Author: Jack Inabinet, Bankless; Translated by: Tao Zhu, Golden Finance

Each crypto bull cycle has brought exponential growth, both in terms of value creation and in terms of more and more people believing that they are part of a financial/technological revolution.

Cryptocurrency finds itself in direct competition with artificial intelligence to achieve the same bull mark of this cycle but simply cannot keep up the pace, and despite seemingly high cryptocurrency prices in USD terms, industry sentiment remains subdued.

Unfortunately, while AI has almost single-handedly propelled stock indices to record highs, troubling warnings continue to suggest that the market is in an unprecedented bubble, with recent signs supporting the view that the bubble has begun to burst.

Cryptocurrency narrative slows down

Crypto assets are worth holding largely because of their past performance.

In January of this year, in order to promote its IBIT spot BTC ETF to potential buyers, BlackRock claimed that BTC was the undisputed best performing asset of the past decade, with an annualized return 10 times that of the stock market index, and investors who held BTC since 2013 had earned an astonishing 315,678%!

In the first six months of 2017 alone, Ethereum surged by more than 5,000%, and by January 2018, that figure had reached 17,500%, before the ICO market hit bottom and the crypto industry disappeared from the mainstream market for the next two years.

In 2020, a significant portion of the monetary stimulus designed to combat COVID contraction was poured into crypto assets, leading to inflated valuations. Meanwhile, 2021 has unsurprisingly seen inflation as economies reopened, increasing the appeal of decentralized cryptocurrencies as a tool to avoid the debasement of fiat currencies.

While crypto assets have once again outperformed many alternative investment classes on a percentage basis this cycle, the industry finds itself taking a backseat to a new investment class that claims to revolutionize humanity: artificial intelligence.

While the broad-cap S&P 500 (SPX) and tech-heavy Nasdaq 100 (NDQ) have been on an almost unstoppable run to new all-time highs, Bitcoin peaked more than four months ago on March 13. Since then, the cryptocurrency market has failed to deliver returns that outperform stocks; even small-cap stocks (RTY) and the equal-weighted S&P 500 (RSP), considered laggards among the major indices in 2024, have consistently outperformed BTC!

In past cycles, mainstream investors flocked to crypto assets as a bastion of higher returns, but in 2024, the industry has failed to deliver on those promises despite continued large price swings or high volatility.

Herein lies the problem: increased volatility means higher underlying investment risk, and investors expect higher returns as compensation for this marginal risk. While BTC and Nvidia have experienced similar volatility, the former has underperformed by 100% this year.

While cryptocurrencies have been nascent in past cycles, achieving incredible gains despite failing to achieve meaningful adoption, the industry appears to have reached a critical mass that must catalyze real-world usage in order to explode into growth.

Bitcoin proponents have long hailed its primary use case as a store of value, yet amid fears of escalating conflict in the Middle East in April this year, BTC plunged 15% as on-chain investors rejected internet money in favor of “tangible” tokenized gold at premiums of up to 40%!

BTC is not a store of value that has the potential to replace gold, but rather a “Veblen good,” a commodity whose demand increases when its price rises.

Plotting BTC/SPX against BTC’s relative valuation shows an extremely strong positive correlation that has persisted since BTC’s inception (i.e. they are essentially the same graph), suggesting that buyers only want BTC during periods of relative strength because they believe they can sell it to someone else at a higher price.

As BTC currently underperforms AI stocks with similar risk levels, the likelihood of holders making a profit is increasingly in question.

A tough road ahead

Practical blockchains like Ethereum and Solana are designed to foster the next generation of on-chain financial ecosystems.

But in my opinion, smart contract platforms haven’t made the same leap this cycle, and high-profile consumer-facing innovations have focused on Ponzi-economic point system mechanics and tools to fan meme coin frenzy by extracting celebrity scams. Everything feels different.

Blockchain has undeniable advantages over traditional financial systems, such as higher transaction speeds and innovative composability, but the use of cryptocurrencies for tokenization and payments has failed to gain adoption outside of black market environments, namely for stablecoin payments in jurisdictions such as Argentina, where many forms of U.S. dollar transactions are banned.

While reputable asset managers like BlackRock and Franklin Templeton offer tokenized U.S. Treasury products, the real-world asset sector remains a small player compared to the trillions of dollars of global wealth ready to be tokenized. Just last week, leading multinational investment bank Goldman Sachs announced its intention to delve deeper into tokenization in 2024; this announcement came with a key caveat, namely that Goldman Sachs will only operate on private blockchains.

