🎙️ Crypto Crusade

💭 Exchanges, whether for stocks, commodities, or crypto, have a fairly intuitive business model.

More trading volume = good. Less trading volume = bad.

Once valued at over $80 billion, Coinbase, America’s de facto crypto exchange since FTX’s implosion, seemed primed to emerge stronger on the other side of this “crypto winter.”

Still, with crypto prices, trading volumes, and revenues way down, Coinbase faced tough challenges. Now, lawsuits from the SEC put its very existence at risk.

More on that below.

— Shawn

Here’s the rundown:

Today, we'll discuss the three biggest stories in markets:

• Updates on the ongoing saga between Coinbase and the SEC

• How surprise rate hikes are disrupting global bond markets

• Why home insurance is changing

All this, and more, in just 5 minutes to read.

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CHART(S) OF THE DAY

IN THE NEWS

📣 The SEC’s Crypto Crusade Continues, Coinbase Speaks Out (Reuters)

On Tuesday, we outlined the Securities and Exchange Commission’s (SEC) near-existential lawsuits for the crypto industry, aimed specifically at Binance and Coinbase, which act as intermediaries facilitating digital asset trading on their exchanges.

It’s a big, nuanced story. Bloomberg’s Matt Levine raises an interesting question, “Is the SEC suing Coinbase and Binance for being crypto exchanges, or for being bad crypto exchanges?”

• Meaning, are cryptocurrency exchanges fundamentally illegal in the SEC’s view?
  

• Or are these exchanges, with FTX being the poster child, in violation for mismanagement but not the nature of their business itself (i.e., enabling crypto trading to the public)?

The heart of this debate revolves around determining whether cryptocurrencies are securities. While nearly everyone agrees Bitcoin isn’t a security — Bitcoin has never sought public funds to develop its technology, and it does not pass the Howey Test used by the SEC to classify securities — things are less clear for the rest of the space.

• Collectible baseball cards, for example, aren’t securities, so trading them doesn’t necessarily violate securities laws. But Apple’s stock is clearly a security. Crypto generally exists between these two ends of the spectrum, with differentiating factors for each project.

Why it matters:

If most cryptocurrencies are securities, then exchanges like Coinbase, despite being a publicly-traded company audited by Deloitte, are in violation for failing to register with the SEC as a securities exchange.

• With its business model on the line, Coinbase naturally disagrees. But Binance's chief compliance officer offered a more frank insight in 2018, saying in a private message, “We are operating a fking unlicensed securities exchange in the USA bro.” Not good, bro.

At the top of the SEC, Gary Gensler isn’t amused, remarking that in four decades of experience, “I’ve never seen so much noncompliance and hype masquerading as reality as I’ve seen in this field.”

• Brian Armstrong, Coinbase’s CEO, pushed back. If everything in crypto is considered a security besides Bitcoin, it would mean “the end of the crypto industry in the U.S.,” and Coinbase would be proud to challenge that in the courts for “the industry and America.”
  

• He suggests the SEC is partially right, though. Some “90%” of crypto tokens are securities. And Coinbase, in his view, has aimed to exclude those, only offering digital assets decentralized enough to be considered commodities (like Bitcoin is.)

Ultimately, we’re in the early innings of a years-long battle. Short of an SEC regime change, Levine argues that Coinbase and the crypto industry are hoping for new legislation from Congress, tweaking securities laws to “avoid stifling innovation.”

🏠 The Changing Home Insurance Landscape (WSJ)

Hurricanes. Wildfires. Floods. Insurance companies are pulling back on homeowners' policies in vulnerable areas nationally as climate change complicates the insurance business and increases the cost of rebuilding.

• For example, American International Group (AIG) halted home insurance sales to wealthy customers in about 200 ZIP codes at high risk of floods or wildfires, including New York, Delaware, Florida, Colorado, Montana, Idaho, and Wyoming.
  

• AIG has already stopped selling new policies in California, where wildfires have increased in frequency and severity.
  

• Farmers Group is also pulling back. A spokesman said that “with catastrophe costs at historically high levels and reconstruction costs continuing to climb,” the pause was designed to help Farmers manage risk exposure more effectively.

Rising losses: In turn, it's getting harder for buyers to insure their homes. Meanwhile, insurers have struggled to recoup an inflation-driven surge in rebuilding costs, plus rising losses from wildfires.

• Payouts on claims to California homeowners more than doubled from 2019 through 2022, while premiums increased by only around a third.

Why it matters:

The warming climate already impacts global food markets, travel, and housing. In select areas, homeowners have fewer choices or, in some cases, no choice with insurance policies.

Consider California, where State Farm and Allstate were “the only game in town” for multimillion-dollar homes in wildfire-exposed areas such as Lake Tahoe or Carmel.

• For instance, properties, including a Beverly Hills mansion, might not be insurable. Allstate and State Farm are two of the five biggest insurers in the state. California has an insurer of last resort, the Fair Access to Insurance Requirements Plan, but that is expensive and offers bare-bones coverage of at most $3 million.
  

• “California is a broken insurance system,” one San Francisco-based broker said. “It’s a ticking time bomb.”

Allstate blames California's rate-approval system for its decision to pause new applications. It said the system doesn't account for inflationary increases in rebuilding costs and climate change.

• “The cost to insure new home customers in California is far higher than the price they would pay for policies,” the company said.

Insurers are also calling for a better system altogether, ideally one that relies on historical claims data and uses models of potential wildfires. In other words, they’re asking for a modern system.

😅 Bonds Globally Selloff After Surprise Rate Hikes (Bloomberg)

In overseeing the world’s largest economy, the Federal Reserve usually sets the tone globally for central banks.

• But surprise rate hikes by the Bank of Canada and the Reserve Bank of Australia are rattling bond markets everywhere, raising renewed concerns about the collateral damage done to markets by interest rates staying at current levels or going higher.

• As a result, bonds on the front end of the yield curve, those coming due relatively sooner, have surged back toward recent highs in the U.S. Treasury market.

The two “shock interest-rate hikes” reminded traders that victory celebrations in the fight against inflation remain premature, prompting a reevaluation of bets that the Fed will cut rates later this year — a pivot only imaginable (under normal circumstances, at least) with inflation firmly in the rearview mirror.

Deutsche Bank strategists commented that the latest developments “run against the prevailing market narrative that central banks are on the verge of pausing rate hikes, particularly given Canada was one of the first to formally signal a pause back in January.”

• Adding, “The big question now is whether the Fed might follow up with a hike of their own next Wednesday, or whether they’ll finally keep rates on hold after 10 consecutive increases.”
  

• Odds of a rate hike in June rose to 36% from 28%, and most traders now predict a 0.25% July rate hike.

Why it matters:

Exuberance around artificial intelligence is often cited as a driving factor behind the stock market’s returns this year. Still, expectations for lower interest rates over the next year have undoubtedly supported stock prices, too.

• Should those expectations continue to shift in favor of higher rates, stocks, particularly tech companies, would face major headwinds. Companies and the U.S. government would also face painfully-elevated financing costs for longer.

What’s next: Several anticipated rate cuts later this year have already been priced out of interest-rate markets, though there’s still an expectation that the Fed will begin lowering rates to some extent before 2023 ends.

• Whether that optimism is actually feasible will depend on fresh economic data informing the Fed’s decision-making, with all eyes on next week’s CPI inflation report.

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See you next time!

That's it for today on We Study Markets!

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