Bitcoin’s “Milkshake Moment”

• Dividend-paying cryptocurrencies?
• The Fed broke it, now it buys it
• Bitcoin’s “Milkshake Moment”

Dear Reader,

Welcome to our weekly mailbag edition of The Bleeding Edge. All week, you submitted your questions about the biggest trends in tech and biotech. Today, I’ll do my best to answer them.

If you have a question you’d like answered next week, be sure you submit it right here. I always enjoy hearing from you.

Dividend-paying cryptocurrencies?

Jeff,

I’m a Brownstone Unlimited subscriber. I’ve been hearing about “dividend” paying altcoins. I’m not sure what they are, but I understand some of them can make you money two ways–the dividend they pay and capital appreciation. What makes one a winner and another a loser? Will you be offering any suggestions in that arena? Thanks,

– Charles C.

Hi, Charles. I’d be happy to answer your question.

I believe what you’re referring to is something known as “staking.” And yes, users that stake their digital assets do receive payments, similar to a dividend. Here’s how it works…

We can think of a blockchain as a distributed ledger. These ledgers are typically immutable, decentralized, and transparent. In other words, nobody can change it, nobody “owns” it, and nobody can hide what they do with it.

In order to maintain this ledger, transactions must be verified by network participants. One of the ways blockchains do this is through something known as “proof-of-stake” (PoS).

PoS uses what’s known as “validators.” These are individuals who will “stake”—or lock up—their digital assets to help with these validations. The specifics will differ between blockchain projects. But at a high level, by staking, we are contributing to the network and helping to maintain it.

And as you mentioned, validators are compensated for this service in the form of payments (crypto dividends).

This is the beauty of a well-designed blockchain. There is no central entity—like a bank—that maintains this network. It is kept operational purely through the contributions of users.

And staking rewards can be quiet compelling. I’ve seen projects that will deliver a double-digit yield on staked assets.

Charles, if you are interested, my team has published research on this topic. Feel free to catch up here and here.

But I would mention that staking doesn’t come without its challenges.

Staking can be a technical process. For those investors that are not already familiar with digital assets and decentralized applications, the learning curve can be prohibitive. But there is also a middle ground for interested investors.

Centralized applications like Coinbase currently offer an “earn” feature for its customers. What Coinbase does is stake customer assets on their behalf. The exchange manages all the technical details and, in exchange, receive a portion of the staking rewards.

What this means is that Coinbase’s “earn” feature will deliver a lower yield compared to what we might see if we staked our own assets. But the process is as easy as clicking a few buttons. That convenience in exchange for a slightly lower yield is a fair trade off for most investors.

And I hope Coinbase can continue with this feature. But sadly, Coinbase’s “earn” service has recently come under the scrutiny of regulators (SEC). I’ll of course monitor the situation and keep readers informed as the situation plays out.

Is the Fed bad for investors?

Jeff,

I appreciate that you’ve reported on the SVB failure and fallout. Central banking is very confusing, and just this week I learned from you about currency swap lines. It seems like there is no end to the archaic system of manual levers, switches, and bandages.

On one hand, the BTFP is holding up prices of startup companies—many of which we hold across Brownstone portfolios. On the other hand, it seems that the BTFP would incentivize banks to take even more risk. Have the Fed’s actions been good or bad for main-street investors overall?

Best Regards,

– Joe B.

Hi, Joe. Thanks for being a reader and for your question. I would—and have—argued that the Fed’s actions over the past two years or so have been decidedly bad for investors and the public in general.

You mentioned the Bank Term Funding Program (BTFP). For the benefit of newer readers, this is an emergency lending program the Fed set up to provide emergency liquidity to the banks. At a high level, the program lets banks borrow against the par value of their bond holdings.

Just to be clear, the BTFP is supporting the banking system and ensuring that other banks don’t have a liquidity crisis. It doesn’t have anything to do with the prices of startup companies or anything in the Brownstone portfolios.

Here’s how the BTFP works. If a bank holds a bond that has a par value of $1,000, but has declined in value to $500, then the Fed will allow the bank to borrow as if that bond were still valued at $1,000. It can basically provide $1,000 of collateral in the form of a Treasury bond in exchange for $1,000 of cash.

And at least as of this writing, it appears that the BTFP has helped to stabilize the banks. But it’s worth pointing out that the only reason the banks would need an emergency program like this is because of the Fed’s own policies.

