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2020: The year bitcoin went institutional

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On December 11, a prominent but very private financial newsletter author noted to clients that while he had never previously written about bitcoin, it was correct to say that institutional capital had now started to arrive in scale and that it would be churlish to pick a fight with it. Demand for bitcoin would now outstrip supply.

Bitcoin, he observed, would become an excellent metaphor for risk appetite in 2021 as a result.

Less than a week later, Coindesk confirmed that UK-based asset manager Ruffer had accumulated some £550m of bitcoin since November, representing some 2.7 per cent of the firm’s AUM.

Ruffer’s move is now being widely interpreted as the beginning of a major portfolio diversification trend into bitcoin. It seems institutional money can no longer afford to ignore it. And bitcoiners are understandably overjoyed.

Price moves since certainly could be indicating some sort of pragmatic acceptance of bitcoin in investment circles:

© Courtesy of Coinmarketcap.com

So have these institutions gone mad? Or are things genuinely different now?

If they are, we think it all comes down to four key factors.

1. Bitcoin’s asset class status

Whether critics like it or not, bitcoin’s status as an asset class is now much harder to dispute. Yes, the cryptocurrency remains relatively useless as a medium of exchange outside of the dark markets. But it’s no longer clear whether that really matters. Bitcoin’s value has instead become linked to something more profound: its incapacity to go to zero despite having no central point of support or guarantor.

This, we would argue, is a function of two key elements: a) too much vested capital in the system to actually let it go to zero and b) enough shorts in the system to ensure short-covering at zero would inevitably be supportive.

But it is also a function of another important phenomenon: the emergence of a competing tax authority to that of the state in the shape of the hacker.

This is important because the longstanding economic argument against bitcoin as an effective store of value has always been that fiat money is ultimately stabilised by the state’s capacity to demand taxes in its own currency. As was noted by Dealbook in 2013, “money is inevitably a tool of the state” and “no private power can raise taxes or pass laws to unwind monetary excesses”.

In 2020, however, that doesn’t seem quite right. Private “hackers” routinely raise revenue from stealing private information and then demanding cryptocurrency in return. The process is known as a ransom attack. It might not be legal. It might even be classified as extortion or theft. But to the mindset of those who oppose “big government” or claim that “tax is theft”, it doesn’t appear all that different.

A more important consideration is which of these entities — the hacker or a government — is more effective at enforcing their form of “tax collection” upon the system. The government, naturally, has force, imprisonment and the law on its side. And yet, in recent decades, that hasn’t been quite enough to guarantee effective tax collection from many types of individuals or corporations. Hackers, at a minimum, seem at least comparably effective at extracting funds from rich individuals or multinational organisations. In many cases, they also appear less willing to negotiate or to cut deals.

In an increasingly polarised world where a near majority of people don’t recognise the legitimacy of their governments, a bitcoin enthusiast might legitimately question what really constitutes legal extortion anyway?

When established norms are in flux, everything becomes a matter of perspective and it would be irresponsible for fiduciary agents to bet on only one horse.

2. Bitcoin fought the law and the law won.

For a long time, institutional investment in bitcoin was hampered by strict investment mandates and regulatory compliance. Now that bitcoin has been formally recognised by many regulators, and regulated accordingly, this issue is far less of an obstacle than it used to be.

We used to argue that bitcoin’s submission to authority was indicative of the core system’s superiority. If bitcoin wanted to play with the big boys it would have to also play by the rules they were governed by, and in so doing give up on its status as a renegade system. But there may be an important counterpoint we failed to consider. In bowing to regulation bitcoin abandoned its key “censorship resistant” attributes, but it also paved the way for large scale institutional investment.

And that arguably is more important than temporarily bowing to the rules of the land. As with ESG investing, once you command sizeable institutional money, you have the power to influence the rules themselves through the threat of divestment. In bitcoin’s case, that might include changing the rules to favour censorship resistant forms of money.

If you consider institutional flows into bitcoin as a form of ideologically-motivated divestment from fiat you can see they’re worth paying attention to.

