WEEKLY, Feb 11, 2023

A regulatory chill, yield shifts, inflation complacency, tokenized securities vs security tokens, and some links...

Feb 11, 2023

You’re reading the free weekly Crypto is Macro Now email, where I look at the intersection between the crypto and macro landscapes, pick at established narratives and share listening recommendations. Nothing I say is investment advice!

Since many of you are new here (welcome!), I’ll introduce myself again: I’m Noelle, and I’ve been writing investor-focused crypto newsletters for over six years now, first for CoinDesk and more recently as Head of Research at Genesis Trading. Now that I’m focusing on an independent research project (the topic is in the newsletter name), it felt only natural to continue.

For more detailed market updates and news commentary and narrative updates, I hope you’ll consider subscribing to the premium daily newsletter. 😊

Some topics covered in the daily emails:

Conflicting dollar narratives
The two sides of low unemployment
Retail investors
Ethereum dominance
Bitcoin NFTs

MARKETS

Regulatory and macro jitters conspired this week to send crypto markets lower, with BTC down 7% and ETH down more than 8% on the week. Although ETH at one stage during the week briefly caught up to BTC’s year-to-date performance, its sharper drop over the past day pushed the BTC/ETH ratio back up to early February levels.

(chart via TradingView)

Yield moves

On the macro front, traders and investors continued to reposition after last Friday’s strong employment data, and Powell’s non-committal comments at the Economic Club event on Tuesday did nothing to change the trend.

CME futures are now pricing in another 25bp hike in May and odds for another one in June are almost at 40%, according to the FedWatch tool. A month ago, futures traders assigned an almost 0% probability to the official Fed forecast of a 5.00-5.25% fed funds range for December 2023. Now it’s above 30%, with a 10% probability of ending the year even higher.

(chart via CME FedWatch)

The US 10-year yield ended the week more than 20bp higher, dragging the DXY dollar index up with it. The 2-year yield increased by even more, at one point pushing the 10y2y spread to its most negative point since 1980. This is more headline-grabbing than relevant, however, as the below chart shows that the steepness of the inversion does not have much to do with the length or the depth of the recession that follows.

(chart via St. Louis Fed)

Inflation complacency

As rate-watchers’ focus turns to the US CPI print for January out next Tuesday, some warning signs were flashing this week as to a possible uptick in inflation, not necessarily just yet but possibly soon.

Norway reported inflation data for January that came in much stronger than expected and than in December. CPI increases were also reported this week in Hungary, the Czech Republic, Estonia and Philippines, and this comes on top of earlier reports from Spain, France and perhaps others I have missed.
One driver of the uptick in core inflation in several regions is that corporates are finding they can no longer hold back price increases. Earlier this week, Ralph Lauren revealed that it will be raising prices – it’s not exactly a mainstream brand, but it could end up being representative of boardroom discussions across the consumer sector.
Much of this pressure comes from shareholders demanding solutions to recent margin squeezes, just as labour unrest gears up to increase wage costs. Earlier this week, Inditex – one of the world’s largest fast fashion businesses – announced an average 20% pay increase for all store workers in Spain (where the company is based), with some groups receiving as much as a 40% bump.
A key input for almost all industries – oil – is showing signs of upward pressure, given higher expected demand from China’s reopening, cold weather sweeping much of the northern hemisphere and an announced production cut in Russia. Prices are still notably lower than a year ago, but the “base effect” from the market tension after the invasion of Ukraine will soon wear off.
Price hikes are especially likely given the strength in consumption. Hertz and Uber reported strong Q4 results largely due to resilient consumer spending. Consumption is even still reportedly strong in the beleaguered UK, where it seems every sector is either striking or thinking of doing so.
Last week, the Atlanta Fed raised its GDP Nowcast for Q1 from 0.7% to 2.2% – that’s a whopping increase.
And on Friday, the University of Michigan Consumer Sentiment index reached a 1-year high at 66.4 vs 64.9, while 12-month inflation expectations rose to 4.2% vs 3.9%.

The Cleveland Fed’s inflation nowcast predicts core CPI for January to come in at around 5.6% year-on-year, vs December’s 5.7%. That would be a good result, but would also remind us that further drops from here are probably going to be in small increments. In sum, it feels like the market is too confident that the inflation battle has been won, the slope is downwards from here. Strong employment data last week spooked the market – just imagine how much the market would be spooked by an unpleasant inflation surprise.

