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THE COMPLETE CRYPTO GUIDE: Where it’s been, where it’s at, where it’s heading

It’s been around for more than a decade and, according to a recent Finder survey, one in six Australians now … Read More
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This article was originally published by Stockhead

It’s been around for more than a decade and, according to a recent Finder survey, one in six Australians now own some. It’s no longer going out on a limb to say this: cryptocurrencies are here to stay.

The crypto market has been through booms and busts as well as countless scams, hacks, “rugpulls” and China bans. Yet still it survives and thrives to the point where old-money institutions and fund managers are piling in as serious projects aim to completely disrupt finance and regulators scramble to get it all under control.

In this guide and general overview, we look at some crypto basics, the industry’s recent past, and where it all could be going from here.

 

What is a cryptocurrency?

A cryptocurrency – crypto for short – is a code-based digital asset or form of digital money enabled by blockchain technology. They’re often referred to as “coins” or “tokens” and they function outside of traditional banking and government systems.

That’s the short-ish answer. Feel free to use it down the pub.

“Okay, but what’s blockchain?” It’s a distributed ledger of transactions that’s publicly available and secured by cryptography. “Right… so how do I buy Dogecoin?” We’ll get to that.

There are many different types of cryptos (more than 9,600 at the time of writing according to CoinGecko) and many have different purposes and utility beyond being a medium of exchange.

The first crypto to achieve mainstream success was Bitcoin (BTC). For many crypto investors, Bitcoin is viewed as a “store of value”, akin to gold. It can also be seen as a barometer for the health of the entire crypto market. (In fact, it’s on a bit of a fun run as we write this, having jogged past US$57K for the first time since April 2021.)

Bitcoin led the way for the proliferation of what have become known as “altcoins” (alternative coins) – which simply refer to cryptos that aren’t Bitcoin.

Bitcoin maxis” tend to call altcoins “shitcoins”. And, while it’s probably true that the vast majority of those 9000+ coins are utter crap, there are gems among them, too – with serious teams building serious levels of innovation, backed by some seriously big investors.

 

How are cryptos created?

crypto guide
Crypto: this is the way. (Well, not literally.)

Maths. A Beautiful Mind-level maths. Cryptocurrencies are created by “consensus mechanism” algorithms that rely on cryptography, which is a significant part of blockchain technology.

These algorithms participate in every transaction of a cryptocurrency in order to reach a mathematical/cryptographic agreement on the state of the blockchain ledger, including the order of the transactions.

There are different types of consensus mechanisms that different crypto projects can use to create their tokens. Most projects traditionally use either what is known as Proof of Work (PoW) or Proof of Stake (PoS), although it’s a constantly evolving space and other consensus models are also coming to the fore, such as Solana’s Proof of History (PoH).

For further explanation on the main crypto-creating consensus mechanisms, head to “P” in our Cryptionary crypto glossary.

 

How is the value of a cryptocurrency determined?

The straightforward way of answering this is: market capitalisation. And this refers to the total dollar (US) market value of a company’s shares of stock, or in the case of crypto, its tokens. Market cap is calculated by multiplying the circulating supply of a crypto by the individual price of the token.

When looking for crypto buying opportunities and considering all angles, it’s important to remember that market cap is generally a more useful metric than price. A “cheaper” crypto at, say, less than US$10, isn’t necessarily a bargain compared to one with a considerably higher individual price. In other words, unit bias is no basis for an investment decision.

Also, cryptos with lower market caps have potential to offer greater reward, but at greater investment risk than established cryptos with higher market caps.

Other factors that can help determine a crypto’s value include good old supply and demand (the scarcity level of the supply and the user demand for, and utility of, the token); level of community engagement and sentiment; the competence and reputation of the team; and the type of investors (e.g. VCs) and backers it’s attracted.

With all this in mind, it should be remembered that cryptocurrencies are highly speculative and unpredictable assets that are difficult to value with a complete level of accuracy.

 

How are cryptos bought and traded?

When first buying cryptocurrency, most new investors do so through a centralised cryptocurrency exchange (although crypto ATMs can also be used, but often charge pretty high fees).

Creating an account on major exchanges is reasonably quick and easy – you’ll just need some identification as part of their KYC (Know Your Customer) setup process, and a bank account that lets you participate in crypto trading.

There are several reputable exchanges that serve the global and Australian crypto market, some of which include: CoinJar, BTC Markets, Binance Australia, Coinspot, eToro, Swyftx, Coinbase, Kraken and Independent Reserve. All these exchanges deal in a multitude of different cryptos – from Bitcoin and Ethereum to Cardano and Dogecoin to tokens you’ve almost certainly never heard of.

The rise of decentralised exchanges (DEXs) in the past couple of years, such as Uniswap, Balancer and SushiSwap, now provide crypto investors and traders with even greater choice, as well as extra flexibility and control with peer-to-peer swapping and trading.

There are no fiat on-ramps or off-ramps associated with DEXs at this time, however, so moving your old money in and out of crypto is still achieved through centralised means.

 

The past 18 months or so

crypto guide

The crypto market has got to be the wildest ride in finance. Its history is worth delving into, including Bitcoin’s inception, wilderness years, the Initial Coin Offering (ICO)-led bullrun of 2017, the bubble burst of 2018 and the subsequent “crypto winter”.

But the past year and a half is what we’ll focus on here – a period that has seen huge growth in the industry shaped by at least three big factors…

 

Factor 1: going viral

COVID-19 isn’t a great reference point for anyone but there’s no denying the pandemic’s effect on the growth of Bitcoin and crypto has been significant as the world has delved further and further into digitally dominated lifestyles.

When news of the spread of coronavirus really began to hit the mainstream, financial markets took a hit amid the immediate uncertainty. Bitcoin’s price took a nosedive from about $US10K to US$5,389 in March 2020.

Its rise from there, however, was nothing short of astonishing, reaching an all-time high of US$64,804 a bit over one year later in April 2021.

The US government’s fiscal stimulus policy during that time, printing more than US$5 trillion, served to strengthen the narrative of crypto (particularly Bitcoin) as an investment hedge against a weakening US dollar.

 

Factor 2: the institutional herd

The ex-Goldman Sachs hedge fund manager Mike Novogratz, now CEO of crypto investment firm Galaxy Digital, was telling anyone who cared a good two years ago that “the herd is coming”. He was referring to institutional players – Wall Street, big banks, significant fund managers, big corporates – entering the crypto-investment world.

He wasn’t wrong. One by one, significant players in US and global finance have shown they’ve been dipping a toe, sometimes much more, into digital assets and blockchain tech. This part of the story has been a big factor in the 2020/21 crypto rise.

Bitcoin has been the gateway drug, so to speak, for institutional entry, closely followed by Ethereum.

And due to their relentless bullishness on Bitcoin, two of the most important entities driving the narrative have been US asset management company Ark Invest, headed by Cathie Wood, and US business intelligence firm MicroStrategy, led by Michael Saylor.

Both can be directly attributed to kicking off serious institutional FOMO for Bitcoin and Ethereum over the past 18 months. And you can throw in the digital asset specialist Grayscale Investments into the mix, too.

Its GBTC trust product offers big investors exposure to Bitcoin through a traditional investment vehicle in lieu of a Bitcoin ETF (Exchange Traded Fund), which is still yet to be approved in the US (although this is looking more and more likely to happen as October rolls on).

