This is Flow

Malt Liquidity 125

One could say I’m not exactly the most positive person about the structure of markets nowadays, and I’ve given various thoughts about the state of passive markets:

We can logically conclude that a sort of push-and-pull effect occurs: “real” flow goes into large caps, they rebalance as part of the ETFs they are in, “passive” flow goes into ETFs and drags the rest of the stocks up along with the large ones to a smaller extent.

I’m not a fan of this dynamic — a core concept of mine is that trading is supposed to reflect information asymmetry (as that’s how it becomes more efficient.) With markets trending towards majority-passive and therefore crowding everyone in the same trade, “real trading” (more on this later) seems to be, well, disincentivized:

While this has recently been noticed with regards to NQ and its overweighting to six companies (which led tothe process of rebalancing it), this doesn’t remove the cross-market correlated trading patterns that developed due to the fact that liquidity across ETF components is equal opportunity, not equal outcome, and that the market is “made” as a whole rather than each individual ticker having a specialized book — Stock #372 in SPY simply will see nowhere near the volume of AAPL, as congregated drift is a function of true volume in the market rather than the gravity of the heaviest components….

…what’s the point of realizing something if the market is unwilling to make it profitable enough to capture the edge? Hence the whole theory that shorts need catalysts (and why shorting is a fool’s game — betting on reality righting itself when the entire fiat system depends on denying reality is delusional. I always say this about that Big Short scene because it’s so true: investors are right to get mad when you’re betting against the forces that manipulate reality. 99.9% of the time you just blow up.) Thus the best trades became the simplest ones. Buy big tech. Buy what everyone else is doing. The market will go straight up due to the nature of ETFs and passive inflows. In Berkshire’s entire history, somehow their period of best returns came when they did what everyone else did: buy AAPL. What is the point of having novel research or information if the market is going up anyway?

Circling back to topical events, this naturally brings me to a question I’ve been asked a lot recently: what is going to happen to BTC after a spot ETF starts trading? (Note that I’ve looked at the legal side of things prior and assume that this is going through.) While the product is not necessary, it certainly should be allowed to trade, but I can’t see what exactly the purpose is for anyone who actually wants to long or trade BTC:

Currently, there are essentially these “approved” channels of easily gaining exposure to Bitcoin in the US if one desires so:

1. You can buy Bitcoin directly through an approved exchange, such as Coinbase

2. You can buy shares in a company who has tied their stakes to Bitcoin, either by holding a lot (a la MSTR) or by tying their business’ future to it (COIN)

3. You can buy a futures Bitcoin ETP, which tethers to CME Bitcoin futures (or buy those futures directly, of course)

4. You can buy a “pot” of Bitcoins held in a trust for you, which cannot be liquidated directly themselves,which leads to a divergence of the value of the “pot” relative to the actual Bitcoin value held, as I’ve written about before

If I was long the crypto industry or trying to make a lot of money fast (not levered — more on that later), I don’t think I’d ever want to purchase BTC through an ETF, nor would I want it directly tied to the actual spot price itself. BTC (and crypto) is particularly unique in that it’s positive skewed without passive inflows — as I wrote about years ago,

Beyond pure "inflows and outflows", here's the model I use for crypto, and why the moves are so rapid: While tokens are built on 'hot air' - there isn't an underlying cash flow/debt to coins - the fact that there is liquidity *is* fundamental value. I think of tradable crypto as essentially a put on central bank stability - <1 delta in, say, the U.S., much higher delta in, say, Turkey. Specifically, they are far dated, far otm puts. This would imply that the extrinsic 'value' crypto has (bc there's no intrinsic for these options, obviously) is almost entirely IV (given that they're on the extremes of the volatility smile), and there is no 'exercisability'. As a result, crypto "inflows and outflows" are more akin to rapid bidding/crushing of the implied volatility of an option rather than normal delta one products, which exponentiates the nature of the move when it comes due to the nonlinearity of option movement itself.

If I am long any crypto, this is great (as long as the alt doesn’t get drained or exploited or some other somewhat common affair): when volumes are low, “correlated drift” and “beta” tend to be realized because of the general nature of statistical “arbitrage”. The implied correlation is reinforced by the actual trading. But he who predicts the flow rules the galaxy:

There is no "wealth" unless there is a liquidity event. Mark-to-market "valuations" have been an absolute disaster in how they're thought about. Most real-time stock prices are an illusion as well. Go look at lit book depth and see if any of those orders get hit during intraday drift. There is a reason trading clusters around the open and the close and why less trading hours, not more, are a better idea. The entire point of dark pools, private deals, block trades, is because everyone is deathly afraid of hitting the tape when they actually need to transact in size. If you mandate this, it would be an unmitigated disaster.

