Actively Speaking Podcast
Steve Bleiberg, portfolio manager and thought leader at Epoch Investment Partners, Inc. (TD Epoch) takes on current topics and issues facing today's investor.
Actively Speaking Podcast
Cryptocurrency: After the Fall
2022 has been a vicious year for crypto assets, but why now? In this episode, Global Investment Strategist Kevin Hebner explores the different types of stablecoins including those at the center of the latest downturn. We also discuss the potential for contagion into other asset classes, the diversification value of crypto and the outlook for the regulatory environment. (May 25, 2022)
Important Disclosures:
For institutional investors only. TD Global Investment Solutions represents TD Asset Management Inc. ("TDAM") and Epoch Investment Partners, Inc. ("TD Epoch"). TDAM and TD Epoch are affiliates and wholly owned subsidiaries of The Toronto-Dominion Bank. ®The TD logo and other TD trademarks are the property of The Toronto-Dominion Bank or its subsidiaries. The information contained herein is distributed for informational purposes only and should not be considered investment advice or a recommendation of any particular security, strategy or investment product. The information is distributed with the understanding that the recipient has sufficient knowledge and experience to be able to understand and make their own evaluation of the proposals and services described herein as well as any risks associated with such proposal or services. Nothing in this presentation constitutes legal, tax, or accounting advice. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed. Certain information provided herein is based on third-party sources, and although believed to be accurate, has not been independently verified. Except as otherwise specified herein, TD Epoch is the source of all information contained in this document. TD Epoch assumes no liability for errors and omissions in the information contained herein. TD Epoch believes the information contained herein is accurate as of the date produce...
Hello,
Speaker 2:And welcome to Actively Speaking. I'm your host, Steve Bleiberg . Join us each episode as we discuss current issues concerning capital markets and portfolio management from the perspective of an active manager.
Speaker 1:Welcome back to , uh, another episode of Actively Speaking. And , uh, it's my pleasure to welcome back a frequent podcast , uh, visitor, Kevin Hebner , uh, Epic's Global strategist. Welcome back, Kevin.
Speaker 3:Um , thanks Steve.
Speaker 1:So , uh, last year we did a , we had a discussion on this podcast about cryptocurrencies, and , uh, thought it would be a good time to revisit that because there's a lot, there has been a lot going on in the world of cryptocurrencies in recent , uh, weeks and months. Not all of it good from the standpoint of a, of an investor in crypto. But Kevin, why don't you start off by just kind of summarizing what's been going on lately , uh, in the world of cryptocurrencies?
Speaker 3:Yeah , certainly it , it's been, it's been a vicious year for crypto assets. It's been a rough year for lots of risk assets , uh, but overall for crypto, the asset class is down, you know , roughly 50%. And , uh, it's , it's been pretty difficult and, and it's raised a lot of question about the future of the asset class, if parts of the asset class , um, are going to disappear. And , and I , I think some of the discussion misses a few points. One is, if you look at the change, say over the last three months or six months, it's down 40% over the last three months. Um, that's the sixth time that's happened in the last five years. And every time it happens, people come out and say, oh my God, the asset class is terrible. It's gonna disappear. Well, well, maybe it's true. Um, but it has stabilized over the last two weeks, and it has happened before. And , and sort of coincidentally, you know , in terms of fresh money coming in the asset class , uh, one of the biggest , uh, Silicon Valley VC firms , uh, Anderson Herwitz , um, they just raised this week a 4.5 billion crypto fund. That's the largest , uh, crypto fund that's been raised so far by any VC firm. Um, so looks at least like the , the VC money hasn't been scared off by a pretty vicious start to the year for crypto. So
Speaker 1:Why, why is this, you know, why now, I guess is my question, why has this been happening?
Speaker 3:Well, I, I think, you know, with the Fed , uh, clearly signaling, you know, they're , they're tightening, they're gonna tighten a lot more , uh, and they need to do that until , um, the domestic demand rules over the labor market weekend . And we do get inflation prints looking like they're heading towards the target of 2%. So we're gonna see the Fed continuing to tighten. And with that, we've seen financial conditions tighten the most if you look at over the last three months or six months by the most, since the global financial crisis 15 years ago. So liquidity is drying up, it's hitting lots of risk assets and certainly unprofitable speculative tech companies have taken a big hit. But , um, crypto has been, been part of the, the damage from that.