Just some of the significant names now with hooks into crypto and blockchain in one form or another include: Goldman Sachs, JP Morgan Chase, Morgan Stanley, Barclays, Rothschild Investment Corporation, Fidelity Investments, BlackRock, Paul Tudor Jones, Ray Dalio, George Soros, BNY Mellon, Bank of America, Standard Chartered, Mitsubishi UFJ Financial Group, Fenbushi Capital, Andreessen Horowitz, PayPal, Visa, Mastercard, Square/Twitter, Walmart, AMC… and let’s not forget Tesla.

This is tip-of-iceberg stuff – there are many more. Google? Apple? Nothing too FOMO-inducing just yet, but there have been some tentative toe-dipping and rumours. As for Facebook, it’s definitely interested – largely in its own thing, including metaversal moves, but it’s interested.

Australian institutional moves

In Australia, the institutional rush is perhaps yet to really kick into gear, but there are signs…

The leading managed fund performer for the 2021 financial year, for instance, was the Apollo Capital Fund, which is blockchain-focused and diversified across a variety of crypto assets.

It blew out of the water 9,000 or so other funds vying for top dog on the annual Morningstar performance table, returning almost 700% in the year to April 30, according to the Australian Financial Review.

And then there’s this news: Australian neobank Volt has joined forces with Melbourne-based digital asset exchange BTC Markets, in what’s believed to be a world-first partnership between a traditional regulated financial institution and a cryptocurrency platform.

Perhaps this is the spark the Australian crypto scene needs for greater institutional adoption. BTC Markets chief executive Caroline Bowler certainly believes it’s the start of something:

“Crypto in Australia – it’s gone from a standing start, from nothing, to where we are now, and the technology has gone along with it. This is the inflection point, the tipping point, where the whole thing is going to go gangbusters.”

 

Factor 3: the dawn of DeFi

The third big factor in crypto’s boom in 2020/21 has been the rise of decentralised finance (DeFi) – a suite of smart-contract-powered financial products and applications that attempt to improve upon, and disrupt, traditional financial services by operating without intermediaries.

Popular DeFi applications include decentralised exchanges (DEXs) and Automated Market Makers (AMMs) such as Uniswap and SushiSwap; lending and yield-farming platforms such as MakerDAO, Compound and Aave; derivatives liquidity protocols such as Synthetix; stablecoins such as USDT and USDC; and yield-farming optimisers such as yearn.finance.

DeFi’s Total Value Locked (TVL) metric saw a rise from less than $700 million in January 2020, to about US$20 billion by the end of that year, despite cooling off somewhat in August 2020. It’s been an incredible surge of use and users.

According to analytics platform DeFi Llama, the DeFi TVL figure now stands at more than US$206 billion. As long as the crypto market remains healthy, and unless regulators manage to significantly stifle the sector, this growth has strong potential to continue for quite some time yet.

Why DeFi?

The main drawcard of DeFi, for savvy investors and crypto degenerates alike, is clear. It’s the stupendously high levels of annualised percentage yield (APY) on offer. And this can be achieved through means of staking, yield farming and liquidity mining.

These are all ways of putting idle digital assets to work, and the returns can be extremely lucrative compared with traditional finance. In fact, in most cases it’s no contest. Large banks might earn you 0.01% to 0.25% annual interest at best, which simply can’t hold a green candle to the 20% or even 200% returns some DeFi protocols offer.

While the returns can be staggering, locking funds into DeFi comes with substantial risk, as this sector of crypto has had more than its fair share of hacks and exploits – with some protocols taking horrendous losses this year.

But that’s why the continued evolution of smart-contract-cover insurance projects such as Nexus Mutual are so important to a sector of finance that lacks the protection that regulated, traditional financial products receive.

(Note, we’re not forgetting the significance of the NFT boom, either. See further below.)

 

The Elon effect

crypto guide

In March this year, Elon Musk, the enigmatic Tesla and SpaceX CEO, tweeted that Tesla vehicles could now be bought using Bitcoin. This came on the back of news that Tesla had invested US$1.5 billion into the OG crypto asset.

It sent an already thriving Bitcoin price soaring like a SpaceX rocket to its US$64K all-time high. The cryptoverse could barely contain its euphoria, with $100K+ price targets before the end of the year suddenly seeming conservative to many.

And then… Musk made another tweet. On May 13, he informed the crypto world he’d changed his mind on the whole Tesla-accepting-Bitcoin-as-payment thing due to environmental concerns based around excessive amounts of electricity being consumed by Bitcoin mining.

It’s a contentious point, as Bitcoin’s strongest proponents believe the majority of the original crypto is now mined using renewable energy – especially since China’s latest crackdown forced almost all crypto-business activities from the formerly proof-of-work, mining-dominant nation.

Nevertheless, the price of BTC consequently crashed by almost 50 per cent, bringing the rest of the crypto market down dramatically further in many instances. And this is despite the fact Musk, overall, has long held a positive view on the outlook for Bitcoin and crypto.

According to many technical analysts, however, the market was heading for a dip irrespective of Elon-induced FUD (Fear Uncertainty and Doubt). It was all apparently right there for anyone to see in the natural gravitational pull of the charts, the “Wyckoff patterns”, the “Pi Cycle Top” indicator, and probably the tea leaves, too.

One thing that Elon Musk doesn’t seem to waver on, however, is his love affair with Dogecoin (DOGE), which is also the beneficiary of wild price swings based on the whims of the billionaire and his thumbs.

This year, the Tesla CEO has made it clear in numerous tweets, interviews, and even a Saturday Night Live hosting appearance that DOGE is his favourite crypto. If only for the memes.

 

The China crackdowns

On top of the Elon effect, China, previously one of the world’s biggest crypto markets, decided to get in on the buzzkill act in May and June by banning cryptocurrency mining in the country and restricting all crypto trading by its financial institutions and citizens.

This prompted a crypto mining-business exodus out of China, dispersing to neighbouring central Asian countries such as Kazakhstan and then on to North America. And it also triggered further crypto price stagnation, with Bitcoin dipping just under US$30K in mid July.

China then went a step further in September, announcing what is tantamount to a full-on ban for most crypto activities in the nation. That said, there have been some pretty clear signs that even a determined authoritarian state may never be able to completely control Bitcoin and crypto usage.

With surges in decentralised exchange usage since centralised crypto exchanges have ceased trading in China, it’s suspected many Chinese citizens are still finding ways to stay in the market.

Bitcoin and crypto have been recovering in stages since these bans and many crypto proponents believe there are net positives to be found in both the Elon-highlighted Bitcoin environmental concerns and even in the China crackdowns.

In the wake of the Chinese mining ban, for instance, MicroStrategy’s Michael Saylor and Elon Musk announced the formation of the Bitcoin Mining Council, which has a focus on pushing the crypto mining industry further into sustainable energy usage.

In fact, Elon Musk has said that if it can be proven that more than 50% of Bitcoin mining is achieved by renewable energy, then Tesla would begin accepting BTC as a payment method once again. According to Michael Saylor, that 50% was achieved some time ago, in the first half of 2021.

As for Chinese mining movements, the dispersing of mining activities away from the dominance of one economic region might be viewed as ultimately a good thing for bolstering the decentralisation of the Bitcoin network and effecting a fairer distribution of hashing power geographically.

