Breaking Away

While we maintain that macro conditions are still the most critical factor in assessing the medium/long-term trajectory of BTC prices, daily returns of the leading cryptoasset continue to exhibit a lack of defined correlation with any major macro asset.

To us, the biggest reason for this sustained lack of correlation is the advent of the spot BTC ETF. A prime example of how ETFs are influencing BTC’s performance during US market hours occurred on Tuesday. We observed a significant divergence in the response of BTC versus gold following a hotter-than-expected CPI number.

The dynamic between BTC and QQQ was similar, albeit less pronounced. It’s worth noting that traditionally, BTC reacts with higher sensitivity to rates and changes in conditions for risk assets. Thus, observing equities drawdown over 1% while BTC barely flinches should capture investors’ attention.

As mentioned above, the major reason for this divergence in performance is the advent of spot BTC ETFs. They led to an accumulation of flows leading up to the big launch, despite rising rates and a strong dollar.

Actual flows are now reducing the downward sensitivity of BTC to any tightening in financial conditions. The sample size is small, but the effects are real and serve as a great example of how passive flows can alter the way BTC trades moving forward.

Below are charts displaying the rolling correlations between BTC and the DXY, Gold, and QQQ. Correlations are generally still very low across all timeframes. It is worth noting that correlations with equities are beginning to rise. This might be emblematic of the increasing flows from a cohort of investors that view BTC as beta to tech. The increase has been slight, but it is worth monitoring going forward.

Market Breadth Expanding (In a Good Way)

Market breadth is a useful tool to measure the overall strength of the market, gauge the prevalence of animal spirits, and assess market frothiness. Our analysis indicates that breadth is expanding again, akin to the patterns observed in December, and reminiscent of the patterns observed in the early stages of prior bull markets.

ByteTree, a crypto data provider, offers a comprehensive breadth score ranging from 0 to 5 — with 5 indicating the strongest momentum — for the top 170 coins. This score is derived based on several key criteria:

1. The price exceeds the 280-day moving average.
2. The price is above the 42-day moving average.
3. There’s an upward trajectory in the 280-day moving average slope.
4. The 42-day moving average slope is on the rise.
5. The most recent interaction with the 20-day maximum/minimum boundary occurred at the maximum.

Using this scoring system, we can determine an aggregate breadth score (the market average) for both USD and BTC pairs. Our analysis reveals that the market’s breadth is indeed broadening. However, this expansion is happening against USD, not against BTC.

Below is the market breadth vs USD. It’s evident that more assets are experiencing strong momentum relative to their respective moving averages lately.

However, the chart below highlights the market’s continued bitcoin-led nature. Despite market breadth soaring over the past several weeks, market breadth denominated in BTC is declining. This is an incredibly bullish dynamic, indicating a healthier, less speculative market characterized by significant capital inflows. It suggests that altcoins have ample room to appreciate in the near term relative to BTC without entering what we would consider overly frothy conditions.

To better illustrate how market breadth can signal frothy conditions over a cycle, we created a ratio of market breadth against USD vs market breadth against BTC. This ratio tends to increase (market breadth against USD higher) and stay generally elevated during the early stages of a bull market. It’s in the frothier stages, when this ratio decreases (market breadth against BTC higher), that we observe an increased prevalence of leverage and stronger allocation towards and momentum in altcoins.

In summary, despite the strength in select altcoins over the past several months, we are witnessing a bitcoin-led market, which bodes well for medium/long-term continuation.

Signs of Market Strength in Older Wallet Behavior

Below is a chart illustrating the total BTC supply held by long-term holders, representing supply purchased at least five months ago, though many acquired their BTC well before this timeframe. You’ll notice that this cohort’s supply is beginning to diminish as new investors enter the market.

At first glance, this trend might seem bearish, but we assure you, it is not. A broader perspective reveals that this phenomenon recurs in every bull market, as investors who bought at the cycle’s bottom begin to realize profits. They may then rotate into other altcoins or different asset classes.

This pattern typically emerges in moments of capitulation, at the cycle’s bottom, or when the market gains enough strength to provide exit liquidity for these long-term investors. Therefore, this trend should be interpreted as a positive indicator of market strength and an additional hint about our current position in the cycle.

ARB Unlock Approaching

As a quick refresher, Arbitrum is a Layer 2 scaling solution for Ethereum, designed to enhance its scalability and efficiency. It operates atop the Ethereum blockchain, processing transactions more swiftly and affordably while leveraging Ethereum’s security and decentralization.

Arbitrum utilizes Optimistic Rollup technology, which assumes transactions are valid by default and only conducts full computation and state execution in case of a dispute. This optimistic approach allows for faster and more cost-efficient transaction processing than executing all transactions directly on the Ethereum mainnet.

Our bullish stance on ARB stems from its impressive adoption level, reliable beta exposure to ETH, and the expected benefits from the forthcoming Dencun upgrade. This upgrade, poised to reduce transaction costs for L2 networks through proto-danksharding, should significantly benefit ARB alongside other L2 solutions.