Regulatory chill

On the regulatory front, the announcement yesterday of Kraken’s settlement with SEC, which involves payment of a $30 million fine and the immediate shuttering of its US staking service, sent tremors through a market already concerned about a rapidly chilling atmosphere in the halls of power. This seemed at first like a move against staking generally, and an insinuation that staking assets were securities. As the dust settled, however, some nuances emerged:

This is not a move against retail staking – it is specifically against the way Kraken’s staking service was set up.
It can be argued that Kraken’s staking service wasn’t really staking as most of us know it – users did not have to deal with minimums or lock-ups.
What’s more, the staking service guaranteed a return and paid out regularly, unlike actual staking. Kraken, not the protocol, chose the reward conditions.
Like other communal staking services, it pooled users’ tokens, which would give the service a better chance of earning the reward. But, unusually, Kraken decided when and how much to stake.
Effectively, it seems that Kraken´s service was more like a staking *fund* than actual staking, with conditions, returns and payout timing set by Kraken, not the protocols.
With all this, we can start to see why the SEC might decide it’s a security.

This does not excuse the finger-pointing at “disclosures” when there is little guidance as to what those should be, nor the apparent unwillingness to work with service providers to fix errors. Nor does it explain the accusations of “no registration” when there is no clear registration path.

SEC Commissioner Hester Peirce published a dissent, with some amazing lines. For example:

“Using enforcement actions to tell people what the law is in an emerging industry is not an efficient or fair way of regulating. Moreover, staking services are not uniform, so one-off enforcement actions and cookie-cutter analysis does not cut it.”

And there’s this one:

“A paternalistic and lazy regulator settles on a solution like the one in this settlement: do not initiate a public process to develop a workable registration process that provides valuable information to investors, just shut it down.” 🔥

The move is not good for perception, and the way it was handled triggers a lot of questions about process and recourse. But, there are some upsides:

Some grouped staking platforms might escape Kraken’s fate by improving disclosures and replicating more closely the staking process and benefits.
The SEC is essentially supporting the idea of decentralized services over centralized control. Individual staking, even by US-based participants, is fine.
This could lead to a more dispersed distribution of staking influence, if more centralized staking services have to scale back or close.
In a CNBC interview earlier, Gensler actually said “not your keys, not your coins”, which many in the industry wholeheartedly agree with.
The pushback from the industry will hopefully coalesce some dialogue around the SEC approach, give even more impetus to the strength of the efforts on the Hill, and renew the industry’s efforts on transparency and education.

COLUMN

Security tokens and tokenized securities are not the same thing

Tokenization is back. Some of you may remember the heyday of 2017-18, when everything was going to be tokenized and put on the blockchain, banks were lining up to launch proofs of concept but clients were thin on the ground. Now, experimentation has spread well beyond the initial cohort, and even regulators are turning their attention to the topic.

Along with greater interest comes greater confusion. You’ve probably noticed that sometimes the assets in question are called “security tokens” and sometimes they’re “tokenized securities”. Now, most people won’t care what they’re called – it’s the idea that matters, right? We’ll sort out the terminology later. Pedants like me, however, exist to point out that nope, terminology does matter, even from the beginning. Here’s why.

First, the two terms do not refer to the same thing:

Security tokens are tokens that share some characteristics with securities. To get more technical, they are blockchain-based representations of certain privileges, such as revenue sharing, access, governance rights or a combination of these and others, and because of their incentive structure are likely to be classified as securities.
Tokenized securities are securities that move on blockchains. They are tokens that represent either specific off-chain assets, or that mimic established asset groups such as bonds, shares or funds.

All tokenized securities could be classified as security tokens, but not all security tokens are tokenized securities. By lumping the terms together, we are blurring the distinction, and this hurts the broader understanding of the underlying potential and hinders classification attempts, which in turn impacts both regulation and investment.

What’s the difference?

Security tokens are a new concept. They are created on-chain, for on-chain purposes, and do things that haven’t been done before on rails that didn’t exist until a few years ago. They enable new forms of financing, user engagement, investor reward, project governance and much more – we haven’t even begun to scratch the surface of how the concept can influence the evolution and implementation of ideas.