 

El Salvador and Latin America’s Bitcoin push

As of September 7 2021, El Salvador has become the first country in the world to make Bitcoin legal tender, which can now be used as an option in addition to the country’s main currency – the US dollar.

The country’s president, Nayib Bukele, used the Bitcoin 2021 conference in Miami to announce this goal to the world via a video-recorded message in June. Politicians then put the bill to vote and the law was passed in double quick time, although not everyone in the country is happy about their president’s plan to turn El Salvador into a Bitcoin paradise.

Why has El Salvador done this? Probably the biggest reason is Bukele’s aim to independently stabilise his country’s economy, which has been at the mercy of the performance of a consistently weakening US dollar being printed to excessive levels by the US Federal Reserve.

Another motive reportedly stems from Bukele’s desire to “bank the unbanked” and increase financial inclusion for his citizens. El Salvador is a country where 70 per cent of the population has no access to banking or borrowing facilities. To quote a common crypto catch cry: “Bitcoin fixes this”.

And then there’s the fact that Bitcoin can completely cut out the extreme middleman (we’re looking at you, Western Union) fees for remittances. Financial service institutions take roughly a 30 per cent cut of cross-border money transfers from workers employed in, say the US, sending their funds back home to poorer countries. Bitcoin fixes this, too.

Other Latin American countries now looking to either follow El Salvador’s lead, or at least increase involvement with Bitcoin and cryptocurrencies, include Panama, Brazil, Argentina Paraguay, Uruguay and Colombia. The Pacific Islands nation Tonga is showing interest, too.

Venezuela, meanwhile has had a high usage of cryptocurrencies for some time. According to blockchain intelligence firm Chainalysis, the South American nation has one of the highest levels of everyday crypto usage in the world. This is due to hyperinflation pulverising its own national currency, the bolivar.

 

The development of CBDCs

Following in China’s footsteps, several nations this year have been reportedly ramping up efforts to create guidelines for Central Bank Digital Currencies (CBDCs) in order to put them to trial before rollout.

Not to be confused with the digital currencies the majority of the crypto world covets, CBDCs are digital versions of nations’ national fiat currencies.

China is well ahead of the game here with the development of its digital yuan, which it has been gradually rolling out nationally in 2021.

There have been CBDC pilots in parts of Europe, such as France and Switzerland, and in the Bahamas this year as well. Most recently, Nigeria and Singapore have been making moves in this regard, too, with the latter shortlisting 15 “Global CBDC Challenge” participants to help build an in-house retail CBDC.

And Australia’s Reserve Bank is reportedly involved in a joint initiative called “Project Dunbar” with the central banks of Singapore, Malaysia and South Africa, to trial international settlements using CBDCs.

CBDCs, although seemingly inevitable, are generally treated with suspicion and scepticism from much of the libertarian, freedom-loving cryptoverse, or indeed with anyone who views them as a tool for further government control.

 

The regulators

Another narrative that’s come to the fore in 2021 is the increasing regulatory scrutiny on the crypto industry, particularly in America, the world’s leading economy.

Led by the US Securities and Exchange Commission and its Chairman Gary Gensler, regulators are now targeting almost every cryptocurrency except Bitcoin and have been asking politicians for more power to police and regulate the cryptocurrency industry in general, including DeFi.

Given the less-than-positive crypto stance of certain powerful politicians in the US, such as Democratic Senator Elizabeth Warren, and Treasury Secretary Janet Yellen, it would seem likely that the SEC will be granted certain regulatory powers it needs to try to keep on top of crypto and its users. All under the guise of investor protection.

The SEC contends that most cryptos should be classified as securities and therefore fall under its tight framework of regulation. The reason Bitcoin is excluded from this is because it does not have any single entity that is leading investors to expect profit from buying BTC. There is no third party involved with Bitcoin that can possibly be singled out to gain from investor profits.

The SEC vs XRP

A cryptocurrency such as XRP, on the other hand, could in theory be classified as a security simply because anyone invested in XRP is expecting profits based on the actions of Ripple Labs, the company behind XRP.

And, in fact, this is the subject of an ongoing lawsuit levelled at Ripple Labs by the SEC, which contends that the XRP founders broke the law by selling the asset without first registering it as a security.

Ripple Labs’ defence is based on its belief that it, and XRP, is sufficiently decentralised to not meet the SEC’s security criteria.

How this legal drama plays out is important to the future of the crypto space and will affect how every cryptocurrency is regulated and treated into the future. The lawsuit is not likely expected to reach a resolution, however, until sometime in early 2022.

Stablecoins in their sights

Senator Warren, meanwhile, has a bee in her pretty full bonnet about stablecoins, recently commenting in a New York Times interview that, in her view, “it’s worth considering” banning US banks from holding the reserves to back private stablecoins. A move that she believes “could effectively end the surging [stablecoin] market.”

Stablecoins have developed over the past two years as a hugely important and highly traded sector of cryptocurrency.

Pegged to external assets, such as the US dollar or a commodity such as gold, stablecoins effectively offer a solution to the volatility risk of cryptos, offering a fast and reliable option for traders and investors to move their crypto positions into “stable” digital assets with low volatility.

In mid-July, US Treasury Secretary Janet Yellen called on financial authorities to establish a proper regulatory framework for stablecoins.

The Australian regulatory landscape

Australia’s position on cryptocurrencies and blockchain technology meanwhile has, for the most part been pretty encouraging in the past couple of years.

The government has even committed significant funding towards innovation and growth in the space, with initiatives such as its Blockchain Pilot Grants as well as forking out $60 million worth of funding for the country’s Digital Finance Cooperative Research Centre.

And, while Steve Vallas, the head of the country’s peak crypto industry body Blockchain Australia, believes the government could be doing more to engage on the topic of regulatory clarity, Senate conversations at least seem to be attempting to find constructive paths ahead.

As it stands, crypto trading is legal within Australia and is subject to capital gains taxation (CGT), with various stipulations pertaining to staking, airdrops, mining and more.

Cryptocurrencies had previously been subject to a controversial double-taxation law in Australia, but the change in this policy shows the government’s overall progressive and adaptable approach to crypto so far.

CoinJar has put together an excellent, comprehensive guide to crypto taxation in Australia, which you can read here.

 

The US taxation complication

When it takes breaks from aping into animal-themed NFT avatars and pixelated punks, the crypto world still keeps half a concerned eye on exactly how the US plans to treat crypto regulations and taxation.

A controversial crypto-related amendment to the trillion-dollar US infrastructure bill has currently been pushed through the US Senate and is awaiting passage through the House of Representatives.

The TLDR on that is: if passed and signed off by President Biden, it’s an amendment that could place stifling taxation implications on the cryptocurrency industry in America due to its extremely vague classification of “crypto brokers”.

It could, for instance, make operating mining pools and DeFi protocols in the US untenable as collecting KYC (Know Your Customer) information on everyone the protocols interact with, would be virtually an impossible task.

If the infrastructure bill passes as is, the crypto-related section could result in one big wet blanket being thrown over US-led innovation in the space. There are fears that it could force US crypto and blockchain businesses to relocate offshore to other countries, such as Singapore or Switzerland, and provide a major setback to the industry as a whole.

That said, as SEC commissioner Hester Peirce (aka “Crypto Mom”) hinted in early August, the best path forward for crypto projects in the US is to set up from inception as being truly decentralised – like Bitcoin.

