JPMorgan Has Some Bad News For Bitcoin Bears

Just over two months ago, JPMorgan CEO Jamie Dimon said he considered bitcoin to be a "fraud" that "will not end well," and would fire any JPM trader trading it. The very next day, one of JPM's most respected analysts, quant wizard Marko Kolanovic wrote a lengthy report to substantiate his boss' anger and skepticism, concluding that cryptocurrencies are most likely pyramid schemes and "that the future for cryptocurrencies will likely not be bright."

Predictably, since then the price of bitcoin has tripled, ensuring that virtually all retail (and most institutional) investors are far more interested in trading highly volatile bitcoin, ethereum, and other cryptos than stocks, and JPM has been dragged - kicking and screaming - into reversing its position on cryptos, and at the end of November the WSJ reported that the bank was willing to help clients trade bitcoin (for a hefty fee) even as the bank's CEO explicitly called the digital currency a fraud, effectively violating its fiduciary obligation.

And now, with just two weeks until December 18 when bitcoin futures will start trading on the CME and CBOE, JPM's reversal has gone so far as prompting one of the bank's top strategists, "Flows & Liquidity" author Nikolaos Panigirtzoglou to predict that the "introduction of bitcoin futures has the potential to elevate cryptocurrencies to an emerging asset class." Which sounds quite different from "Bitcoin is a fraud."

In "The emergence of cryptocurrencies", Panigirtzoglou's thesis is simple: the more widely accepted bitcoin becomes and the more widely traded especially on regulated trading platforms, the greater the cryptocurrency's credibility, making it more appealing to both institutional and retail investors:

With bitcoin reaching the $10000 mark this week (Figure 1) partly fuelled by the prospective launch of bitcoin futures contracts by established exchanges such as CME and CBOE, the question that arises is about whether a new asset class is emerging, potentially competing with other more traditional asset classes. The prospective launch of bitcoin futures contracts by established exchanges  in particular has the potential to add legitimacy and thus increase the appeal of the cryptocurrency market to both retail and institutional investors.

In slamming his boss' skepticism, the JPM strategist also writes that the perceived value of bitcoin would rise over time if more people use bitcoin and other cryptocurrencies as a store of wealth and more merchants accept it as a means of payment in exchange for goods or services. Panigirtzoglou goes so far as to suggest that crypto may be a better architecture than fiat: "one could even argue that the soundness of the technology on which bitcoin or other cryptocurrencies run makes them even more attractive as a means of payment." We hope Jamie Dimon is paying attention here. "Cryptocurrencies are easily transferred and are not easily counterfeited because blockchain, which serves as the public ledger for all transactions without the need of a central server, avoids the risk of double spending."

But wait, more praise from JPM is forthcoming: the Flows & Liquidity report list numerous other reasons why the price of "cryptocurrencies jas the potential to grow further from here" among which:

  • The total market capitalization for the cryptocurrency market has exceeded $300bn for the first time this week. In particular, data from shows that the market capitalization for all cryptocurrencies stands currently at roughly $302bn with bitcoin’s market cap accounting for more than half at about $168bn as of Nov 30th. Ethereum, the second-largest cryptocurrency, has a market capitalization of $42bn followed by Bitcoin Cash at $23bn.
  • This rapid rise in the market cap of the cryptocurrency market, which has tripled in terms of AUM since June, is at first glance making it comparable to other competing asset classes such as gold. In fact, the rise in market cap above $300bn means that the AUM of the cryptocurrency market greatly exceeds the total size of gold ETFs at $90bn. Does this mean cryptocurrencies have grown in size well beyond competing asset classes such as gold? Not necessarily.
    • First, gold ETFs is not the main way wealth is stored via gold. Wealth is mostly stored via gold bars and coins the stock of which, excluding those held by central banks, amounts to 38,000 tonnes or $1.5tr. In other words, the market cap of cryptocurrencies would have to rise five times from here to match the total private sector investment to gold via ETFs or bars or coins.
    • Second, in theory, the market value of cryptocurrencies could eventually rise beyond what could be justified by only valuing them as store of wealth. As mentioned above, cryptocurrencies derive value not only because they serve as store of wealth but also due to their utility as means of payment. The more economic agents accept cryptocurrencies as means of payment the higher their utility and value.

