Bitcoin’s weak correlation with traditional investment assets and its high yield have made it an absolute star in the cryptocurrency secondary market, and its market value has also increased in recent years. The active secondary market has made the influence of external factors on the price of Bitcoin increasing.
We believe that the addition of institutions and the improvement of derivatives will make the price of Bitcoin more stable and at the same time make the market more efficient. Therefore, in the future, institutions will be the new leaders on the way for Bitcoin to become a mainstream asset.
Part.1 Bitcoin becomes the secondary market for cryptocurrencies
The most popular investment target
The mining industry as a factor in the industry has been the dominant price of Bitcoin before, but as the market value of Bitcoin continues to increase, the secondary market of cryptocurrency becomes more and more active. With the influx of individual and institutional investors, we see that the price of Bitcoin is increasingly affected by external factors.
One of the reasons why Bitcoin is popular in the cryptocurrency secondary market is its weak correlation with the traditional market. The chart below shows the correlation analysis of Bitcoin and a basket of global assets from the birth of Bitcoin to April 1, 2012.
Source: Coin Metrics’ State of the Network
We saw that Bitcoin had a weak correlation with the overall macro market before the epidemic , but Bitcoin and the macro market showed an unprecedented correlation after the epidemic. At the Black Swan event in March 2020, the Pearson correlation between Bitcoin and the S&P 500 index surged to a record high of 0.32, and all previous highs were below 0.2. This shows that crypto assets are increasingly intertwined with traditional markets, and that they have responded more to external events than ever before.
All assets have fallen under the liquidity crisis caused by the epidemic
Source: IOSG Ventures, Yahoo Finance
We saw that during the Black Swan incident in March this year, all assets showed a downward trend, mainly due to serious market liquidity problems. The current liquidity of the US dollar is showing signs of shortage. The current US debt rate is as high as 254%, of which the corporate sector debt rate is 75%. Affected by the epidemic, the company’s future cash flow will be hit to a certain extent, and the pressure of debt repayment will increase.
Impact factor of Bitcoin price
Source: IOSG Ventures
When the impact factors such as mining rewards, geopolitical events, and regulatory changes change, the price of Bitcoin will change accordingly. These are very sensitive factors in the impact of Bitcoin prices. Factors such as market value and market structure are very important for the long-term price stability of Bitcoin. Because these factors are the long-term development direction, minor changes in these areas will not cause immediate fluctuations in Bitcoin prices.
Is Bitcoin valuable?
Currency VS Investment/Speculative Assets
In the “Bitcoin: Medium of exchange or speculative assets?” report, Baur Drik G and Hong KiHoon analyzed the characteristics of bitcoin users and found that: multiple two-way small transactions (sent & accepted and the transaction amount is less than 2000 US dollars) users The proportions are all single digits. It can be seen that most users hold bitcoin for investment or speculative purposes rather than as a daily trading medium. Bitcoin is more volatile than traditional financial markets, so it is not surprising that the Bitcoin market is highly risky and speculative. In another study on whether Bitcoin is investment or speculation, Baek C and Elbeck stated that only the price difference between the daily high and low prices within Bitcoin is statistically significant. None of the external economic factors seem to have any significant impact on the Bitcoin market returns. This means that most of the returns in the Bitcoin market are driven internally by market participants.
In summary, Bitcoin is still in the entry stage of its life cycle. Once the public accepts Bitcoin, the impact of external factors on Bitcoin will increase. Whether Bitcoin is an investment asset or a speculative asset depends on the investor’s risk appetite.
IOSG bitcoin value perspective
Most investors aim to hold Bitcoin, so it is not currently a trading medium. We believe that Bitcoin has a non-quantitative social value. Although the issuance and output of Bitcoin are very different from traditional currencies, due to factors such as the global liquidity of Bitcoin and the freedom of market entry, bitcoin Coins can become a tool for value storage and transmission after the future structure is perfect and mature.
Bitcoin is obtained by mining, and the production cost of miners also provides a good mathematical model for the valuation of Bitcoin. In theory, the intrinsic value of Bitcoin should be the cost of mining by miners.
