Sinking Alts

ByteFolio 62;

ByteFolio brings together ATOMIC, ByteTrend and Token Takeaway to create ByteTree’s model portfolio, known as ByteFolio. This is a selection of crypto tokens, which are weighted according to their risk/reward characteristics. ByteFolio has a modest turnover and will not suit traders. It will appeal to investors who wish to diversify beyond bitcoin, with the aim to beat it.

The portfolio drifts downwards in BTC terms, but the absence of any exposure to altcoins means we’ve side-stepped last week’s carnage. These sharp declines were triggered by the SEC’s decisions to prosecute Coinbase and Binance, which resulted in a reduction in system liquidity. When liquidity is compromised, small caps are the first to suffer.

All financial systems rely on liquidity. When market participants withdraw, whether enforced or voluntary, it has an impact. The old joke about Emerging Markets was that they were so-called because “they were impossible to emerge from in an emergency”.

Decentralised Finance presents itself as an adjunct to the current financial system. But it needs participation to thrive. At the moment, the US regulator is making life difficult for bonafide investors to allocate into this new universe, and you can see the results in some of the charts below, which show how transaction activity has flatlined.

This won’t last forever. As the technology becomes more widely understood, adoption will increase. One of the beauties of smart contracts is that they don’t fail in a liquidity-constrained environment, for example. Secondly, at the point where investors understand where they stand in relation to regulation, they will return. At that point, the liquidity drain will go into reverse.

The ByteFolio process prevents us from catching falling knives, but our guess is that there will be some selective buyers out there who will one day be very happy to have taken the other side in a forced selling environment.

No changes again to the portfolio. We are liquid and defensive, perfectly positioned for when the tide turns.

Action:

No action.

Movers

Bitcoin (BTC)

BlackRock, the world's largest asset manager, has submitted a Bitcoin ETF application to the US Securities and Exchange Commission (SEC). After a long list of failed attempts by multiple groups, this one may have a higher chance of approval.

The key factor in their proposal is the inclusion of a "surveillance-sharing agreement" between exchanges, which aims to address one of the SEC’s central objections to prior approval, namely concerns around market manipulation. The agreement involves Nasdaq entering into a partnership with a Bitcoin spot trading platform to share information about trading activity, clearing activity, and customer identification. This would significantly reduce the risk of market manipulation.

It’s a canny move from BlackRock and comes in the wake of a regulatory storm for crypto, but a storm that has left Bitcoin as an asset that even Gary Gensler doesn’t seem to have a problem with. Maybe the SEC will find another objection to hold it back, but if it gets accepted, it would be a huge boost for the industry and set a precedent for other jurisdictions.

UK Regulation

We mentioned last week that venture capital monster Andreessen Horowitz (a16z) had selected London as the location for its first office outside the United States. It’s worth noting that a16z believes the UK is on the right path to becoming a leading hub for crypto regulation, given its strong presence of unicorns (privately owned startups valued at $1 billion or more), large financial markets, abundant capital, and sophisticated regulators.

UK Prime Minister Rishi Sunak welcomed the firm's decision, emphasising the importance of embracing innovations like Web3 and blockchain technology for economic growth. It’s an odd situation though. On the one hand, the government is falling over itself to attract corporate crypto investment into the UK. On the other, it still heavily restricts participation by ordinary investors. Well, which is it to be?

Ethereum (ETH)

While trading in crypto might be subdued, we’re keeping a close eye on blockchain activity. So far, the news is encouraging. On Ethereum, there has been a return to normality rather than an abject collapse. The short-term moving averages remain in a range.

It’s important to remember that the more activity there is on the Ethereum network, the more fees that are generated and the more ETH that gets “burned”. This means that when the network is very active, ETH becomes a deflationary asset, with supply actually going down. Theoretically, this is a double positive for the price – lower supply plus a busier network should equate to a higher value.

Of course, the reverse is also true. As it happens, the prices have been rangebound since the Shapella fork, despite supply being deflationary and liquid staking being introduced. Recent reduced activity has moderated the deflationary impulse, but it’s far from problematic, as shown below.

International Regulation

While the US Securities and Exchange Commission (SEC) hammers away at crypto exchanges, the Hong Kong Monetary Authority (HKMA) seems determined to establish Hong Kong as a major alternative destination for the industry. In a somewhat surreal development, given the industry was banned only a few months ago, the HKMA has been urging major banks like HSBC, Standard Chartered, and Bank of China to onboard crypto exchanges as clients. Furthermore, the Securities and Futures Commission (SFC) of Hong Kong has recently opened applications for licenses from crypto trading platforms, starting from 1 June 2023. Not to be outdone, a Hong Kong lawmaker has even extended an invitation to Coinbase to register in the region. These developments clearly indicate that the lawsuits initiated by the US SEC against several crypto platforms in recent months have created a significant opportunity for Hong Kong to position itself as a global hub for the crypto space.

Shakers

Arbitrum (ARB)

A major constraint for Ethereum’s long-term adoption and usage is the slowness of transactions and the fact that fees rocket higher when the network is congested. Enter Arbitrum, a leading Layer-2 scaling solution for the Ethereum blockchain.

Developed by Offchain Labs, it addresses Ethereum’s limitations by utilising a technology called “optimistic rollups”. Arbitrum aims to significantly increase transaction throughput and reduce costs while maintaining the security and decentralisation of Ethereum. It achieves this by processing transactions off-chain and submitting the processed data to the Ethereum mainnet. With its focus on scalability, Arbitrum offers developers a more efficient and cost-effective environment to build dApps and other blockchain projects. You can read about Arbitrum in our latest Token Takeaway.

Quant (QNT) and Central Bank Digital Currencies (CBDC)

An announcement from the team at Quant (QNT) reached us that they have played an important role in building the infrastructure for Project Rosalind, part of whose mission is to see how CBDCs can “support a more digitalised economy in the future”. While ostensibly the message is that it will help cut costs for consumers, the idea of programmable money still raises ethical questions that don’t seem to have been fully addressed. This comes on a day when The Times reports that police will use drones to chase suspects. The surveillance state closes in.

ByteFolio Performance

ByteFolio Asset Allocation