Speaker 1:Uh , yeah, I , that's a common thing I see people pointing out when people who are defenders of cryptocurrency , uh, will respond to somebody who's kind of mocking them because of how much, you know, Bitcoin is down this year and they point out how much some of these well known tech companies are down this year , uh, in response. So one of the other, I think, interesting , uh, to me anyway, aspects of what's been going on recently is , uh, this kind of perhaps a little known area to some people. And everybody I think by now has probably heard of Bitcoin, but there's this other area within the world of cryptocurrency called Stable Coins , uh, where , uh, some of these coins are , uh, you know, they've come up with various mechanisms to try to keep them linked in some way to a currency like the US dollar. Um, talk a little bit about , uh, what's been going on with, with stable coins.
Speaker 3:So, stable coins are, you know , it's a type of crypto , um, and it's, it's on a crypto platform and it , it's used a bit like bank deposit. That's a place to keep money that you want to fund, you know, say other type of crypto investments or maybe you wanna take your money , um, offline and into the real world, into a , a normal bank account or something like that . Stable coins have become, I import , uh, initially there were what are called fiat backed , uh, stable coins. And , and these are a bit akin to unregulated money market funds. So they're backed in , in the case of US dollar , stable coin by treasuries, US dollar commercial paper and , and things like that. And , and typically, well , you could say typically they're over collateralized, but because they're unregulated, we don't really know exactly how they're collateralized. But, and this , this , this asset cost started, say 15 to 20 years ago, you know, fiat box stable coins, and then it morphed into a new type of crypto backed stable coins . So instead of being backed by fiat dollars or um , Euro, they're backed by other types of crypto, which could be , um, bitcoin or , or other things. And normally there are over collateralized by about 70%. So if the crypto that's backing goes down by, you know, anything less than 70%, you still , um, will get your, your dollar back. And then recently , um, really starting , uh, two years ago, but it's , um, become increasingly important. It's a third type of stable coin, and it's a bit of a variance on crypto backed , but they call these algorithmic stable coins. <laugh> , in reality, this is , it's a bit of alchemy going on here trying to turn , uh, lead into gold. But what a platform will do is it'll issue a stable coin and it'll be backed by their own crypto. And , uh, when people wanna redeem the stable coin NS dollars, then they'll issue some of their, their own crypto to pay for that. And , and this is fine, as long as the market value of the crypto they're issuing exceeds the market value of the stable coin . But , um, if things turn pear shaped <laugh> , it goes down really quickly. And , and , and the big story in , um, crypto over the last six weeks has been one of these particular , uh, algorithmic stable coins blowing up.
Speaker 1:I I remember that group from the eighties, the Algorithmics , uh, sorry about that <laugh>. Um , yeah, so talk about that. Yeah, it was , it was Terra and it was linked to something called Luna, which, you know, I only know this from reading this in the news, so , uh, you know, tell me what happened there.
Speaker 3:Yeah , so there's this platform , um, so Terraforms , and it's based in, in South Korea. Uh, but they had , uh, a stable coin called , um, Terra , or its initials were UST . Um, and it was backed by , um, a crypto called Luna. And, and for a long time, Luna was worth a lot more than the stable coin . And so there wasn't real problem. But then in April when we saw a lot of risk assets selling off, a lot of cryptos declining , um, a number of them plummeting , uh, Luna was one of those. And all of a sudden the market value of Luna was less than the market value of Terra , the stablecoin that I was supposed to be collateralizing. Um, and when that point happened , um, everything fell apart. People realized that there really wasn't any collateral for Terra and its value went from roughly , um, a dollar. So this is pegged to the US dollar to about 10 cents. And , and Luna went from a , a , a multi-billion dollar crypto to being essentially worthless very, very quickly. So the whole thing collapsed. And , um, you know , it was very controversial , um, for people following us . 'cause many people thought, you know , that you , you could defend a feeback stable coin and maybe even a crypto back stable coin . But this algorithmic structure , um, it really looked like taking things a bit too far. And , um, there still are a number of algorithmic coins that are out there, but it's difficult to see, at least in the most recent form that these are gonna be , uh, an ongoing viable part of crypto space.