“If you want to be decentralised, you really need to be decentralised,” Peirce told crypto media channel The Defiant. “That is going to put you in a different category from the perspective of regulators because that’s just not something we’ve dealt with before.”

 

When ETF?

One boost the SEC could actually give the crypto market, and potentially as early as this month, is the long-awaited approval of a Bitcoin ETF (Exchange Traded Fund) in the US.

A Bitcoin ETF might be seen as a coming-of-age moment for the cryptocurrency industry in the US. It could do wonders for the perception of Bitcoin and crypto as a legitimate investment, bringing a new level of mainstream trustworthiness, potentially instigating another new wave of money to flood into Bitcoin and, by proxy, the wider crypto market. Well, that’s the theory.

It seems, however, that although “physically backed” spot-market Bitcoin ETFs are operating in Canada and parts of Europe, the type of Bitcoin ETF likely to be approved in the US will initially be CME Futures-backed. At least, this is what market participants have taken from recent comments from SEC Chairman Gary Gensler regarding the matter.

This may not have the desired price-booming effect that many have been hoping for from a crypto ETF.

Physically-backed Bitcoin ETFs require the fund to buy the Bitcoin and store it with a custodian, removing it from circulation.

This would not be the case with a futures-backed Bitcoin ETF, which would be backed effectively by “IOU” agreements that don’t necessarily reflect the performance of the spot Bitcoin price.

That said, even a futures-backed Bitcoin ETF has potential to be a positive step forward for the cryptocurrency industry. And, according to some market participants, it may be a required one on the path to the eventual approval of a spot-backed product that the likes of ProShares, Valkyrie, Galaxy Digital, VanEck and many others crypto-investment players have been craving for a good couple of years now.

 

What’s next for crypto?

crypto guide

Irrespective of  regulators muddying the waters in the US and elsewhere, there are many positive signs for the continued growth of the crypto industry globally, as it moves further into the mainstream.

Bitcoin’s case as an inflationary hedge and store of value continues to grow, particularly in countries affected by economic hardship.

Layer 1 blockchain projects such as Ethereum, Cardano, Solana, Avalanche and more are hitting important roadmap targets and are building momentum by the day.

Layer 2 scaling solutions for Ethereum, such as Arbitrum and Optimism are coming to the fore, strengthening its case further as the leading smart-contract platform and one of the most important pieces of infrastructure for the next generation of the internet.

And blockchain-based games are building strongly and could form the sector that truly brings mass-market adoption to crypto. Several influencers and notable crypto figures believe this, including Tron‘s Justin Sun, who said in late August: “GameFi is going to be the next big thing that makes the DeFi, NFT, and larger crypto space easy to understand and be involved in.”

You only need to look at the success of play-to-earn phenomenon Axie Infinity this year to understand where that could go. People in the Philippines, for example, have been giving up their day jobs to focus on grinding out gaming time on Axie Infinity, due to its potential to net them far more than an average salary.

And this is only the first major play-to-earn gaming cab off the rank, too. Others, such as the buzzy Star Atlas and Illuvium metaverse games have been attracting serious attention and investment, even in the early stages of their development.

Meanwhile, IDOs (Initial DEX Offerings) and launchpads have overtaken ICOs as the new way for fledgling crypto projects to hit the market and, like at the peak of the ICO boom/bubble, there are a spate of new tokens launching every week.

On top of all that, the NFT (non-fungible token) and DeFi sectors have been booming again in the latter half of 2021, too, in terms of volume traded and Total Value Locked respectively.

It’s enough to make any seasoned crypto veteran prettty wary, however, as we head towards the end of the year. Memories of the great crypto blow-off top of January 2018 and brutal bear market that followed still linger with long-term crypto investors.


Is the NFT boom sustainable?

The spike in sales of NFTs (nonfungible tokens) and NFT-related projects in 2021 has mirrored the DeFi mania of 2020 for its frenzy.

The year has seen eye-watering valuations and sales (notably Beeple’s piece Everyday: The First 5,000 Days, which sold through Christie’s in March for more than $US69 million), plus celebrities such as Jay-Z, Tom Brady, Snoop Dogg, Mike Tyson, Gary Vaynerchuk and countless more participating in NFT buying and trading.

Even Visa recently bought a CryptoPunk for US$150K, which is nothing compared to the millions of dollars some NFTs have been trading for.

crypto guide
One of the cleaner bits of NFT spam sent to Visa’s public Ethereum address.

 

But a question still worth posing is: after countless profile-pic avatars and generative AI art projects have flooded the market this year, causing Ethereum network clogging and surging gas fees… have we reached saturation point on NFTs?

Our answer is: like crypto in general, the NFT space will continue to innovate and surprise, will continue to expand into the mainstream and beyond Ethereum to other blockchains, as it’s been doing with Solana, and will likely continue to spew out crap and quality in near equal measures.

But, as a sub-section of crypto, it’s the view of many that NFTs will remain a powerful force within the space – especially as they continue to intertwine with the mass-market-attracting world of gaming, metaverse, sport, art, music and film.

As CurrencyWorks executive chairman Cameron Chell told Stockhead in August:

“I see [NFTs] as part of the blockchain revolution. So, like how email was the first killer application for the internet… for blockchain, the first killer app was cryptocurrencies. And I think the second killer app is NFTs in the form of digital collectibles.

“But NFTs will end up being much broader than that. They’ll drive down into contract management, legal documents and so much more – the sky’s the limit.”

 

Bold predictions

While Stockhead isn’t in the habit of making $500K+ crypto predictions, a la Ark Invest CEO Cathie Wood, (at least not publicly), there are plenty of industry luminaries and influencers who regularly do…

The “Flippening”

Nigel Green, chief executive and founder of UAE-based deVere Group, for instance, has been pushing the case for the “Flippening”, which describes a hypothetical moment when the total market cap of Ethereum passes the total market cap of Bitcoin.

Pointing to a combination of Ethereum’s smart-contract utility, vast network effect, and 2.0 Proof-of-Stake upgrade set to come into effect in early 2022, Green recently commented:

“Ethereum is more useful than Bitcoin… Ultimately, this will mean its value will exceed that of Bitcoin – probably within five years.”

Adding further speculative weight to the Flippening narrative for Ethereum fans is something known as the “Triple Halving” – an extreme “supply shock” that will supposedly set in motion sell pressure for Ethereum that will be the equivalent to three Bitcoin halving events.

Ethereum’s gas-fee-burning protocol EIP-1559 implemented in August, combined with the merge to Ethereum 2.0 and the integration of scaling solutions such as Optimism and Arbitrum, are factors that could supposedly create the perfect storm for the Triple Halving and for Ethereum to become a truly deflationary asset.

As for specific Ethereum price predictions, a Finder panel of 27 experts gave their thoughts in July, with their resulting average price being US$4,596 per ETH by 31 December 2021.

Their average price for 2025 was US$17,810, and US$71,763 by the end of 2030.

 

A billion-dollar Bitcoin?

If Flippenings, Triple Halvings and ETH in excess of US$70,000 sounds crazy bullish to you, check out one of the world’s biggest asset manager’s most recent ultimate Bitcoin price prediction.