Cryptocurrencies should be praised for their efforts to preserve anonymity and privacy, but this model is unworkable for the vast majority of financial system participants and is in clear conflict with nation-states’ desire to gain visibility into these systems in order to prevent crime.

The advantages of blockchain are clear, but that doesn’t mean permissionless blockchains will triumph over “traditional” financial systems that aspire to emulate their strengths.

While it cannot be ignored that hostile regulation has hampered the growth of cryptocurrencies, and that global leaders are beginning to take more pro-digital asset stances, especially in the U.S. where the only thing rising faster than AI stocks is the poll numbers of ostensibly pro-crypto Donald Trump, it is worrying that most cryptocurrency use cases have failed to gain free-market adoption.

With crypto assets now an empirically poor investment on a risk-adjusted basis, and the industry failing to gain meaningful traction for existing use cases that could truly spark adoption, it’s no surprise to see the industry’s long-term value proposition increasingly questioned.

Future economic turmoil

If cryptocurrencies can’t satisfy our inherent human desire to get rich quick, at least we can always fall back on AI stocks! Right?

Artificial intelligence has replaced cryptocurrency as the one asset class that investors must have in their portfolios, and whether you know it or not, your exposure to the sector is likely very large due to the prominence of market-cap-weighted stock indices, which programmatically allocate more exposure to the best-performing constituents.

On July 5, the percentage of S&P 500 stocks that underperformed for 21 consecutive days hit a record high, following weeks of outperformance by high-tech AI leaders. This reveals a huge distortion in the market right now.

Last Thursday, July 11, there was a reversal of fortunes and the pattern seemed to shift as investors found a new leader in an aggressive rotation out of large-cap technology stocks and into previously underperforming small-cap stocks.

While AI stocks are already generating massive revenues and showing high growth potential, the Cambrian Explosion of AI applications will need to continue indefinitely at an unprecedented pace to justify these valuations, and eventually the companies purchasing hundreds of billions of dollars of hardware fueling this bubble will actually need to become profitable.

While there’s no doubt AI is valuable and could revolutionize productivity over time, the looming concern remains that investors have already priced in unsustainable levels of growth in related stocks that won’t plateau until decades into the future, as they did during the dot-com bubble.

To underscore the absurdity of the current stock market bubble, the Buffett Indicator — legendary investor Warren Buffett’s favored value metric that compares U.S. stock market capitalization to GDP — recently hit a modern high of 195%.

Assuming the market capitalization of the top three stocks (Apple, Microsoft, and Nvidia) grows by 15%, and GDP growth is above 3%, the value of these stocks alone will be equivalent to 107% of the US GDP in 10 years, leaving little room for investment in other assets.

It remains an open question to what extent lofty tech valuations will fall once the AI ​​supply shock fades and clients begin to realize that they overestimated their demand for AI services, but given last week’s historic rotation out of AI-related stocks, the industry’s glory days may finally be coming to an end.

Overvalued assets help increase perceived wealth, allowing individuals to spend more freely, but a stock market pullback could unravel an already troubled global economy.

U.S. consumer inflation, as measured by the CPI, slipped month-over-month into “deflation” territory in June, the first time the index has been negative since the COVID peak in May 2020, while the PPI accelerated over the same period, a trend that suggests producers are slashing prices to attract struggling consumers, which could weigh on profitability.

While the biggest risk for many market participants is whether the Federal Reserve will meaninglessly adjust its benchmark policy rate by a few percentage points, as earnings begin to trend increasingly negative, it is not hard to foresee a fundamental downside move in a stock market that is priced for perfection.

The year-over-year decline in full-time employment and the rise in unemployment have triggered “Sam’s Rule,” a lagging indicator that has accurately predicted every recession since 1950, with only one false alarm.

While the ability to control the price of money itself is certainly powerful, it is unclear how much influence central banks can exert on the economy by artificially manipulating interest rates, which are largely determined by expectations of future growth and inflation because their returns are “risk-free.”

Interest rate cuts may be imminent, but it seems unlikely that this so-called panacea will be enough to drive a sustained recovery in the global economy and markets, which are heading for a contraction, as it has failed in past cycles.