By Steven Ehrlich, Forbes
Compiled by: Luffy, Foresight News
Zach Pandl is the head of research at Grayscale Investments, the world’s largest crypto asset manager. Forbes recently had a conversation with Pandl, in which he provided an important perspective on what to expect in the crypto market throughout the year. He offered some interesting insights into the market crash that occurred in August and the impact of future Fed policy. He also shared his thoughts on cryptocurrencies, which assets will stand out, and why others may be struggling.
Forbes: Let's talk about August. At first, the yen carry trade was unwound, and then there was a panic in the market, which lasted for about a week. Then the market rebounded. How do you make sense of all this?
Zach Pandl: Last month was a turbulent month, but it can actually be divided into two phases. From the end of July to August 5, it was a phase of growing panic; then from August 6 to now, the market returned to the recovery phase. Most major asset classes fell, but many of them are now back to the level of early August. Some markets did not fully recover, including carry trade strategies in currency markets (which was the focus of investors at the beginning of the month), Japanese stocks, and Ethereum.
Some markets performed well in early August and then continued to perform well in the second half of the month, such as the bond market and non-US currencies. The Japanese yen, Swiss franc, euro and British pound have all risen this month. I think the market theme of the turbulent August is lower interest rates and a weaker US dollar, which will affect Bitcoin in the coming months.
Forbes: Do you think this panic was a one-off event? If the market gets spooked again, will something similar happen again?
Zach Pandl: First of all, I would like to say that looking back at the market in early August, I strongly feel that the focus on Japan and the yen was a bit of a distraction. Japan is a challenging subject even for professional macro investors, and it is often the source of confusion. I think the real driving force behind the market plunge was the gradually accumulated panic. Some US economic data caused this panic, the most important of which was the increase in unemployment in the first week of August. The increase in US unemployment now has only occurred in recessions. Economists call it Sam's Law, named after economist Claudia Sam. This does not mean that we will definitely fall into a recession, but the data tells us some statistical laws, such as the inverted yield curve and rising unemployment, which are consistent with what happens in a recession. The reason why it has such a big impact on the market is that before August, the market generally believed that the US economy would have a soft landing. People were worried about a recession last year, but the economy performed well, so people became more and more convinced of a soft landing, and the market increasingly agreed with this. Therefore, the increase in unemployment has made many investors think that the economy may fall into recession again. We still need to observe the data for a few months to ensure that the labor market does not deteriorate further. That being said, some of what has happened in the market has been surprising, especially in terms of equity volatility. The VIX has risen to levels similar to past extreme market events, such as the COVID-19 pandemic, the 2008 financial crisis, and the Lehman Brothers bankruptcy. The VIX rose to over 65 intraday in the first week of August, then fell to the low 20s by the close of the same week. Many other indicators, such as high-yield bond spreads, have seen similar reversals. All in all, the market may be overreacting in the short term.
Forbes: Let's talk about cryptocurrencies. I'm interested in whether there will be a divergence between Bitcoin and other cryptocurrencies. For example, the Ethereum ETF has not been as successful as the Bitcoin ETF, and people are a little concerned about the prospects of Ethereum. What do you think?
Zach Pandl: First of all, it is indeed a period of Bitcoin dominance right now. Bitcoin's dominance across the market is rising, and the ETH/BTC price ratio is falling. Will this continue? I think it will continue in the short term because there are a lot of positive factors for Bitcoin, especially the macro economy, the Fed's rate cuts, the presidential election, and the growing demand for Bitcoin ETFs. I think all of these factors combined have created a very positive macro environment for Bitcoin. Therefore, Bitcoin's dominance may rise further in the short term. However, altcoins performed well last week, and we saw parts of the market begin to recover as well.
Compared to the success of the Bitcoin ETF earlier this year, the performance of the Ethereum ETF is disappointing. The Ethereum ETF has very impressive trading volume, and with the exception of the Grayscale closed-end fund that upgraded to an ETF, other products have very impressive inflows. Therefore, I don't think the performance of the Ethereum ETF is too bad.
As for the prospects of Ethereum, I will definitely not give up on Ethereum. I think the pessimism in the market is mainly due to the performance of ETH this month. In my opinion, the performance of ETH this month is technical. In May, when the SEC approved the 19b4 application for ETF products, the leverage of Ethereum futures in the Chicago Mercantile Exchange (CME) and perpetual futures increased, which lasted until August. It happened that under the influence of macro catalysts, namely panic sentiment and the triggering of Sam's Law, all markets fell, and Ethereum suffered a heavy blow because it accumulated a large number of long positions before the event.
