Source: Grayscale; Compiled by: Wuzhu, Golden Finance

Summary

  • Despite the sharp rise in Bitcoin prices, our cryptocurrency sector framework shows that performance across the asset class has been mixed so far this year. Like the stock market, cryptocurrency returns this year have lacked breadth.

  • We are pleased to introduce the Grayscale Research Focus Top 20 Tokens, our pick of high potential tokens for the next quarter. These crypto assets were selected based on the Grayscale Research team's consideration of upcoming catalysts, trending market themes, and specific token fundamentals. Some of the assets in our Top 20 list have high price volatility and should be considered high risk.

  • We expect to see a strong focus on the Ethereum ecosystem this quarter due to the potential approval of Ethereum spot ETPs.

Exploring the crypto asset class can be challenging, which is why Grayscale created Crypto Sectors – a comprehensive framework for understanding all investable crypto assets and how they relate to their underlying technology. Crypto Sectors provides investors with a roadmap comparable to tools commonly found in traditional markets, designed to help investors better understand and navigate the evolving crypto asset class. Additionally, we partnered with FTSE Russell to develop the FTSE Grayscale Crypto Sector Index Series to measure and monitor the cryptocurrency market. [1]

Grayscale Crypto Sectors divides the digital asset space into five distinct sectors: (i) Currency, (ii) Smart Contract Platforms, (iii) Finance, (iv) Consumer & Culture, and (v) Utilities & Services (Exhibit 1). Tokens in the five crypto sectors are associated with unique use cases and investable risks. As a result, their valuations are subject to different fundamental and technical drivers.

Figure 1: The crypto industry divides the digital asset market into five segments

Cryptocurrencies have seen small gains so far this year

While the price of Bitcoin is up about 50% since the start of 2024, our Crypto Sector Market Index (CSMI) is actually down about 3% (Chart 2). The assets and total CSMI of the five crypto industries are weighted by the square root of their market capitalization to reduce Bitcoin’s dominance and better represent the wider range of assets across the industry. On a market-cap-weighted basis, CSMI grew 30%, reflecting Bitcoin’s significant growth and its sizable share of total market cap (around 60%). Of the five segments, the best performing was those with monetary attributes – reflecting Bitcoin’s outperformance – while the worst performing was the consumer and cultural crypto space – largely due to this year’s tie-in with video Assets related to gaming applications were weak.

Chart 2: Despite Bitcoin’s sharp gains, year-to-date performance has been mixed

The large return differential between Bitcoin and the broader cryptocurrency market suggests that gains this year have been limited—much like the case with the U.S. equity market, where a handful of large tech companies have recently dominated index returns. Using the crypto framework, we can create measures of market breadth, much like those applied to other markets. For example, Exhibit 3 shows an “up/down” index, where we track the net percentage of crypto tokens that are up versus down each day. We then calculate the cumulative total over time. According to this measure, cryptocurrency market breadth peaked around late March/early April 2024 and has been declining since then. So far this year, despite Bitcoin’s huge gains, only about 30% of crypto tokens are up.

Chart 3: Market breadth has been declining since March/April

Relatively speaking, a bright spot is some of the assets related to artificial intelligence (AI) technology, which exist in the smart contract platform crypto sector and the utility and service crypto sector. [2] These protocols attempt to solve AI-related problems (e.g., bots and deepfakes, privacy, model validation), provide resources critical to AI development (e.g., compute, storage, data), or provide a general platform for AI-related services. Year-to-date, a weighted index of a basket of AI-related crypto industry tokens has increased by 80% compared to a slight decline in the overall crypto market (Figure 4).

Chart 4: AI-related tokens outperformed the market

In addition to AI, market participants are also focusing on a variety of other topics, which have, to some extent, influenced the relative performance of the entire crypto industry. To help us understand market trends, Grayscale Research uses the "narrative mind share" measure from data provider Kaito. These data measure the relative frequency of social media mentions of specific crypto market themes or narratives, which helps evaluate crypto assets driven by communities of believers and supporters who frequently express their views on social media platforms. For example, in the last month, AI remained the dominant theme, followed by exchange-traded funds (ETFs) - that is, exchange-traded products (colloquially known as "ETFs") approval may be a short-term catalyst for tokens - meme coins and blockchain-based games (Exhibit 5). While market focus may change, themes tend to be persistent, so the measure of narrative mind share may provide clues to market performance in the coming months.

