Cryptocurrency's six-year rise from obscurity

In 2018, when the Hartmann Digital Assets Fund completed its first closing, we entered an extremely new space. At the time, there were probably no more than 100 crypto funds, and it was easy to know everyone and everything. There were only a few OTC desks in the market, such as Circle and Cumberland, and one or two custodians, such as Kingdom Trust. There was only one bank supporting the space, Silvergate. In fact, there were no real products or users other than sending and receiving Bitcoin.

This industry was built almost entirely on vision and ideals. At that time, emerging technologies such as DeFi, DePin, Web3 Gaming, etc., which have only emerged in recent years, had not yet come into being. In fact, many basic financial functions that are taken for granted today, such as on-chain exchanges, loans, and borrowing, did not exist at all at that time - so much so that in that year, the total transaction volume of DeFi worldwide was only about 300,000 US dollars. Today, this figure has exceeded 100 billion US dollars.

In 2018, Larry Fink of BlackRock said he couldn’t imagine any client in the world asking for or wanting to hold cryptocurrencies. However, the situation today is very different: BlackRock’s Bitcoin ETF has set a record for the most successful ETF launch in history, raising $20 billion in less than 5 months.

Regulatory bottlenecks are heating up and about to burst

While the crypto industry continues to expand in size, innovation and adoption face challenges, especially in the context of U.S. regulation. Although Ripple and Grayscale have each won legal battles and the Bitcoin ETF was eventually approved, there has been no significant progress on regulatory issues. Just in April of this year, the U.S. Securities and Exchange Commission continued to take action against major players in the industry, issuing a Wells notice to Uniswap Labs, a U.S.-based unicorn. Uniswap Labs has millions of users and has never been involved in any fraud in the financial and crypto fields, but was chosen to fight against industry leaders such as Coinbase, Kraken and Uniswap. This war is not just about "protecting investors", but also a battle against technology.

The war on tech is already having real effects. Considering how the current hostile regulatory environment is eroding the foundations of the industry, we face some important challenges:

1. Avoiding Risk and Legal Liability: Many people avoid cryptocurrencies because they don’t want to risk jail time. Running a startup is difficult enough, and facing the Fed threatening personal freedoms makes it even more difficult.

2. Unbalanced regulatory pressure: Regulators tend to put pressure on legitimate products, while there are no clear sanctions for "Meme" coins that deceive investors by manipulating the market. This situation leads to more tokens with no real value being launched on the market, rather than those that truly try to capture and transfer value.

3. DeFi’s growth is hindered: The DeFi market has not really grown in the past three years. Although we have reached a scale of up to $100 billion in the decentralized asset sector (down from $180 billion in 2021), to achieve substantial growth, it is necessary to attract institutional capital. However, in the absence of an unclear regulatory environment, institutional capital is reluctant to enter this field.

Digital asset trading can pass from innovators to early adopters without the need for regulatory support. However, the next stage of digital asset trading, from early adopters to widespread adoption, urgently requires regulatory support or the collapse of the existing system. In other words, tokenization and the popularization of blockchain technology are technically inevitable. But it is the power of regulators (and voters) to decide whether we adopt this technology today or wait until the ashes of autocracy and currency debasement. The right trade is the long-term move towards decentralization, abandoning the fiat system, institutional inertia, and any country that is bound by bureaucracy.

However, when managing liquid funds, time horizons are critical. For example, despite setting records for the speed of adoption, the AI ​​industry experienced two “winter” periods in the 1970s and 1990s. However, in the past three weeks, things have begun to change… With former President Donald Trump publicly expressing support for the digital asset industry, we are beginning to see a sudden shift in attitude in Washington:

1. Completely contrary to expectations, the Ethereum ETF was quickly approved by the SEC.

2. Congress opposed the SEC's strict restrictions on cryptocurrency custody rules under SAB 121, and many Democrats who were previously hostile to cryptocurrencies voted in favor.

3. The Financial Innovation and Technology Act is widely welcomed in the digital asset community as it provides more regulatory clarity and limits the SEC’s jurisdiction over the asset class. The bill has passed the House and is headed to the Senate.

4. The digital asset community suddenly and massively supported Trump’s campaign, and the Biden campaign immediately launched its own community outreach. However, a few days later, Biden vetoed Congress’s proposal to repeal SAB 121 and lost all support from the community.