Scholars such as Jamal from the University of Munich studied the impact of 18 independent external economic factors such as gold price and search fever on bitcoin price. The R2 of the linear regression model is only 0.46 (that is, the above factors can only explain 46% of bitcoin price fluncuation). In the face of Bitcoin’s high price fluctuations, the traditional linear regression method of studying the correlation of things can not explain the reason of Bitcoin price changes.
Regarding the view that changes in the bitcoin market’s popularity may have an impact on prices, we believe that this analysis method is still very far-fetched, because mature investors will not search for the term Bitcoin on repeated Google. Search is more like people search it frequently when they use it for the first time.
Therefore, the actual theoretical intrinsic value (minimum value) of Bitcoin is the production cost of miners, and the actual value will be affected by factors such as the risk preference of its participants, the supply and demand relationship on the trading day, and the market heat.
Part.2 The deposit of traditional financial institutions makes the price of Bitcoin more stable
Wall Street’s investment in the crypto market will become an entry point for Bitcoin’s incremental. According to a survey conducted by Bitwise and ETF Trends, 76% of U.S. registered financial advisors received client consultations on adding bitcoin to their portfolios in 2019, and 9% of registered independent investment advisors have added some Crypto assets to their portfolios In general, this ratio is about 6%. 54% of financial advisors believe that the most attractive factor for bitcoin to invest in bitcoin is its overall weak correlation with traditional assets. The study found that some financial advisors will use the funds originally invested in the commodity field to invest in bitcoin. It shows the properties of Bitcoin as electronic gold.
The main factors that attract financial advisers to invest in Bitcoin include: high returns and customer initiative. The survey also revealed that the main reasons for preventing investors in the traditional financial industry from entering the blockchain include:
1. 53% Regulatory reasons
2. 43% too volatile
3. 41% do not know how to value cryptocurrencies
4. 34% storage factor
5. 31% lack of understanding
Through this data, we can see that traditional financial markets are very eager to invest in Bitcoin, and the regulatory factor has become the biggest reason for their stagnation.
At present, we have seen some solutions:
a. Compliance exchanges such as Bakkt have taken a major step on the road to compliance. The entry of Wall Street has truly perfected the industrial chain of compliant finance. Taking ICE’s Bakkt project as an example, Bakkt provides a compliant futures exchange, but to allow large institutions and investors to enter the market, it needs a whole Compliant financial service chain. We can see that Bakkt plans to host Bitcoin by itself, trade through ICE Futures US (Futures Exchange), and clear on ICE Clear US (Clearing House). Since 2018, financial giants Intercontinental Exchange (ICE), Fidelity, Chicago Mercantile Exchange, Chicago Board Options Exchange (CBOE), TD Ameritrade, Nasdaq, JPMorgan Chase, Goldman Sachs and State Street have all invested funds Companies related to cryptocurrencies. Their activities range from custody, trading desks, financial services, derivatives platforms and investment products. This addition of these institutions, so we have a whole chain of financial services compliance possible.
b. The participation of the institution makes the market more stable-solving the problem of volatility. The participation of institutions can reduce the price fluctuation of Bitcoin and make the market more stable. The current market value of Bitcoin is about 11.781 billion US dollars. PayPal is a company with a similar market value to Bitcoin. The current market value is 13.1 billion US dollars, but we see that 86.41% of its stocks are held by institutions , of which the top two shareholders are both Fund company, Vanguard holds 7.96% and BlackRock holds 6.32%. The current institutional investors of Bitcoin are buying Bitcoin through Grayscale, and the current Grayscale position only accounts for 1.7% of the total amount of Bitcoin. The bitcoin market is still dominated by retail investors. Retail investors’ investment is more perceptual and subjective factors such as market heat are more, resulting in more bubbles in the market. The addition of rational institutional investors reduces the market bubble and makes the market more stable. Taking the stock market as an example, individual investors in Hong Kong stocks accounted for only 7.6%, while retail investors in domestic A shares reached 53%, while the volatility index (standard deviation/average value) of the Shanghai Stock Index was 28%, and the Hang Seng Index was 13%. Institutional investors are a stable element of the financial market, so when more institutional investors join the Bitcoin market, the price of Bitcoin will also tend to stabilize.
