This document is being provided publicly in the following form. Please subscribe to FSInsight.com for more. Members Area Crypto Blast CRYPTO BLAST: Maintaining our constructive crypto market o Crypto Blast CRYPTO BLAST: Maintaining our constructive crypto market outlook but uncertainty at Binance & OKEX take us from cautious to sell on exchange tokens while we see greater CME market share – that’s GOOD NEWS October 30, 2020 David Grider LEAD DIGITAL ASSET STRATEGIST We are long term bullish on the overall crypto market but see pockets of the industry that oer greater risks than others – exchange tokens are one of them. In a previous report (Regulatory Actions Highlight Risks But Market Remains Bullish), we urged investors to carefully consider risks associated with assets in the oshore exchange token sector, and specifically Binance (BNB), due to its historical allegations and actions taken by US regulators against the derivatives exchange BitMEX. A week later, the CEO of one exchange token we listed, OKEX (OKB), was taken into custody by Chinese police, leaving user funds unavailable for withdraw since October 16th and causing the value of its token to drop by over 30% on the news. Yesterday, a Forbes sta reported on leaked documents that allege Binance “conceived of an elaborate corporate structure designed to intentionally deceive regulators and surreptitiously profit from crypto investors in the United States.” The reports are unconfirmed by the company, but the news underscores our prior concerns from industry rumors and calls for caution on BNB’s token and the sector in general. The total crypto market cap excluding stable coins is roughly $380B, which makes exchange tokens at roughly $9B ~2% of the market a small pocket of risk with Binance (BNB) being ~1/2 – one we have been questioning if, and now believe, investors should avoid for the following reasons: Headline risk of allegations alone is enough to cause a market sell o on uncertainty. BitMEX news has caused many industry venues to enhance verification procedures and remove unallowed customers, which could lower trading and token value. Actual regulatory investigations and actions like those taken against BitMEX caused material harm to its business as 16% of volume dropped the day after the announcement, which would be bad for venues with tokens with their value derived from trading profits and buybacks. If allegations of regulatory violations are investigated and proven to be true, exchanges could face fines (bad for profits, buybacks, and token price) or worse, exchanges could be shut down and assets could go to zero. Yes, the same set of risks apply to banks, and all businesses, but given industry history, recent regulatory actions, and news announcements, we believe now is the time to be conservative in this area. Further, while a crypto bull market will likely bring increased trading, fees, and token values, we would rather own the underlying crypto assets themselves as we believe they have greater upside potential and risk/reward tradeos. Bottom line: We’re recommending investors who own assets in the exchange token sector sell holdings. However, we would cushion against shorting these volatile crypto assets. We’re watching how oshore exchange risks play out for the broader market short term, but not sounding any alarm bells besides the specific sector risk. We think the real positive is that this news likely drives more volume to regulated venues like CME as has happened since the BitMEX actions. If this happens and if there is any regulatory action (we are not making any speculations there is), the market may have already moved on and it may not cause systemic disruptions as happened with BitMEX due to volume migrating after the March price crash. We see that as GOOD NEWS for crypto markets long term. Point 1: Maintaining our positive long-term view on Bitcoin and crypto while eyeing short-term market risks optimistically for now Bitcoin and crypto have been the top performing asset class in 2020. We’re maintaining our constructive long-term view on the overall market and our FY 2020 BTC price target of $16,500. While we believe the situation at Binance and OKEX are worth watching very closely, it’s too early to sound the alarm bells for systemic risks across the space, but certainly see cause for concern within the exchange token sector. Source: Fundstrat Point 2: We’ve been cautious of the risks associated with crypto exchange tokens and have seen further risks mounting with OKEX and Binance ever since In a previous report, we questioned if the exchange token sector was exposed to regulatory risks after the derivatives exchange BitMEX was announced to be under investigation by U.S. authorities. Source: Fundstrat Binance (BNB) is the exchange we discussed specifically given it’s the largest oshore crypto exchange and the 6th largest crypto asset (ex stablecoins) by market cap sitting at ~$4.25B. Source: Fundstrat Given historical allegations against Binance, we have been urging clients to ask the question – Is the risk/reward of paying nearly the same times earning for BNB and major exchanges worth it? At this point, we think the answer is clearly NO. Source: Fundstrat Point 3: OKEX CEO investigation very well may be unrelated to the exchange, but it has been ongoing for 2 weeks, which is bad for its business & OKB token… but we are not sounding any other alarms yet One of the leading Asian exchanges OKEX had its CEO taken into custody by Chinese authorities on an investigation. User exchange balance withdraws were halted after, presumably because the CEO is a private key signer required to approve such transactions. Many have claimed that this investigation has nothing to do with the exchange and that its related to personal matters and that users funds are safe. Without speculating on what caused the investigation or what’s going on, users are surely not happy with their funds being held on the exchange going on two weeks now, and its harmed trading activity which was paused for a period of time, which are both bad for the value of the OKB token. Source: Coindesk Some market participants have found a work around to help users get funds o the exchanges. Trusted parties, usually other exchanges with accounts at OKEX, much like correspondent banks, have allowed users to use the internal transfer mechanism at the exchange to move funds into their account. From there, these trusted parties issue IOU tokens for the assets held at OKEX in their account and deliver them to the owner. They then can sell them on the secondary market to gain access to liquidity. The buyer assumes the counterparty risk of collecting from the exchange once withdraws are opened and usually demands a discount to face value. Thus far, we know of this happening firsthand with TRON and USDT and have heard second hand unconfirmed of it happening with other assets like BTC. Source: Google, Poloniex On some exchanges, we have seen the IOUs for USDT, a stable coin usually valued at $1, trading at a $0.80, but we’ll note on relatively low volume thus far that we’ve seen. But the price represents some combination of investors’ need for liquidity and the markets expectations for OKEX default risks. Source: CoinEX History doesn’t repeat but it often rhymes. Such a scenario happened before back in 2014 right before the infamous exchange Mt. Gox went under following its hack and loss of Bitcoin. An exchange called Bitcoin Builder popped up that allowed users to trade these Bitcoin IOUs, as can be seen from the 2014 article below. Source: Coindesk What gives us some level of comfort around the situation at OKEX is that the market doesn’t seem to be pricing the same default risk in after two weeks as it did for Mt. Gox back in 2014. At the time, the price of Bitcoin on Mt. Gox was trading at a much more significant discount to Bitcoin on other exchanges than the OKEX USDT IOU discounts we’re seeing today. Source: Bitcoin Charts Point 4: Bitcoin rallied 25% after OKEX announced no withdraws, with it holding ~7% of BTC on exchanges, we wonder how much this supply limitation fueled the move, and question what that means for prices next? Over the short term, for tactical investors, we are considering what eect the reduction in BTC supply locked on the exchange might have had on this recent price rally. Bitcoin has seen its price rise by ~25% since the withdraw restriction was announced, while the price ok the OKEX exchange token OKB has fallen by roughly the same amount. Source: Trading View We estimate Bitcoin held on the OKEX exchange is 7% of all exchange balance supply, which would be a material portion of the traded float and could lead to short term selling pressure if pent up BTC becomes able to move to other exchanges and be liquidated. Source: Viewbase, Coinmetrics, Glassnode, CryptoQuant, Chain.info While trading has resumed on the platform, thus far the only fiat pair enabled have been the CNY, INR and VND, while withdraws have remained closed. Point 5: New accusations against Binance are very serious and potentially as bad or worse than those against BitMEX if proven, but headline risk is enough to cause investors to flee as they did with BitMEX Source: Forbes The Forbes article alleges Binance designed a structure meant evade regulators with its on shore exchange never intended to capture material profits and value. One of the risks we highlighted in our prior note was that very little of the exchange volume at Binance comes from its US based exchange.