Market View
Policy potpourri
We think the overall macro environment still lends itself to better crypto performance in 4Q23, though issues like a looming US government shutdown may contribute to volatility in the very short term. Although contagion from traditional risk assets may affect crypto due to the knee-jerk reaction from market players, we believe that that anxiety could be short-lived. In fact, we believe digital assets like bitcoin should recover quickly as they tend to work well as a hedge against the points of failure inherent in the traditional financial system.
The Federal Reserve’s higher-for-longer monetary policy stance does remain a concern, but at this point, we think that that’s fully priced-in. For example, Fed funds futures currently imply only 65bps of cuts in 2024 compared to the 100bps of cuts they priced in early September. A potential shutdown may impact the Fed’s access to key pieces of information (like the September CPI print) needed for the next FOMC meeting on October 31-November 1. Moreover, the strikes by the United Auto Workers (UAW) and the Writers’ Guild may have negatively impacted a normalizing US economy in 3Q23. All of this could keep the Fed from hiking rates at the next meeting, which in our view could set us up for a rally through year-end.
That said, macro factors only played a marginal role in crypto performance during September. Earlier, we had speculated in our weekly report from September 8 that bitcoin’s historically poor seasonals would be limited in part because of the large 10.9% depreciation in August. We also think the concerns surrounding the sell off in the US Treasury bond market, which pushed the 10-year yield above 4.60%, has disproportionately affected traditional risk assets over crypto - reflected in the low correlation coefficients between crypto returns and macro factors. Bitcoin appreciated 3.5% in September compared to losses of 3.1% and 3.7% on the S&P 500 and Nasdaq, respectively. See chart 1.
That said, for crypto, fundamentals are still taking a backseat to technical factors like liquidity in the short term. Market depth remains relatively unchanged, but volumes have declined from a daily average of US$38.2B in August (traded across BTC and ETH spot, perpetual futures and traditional futures) to $30.1B in September, based on CoinMetrics data. Participants have mainly been preoccupied by progress on the growing list of bitcoin spot ETF applications, but this week, the SEC deferred a number of these including Ark21Shares, Bitwise, BlackRock, GlobalX and Valkyrie. Because 90% of the SEC’s staff could be furloughed in a US government shutdown, some analysts have speculated that the SEC is trying to get ahead of this potential event risk.
Note, however, that Valkyrie announced on September 28 that its Bitcoin Strategy ETF has begun buying ETH futures contracts in preparation for a formal shift to a blended BTC and ETH investment strategy on October 3, indicating that it had received approval from the SEC. Valkyrie is unique insofar as it made a change to the existing investment objectives of its bitcoin futures ETF in early August to include managed exposure to ETH futures, rather than rely solely on a separate ETH futures ETF application. As of publication, it is not clear whether the SEC will approve any of the other ETH futures ETF applications that are awaiting approval, with deadlines ranging from October 11 to October 18.
Onchain activity
The number of onchain transactions on the Bitcoin network per day declined sharply this week. This coincided with a proposal from Ordinals creator Casey Rodamour to replace the current BRC-20 protocol with an alternative called “Runes.” Rodamour suggested that fungible tokens like BRC-20s “weaken bitcoin’s purity” by propagating “junk” unspent transaction outputs (UTXOs).
In 2Q23 and 3Q23, the minting and transfer of BRC-20 tokens created via the Inscriptions process (used in Ordinals) has driven the total number of transactions up by 51% compared to the 1Q23 average. The transaction count averaged 465k per day in August and 535k in the first three weeks of September with Inscriptions representing an average 44% of those (see chart 3). In the last three days, however, bitcoin transactions have fallen to an average of 311k per day. Note that despite the increase in transaction volume, the total USD value transferred on the network has remained constant, as the median value of each transaction has dropped due to the increase of lower value transactions on the network.
According to Rodarmor, “Runes” would be a UTXO-based alternative to the BRC-20 standard. The new protocol would be dedicated to fungible tokens and have a “lighter onchain footprint.” Indeed, BRC-20s are not UTXO-based and their design may have contributed to higher network transfer fees in recent months, whereas the proposal for the Runes protocol would permit UTXOs to be able to hold any amount of runes.