Naturally one way to gauge public adoption and interest, and thus future price appreciation, is by observing daily trading volumes: how much money changes hands every day in cryptocurrencies vs. competing asset classes such as gold?

According to publicly available data monthly volumes of Bitcoin traded has sharply increased in dollar terms around $140bn in November while volumes of Ethereum, the second largest cryptocurrency in terms of market capitalization, rose to around $30bn (Figure 3). The surge in Bitcoin volumes was largely a function of price appreciation, however, as in terms of units of the respective cryptocurrencies the increase simply brought trading volumes of Bitcoin back to levels seen in May, while trading volumes of Ethereum were some way below their peaks earlier this year (Figure 4).

By comparison, JPM notes that "monthly trading volumes in gold futures have averaged nearly $900bn in recent months, while gold ETF volumes have averaged around $30bn (Figure 5). This means that that  trading volumes in the two largest cryptocurrencies would also need to rise by more than five times to match volumes of gold traded on via futures and ETFs."

That said, JPM correctly predicts that bitcoin trading volumes will most likely increase further once futures contracts are introduced on bitcoin in the coming weeks, especially once those eager to short bitcoin finally have an instrument that allows them to do so. Then again, the (potential) shorts may want to re-evaluate, if only for one key reason...

While all of the above has been covered on Zero Hedge previously, and is hardly news, the JPM report revealed one particular piece of very bad news for bitcoin shorts.

Consider that as of this moment the market cap of all cryptos is $330 billion: a respectable number, if well below the total value of wealth stored via gold bars and coins the stock of which,  excluding those held by central banks, amounts to 38,000 tonnes or $1.5tr, as noted above. What is striking, however, is not how large the market cap is for an asset which so many say has no intrinsic value, or is a bubble, but how it got there. Because due to the unique features of bitcoin - which still remains a relatively illiquid asset - while its market cap may be $186 billion, or just over half that of the total crypto space, what is stunning is how it got there.

As JPM explains, "high trading volumes or market cap does not mean that the net flow directed into cryptocurrencies has been equally big."

Here is the bank's punchline: "The net flow into cryptocurrencies is very much a function of coin creation which is controlled by computer algorithms and in the case of bitcoin is diminishing over time. Figure 6 shows the net amount of money invested every year since 2009. The cumulative amount has totaled around $6bn since 2009, well below the current market cap of $300bn." For Ethereum, the number is just as stark: with a market cap of $45 billion, net inflows have been under $2 billion in the past two years. This is shown in the chart below:

If JPM is right, the implications are staggering:  contrary to expectations that bitcoin's market cap is a rough reflection of its inflows, JPM's calculations reveal that a mere $6 billion in net inflows since 2009 has resulted in a market cap of $330 billion. This goes to what Mike Novogratz said last week when he said that cryptos are unique, because unlike all other asset classes, there is no corresponding increase in supply when prices surge.

This also means that as new capital flows into the crypto space as more retail and institutional investors scramble for "a piece of the pie", the potential market cap gains are unprecedented.

Putting this number in context, so far in 2017, there has been $283BN in global equity inflows ($402BN in ETF inflows and $120BN in mutual fund outflows), and $346BN in bond inflows, as this BofA table reveals:

If only a fraction of these institutional and retail flows were redirected toward bitcoin, then the next, and even more parabolic leg higher would be upon us, inviting even more bubble comparisons, even more skeptics and even more converts... just like none other than Jamie Dimon humself. In other words, shorts, beware, especially now that shorting - and short squeezes - is about to get much easier thanks to bitcoin futures.