Market View
The third quarter started on a sour note with supply overhangs generated by indiscriminate bitcoin selling from price-insensitive sources. That includes the German government’s Bundeskriminalamt (BKA), which began selling their supply of seized bitcoin on June 19. Even though the size of their bitcoin sales (averaging US$85M/day) haven’t been particularly large relative to daily BTC spot volumes of $10.6B/day (across global centralized exchanges, since June 1), the way that the BKA has been indiscriminately selling that bitcoin has been unnerving markets and putting pressure on bitcoin prices. On the upside, according to Arkham Intelligence data, the BKA may be almost done after it reduced its holdings from around 50k BTC ($3.55B) in mid-June to less than 5k BTC ($285M), as of July 11. That suggests some of these market distortions should dissipate soon, in our view.
Meanwhile, the Mt. Gox Rehabilitation Trust repayments that started on July 5 have also been relevant for markets, but it’s less transparent how much of the repaid BTC are actually being sold. According to the details being reported, the approved exchanges for processing repayments include Bitbank, BitGo, Bistamp, Kraken, and SBI VC Trade. But the processing time for repayments can vary depending on the exchange and the exchange’s internal verification procedures-- spanning from immediately (Bitstamp) to 90 days (Kraken). We think the uncertainty is more damaging to markets than any actual selling, as the largest creditors (i.e. third parties who purchased the claims of others) are likely hedged. Moreover, we would expect any selling that does take place to be gradual and orderly, putting only a moderate impact on markets.
But zooming out, what does the rest of this quarter look like? Lately, we’ve been seeing more reports citing concern that the US could fall into a recession later this year or in early 2025. We’ve held the opposite view that rising productivity from the acceleration of technological adoption in a post-pandemic world (including but not limited to generative artificial intelligence models) will kick start a new multi-year economic cycle that could begin as early as 4Q24. (Timing is incredibly hard to predict.) However, typically the disparity in economic views don’t tend to be this wide, which speaks to the challenge of parsing an increasingly wider array of potentially relevant signals.
That said, the macro data has given a lot of evidence that the US economy has slowed down (ISM manufacturing, unemployment, domestic demand, etc), which we’ve acknowledged. In fact, we think it’s very likely that the economy peaked in 2Q24 – one of the reasons we think the Fed will cut interest rates starting September 18 (this month is too soon and there’s no August meeting). Indeed, the CPI print from June released this week (-0.1% MoM or 3.0% YoY) came in under median forecasts of +0.1% and 3.1%, which could support a more dovish Fed bias.
The concern is that cuts may not be bullish for markets if there’s a fear of a bigger slowdown. That is, retail investors will likely be reluctant to enter new stock or crypto positions if the US economy falls into recession. On the other hand, if the economy is still doing relatively well, and the Fed cuts, then that could unlock more liquidity and invite more retail participation. Plus we have a US election coming in November, where fiscal expansion seems like a strong possibility whoever wins. That’s a strong incentive to buy bitcoin as an alternative to the traditional financial system, in our view.
For now, we expect the price action to remain choppy in 3Q24, as crypto markets still lack strong narratives. For example, the market can’t decide whether potential spot ETH ETF flows (a launch is expected by pundits fairly soon) will be bullish or bearish, although we think that may not necessarily be a bad thing from a positioning perspective. This could leave room for surprise outperformance and offer ETH more support, even if the flows take time to materialize. Overall though, we believe the next two months are likely to produce more volatility before things start to improve more earnestly in late September.
Takeaways from EthCC
The 7th Ethereum Community Conference focused on key technical themes including layer-2 (L2) scaling and differentiation, ETH staking issuance, cross chain interoperability, and more. Conference panels and discussions (including Ethereum co-founder Vitalik Buterin’s keynote talk) reaffirmed Ethereum’s roadmap as a maximally decentralized and secure settlement layer-1 (L1) for various L2s.
Ethereum’s continued focus on being a settlement L1 suggests that its execution layer is unlikely to significantly scale in the near term as measured by gas (computation units) per second. Instead, it is focusing more heavily on increasing data availability bandwidth for L2 storage. This, however, does not mean that ETH’s utility is stagnating. To the contrary, the multiplicity of L2s enables different technological approaches to rapidly compete. L2 platforms such as Optimism, Base, Arbitrum and Starknet showcased their unique technological and ecosystem advantages at EthCC. The ability of L2s to rapidly iterate on competing technology is a unique strength of the modular approach, and is something we previously highlighted as one of Ethereum’s strengths.
That said, generalized interoperability between L2s continues to be a contentious issue. While many solutions appear to be technologically feasible (with varying tradeoffs), there is not yet a dominant winner that spans all chains. Communication standards tend to be a winner-take-most market due to network effects, but crypto interoperability has an additional challenge in resolving competing interests. That is, the ability for interoperability protocols to monetize the adoption of their standard makes this space a near-zero-sum game. In our view, full interoperability remains an open challenge, and may take many months if not years to coalesce into a clear standard.
We don’t think the obstacles surrounding interoperability mean that the crypto user experience (UX) will prevent user onboarding, however. Account abstraction and smart account adoption is gaining momentum. Beyond the core infrastructure layer, there appears to be more decentralized application (dApp) developers that are looking to make use of gas abstraction and bundled transactions to simplify the dApp experience. In addition, session key technology – which enables automatic transaction approval under certain conditions – show promise as a means of further reducing dApp UX friction, particularly in DeFi (swaps) and gaming.
Staking and restaking were also pertinent issues. The rising staking ratio (now at 28% of total ETH supply) and the resulting reduction of net staking APY may pose challenges to the economic feasibility of solo stakers in the long term. Likewise, concerns around the growth and centralization of liquid staking tokens (LSTs) were also raised. Although no firm conclusions were reached, suggestions ranged from lowering the base issuance curve (which should theoretically moderate staking growth) to enshrining LST standards to enable more LST diversity and competition. Restaking, meanwhile, grappled with challenges around implementation timelines. Neither payments nor slashing have gone live on any shared security layer yet. In addition, there was some uncertainty voiced on the significance of actively validate services (AVS)-based yield relative to the size of restaked ETH in the short to medium term (which we highlighted as a risk earlier this year).
In large part, the discussion at the main EthCC event focused on the infrastructure layer, though a number of consumer-facing apps were showcased at the many side events. Applications ranged from AI-parsed blockchain data to perpetual onchain games to novel prediction markets. That said, the infra-to-app ratio still seemed more heavily skewed towards infrastructure projects than many hoped for, in our view.
