What’s driving the blockchain rally?

Blockchain technology is often conflated with cryptocurrencies, and associated with the speculation that takes place around these assets. While a boom for crypto stocks has driven the performance of the blockchain theme in the first half of 2023, various other developments in the space, from Amazon expanding its blockchain-as-a-service offering, to the formation of the first financial institutional blockchain. network, drives the theme. Blockchain technology is often conflated with cryptocurrencies, and associated with the speculation that takes place around these assets. While a boom for crypto stocks has driven the performance of the blockchain theme in the first half of 2023, various other developments in the space, from Amazon expanding its blockchain-as-a-service offering, to the formation of the first financial institutional blockchain. network, drives the theme.

• Despite a rocky start, blockchain stocks rallied in the first half of 2023.
• Canton Network represents the first major collaboration between financial institutions utilizing blockchain technology.
• The Global X Blockchain ETF is up 57% in the past six months.

Blockchains are actually distributed digital records. Existing as a global network, each blockchain is nevertheless distinct, and each has individual characteristics and use cases.

While blockchain is sometimes conflated with cryptocurrency, this is just one of many applications of the technology. Hundreds of blockchains exist for non-cryptocurrency purposes, from supply chain management to medical records and IP management.

However, cryptocurrency is by far the most widespread use. There are over 23,000 cryptocurrencies in circulation and each has its own blockchain that supports it. Their characteristics vary considerably. For example, while the Bitcoin blockchain exists solely to support the bitcoin cryptocurrency, Ethereum can support a wide range of use cases.

From non-fungible tokens to the fight against financial fraud, blockchain technology has the potential to completely transform how information is shared across the global economy. The topic is in its early stages: according to Precedence Research, it was valued at $5.7 billion in 2021, but with the potential to reach $1.6 billion by 2030, at a massive CAGR of 87.1%.

Blockchain theme binds include miners such as Riot Platforms [RIOT]exchanges like Coinbase [COIN]and companies directly exposed to cryptocurrency prices, such as MicroStrategy [MSTR].

Proponents of cryptocurrencies, or “decentralized finance” (de-fi), are attracted by the fact that blockchain technology makes these currencies independent of any nation-state or central bank.

In the long term, de-fi proponents argue that cryptocurrencies are more resistant to inflation than fiat currencies, because it is more difficult to increase the supply of currency. For example, the total number of bitcoins is limited to 21 million, and the rate of mining new bitcoins will be halved every four years.

The crypto spring

Stocks within the blockchain theme suffered during 2022. Starting in May, a crash in the value of TerraUSD and Luna stablecoins eroded investor confidence in cryptocurrencies. In June, crypto hedge fund Three Arrows Capital was liquidated after defaulting on a payment to crypto lender Voyager Digital, which itself filed for bankruptcy the following month.

In November, the industry was further rocked by the collapse of leading exchange FTX, with criminal charges against its founder, Sam Bankman-Fried.

The price of bitcoin fell over 64% throughout the year as investors fled cryptocurrencies. The bear market was called a ‘crypto winter’.

However, assets increased in 2023. Bitcoin is up 59% in the year so far, and miners like Riot are up over 232%.

Crypto stocks ‘climbed a wall of worry last year’, Mike Venuto, portfolio manager of Amplify Transformational Data Sharing ETF [BLOK]told Opto sessions in May. “Three Arrows … FTX, Voyager, you name it, it happened.”

However, “not a single one of these was really about Bitcoin. And not a single one of these was about decentralized finance, and not a single one of them was about blockchain. All of these were the second oldest profession in the world, which is financial fraud. They were all Ponzi schemes.”

However, as investors have regained confidence in the scandal-plagued industry and as interest rates continue to rise globally, cryptocurrencies have regained their status as a popular safe haven against inflation.

Indirect exposure

Buying shares in companies like Coinbase has long been considered one of the best ways to gain exposure to cryptocurrencies without owning them outright. But Berenberg analysts suggested in May 2023 that MicroStrategy could be a better remedy than Coinbase.

