Bitcoin is volatile.
That’s perhaps the only thing crypto proponents, detractors and everyone in-between can agree on.
I’ve argued volatility in Bitcoin (and Ether, for that matter) makes it a non-starter for the vast majority of portfolios. The simple figure, below, underscores the point.
I’ve also variously suggested that corporate treasurers who add Bitcoin to balance sheets are making a potentially serious error, unless the company is engaged in parallel lines of business akin to RBC’s amusing “suggestion” for how Apple might go about making its mark in the cryptosphere.
My take on this is, I think, straightforward enough. In What If Bitcoin Just Never Matters?,” I wrote that,
Even if you want to argue that Bitcoin is an asset, it’s pro-cyclical and that’s a problem for portfolios. While everyone’s needs are different, introducing an extremely volatile position that’s i) impossible to value on a fundamental basis, ii) is sometimes positively correlated with risk assets, iii) trades 24/7 and iv) can react violently to totally unpredictable events (e.g., tweets), is a decision that, at best, is conducive to sleepless nights. At worst, it could be a career killer.
Most of that isn’t opinion. Those are mostly just statements of fact.
“Since 2014, Bitcoin has actually often declined during equity drawdowns like in 2015, 2018 and Q1 2020,” Goldman’s Christian Mueller-Glissmann said, in a recent note. “These large drawdowns, combined with Bitcoin’s high volatility, have eventually outweighed the benefits of having it in a portfolio at higher allocations,” he went on to remark, adding that “even with just a 5% allocation in a 60/40 portfolio, Bitcoin drove roughly 20% of the portfolio’s volatility, while US 10-year bonds contributed only 2%.”
That’s not to say you would’ve done poorly having Bitcoin in a portfolio. Indeed, Goldman also noted that “just a small allocation to Bitcoin in a standard US 60/40 portfolio would have enhanced risk-adjusted returns materially since 2014.”
The problem, Mueller-Glissmann emphasized, is that the volatility represents “too much concentrated risk exposure for an institutional multi-asset portfolio, and also limits the potential allocations from investors employing risk parity strategies or targeting a specific level of risk.”
If “volatility is your exposure toggle” (as Nomura’s Charlie McElligott is fond of putting it), you’d be dialing back constantly, sometimes for absurd reasons (e.g., Elon Musk decides to tweet a cryptic emoji at 3 in the morning).
It’s with all of the above in mind that I wanted to (very briefly) address a Bloomberg article dated Saturday called “Bitcoin’s Volatility Spawns New Crypto Balance Sheet Alternative.”
The gist of it is simple. Corporate treasurers who want to earn more on their cash but fear the volatility associated with Bitcoin can put money on deposit in stablecoin accounts (pegged 1-to-1) and earn 7% (or more) annually on the deposit versus… well, versus basically nothing on bank deposits and a little more than basically nothing in T-bills.
Before I go any further, I should emphasize that I’m not attempting to cast aspersions and I don’t claim to be any kind of authority on stablecoins or businesses derived from them. I’m merely offering my opinion — nothing more, nothing less.
With that obligatory caveat out of the way, allow me to opine that this is probably a terrible idea.
First, let’s just dispense with the obvious. If you go this route, you absolutely have to be sure the entity offering the product has fully-audited reserves. I assume no corporate treasurer would ever screw that part up, but then again, it’s 2021.
Let’s assume you check that box. How can a stablecoin deposit possibly offer to pay 7% annually in the current low-yield environment? Well, by putting the deposits into something that yields at least that much (and a bit more if this is supposed to be a profitable line of business). John Griffin, a finance professor at the University of Texas, stated the obvious in an email to Bloomberg. “If the account is paying out a higher yield than bank account yields, then it is not merely invested in some risk-free asset,” Griffin said.
Bloomberg explained one program planned by Circle as follows,
Treasurers would open a “digital-dollar account” where the company’s fiat money is converted into [the stablecoin USDC] and interest is paid out in USDC. The yield is generated by Circle lending the digital dollars to a network of institutional investors that are willing to pay an interest rate for access to additional capital.
With an apology to anyone who feels like they’re owed one, this sounds like something right out of a tome documenting the history of speculation and financial bubbles.
These are term deposits. Early redemptions apparently aren’t allowed and the “real” dollars are lent out to a third party, which, one assumes, is free to do what it pleases with the capital.
Bloomberg described this as “a bit tamer” than an outright investment in Bitcoin, but I’m not sure that’s true.
I’m not questioning the audit side. Apparently, Circle (and a similar offering from Gemini) have that part pretty well covered.
Rather, what I’m questioning are the myriad ways in which the setup could create maturity and liquidity mismatches for pretty much everyone involved.
That’s not (at all) to say there’s anything untoward about this. It sounds as though the terms are clear enough.
But nobody ever thinks this kind of lending is going to be problematic — until it is. In order to generate that 7%, somebody, somewhere, will need to take some risk, pile on some leverage or engage in some kind of financial engineering. There isn’t a liquid, risk-free asset on the planet that generates anything close to 7%, especially not over a short horizon.
Presumably, every corporate treasurer understands that, and what’s unclear to me is why a corporation needs a third party to facilitate this transaction in the first place.