Jerome Powell—Chair of the Federal Reserve—was caught completely flat footed in 2021 when inflation started to rise. Powell famously referred to inflation as “transitory.” But of course, we know it wasn’t…

When rising inflation became impossible to ignore, the Fed raised rates higher and faster than any time in recent history. In essence, they were trying to play catchup.

The market and the financial system have experienced low rates since the aftermath of the Great Financial Crisis. And in the span of one year, the Fed raised rates by 475 basis points (the Fed hiked rates again earlier this month).

This was a shock to the system. It was inevitable that something would break. As it happens, the first thing to break was the banks. And as I shared last week, the Fed knew the banks were under pressure (and at risk of a liquidity crisis) all the way back in June of 2022.

Some readers have pointed out that Silicon Valley Bank could have done things differently. And I agree. There was plenty going on at SVB that I didn’t like. But were it not for the Fed’s reckless actions, this would have never happened in the first place.

The Fed broke it, so now it has to fix it…

And Joe, your instincts are correct. The Fed does have all sorts of levers and switches that it can use to obfuscate the problems caused by irresponsible and destructive fiscal and economic policy. 

At the core of the problem is “printing” more than $5 trillion in the last two years and running a fiscal deficit of more than $1 trillion this year. The Feds “tools” are just blunt instruments used to cover up the mess and avoid a complete meltdown.

And to your final question, the Fed’s actions have been horrible to all investors, especially normal investors like us who do not have access to exotic financial instruments that can be used to offset this kind of environment.

What the Fed has done has come at an incredible cost to normal investors. The damage to the economy continues to get worse and as we can see already, millions of jobs are being lost due to the slowdown in economic activity.

Bitcoin’s “Milkshake Moment”

Hi Jeff,

As a charter member of Unchained Profits, I’m worried now about crypto investments after all the latest bad news for crypto-friendly banks, and gov’t. digital currency coming. It’s been a brutal year+ of big losses all around – do you recommend buying, selling, or holding here?

Thanks,

– David B.

Hi, David. I hope you had a chance to catch up on our most recent update for Unchained Profits. I think it would answer many of your questions. Feel free to catch up here.

But I think some of the analysis shared in that update would also be of interest to readers of The Bleeding Edge.

It has been a brutal year for digital assets. Last year was the worst I’ve seen. But there are reasons to be optimistic. Here’s an excerpt for readers that I hope will answer this question:

Starting in December of last year, we began to mention Bitcoin’s halvings. These halvings take place approximately once every four years. The event reduces the number of new tokens that are created.

What’s interesting is Bitcoin revolves around this event. After the last three halvings, Bitcoin has bottomed around 900 days afterward.

Once bottomed, price trends higher until about 350 to 500 days after the next halving.

The next halving is likely to occur in Q2 of 2024, which tells us we have about two years ahead of us to play this trend. It also means if we are interested in digital assets, Web3, or blockchain, that this is the most opportune time to be involved.

That might be hard to believe. After all, even with the bullish price action, Bitcoin is still more than 50% below its all-time high of $70,000 set in November of 2021.

But as I mentioned above, Bitcoin’s historic bullish action around its halvings is on our side. And it’s also worth remembering that the “Crypto Winter”—when bitcoin traded as low as $3,600—was one of the best times to deploy capital into these assets in preparation for the next bullish cycle.

To really cement home this point, I want to bring up an event that tends to happen whenever the market signals it is climbing out of its bottom formation.

We can think of it as Bitcoin’s “milkshake moment.”

The Dollar Milkshake Theory is a relatively new concept in economics. The idea was put forward by Brent Johnson, CEO of Santiago Capital, back in 2019.

At a high level, the Theory says that central banks across the globe have created a giant “milkshake” of liquidity courtesy of the very accommodative monetary policies (ultra-low rates, quantitative easing, etc.) since the Great Financial Crisis.

When the Fed begins tightening monetary policy and raising rates—as it has done since 2022—it will turn the U.S. dollar into a “straw.”

Rising rates lead to investors flooding out of debt from countries with poor credit and into U.S. sovereign debt (the “safe” debt). Rising rates would also raise the cost of borrowing for countries that must price their own debt in U.S. dollars.