3. Bitcoin’s volatility is a useful metric

When FT Alphaville’s Tracy Alloway (now at Bloomberg) first cottoned on to bitcoin on June 6, 2011 it was worth a piddly $8.

At the time there was great disillusionment with the workings of the core financial system thanks to the global financial crisis. Yet, even then, most commentators viewed bitcoin as a libertarian pipe-dream that was unrealistic about the importance of the state in backing any formal currency system.

By June 13, Tracy had stumbled across bitcoin’s other great weakness: its intrinsic volatility.

In 2020, that volatility factor has not gone away and remains bitcoin’s biggest nemesis with respect to wider public adoption (especially as a form of money). But from a trading and asset perspective, there is some justification in embracing the idea that bitcoin’s volatility is also an important window into market forces that are otherwise being suppressed. Central banks, whether rightly or wrongly, have worked hard to eradicate volatility from the financial system at the cost of ballooning balance sheets and centralised support for specific asset classes. A decisive move by institutional money out of central bank systems and over to bitcoin stands to turn any related volatility into a measure of that suppression.

They say don’t fight the Fed because it will always win thanks to its infinite arsenal of cheap money. The notion is based on the premise that cheap money is preferable to all else. But if you’re an institution looking for a healthy rate of return, your institutional objective is to protect investor capital against things such as negative interest rates.

The fact institutions see bitcoin (in some ways the “hardest” of all currencies) as a mechanism to do that, is indicative of something important.

The bigger question is how do they see bitcoin offering a return after the inevitable capital appreciation honeymoon they themselves trigger is over?

The answer comes in the one thing that can’t be easily cultivated until bitcoin stops appreciating: a large and extensive debt capital market in which corporations can easily raise capital for real-world (not just digital) enterprise.

The irony is it’s only once the price of bitcoin stabilises that such a market can truly develop. And even after it does, some might argue why would anyone borrow in bitcoin rather than much cheaper fiat? Bitcoiners might retort that similar questions used to be asked of the offshore eurodollar markets. They mushroomed in size from the 1960s onwards regardless.

4. Bitcoin has successfully defied scrutiny

Scientists invite scrutiny because they know nothing is a better testament of success than having their inventions or discoveries defy continuous critique.

Bitcoin may have started off as a belief system far removed from scientific method, but in a round about way it has in the last 12 years invited as much, if not more, scrutiny than even Donald J Trump.

As much as critics may loathe to admit it, the fact the system is still standing (if not flourishing by some people’s measures) constitutes something important.

Yes, bitcoin is yet to prove itself as more efficient or user-friendly than the conventional fiat money. But it is no longer possible to deny its overall resilience. And since resilience was always part of bitcoin’s raison d’être that’s an important win for the would-be challenger system. All the more so if you consider that institutional money feels it can no longer afford to ignore it.

Related links:
Bitcoin finally finds a rationale in doomsday scenarios — FT



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Oil hits highest price since April 2019 before moderating

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The price of crude oil briefly hit its highest level for more than two years on Monday, lifting shares in energy companies, as traders banked on strong demand from the rebounding manufacturing and travel industries.

Brent crude crossed $75 a barrel for the first time since April 2019 before falling back slightly, while energy shares were the top performers on an otherwise lacklustre Stoxx Europe 600 index, gaining 0.7 per cent.

The international oil benchmark has risen around 50 per cent this year, underscoring strong demand ahead of next week’s meeting of the Opec+ group of oil-producing nations.

US manufacturing activity expanded at a record rate in May, according to a purchasing managers’ index produced by IHS Markit. Air travel in the EU has reached almost 50 per cent of pre-pandemic levels, ahead of the July 1 introduction of passes that will allow vaccinated or Covid-negative people to move freely.

“This is a higher consuming part of the year,” said Pictet multi-asset investment manager Shaniel Ramjee, referring to the summer travel season. “And the oil market is pricing in strong near-term demand that is better than previous expectations.”