In my opinion, the recent underperformance of ETH is primarily a technical issue, not an issue with the Ethereum ecosystem. I would say that Ethereum and Bitcoin are completely different assets that require different education for investors. Bitcoin and Ethereum ETFs provide a channel for a new range of investors and financial advisors to gain exposure to crypto products. But they are completely different assets. They are both blockchains, but we would put them in different categories in the Grayscale crypto industry framework. Bitcoin is primarily a currency, while Ethereum is primarily a smart contract platform. They are both blockchains, but they function differently. I think the education process for Ethereum is longer than Bitcoin. It is the foundation for smart contracts, decentralized applications, tokenization, stablecoins, and DeFi, which is probably why the demand for Ethereum ETFs has been slower to grow than Bitcoin.
Forbes: Another big difference between Bitcoin and Ethereum is that Bitcoin doesn’t have to face competition from networks like Arbitrum, Optimism, and Base. Especially after Dencun, the cost of using these networks has become very low. How does this relate to the current situation of Ethereum?
Zach Pandl: I think cryptocurrency investors should apply some of the investment principles of the securities market to new markets, such as the nature of competition, whether it is a monopoly market or a competitive market. Bitcoin is dominant and no longer faces intense competition. In the smart contract platform space, while Ethereum is also dominant, it faces more intense competition from many competitors. I think there are important investment opportunities among these competitors, and they are valuable. Perhaps it is better to take a more diversified investment approach in the market segments where Ethereum faces more competition. That being said, we firmly believe in the idea of network effects, and it is possible that there will be a few very dominant blockchains in the future, rather than hundreds or thousands of small blockchains. Under the network effect, investors and users benefit from the network with the most capital, the most applications, and the most developers. Today, Ethereum is still such a network. Ethereum is ahead of other networks in terms of network effects, and I think Ethereum is expected to remain dominant in the long term despite the fierce competition in this market segment.
Forbes: Why do you think now is the right time to launch Avalanche?
Zach Pandl: All smart contract platform blockchains make their own design choices, and it will take a few years to determine which blockchain's design works best to attract users, generate fee income, etc. But I think Avalanche has established itself as an effective platform with a solid design and complete functionality. It is mature enough that we think it is certainly a reasonable choice for investors to pay attention to. In terms of specific catalysts in the near term, Avalanche may have application in the asset tokenization theme. Avalanche has been used in various TradFi tokenization proofs of concept over the past few years. In my opinion, the tokenization of real-world assets is just getting started. We have invested tens of millions of dollars in some of these products, and major financial institutions are involved, but we can't predict how it will develop. I think the Avalanche infrastructure, with its combination of permissionless and permissioned structures, may be a good fit for certain tokenization projects, and now is a reasonable time to revisit the network.
Forbes: Solana has become the most popular blockchain after Bitcoin and Ethereum. However, it seems that a lot of activity on Solana is copying Ethereum and other chains. What do you think?
Zach Pandl: Solana offers an excellent user experience. For a cryptocurrency newcomer, few experiences are as easy and enjoyable as downloading the Phantom wallet and starting to use Solana: it's fast and it's cheap. In that sense, it has been very successful in attracting new users. I also think that Solana has established itself as the third largest blockchain. At the same time, I don't think user experience necessarily creates a lasting moat for a project. Ultimately, the real value accumulation will occur on Layer 1, which can be integrated into the largest real-world use cases, and major companies and industries can build on Layer 1 networks. For Solana, this is an open question: does tokenization happen on the Solana blockchain, and do large consumer products companies (Sony or Disney) build on Solana?
Forbes: What do you think of DeFi?
Zach Pandl: It's hard for this space to avoid the U.S. election and the politics surrounding cryptocurrencies. The Biden administration is taking approaches to regulate this market. I think it's hindering innovation and adoption, and the Biden administration's attitude toward DeFi is hindering the development of the market. (Editor's note: In April, the U.S. Securities and Exchange Commission issued a Wells Notice to Uniswap, indicating that enforcement action may be taken.)
For DeFi to continue to succeed, we may need to change the way regulation works. A Republican win, especially in the Senate, would give control of the Senate Banking Committee. This could affect the appointment of certain officials who are responsible for overseeing the industry. I think DeFi is a core part of cryptocurrency. It is one of the core use cases for smart contracts, but to be more successful in the United States, it needs to be combined with traditional financial assets in some way. And you can't do that without clear regulatory guidelines. So, we are waiting for more regulatory clarity in order for DeFi to fully prosper.
Forbes: Then, let's talk about AI. For me, the connection between cryptocurrencies and AI has always been a bit fuzzy. The prices of many AI tokens tend to rise and fall with the price of Nvidia, but the connection between the two doesn't seem to be deep. What do you think about this?
