After a bullish 12 months, it’s time for some sober crypto thinking

by Temple Melville

I TRUST you all had a wonderful Christmas and a spectacular New Year. I regret, however, to tell you that the hangover experience this year is unlikely to be pleasant.

I’m going to start with a macro angle. I’m sure you all know that the Bank of England has been ‘printing money’ to support the Treasury and, by extension, the government. What is often misunderstood is that, to do this, someone has to buy the gilts — or government securities — that are created in order to get the money into the economy, which is what printing money is all about.

The problem is that for the past almost couple of years ALL the net issuance of gilts has been bought, not by the natural buyers thereof i.e. pension funds and overseas buyers, but by the Bank of England itself. This, of course, has massively bloated the Bank’s own balance sheet — never mind massively increasing the Treasury’s need to pay interest.

Just to dwell on the pension funds for a moment, they have avoided buying gilts because anyone with half a brain knew interest rates were going to rise, and that would mean a long and precipitous fall in the value of the underlying gilts. Craftily, they waited until interest rates had risen and then started loading up with higher yielding instruments.

Now many underlying pension funds are fully covered and then some. It’s a bit arcane, but actuaries work out what each fund needs to have to pay out to pensioners, so lower rates mean they require more cash and higher rates lower the figure substantially. The rise in interest rates means that quite a number of said pension funds are now in surplus. Result? They don’t need to buy any more gilts.

The extra bad news is the supply of gilts is going to increase because the good old Bank is selling its existing holdings of gilts as well as creating new ones to fund the current Government deficit. Normally this should lead to a fall in prices, but the difficulty is that every other government worldwide is in exactly the same boat. The only weapon is to pay more cash to potential buyers and, in order to do that, interest rates on gilts will need to rise to clear the market.

My first point, then, is to not believe all the hype about interest rates falling worldwide just yet. There may be a little loosening, but we are almost certainly never going back to the ultra-low rates that were around even a very short time ago.

What does all of this mean for the crypto landscape? Speculation that we are reaching what looks to be peak interest rates, and the subsequent fall in yields on government debt, has helped Bitcoin to double in the space of a few months. While this is fairly usual behaviour, quite a lot of it is also predicated on ETFs being approved in the near future.

I would be willing to bet that some of the rise has been achieved by the likes of BlackRock buying ahead of the deal to make sure it doesn’t have to play catch up if it all goes their way.

But, there is an interesting sideline here. Normally, ETFs are a basket of stocks which big institutions buy and sell to smooth the market, and settlement for buys and sells is made in the underlying stocks. The SEC has said if ETFs in Bitcoin are allowed, settlement will have to be in cash. That is a massive difference and may well have profound consequences.

Given the market’s large rise on the prospect of ETFs, if they are not approved then it feels fairly obvious that there will likely be carnage in the markets. However, interestingly, if ETFs are allowed there could still be trouble — but, in this instance, for crypto exchanges.

Why, for example, would you trade the individual tokens when you can buy and sell ETFs at half the price and for a lot less hassle? They also come with the added bonuses of investors being able to put a bit more faith in the people who are actually offering these products, as well as a properly regulated environment.

So, I’m not getting totally excited about prospects of 2024 just yet. Mind you, as I’ve said before, Bitcoin and crypto more generally like to keep you off balance and provide a few surprises. This just may be another one of those moments.

Temple Melville, CEO of The Scotcoin Project Community Interest Company (CIC)

If readers of the Digital Commonwealth would like to know more about blockchain and crypto, please drop me a note on temple@scotcoinproject.com and I will send you my book on both topics for free along with some Scotcoin for those who want to register for Scotscan.io.