The largest institutional admission channel “Bitcoin Fund” has a serious premium
At present, the main method for institutions to enter the Bitcoin market is through Grayscale’s Bitcoin Trust Fund , which focuses on investing in Bitcoin, so its NAV (Net Asset Value) is to track the price of Bitcoin. Scholars from the University of Kuwait collected the NAV performance of the fund from May 2015 to November 2016 through Bloomberg, and studied the price deviation between the fund price and NAV. Through the statistical analysis of the return of Bitcoin funds, we found that:
Source: Almudha, 2018
The average premium rate of Bitcoin funds from May 2015 to November 2016 reached 44% . If we analyze the fund price and NAV, we find that:
Source: Almudha, 2018
1. Price is the price of the Bitcoin fund, NAV (the price of Bitcoin under it) is the dependent variable
2. Bitcoin trust funds have been trading at a premium
3. We found that the standard deviation of the fund is higher than NAV (under Bitcoin), indicating that buying a bitcoin fund is more risky
4. But we see that the return of the Bitcoin fund is also higher than the return of Bitcoin, so the risk will be compensated
In fact, this premium of the Bitcoin fund has always existed. When Grayscale disclosed its first quarter data in April 2020, we saw that investors who bought a GBTC will receive 0.00097368 bitcoins, and the price of a GBTC is $9.28 (2019 October 16, 2016). Based on the bitcoin market price of 8,175.10 USD, 0.00097368 bitcoins are worth 7.60 USD. Therefore, the premium was 32% at the time, and it was as high as 85% when the historical premium was the highest. Bitcoin funds can be regarded as the most important channel. Institutional investors have limited access to invest in bitcoin. This has led to the preference of institutional investors for the price of bitcoin funds even if they are not capital efficient. This low capital efficiency also shows that institutional investors need better financial instruments to enter the Bitcoin market.
Will the addition of institutions help Bitcoin go mainstream
Institutional investors are constantly attracted by Bitcoin’s high returns, but they are not satisfied that they can only invest in Bitcoin through Bitcoin funds. We see that institutional investors are also actively participating in the innovation of Bitcoin financial instruments. This financial innovation is a positive factor for the price of Bitcoin. Geanakoplos and Fostel wrote in 2012 in the American Journal of Economics that the rise and fall of the US housing loan market around 2000 was caused by financial innovation. At that time, the United States attracted a large number of investors to securitize the housing loan. Before 2017, there was no derivative market in Bitcoin. Generally, the prediction and investment of spot declines were achieved through short selling derivatives. Therefore, the absence of a derivative market would make the predicted investment decline. Very difficult.
Through bitcoin futures contracts, investors can invest in the downward price of bitcoin . For example, investors can buy futures to promise to sell bitcoin at a lower price than the current spot price in the future, but if investors think bitcoin The currency will continue to fall in the future, he can buy bitcoin at a price lower than the contract price during the period, and then sell it later to make a profit.
For the current derivatives market, we find that perpetual swap contracts are the most popular tool in the field of cryptocurrency, but such futures use cash settlement methods, so they can be manipulated using the price of the spot market, through contract funds Funding rate creates the illusion that contract price and spot price are the same.
Bitmex’s annualized funding rate in 2019 reached 300%, but its transaction fee was only 0.05%, which is much lower than the spot market, resulting in the illusion of low transaction fees. For example, for people who are long ETH, even if the price of ETH rises, people who are long may still lose all their assets. The actual cost behind a contract transaction with a funding rate may be unusually high . In the first half of 2019, Bitcoin’s 8-hour funding rate reached 0.047% (annualized 67%). The actual reason for this illusion is that high leverage will greatly amplify investors’ interest costs. Although it looks like the annualized rate is 60%, this 60% is not multiplied by the leverage ratio. If the leverage ratio is 5 times leverage, then the interest cost of the principal is actually 300%. It is possible that even if ETH rises, investors’ returns may not be positive.
