Goldman’s not giving up hope on Bitcoin

If there’s one meme to really sum up the past week in crypto, it’s probably this:

For those who don’t know, cryptocurrencies experienced one of their wildest rides ever after Chinese authorities said on Wednesday that they would ban financial institutions and payment companies from offering crypto services.

But the drama didn’t end there. After regaining a chunk of losses, crypto took another toppling on Friday. Then again on Sunday. This time the price fell on news (and later confirmation) that China wasn’t only banning crypto services but coming directly after Chinese bitcoin mining operators as well.

The South China Morning Post reported at the weekend:

The government will “crack down on bitcoin mining and trading behaviour, and resolutely prevent the transfer of individual risks to the society”, according to a statement by the State Council’s Financial Stability and Development Committee chaired by Vice-Premier Liu He, the Chinese president‘s top representative on economic and financial matters.

While many see the 50 per cent or so rout in bitcoin’s value since it achieved a record $63,729 on April 13 as confirming the cryptocurrency’s unsuitability for mainstream financial usage, other more dedicated voices have not given up hope.

Among those voices appears to be Goldman Sachs, whose global macro research team put out a comprehensive deep dive into crypto assets on Friday, which included bullish interviews with the likes of Michael Novogratz, the co-founder and CEO of Galaxy Digital Holdings, and Michael Sonnenshein, CEO of Grayscale investments, albeit buttressed by the views of the ever-cynical-about-crypto economist Nouriel Roubini.

Even so, it was the views of Goldman’s own head of digital assets, Mathew McDermott, that really drew our attention.

McDermott argues that Goldman’s interest in the sector is being led by client demand. Notably, from the institutional side of things. Even more interestingly, McDermott notes it’s not just institutions making inquiries but also corporate treasurers, especially those whose firms are facing negative interest rates or who fear asset devaluation amid the extraordinary amount of fiscal and monetary stimulus in the economy. In their minds, he says, having some portion of their balance sheet in bitcoin rather than paying to keep cash on deposit or holding negative yielding government bonds may make sense.

This is an important point given that a key challenge for central banks who wish to launch their own digital currencies is how to avoid institutional money from using their coins to avoid negative interest rates in the broader financial system. This is because, for the most part, they are expected to be zero interest bearing, but also as a consequence par protecting. If they weren’t, retail users would be unlikely to see them as beneficial. One way to deal with this is to not only limit currency held in CBDC form to a specific quota, but also make it identity-linked and thus firmly retail in nature. But that, as observed by McDermott, leaves a major use case for bitcoin – its capacity to protect institutions from negative interest rates.

More broadly, McDermott notes there is a general sense of FOMO being experienced by institutional names, and that this potentially overshadows concerns about volatility. As he notes (our emphasis):

There’s no doubt that “fear of missing out” (FOMO) is playing a role given how much bitcoin and other crypto assets have appreciated and how many interested parties of all flavors have jumped into this space. If you’re an asset manager or running a macro fund and your closest rivals are all investing and seeing material returns, your investors will naturally wonder why you are not investing. But I see investor interest in crypto enduring; we’ve crossed the Rubicon in terms of institutional buy-in, and there is much greater value in the space than there was three or four years ago.

The scale of adoption among Goldman’s won client base, meanwhile, is far greater than even we would have expected, especially given the ongoing restriction of mandates:

A survey from our Digital Asset team conducted in early March found that of the 280 clients that responded, 40% have exposure in some form to cryptocurrencies, with 61% expecting their holdings to increase over the next 12 months, and I suspect that would be more now. Another indicator of increased activity is the almost 900% yoy increase in CME bitcoin future daily activity in April.

All of which appears to be translating into big opportunities for Goldman’s prime brokerage business:

From a prime brokerage perspective, we plan to offer clients the ability to go synthetically long/short bitcoin-linked securities and exchange-traded notes (ETNs) in Europe. We’re also looking into offering lending structures in and around the crypto space to corporate clients as well as structured notes. And from a wealth management perspective, we are gearing up to offer access to cryptocurrencies, specifically bitcoin, via fund or structured note-like products.

ETNs, structured notes and leverage!? But how would the margin calls work out on a week like this one? That’s not directly answered by McDermott.

But one other controversial point that is, is just how clients feel about bitcoin’s extensive carbon footprint. In one short phrase: not bothered. In fact, if anything, they seem more interested in how bitcoin miners are finding solutions to their carbon intensity issues by their own means:

Generally, the environmental concerns have not caused investors to fully close the door, but they are looking at improved sustainability options. Investors are intrigued to hear about miners leveraging renewable energy sources to mine crypto assets. And carbon neutral funds are emerging, that, for example, calculate the carbon cost of crypto mining, and buy credits to offset their environmental impact.

And that leads McDermott to conclude bitcoin might indeed be considered an investable asset these days, even if it doesn’t always behave as one would intuitively expect it to relative to other assets.

Though, given exactly that ambiguity, it’s surprising Goldman offers no insight into the scale of shenanigans investors might be exposed to in the market or the degree to which a handful of mega whales currently have influence on market pricing.

Take the following Nostradamus-esque note which was supposedly posted to 4chan last Tuesday, May 18 predicting the entire ugly trading episode of last week:

How did this insider really know what was coming? Or was it simply a lucky coincidence? Who was his group trying to shake out anyway? (Was it Elon?) How does that bode for other sizeable and clearly transparent corporate treasury holders of bitcoin in the future? And why did they share this information on 4chan?

More pertinently: does any of this seem good and proper for an institutional investor? It’s not, in our opinion, the sort of symmetrical information environment usually considered beneficial for those in the business of managing other people’s money with care.

We can’t be sure the note is legit of course. The original posting has since been deleted. The snapshot doing the rounds is dated Tuesday, May 18, but we can’t find the internet footprint proof that confirms it was actually posted ahead of the rout.

But the reason we mention it is because this sort of thing happens in cryptocurrencies all the time. And we are not quite sure institutional investors really understand the information disadvantage they are coming into the market with. Or the degree to which the whales dominate and influence both liquidity and price.

In the meantime these two charts from Goldman are the best we’ve got when it comes to highlighting “whale” risk:

And here’s the chart that really clarifies the degree to which that disadvantage versus the “whales” is now entrenched in the system.

Perhaps one day there will be a Michael Lewis book that explains it all.