Bitcoin Public Markets, 5/9/22: Macro Correlation Here to Stay — Hard Landing, Rig Price, Hashrate Risks Compound; We Seek Hedged Miners and Distressed Deals

The markets are digesting the limitations of fed policy on containing inflation and the risks of stagflation. Raising rates slows economic activity by constraining demand — whether for final products and services or for upstream equipment and investment to deliver final goods and services. The notion is that raising rates incentivizes saving over spending and thus reduces consumption and capital expenditures — with capital expenditures likely proving more sensitive owing to a stronger rational decision making process. If volume demanded falls, prices should fall or at least grow slower to clear the market. Read the full report here.

To the extent that inflationary pressures emanate from global supply side bottlenecks – whether from Asian Covid lockdowns, the Russian invasion of Ukraine, transportation shortages and rising energy prices, the demand — supply volume mismatch driving inflation is more led by below trend supply than above trend demand.

Demand management requires a coordinated global response that may not be forthcoming. Without a coordinated response, Fed policy will necessarily have a much greater impact on domestic demand than overseas, in an effort to balance the much broader global demand with global supply. Furthermore, we assess that raising rates to drive demand volume below trend to meet the much harder to fix (with monetary policy) supply volume shortfall essentially means very little margin for error to avoid a hard landing.

Raising rates essentially compresses the P/E multiple across asset classes. This results in a correlated trade that extends to crypto as institutional capital increasingly drives crypto flows.

Thus, the broader policy response function of financial institutions has a growing weight in the crypto markets.

We think the risk off environment is likely to persist longer than we originally anticipated, and that crypto will remain a correlated trade in this environment.

Equally, we believe that the steadily expanding role of crypto long‐term disruption of existing financial systems makes the asset class resilient. Thus investors need to maintain exposure to the space. By the same token many of the public equities in the space face growth challenges as capital access erodes and the volatility of the asset weighs on treasury Bitcoin.

Hedging needs for the space are more critical than ever and will ultimately differentiate the winners in the space — particularly those that use creative structured products to mitigate multiple risks to emerge with a superior business model. The days of a miner being viewed as a proxy for Bitcoin to fit within a fund manager’s mandate are over, by our assessment.

We believe that smaller, undercapitalized crypto miners are at risk of default on their equipment purchase schedule. Further, very few, if any, miners or hosting facilities have fixed price power contracts. Which means that the energy market dislocations, coupled with capital calls on rig deliveries, could pose significant downside risk to ASIC rig pricing as well as capacity growth, resulting in network target Hashrate below our prior estimates.

This downside could come from accelerating shut down of older gen rigs, fewer deployments, and miner / hosting defaults that create distressed asset opportunities.

Key Takeaways

• We assess the macro environment is going to be weaker for longer

• We see very little margin of error to avoid a hard landing for the economy

• Crypto markets are likely to stay deeply correlated to macro risk assets for an extended period

• Longer term, we believe investors should maintain exposure to the asset class as the disruption to existing financial systems could accelerate in the current policy environment

• Miners who have avoided hedging so far must reassess their risk management strategy, in our view

• There could be opportunities for well capitalized players in the coming weeks and months

• In the interim, we believe there is significant downside risk to both ASIC rig prices and Hashrate growth estimates