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FT Alphaville doesn’t understand crypto. Never has, never will. So when something happens in crypto that we don’t get, we turn to you, valued readers.
Here are five things we don’t understand about crypto’s current and ongoing sell-off.
Why doesn’t network difficulty fall?
Bitcoin’s proof-of-work algorithm has a difficulty ratchet to keep production steady. Network difficulty adjusts every two weeks, approximately, based on whether miners have been finding new blocks for the blockchain too quickly or too slowly.
In effect, difficulty is the probable approximate number of network calculations needed to mine the next block and reward its lucky creator 3.125 bitcoins. It’s an elegant system that doesn’t seem to work:
Difficulty tightens when a higher bitcoin price is encouraging miners to join the market, that much makes sense. But when a lower bitcoin price is squeezing margins and pushing the least efficient miners out, shouldn’t difficulty fall? The above chart indicates that’s not happening.
Maybe difficulty lags behind the price? As said above, the ratchet only adjusts approximately every two weeks. Total hashrate offers a more dynamic measure of power deployed to the network, albeit an estimated one based on how long it’s taking to mine a block. Any change in market structure might show up there first.
And has it? Not really:
What’s going on? Do miners with sunk costs keep running on negative margins in the hope of getting lucky? Are a handful of big miners, maybe advantaged by free power or whatever, keeping difficulty high to drive out competitors, either inadvertently or as part of some devious plan to centralise production and control the network? Or has mining become 55 per cent more efficient since last November?
Related, is it a worry that just three mining pools accounted for more than 45 per cent of this week’s block production? Given nearly all the hardware used across the network is Chinese-made, with Beijing-based Bitmain Technologies alone having an estimated market share of 82 per cent, when do concentration levels among a few organisations become a security concern?
What’s the deal with Tether?
Stablecoins have long been pitched as crypto’s on-ramp. Swapping fiat money for a fiat-pegged stablecoin like Tether’s USDT or Circle’s USDC allows a trader to switch in and out of positions without having to touch tradfi.
Shouldn’t an on-ramp also work as an off-ramp? There’s not much evidence it does. In the six weeks or so when $1.2tn in value was drawn down from the cryptoverse, the market cap of USDT has increased by approximately $20bn:
USDC hasn’t been quite as resilient but over the period is still basically flat:
Even if we assume a large percentage of stablecoins are used for non-crypto things (sports betting, remittances, crimes), the recent issuance still looks at odds with the trend.
Maybe demand is high because crypto traders have been parking money rather than seeking to withdraw it? More idle money in the system ought to be good news for the likes of Coinbase, which uses the promise of higher yields on USDC deposits to sell monthly subscription schemes.
And how have Coinbase shares been doing?
Ah.
What explains trash crash PTSD?
A popular argument among crypto commentators is that token prices are down because traders are still digesting one bad day in early October.
Reasons for the October drawdown go from banal (maybe the high-beta cryptosphere just amplified an equities pullback on US-China trade tensions?) to wonky (maybe it all cascaded from a weird synthetic stablecoin depegging on one marketplace?) to the darkly cynical (maybe the big sharp drop was to let bucket-shop crypto brokers close out customer positions they’d never actually bought?).
Whichever the preferred explanation, it’s not obvious to us why the trash crash would still be taking the blame. If a market’s not deep, efficient or clean enough to digest a bit of one-day volatility, why get involved?
Where’s the volume?
Crypto exchange-traded products have been haemorrhaging money all week. Spot ETP net redemptions yesterday were $1.14bn, including $901mn just from bitcoin ETPs, according to JPMorgan estimates. That’s the worst single day for net outflows since February.
With so much selling, you might expect to see an increase in bitcoin velocity, which measures the rate at which tokens move on the chain.
Bitcoin velocity has been plummeting for years, for reasonable reasons. “Digital gold” overtook “internet money” as the preferred reason to hold, while derivatives like perpetual futures removed any need to faff around with the underlying asset.
Nevertheless, is it odd to have a sudden wave of selling that’s almost invisible in the underlying asset? Bitcoin velocity has barely changed over the past month, having bounced meekly off a record low in early October. Why? Absolutely no idea.
Is a price crash on very low primary-market volume just delaying the inevitable wave of actual selling? Again, not a clue.
Is past performance indicative of future results?
Alex “Crypto Alex” Saunders, of Citigroup, writes in his Digital Asset Monthly:
The halving cycle is a reason that long-time Bitcoin holders are nervous. We show the price performance in the years after halvings in Figure 3 with the second year showing weakness. These crypto winters have been associated with 80%+drawdowns in the past as shown in Figure 4.
The point, presumably, is not to claim magical patterns in lines but to suggest bitcoin elders are worried about history repeating. Evidence that they are is the chart below and, well . . . see what you think:
Chart necromancy is an always-popular way to fill crypto blogs and Reddit forums, but is it really what Citigroup clients want? Perhaps it is. We don’t know. We don’t know the answers to any of these questions, because FT Alphaville Doesn’t Understand Crypto ©
If you do, the comment box is your lectern.