In addition, cash-settled contracts can also be easily manipulated . Cash-delivered futures are calculated by applying formulas, and the trading volume in the formulas is obtained from some exchanges, which allows cash-delivered futures markets to be Be easily manipulated. The form of manipulation generally has the following three steps:
• Long/short the cash-settled futures or swap contract
• Taking advantage of the fact that the spot market has lower liquidity than the futures market, during the settlement period, another fund is used to buy or sell in the spot market to affect the price calculated by the formula (because the formula uses spot price settlement)
• Close the position after receiving the profit generated by cash delivery futures at the time of settlement
This kind of manipulation mechanism is well known. Unless investors know that they have more capital than the manipulator, this kind of manipulation is difficult to resist. We can see that when CME and CBOE are settled, there will often be big changes. BitMEX’s fund rate is updated every 8 hours, and there will often be chaos during settlement. This manipulation during settlement also increases investment costs. Since there will be no exponential and mathematical calculation problems in physical delivery, such problems will not occur.
The participation of institutional investors will help bring about financial innovation. ICE’s parent company is certified by the U.S. Commodity Futures Trading Commission and launched the world’s first physically-delivered bitcoin futures, which will give institutional investors and large-volume clients Provides the possibility to invest in larger positions. For example, if an investor wishes to buy 10 million USD in bitcoin, it is very irrational and dangerous to buy bitcoin through cash-settled futures, because the cash-settled bitcoin futures market is more liquid The futures market is low, so users with large positions are easily regarded as price operators. Many institutional investors can only choose not to hold large positions in the face of this problem. The futures prices of spot delivery are not through the spot market. The price is calculated to avoid this problem, and provides a good entry platform for large institutional investors.
In addition, this kind of bitcoin futures with spot delivery also makes bitcoin a payment tool. Spot delivery of Bitcoin futures provides investors with a simple hedging method to reduce the impact of Bitcoin’s high volatility.
Spot-delivered futures have also injected vitality into lending. Genesis Trading, Nexus, Salt, and Unchained Capital are also focused on making loans. Due to the requirement of over-collateralization, borrowers do not need to do credit investigations, and the improvement of futures can increase the borrowing market. This is because the futures show another way of lending. A lender who collects bitcoin as collateral and lends USDT can sell bitcoin in the spot market to obtain USDT and then buy BTC/USDT futures through leverage, which greatly reduces The lender’s dependence on other lenders, because they can operate through the centralized clearing futures market. In the same way, lenders collateralized in US dollars or USDT can also lend cryptocurrencies through the reverse operation.
We believe that derivatives will be one of the important windows for institutions to enter the Bitcoin field. The global derivatives market is huge, with an estimated value of more than 500 trillion US dollars. Compared with it, the current cryptocurrency market is still very small, and the current daily trading volume Between US$5 billion and US$10 billion.
Therefore, Bitcoin still has a lot of room for development in the derivatives market and institutional investor entry. From an institutional perspective, if you want to be accepted in the broader global currency market, the derivatives market is indispensable. . If used properly, they actually provide a way to hedge transactions and manage risk. Without these derivatives, many institutional traders would not even consider entering this field.
In addition, the current volatility of Bitcoin is relatively large compared to traditional assets, which is also a good time for derivatives to enter, because a certain degree of volatility in leveraged trading is a positive factor. One advantage of bitcoin derivatives is that they can leverage a small amount of capital to leverage transactions, while being able to predict and control future market risks and price fluctuations in speculative markets. Derivatives provide investors with more financial instruments, allowing them to implement the investment strategy they think is right. From a macro perspective , more investment instruments will quickly restore the market to balance when there is noise in the market. The market can show the true value of bitcoin, which helps investors estimate bitcoin while reducing price fluctuations caused by market inefficiency.
In general, Wall Street’s involvement in cryptocurrencies is an important step in bringing Bitcoin into mainstream applications. These traditional financial institutions will bring more financial products to the Bitcoin market and improve the Bitcoin financial system. Under the perfect financial system, more institutional investors will be willing to join the Bitcoin game. Bitcoin investors can also implement more investment strategies through derivatives, which will make the Bitcoin market more The rich and efficient, perfect and efficient market and increased market value help reduce price fluctuations and lay the foundation for Bitcoin to enter a larger market.
Bitcoin still needs technological innovation
Bitcoin’s performance problems were highlighted in the March Black Swan event. For the side chain, sharding and other Layer 2 research and development still need more substantial progress to reduce congestion when the transaction volume is large, so that the market can operate more efficiently. In addition, the infrastructure provided for institutional deposits is also a good investment area. These infrastructures include some trading tools. The development of the Bitcoin ecosystem from 2012 to 2014 was supported by the Bitcoin Foundation. We now see that Lighting Lab and Blockstream currently support the most open source Bitcoin projects.