Speaker 1:Well, you know, this, this all reminds me of actually a book I'm reading right now. It's, it's called Ways and Means by Roger Lowenstein . And it's about the US Civil War and, and , uh, how the , the impact on the economy in both the North and the South, and also how it was financed. You know, wars are expensive. Um, and you know, what happened in the US Civil War was both sides were eventually had to simply issue, you know , what in the north were called greenbacks. Uh, and, you know, it was just a paper currency backed by nothing. You know, people at that time, I mean, there was no, we had no federal reserve, of course, at that time. Uh , there was no bank in the United States that had had , uh, Andrew Jackson had gotten rid of the Bank of the United States. So money , uh, the way we know it today didn't really exist. Uh , banks all around the country issued notes, but , uh, you know, they , people felt they were backed by, you know, gold that those banks held or whatever. And then the US government just started issuing, you know, printing up currency and using it to, you know, to pay soldiers and to , uh, you know, pay all the expenses of war, all the material they had to buy. Uh, and of course, you know, the , these greenbacks started devaluing relative to, you know , more traditional forms of money very quickly. And, and the discount got larger and larger as time went on, because people wondered, well , what's behind this? And I, I think it's very analogous to what we see happening with some of these cryptocurrencies that are like the greenbacks kind of being created out of thin air. Uh, and , um, you know, there's, there's , there's nothing you can do that other than sell it to somebody else, hopefully for a higher price than you paid for it. But it's, it's not really, you know , one of the three traditional definitions of money is, you know , a medium of exchange. And , uh, I think people held out some hope early on that, that cryptocurrencies were going to be used that way. But so far it hasn't really been happening. So, you know, my question to you, I guess, after this digression is, you know, what are these cryptocurrencies are , are they, you know, do they still aspire to be money or are they something else at this point? Just a , you know , just an asset class on their own of some kind?
Speaker 3:Yeah, I , I think that's, that's interesting, Steve, that that background, and, and if you think about, you know, where crypto really started cryptocurrencies is immediately after , um, the global financial crisis. So the, the , the paper that , um, created Bitcoin, the 2009 paper by Satoshi , uh, it's a brilliant cryptography paper, but there was , um, a lot of suspicion about the banking system, which had been bailed out and is on the verge of melting down. Um , there's a lot of suspicion about , um, government involvement in the economy, and, and , and clearly there's still a lot of concerns about the, the level of government in different parts of the economy, and particularly in the financial sector. Um, and at the same time, we've had, obviously the growing , uh, online world. So 2009 was right after , um, the, the iPhone was released, and we've had this enormous growth in online shopping, gaming, social media. We've had Facebook renaming themselves with meta , um, vr, ar , you know , it's been the next big thing for a long time. Maybe that's gonna become a big thing. But I think with , with those, those two big catalysts , uh, we've seen this move forward. And , um, you're right, it in terms of a medium exchange online, it can be used as a medium exchange. But in the real world, IRL not so much unit account, it's very volatile. It's hard to argue. It's either a unit account or a store value. And , and if you're thinking about holding crypto as part of an overall portfolio , uh, portfolio that would have equity bonds, credit , um, and some other types of alts, private equity, real estate and so on, is it a good diversifier? Well, so <laugh> not really , um, the, the correlation between crypto and say equities, you know, over time is roughly zero, but it's roughly zero because half the time it's minus one and half the time it's plus one. And when markets fall , fall apart, like they've done recently, it moves to plus one. And right now the , uh, the correlation is very close to plus one. So not a great , um, diversifier, but I think it is increasingly being viewed as a sub-asset class, maybe as part of alternatives along with private equity, real estate infrastructure and hedge funds. And , and certainly we have seen consistent flows into this space over the last five years. Um, you know , this remains to be seen. It's still early days, but at least it's , it's feasible that it'll develop that way.
