Market View
The continued absence of clear macro directionality has led to a persistent chop in bitcoin. This has been mirrored by many altcoins as correlations within the crypto asset class remain near YTD highs. The uncertainty in the current confluence of macro factors is a realization of the thesis in our April outlook that macroeconomic conditions would continue to dominate BTC performance (with altcoins closely following) as spot US ETF inflows tapered and markets began to search for other catalysts beyond the Bitcoin Halving. During this time, higher than expected US inflation prints have led to concerns over delayed rate cuts by the Fed, even as the ECB and other central banks reaffirmed their plans to cut rates in the summer. The expectation of prolonged US rate cut timings has led to a strengthening of the USD, which has in turn weighed down on the broader crypto markets due to its key role as the quote currency in most crypto exchanges.
However, the momentum of USD strength has stalled following a more dovish than anticipated Fed meeting, with market anticipation of the first rate cut (based on Fed Funds Futures) shifting from November to September 2024 after a weaker than anticipated non farm payrolls print on May 3. The higher than expected initial jobless claims on May 9 further gives credence to the thinking around accelerated rate cuts since the Fed has a dual mandate not only to combat inflation, but also to retain low unemployment rates.
That said, we don’t think that a change in the US unemployment rate (currently at 3.9%) will be on the forefront of the Fed’s attention in the short term as it remains near historic lows. In fact, we continue to believe that the US economy will be bolstered both by technological advancements and government spending, and is not on the precipice of entering a contractionary period. Through the next FOMC meeting, we think that the Fed’s attention and rhetoric will remain on inflation metrics, highlighting the importance of the coming PPI and CPI prints on May 14 and 15 next week as expected macro catalysts – particularly if they come in above expectation.
Separately, the Grayscale Bitcoin Trust (GBTC) saw its first two days of inflows since its transition into an open-ended fund. Although the sources of these inflows are yet unclear due to their higher management fee (1.5%) compared to similar spot alternatives (at less than 0.5%), this development signals an important completion of structural capital rotation. We believe that a significant portion of earlier GBTC outflows were linked to bankruptcy proceedings (e.g. Genesis and FTX), profit realization from the GBTC discount trade (40% discount to NAV a year ago), and rotation into lower fee products (<0.5% compared to 1.5%). Going forward, we anticipate little structural distortions to flow numbers, though we have previously cautioned against utilizing flow numbers as leading indicators for future price action.
Onchain: Aave’s Advancement
Meanwhile, Aave recently revealed plans for a fourth iteration (V4) of their protocol as part of a longer term Aave 2030 roadmap. The proposed V4 contains architecture improvements including a unified liquidity layer (for flexibly extending borrowing features), fuzzy interest rates (for rate curves previously controlled by governance), and liquidity premiums (to adjust borrowing rates based on collateral composition). V4 also focuses on bolstering the usage of its GHO stablecoin and incorporates improved risk management and liquidation engines among other improvements.
While the proposed mainnet launch date will be approximately one year from now in Q2 2025, we think this announcement (in conjunction with other major announcements from incumbent DeFi protocols like Uniswap and Maker this year) are early roadmaps for how DeFi protocols could mature in their core features, even as they retain market dominance and continue innovation in other areas. This could set a precedent for newer protocols to follow across decentralization, long term token utility, and iterative feature rollouts.
Expanding DeFi protocol functionality is a technologically challenging task, particularly in comparison to traditional consumer facing web2 companies operating under the mantra of “move fast and break things”. Successful DeFi protocols rarely extend their initial architectures in a manner that is transparent to the end user. Instead they deploy new versions and incentivize active liquidity migrations. This is true not only for Aave, but also for other leading protocols like Uniswap, Curve, Pendle, and more. These cross-version liquidity migrations are non-trivial endeavors since users are required to proactively make this transition. In fact, Aave V3 did not surpass Aave V2 in total value locked (TVL) until September 2023 though it had launched more than a year earlier. We think that Aave V4’s adoption cycle could occur gradually over a similar timeline.
Despite the promise of improved features in newer versions, the cautious migration of liquidity highlights the relative importance of the Lindy effect in the DeFi markets. That is, the trust garnered from extended (exploit-free) time in the market appears to matter more than new mechanics which may only appeal to a niche set of users. The adversarial environment of decentralized technology means that time is often the surest method of ascertaining protocol security, more so than audits and theory. We think this highlights the unique characteristics of smart contract immutability and the financialized nature of web3 products, which leaves no margin for error in the midst of fast-pace innovation. Thus, we think the long-term adoption cycle of crypto products may look different from what we have seen in web2 markets. To end users, the ramifications of a web3 financial exploit are far more severe than a web2 data exploit which doesn’t disrupt core app functionality.
Separately, the Aave 2030 roadmap appears to put it in competition with Maker’s Endgame, particularly with the renewed focus on its GHO stablecoin. Many elements proposed in Aave 2030 such as an Aave-specific network, a cross chain liquidity layer for GHO, enhanced real world asset (RWA) integration, and updated protocol branding are reminiscent of Maker’s Endgame vision.
At $10.5B and $8.2B TVL for Aave and Maker respectively, both of these protocols are significant sources of lending in the space. However, while Maker borrowers are restricted to DAI, Aave enables a wide range of assets for borrowing beyond its own GHO stablecoin. Given that DAI’s market cap has only grown 2% YTD from $5.3B to $5.4B, questions remain around its ability to improve its cross-chain adoption and gain market share. That said, it is interesting that Aave appears to be focusing on the decentralized stablecoin sector, even as that sector has been shrinking relative to centralized stablecoins like USDC. Amidst the pause in DAI demand, Aave actually overtook Maker as the largest lending DeFi protocol in early 2024. We are still in the early days of web3, however. While Maker’s Endgame plan and Aave’s 2030 roadmap provide a promising vision for the future of these protocols, we think these developments could be overlooked in the shorter term as the macro environment remains the anchor of attention in the near term.
