Author: Grayscale Research; Translated by: 0xxz@Golden Finance
Key points:
Cryptocurrency valuations retreated in August 2024, coinciding with a brief rise in financial market volatility. Compared to the broader cryptocurrency market, Bitcoin outperformed, while Ethereum underperformed.
Federal Reserve Chairman Powell hinted at an impending rate cut, which could support Bitcoin and other assets that compete with the dollar, such as physical gold.
Although activity on Ethereum’s Layer 2 network has increased significantly, Ethereum’s scaling strategy may leave some investors uncertain about its long-term prospects.
August also saw a rise in the market capitalization of stablecoins, upgrades to some key protocols, and a heated debate about digital privacy.
Overview
Global stock markets overall did not change much in August 2024, but this masked significant volatility during the month. On August 2, a weaker-than-expected jobs report sent many risk asset prices falling and equity volatility soaring, with the CBOE Volatility Index (VIX) briefly exceeding 65%. However, subsequent economic data showed no further signs of danger, many market sectors rebounded, and the VIX index quickly fell back below 20%.
Meanwhile, news of softening labor market conditions may have influenced the views of Fed policymakers. In his speech at the Jackson Hole annual conference on August 23, Fed Chairman Jerome Powell said that “the time has come to cut interest rates,” which partly reflects the fact that “downside risks to employment have increased.” Interest rate futures now imply that the central bank will reduce the policy rate by 100 basis points (bp) in the remaining three Federal Open Market Committee (FOMC) meetings this year (Chart 1).
Figure 1: The FOMC is expected to cut rates by about 100 basis points over the next three meetings
Taken together, the brief bout of volatility and rate cut signals brought a lot of changes to the market (Figure 2). Certain strategies at the center of the storm (including short volatility strategies and FX carry trades) saw returns fall sharply, the U.S. dollar weakened against major currencies and gold prices, and defensive assets such as high-quality bonds and consumer staples stocks outperformed. Bitcoin fell slightly (-8.5%), while Ethereum fell more (-21.8%) and was one of the assets that performed poorly on a risk-adjusted basis (discussed further below). Our Cryptocurrency Sector Market Index (CSMI), which measures the broad range of investable digital assets, fell 13.2% in August 2024.
Figure 2: Ethereum underperformed during the August pullback
Bitcoin
We believe that if the trend of a weaker dollar and lower interest rates continues, it should have a positive impact on Bitcoin's valuation. Like physical gold, Bitcoin is an alternative monetary system that competes with the dollar in international markets. Lower U.S. interest rates weaken the dollar's competitive advantage and may benefit assets that compete with the dollar, including other fiat currencies, physical gold, and Bitcoin. Over the past few years, as digital assets have become increasingly integrated with mainstream financial markets, Bitcoin has been negatively correlated with both the level of real interest rates and the value of the U.S. dollar (Figure 3). Therefore, those who are concerned about the impact of a weak dollar on their portfolios may consider allocating to Bitcoin to achieve portfolio diversification.
Figure 3: Bitcoin is negatively correlated with the value of the U.S. dollar
Ethereum
As noted above, Ethereum significantly underperformed during the early August decline and failed to stage a significant rebound later in the month. We believe this partly reflects long positioning in CME-listed futures and perpetual futures. In May 2024, around the time the U.S. SEC approved the issuer’s 19b-4 application for the U.S. spot Ethereum exchange-traded product (ETP), traders significantly increased gross perpetual futures positioning and net CME futures positioning, perhaps anticipating further price increases following full regulatory approval; this approval occurred in July 2024, and the U.S. spot Ethereum ETP began trading shortly thereafter. We believe that excess speculative positioning led to a sharp pullback in Ethereum prices and limited any price recovery since then.
More fundamentally, the Ethereum network is undergoing a major transition that could leave some investors uncertain about its future. As we’ve reported extensively in previous work, Ethereum intends to achieve greater scale by moving more transactions to the Layer 2 network, which will then be settled regularly to the Layer 1 mainnet. The strategy is working: activity on Ethereum’s Layer 2 has boomed this year (Figure 4), and major companies such as Sony have announced projects within the ecosystem (see “Exploring the Ethereum Ecosystem” for more details). However, the shift in activity to Layer 2 has also led to lower fee income on Layer 1, which in turn has potential implications for the value of ETH. In addition, uncertainty may have led to relatively low net inflows into the spot Ethereum ETP launched in July. Grayscale Research believes that the current market pessimism about Ethereum is unwarranted, given that the scaling strategy is clearly working. But it may take some time for the market consensus to become more positive.
