Bitwise's Matt Hougan Holds Firm On Crypto

Risk assets, including most if not all cryptocurrencies, have been hit hard by the latest market turmoil. Matt Hougan is chief investment officer of crypto asset manager Bitwise Investments, and his opinion of bitcoin and cryptocurrency as an asset class hasn’t wavered one iota. He considers it a once-in-a-generation opportunity for investors, but he warns against allowing it too prominent a place in one’s portfolio.  

Bitwise has filed for a physical bitcoin ETF and should have an answer from the SEC in July on whether it has been approved. The firm also offers the $51 million Bitwise Crypto Industry Innovators ETF (BITQ). 

ETF.com chatted with Hougan recently about the tanking of cryptomarkets throughout 2022 and why investors shouldn’t ignore the asset class.  

ETF.com: What’s going on with cryptocurrency right now? It seems like they’ve all fallen off a cliff. 

Matt Hougan: The returns of any crypto asset are driven by a couple of factors. There's a macro factor because crypto is a risk asset. There's the crypto industry factor, [such as] regulations of crypto assets. And then there's idiosyncratic factors that are specific to any individual crypto asset, like technological developments.  

If you think about crypto from March 2020, at the start of COVID, until November 2021, all three factors were working in a positive way.  

The Fed was engaged in massive quantitative easing, which benefited risk assets. The crypto industry had a string of hugely positive news. We had the first hedge funds invest in crypto, the first corporations, the first institutions. We had Wall Street turn from anti-crypto to pro-crypto. BlackRock launched the blockchain ETF.  

There was huge amount of positive crypto news, and individual assets had good news too. You had the macro positive, the crypto industry positive and individual assets positive, and bitcoin went up 13 times, from $5,000 to $68,000.  

In November, the Fed changed its tune. In early November, we got the first signal from the Fed that it was moving from quantitative easing to quantitative tightening. We also had a huge CPI reading that made everyone realize the Fed was going to tighten rates.  

Crypto then pulled back sharply. It fell 50% or so by January, and then was treading water for a while. There was no crypto industry news, but the macro environment turned aggressively risk off. And it wasn't just crypto; the Nasdaq-100 sold off, our ETF sold off, everything risky sold off.  

More recently, that pullback exposed some weaknesses in the cryptomarket. It exposed the Luna stablecoin, which collapsed. It exposed Celsius, which is a lending platform that had to pause withdrawals. The largest crypto hedge fund, Three Arrows Capital, dissolved and is insolvent.  

We had a macro environment that turned negative, which pushed down the price of crypto. That exposed weaknesses within the cryptomarket, particularly in illiquid and leveraged areas, and that drove the price down further.  

What's happening today [June 21, 2022] is, over the weekend, FTX, which is a big crypto exchange, stepped in as a lender of last resort to stop the cascade of liquidations from Luna, Celsius, Three Arrows, etc. They provided three-quarters of $1 billion in loans to troubled entities in crypto in the same way Warren Buffett provided loans to Goldman Sachs during the global financial crisis.  

The cryptomarkets have rebounded sharply over the last 48 hours, because there is now possibly this lender of last resort to stop this cascade of liquidity.  

Nothing has happened in crypto to crypto, really. Crypto technology, blockchain technology is still as disruptive and important today as it was six months ago. But the macro market has changed. We've had some negative crypto-specific news, and then we may be seeing the beginnings of a bottom now that FTX has stepped up and stepped in. 

ETF.com: When you say Luna was “exposed,” what does that mean?  

Hougan: Luna was an algorithmic stablecoin, and algorithmic stablecoins don't work. They've never worked. There have been a large number of algorithmic stablecoins collapses over the years, and they—in my view—never will work.  

Luna's collapse was foretold by design. It just took a market pullback to create the conditions to expose that risk. There are probably a few other small crypto projects that will collapse for similar design reasons, but nothing on the scale of Luna.  

For what it's worth, this isn't just Monday morning quarterbacking. Luna was the sixth largest [crypto] asset; we never put it in our index, which is the top 10 assets, precisely because we identified this risk. It was well-known, and I don't think it means we'll see a lot more lapses. 

ETF.com: Why don't algorithmic stablecoins work? And are they excluded from the universe in your index fund? 

Hougan: Algorithmic stablecoins are excluded from the universe in our index funds. We had no exposure to Luna. As a result, our investors were protected.  

But stablecoins are a valuable development. If you're in crypto and you own bitcoin, if you want to trade out of bitcoin and not move your money into the slow-moving sclerotic fiat system, you trade into a stablecoin.  

