Exploring the Volatility of Crypto: Feature or Bug?

Is Crypto’s Volatility a Feature or a Bug?

In this week’s edition, Miguel Kudry, the CEO of L1 Advisors, delves into the performance of cryptocurrencies and their intricate relationship with market conditions. In our Ask an Expert segment, Kevin Tam from Raymond James Ltd. provides insights on institutional filings with the U.S. Securities and Exchange Commission (SEC) and what these can reveal to advisors about the adoption of digital assets.

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In Tumultuous Times, Volatility in Crypto is a Feature, Not a Bug

On Monday, August 5, the Japanese Nikkei index suffered a staggering drop of over 12%, marking its most significant crash since 1987. This dramatic decline followed unsettling announcements from Japan’s central bank regarding potential interest rate hikes. Analysts speculated that this decision stemmed from fears of an impending U.S. recession, while others linked it to conjecture about rate cuts from the Federal Reserve. Such uncertainty disrupted the Japanese carry trade, a strategy estimated to be worth about $1.1 trillion by economists at TSLombard, triggering a global capital market panic as investors scrambled to unwind positions.

During this turmoil, the crypto markets experienced a severe impact on Sunday evening as investors sought the quickest route to liquidity. Bitcoin and ether saw substantial drops of 15% and 22%, respectively, with much of this decline occurring during the Sunday night hours in U.S. Eastern Time (ET).

Contrary to common perceptions, the inherent volatility of crypto markets should be viewed as a feature rather than a flaw. With no circuit breakers to halt trading, the always-on and globally accessible nature of crypto markets often positions them as the primary source of liquidity for investors. During periods of panic, crypto may be the only asset class available for liquidation, as was demonstrated on that fateful Sunday evening in the Western Hemisphere. By the time the U.S. stock market opened on Monday morning, crypto markets had already begun to stabilize, with both bitcoin and ether recovering approximately 10% from their respective lows.

Crypto markets consistently deliver liquidity and availability, even in the midst of chaos. On August 5, several major online brokerages—including Schwab, Fidelity, Robinhood, and Vanguard—experienced outages or were undergoing maintenance, leaving tens of thousands of investors unable to access their portfolios or execute trades. Schwab attributed the outage to a “combination of higher volumes and a technical issue with a key vendor affecting [their] systems,” shedding light on the opaque software and backend systems prevalent in traditional finance. In stark contrast, Bitcoin has demonstrated an impressive 99.98918% uptime throughout its existence, while Ethereum has never gone offline, showcasing the reliability of digital assets when conventional financial systems falter.

As other asset classes begin to transition to crypto rails—often referred to as on-chain—they stand to gain from the inherent accessibility of digital assets. Early adopters are likely to seize arbitrage opportunities that arise between on-chain and off-chain markets. Over time, this accessibility will likely become standard for a new generation of investors who are increasingly disenchanted with traditional market structures. A recent report from Bank of America highlights this shift, indicating that “older investors hold significantly more traditional equities, while younger groups tend to favor crypto and alternative investments.”

During periods of uncertainty, the enhanced accessibility to an investor’s portfolio can mitigate volatility and panic across all asset classes, including crypto-native tokens. An analysis by Amberdata reveals that “the dispersion of volatility across different regions underscores the significant impact of market openings and closings on price movements.” This implies that greater accessibility could play a crucial role in stabilizing markets during critical moments, offering a buffer against extreme price fluctuations.

Earlier this year, as geopolitical tensions escalated between Iran and Israel, PAXG, a tokenized version of gold, traded at a staggering 20% premium over its closing price on Friday, April 12. Such sharp price movements highlight the stark contrasts in flexibility between traditional markets and those utilizing crypto or on-chain formats. This volatility is further evidenced by PAXG’s trading volumes, which tend to spike over weekends and particularly on Sundays, underscoring the dynamic nature of crypto markets compared to their more rigid traditional counterparts.

Source: @Kaledora, who wrote a comprehensive X thread on this subject.

In conclusion, the intrinsic volatility of crypto markets and on-chain assets, especially during turbulent times, highlights the unique characteristics that differentiate them from traditional markets and off-chain assets. The always-on nature of crypto markets, free from circuit breakers, ensures that they remain accessible even when conventional markets falter, providing liquidity exactly when it is needed. As a growing number of assets transition to on-chain rails, this availability will become increasingly crucial, potentially lessening panic and volatility across the broader global financial ecosystem.

– Miguel Kudry, CEO, L1 Advisors

Ask an Expert

Q. How can investors use the SEC 13F or SEDAR filings for due diligence?

As a valuable research tool, these filings can provide investors with insights into the investment strategies and holdings of major institutional managers, often referred to as “smart money.” This information can assist in identifying successful strategies, recognizing market trends, and determining where funds are directing their capital. From a regulatory compliance standpoint, these filings can enhance investor confidence by promoting greater transparency and integrity within the traditional finance (TradFi) markets.

In Canada, SEDAR (System for Electronic Document Analysis and Retrieval) serves a similar purpose to the U.S. SEC’s EDGAR (Electronic Data Gathering, Analysis, and Retrieval). Both platforms enable publicly traded companies to electronically file their financial and regulatory documents, functioning akin to a permissionless and open ledger, much like a blockchain network.

Q. Why would a pension fund or bank consider adding bitcoin to their portfolio?

This move signals a broader acceptance of digital assets as integral components of investment strategies. It can be seen as a response to persistently low interest rates and inflation concerns, while also providing diversification and potential for enhanced returns. For instance, the State of Michigan Retirement System allocated $6.5 million to the Ark 21Shares bitcoin ETF in the second quarter of this year.

Additionally, several Canadian banks, including TD Waterhouse Canada, CIBC World Markets, and National Bank, have incorporated bitcoin ETFs into their latest Q2 13F filings. Collectively, these major banks have reported owning a total of $26.6 million in these spot bitcoin ETFs over the last two quarters. I firmly believe that bitcoin represents a long-duration, institutional-grade asset with the potential for asymmetric return profiles, offering substantial upside while limiting downside risks.

Q. What’s the latest buzz surrounding spot bitcoin and spot ethereum ETFs?

ETFs began to become available in early 2024 and have quickly gained popularity, attracting significant inflows of capital. As of now, total assets under management for these 10 spot bitcoin ETFs have reached around $62.3 billion.

In July, the launch of the spot Ethereum ETF made it even easier for investors to enter the digital asset space through traditional financial markets. In just a few weeks, the spot Ethereum ETF witnessed a remarkable total net inflow of $17 billion across eight different ETFs. This marks a significant evolution in digital asset investing, particularly with the introduction of ETF products, which enhance both accessibility and legitimacy for a wide range of investors.

– Kevin Tam, Digital Asset Research Specialist & Senior Branch Compliance Supervisor, Raymond James Ltd.

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