Tokenized securities are an old concept in a new wrapper. They take existing formats and add additional conveniences such as improved settlement, greater transparency, more flexibility and a broader reach. They are also undergoing a dizzying burst of experimentation: Over the past couple of months, we’ve seen financial institutions and official organizations not just trialling but actually issuing shares, credit notes, municipal bonds, development bonds, funds, commercial paper and gold.

Security tokens, however, are struggling against a lack of regulatory clarity, and the all-too-familiar regulation-by-enforcement from the SEC. To pick an example, starting in 2016, LBRY – a decentralized storage protocol and media service – financed its development through the issue of LBC tokens, which would enable access and engagement once the platform was up and running. For many, these were obviously utility tokens since they enabled use of the service. For the SEC, they were security tokens since their issue financed the project, and in 2021 brought an enforcement action against LBRY. The issuer pushed back, but in November last year, a judge ruled in the SEC’s favour.

The two concepts on the surface may appear similar, but lift the lid and you can see that the difference is stark: it’s about clarity and establishment support vs the lack thereof. It’s also about development. With security tokens, the fear of SEC reprisals is holding back many worthwhile projects from testing out their ideas in the market, while tokenized securities are getting busy.

Why it matters

This brings us to one of the main reasons the distinction is important: the divergent regulatory approaches. Tokenized securities are unlikely to attract much attention other than classification tweaks and requirements that custody practices check the right boxes. International regulators are working on explicit rules to deal with the adaptation of securities to blockchains, and along with official support will come even more establishment experimentation and eventually client demand.

Security tokens are somewhat contentious, however. The process initiated against LBRY, mentioned above, took almost two years to work through the courts, and the SEC’s case against Ripple for allegedly issuing unregistered securities is now in its third year. In the US judicial system, precedents matter, but imagine the sheer consumption of legal resources should more SEC targets decide to push back. This is unsustainable, but until the US regulators understand this, progress is hindered.

The distinction also matters from an investment point of view. Conflating the terms implies an establishment acceptance of security tokens which is not yet there. It also underplays the innovative potential of security tokens by suggesting they are merely securities on a blockchain.

Don’t get me wrong, tokenization of securities is exciting, and the recent activity around the concept is the welcome result of years of solid behind-the-scenes work by developers, market infrastructure firms, banks and financial overseers. The tokenization of securities is one of the main vectors through which crypto markets will transform traditional markets.

Security tokens, however, have an even loftier goal. Once the legal parameters are worked out, they could end up impacting much more than markets: they could end up transforming the very concepts of investment and engagement, possibly unleashing not only new business models but also new sources of value.

In sum, tokenized securities and security tokens are similar on the surface, but looking deeper, have significant differences that are worth acknowledging. And both concepts are important enough to warrant better care as to their labels.

GOOD READS/LISTENS

The Odd Lots episodes are always excellent, but this Steve Eisman interview was one of the most interesting episodes I’ve heard in a while.
Arthur Hayes dissects the outlook for liquidity in the short- and medium-term, and offers ideas for trading crypto around those moves – as always, a good read with original insight.
Nic Carter lifts the lid on the strategy of the US administration to use financial rails as a way to hobble the crypto ecosystem. How’s this for a quote:

If there was any doubt, it’s now evident that the Obama administration and its successor in Biden’s regime are comfortable circumventing the First Amendment by engaging nominally private companies to do their dirty work.

HAVE A GOOD WEEKEND

I’ve shared with you before some of my favourite non-crypto newsletters. Today it’s the turn of podcasts. I listen to a lot of podcasts, generally while I’m doing my workout, getting dressed and putting my face on, making breakfast/lunch/dinner, going grocery shopping, getting some steps in… And usually they’re crypto- or finance- or economy-related, but not always. Here are a couple I regularly turn to when my brain needs a break:

99% Invisible – many of you probably already know this one, it’s an icon in the podcasting industry. For years now, Roman Mars (who has one of the smoothest voices out there) talks to us about design. Yes, a podcast about design. But it works, and helps you look at things in a new way, which is always fun.
On the Media – it’s about much more than media, although that itself is an interesting enough topic to produce volumes. It’s also about our culture, how we engage with world events, the relationship we have with institutions, and how format can influence form.