Fidelity Investments has predicted a… wait for it… one billion dollar Bitcoin by 2038…

crypto guide

Sure, that’s 17 years away, so maybe don’t go picking out the colour of your Lambo just yet, but it’s certainly the most outlandish long-term prediction we’ve seen to date.

It appears to be an extension of PlanB’s famed Stock to Flow (S2F) model that is often referenced within crypto and has so far proven pretty accurate.

If Bitcoin does continue to roughly follow the S2F model, it could mean a Bitcoin price in the vicinity of US$135,000 by the end of the year. And that’s something that looked close to being out of the question a few short months ago when the price was dipping below US$30K.

The crypto market loves a good prediction, though, and loves getting ahead of itself. At the time of writing Bitcoin is taking a shot at turning US$56K into support. It’s really not too far off it’s all-time high right now, but there’s still a way to go to hit the magical US$100K mark.

We certainly wouldn’t want to bet against it, or PlanB’s model, for that matter.

 

Popular cryptos

As previously mentioned, there are more than 9,600 cryptocurrency projects to look into if you have a spare hundred hours or so up your sleeve to scroll through CoinGecko or CoinMarketCap.

With good fundamental research, you might even find the odd low, or even micro market-cap gem within those lists. Here, however, is a selection of some of the more well-established cryptocurrencies and their historical price charts.

 

Bitcoin (BTC) #1

The original cryptocurrency – a peer-to-peer network of nodes that maintain a blockchain-based distributed ledger of BTC balances. Established in 2009, Bitcoin pioneered the Proof-of-Work (PoW) technology for reaching consensus on a decentralised network. Bitcoin is considered a “store of value” by its proponents.

crypto guide
Source: CoinMarketCap

 

Ethereum (ETH) #2
An open-source, decentralised, blockchain infrastructure transitioning from a Proof-of-Work protocol to Proof-of-Stake. Launched in 2015, Ethereum has become a vast ecosystem of interoperable decentralised applications (dApps) powered by automated smart contracts. Ethereum is the no.2 crypto by market cap, and is hugely important to the industry for its innovation, which includes helping to spawn DeFi, stablecoins and NFTs.

crypto guide
Source: CoinMarketCap

 

Cardano (ADA) #3

Number three by market-cap, Cardano is a Proof-of-Stake smart-contract platform competitor to the more widely used Ethereum. Built from the ground up by Charles Hoskinson’s IOHK company, the project is notable for its academic and peer-reviewed approach to development.

crypto guide
Source: CoinMarketCap

 

Bitcoin Cash (BCH) #19

Don’t make the mistake that this is Bitcoin. BCH is a “hard fork” of the Bitcoin network and a completely different crypto in its own right. It pitches itself as a more practical, transactional cryptocurrency than BTC.

crypto guide
Source: CoinMarketCap

 

Litecoin (LTC) #13

Introduced in 2011 by Charlie Lee, Litecoin is forked from Bitcoin’s code but is optimised for lower cost transactions. Along with Bitcoin, Ethereum and Bitcoin Cash, it is one of the cryptocurrencies so far favoured for transactional usage on PayPal.

Source: CoinMarketCap

 

Solana (SOL) #7

Solana is a high-performance, high-speed Proof-of-History smart-contract blockchain that aims to solve many of the scaling and congestion issues potentially faced by other networks. Solana began gaining traction and high volume of usage in July and August, especially in the realm of NFTs, offering a cheaper and faster transactional alternative to Ethereum.

Source: CoinMarketCap

 

Polkadot (DOT) #8

Polkadot is a Nominated-Proof-of-Stake (NPoS) smart-contract blockchain protocol founded by former Ethereum co-founder Dr Gavin Wood. One of its core aims is to allow independent blockchain networks to connect and transfer data through cross-chain interoperability.

Source: CoinMarketCap

 

Avalanche (AVAX) #15

Avalanche self describes as “the fastest smart contracts platform in the blockchain industry, as measured by time-to-finality, and has the most validators securing its activity of any proof-of-stake protocol.”

Source: CoinMarketCap

 

Uniswap (UNI) #12

A decentralized exchange (DEX) and Automated Market Maker (AMM) that is used to exchange cryptocurrencies on the Ethereum blockchain through the use of smart contracts and without centralised intermediaries.

Source: CoinMarketCap

 

Polygon (MATIC) #21

Polygon, formerly known as the Matic Network, is an Ethereum-based scaling solution and sidechain framework for building and connecting Ethereum-compatible blockchain networks. 

Source: CoinMarketCap

 

Aave (AAVE) #45

A DeFi “blue chip” coin, Aave is a decentralised lending and borrowing platform built on Ethereum. Users can take out loans by providing crypto asset collateral. Lenders who provide collateral to Aave receive aTokens, which pay interest to the holder with funds earned from platform trading fees.

Source: CoinMarketCap

 

Synthetix (SNX) #89

Synthetix is a DeFi protocol and token-trading platform built on Ethereum that allows users to exchange tokenised “synthetic” representations and derivatives of cryptocurrencies, stocks, currencies, precious metals, and other assets in the form of ERC-20 (Ethereum-based) tokens.

Source: CoinMarketCap

 

The Graph (GRT) #50

The Graph is an open-source protocol designed to index and query data from blockchains to facilitate information retrieval. In simple terms, it’s sometimes referred to as “Google for blockchain”. Its native cryptocurrency, GRT, is a utility token used to ensure the integrity of the stored data and reward the network’s indexer, curator and delegator participants.

Source: CoinMarketCap

 

Axie Infinity (AXS) #28

A metaverse crypto in which players collect and breed digital pets called Axies that can be used to compete in a turn-based battler game. Axies can also be bred and sold.

Source: CoinMarketCap

 

XRP (XRP) #6
A cryptocurrency created by Ripple Labs, designed primarily as a medium of exchange and a low-cost bridge between fiat currencies for a range of fast and seamless global transactions.

Source: CoinMarketCap

 

Binance Coin (BNB) #4
The native cryptocurrency of the Binance Smart Chain (BSC) smart-contract blockchain ecosystem and, at the time of writing, a top 5 crypto by market capitalisation.

Source: CoinMarketCap

 

Chainlink (LINK) #18

A decentralised “oracle” network that provides real-world data to smart contracts on the blockchain. There are other oracles, but LINK is important as it is the first innovator in this area of crypto/blockchain and, like Ethereum has the “network effect” as the most widely used.

Source: CoinMarketCap

 

Dogecoin (DOGE) #10

A crypto “memecoin” that began life as a joke in 2013, but, incredibly, is now a top 10 crypto by market cap and a pet project of Elon Musk. It’s based on a Shiba Inu dog meme that was initially popular around the time of the crypto’s creation. Dogecoin was forked from something called Lucky Coin, which was forked from Litecoin, which was forked from Bitcoin. A fair bit of forking around going on there.

Source: CoinMarketCap

 

 

 

The post THE COMPLETE CRYPTO GUIDE: Where it’s been, where it’s at, where it’s heading appeared first on Stockhead.

Precious Metals

Bitcoin Soars to Highest in 5 Months as Correlation With Gold Turns Negative

The price of bitcoin hit the highest in over five months, as an increasing number of traders dived into the
The post Bitcoin Soars to Highest in 5 Months…

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The price of bitcoin hit the highest in over five months, as an increasing number of traders dived into the cryptocurrency in hopes that it would once again soar to the record highs witnessed earlier this year.

