Standard Kepler

Regulatory Framework Equals the End of the Crypto Party?

03/05 – 03/12

OVERALL MARKET SITUATION

The crypto-currency market experienced another round of global sell-offs upon entering March. While the financial market remained largely muted alongside the spark of a possible trade war, the digital currency market dropped 10-17% in the week due to tightening regulatory frameworks in the US and Japan, a hacking attempt at one of the biggest trading venues, and the large-scale sell-off by Mt. Gox’s bankruptcy trustee.


ANALYSIS ON TIGHTENING REGULATIONS

From an investment point of view, tighter regulatory frameworks may shock the market in the short term. After all, the price movements of digital currencies were driven by demand-supply balance and speculations within an unregulated environment. The fear of that governments will seek to ban or regulate booming markets is always present. However, we believe a regulated market can indeed attract capital from other asset classes/markets in the longer term.

Take the Dodd-Frank Act, the largest regulatory reform since the 2008 Financial Crisis, as an example. A decade ago, the financial market collapsed due to the default of risky assets. The creation of these securities was largely a result of a long chain of deregulations. To tackle this problem, the US introduced the Dodd-Frank Act to raise capital requirements along with other policies to protect investors. An immediate effect was no doubt the reduction in liquidity. This also led capital to flow to other markets with looser regulations. However, according to US economist and former chair of the US federal reserve Janet Yellen, this benefited the financial market in the long term with limited repercussion on economic growth.

The digital currency market is no exception. Indeed, the effect crucially hinges on whether any regulations introduced sound a positive note or not. For instance, CNY nearly lost all its market share in Bitcoin after the authorities banned all ICO activities. This outcome suggests that a ban on crypto trading would certainly have a negative effect on prices. On the other hand, coin prices may gain further upward momentum due to regulatory news. For example, BTC went up to then-record high levels after the Japanese government indicated they would embrace the development of the digital currencies after China’s cryptocurrency crack down.

 

Figure 1. Rebound of BTC/USD in mid-October 2017 (Source: Coindesk)

For this round of regulatory actions, we believe it will only bring down the price in the short term as the US SEC and Japanese FSA actions were paving a straighter way for market development – SEC said for the first time that trading platforms will be required to be registered with the agency as national exchanges; while the FSA halted the operation of two exchanges for improvements of anti-money laundering aspects. In fact, the price of BTC has rebounded from US$8,495 on Thursday to US$9,323 (9.7%) on Sunday. Meanwhile, ETH also bounced back from 2 month low of US$666 to US$717 as at Sunday.
In the longer term, we believe that regulators will continue to keep an eye on:

  • Illegal ICOs
  • Money laundering
  • Tax evasion
  • Cyberthefts
  • Exchange outages
  • Excessive speculation


OUTLOOK – INTERACTION WITH THE FINANCIAL MARKET

Cryptocurrencies may have room to rebound further in the week ahead, barring any abrupt further negative shocks. Indeed, this maybe a good buying opportunity. In fact, BTC price tend to bounce back strongly and this is not uncommon in financial markets. There are a few factors that may fuel up the momentum:

As our earlier report pointed out digital currencies, especially BTC, will continue to develop among institutional investors. After Wellington Management Co. was reported to consider including digital currencies in some portfolios, Grayscale Investments announced it will create four new trusts. These developments will fuel the market development in the coming months. We foresee the trading volume of major equity indices and BTC will enter a more synchronised trend. As such, the stronger negative correlation between the two asset classes during equity market sell-offs will be increased.

Secondly, the rising trade friction and positive global inflation outlook would dampen the global equity market and hence give a reason for crypto currencies to rebound. Indeed, the resignation of Gary Cohn, the Chief Economic Advisor of the White House, indicates that the US may take on another round of trade wars in the coming months. This, coupled with the 100% rate hike expectation in late March (90% for rising the Fed Fund Target Rate by 0.25% and 10% for rising by 0.5%), will add further upside pressure for the price of BTC.

© 2018 Standard Kepler