The core problem is, with a spot ETF, due to how create/redeem works, all of a sudden you have actual selling. People do not trade crypto to passively invest or make bips — they’re looking to multiply their initial sum quickly (seriously, the expectations for % returns on a trade or a coin are absurd when you talk to very legitimate traders — and they’re totally within reason.) Thus, given the fact that you are allowed much, much more leverage in the crypto markets, there’s no actual reason to ever short a crypto unless you’re the one about to hit the tape (and this is why fake news is particularly effective in crypto — selling big blocks on no news means sharp money moves out of the way, while if the ‘news’ is proven ‘fake’, people will bid things back up into your sell, creating book depth.) Markets don’t drop due to “massive selling”; they drop due to lack of bid. The biggest fear anyone long the crypto industry or BTC should have is that BTC trading moves closer to delta one than to option-esque — you’re not doing 200% on a ludicrous Sharpe YOY on something that’s just levered beta. If money flows to an ETF, rather than to companies building innovative products (because, yes, there is legit tech built out, even though everyone seems to still be splashing about in the transaction layer kiddie pool), there is no “store of value” or “crypto-stable” thesis to ever long BTC on. You’ll get an illiquid asset that randomly moves here and there with some sort of tangential, enforced beta that serves no purpose whatsoever, like gold.

So, let’s review: no “enabled access” in any meaningful manner, no actual inflows into development of a real product, curbing the positive skew — who exactly does this benefit if actual volumes start to hit spot ETFs? Well, naturally, the people who miss the forest for the fees — lawyers, bankers, wealth managers, journalists — and people who hold ultra large stashes that can’t liquidate or collapse the spread in their product, as an ETF mechanism acts as sort of a “buoy” by providing passive trading volume that you can slowly liquidate into. I think the only true winner here is GBTC, as, assuredly, they no longer have the premium/discount issue after the product transition. I suppose less volatility and BTC not able to just implode and go to zero is a “net good” on a surface level. But that’s the entire point of this post: less volatility is only good if an asset is normally distributed. If it’s biased towards one direction, you want more volatility — wouldn’t you want to spin as much as possible on a roulette table that pays out more for black and lands on it more often?

I am not a crypto true believer by any means (I just don’t think it’s optimal to buy into something beyond a reasonable threshold, but this is why I’m not Elon Musk — yet), but a successful absorption of BTC into the traditional system seems like the death of the crypto ethos to me. “Code is law” naturally implies “MY code is law”; crypto originally was conceived as something that invalidated the concept of regulatory capture rather than with the intent of being enveloped by regulations and monitoring themselves. I don’t see what purpose any of this serves other than to (probably) strike out in selling low-fee ETFs to funds that don’t want exposure anyway. What exactly are they invested in? A product tied to a product of nebulous value that only goes up because it, well, goes up? Crypto doesn’t die by going to zero — it dies by becoming illiquid and fading away. There was no “rug pull” in most NFTs — they simply stopped trading. A market cap castle in the sky becomes too unstable as the amount of hot air underneath the stairs increases — Wile Coyote only ever made it a few steps past the cliff before sinking down.

The solution to crypto isn’t going “backwards” — I don’t think anyone is going to buy into the “fundamental valuation future cash flows” mentality again — but there needs to be some tethering to reality and some use case to make this all work. The way to change reality is to delude yourself that you are doing it until it does shift. The only way is to delve further into post-modernity rather than accepting the “irony” of a BTC long thesis on “mainstream institutional adoption”. The only thing an ironic meta can lead to is the death of any meaning whatsoever:

Sarcasm, parody, absurdism and irony are great ways to strip off stuff’s mask and show the unpleasant reality behind it. The problem is that once the rules of art are debunked, and once the unpleasant realities the irony diagnoses are revealed and diagnosed, "then" what do we do? Irony’s useful for debunking illusions, but most of the illusion-debunking in the U.S. has now been done and redone. Once everybody knows that equality of opportunity is bunk and Mike Brady’s bunk and Just Say No is bunk, now what do we do? All we seem to want to do is keep ridiculing the stuff. Postmodern irony and cynicism’s become an end in itself, a measure of hip sophistication and literary savvy. Few artists dare to try to talk about ways of working toward redeeming what’s wrong, because they’ll look sentimental and naive to all the weary ironists. Irony’s gone from liberating to enslaving. There’s some great essay somewhere that has a line about irony being the song of the prisoner who’s come to love his cage.”

This isn’t an essay, but it is the great blog post about the fact that people in crypto being excited about crypto ETFs is precisely the song of the trader who came to love his cage.