Bitcoin was up by more than 1% on Tuesday morning before settling to just above $56,000, marking a weekly gain of over 15% and the highest since May. The latest rally is the result of a number of factors, particularly the fading of concerns regarding regulatory efforts in the US and China, as well as the SEC potentially approving the first bitcoin ETF.

In the meantime, according to Ned Davis Research strategist Pat Tschosik, the one-year correlation between gold and bitcoin has been steadily declining, and is about to turn negative, suggesting that the prices are no longer moving in unison. “Bitcoin could be seen as the preferred inflation hedge if the dollar and real rates are rising,” Tschosik told CNBC.


Information for this briefing was found via CNBC. The author has no securities or affiliations related to this organization. Not a recommendation to buy or sell. Always do additional research and consult a professional before purchasing a security. The author holds no licenses.

The post Bitcoin Soars to Highest in 5 Months as Correlation With Gold Turns Negative appeared first on the deep dive.

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Economics

Stocks Stink As Curve Pancakes On Stagflation Fears

Stocks Stink As Curve Pancakes On Stagflation Fears

It was another choppy day in the market which saw an overnight attempt to recover from…

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Stocks Stink As Curve Pancakes On Stagflation Fears

It was another choppy day in the market which saw an overnight attempt to recover from losses get sabotaged at the open when a sell program knocked spoos lower and the result was a rangebound, directionless grind for the rest of the day as the continued pressure of negative gamma prevented a move higher, and since they couldn't rise, stocks sold off closing near session lows. 

Granted, there was the usual chaos in the last 30 minutes of trading, when a huge sell program was followed by an almost identical buy program...

... but it was too little too late to save stocks from another down day.

While the Russell, energy stocks and banks managed to bounce and drifted in the green for much of the day - perhaps as investors looked forward to good news from JPMorgan tomorrow when the largest US bank kicks off earnings season - the rest of the market did poorly with most other sectors in the red.

Earlier today we noted that the SPY remains anchored by two massive gamma levels, 430 on the downside and 440 on the upside...

... however that may soon change. As SoFi strategist Liz Young pointed out, "It's been 27 trading days since we hit a new high on the S&P 500. The last time we went this long was...exactly this time last year. New highs happened on Sept 2nd, both years, before a pause."

In rates we saw a sharp flattening with another harrowing CPI print on deck tomorrow which many expect to roundly beat expectations...

... with the short end rising by 3bps, a move that was aided by a poor 3Y auction which saw a slump in the bid to cover and a plunge in Indirect takedown, while the long end tightened notably, and 10Y yields on pace to close 4bps lower.

The dollar went nowhere, and while oil tried an early break out and Brent briefly topped $84, the resistance proved too much for now and the black gold settled down 31 cents for the day at 83.34 although WTI did close up 4 cents, and above $80 again, at $80.54 to be precise. Still, with commodity prices on a tear, it's just a matter of day before Brent's $86 high from October 2018 is taken out.

With stocks failing to make a new high in over a month, investor sentiment has predictably soured with AAII Bulls down to the second lowest of 2021, while Bearish sentiment continues to rise.

There is another reason sentiment has been in the doldrums: traders are concerned that price pressures and supply-chain snarls will drain corporate profits and growth, and expect disappointment from the coming earnings season which according to Wall Street banks will be a far more subdued affair compared to the euphoria observed in Q1 and Q2.  Quarterly guidance, which improved in the runup to the past four reporting periods, is now deteriorating, with analysts projecting profits at S&P 500 firms will climb just 28% Y/Y to $49 a share. That’s down from an eye-popping clip of 94% in the previous quarter.

Meanwhile, adding to the downbeat mood, Atlanta Fed President Raphael Bostic finally admitted that inflation is not transitory, and the Fed should proceed with a November taper amid growing fears that inflation expectations could get unanchored. Earlier in the day was saw that 3Y consumer inflation expectations hit a record high 4.3% confirming that the Fed is on the verge of losing control.

Vice Chair Richard Clarida agreed and said that conditions required to begin tapering the bond-buying program have “all but been met.”

Finally, the IMF delivered more bad news today when it cut its global GDP forecast while warning that inflation could spike, and cautioned about a risk of sudden and steep declines in global equity prices and home values if global central banks rapidly withdraw the support they’ve provided during the pandemic. In short, the world remains trapped in a fake market of the Fed's own creation.

Tyler Durden Tue, 10/12/2021 - 16:02
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Economics

The funding challenges ahead

This article looks at the Fed’s funding challenges in the US’s new fiscal year, which commenced on 1 October.There are three categories of buyer for…

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This article looks at the Fed’s funding challenges in the US’s new fiscal year, which commenced on 1 October.

There are three categories of buyer for US Federal debt: the financial and non-financial private sector, foreigners, and the Fed. The banks in the financial sector have limited capacity to expand bank credit, and American consumers are being encouraged to spend, not save. Except for a few governments, foreigners are already reducing their proportion of outstanding federal debt. That leaves the Fed. But the Fed recently committed to taper quantitative easing, and it cannot be seen to directly monetise government debt.

That is one aspect of the problem. Another is the impending rise in interest rates, related to non-transient, runaway price inflation. Funding any term debt in a rising interest rate environment is going to be considerably more difficult than when the underlying trend is for falling yields. There is the additional risk that foreigners overloaded with dollars and dollar-denominated financial assets are more likely to become sellers.

Not only are foreigners overloaded with dollars and financial assets, but with bond yields rising and stock prices falling, foreigners for whom over-exposure to dollars is a speculative position going wrong will undoubtedly liquidate dollar assets and dollars. If not buying their own national currencies, they will stockpile commodities and energy for production, and precious metals as currency hedges instead.

The Fed will be faced with a bad choice: protect financial asset values and not the dollar or protect the dollar irrespective of the consequences for financial asset values. And the Federal Government’s deficit must be funded. The likely compromise of these conflicting objectives leads to the risk of failing to achieve any of them.

Other major central banks face a similar quandary. Funding ballooning government deficits is about to get considerably more difficult everywhere.


Introduction

Our headline chart in Figure 1 shows the excess liquidity in the US economy that is being absorbed by the Fed through reverse repos (RRPs). With a reverse repo, the Fed lends collateral (in this case US Treasuries overnight from its balance sheet) to eligible counterparties in exchange for overnight funds, which are withdrawn from public circulation. As of last night (6 October), total RRPs stood at $1,451bn, being the excess liquidity in the financial system with interest rates set by the RRP rate of 0.05%. Simply put, if the Fed did not offer to take this liquidity out of public circulation, overnight dollar money market rates would probably become negative.

The chart runs from 31 December 2019 to cover the period including the Fed’s reduction of its funds rate to the zero bound and the commencement of quantitative easing to the tune of $120bn every month —they were announced on 19th and 23rd March 2020 respectively. Other than the brief spike in RRPs at that time which was a wobble to be expected as the market adjusted to the zero bound, RRPs remained broadly at zero for a full year, only beginning a sustained increase last March.

Much of the excess liquidity absorbed by RRPs arises from government spending not immediately offset by bond sales. Figure 2 shows how this is reflected in the government’s general account at the Fed. The US Treasury’s balance at the Fed represents money not in public circulation. It is therefore latent monetary inflation, which is released into the economy as it is spent. Since March 2021, the balance on this account fell by about $800bn, while reverse repos have risen by about $1,400bn, still leaving a significant balance of liquidity to be absorbed arising from other factors, the most significant of which is likely to be seepage into the wider economy from quantitative easing (over two trillion so far and still counting).




