Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
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The crypto space is getting cold when the hype disappears
Anders Nysteen
Senior Quantitative Analyst, Saxo Bank
Summary: The crypto market has been in a frozen state over the summer due to the increased global unrest, rising inflation and lower interest in crypto investments this year, and speculative traders are getting cold feet. Rising energy costs are raising concerns, especially for the energy-intensive cryptocurrencies, and the profitability of crypto miners is under pressure. One bright spot in the otherwise cold winter is that the institutional interest in crypto seems to persist, although cracks are starting to appear.
The crypto market has been quite dormant over the summer, driven by the global inflation fears as well as geopolitical tensions. These have been the main drivers of the decrease in risk appetite for investors both in the equity and crypto markets, and to a large degree these markets have been moving in sync in 2022. What will be driving the crypto space from here? Will the energy crisis be a limiting factor for a comeback in crypto, or will other parts of the crypto space be able to fuel a new rally?
Energy limitations are raising concerns
Bitcoin and several other big cryptocurrencies are relying on huge amounts of computational power to run their network and make sure that transactions are verified properly. Estimates from early September predict Bitcoin to have the same daily energy consumption as Sweden. A key feature for Bitcoin is that the network is run in a decentralised way, where multiple independent agents around the globe validate the transactions to ensure that no single entity is controlling the network. These so-called miners are rewarded in newly issued Bitcoins, but with the decreasing value of the crypto market and the rising energy cost, miners are facing challenges when it comes to profitability, as shown in figure 1. The decline in Bitcoin prices in 2022 is forcing miners to either relocate to countries with cheaper power or close down their operations. With fewer miners running the network, it will be less secure and may become less decentralised. However, with the current amount of Bitcoin miners, we do not see increased centralisation as a major risk within the next couple of years.
Neither centralisation or energy consumption appear to be a major concern for the classical crypto trader. However, larger governmental institutions are becoming increasingly concerned with the computationally heavy “proof-of-work” validation scheme which Bitcoin is using. At the beginning of September, the US White House Office of Science and Technology Policy found in a report that cryptocurrencies have a significant impact on energy usage as well as on the emission of greenhouse gases, and they recommended increased monitoring and potential regulation. This happens half a year after the EU Parliament was discussing a ban of the energy-intensive “proof-of-work” validation which Bitcoin is using, which in the end was rejected. We see a major risk to cryptos if governmental institutions start regulating the use of cryptocurrencies due to their energy consumption. If strict regulation is imposed, it may limit the number of use cases for cryptocurrencies and thus make it less attractive to employ crypto technology.
Retail traders are watching from the side-lines – institutions are still in the game
Speculative traders seem to have disappeared from the crypto space in 2022, as the fear-of-missing-out trends driving the price rally in 2021 has now gone. Additionally, non-fungible tokens (NFTs - digitalised versions of items, images, videos, etc.) are trading at record-low volumes over the past year, confirming the cooling of the speculative trading mania. One bright spot in the crypto winter seems to be the institutional interest, which has not faded in the same way as with retail traders of crypto. During the past couple of months we have seen multiple bigger institutions investing in the crypto market or expanding their services within digital assets, despite the crypto market rout. Examples are BlackRock who announced a partnership with Coinbase to expand their crypto investment services to institutional investors, and Brevan Howard raising more than $1Bn for a crypto fund from institutional investors.
Cracks are however starting to appear. For example, Snap announced a layoff of their Web 3.0 department at the beginning of September, and crypto trading firms are looking to reduce their headcounts due to the crypto market conditions. The number of developers in the crypto space has been declining throughout the past three months according to Artemis, but the record-high amount of venture capital which has flown into the crypto space in 2021 and beginning of 2022 can hopefully keep crypto organisations flowing for some time.
We see applicability as the driver for cryptos going forward. We will likely see a shift from investments into random crypto tokens and NFTs into crypto technologies with a specific use case. Some are already in the pipeline: Sony is looking into creating NFT-backed media to give the artists faster and more equitable agreements; GameStop is developing the ownership of digital items in games through NFT technology; and Ticketmaster has entered a collaboration of issuing tickets as NFTs.
The crypto winter is changing the crypto market into a more mature and healthy one, removing speculators and unreliable businesses. The key focus from here will be on the scalability to be able to process more transactions, for example, for payment processing, as this is crucial for developing crypto applications. It is important for cryptocurrencies that larger institutions embrace crypto applications to show that cryptos are more than an arena for blockchain enthusiasts and speculative traders. And this is of course while hoping that regulators will not put a stick in the wheel due to environmental concerns.
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