You can design stablecoins in two ways. One, you can design it like a money market fund. They buy Treasuries and they hold Treasuries, and they create a digital representation of the dollar. And those stablecoins have worked well for many years. USDC is the largest well-regulated stablecoin. Tether is a version that's less regulated.  

Algorithmic stablecoins are a different idea. They really don't deserve the word “stablecoins”—they're really financial alchemy. You create something and say it's worth $1. And then you create another asset. And the rule is if the thing you say is worth $1 becomes worth less than $1, you can trade it for the other asset valued at $1, and theoretically, that could keep the price stable. But as soon as people lose confidence in that, both assets can go to zero.  

The trouble is, when people lose confidence is exactly the moment the first asset starts trading at not $1. So it's got like a procyclical disaster mechanism built in from the start. And parts of the crypto industry want there to be a decentralized, algorithmic stablecoin that doesn't rely on some centralized entity holding a bunch of Treasuries, but you can't always get what you want. 

ETF.com: Have the latest movements in the cryptocurrency space detracted from the argument that it’s an uncorrelated asset? 

Hougan: My view is it still holds. So what's always been true in crypto is that it sells off during risk off periods. During the taper tantrum of 2018, crypto fell 45%. During the original taper tantrum, crypto cratered. During the panic phase of COVID, crypto went down very sharply, with bitcoin trading below $5,000.  

It's always been the case that, during acute risk-off periods, crypto trades like a risk asset, which is not surprising. If anyone is surprised that crypto is risky, they haven't been paying attention over long periods of time.  

The core drivers of crypto in a normalized macro environment are still not correlated to stocks and bonds, which is why if we looked over a year or two years or three years, you'll still find that crypto is not correlated to other assets. I think that's still intact. 

The lesson for investors is one we've been preaching for a while, which is that one key to having crypto in a portfolio is that you have to rebalance. And if you rebalanced your crypto exposure in [the fourth quarter], you're still great.  

That means, on the flip side when it’s down, if you're following your rebalancing policy, you have to buy more. But I still think it's intact. I still think it's not correlated over long periods of time. 

ETF.com: What gives cryptocurrencies their value? Is it mostly driven by sentiment? What else needs to be factored in there? 

Hougan: The answer is different for different crypto assets. Bitcoin has a primary use of being digital gold. The returns of bitcoin are based solely on supply and demand, and in fact, supply is fixed, so it's really just demand. That's not satisfying to some people who want there to be intrinsic value, but gold’s value is based on supply and demand. So it's no surprise that digital gold is as well.  

Other crypto assets, like ethereum, are completely different economic drivers. The theory of it is it’s like a decentralized [software as a service] company. If you want to use the ethereum database, you have to pay a fee in ethereum. When you do, that fee is consumed and destroyed forever, and therefore, the value of ethereum is based on how many people want to use the decentralized ethereum database. Ethereum is really just a commodity that lets you use that database, and you can almost value it on a discounted cash flow basis.  

Crypto assets have different drivers of value, and it depends on their use case. People want there to be one simple answer. Unfortunately, the answer is slightly more complex. 

ETF.com: What is your advice for investors approaching the crypto space for the first time? 

Hougan: The key rules are: Crypto is best-positioned as a long-term investment; over a short period it can be extraordinarily volatile. And you have to right-size your portfolio. The studies we've done show that somewhere in the 1-5% range is the right range for most investors. Above 5% introduces too much volatility to your portfolio and increases your maximum drawdowns and standard deviation significantly.  

Think long term. Right-size your portfolio—don’t buy too much. But recognize that it’s a once-in-a-generation technology. It lets us do things we've never been able to do before in the history of the world with money. And you shouldn't dismiss it. 

ETF.com: Any final thoughts? 

Hougan: I think crypto remains in the land of hype and hyperbole. On the way up to $68,000, crypto was the greatest thing since sliced bread, and everyone wanted to jump on board. And now everyone is talking about crypto being over. And neither of those were right.  

Crypto is a disruptive, early-stage technology that's tackled an enormous market. The right way to think of crypto is it is the means by which the internet tackles the markets of finance and money, which are the largest markets the internet has ever gone after.  

If crypto pans out the way people like me think it will, it's an enormous opportunity. But there's no guarantee it pans out that way because it remains very early and it's very disruptive. It's hard to know how those how early-stage disruptive technologies work out.  

So I would tell people to look at both extremes with skepticism. Think of crypto as an interesting early-stage disruptive technology with big potential and big risks. And that's probably as close as you can come to the truth. 

Contact Heather Bell at [email protected]