The US Treasury has draw down on its general account because had it accumulated balances from bond funding in excess of its spending ahead of the initial covid lockdown. And its debt ceiling was getting closer, which is currently being renegotiated. But this is only part of the story, with the Federal deficit running at about $3 trillion in the fiscal year just ended.

That is a huge amount of government “fiscal stimulus”, and clearly, the private sector is having difficulty absorbing it all. The scale of this deficit, debt ceilings aside, is set to increase under the Biden administration. If the US economy is already drowning in dollars, it is likely to worsen.

Assuming the debt ceiling negotiations raise the Treasury borrowing limit, the baseline deficit for the new fiscal year must be another $3 trillion. Optimists in the government’s camp have looked for economic recovery to increase tax revenues to reduce this deficit enough together with selective tax increases to allow the government to invest additional capital funds in the crumbling national infrastructure. A more realistic assessment is that unexpected supply disruption of nearly all goods and rising production costs are eating into the recovery, which is now faltering. And it is raising costs for the government in its mandated spending even above the most recent assumptions. It is increasingly difficult to see how the budget deficit will not increase above that $3 trillion baseline.

This article looks at the funding issues in the new fiscal year following the expected resolution of the debt ceiling issue. The principal problems are its scale, how it will be funded, and the impact of price inflation and its effect on interest rates.

Assessing the scale of the funding problem

There are three distinct sources for this funding: the Fed, foreign investors, and the private sector, which includes financial and non-financial businesses. Figure 3 shows how the ownership of Treasury stock in these categories has progressed over the last ten years and the sum of these funding sources up to the mid-point of the last US fiscal year (31 March 2021). Over that time total Treasury debt more than doubled to nearly $30 trillion.


The funding of further debt expansion from these levels is likely to be a significant challenge. Initially, the Fed can release funds by reducing the level of overnight RRPs, some of which will become absorbed directly, or indirectly, in Treasury funding. But after that financing will become more problematic.

Since 2011, the Fed’s holdings of US Treasury debt have increased from 11% to 19% of the growing total, reflecting QE particularly since March 2020. At the same time the proportion of total Treasury debt owned by foreign investors has fallen from 32% to 24% today, and now that they are highly exposed to dollars, they could be reluctant to increase their share again, despite continuing trade deficits. Private sector investors, whose share of the total at 57% is virtually unchanged from ten years ago, can only expand their ownership by increasing their savings and through the expansion of bank credit. But with bank balance sheets lacking room for further credit expansion and consumers inclined to spend rather than save, it is difficult to envisage this ratio increasing sufficiently as well.

Clearly, the Fed has been instrumental in filling the funding gap. But the Fed has now said it intends to taper its bond purchases. Unless foreign investors step in, the Fed will be unable to taper. Excess liquidity currently reflected in outstanding RRPs can be expected to be mostly absorbed by expanding T-bill and short-maturity T-bond funding, which might buy three- or four-months’ funding time and not permit much longer-term bond issuance. But after that, the Fed may be unable to taper QE.

Foreign funding problems

While we cannot be privy to the bimonthly meetings of central bankers at the Bank for International Settlements and at other forums, we can be certain that there is a higher level of monetary policy cooperation between the major central banks than is generally admitted publicly. On matters such as interest rate policy it is important that there is a degree of cooperation, otherwise there could be instability on the foreign exchanges. And to support the dollar’s debasement, policy agreements between important foreign central banks may need to be considered.

This is because the dollar’s role as the reserve currency gives the US Government and its banks not just an advantage of seigniorage over the American people, but over foreign holders of dollars as well. Dollar M1 money supply is currently $19.7 trillion, approximately 50% of global M1 money stock.[i] Therefore, its seigniorage and the world-wide Cantillon effect from increasing public circulation is of great advantage to the US Government, not only over its own people but in transferring wealth from foreign nations as well. This is particularly to the disadvantage of any other national government which, following sounder monetary policies, does not expand its own currency stock at a similar rate while being forced to use dollars for international transactions.

Ensuring currency debasement globally is therefore a compelling reason behind monetary cooperation between governments. By agreeing on permanent currency swap lines with five major central banks (the ECB, the Bank of Japan, the Bank of England, the Bank of Canada, and the Swiss National Bank) they are drawn into supporting a global inflationary arrangement which ensures the stock of dollars can be expanded without consequences on the foreign exchanges.

Ahead of its massive monetary expansion on 19 March 2020, to keep other central banks onside temporary swap arrangements were extended to nine other central banks, ensuring their compliance as well.[ii] But notable by their absence were the central banks whose governments are members and associates of the Shanghai Cooperation Organisation, which will have found that their dollar holdings and financial assets (mainly US Treasuries) have been devalued without consultation or recompense.

It is therefore not surprising that foreign governments other than those with permanent swap lines are increasingly reluctant to add to their holdings of dollars and US Treasuries. By selectively excluding major nations such as China from swap line arrangements, by default the Fed is pursuing a political agenda with respect to its currency. International acceptability of the dollar is being undermined thereby when the US Treasury is becoming increasingly desperate for inward capital flows to fund its budget deficits.

Even including allied governments, all foreigners are now reducing their exposure to US dollar bank deposits, by 12.9% between 1 January 2020 and end-July 2021, and to US T-Bills and certificates by 20.7% over the same period. The only reason for holding onto longer-term assets is in expectation of speculative gains.

The situation for longer-term Treasury bonds is not encouraging. The US Treasury’s “major foreign holders” list of holders of longer-maturity Treasury securities, shows the list to be dominated by Japan and China, between them owning 31.5% of all foreign owned Treasuries. Japan’s cooperative relationship with the Fed was confirmed by Japan increasing her holdings of US Treasuries, but only by 1.3% in the year to July 2021, while China and Hong Kong, which between them hold a similar amount to Japan, reduced theirs by 3%.[iii] The ability of the US Treasury to find foreign buyers other than for relatively smaller amounts from offshore financial centres and oil producing nations therefore appears to be potentially limited.

We should also note that total financial assets and dollar cash held by foreigners already amounts to $32.78 trillion, roughly one and a half times US GDP — dangerously high by any measure. This total and its breakdown is shown in Table 1.


If foreign residents are to increase their holdings in US Treasuries, it is most easily achieved by foreign central banks on the permanent swap line list drawing them down and further subscribing to invest in T-Bills and similar short-term securities. As well as being obviously inflationary, that recourse has practical limitations without reciprocal action by the Fed. But a far greater danger to Federal government funding comes from dollar liquidation of existing debt and equity holdings, especially if interest rates begin to rise, bearing in mind that for any foreign holder of dollars without a strategic reason for holding a foreign currency, all such exposure, even holding dollars and dollar-denominated assets, is speculative in nature.

The question then arises as to what foreigners will buy when they sell their dollars. Governments without a strategic imperative may prefer at the margin to adjust their foreign reserves in favour of the other major currencies and gold. But out of the total liabilities shown in Table 1 official institutions only hold $4.284 trillion long- and short-term Treasuries, which includes China and Hong Kong’s holdings, out of the $7.2 trillion total shown in Figure 2 earlier in this article. The $3 trillion balance is owned by private sector foreign investors.