If the answer is that it would sound crazy to shareholders if a company decided to plow a portion of its cash and equivalents into CCCs or, say, student loan refis, then it seems to me that the stablecoin intermediary is providing cover for CFOs to take risks with corporate reserves.
Historically, similar (albeit not identical) arrangements have run into trouble in the event of a credit crisis or some other systemic tremor. The Australian “Land Boom” of the 1880s comes to mind.
Then again, every kind of arrangement tends to suffer during systemic tremors so, sure, go ahead and convert your corporate cash pile into a stablecoin stash. It’ll make you seem ultra-trendy to the Robinhood set.
There is no risk (other than counterparty) and no leverage. The returns come from arbitrage. I’m surprised you don’t know this. As more dollars enter the crypto ecosystem, these rates will fall. For now, there is massive demand for lending stablecoins.
With all due respect, this comment is patent nonsense.
A 7% return on parked cash in a world where risk-free rates are zero (or below) isn’t risk-less, Kamil. That’s an extraordinarily naive thing to say.
These are not “deposits” in any traditional sense, they are not risk-less, and nobody should think of them as such.
Here is a nice Bloomberg piece explaining where the interest comes from:https://www.bloomberg.com/news/articles/2021-03-27/crypto-shadow-banking-explained-and-why-12-yields-are-common
Of course these are not banking deposits. I’m willing to let the Winklevoss twins play with my money for a 7% interest though.
That’s not “risk-free,” Kamil. But more to the point, listen to what you’re suggesting. You’re saying corporate treasurers should lend their cash reserves to a crypto shadow bank so that hedge funds can play the basis in Bitcoin. That’s sheer lunacy. Any large shareholder in a company caught doing that should immediately pressure the board to reverse the decision or else sell their entire stake. I don’t even know why I’m having this discussion. It’s nuts. And besides that, there’s nothing here that says that’s the only way this has to work. Who’s to say the shadow banks don’t lend the money to institutional investors who find other ways to pay the interest? In other words: What happens if there’s an even more profitable opportunity out there for that borrowed cash? You reckon they won’t take it? And do you seriously think regulators are going to allow a sprawling crypto shadow banking network to develop and prosper? This whole thing is laughable.
I’m hoping corporate treasurers listen to you, so that serious money does not pour in and I keep collecting my 7 percent!
Here we go: https://www.bloomberg.com/news/articles/2021-06-22/bitcoin-s-money-printing-machine-breaks-down-as-futures-collapse
I expect that when Tesla reports 2Q earnings, there are not any cryptos on the June 30, 2021 balance sheet.
Uh no.
If I recall, Bernie Madoff was paying 8%.
“Stable Coins” are an elaborate Ponzi scheme.
No one can figure out where the money has gone because they are not meant to figure out where the money has gone.
In my view, earning high interest lending out stablecoins is a similar type of investment to earning high interest on a bank deposit in an unstable emerging market that’s trying to maintain a 1-for-1 currency peg. i.e. it’s a short vol trade where the risk is hard to quantify ex-ante but catastrophic when it materializes.
Given stablecoins are functioning as ‘shadow’ US dollars, similar to how the eurodollar market evolved pre-GFC, it’s not surprising we’re seeing more central bank officials coming out and raising the financial stability risks (e.g. Brainard last week), especially as stablecoin issuance has exploded the past few months (total USD stablecoin market cap is now > US$100b).
Stablecoins are either “money” issued by shadow banks (as they function as ‘money’ in crypto ecosystem) or they are unregulated money market funds. Either way, a regulatory response/crackdown should be expected.
In my opinion, the main problem with this gambit is not that a given BTC spot/futures trade won’t pay off consistent with the quoted numbers.
The main problem, I think, is that the window of opportunity for profitable trades is short and unpredictable.
For example, let’s look at the long spot/short futures trade described in the March 2021 BBG article mentioned above. Today, just two months later, BTC00 is $36,805, September 2021 futures contract BTCU21 is $36,335, so you get a -4% annualized return on that long spot/short futures trade.
In just two months, the can’t-miss no-brainer high-return trade vanished. Sure, maybe you can buy the spot on a dip or snatch an uptick on the future, and make a profitable trade – and maybe, a minute or a day later, you can’t. It’s day to day, at best. But . . . you’re promising depositors a guaranteed 7% annual return from this?
So, look at the treasurer’s dilemma. When he puts the company’s cash in the Circle account, and a couple months later the high-return “allegedly safe” trade vanishes, what happens? Does Circle renege on the 7% interest it promised (and you have to explain yourself to the CEO CFO and board)? Does Circle go find another trade, that isn’t quite as “allegedly safe” (and you have to re-explain the risk-beneift to the CEO CFO Board, assuming you even know what Circle’s done)? Does Circle pay your interest from recent deposits (and you’re now participating in a Ponzi scheme)?
Any competent corporate treasurer will see that the promised 7% return is very fragile, and that the risk to his own career far outweighs the potential return to himself and the company.
Today BTC00 $37,140, BTCU21 $36,335, annualized -9% return. The CFO is starting to ask questions and the treasurer is biting his nails.