Number of Bitcoin open source projects supported by different institutions (Source: BitMEX)
Blockstrams supports 8 developers of open source projects. Lightning Labs has at least 8 developers using open source Lightning software. The sources of support for the developers of the Bitcoin core project are more diversified. We can see that the 33 contributors who have historically contributed the most to GitHub are mostly independent developers. At the same time, there are many other anonymous contributors that cannot be easily tracked. Chaincode Labs is the most prolific financial supporter in Bitcoin development.
Currently the top 33 Bitcoin core investors by number of capital injections – number of developers
At present, the development of Bitcoin has been solving the scalability of Bitcoin. Both Lightning Lab and Blockstream are continuously working to expand the side chain and Layer 2 solutions to curb the congestion of the main network, which also makes them open source for Bitcoin. The biggest contributor to the project. Diversified development in the future can make the Bitcoin ecosystem healthier, more stable and mature. In the future, the core contributors of the community should provide funding and training for new developers entering the field, and ensure that developers can effectively collaborate so that they can independently obtain funding sources in the future to ensure the sustainability of financing.
Part.3 Bitcoin’s future price trend
Affected by the epidemic, since February this year, the Federal Reserve, the European Central Bank, the Bank of Japan, the Bank of England, the Bank of Switzerland, the Bank of Australia, the Bank of Canada, the Bank of Canada and the People’s Bank of China have continued to quantify easing policies of 3.9 trillion US dollars. The amount of water released by the central bank in the first three months has reached 4.5% of global GDP in 2019.
Source: Market Outlook – Macro perspective by Paul Jones & Lorenzo Giorgianni
Due to the large amount of money printed, the central bank’s assets have risen sharply . Since February, the Fed’s total assets have risen by 60%. The current total assets have doubled at the end of last year, and the Bank of Canada’s assets have tripled at the end of last year. Total assets rose by 43%. The People’s Bank of China’s currency issuance in the second half of 2019 remained at about 8 trillion yuan per month, while the average issuance in the first two months of 2020 was close to 10 trillion yuan, up 25%. The opposite of the rapid expansion of the central bank’s balance sheet is a sharp increase in the total amount of money . According to the latest data from the Federal Reserve, M2 in the United States rose by 18% on the basis of last year. According to the current situation, the annualized growth of M2 by the end of the year may be in Between 20%-40%. The last significant increase in M2 like this was during World War II, when the annual growth of M2 reached 27%.
Source: Market Outlook – Macro perspective by Paul Jones & Lorenzo Giorgianni
In addition to the issue of additional issuance, the circumstances under which additional issuance is also important for whether the additional issuance will cause inflation. Take Japan as an example. Japan was one of the first countries to experience deflation in history. We see that Japan has not effectively controlled the deficits of enterprises and individuals through monetary policy. Therefore, the magnitude of the deficit and the additional issuance of government banknotes will jointly affect the future inflation rate . Under the big financial crisis, the government’s quantitative easing may not necessarily lead to inflation.
At the same time, we have noticed that the recovery of the epidemic is very different from the recovery of the global financial crisis. Such differences can be explained by the Money Multiplier, which describes the multiple of the expansion of the money supply. It refers to the multiple relationship between the amount of money supply and the base currency. Simply put, the money multiplier is a unit of preparation The amount of money generated by gold. In the process of money supply, there is a multiple expansion (or contraction) effect between the initial supply of central bank money and the final formation of social money, the so-called multiplier effect.
His calculation formula is: M2/Money base
-Money base is the total reserve and cash in circulation for commercial banks
Determined by the statutory reserve ratio (determined by the central bank), excess reserve ratio (excessive portion held by the bank) + cash ratio + fixed/current deposit ratio
-M2 is liquid currency + demand deposit + other bank deposits.
