Market View
There seems to be only one story in crypto right now, as animal spirits are high and crypto outperforms stocks on a risk-adjusted basis. Bitcoin remains the anchor for the asset class, but currently, investors have several alternatives for gaining exposure to the token. Not only can market players buy (1) bitcoin (BTC) directly but they can also tap (2) spot bitcoin ETFs or buy (3) bitcoin proxies like MicroStrategy (MSTR) or (4) bitcoin miners. What’s interesting is that the performance among these choices has diverged sharply since late February. Between January 11 (marking the launch of spot bitcoin ETFs in the US) and March 14, bitcoin (based on the CME Bitcoin Reference Rate NY) has gained 57% while ETFs have tracked this closely with an AUM weighted return of 59%. Miners have underperformed with a loss of 8%. MSTR has been the biggest outperformer with an impressive return of 192% - more than 3x greater than the spot bitcoin return.
MicroStrategy (MSTR)
MicroStrategy is a significant holder of bitcoin, making its stock performance highly sensitive to the token’s price movements. The company holds over 205,000 BTC acquired at an average price of $33,706 per BTC, according to Executive Chairman Michael Saylor as of March 10, giving them a cost basis of around $6.9B on a position worth $14.8B today. We think part of MSTR’s outperformance to other bitcoin beta plays reflects confidence in the company’s borrow-and-acquisition strategy, while they’ve improved their expense ratio by reducing total operating expenses in 2023 according to the latest 10-K filing. The ease of purchasing and storing MSTR in a brokerage account is also likely a factor here. Of course, investing in MSTR exposes investors to the company's business performance and any decisions made by its management.
Public bitcoin miners
Similar to MicroStrategy, public bitcoin mining stocks can be purchased through a brokerage and can provide exposure to bitcoin without direct ownership. However, their business performance depends on the costs of production (electricity, hardware etc) as well as bitcoin difficulty adjustments like the upcoming halving in April. In our view, mining stocks have not been tracking bitcoin’s upward trend in recent weeks for several reasons. First, miners have been selling their bitcoin reserves to raise liquidity ahead of the halving, precisely at a time when market players are trying to accumulate bitcoin. Second, their revenues are due to be reduced in just over a month, albeit we think this should already be priced in as the halving is programmatic and known well in advance. Third, the US government is proposing a crypto mining excise tax, although a similar provision was not adopted by Congress in the past. Regardless, we think that we could see a recoupling in the correlation between the performance of mining stocks and bitcoin itself perhaps some time after the halving.
Spot bitcoin ETFs
Over the last two months, we’ve gone into depth on the significance of US-based spot Bitcoin ETFs and their value as a means of investing in bitcoin through a regulated financial product. However, the expense ratios for these ETFs vary, ranging from 0.20% to 1.50%, albeit introductory fees are lower (zero for some) on the majority of funds. BlackRock’s iShares Bitcoin Trust (IBIT) seems to be attracting the lion’s share of net inflows into these products with over $12B since inception. ETFs directly track bitcoin price but with varying degrees of premium or discount to net asset value (NAV) due to operational factors, timing discrepancies and supply-demand constraints. That may account for the very slight performance gap to trading bitcoin directly.
Direct bitcoin ownership
Purchasing bitcoin forgoes the management fees or expense ratios associated with the other bitcoin beta plays. However, owning bitcoin directly involves other considerations such as custody (whether self-managed or via a third party), potential transaction fees when buying or selling, and the risk of security breaches in personal wallets. On the other hand, this is the lowest cost means of getting bitcoin exposure over the long run and gives users full control over their private keys, compared to the potential convenience and/or complexity of getting bitcoin exposure through other means.
Of course, returns are only one part of the story. Over the period since the ETFs launched, MicroStrategy’s annualized volatility of 130% is more than double the 55% for spot bitcoin ETFs and bitcoin itself. The magnitude of the increase compared to last year also outpaces bitcoin as MSTR previously had an annualized volatility of 81% vs 45% for bitcoin in 2023. MicroStrategy's higher volatility is understandable given that it is taking credit risk and has the added business risks of being a public company on top of its bitcoin price exposure. Indeed, bitcoin miners share some of these attributes with annualized volatility of 110% this year. By contrast, spot bitcoin ETFs (and direct bitcoin purchases) only face crypto market volatility, for the most part.
Onchain: Destination Dencun
Ethereum smoothly underwent the Dencun fork on March 13, perhaps its most technologically complex upgrade since the Merge. At a total of nine Ethereum Improvement Proposals (EIPs), the fork contained more EIPs than any upgrade since the Byzantium fork in 2017. That said, most of the EIPs were developer-centric, and the bulk of attention has been on EIP-4844: Proto-Danksharding and its impact on layer-2 (L2) fees. EIP-4844 introduced blob storage, a new transaction type tailored for posting L2 data at a lower cost. We previously covered the details of EIP-4844 as well as the more relatively underappreciated EIP-7514 that limits validator churn in the previous weekly.
Following the mainnet’s transition to Dencun, the migration of the Optimism and Base L2s to utilize blob storage (via their own Ecotone upgrade) showcased the long-term potential of Ethereum’s scalability roadmap. Upon launch, transaction fees on these L2s dropped to effectively one-tenth of one cent for several hours, lower than most high-performance integrated blockchains. Transactions on other migrated L2s such as Arbitrum, zkSync, and Starknet also saw transaction fees drop several-fold, and other L2s like Scroll and the Polygon zkEVM family are also preparing to switch in the coming weeks. Altogether, we think this is a strong step towards the realization of Ethereum’s vision of L2 scaling.
That said, the cheap blob pricing in these early stages are unlikely to persist as more L2s come online and compete in the market bidding for storage. As we go to publish, the base gas fee for blobs has not yet been bid up from its initial value as the blob count per block remains below the target of 3 per block (of a maximum 6), though it is approaching that threshold (see Chart 2). In a future competitive blob market, we still think there’s still space for alternative data availability solutions which remain cheaper than blob storage at scale. Additional sources of congestion on individual L2s (e.g. at the execution layer) can separately drive up transaction fees as a byproduct of increased onchain usage, so a continued focus on other cost reducing measures for L2s will remain pertinent.
