SM Market Review (Feb 2022): Bitcoin’s border is never closed

Conclusions:

  • War in Ukraine provides further evidence of bitcoin use-cases
  • Risk appetite pressured in Feb but stretched & recovery possible
  • Trad-fi macro should conditions continue to deteriorate through 2022
  • Bitcoin fundamentals are strong, long-term holders firm
  • Institutional demand confirmed but broad-based demand still weak
  • Gold recovers but underperforming BTC
  • High beta relief rally expected to be temporary
  • Cyclical conditions advise patience in 2022

I will avoid going into detail on Russia-Ukraine as I am sure you have heard enough about it from other sources. Clearly its important to assess the impact on crypto markets though. Last month I wrote about potential BTC demand from ‘Rogue States’ like Russia. Who knows if the Russian central bank is actually purchasing bitcoin (probably not), but Russia and Ukrainian citizens alike saw the power of censorship resistant money during February.

Source: bitcoin magazine
Source: CoinDesk
  • Bitcoin provided protection for Russian holders who saw the value of the RUB fall 37% during Feb on account of their tyrannical and reckless leader.
The Russian RUB fell 37% vs. the USD in Feb. Source: Trading View

Bitcoin spiked on the last day of Feb after Putin restricted Russian’s from accessing foreign currency. Russians appear to be flocking to bitcoin due to imminent need to get capital out of Russian RUB. The spread between the Russian bitcoin price and the rest of the globe is reported to be around 20% in peer to peer markets at the moment.

It is possible that Russian oligarchs were involved in the BTC demand. If indeed this speculation turns out to be true, watch out for any Public Relations (PR) backlash. As I said last month, “Bitcoin’s detractors (of which there are many) will likely use rogue state adoption as a stick to beat bitcoin with, calling it un-American and anti-West. Holders will face a real test under this weighty narrative and we must prepare in advance.” Western media will see oligarchs in the same light as rogue states.

Additionally, western governments have told the Russian central bank that it will not be able to sell its foreign currency reserves. This is a pretty incredible event. Countries spend years accumulating foreign currency reserves but cannot use them when they want to…? Russia has effectively been censored from global bond markets. I know Russia is in a pretty extreme situation and the censorship might be justified, but what do you think the Chinese make of this situation?

China wants to claim Taiwan in the coming years. China will now have to seriously consider a potential restriction on its ability to sell its own reserve assets under an invasion scenario? That is a potential game-changer.

Whether or not Russia has bitcoin or has ever considered buying it, the case for a censorship resistant global monetary network grows ever stronger.

The 14.5% BTC rally on the last day of Feb was absolutely breathtaking. It is the biggest one-day rally since February 6th, 2021. This is a perfect reminder of the risk of being short bitcoin or holding too much cash. The upside potential is asymmetric.

Risk Appetite under some pressure in Feb but looking stretched

Risk appetite came under pressure in the lead up to the war and the announcement thereof. It was no surprise to see a recovery in risk appetite after the initiation of conflict, as historically markets have tended to sell the rumour, buy the fact with regard to war. Additionally, there are many signs that equity investors were getting fearful in February with unusually high put options volumes. Negative sentiment sets up a potential rebound in risk appetite thereafter.

Equity market performance around the time of invasions. Source: Fund Strat

The somewhat complicating matter to this conflict is: It does not look like Russia will steam role Ukraine into a quick end to the conflict, Putin is threatening the nuclear weapon usage and widespread support from Ukraine in the western media has led to a change in economic policy amongst Western politicians. Initially the sanctions imposed on Russia were pitiful, but they intensified over the weekend to such a degree that Russian banks have been excluded from SWIFT.

The SWIFT restrictions pose potential credit risks for the global banking sector as many global banks are intertwined with Russian banks. So, while there is certainly a case for short-term recovery in risk appetite after risk assets got very fearful in late February, some degree of caution is warranted. I will be watching market liquidity very closely in the coming weeks. It does not matter how bullish the BTC outlook might be, if trad-fi liquidity tightens sharply, bitcoin will come under some pressure.

SWIFT restrictions pose potential credit risks to global banks

Cyclical conditions within traditional financial markets continue to deteriorate as a trend with the yield curve flattening, the USD dollar strengthening and central bank balance sheet growth is slowing.

The Ukrainian conflict has impacted rates markets. Participants only expect the Fed to hike interest rates once in March, after previously expecting 50bps worth of hikes. Less hikes may give impetus to a short-term rally in risk appetite, but further tightening is still on the cards this year. Sanctions, conflict and redeployment of national spending towards defense will only spur inflation higher, creating additional pressure for the Fed to remain hawkish.

