing them off in the future.

Bitcoin’s Promise Has Not Been Realized

If you can recall the concept behind the creation of Bitcoin in 2009 it was central banks as middlemen are too easily influenced by politicians and powerful monied interests and, therefore cannot be trusted to resist using their power to print money to avoid financial crisis. A new system based on a world digital currency with a peer-to-peer validation system, 24-hour availability and a finite amount of currency would become a competing world currency. Many flaws in this system emerged including the energy cost of validating the bitcoin blockchain, the slow transaction speeds, no yield and troubling anonymity for drug dealers, arms dealers, criminals and extortionists who adopted it as their currency.

Warren Buffet and Jamie Dimon called Bitcoin a fraud, but speculators everywhere found it was an appealing asset class. The introduction of futures markets for Bitcoin and Ethereum allowed “old economy” derivative traders to profit from wild price gyrations up and down without actually owning (and validating) the crypto asset class.

Here is year to date performance information from Cryptotank.io on the top crypto offering vs S&P500 and Nasdaq:

Bitcoin -64.3%
Ethereum -67.0%
XRPL -50.9%
Dogecoin -39.3%
Cardano -75.89
Polygon -66.0%
Polkadot -79.0%
Shiba Inu -71.9%
Lite Coin -47.3%
Solano -91.6%
S&P500 -15.53%
NASDAQ -29.09%

The irony of these comparative statistics is without Fed intervention in equity, bond, mortgage, and money markets by buying these faltering assets classes in 2021 to stem contagion, the drawdowns between crypto and traditional asset classes may have been closer. There are no middleman for the crypto asset class and once you have entered the Upside Down all the money flows against you, especially when the positions have been leveraged.

The incumbent system wins this round and signals it will vanquish its competitors. It has proved impossible to beat the Fed, Jamie Dimon and Warren Buffet and the incumbent financial system is now delivering a confident inflation remedy.

The early vision of a new financial order based on Bitcoin as digital gold is now a failed trade. My fascination with Bitcoin and Ethereum as a component of a new world currency is still alive, but for now the world will just have to accept the US dollar as its reserve currency and the Bretton Woods system as its only alternative.

The above commentary is for informational purposes only. Not intended as legal or investment advice or a recommendation of any particular security or strategy. Information prepared from third-party sources is believed to be reliable though its accuracy is not guaranteed. Opinions expressed in this commentary reflect subjective judgments based on conditions at the time of writing and are subject to change without notice.

Index Disclosure: An index is an unmanaged portfolio of specific securities, the performance of which is often used as a benchmark in judging the relative performance of certain asset classes. Investors cannot invest directly in an index. An index does not charge management fees or brokerage expenses, and no such fees or expenses were deducted from the performance shown. Index returns shown are price returns, which exclude dividends and other earnings. The S&P 500 Composite Index is a market capitalization-weighted index of 500 widely held stocks often used as a proxy for the stock market. It measures the movement of the largest issues. Standard and Poor’s chooses the member companies for the 500 based on market size, liquidity and industry group representation. Included are the stocks of industrial, financial, utility, and transportation companies. The Nasdaq Composite is a market capitalization-weighted index of more than 3,700 stocks listed on the Nasdaq stock exchange.

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Rob McCreary

Rob McCreary has more than 40 years of transactional experience as an attorney, investment banker and private equity fund manager, and has spent his career in building entrepreneurial organizations with successful track records. Founder and chairman of CW Industrial Partners (originally CapitalWorks, LLC), he is responsible for developing and maintaining senior relationships with investors and portfolio governance.

This blog represents the views of Rob McCreary and do not reflect those of CW Industrial Partners or its employees. This blog is not intended as investment advice. Any discussion of a specific security is for illustrative purposes only and should not be relied upon as indicative of such security’s current or future value. Readers should consult with their own financial advisors before making an investment decision.