Crypto for Advisors: Crypto Volatility and Market Conditions

Is crypto’s volatility a feature or a bug? In today’s issue, Miguel Kudry, CEO of L1 Advisors explores cryptocurrencies performance and its relation to market conditions.

In Ask an Expert, Kevin Tam from Raymond James Ltd. looks at institutional U.S. Securities and Exchange Commission filings and what they can tell advisors about adoption.

– Sarah Morton

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On Monday, Aug. 5, the Japanese Nikkei plunged over 12%, marking its worst crash since 1987. This followed unsettling comments from Japan’s central bank about potential interest rate hikes. Some attributed the decision to fears of a possible U.S. recession, while others linked it to speculation about Federal Reserve rate cuts. This uncertainty disrupted the Japanese carry trade, a strategy estimated at $1.1 trillion by economists at TSLombard, leading to a global capital market panic as positions were unwound.

Crypto markets bore the brunt of the impact on Sunday evening as investors sought the fastest liquidity route, with bitcoin and ether experiencing dramatic drops of 15% and 22%, respectively, much of which occurred during Sunday night in U.S. Eastern Time (ET) hours.

Contrary to popular belief, the inherent volatility of crypto markets is not a bug but a feature. With no circuit breakers in place, the always-on, globally accessible nature of crypto markets often makes them the first source of liquidity for investors. In fact, during times of panic, crypto might be the only asset investors can sell, as was evident on Sunday evening in the Western Hemisphere. By the time the U.S. stock market opened on Monday morning, crypto markets had stabilized, with both bitcoin and ether recovering approximately 10% from their lows the previous night.

Crypto markets consistently provide liquidity and availability, even in the most tumultuous times. On Aug. 5, several online brokerages, including Schwab, Fidelity, Robinhood and Vanguard experienced outages or were under maintenance, leaving tens of thousands of investors unable to access their portfolios or place trades. Schwab attributed the outage to a “combination of higher volumes and a technical issue with a key vendor affecting [their] systems,” which paints a picture of traditional finance’s opaque software and backend systems. In contrast, Bitcoin has maintained 99.98918% uptime throughout its existence, and Ethereum has never gone offline, highlighting the reliability of digital assets even when traditional financial systems falter.

As other asset classes transition to crypto rails (also known as on-chain), they will benefit from the always-accessible nature of digital assets. Early adopters are likely to capitalize on arbitrage opportunities between on-chain and off-chain markets. Over time, this accessibility will become the norm for a new generation of investors who have grown disillusioned with traditional markets. A recent Bank of America report highlights this shift, noting that “older investors hold significantly more traditional equities, while younger groups hold more crypto and alternative investments.”

During times of uncertainty, the increased availability and accessibility of an investor’s portfolio can lead to reduced volatility and panic across all asset classes, including crypto-native tokens. An analysis by Amberdata highlights that “the dispersion of volatility across different regions underscores the significant impact of market openings and closings on price movements.” This suggests that greater accessibility could help stabilize markets during critical periods, providing a buffer against extreme fluctuations.

Earlier this year, as geopolitical tensions between Iran and Israel escalated, PAXG, a tokenized version of gold, traded at a 20% premium over its closing price on Friday, April 12. These sharp price swings reflect the stark differences in flexibility between traditional and crypto or on-chain markets. This volatility is evident in PAXG’s trading volumes, which typically peak over weekends and particularly on Sundays, highlighting the dynamic nature of crypto markets compared to more rigid traditional markets.

Source: @Kaledora, who wrote a whole X thread on this subject.

In conclusion, the inherent volatility of crypto markets and on-chain assets, especially during tumultuous times, underscores the unique characteristics that set them apart from traditional markets and off-chain assets. The always-on nature, free from circuit breakers, ensures that crypto markets remain accessible even when traditional markets falter, offering liquidity when it’s needed most. As more assets transition to on-chain rails, this availability will become increasingly vital, potentially reducing panic and volatility across the broader global financial ecosystem.

– Miguel Kudry, CEO, L1 Advisors

Q. How can investors use the SEC 13F or SEDAR filings for due diligence?

As a research tool, investors can gain insights into the investment strategies and holdings of large institutional managers (“smart money”). To help identify successful strategies, spot any market trends and where funds are allocating capital. From a regulatory compliance perspective, this may boost investor confidence by increasing the transparent and integrity of the TradFi markets.

In Canada, SEDAR (System for Electronic Document Analysis and Retrieval) in Canada is similar to EDGAR (Electronic Data Gathering, Analysis, and Retrieval) in the USA. Both systems serve as electronic filing platforms for publicly traded companies to submit their financial and other regulatory documents. I tend to think of this like a permissionless and open ledger, similar to a blockchain network.

Q. Why would a pension fund or bank add bitcoin to their portfolio?

This signifies a shift towards embracing digital assets as part of their investment strategy. This move can be seen as a response to low interest rates and inflation concerns while providing diversification and some better returns. For example, the State of Michigan Retirement System added $6.5 million in Ark 21Shares bitcoin ETF in Q2.

Additionally, Canadian banks like TD Waterhouse Canada, CIBC World Markets and National Bank all have included bitcoin ETFs in their latest Q2 13F filing. All the big banks hold some position in these spot bitcoin ETFs. In the last two quarters, the banks collectively own a total of $26.6 million.

I do believe bitcoin is a long-duration, institutional-grade asset and can provide asymmetric return profiles that maintain significant upside potential while limiting downside risk.

Q. What’s the latest buzz around spot bitcoin and spot ethereum ETF?

ETFs have become available in early 2024 and have become very popular with money flowing into them. Currently, total fund assets amount to around $62.3 billion held with the 10 spot bitcoin ETFs.

In July, the spot Ethereum ETF became available, making it easier for everyone to invest in these digital assets through the traditional financial market. In the short few weeks, the spot Ethereum ETF saw a total net inflow of $17 billion with the eight ETFs.

All this marks a significant evolution in digital asset investing, especially with the introduction of ETF products, enhancing accessibility and legitimacy for all investors.

– Kevin Tam, Digital Asset Research Specialist & Senior Branch Compliance Supervisor, Raymond James Ltd.