Viridi Crypto Mid-Year Outlook
In the midst of a Ukraine crisis, record inflation rates, and the start of an official recession in the United States, the value of cryptocurrency companies and tokens have dropped significantly. This series of macroeconomic issues have stress tested the cryptocurrency ecosystem and as a result the market valuations have experienced a significant drawdown, bringing the total market capitalization of the space down to a low of $827 billion, a 71% reduction since the $2.9 trillion dollar peak in November 2021.
The stress on crypto prices has also caused a “shake out” of companies in the cryptocurrency space that took on extreme leverage. In our view as we enter the second half of the year the Viridi Funds team is cautious about the cryptocurrency space in general but holds a strong view that Bitcoin will perform better than other cryptocurrencies.
Bitcoin Performance and Metrics
Despite the massive price fluctuations, the Bitcoin protocol continues to perform without any issues. While many alternative cryptocurrencies have suffered outages or material changes to their use cases, Bitcoin remains a strong store of value and offers unparalleled security for investors. In our view, during depressed economic prices for altcoins, we see investors returning to larger Bitcoin allocations within their portfolio. Bitcoin dominance, a metric that tracks Bitcoin market cap against the total cryptocurrency market cap, increased from a low at the start of 2022 of 39% to a high of 49%. While many altcoins have decreased in price more significantly than Bitcoin in H1, it is our estimate that Bitcoin will remain a dominant allocation for many investors going forward. By the end of the year, Viridi Funds would expect the allocation to be in between 45% and 50%.
Additionally, Viridi Funds continues to view the supply of Bitcoin as an important factor to track and understand how Bitcoin is being utilized. Bitcoin exchange reserves, a general metric that tracks all Bitcoin that are currently on public exchanges, continues to decrease throughout the year. Despite Bitcoin mining companies selling supply to the market, the general trend of Bitcoin exchange reserves continue to decrease. We expect that this metric may flatten or continue to decrease over the next six months, which would suggest that investors are purchasing Bitcoin and moving it off exchanges and into more long-term cold wallets. As a result of continued supply reduction on exchanges, the Viridi team would anticipate that Bitcoin demand will drive prices higher for the rest of 2022.
Bitcoin Mining Companies and Mining Profitability
Some Bitcoin miners participated in the recent selloff. Most notably, Bitfarms and Core Scientific sold significant parts of their “HODLs” i.e. their long term Bitcoin positions, in order to boost liquidity and de-lever parts of their balance sheets that had become stressed. This selling pressure added fuel to the fire in an already weak Bitcoin market.
*Aggregated from the monthly operational updates of CORZ, BITF, RIOT, MARA, HUT, and ARB.
The steep drawdown in Bitcoin has resulted in a reduction in hashprice, a metric used to track the value of one unit of compute power from a mining machine. Hashprice has decreased by 63% since the start of the year and has impacted top-line revenue for many companies. In light of the selloff, Bitcoin miners with top efficiency ASIC fleets and access to industrial electricity rates can still achieve gross margins of 60-70% at $20k Bitcoin. We believe the lowest breakeven operators and those with robust balance sheets and economies of scale will be the best performers over the next six months.
United States Crypto Regulation
The astronomic rise in growth for cryptocurrency has caused politicians and the federal government to quickly react with policies and proposed regulatory changes. Early in the year, United States President Joe Biden announced an executive order focused on ensuring the responsible development of digital assets. The executive order called for significant exploration into central bank digital currencies and called upon the Secretary of Treasury to provide a report on the future of money and payment systems. This unprecedented callout from the president, as well as the dedicated government resources now allocated towards cryptocurrency regulation, will likely cause significant policy implications over the next year.
Another key concern from regulators includes the determination of cryptocurrency as securities and if they are deemed as securities, existing laws obligate them to protect investors from fraud. In the case of Bitcoin, SEC Chairman Gary Gensler has confirmed that Bitcoin is not a security and instead should be regulated as a commodity. The Viridi view sees that many other cryptocurrencies will fall into the category of being a security and require significant registration and consumer protections. Viridi also notes that over the course of the next six months, it is likely that many loopholes in cryptocurrency today will be presented with a regulatory solution. One clear example includes the “wash rule” concept, which allows someone to sell a cryptocurrency at a loss and immediately buy it back for a tax benefit, which does not currently apply today. As the government becomes more involved in cryptocurrency regulation, these loopholes will likely cease to exist over time. Our outlook continues to be that Bitcoin will remain a significantly easier asset for institutional investors to consider given the clarity that has been provided by the federal government.