In stock markets, the Stoxx Europe 600 dipped 0.3 per cent while futures markets signalled Wall Street’s S&P 500 share index would add 0.1 per cent at the New York opening bell.

The yield on the 10-year US Treasury was steady at 1.494 per cent. Germany’s equivalent Bund yield gained 0.02 percentage points to minus 0.154 per cent.

Equity and bond markets have consolidated after an erratic few sessions since US central bank officials last week put out forecasts indicating the first post-pandemic interest rate rise might come in 2023, a year earlier than previously thought.

US shares tumbled last week, while government bonds rallied, on fears of tighter monetary policy derailing the global economic recovery.

Wall Street equities then bounced back on Monday, with a follow-on rally in some Asian markets on Tuesday, as sentiment got a boost from more dovish commentary from Fed officials.

Fed chair Jay Powell, in prepared remarks ahead of congressional testimony later on Tuesday said the central bank “will do everything we can to support the economy for as long as it takes to complete the recovery”.

John Williams, president of the Federal Reserve Bank of New York, also said that the US economy was not ready yet for the central bank to start pulling back its hefty monetary support.

Jean Boivin, head of the BlackRock Investment Institute, said that “the Fed’s new outlook will not translate into significantly higher policy rates any time soon”.

“We may see bouts of market volatility . . . but we advocate staying invested and looking through any turbulence,” Boivin added.

The dollar index, which measures the greenback against trading partners’ currencies and has been boosted by expectations of US interest rates moving higher before other major central banks take action, was steady at around a two-month high.

The euro dipped 0.1 per cent against the dollar to purchase $1.1901, around its lowest level since early April. Sterling also lost 0.1 per cent to $1.3909.



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Wall Street rebounds as markets adjust to Fed rate rise outlook

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Wall Street stocks bounced back and government bonds softened on Monday following tumultuous moves last week after the Federal Reserve took a hawkish shift on interest rates and inflation.

The S&P 500 added 1.2 per cent in early New York dealings. The share index’s resurgence came after it posted its worst performance in almost four months last week in the wake of Fed officials signalling the central bank could raise rates to tame inflation sooner than investors had expected.

The yield on the benchmark 10-year US Treasury bond dropped sharply last week as investors viewed the Fed as ready to control surges in inflation that erode the returns from fixed interest securities. On Monday it rose 0.02 percentage points to 1.472 per cent.

Fed policymakers on Wednesday projected that interest rates would rise from record-low levels in 2023, from their earlier median forecast of 2024. James Bullard, president of the St Louis Fed, told television network CNBC on Friday that the first rate increase could come as soon as next year as inflation grew.

However, Gregory Perdon, co-chief investment officer at private bank Arbuthnot Latham, urged caution. “The facts are that the Fed hasn’t done anything yet. Wall Street loves to climb the wall of worry.”

Fed officials’ statements last week prompted fears of rapid policy tightening by the world’s most powerful central bank that could derail the global economic recovery from Covid-19. Investors also backed out of so-called reflation trades, which had involved selling government bonds and buying shares in companies that benefit from economic growth, such as materials producers and banks.

On Monday, however, energy, basic materials and banking stocks were the best performers on the S&P 500. The technology-focused Nasdaq Composite index was also up, gaining 0.7 per cent in early dealings.

The Russell 2000 index of smaller US companies, whose fortunes are viewed as pegged to economic growth, gained 1.7 per cent. Europe’s Stoxx 600 share index rose 0.7 per cent, with materials stocks at the top of its leaderboard.

The yield on the 30-year Treasury briefly fell below 2 per cent on Monday morning for the first time since February 2020 before bouncing back to 2.065 per cent.

Investors last week had taken profits on reflation trades that had become “crowded” and “expensive”, said Salman Baig, portfolio manager at Unigestion.

Baig added that, following the initial shocks after the Fed meeting, markets would probably return to betting on “a cyclical recovery as economies reopen”.

Other analysts said the bond market reaction had been too pessimistic, predicting a broad-based economic slowdown in response to Fed rate increases that had not happened yet.