A new era of digital assets

Beyond Bitcoin’s digital gold theory, for the broader digital asset space, the most meaningful shift from speculative assets to investable assets occurs the moment a token can accrue value without running afoul of regulators. While one part of the debate is whether digital assets are commodities or securities, another meaningful debate is how crypto assets can be compliant without violating the underlying technology. For example, requiring KYC for every holder is impossible when the fundamental principles are privacy and permissionlessness. With regulatory clarity, the digital asset market could shift, ushering in the biggest bull run yet. Here are some of the standout predictions:

1. The shift from narrative to product-market fit

Currently, most cryptoasset issuers lack a path to legal value-added, so there is little motivation to create products that can truly create value. Ironically, product creation ability itself is a good litmus test to determine whether a product truly meets market needs and whether it can attract consumers to invest money. Instead, many cryptocurrency founders develop products that do not meet the actual needs of users, and they have to incentivize users to use these products through tokens. Therefore, this situation raises some questions. The quality of construction has been improved, but...

2. Projects will have clearer success metrics

Currently, many digital assets are valued based purely on sentiment and free-floating numbers amid intense competition. While most markets are clearly inefficient, as even stocks often trade far from actual earnings, the stock market does a good job of elevating key elements to the highest levels. As a result, those tokens with the best product-market fit and earnings may start to dominate conversations and portfolios more frequently. This shift, in turn, leads to…

3. A more convenient digital asset financing environment

Since funding for digital assets is mainly concentrated in the private market, the ability to raise funds after the token issuance is often dependent on the market conditions faced by the founders, which becomes a gamble. This leads to cyclical fluctuations in so-called "alternative investments", with each new cycle bringing a new batch of projects that have raised wonderful funds when they are not listed, but often face challenges when funds dry up or cannot be fully utilized in the next bear market, even though they may actually have developed excellent products. The private market will then turn to the next batch. In this cycle, there is a lot of repeated costs and wasted value. Therefore, building a stronger infrastructure can make it easier for protocols to raise funds, while also enhancing...

4. The M&A market is booming

Between 2022 and 2023, we witnessed many DeFi projects stranded, which could have become prime acquisition targets for more well-funded DeFi projects. For example, well-funded projects like Uniswap and AAVE can expand their offerings and become super-applications in the DeFi space by acquiring well-functioning but cash-strapped players in on-chain trading and options markets. Additionally, they could gain more substantial access to real-world asset markets by facilitating token swaps with one of the leading real-world asset (RWA) protocols (which may trade at the equivalent of 1% of Uniswap’s market capitalization). The maturation of crypto-asset individuals and the overall market may open the door for truly savvy dealmakers and operators to create value in unprecedented ways and significantly accelerate product development and innovation, further driving industry adoption. For example, some layer 1 blockchains may use mergers and acquisitions to acquire much-needed products and turn them into public goods. Such a move would reduce costs for users while increasing usage and gas spending on the chain itself, thus driving the value of the network token.

We have been considering catalysts and fundamentals for digital assets since they entered the market, and this may be the most promising era for the market. This structural change may also bring the largest capital inflows as institutional allocators can apply similar models to find true value, just as they have done with other asset classes over the past century.

Light the Fuse

The timing of the U.S. presidential election and the regulatory fate of the digital asset space coincides with an upcoming central bank pivot. While the European Central Bank has taken the first step toward cutting interest rates, the Federal Reserve has yet to make a similar move, with the first rate cut expected in 2024. According to the June economic forecast, interest rates could fall to around 4% by 2025.

Although the Fed has successfully reduced its balance sheet by about $1.7 trillion since the start of its tightening policy, the M2 money supply remains near all-time highs.

So far, about $6.44 trillion of this money supply has been invested in money market funds, with an annualized return of about 5%. As interest rates fall, not only do risky assets become more attractive because capital becomes easier to access, but risk-free alternatives become less attractive. When the approximately $2-3 trillion of idle funds flow back into the market, we may see a significant increase in the price of digital assets, both in the early stages of loose policy and throughout the low interest rate environment.

Regardless of how the political situation changes, interest rate cuts are imminent, which will lead to the flow of funds. Where these funds go is largely influenced by whether there is a change in the leadership of the SEC or its authorized agencies, and whether the courts and Congress lose their regulatory power over digital assets. However, the outcome is still binary: under the current system, Bitcoin and memecoins are thriving; under a more constructive regulatory framework, real innovation in digital assets can begin to serve trillions of dollars in financial value and create hundreds of billions of dollars in market value.

Trading is still a two-way street, the key is to seize the opportunity and choose the right system. Regardless of the outcome, there is huge potential for both camps to become a profitable trading space in the next four years.