Excluding China and Hong Kong’s $1.3 trillion, US Treasury debt held by foreign governments is under 10% of all foreign holdings of dollar securities and cash. What is held by foreign private sector actors therefore matters considerably more, bearing in mind that it can all be classified as speculative, being a foreign currency imparting accounting risk to balance sheets and investment portfolios. If interest rates rise because of price inflation not proving to be transient, it will lead to significant investment losses and therefore selling of the dollar, triggering a widespread repatriation of global funds. A global increase in bond yields and falling equity values will also force sales of foreign securities by US investors. But with US investors being less exposed to foreign currencies in correspondent banks and with a significantly lower level of foreign investment exposure, the net capital flows would be to the disadvantage of the dollar.

Some of the proceeds from dollar liquidation by foreigners are likely to lead to commodity stockpiling and at the margin some of it will hedge into precious metals, driving their prices higher. The long-term suppression of precious metal prices would to come to an end.

Domestic problems for the Fed

Clearly, the resumption of government deficit funding will no longer be supported by foreign purchases of US Treasuries at a time when trade deficits remain stubbornly high. This throws the funding emphasis onto the Fed and domestic purchasers of government debt. But as stated above, the private sector will need to reduce its consumption to increase its savings. Alternatively, banks which have limited capacity to do so will have to expand credit to purchase Treasury bonds, which is not only inflationary, but diverts credit expansion from the private sector.

Consumers are charging in the opposite direction from increasing savings, drawing them down in favour of increased consumption. This is partly due to them returning to their pre-covid relationship between consumption and savings, and partly due to a shift against cash liquidity in favour of goods increasingly driven by expectations of higher prices. With their fingers firmly crossed, the latter is believed by central bankers and politicians to be a temporary phenomenon, the consequence of imbalances in the economy due to logistics failures. But the longer it persists, the more this view will turn out to be wishful thinking.

Increasing prices for energy and essential goods, which are notoriously under-recorded in the broader CPI statistics, are emerging as the major concern. So far, few observers appear to accept that they are the inevitable consequence of earlier currency debasement. There is a growing risk that when consumers realise that rising prices are not just a short-term and temporary phenomenon, they will increasingly buy the goods they may need in the future instead of buying them when they are needed. This alters the relation between cash liquidity-to-hand and goods, increasing the prices of goods measured in the declining currency. And so long as consumers expect prices to continue to rise, it is a process that is bound to accelerate until it is widely understood by the currency’s users that in exchange for goods, they must dispose of it entirely. If that point is reached, the currency will have failed completely.

It is this process that undermines the credibility of a fiat currency. Before it develops into a total rout, it can only be countered by an increase in interest rates sufficient to stop it, as well as by strictly limiting growth in the stock of currency. And even then, some form of convertibility into gold may be required to restore public trust.

This, the only cure for fiat currency instability, is too radical for the establishment to contemplate, and is a crisis that increases until it is properly addressed. The rise in interest rates exposes all the malinvestments that have grown and persisted while interest rates were suppressed from the 1980s onwards, finally ending at the zero bound.

The shock of widespread business failures due to rising interest rates will impact early in the currency’s decline when it becomes obvious that initial increases in interest rates will be followed by yet more. Importantly, the supply of essential goods is then further compromised by business failures instead of being alleviated by improving logistics. And consumer demand shifts even more in favour of the essentials in life and away from luxury and inessential spending. The poor are especially disadvantaged thereby and the middle classes begin to struggle.

The private sector’s growing economic woes further undermine government finances. Unemployment increases and tax revenues collapse, adding to the budget deficit and therefore to the government’s funding requirements. Mandatory costs increase more than budgeted. Interest charges, currently about $400bn, add yet more to the deficit.

Today, in all the major currencies control over interest rates by central banks is being challenged. Like the Fed, other major central banks are also insisting that rising prices are temporary, while markets are beginning to suspect the reality is otherwise. All empirical evidence and theories of money and credit scream at us that statist control over interest rates is being eroded and lost to market-driven outcomes.

The consequences for markets and government funding costs

There is growing evidence that accelerating monetary expansion in recent years is feeding into a purchasing power crisis for major currencies. Covid and logistics disruptions, coupled with lack of inventories due to the widespread practice of just-in-time manufacturing processes have undoubtedly made the situation considerably worse. But in the history of accelerating inflations, there have always been unexpected economic developments. Shifting consumer priorities expose hitherto unforeseen weaknesses, so it would be a mistake to disassociate these problems from currency debasements.

It is leading to a situation which confuses statist economists, who tend to think one-dimensionally about the relationships between prices and economic prospects. For them, rising prices are only a symptom of increasing demand. And so long as expansion of demand remains under control and is consistent with full employment, it is their policy objective. They do not appear to understand rising prices in a failing economy.

But classical economics and on the ground conditions militate otherwise. Inflation is monetary in origin, and it is the destruction of the currency’s purchasing power that is evidenced in rising prices. And when the public sees prices of needed goods rising at an increased pace, they begin to rid themselves of the currency. And far from stimulating production and consumption, high rates of monetary inflation act as an economic burden. Monetary policy now faces the dual challenge of rising prices and rising interest rates as the economy slumps. When central banks would expect to reduce interest rates, they will now be forced to increase them. When deficit spending is deployed to stimulate the economy, it must now be curtailed

Just when they matter most, bond yields will rise along their yield curves from the short end, and equity market values will be undermined by changing yield relationships.

Falling financial asset values become a consequence of earlier monetary inflation undermining a currency’s purchasing power. The Fed, the Bank of England, the Bank of Japan, and the ECB have all acted together to accommodate government budget deficits, to be funded as cheaply as possible by suppressing interest rates. That they have acted together has so far concealed the consequences from bond markets, whose participants only compare one government bond market with another instead of valuing bond risks on their own merits. And through regulation, banks have been made to view investment in government bonds as being risk-free for counterparty purposes.

All this is about to change with the turn in the interest rate trend. Monetary policy will have two basic options to weigh; between supporting the currency’s purchasing power by increasing interest rates, or to support financial markets by suppressing them. If the latter is deemed more important than the currency, it will most likely require more quantitative easing by the Fed, not less. Expressed another way, either central banks will pursue the current policy of maintaining domestic confidence and the wealth effect of elevated financial asset values and let the currency go hang. Alternatively, they can aim to support their currencies, and be prepared to preside over a collapse in financial asset values and accept the knock-on consequences.

It is a dirty choice, with either policy option likely to fail in its objective. The end of the neo-Keynesian statist road, which started out lauding the merits of deficit spending is in sight. Mathematical economics and the state theory of money are about to be shown for what they are — intellectualised wishful thinking. As the most distributed currency, the dollar is likely to lead the way for all the others, slavishly followed by the Bank of England, the Bank of Japan, and the ECB. And all their high-spending governments, addicted to debt, will face unexpected funding difficulties.



[i] See rankred.com/how-much-money-is-there-in-the-world

[ii] Reserve Bank of Australia, Banco Central do Brasil, the Danmarks Nationalbank, The bank of Korea, the Banco de Mexico, the Monetary Authority of Singapore and Sveriges Riksbank —all for up to $60bn each.

[iii] See US Treasury TIC figures









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