Speaker 1:So, so we're recording, you know, toward the end of May. And , uh, there was just a statements recently from about worrying essentially about contagion risk from, you know, the , the decline in crypto. You know, it seems like at the beginning of , was kind of a world unto itself. I mean, that was kind of the whole point. As you say, people wanted , uh, something that was detached from, from traditional money, from government involvement. Uh, but it seems like over time the links between crypto and the regular banking system have begun to grow. Uh, like we talked about some of those stable coins where the whole point was to be able to sort of link them to a , uh, you know , a , a a traditional currency, which seems sort of ironic, but so what , what is the, is there a risk of contagion of any kind , uh, to the, to the rest of the financial system from what happens in, in crypto ? Yeah ,
Speaker 3:Yeah. So, you know , so how likely is contagion into other asset classes? And my , my guess is that what happens in crypto stays in crypto, and , and the way we've been thinking about this, if you look at the us , um, the net worth of US households is about $150 trillion. That's a lot of money. And that 150 , the big buckets are stocks about 50 in real estate, about 40. Um, crypto is probably less than one , uh, 1 trillion. It , it's, you know , there's no formal estimates because it's an unregulated asset class , and it's not covered by any of the Fed data, but it's , it's almost certainly less than 1% of us Netwealth. And then if you think what's happened to markets year to date , our , our guess is that Netwealth has declined by about 12 trillion. So it, it's a big number, but almost all of that is due to the decline in equity markets. And our guess is that the decline in crypto at maximum would be about half a trillion dollars. You know, that's a, a big number, but relative to overall net worth, it's pretty small. And in crypto, it's concentrated in, you know , a small number of people. And that could be that those people are feeling real pain. Uh, and certainly if you look at Reddit forms and such, it certainly seems that there are people who are being forced to sell their homes, who are being referred to , uh, hotlines for , um, you know, to help people to avoid self harm and so on. So I think for some, a small number of people, it's been really rough, but overall , um, it looks like it's not going to have contagion into other asset classes that that would, that would be my guess. But given, given the absolute lack of data, it's, it's <laugh> , um, it's, in some sense it's hard to know, but looking at high level at the numbers that the Fed publishes, it looks like it's, it's not di minis , but it's too small to really have the sort of impact that we had 15 years ago from housing or 20 years ago from the tech collapse .
Speaker 1:Right. Well, but based on the, you know, those comments from the ECB to me are, well, and , and to others I'm sure are indicative that , um, regulation is probably on the way. Is that , would you , would you agree with that?
Speaker 3:Yeah, I think, I think it's, it's been discussed , um, for a long time, but in all likelihood, recent events will accelerate the , the regulation of , um, certainly stable coins , but also other types of crypto, including the crypto exchanges, which themselves are, are largely unregulated. And, and , and the focus seems to be on providing more reliable information to investors. And, and so for example, with stablecoin to know, you know , what exactly is the collateral, whether it's feedback or crypto back , orgo exactly how this works . And, and that's, that's very difficult. It's very opaque at this point. Um, also if you look at the experience with Tara that we're talking about , um, it really looks like there was, I , you know , I , I , I'm , I'm not , I I have to be careful how I say this, but you know, one could argue that there has been self-dealing, there's been front running , there's been various types of fraud. One could make that argument. Um, and so presumably, you know , regulation should try to address these issues, create transparency and , and make the rules for how these things more sensible. And , and ultimately this should be good for the, the mainstream parts of the asset class , the big exchanges like Coinbase and the , um, big cryptocurrencies like Bitcoin Tether , uh, and so on. But , uh, my guess is we, we will be seeing this whether we actually will get legislation , um, passed either in DC or Brussel . I think that's a different question, but there's certainly a lot of discussion about it.
Speaker 1:Okay. Thanks Kevin. Uh, you know, that's it . A lot's going on in that world, and I'm sure there will be further developments in recent months and maybe we'll do another, we'll probably have to do another podcast about this in a few months. But for now , uh, thanks for joining me and folks, if you like this podcast, so if you do us a favor and lead us a , a good review, or at least give us a good rating on whatever platform you're, you're listening to this on . And thanks again for listening and we'll be back again soon.
Speaker 2:Remember to subscribe to actively speaking on Apple Podcast, Spotify, or Google Play. You can find all of our previous episodes and additional content on our website, www.eipny.com.
Speaker 4:The information contained in this podcast is distributed for informational purposes only, and should not be considered investment advice or a recommendation of any particular security strategy or investment. Product. Information contained herein has been obtained from sources believed to be reliable but not guaranteed the information is accurate as of the date submitted, but is subject to change any performance information referenced represents past performance and is not indicative of future returns. Any projections, targets, or estimates in this presentation are forward-looking statements and are based on epic's research, analysis, and assumptions made by Epic. There can be no assurances that such projections, targets or estimates will occur, and the actual results may be materially different. Other events which were not taken into account in formulating such projections, targets or estimates may occur and may significantly affect the returns or performance of any accounts and or funds managed by Epic. To the extent this podcast contains information about specific companies or securities, including whether they're profitable or not, they're being provided as a means of illustrating our investment thesis. Each security discussed has been selected solely for this purpose and has not been selected on the basis of performance or any performance related criteria. Past references to specific companies or securities are not a complete list of securities selected for clients. And not all securities selected for clients in the past year were profitable. The securities discussed herein do not represent an entire portfolio, and in the aggregate may only represent a small percentage of a client's holdings. Client's portfolios are actively managed and securities discussed in this podcast may or may not be held in such portfolios at any given time.