Market View
Crypto markets have chopped lower following comments from the Federal Reserve Chairman, Jerome Powell, at talks on March 29 and April 3 suggesting a continued cautious approach toward rate cuts. The uncertainty in market direction is not unique to crypto – equities and other risk assets have generally also plateaued in the past week. Coupled with concerns over reflation, the implied magnitude of rate cuts by year end (based on the Fed Funds Futures) has even turned slightly more hawkish than the Fed for the first time in 2024. As of April 4, the market is pricing a year end rate of 4.631, well above the 3.825 predicted at the start of January (and above the median Fed dot plot target of 4.625).
In this environment, gold has been the largest winner, printing new highs amidst increased central bank buying, heightened geopolitical risks, and reflation concerns. What makes gold’s performance notable is that its appreciation has generally been associated with both Fed rate cuts as well as higher inflation. Given the market’s recent hawkish views on rate cuts, we think gold’s performance signals an overweighting on inflation relative to Fed rate changes as well as an overall belief that certain inflation bumps could materialize more problematically than anticipated.
In our view, bitcoin’s increased acceptance as a form of “digital gold” could enable demand from a new subset of investors in this market regime. As a result, we think dips are likely to be more aggressively bought compared to previous cycles, even as volatility persists during price discovery. Bitcoin’s broader access to capital as a result of the launch of US spot bitcoin ETFs could also contribute to dampened volatility (relative to previous cycles) in our view.
The impact of these ETFs and the larger inflow of institutional demand can be seen in the open interest of bitcoin futures, which can be used as hedging instruments. The CME bitcoin futures open interest at US$9.9B has surpassed that of any single centralized exchange (CEX) and accounts for more than one third of the total bitcoin futures market (including both perpetual and fixed futures). In our view, the capital unlocked by the ETFs perhaps represents the most fundamental shift in market structure between the previous 2020-21 cycle and today. These capital unlocks, coupled with the upcoming Bitcoin halving (estimated to occur on April 20-21 subject to variations in network hash rate) and other positive catalysts, make us still largely constructive in our view throughout Q2.
Onchain: Endgame Extravaganza
Maker has been a notable outperformer throughout the past several weeks following its Endgame announcement on March 13. The announcement detailed a number of changes across four major phases. The first phase centers around a rebranding of the DAI and MKR tokens (including a 1:24,000 redenomination of MKR into a new governance token), updating the governance protocol incentives, building out new bridges, and launching the Spark subDAO. Phase 2 revolves around scaling up the number of subDAOs, bridges, and governance responsibilities. Phase 3 outlines plans to move Maker to an independent chain several years into the future, and the final phase 4 makes all foundational governance contracts immutable.
As more details have surfaced, particularly around future subDAO governance tokens, speculation around airdrops for MKR holders and DAI stakers has increased. Given the sector’s broader attention on airdrops, we think part of the increased token valuation is driven by future airdrop token values (in addition to other recent governance proposals that increase their protocol revenue). In our view, Maker’s changes are a continuation of a movement by established DeFi protocols to more concretely deliver on plans that have been alluded to for a number of years (e.g. Uniswap’s fee switch). We think that long running DeFi protocols, which may currently be seen as somewhat stagnant, have the branding and market share to more powerfully capitalize on innovations due to the network effects of their protocol liquidity.
While there has been a focus on Maker’s Endgame rollout, more recent governance changes have stirred some controversy in the DeFi community. Maker has been rapidly passing changes, including integrations with Morpho and USDe, and is considering scaling up those operations meaningfully with higher collateral limits. While these changes are set to greatly increase Maker’s revenue, some feel that the pace of changes greatly elevates risk levels. In light of this, Aave’s community has been seriously discussing removing DAI’s ability to be used as collateral. These discussions have garnered the support of key Aave leaders, including its founder Stani Kulechov who is in “full favour for offboarding DAI from all the Aave markets completely.”
We think this conflict could foreshadow shifts in the decentralized stablecoin marketplace. Ethena's USDe has been gaining rapid market share relative to DAI due to its higher yields and airdrop incentives. That said, both of these assets have intrinsic limitations on their issuance capacity (in contrast to centralized stablecoins). DAI supply requires overcollateralization and is thus bound by loan borrower collateral. Meanwhile, USDe is bound by the futures open interest market where rates become untenable if its short interest becomes too large.
Creating and scaling new decentralized stablecoins continues to prove challenging due to the network effects of liquidity. More than 160 stablecoin are tracked by DefiLlama, the majority of which see very little usage outside their originating protocol. Even as the number and market capitalization of decentralized stablecoins continues to increase, their growth is outpaced by that of centralized stablecoins. In particular, USDC and USDT increased their share of stablecoins to 90% of the market. With the advantage of native stablecoin issuances across chains and improved bridging experiences underpinned by technologies such as Circle’s Cross-Chain Transfer Protocol, we think that decentralized stablecoin adoption could continue to face adoption challenges relative to their centralized counterparts.
