Guotai Junan: What does the currency crash mean? The current round of bubble is not far from the end

Looking ahead to the next phase, the interlude of the currency crash does not change our judgment on the next phase of the double bull in stocks and bonds

Guotai Junan: What does the currency crash mean? The current round of bubble is not far from the end

Author: Qin Han, Pan Qi

While we have been suggesting that commodity prices may be topping out, virtual currencies have unexpectedly crashed and suffered a “Black Wednesday”. In the past week, Tesla’s CEO first announced that Tesla was suspending its acceptance of bitcoin payments, and then hinted that he might sell his bitcoin position. As the most influential “internet sensation” in the current bull market, Musk’s change of stance has triggered a continued decline in the cryptocurrency world.

The catalyst for Wednesday’s “cryptocurrency disaster” was the escalation of regulation in China and the U.S. Three major Chinese associations reiterated that virtual currencies should not be used as a payment settlement method, the NDRC tightened regulations on “mining” companies, and U.S. regulators plan to set up a virtual currency regulatory panel.

Bitcoin fell by more than 30% in 24 hours and struggled to hold the $30,000 barrier, while ethereum fell by more than 45% and once fell below $2,000. The plunge triggered a series of blowouts and passive deleveraging, which further amplified the decline. As of Wednesday’s close, the cumulative decline from the year’s high was more than 40%.

With the emergence of bottom-funding after the crash, aggressive shouting from bitcoin “long” Musk and ARK Fund’s Cathie Wood, prices began to rebound, with bitcoin and ethereum back above $40,000 and $2,600 as of Thursday afternoon.

Whether bitcoin has value or not is a matter of opinion, with advocates based on their belief in blockchain technology, distrust of cryptocurrency credit, and interest in virtual assets, and critics based on concerns such as immaturity of the technology, speculative attributes, and regulatory risks.

The current bitcoin bull market since 2020, in addition to technical factors such as halving production, increasing institutional participation, and the influx of retail investors, is still essentially driven by a flood of global liquidity, which can be seen in the positive correlation between bitcoin price trends and the Fed’s total asset size.

A visual example of increased institutional participation is the rapid expansion in the size of virtual currency trust assets. One of the most prominent channels for institutional participation in virtual currencies is the Bitcoin Trust (GBTC) launched by the US-based Grayscale Fund. The total market value of assets held by the trust, compared to the end of 2019, has grown more than 14 times, peaking at 70% of the total market value of assets held by the world’s largest SPDR gold ETF.

Given that bitcoin production is halved every four years (three halves have already been accomplished) and has a low correlation to other major asset classes, some argue that it is even seen as “digital gold,” and the data does confirm that bitcoin is diverting funds that some institutions had intended to allocate to gold.

If it is difficult to give a quantitative “reasonable” valuation for commodity futures, it is even more difficult to value bitcoin, which has to face “high speculation and high volatility”. The mainstream valuation methods are: ① unit cost method, that is, the cost of each “mining” a bitcoin (arithmetic, energy consumption, etc.); ② reserves – production model, that is, reference to the valuation of precious metal reserves and annual production relationship; ③ electronic gold method, that is, if bitcoin replaces the gold part of the safe-haven, anti-inflationary demand corresponding to how much price; ④ price-earnings ratio method which is the total value of the market value of Bitcoin versus the total value of network transfers on the blockchain (the value of utility generated to users); and ⑤ the technical analysis method (currently the most common).

Referring to the last virtual currency bull market in 2016-2017, we believe that Wednesday’s “coin crash” means that the current bubble is not far from the end. In the first half of a bull market, bitcoin tends to outperform the “high yield coins” (i.e. virtual currencies other than bitcoin), and in the second half, the market spreads to the high yield coins and significantly outperforms bitcoin.

This is because bitcoin has the largest market cap, the lowest price volatility, the best liquidity in terms of volume and transfers to different exchanges, and new entrants or those with a lower risk appetite (relative to high-yield coins) tend to buy bitcoin at the beginning of the bull market. As the “money making effect” continues to strengthen, social media pushes, and risk appetite gradually rises, funds will switch to high yield coins, leverage behavior on the field intensifies, and the market will further spread to less liquid small and medium cap coins, and even small demon coins will skyrocket frequently.

The real inflection point of the bubble often corresponds to the bitcoin price shock but not new highs, and the high yield coin dollar price is still rising, and this deviation continues for about a month, the bubble will completely come to an end. Since bitcoin is the main outlet for liquidating to fiat currency, coin disasters tend to stampede. bitcoin price peaked near $20,000 on December 16, 2017, and fell back to near $14,000 in the following month, but ethereum (commonly understood as the ios system dedicated to building a blockchain world) still achieved a doubling, from $700 to The virtual currency officially began a year-long bear market after late January.

Looking ahead to the next phase, the interlude of the cryptocurrency disaster does not change our judgment on the next phase of the double bull in stocks and bonds. The recent plunge in virtual currencies is ultimately a result of the collapse of the microstructure under the regulatory black swan against the backdrop of easing liquidity and excessive early rises. The ecology of the coin circle is still not dominated by institutional investors, and the institutions involved in the early stage have either reduced their positions before the plunge or migrated some of their funds to equity or gold after the plunge, so the impact of the coin disaster on the global capital markets is only emotional and temporary, and does not affect either the fundamentals or the attitude of major central banks towards liquidity. The low opening of U.S. stocks on Wednesday evening also illustrates this logic.

The reason why we believe that the early by inflation expectations, risk-free interest rates are expected to suppress the relevant assets will enter a friendly window of time, the core logic lies in the domestic and foreign monetary tightening concerns gradually recede: internally, commodities in the policy under the top of the stage, inflationary alarms are basically lifted; externally, the U.S. recovery is not stable, employment will not be strong and vaccination will not become a new constraint, the Fed’s tolerance for inflation may eventually let the market choose to follow rather than bet against.

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