Figure 5: Artificial intelligence remains the dominant theme in the market

Looking Ahead: Ethereum Takes Center Stage

Grayscale Research expects that the cryptocurrency market will be impacted by the approval of spot Ethereum exchange-traded products (ETPs) in the United States over the next quarter. In late May, the U.S. Securities and Exchange Commission (SEC) approved Form 19b-4 filings submitted by multiple issuers to list these products in the United States. Furthermore, SEC Chairman Gensler recently stated that the regulator could approve the remaining applications “sometime this summer.” [3] Therefore, while the timing remains uncertain, for the purposes of our market analysis, Grayscale Research assumes that these products will begin trading in the third quarter of 2024. As with the launch of the spot Bitcoin ETP in January 2024, the Grayscale Research team also expects these new Ethereum products to generate meaningful net inflows (albeit less than the Bitcoin ETP), potentially supporting the valuation of Ethereum and its internal tokens.

The Ethereum ecosystem has several unique features that the launch of the spot Ethereum ETP may highlight. For example, the Ethereum network is pursuing a modular design philosophy, where different components of the blockchain infrastructure work together to provide a more optimized end-user experience and reduce costs. In addition, Ethereum is home to the largest decentralized finance (DeFi) ecosystem in the cryptocurrency space and the majority of tokenized projects.

If the approval of ETPs spurs interest and adoption of Ethereum, we may also see increased activity and valuation support for specific Layer 2 tokens (e.g., Mantle), Ethereum DeFi protocols (e.g., Uniswap, Maker, and Aave), and other assets that are critical to the functioning of the Ethereum network (e.g., Lido, a staking protocol).

In addition to the U.S. spot Ether ETP approval, Grayscale Research expects various current market themes to continue to take center stage in the next quarter, particularly the potential intersection between blockchain technology and artificial intelligence. One asset in this category is Near, which was founded by the co-creator of the “Transformer” architecture that powers AI systems such as ChatGPT. Near is one of the top smart contract platforms in terms of daily active users and has seen widespread real-world adoption in non-financial use cases. Recently, however, Near began to leverage its AI expertise by announcing the development of “user-owned AGI” through an R&D division led by a former OpenAI research engineer advisor. [4] Decentralized GPU marketplaces such as Render and Akash may also benefit from the market’s continued preference for AI.

In addition to the main market themes, various projects seem to benefit from their own unique adoption trends, whether due to innovative technology or integration with platforms that provide room for user growth. Two famous examples are Toncoin and Pendle. The TON blockchain, a smart contact platform tied to the Telegram messaging platform, is seeing significant growth in users, transactions and fee revenue. Pendle Finance is a relatively new DeFi protocol that allows users to customize the yield profile of their strategies. While not a new trend, we also believe that adoption of the Solana network is growing organically due to a compelling user experience.

Finally, the crypto market will likely continue to differentiate between tokens with relatively low and relatively high supply inflation. While Bitcoin has the largest total supply and a fairly low annual inflation rate, many tokens in our crypto space do not have this structure. In fact, in many cases, tokens have a relatively low circulating supply and relatively large monthly or annual supply inflation (“unlocks”). In these cases, even if a project is experiencing user adoption and revenue growth, supply growth may dilute returns for existing token holders. Examples include well-known Ethereum Layer 2 networks such as Arbitrum and Optimism, which have experienced relatively low returns despite user adoption of the native tokens, perhaps due to high growth in circulating supply.

Grayscale Research Top 20 Introduction

To highlight high-potential tokens in specific cryptocurrency sectors, we have launched the Grayscale Research Top 20 Tokens (Exhibit 6). We believe that the top 20 assets represent a diverse range of assets in the crypto sector that have high potential to rise in the coming quarter due to (i) immediate catalysts or trending themes, (ii) favorable specific protocol adoption trends, and (iii) low or moderate token supply inflation. These assets were selected to represent the near-term market outlook and may therefore exclude higher-cap assets without immediate catalysts or sustained improvement in fundamentals. We intend to update the Grayscale Research Top 20 list quarterly. Some of the listed assets have high volatility (as shown in the far right column of Exhibit 6) and should be considered high-risk assets.

Figure 6: High potential assets in Q3 2024

references

[1] The FTSE Grayscale Crypto Industry Index Series underwent its scheduled quarterly rebalancing on June 21.

[2] Grayscale Research believes that the crypto industry tokens that may be related to AI technology are listed in alphabetical order: AGIX, AKT, AR, FET, FIL, GLM, LPT, NEAR, OCEAN, PRIME, RNDR, RSS3, TFUEL, THETA, TRAC and WLD.

[3] Source: CoinTelegraph.

[4] Source: Near and Crunchbase.