Since adding ARB to our Core Strategy in August, it has more than doubled in value. However, it’s important to note the substantial upcoming unlock, nearly equivalent to the entire current float. Of course, one who believes in the efficiency of markets should see this as a non-issue, since this has been publicly available information for a very long time. But, for better or worse, cryptoassets do not always abide by the efficient markets hypothesis, giving us something to manage around.

The topic of unlocks is nuanced. Typically, new supply is bearish, but this depends on whether demand remains below the growth in supply. Furthermore, the behavior of token holders varies by cohort—not all will sell upon unlock, influenced by long-term conviction or favorable market conditions. Additionally, more sophisticated holders may utilize derivatives to hedge long positions, allowing them to await market reactions post-unlock.

The upcoming ARB unlock is set to provide liquidity to private investors, the team, and advisors. These individuals or funds, often receiving tokens at a significant discount, might opt for selling their holdings through OTC deals before the unlock, ensuring considerable returns while reducing market sell pressure post-unlock. This strategy frequently leads to a bullish outcome post-unlock, as evidenced by data from TokenUnlocks. This data shows the average token performance leading up to and following unlocks, segmented by different recipient types.

Despite this nuanced data, we think that the sheer volume of this unlock should be respected. This unlock amounts to nearly 90% of ARB’s circulating supply and 5-6x its daily volumes.

Given the magnitude of this unlock and alternatives for exposure in other ETH beta and L2 names post-unlock, reducing exposure just before the unlock seems prudent.

The DYDX Playbook

We can draw from the recent DYDX unlock, which saw 120% of its circulating supply come to market in December without immediate adverse effects but thereafter underperformed in a buoyant crypto market.

Notably, a rally preceded the unlock, and was spurred by significant platform updates. The DYDX team essentially launched its new standalone chain mere days before the unlock to increase demand for the token. This suggests that fundamental demand and strategic announcements can mitigate unlock impacts and provides clues for how the Offchain Labs (Arbitrum development org) might be approaching this unlock.

With the Decun upgrade scheduled for March 13th, shortly before the unlock on March 16th, we see a strong possibility of bullish momentum from potential announcements or updates from developers or ecosystem participants, followed by a period of churn as the market absorbs the new supply – similar to what transpired with the DYDX token.

In summary, we remain long ARB ahead of the Dencun upgrade to Ethereum, but we will look to derisk ahead of any major rally due to the impending unlock’s size.

Flows

Finally, an update on the impressive ETF flows to date. As alluded to above, inflows have been nothing short of impressive, smashing records left and right. Thus far this week we have seen nearly $2 billion in aggregate net inflows.

It is worth noting that in recent days, outflows from GBTC have started to increase again. These figures are still well below the redemption amounts in the earlier days post-launch and do not concern us a great deal, given the amount of constant offsetting demand. However, this is something we will be paying attention to over the next week.

On the stablecoin front we continue to see very strong creations, demonstrating the persistent inflow of capital into the on-chain economy.

In fact, Wednesday saw the greatest single daily flows into stablecoins over the past 6 months. This certainly suggests that the strong breadth that we discussed above should continue in the near term.

Core Strategy

Our Q1 outlook anticipated some headwinds, and it seems the initial turbulence has subsided for now. Flows into crypto remain strong and breadth against BTC remains subdued. We maintain that ETH, L2s, and STX offer compelling idiosyncratic upside due to their near-term catalysts. Further, we have no reason to fade the recent strength out of SOL.

A brief summary of the theses behind each component of the Core Strategy/Active Trades:

• Bitcoin (BTC): Censorship-resistant money that serves as a liquidity sink in developed markets and base layer money in the global south. It is provably decentralized and can be used to build out a more robust, green energy grid throughout the globe. Potential catalysts include the halving (April 2024).

• Ethereum (ETH): Distributed internet architecture whose proven use cases include the distribution of fiat currencies on global rails and a venue through which one can exchange digital assets globally in a permissionless fashion. Potential to supplant rent-seeking intermediaries via immutable smart contracts and digital ownership rights. Key catalyst is the possibility of a spot ETF coming to market in Q2.
• Solana (SOL): The monolithic competitor to Ethereum’s layered strategy. High throughput L1 relying on the eventual reduction in hardware costs to scale. Goal is to be a global shared state operating at the speed of light. A hated token due to affiliation with SBF but has proven resilient.
• Optimism (OP) & Arbitrum (ARB 0.09% ): As ETH looks to scale in layers, more applications and users will migrate to layer 2 networks. The two leaders in this arena with publicly traded tokens are poised to outperform as we near EIP 4844.
• Stacks (STX): A bet on the development of a bitcoin economy. Key catalysts include the bitcoin halving and the Nakamoto upgrade in Q1 2024.
• DOGE (DOGE): Given (1) the return of animal spirits in the crypto market, and (2) two impending space missions with connections to DOGE, we think it is an opportune time to think about developing a position for a near-term (1-3 month) trade.