- We expect the cryptocurrency musical chair to keep going as long as the bitcoin carry trade works and regulators stay on the sideline.
- Governments are likely to intervene by employing measures to protect Main Street investors and regulate the capital formation market.
- In this article, we explain the bitcoin carry trade and how governments may regulate cryptocurrencies and ICOs in a near future.
Cryptocurrencies are a revolution in the financial sector just as the internet was innovative to the tech sector in the 90’s. With this technology, anyone has the freedom to seamlessly transfer an electronic currency without the need of any financial institution and this is what makes it valuable.
With the advent of this disruptive technology and thanks to record low interest rates in most developed countries, risk-seeking speculators are embracing the bitcoin carry trade in a similar fashion the yen carry trade occurred in 2007. What’s the yen carry trade? Let’s take a short history lesson to explain:
Yen Carry Trade
A decade ago, traders would borrow yen at a low interest rate, convert into a foreign currency and invest the proceeds in an asset class earning a total return exceeding the initial borrowing costs. The yen carry trade was done mostly on bonds to earn a low-risk profit. However, a few investors dared to invest the proceeds in riskier investments such as energy commodities.
Bitcoin Carry Trade
Today, most developed currencies in the world are the “yen” and bitcoins act as both the currency and the investment vehicle. With the meteoric rally underway, the desire to borrow money to engage in the greatest musical chair of all time is very high. After all, the fear of missing out is a widespread public sentiment and the average Main Street investor have little equity to spare.
The good news is that prices may keep rising as long as speculators benefit from the carry trade and governments remain on the sidelines. In the chart below, the mania phase could reach an LN of 11, which converts roughly to $60,000. This represents 400% gains from the current price of $15,000.
Source: Inovestor Asset Management (IAM)
The bad news is that once many governments agree on measures, they are expected to go hard and fast. Regulators will do whatever it takes to promote sound capital markets and protect Main Street investors. We believe they will consider various measures that may burst the cryptocurrency rally:
Restrictive Monetary Policy
The key to a successful carry trade is for the total return of an investment to exceed its initial borrowing costs. With the OECD economies running above their potential, it is very likely that central banks across the world decide to increase interest rates. This may eventually trigger a risk-off contagion that would spread to cryptocurrencies squeezing speculators on both ends: loss of capital in the investment vehicle and higher interest on borrowed funds.
Forced Security Law Compliance
Based on the latest SEC Statement, it becomes increasingly clear regulators are leaning toward classifying virtual coins and tokens as securities. If this conclusion becomes unanimous, any platform or operating system facilitating transactions of these products would be in violation of existing regulations and will be forced to fully comply with the law regarding registration, offering process and disclosure requirements of securities or be shut down.
Lawsuits Against Unregistered Actors
Anyone acting as an Investment Advisor, Financial Analyst, Portfolio Manager, Financial Bank or Securities Broker soliciting to buy or sell virtual coins and tokens through any means (websites, forums, social media, etc.) will be facing hefty fines related with the illegal distribution of securities. In the future, only registered professionals will be involved in this regulated environment. As for market manipulations and fraud, governments are already on it.
Cryptocurrency Taxation Enforcement
As the adage says, there are two certainties in life: death and taxes. Based on the assumption governments can oblige exchanges to become transparent on their account holders, cryptocurrencies may be taxed as a capital asset. In the US, the tax rate is as high as 20% for long-term gains and as high as 37% for short-term gains. Moreover, governments are very likely to enforce a sales tax to companies accepting cryptocurrencies as a form of payment.
More Bans From Frontier / EM Countries Regulators
Despite its currency features, cryptocurrencies are used mostly for two things: speculation and capital flight. The latter is exclusive to emerging frontier / emerging countries for various reasons such as poverty (Yemen), war (Syria), high unemployment (South Africa), high inflation (Venezuela), corruption (Russia), capital control (China), etc. These countries have high incentives to ban cryptocurrencies. Therefore, more harsh measures are expected.
The cryptocurrency rally may continue as long as the bitcoin carry trade works and regulators are busy debating and drafting upcoming regulations. We should pay attention to all central bank bulletins as they become available and the G20 summit in April where cryptocurrencies may be openly discussed.
When these measures become official, the largest bear market may finally unravel. We expect 99% of cryptocurrencies and ICOs to disappear during the burst of this bubble that already exceeded the tulip mania. However, we believe there will be survivors that will become blockchain technology leaders.
From a trading perspective, bitcoins have a strong support around the LN 6, which converts to a price of $400. This represents a potential loss of 98% from the current level. Is it worth to chase a potential gain of 400% with such a loss potential? Maybe for further speculation but not for an investment.