Decentralized finance (DeFi) and traditional finance are perhaps not as oil-and-water as most think.

There are few topics as controversial in the crypto sector as decentralized finance. Many believe it is the future of finance – removing middlemen will lower costs, unleash efficiencies and create a more transparent, resilient and better-distributed framework. Others (myself included) find the idea terrifying – a financial system without oversight or an off switch is even more vulnerable to manipulation and error than one that is legally accountable to the user and can be fixed when things go wrong. If a DeFi platform can be “fixed” when things go wrong, just how decentralized is it?

You’re reading Crypto Long & Short, a newsletter that looks closely at the forces driving cryptocurrency markets. Authored by CoinDesk’s head of research, Noelle Acheson, it goes out every Sunday and offers a recap of the week — with insights and analysis — from a professional investor’s point of view. You can subscribe here.

An example of this happened this week: decentralized exchange Bisq, which allows users to trade crypto assets anonymously, suffered a hack involving the theft of $250,000. To prevent a greater loss, the platform developers switched it off.

Obviously, from the users’ point of view it is a good thing Bisq did so. But Bisq also showed the world that it can, which calls into question the concept’s resilience – this time it was for the users’ benefit, but who’s to say that will always be the case? (No aspersions cast on the Bisq team, it’s the concept I’m talking about here.)

Read more: How DeFi Dinner Bonds Can Help Restaurants During Crisis

While I am personally skeptical of the concept, I am very intrigued by the potential impact DeFi could have on traditional finance. The two are not oil and water, and the automation and transparency of some innovative market functions emerging from the sector could broaden the scope and reach of the fintech applications of tomorrow. 

So I perked up when I read about a group of Chicago-based institutional-grade crypto market participants banding together to form the Chicago DeFi Alliance, which aims to support crypto startups during the current coronavirus crisis. TD Ameritrade, Cumberland, CMT Digital, DV Trading and Jump Capital – many of them blue-chip names from traditional markets – have joined with venture capital firm Volt Capital and DeFi startup Compound, to provide advisory services to selected projects.

This group of organizations has plenty of experience in traditional business and finance. Its participants also understand the potential appeal of an alternative system of value based on a decentralized network. 

By focusing their energies on enabling institutions to invest in and trade crypto assets, they have already started to build up the intersection between the centralized and decentralized worlds. This new alliance, if successful, can move that relationship beyond the purely transactional – rather than just investing in and (hopefully) profiting from decentralized assets, its participants will be able to start to sketch out what a deeper interaction could look like, with the experience and sector-wide view necessary to keep it practical. 

Getting better

You may be wondering why I’m featuring a technical upgrade in a newsletter that focuses on investment principles. It’s because bitcoin (BTC) is not just an investment asset – it’s a new technology whose use case is still evolving, and changes to that technology could be material in determining the eventual outcome.

Many investors see bitcoin as an asset without tangible fundamentals, whose price will go up or down according to market sentiment. While this is true, those who insist bitcoin has no intrinsic value overlook that it is more than just consensus around a price.

The intrinsic value of technologies depends on their use case. The narrative around bitcoin’s use case is still evolving – so far, it has not fulfilled its initial promise as a payments mechanism, but that doesn’t mean it never will. Some dispute its role as digital gold given its high volatility. Adoption as an alternative financial rail in areas with rickety and/or intrusive legacy systems is so far muted, given barriers to access and exit. 

One bitcoin improvement proposal seriously being considered by the community is known as Schnorr/Taproot. If approved, this could enhance bitcoin’s privacy and scalability features, and support better payments functionality and improved smart contracts. If you’re interested in the details, my colleague Alyssa Hertig explains the proposed changes and their potential ramifications in depth. 

Read more: Post COVID-19, Companies Must Be Resilient, Not Just Efficient

But whether tech upgrades are your thing or not, even just talking about it highlights an often overlooked feature of crypto asset investing – it’s not just buying into a technology, it’s buying into an evolving technology. It’s like venture investing, getting in at the ground floor of a potentially important innovation – but in the form of a liquid asset. You enter without extensive contracts and exit whenever you want. 

Even beyond the potential of the technology itself, whatever your views on that may be, that ease of access to the possible upside in itself is powerful. (In our just-released CoinDesk Quarterly Review Q4 2020, we summarize the most significant technical upgrades expected in the crypto asset market over the next few months.)

Deeper relationship?

In a confused market peppered with dividend cuts and the unwelcome realization that we are already in a recession, we can expect renewed interest in bitcoin’s correlation with the S&P500. 

performance-chart-asset-classes-apr-9-with-date-1000

While last month saw a strong spike in correlations as everything crashed and then rebounded and crashed and rebounded again, it’s likely that we are starting to see an uncoupling. Bitcoin has so far performed better in April than any of the other major indices, in spite of the much-celebrated S&P 500 rally. It has even handily outperformed gold, although the shiny metal is still one of the top-performing assets for the year to date. 