Zach Pandl: Blockchain technology can connect with the artificial intelligence industry through several specific channels. The first is to provide infrastructure. I think shared computing networks are a great example of something that's working and is just getting started. Intellectual property rights and deepfakes are another important issue and one of the most challenging to face with this new technology. I use generative AI tools so much in my work that I don’t even need a research assistant anymore. At the same time, I know that when I query these tools and pay my clients, not all of that revenue goes to the original authors of the materials used. Therefore, protecting intellectual property is a very important issue, and public blockchain technology can provide us with detailed information about the source of specific data. Again, these projects are just getting started, but I believe they have potential synergies.
Finally, there is the broader category, including Bittensor, which is a project that is trying to use blockchain technology to build AI projects from the bottom up. I think the vision is impressive. Bitcoin showed the value of using a decentralized network of computers to develop a monetary system. What projects like Bittensor are trying to do is use the same idea: the power of a decentralized community to build machine intelligence or AI on the internet and create an open system where anyone can add or use the technology without going through a central authority. Anyone who has lived in an environment where the monetary system is restricted, where there are capital controls, bank failures, or hyperinflation, understands the value of having an independent open monetary system like Bitcoin.
I believe that in the future, as more and more people use generative AI tools, they will realize the need for an open structure that is not controlled by a single government or a single company. This is what projects like Bittensor are trying to do.
One of our broader views is that as more investors look closely at the fundamentals of AI tokens and try to understand them, their correlation with AI will gradually decrease. Worldcoin rose because of Nvidia, and there was not much fundamental reason behind it. In some ways, cryptocurrency is still an immature market, and I think the high cross-correlation between assets is an example of this, and as the market matures, this correlation will decrease.
Forbes: What are your expectations for the rest of the year?
Zach Pandl: We think the core outlook for Bitcoin is quite positive because there are three positive factors at play. 1. Bitcoin ETFs are attracting new money. 2. The political situation in the United States regarding cryptocurrencies has improved. There are still unknown factors in this issue, especially the position of the Democratic Party. But in my opinion, things are moving in a favorable direction. 3. The Federal Reserve cuts interest rates, and the economic environment is healthy. I think the last point is very important. This may be a point that people overlook. Usually, the Fed cuts interest rates because of a recession. This time, the Fed cuts interest rates because it has won a long-term fight against inflation. Therefore, these interest rate cuts are the result of mission accomplished, which is very different from the past.
Cutting rates in the context of a soft landing is quite negative for the dollar, but positive for assets like Bitcoin. Putting all these factors together, I believe we will retest all-time highs in the coming months. The main risk now is the health of the US economy and whether it can have a soft landing. I think that's the view of most economists today, but we need to keep a close eye on the labor market data. If unemployment continues to rise and layoffs begin to show signs, we may see a period of economic weakness during which many assets such as Bitcoin and technology stocks will also weaken in a typical cyclical manner. My view is that recessionary periods will be excellent times to accumulate Bitcoin because you will most likely see loose monetary policy and loose fiscal policy next, just like what happened during the COVID-19 pandemic. But if the US labor market continues to deteriorate and the US economy falls into a short recession, we may face downside price risks. This is the main risk we face in the next 6 to 12 months.
Forbes: Do you have any contrarian views? Are there any other projects or tokens that are worth our attention?
Pandl: First, cryptocurrencies are an indispensable asset in most investors’ portfolios. Most of my time at Grayscale has been spent educating investors on how to understand this asset class, the fundamentals of blockchain technology, and the statistical properties of the assets themselves. This is a contrarian view in the broader financial markets: cryptocurrencies should have a place in the portfolio of almost every investor except the most conservative. For short-term liquidity alone, I believe cryptocurrencies can serve as a diversification asset.
The second thing I want to say, and maybe a contrarian view in the cryptocurrency community, is that I think in some ways, blockchain tokens are less risky than stocks. Cryptocurrencies have different volatility factors, but in at least one factor, they are less risky than stocks, because they have no debt. Public companies can disappear because they have debt. Their revenue needs to support those liabilities. Blockchains mostly have no debt. They have revenue, they have activity, they have a community of users around them, but they don't have liabilities that need to be paid continuously. So I think when a lot of people talk about the risk of public blockchain tokens going to zero, it's a bit misleading. We would be surprised to find that even some of the less successful projects will last for a long time.
I want to emphasize that we are still in the early stages of analysis of public chain tokens, and there are not many traditional financial analysts publishing research on valuing these assets. And some very basic things, such as the liability structure of crypto projects, are still not well understood. So, I am lucky to be able to write some articles on these topics in a market that I think is still in its very early stages.
