Crypto stocks like Coinbase continue to rise. If the rally can last.

Crypto stocks like Coinbase continue to rise.  If the rally can last.

Bitcoin may be one of the best investments this year, but the prices of some of the crypto companies put it to shame. Tread carefully – Uncle Sam could soon crash the party.

Bitcoin has risen about 65% in 2023 to $27,350. That was after the oldest cryptocurrency limped through 2022 when a series of scandals and bankruptcies sent the industry into a tailspin. Few expected token prices to recover so quickly. Some analysts have attributed the recent downturn since March to the regional banking crisis, which token advocates say strengthens Bitcoin’s case as an alternative to the traditional financial system.

But the token’s performance is nothing compared to some of the companies that do business in them. Crypto trading platform Coinbase Global (ticker: COIN) has soared 81% to $60.94 so far this year. Shares of Bitcoin miners Marathon Digital Holdings ( MARA ) and Riot Blockchain ( RIOT ) have surged 192% and 254%, respectively.

Even enterprise software company MicroStrategy ( MSTR ) — whose CEO Michael Saylor stepped down from the top role during last year’s crypto meltdown — has more than doubled this year to $310 a share, boosted by the company’s large holdings of Bitcoin.

Investors who expect these gains to continue over the long term should take note. Crypto companies depend both on token prices continuing to rise and on their ability to continue making money in the market. Both of these pillars are under threat.

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On the symbolic side, recent gains have largely been driven by the same factors that have helped all risky assets: the prospect that interest rates are poised to stall or even begin to fall.

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Higher interest rates tend to hurt returns on investments with the least prospect of short-term profit. By design, Bitcoin and other crypto-tokens generally do not generate income. Proponents say Bitcoin will one day be widely used as a store of value — and that other tokens will eventually have practical value as their blockchains become useful for the real world. But since those days still seem years away, higher prices have an overall negative impact on returns, as they do on other higher-risk investments.

So this year, the prospect of the Federal Reserve nearing the end of its rate hike campaign was a huge boost for token prices. The problem now is that the tailwind has probably gone. Investors have not only priced in a pause in interest rates, but expect the Fed to start cutting later this year. It’s a risky bet, and if cuts aren’t forthcoming, token prices can turn on a dime.

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“Any indication of further rate hikes could see crypto assets trade sideways to down until there is more clarity,” Compass Point Research & Trading analysts said in a note last week.

The crypto companies’ other big problem extends beyond the token prices themselves and into a regulatory sphere that is as negative for the industry as it has ever been.

Even since the crash of FTX last year, “the tone in Washington shifted from one where they were open to talking about crypto to one of ‘We really want to eliminate this,'” says Marathon Digital Holdings CEO Fred Thiel. “Although I don’t is a conspiracy theorist, there is definitely a concerted effort, coordinated or not, by various branches of government to put pressure on the industry.”

Last week, the White House proposed a 30% tax on electricity used by crypto miners, a move the Biden administration said was necessary to offset mining’s environmental impact. Miners, for their part, say their practice encourages the development of sustainable energy sources and helps power companies sell excess energy that would otherwise be wasted.

For crypto platforms like Coinbase, the biggest threat is from the Securities and Exchange Commission, which in March sent the company a notice that it is likely to sue the firm for securities violations. While the firm said the agency’s goals were not entirely clear, executives say they believe it is likely to look at which tokens it lists as well as products it offers clients that generate returns. Coinbase has long denied that it offers securities on its platform.

Coinbase executives on an earnings call last week noted that the smaller tokens and stake products that the SEC could target represent a relatively small portion of the company’s current profits. However, analysts covering the stock have seen the yield business as one of the most promising growth areas for the firm.

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“We continue to believe that retail crypto volumes will remain weak and regulatory overhangs will persist for some time,” BofA Global Research analysts wrote in a note after the earnings report. The analysts rate the share as “Underperform”.

And while last year there appeared to be growing support in Congress to pass legislation that could limit the SEC’s powers, it now appears that crypto-skeptics have the upper hand and are cheering the crackdown.

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“The problem is not regulatory ambiguity, it’s mass failure,” said Rep. Stephen Lynch (D., Mass.) during a hearing Wednesday.

That’s not a good sign that crypto firms will get congressional protection from enforcement agencies — and certainly not a good environment for their profits while the scrutiny persists.

Whether it’s through a rude awakening by the Fed on token prices or an attack by the SEC on corporate profit centers, the risk for crypto-stock investors is high.

Write to Joe Light at [email protected]

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