“We believe MicroStrategy, which has a unique business model focused on buying and holding bitcoins, represents an attractive alternative to Coinbase in the current environment,” Berenberg analysts Mark Palmer and Hassan Saleem wrote in a note seen by Coindesk.

In 2021, MicroStrategy sold $500 million in bonds to buy bitcoin, and has since continued to buy bitcoin with excess cash. While primarily a maker of business intelligence software, the approach gives MicroStrategy’s stock clear exposure to bitcoin prices. As of March 2023, MicroStrategy’s bitcoin holdings were worth $3.8 billion.

MicroStrategy is far from the only technology company diversifying into blockchain technology. Amazon [AMZN] has offered blockchain-as-a-service through Amazon Web Services (AWS) since 2018, enabling users of the service to host their own blockchains on the technology. AWS hosts 25% of all Ethereum networks, according to Amazon.

In January 2023, the e-commerce giant partnered with blockchain startup Ava Labs to accelerate institutional and government adoption of blockchain, by enabling faster node deployment of Ava’s Avalanche network through AWS.

Calls for regulation

The most important factor in the near future of cryptocurrencies is the extent of regulatory action the US government ultimately takes.

“The biggest threat to Bitcoin right now is continued inaction by the US government,” Venuto said. “The longer we wait for some clarity, the more likely we are to have more fraud, which sets us back.”

As always, what is happening in crypto is in many ways a distraction from the broader potential of blockchain technology, which is developing rapidly in the business world, regardless of the macro environment.

In early May 2023, a group of financial institutions and other companies including BNP Paribas [BNP.PA]Deloitte, Goldman Sachs [GS] and Microsoft [MSFT] formed the Canton Network, “the industry’s first privacy-enabled interoperable blockchain network,” according to a press release. Built on Daml, a smart contract language from network provider Digital Asset, the “network of networks” will facilitate the secure transfer of data between participating institutions.

Increases throughput

According to Larry Cermak, CEO of The Block, one of the biggest innovations in the blockchain space is set to be Layer-two (L2) blockchains, specifically zero-knowledge digests. These have the potential to provide greater fairness and efficiency, thereby driving blockchain adoption by increasing reliability.

“The problem we constantly face is that when there’s a bull market or any kind of surge in interest, the blockchains just can’t handle the throughput required to actually bring in enough users,” Cermak said on this week’s episode of Opto sessions.

“It scares the users [because it] creates unfair rules where the bigger or wealthier players are the ones who get the benefits of getting into the blocks faster, because they pay more.”

Fund in focus: Global X Blockchain ETF

BLOK, Venuto’s fund, limits each of its segments to a maximum of 25% of its holdings. As of March 31, transaction stocks (exchanges such as Coinbase, the fund’s seventh largest holding) made up 25% of the fund’s industry allocation. Miners were at 20%, venture at 11%, while application, exposure and private blockchain were allocated 10% each. The rest of the fund’s exposure is to conglomerates and semiconductors.

BLOK is down 9.2% in the last 12 months, and up 20.7% in the last six.

Global X Blockchain ETF [BKCH] is one of the top blockchain funds in 2023, gaining 57.2% over the past six months, although it is down 18% over the past 12 months. As of April 30, its holdings are primarily in the information technology (IT) sphere (76.8%), with financials (18.5%), industrials (2.6%), consumer discretionary (1.6%) and real estate (0 .5%) follows. .

Investors seeking exposure to companies using blockchain technology without obvious crypto exposure can choose the First Trust Indxx Innovative Transaction & Process ETF [LEGR]. As of May 23, the fund offers exposure to financials (37.84%), IT (30.58%), consumer discretionary (8.92%), communications services (8.86%), industrials (5.50%) and utilities (2.98%) poised to take advantage of blockchain technology, with the rest of the exposure going to consumer goods, materials, healthcare and energy.

LEGR is up 4.1% over the past 12 months and up 7% over the past six.