Going forward, times of heightened volatility in traditional markets are likely to aggravate bitcoin’s volatility even further; but as things settle into a “new normal,” bitcoin’s resilience and monetary policy, especially as the halving narrative gains in volume, are likely to support further outperformance. 

Watch out also for fractures in the physical gold market, which could further destabilize markets overall, while highlighting bitcoin’s relative advantages.

Chain links

Digital assets are not a claim on assets or income streams, as are bonds and equities – they’re a claim on future services, and as such, don’t lose value in a recessionTAKEAWAY: This draws on something that we touched on in THE BRIEFING above: the “intrinsic value” of crypto assets. In the case of bitcoin, for example, the future services are the eventual use case of this new technology; in ERC-20 tokens, on the other hand, the future service is more clearly defined, but requires some platform building and/or user growth first. Either way, this highlights the unusual investment characteristics of crypto assets, and hints that just because they don’t have tangible assets or flows doesn’t mean that due diligence can be overlooked. Will this future service generate enough interest for the token in question to at least maintain its value? 

The Bitcoin Fund, managed by Canadian investment firm 3iQ, has started trading on the Toronto Stock Exchanges under the symbol QBTC.U. TAKEAWAY: The market now has another way for investors to gain exposure to bitcoin without worrying about onramps and custody. So far, it’s still small – the market cap for the listed shares is approximately $14 million – but it’s the first such fund listed on a major stock exchange. It also highlights how hard it is to be a first mover in this space – the firm spent almost three years negotiating with the Ontario Securities Commission before approval was granted. 

China-based bitcoin mining equipment manufacturer Canaan Creative, which listed on Nasdaq (CAN) in November, disclosed a net loss of $148.6 million for 2019 on revenue of $204.3 million. Although computing power sold (measured in Thash/s) was up almost 50 percent, net revenues for the year were down almost 50 percent, according to the company largely as a result of the lower price of bitcoin. TAKEAWAY: Since the figures were released, the share price fell by over 10 percent (to $3.20 at time of writing); it is now down almost 50 percent year to date, and over 60 percent below its listing price. What’s more, the company has downgraded its expectations for 2020 as a result of the crisis, which is likely to hit the Q1 figures. In an earnings call , the CEO and founder acknowledged a significant drop in December’s revenue. It’s also worth remembering the company is being sued in a class-action lawsuit amid allegations it released false and misleading statements to make its financial health appear better than it was prior to its initial public offering.

Read more: Bitcoin Halving, Explained

Those of you who have been watching this sector for a while will remember the heady days of 2017, when bitcoin’s price climbed ludicrously fast, starting the year at under $1,000 and reaching an all-time high of just under $20,000. Then came 2018, when the price fell by 60 percent over the course of a month. Well, bitcoin is even more volatile now, if you look at the standard deviation of the natural log of daily returns over the past 30 days. TAKEAWAY: Unprecedented times bring the greatest risk and the greatest opportunity (profound, I know).

volatility-090420

Bitcoin’s hashrate is on the rise again. TAKEAWAY: You may remember that after the price crash of mid-March, Bitcoin’s hashrate (which represents the resources invested by miners in maintaining the network) also fell. Then bitcoin’s self-correcting mechanism known as the difficulty adjustment kicked in a couple of weeks ago, with the second sharpest drop in the network’s history. That, plus the recovery in the bitcoin price, seems to have done the trick: the hashrate is picking up again. 

btc-hash-rate-and-diff

(See our recently released Halving Report for more detail on hashrates and the upcoming halving.)

Related to THE BRIEFING above, DappReview has published its Q1 report on decentralized application (dapp) activity, which shows solid growth, unevenly distributed. The number of dapp transactions grew over 80% year-on-year, fueled by ethereum-based financial applications. TAKEAWAY: The growth may be strong, but the financial figures are still low at under $8 billion (not inconsiderable, but not yet a threat to traditional finance). However, they do hint at a strong coalescence around the ethereum network, in spite of the efforts of competing blockchains. And the focus on financial applications underlines users’ interest in an alternative market system, which traditional providers should take note of.

dapp-activity-q1

I don’t have nearly as much time to listen to podcasts as I would like, especially during lockdown. (I miss going for walks!) But the CoinDesk podcast stable under Adam Levine is putting out some powerful stuff I have to flag. 

  • My colleague Christine Kim’s interview with Ethan Vera of Luxor Technologies and Wolfie Zhao from our China office gives a rare peek into miner economics.
  • Nathaniel Whittemore’s chat with Ben Hunt is a grounding look at the current rally.
  • Nathaniel also talked to Hidden Forces host Demetri Kofinas (whose podcasts are also well worth a listen) about the struggle with so many unknowns, including how we’re going to turn the economy back on.
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