Figure 4: Ethereum’s scaling strategy is working
Other highlights of the agreement
The FTSE/Grayscale Crypto Sector Index Series also fell in August, but less than Ethereum (Figure 5). Despite the overall market setback, there are several noteworthy bright spots, especially in the monetary and financial crypto sectors.
Figure 5: Bitcoin outperformed most crypto sectors
For example, ZCash (ZEC), a privacy-preserving asset in the cryptocurrency space, rose 29.5% in mid-August before retreating later that month. In early August, the founders of ZCash joined Shielded Labs to develop a "Crosslink" hybrid consensus mechanism. Historically, ZCash is a proof-of-work protocol, and this upgrade will add proof-of-stake as a final layer designed to enhance network security and allow ZEC holders to stake. The move has received a lot of support, including donations from Ethereum founder Vitalik Buterin and others. In addition, the second ZEC halving event is scheduled to take place later in November this year, further stimulating investor interest.
As part of the financial cryptocurrency sector, the Aave Protocol was another bright spot. The protocol hit a record high in weekly active borrowers, and its governance token AAVE rose 21%. Meanwhile, a new proposal from the Aave community would deploy a "buy and distribute" model, using Aave's excess revenue to buy AAVE tokens from the market and distribute them to stakers - similar to the smart burn engine used by the Maker Protocol. The proposal is expected to go live by the end of 2024, but it still needs community approval. In related news, the Maker Protocol changed its name to Sky and introduced a number of other project updates related to its Endgame strategy.
Stablecoins
In August, the market capitalization of stablecoins rose again and is now approaching its previous all-time high (Figure 6). Importantly, Apple's software update could lead to greater adoption of stablecoin payments in developed markets. Circle CEO Jeremy Allaire said that tap-to-pay using Circle's USDC stablecoin will soon be available on iPhones due to Apple's decision to open NFC payment capabilities to third-party developers. This feature is independent of Apple Pay and does not involve a direct relationship between Circle and Apple, enabling USDC transactions through taps, with FaceID confirmation and blockchain settlement. Separately, Latin American e-commerce platform Mercado Libre announced the creation of its own stablecoin pegged to the U.S. dollar, while stablecoin issuer Tether said it would create a token pegged to the UAE dirham.
Figure 6: Stablecoin market capitalization rises
Durov and TON
Finally, there has been growing attention on the potential connection between blockchain technology and digital privacy following the arrest of Telegram founder Pavel Durov in France at the end of the month. French authorities said the charges were related to “failure to mitigate the misuse of encrypted messaging applications” that were used for criminal activity. TON, the asset that supports the Open Network (a smart contract platform natively integrated with Telegram), fell more than 20% following the news, before recovering slightly in the following days.
Elsewhere in the smart contract platform cryptocurrency space, Near Protocol launched Nightshade 2.0, designed to make the blockchain faster, while Stacks Protocol rolled out its long-awaited Nakamoto upgrade.
Bitcoin Outlook
Since the first quarter, the price of Bitcoin has remained in a fairly narrow range, with the cryptocurrency market benefiting from positive fundamental news on the one hand and selling pressure on the other. Grayscale Research believes that the selling pressure from the German government, Mt.Gox Asset Management and other institutions has basically passed, and the improvement in fundamentals should become more and more obvious. If the US labor market remains stable, the Federal Reserve's interest rate cuts and US political changes surrounding the cryptocurrency industry may allow prices to retest all-time highs later this year.
We believe the main downside risk to valuations is a further rise in unemployment and a possible recession. Investors should therefore keep a close eye on upcoming labor market data, including the next monthly jobs report, scheduled for September 6. However, even if recession risk emerges, Grayscale Research believes that tolerance for a deep recession is very low, and we believe policymakers have an incentive to print money and spend at the first sign of trouble. The unregulated approach to monetary and fiscal policy is one reason some investors choose to invest in Bitcoin; therefore, a period of economic weakness could strengthen the long-term investment thesis for Bitcoin.