Banks’ liquidity preferences have changed dramatically under the global financial crisis. The central bank’s adjustment of the reserve ratio will also lead to changes in bank liquidity. Therefore, although the central bank injected a large amount of funds under the financial crisis, it is actually only a small Part of the money is really lent out again in the banking system. In this case, the money supply on the market never rises by more than 10% , so naturally the multiplier for measuring the initial money supply and social money will not happen. A substantial increase (money issued by the central bank did not flow to the market, but was diluted by the liquidity requirements of the bank).
Source: IOSG Ventures, St. Louis Fed
Recently, due to the epidemic, banks have become more cautious about lending applications, and the currency multiplier has begun to decline, but the epidemic is different from other financial crises: Overall, M2 and CPI or inflation have a positive correlation. Due to the 2008 financial crisis Mainly affecting the financial industry, the sub-prime crisis has led to an increase in bank margin reserves, so the increase in the money base (Money base) so that the government’s additional funds issued in 2008 did not flow into the society, did not lead to price increases and the occurrence of currency. This year’s epidemic is different from the previous financial crisis. Due to the social control measures of the epidemic, the retail industry and other consumer industries are currently in a state of shutdown and shutdown, so the central bank’s currency issuance did not immediately appear in the CPI changes (even the CPI decline caused by the shutdown and shutdown). ), but because the additional issuance of the central bank in this outbreak is to transfer funds directly to the society and reduce the bank’s margin requirements, we believe that this additional issuance will increase the currency multiplier, meaning that the additional funds will eventually flow to consumption, resulting in The rise of CPI and the occurrence of inflation. Even better, the current US central bank’s cessation of statutory reserve requirements makes it easier for additional funds to flow into society.
Will inflation happen?
We finally consider, will the central bank raise interest rates after the epidemic ends to absorb the funds previously issued? We think it is unlikely. The United States is now the leading country in the global economy and the most severely affected country. At present, the core of the Fed’s monetary policy is to make every effort to complete the currency target during the epidemic (a large number of additional issuance). Therefore, after the epidemic recovers, it is necessary to dilute these funds back to a large increase in interest rates. It is unrealistic to raise interest rates drastically while the industry is highly leveraged. In addition, current political factors have greatly affected the independence of the Fed.
The large number of additional issuances directly to enterprises and people, and the highly leveraged economic situation make the possibility of future inflation a reality greatly increased.
Source: IOSG Ventures, St. Louis Fed
At the same time, if we observe the consumption and deposits of American residents, we can see that the consumption of American residents continues to rise until a significant decline occurs in March 2020. At the same time, we see an increase in the issuance of the central bank As a result, people’s deposits are rising and reaching historical peaks. The decline in consumption explains the short-term decline in CPI, and the rise in deposits once again proves the potential of future consumption and investment, which is a strong indicator of future inflation. Judging from the current cold winter of the commercial retail industry, we believe that the American people may not choose to consume quickly in the near future, but will choose assets with better investment returns.
As the epidemic occurs, we can see the trend of currency digitization. Libra endorsed by the US dollar and DCEP launched by the People’s Bank of China will make electronic currency wallets a tool for everyone. Due to the nature of these cryptocurrencies endorsed by sovereign assets Make them not a means of value storage. But the popularity of this type of Crypto currency will make people better understand cryptocurrencies and bring orders of magnitude growth to the current 60 million users of Bitcoin.
Sources: IOSG Ventures, Glassnode studio
The transaction flow graph of the Bitcoin Exchange shows that since the outbreak, the Q1 2020 direct currency purchases of Bitcoins began to show a large increase in funds, which once again proved that Bitcoin is a good investment product in the epidemic stage. Was welcomed by investors.
The current position of Bitcoin is like the position of gold when it was just accepted by the public as a safe-haven asset and the launch of futures products in 1976. If we compare it with the recent price trend of Bitcoin, we will find a higher Of similarity.
Source: Market Outlook – Macro perspective by Paul Jones & Lorenzo Giorgianni
Look at the performance of gold since 1976:
Source: Market Outlook – Macro perspective by Paul Jones &Lorenzo Giorgianni
Bitcoin is currently in the same position as gold in the 1970s. With the maturity of assets, we can see the upside of Bitcoin prices in the future, thus creating a good buying opportunity.
Let’s look at the current macro environment. Inflation in the future will provide a huge impetus for the rise of Bitcoin and become a promoter of its high price.