Bitcoin fundamentals remain strong but broad-based demand weak

Bitcoin internals have remained strong despite the sharp correction in Dec and Jan. Coins have moved to strong hands and long-term holders have not been selling on masse. Our medium term liquidity metric has remained very resolute. This can create a supply squeeze and push prices higher, which definitely contributed towards the sharp rally at the end of Feb.

Last month I spoke about institutional demand for BTC below $40K. We have now received news that Morgan Stanley has been adding exposure to its asset management portfolios.

https://fintel.io/so/us/gbtc

Despite the anecdotal evidence of institutions buying bitcoin and the constructive behaviour of long-term holders, broad based demand is still pretty weak relative to levels seen through the 2020 and 2021 bull market. Demand is stronger than the 2018 bear market, which is encouraging. But given the tough global macro conditions, I cannot rule out the possibility that demand ratchets another leg lower though 2022.

Gold having its time in the sun, but underperforming BTC

Gold rallied 6.1% on the back of the Russia-Ukraine news, which catches my eye. I think gold still has a place in portfolios, particularly given the weak correlation between bitcoin and gold. I.E. The bitcoin-gold correlation is not consistent so the assets provide something different within a portfolio.

Bitcoin does not currently act as a safe-haven asset in portfolios like gold or US Treasuries, which can rally during times of market distress. Why? Bitcoin outsized return potential implies that it trades more like a risk asset than a safe haven. I.E. Bitcoin has a stronger correlation with the S&P500, than gold.

But the correlation to the S&P500 does not imply that bitcoin does not protect investors against numerous risks, nor is bitcoin just a high beta tech stock. Feb was case in point: bitcoin rallied on the last day of Feb because investors needed a borderless, censorship resistant monetary technology. The S&P500 lagged.

Despite the strong performance of gold and its continued relevance in portfolios, it is noticeable that during one of the strongest months for gold in recent history, bitcoin outperformed gold. Obviously gold has outperformed bitcoin over the past quarter and year (32% q/q and 24% y/y respectively) because bitcoin has fallen. But bitcoin held its own due to Feb volatility which is quite something. Bitcoin also outperformed the S&P500 by 9.2% after the S&P500 fell 2.9%.

Bitcoin poses serious competition to gold and the S&P500 as a store of value. Those who do not see this are missing the woods for the trees

Relief rallies possible but not a good time for high-beta

After falling 25.8% in Jan 2022 and falling 17.8% in Dec 2021, ETH rallied 5.3% in February 2022. By comparison, bitcoin rallied 12.3% in Feb after falling 18.6% in Jan and falling 16.7% in Dec 2021. The ETH underperformance vs. BTC highlights our 2022 thesis that this is not the conditions for high-beta. We could certainly see a big rally into ETH and alts if this BTC rally gets going into the $50Ks, but I am not convinced that BTC is heading into another long-term bull-market just yet and I think it will be difficult to everything else to outperform bitcoin under these conditions.

I still expect pain to emerge in the NFT market and we have not seen anything of the sort yet.

More froth may still need to come out of the crypto markets this year

Bitcoin marches on but patience is required in 2022

I know I sound like a broken record player on bitcoin sometimes because everything is a potential bitcoin catalyst to me. But that is just the reality of the world that we live in. The monetary system is archaic, it is decaying in front of our eyes and bitcoin is a potential solution so use-cases for bitcoin are everywhere! Who would have thought that a war between Russia and Ukraine could be such an important use-case for bitcoin.

I have steered away from economic, political or humanitarian comments re Ukraine so let me just clarify quickly: war is tragic, devastating and my heart goes out to all of those in Ukraine and Russia that are effected by this unnecessary conflict. Whatever your opinion on that matter, Russians and Ukrainian’s need bitcoin more than ever and the evidence for this view is clear in Feb 2022.

Pulling back the lens from Ukraine, macro conditions remain tough so while the short-term outlook for bitcoin is strong, I still think that further headwinds cannot be ruled out this year. We are not seeing broad-based demand in terms of new users and on-chain transactions. Plenty selling pressure could emerge in the high $40Ks. ETH could experience a nice relief rally in response to BTC, but I do not think this is the time for a multi-month high-beta rally yet.

I would get substantially more constructive on BTC if the correlation broke down vs. the S&P500 and or the Fed changed its tune on monetary policy. Both will likely take place this year, but patience is required.

See you in April!

Conclusions

  • Risk appetite pressured in Feb but stretched & recovery possible
  • Trad-fi macro should conditions continue to deteriorate through 2022
  • Bitcoin fundamentals are strong, long-term holders firm
  • Institutional demand confirmed but broad-based demand still weak
  • Gold recovers but underperforming BTC
  • High beta relief rally expected to be temporary
  • Cyclical conditions advise patience in 2022

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