Court-in’ Crypto

The summer doldrums that I alluded to in last month’s update continued to be the most apt description of crypto markets for the first half of August. Year-to-date gains in the Trakx Top10 Crypto CTI flatlined at 40% (a performance that, nevertheless, exceeds all the other major asset classes, including the AI-goosed NASDAQ). Given the lack of price action, investor apathy was palpable and perhaps best illustrated by the popularity of the following meme on crypto twitter and other social media platforms.

Meme Evolution – August 11

Source: Twitter

However, the situation abruptly changed with the mid-month release of the minutes from the July 25/26 FOMC meeting. They showed that US central bankers maintained their hawkish bias as “most participants continued to see significant upside risks to inflation, which could require further tightening in monetary policy”. Reinforced by the ongoing resilience of US growth data, which for the most part had been stronger than anticipated by the Fed¹, investors revised up their expectations as to the terminal Fed funds rate of the cycle. At one stage, the CME’s Fed watch tool implied a greater than 50% probability of a 25bp hike at the November FOMC meeting.

This might not seem like much of a change, given investors have already had to contend with the most aggressive Fed tightening cycle in four decades, but it was more than enough to unsettle crypto markets. Prices of the larger cap cryptocurrencies slumped more than 10% over the following 24 hour period – see image.

Meme Evolution – August 18

Source: @cryptomemeelite

Crypto: 1, SEC: 0

However, it turned out that August had yet more surprises in store for crypto markets. On August 29, a US appeals court overturned the SEC’s decision to reject Grayscale’s application to convert its Bitcoin Trust into a spot ETF. The news sent Bitcoin, and the broader crypto market, up more than 5% in a matter of hours – see image.

Meme Evolution – August 29

Source: Twitter

Contrary to what was initially reported by some crypto-focused media outlets, the court ruling does not mean Grayscale is now permitted to convert its trust into an ETF. Rather it means the SEC must go back and review Grayscale’s application or, alternatively, seek to have the ruling overturned by a higher court such as a full federal appeals court or even the Supreme Court.

The SEC has a 45 day window to launch an appeal and it may well attempt to have the court’s decision overturned, but the US regulator will no doubt recognize that it faces an uphill battle because the language used by Judge Rao in the ruling was pretty damning.

The court described the SEC’s denial of Grayscale’s proposal as “arbitrary and capricious because the commission failed to explain its different treatment of similar products” (Bitcoin futures ETFs having been allowed by the SEC since October 2021). Not only are these terrible optics for a regulator already facing considerable criticism for it aggressive regulation-by-enforcement approach towards the crypto industry (cf. our research paper Regulation Ramp-Up) but absent getting the ruling overturned by a higher court, the SEC will have to present new arguments in support of their decision to reject Grayscale’s spot Bitcoin ETF application. Assuming, of course, the SEC used what they considered to be their strongest arguments in their initial decision to reject Grayscale’s application, this could prove to be a rather onerous task.

Consequently, I agree with those who consider the ruling against the SEC as significantly boosting the odds that a spot Bitcoin ETF will, finally, be realized, especially given that the SEC is also currently considering spot Bitcoin ETF applications filed by such established tradfi institutions such as BlackRock and Fidelity.

Interestingly, it was not just Bitcoin received a fillip from the court ruling against the SEC, but the other major cryptocurrencies also rallied on the back of the news, much to the bemusement of some market commentators . Yet, when one thinks about it more deeply, the reaction is not that surprising. It is not beyond the realm of imagination to think that the ruling could open the door for spot ETFs in other cryptocurrencies, meaning it has much broader applicability than just Bitcoin.

There is another, even more fundamental, reason.

As mentioned, the SEC is also currently considering spot Bitcoin ETFs from large, regulated, tradfi players. If, as argued, the odds of such products being allowed is now higher after the ruling, this could have a powerful impact because crypto adoption by such institutions brings with it an increased perception of legitimacy to an asset class that has long been plagued by “criminal-friendly”, “hi-tech Ponzi scheme” narratives. Indeed, as I have stated in my previous research notes, Roadmap to Utopia, I judge that this will be a key driver for wider social acceptance of cryptocurrencies or, using more colloquial language, help crypto “go mainstream”. Given the overall market cap of crypto currencies stands at $1tr, which is orders of magnitude smaller than other more established asset classes, it is not hard to see why the response of crypto prices was so positive when viewed from this perspective.

The X Factor

It is not just large tradfi institutions that are been embracing crypto. Hours after the SEC story broke, it was revealed that Twitter Payments, the payment arm of Twitter (now X – still can’t get used to that!), was officially approved a Currency Transmitter License by Rhode Island. Readers notes were swiftly added to tweets (should they be X’s - idk?) clarifying that the license is not crypto-specific but is required for all payments and money handling. However, in light of Elon Musk’s stated desire to turn the blue bird into an “everything app”, and given his penchant for crypto (Dogecoin being a notable favourite), the news fueled speculation that X is moving closer towards integrating cryptocurrencies into its offering. This provided yet another fillip to a market already in ebullient mood, although this positivity faded as the month drew to a close after crypto investors were disappointed by the SEC announcement on August 31 that it was delaying its rulings on the various (non-Grayscale) spot Bitcoin ETF applications for a further 45 days⁴.

1 Over the past few days some cracks have been appearing, notably in data pertaining to the labour market.

4 I warned this might happen in the previous monthly update. For more details - see: https://blockworks.co/news/sec-delay-decision-bitcoin-etf-blackrock

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