The fall in long-term yields “is only justified if the Fed is making a policy error, choking the economy”, said Peter Chatwell, head of multi-asset strategy at Mizuho. “We think this is far from the truth — the Fed has simply sought to prevent inflation expectations from de-anchoring.”

Elsewhere in markets, the dollar index, which measures the greenback against other major currencies, dropped 0.3 per cent after gaining almost 2 per cent last week.

Brent crude, the international oil benchmark, rose 0.9 per cent to $74.18 a barrel.

Additional reporting by Tommy Stubbington in London

Unhedged — Markets, finance and strong opinion

Robert Armstrong dissects the most important market trends and discusses how Wall Street’s best minds respond to them. Sign up here to get the newsletter sent straight to your inbox every weekday



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Saudis agree oil deal with Pakistan to counter Iran influence

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Saudi Arabia has agreed to restart oil aid to Pakistan worth at least $1.5bn annually in July, according to officials in Islamabad, as Riyadh works to counter Iran’s influence in the region.

Riyadh demanded that Pakistan repay a $3bn loan last year after Islamabad pressured Saudi Arabia to criticise India’s nullification of Kashmir’s special status.

But the acrimony between the two longtime allies has eased after Imran Khan, the prime minister, met Saudi Crown Prince Mohammed bin Salman in May.

News of the oil deal with Pakistan comes as Saudi Arabia embarks on a diplomatic push with the US and Qatar to build a front against Iran, said analysts. Riyadh lifted a three-year blockade of Qatar in January in what experts said was an attempt to curry favour with the newly elected Joe Biden.

Pakistan had shifted closer to Saudi Arabia’s regional rivals Iran and Turkey, which, along with Malaysia, have sought to establish a Muslim bloc to rival the Saudi-led Organisation of Islamic Cooperation.

Khan has developed a strong rapport with President Recep Tayyip Erdogan, encouraging Pakistanis to watch the Turkish historical television series Dirilis Ertugrul (Ertugrul’s Resurrection) for its depiction of Islamic values.

Ali Shihabi, a Saudi commentator familiar with the leadership’s thinking, said that “bad blood” had accumulated between Riyadh and Islamabad, but recent bilateral meetings had “cleared the air” and reset relations to the extent that oil credit payments would restart soon.

A senior Pakistan government official said: “Our relations with Saudi Arabia have recovered from [a downturn] earlier. Saudi Arabia’s support will come through deferred payments [on oil] and the Saudis are looking to resume their investment plans in Pakistan.”

The Saudi offer is less than half of the previous oil facility of $3.4bn, which was put on hold when ties frayed.

But Fahad Rauf, head of equity research at Ismail Iqbal Securities in Karachi, said: “Any amount of dollars helps because time and again we face a current account crisis. And with these prices north of $70 a barrel anything helps.”

Pakistan’s foreign reserves were more than $16bn in June compared with about $7bn in 2019 before it entered its $6bn IMF programme.

Robin Mills at consultancy Qamar Energy said: “Saudi Arabia and Pakistan are allies, but their relationship has always been rocky. And the Pakistan-Iran relationship is better than you might think.”

Mills said that the timing of the Saudi gesture was “interesting” given that Iran was preparing to step up oil exports with the US considering easing sanctions.

“The Saudis are on a bridge-building mission more generally. They have sought to mend fences with the US and there is also the resumption of relations with Qatar,” he said.

Ahmed Rashid, an author of books on Afghanistan, Pakistan and the Taliban, said that there were a variety of factors that might have spurred Riyadh to restart the oil facility.

It may be “partially linked to the American need for bases” to launch counter-terrorism attacks in Afghanistan from Pakistan, he said, but added that its priority was probably to prevent Islamabad from falling under Tehran’s influence.

Rashid pointed out that Pakistan was caught between China, which has invested billions of dollars in infrastructure projects, and the US.

“Pakistan has to play it carefully, it is dependent on China for the Belt and Road, dependent on the west for loans,” said Rashi. “This is a very complex game.”

Anjli Raval in London and Simeon Kerr in Dubai



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