If this goes on for a long enough time, we could see sovereign debt crises and defaults. In essence, the U.S. dollar “drinks the milkshake.” This is in part why 2022 was such a strong year for the U.S. dollar relative to other assets.

But what does this have to do with digital assets?

Bitcoin has its own version of tighter monetary policy. This is its halving event. When this happens, fewer new tokens are entering the market.

This tightening event has a profound impact on the market as it begins to unfold. We can see this by comparing Bitcoin to the other tokens in the marketplace.

We can measure the amount of crypto market share is comprised by Bitcoin through a metric called “Bitcoin Dominance.” It’s expressed as a percentage.

When we look at this chart, take note of all the areas where Bitcoin dominance (blue line) is rising.

And if we go ahead and box off the area that represents 900 days or so after the halving, we get the red boxes below.

What’s interesting is we see these areas are where both dominance and Bitcoin’s price rises. It represents the start of a new trend for Bitcoin, a trend that represents a massive leg higher for the start of the new cycle.

To sum up this chart, it represents activity where the entire crypto market is growing. But Bitcoin is growing faster than all the other currencies. It is quite literally sucking all the value entering the sector. Put another way, Bitcoin is “drinking the milkshake.”

We can zoom in on 2019 and compare it to today’s current Bitcoin Milkshake Moment. In the chart is Bitcoin’s Market Cap compared to all of crypto, minus Bitcoin and Ethereum.

Here is today’s chart for comparison.

Bitcoin has historically performed well in an environment like this. However, smaller assets do perform well after the market cools off from this initial milkshake moment.

If we can only take one thing away from today’s update it’s that the market is coming back to life for a multi-year period of excitement thanks to Bitcoin’s halving cycle.

And it also suggests that Bitcoin is likely to outperform smaller assets in the near-term before smaller assets accelerate over the longer-term.

The other question that you raise is around the government’s actions. I’ve been writing a bit about that in the Bleeding Edge this year. I agree, the current government actions are not positive, and they appear to be getting worse.

After all, Coinbase just received a Wells notice implying that the SEC plans to take action against one of the most compliant and buttoned up firms in the entire industry. 

Even more ironic was the close relationship between SEC Chair Gensler and FTX CEO Sam Bankman-Fried. Go after the good guys and partner with the criminals? That’s an odd regulatory stance.

With that aside, my belief is that this aggressive regulatory stance is designed to slow down the industry until the Fed and the Treasury have deployed their new payment system which will incorporate some form of digital dollar. I believe that the Fed is gating the digital asset industry until it can carve out its role with respect to digital money.

Once this has been accomplished, I believe that we’ll see the regulatory posture shift to a more accommodating stance. Aside from the reasons to be bullish about bitcoin which I shared above, this shift will be bullish for the broader cryptocurrency markets.

Every digital asset should be analyzed for its own merits. Just like any technology company, there are good projects and bad ones, and it’s important for us to understand the quality of the underlying project. Of course, that’s what we’re focused on in Unchained Profits.

The only publication where we don’t use any fundamental analysis is Neural Net Profits. This is entirely driven by an artificial intelligence that my team and I designed and programmed. It has been remarkably good at finding shorter term trading opportunities in digital assets. Unlike Unchained Profits, this is not a buy and hold strategy for long term capital gains, but a strategy that takes advantage of volatility and momentum in the market that can be predicted by the AI.

As painful as the last 15 months have been in both equities and digital assets, we will turn a corner. My best estimation of when will be in the second half of this year, probably in the third quarter.

I’ve predicted that the Federal Reserve, and government, will have to swing to easing and stimulus again and eventually the Fed will be forced to reduce interest rates.

When that happens, capital will flow back into the markets and more normal economic growth will return. In fact, we’ve already seen the first major stimulus in the form of the Inflation Reduction Act, which has nothing to do with inflation. It is an economic stimulus package, plain and simple, focused on electrification.

One final point.

We’ve entered an incredible period in time of technological breakthroughs. What is happening right now with semiconductors, computing systems, artificial intelligence, and biotechnology is unlike anything I’ve ever seen in my life.

I know it can be difficult to see in times like this, but we’re in for a period of explosive growth and a roaring bull market in related companies when markets return to health. I’m excited for what the future will bring us, we have a lot to look forward to.

Regards,

Jeff Brown
Editor, The Bleeding Edge