Staying the Course

Key Takeaways

• Bitcoin and wider crypto market stalls on macro uncertainty. We provide insights on why we think the party continues through year-end.
  
• Bitcoin volatility is still relatively muted compared to historical measures. The Bitcoin “VIX” is approaching a historically bullish range.
  
• Seasonal trends point to a favorable environment for BTC and other strong performing cryptoassets in December.
  
• Ethereum is trading at a relatively modest multiple of annualized fees. We focus on a pair of factors driving recent fee growth.
  
• We highlight a basket of altcoins that we think present an opportunity into the end of Q4.
  
• Bottom Line: Despite recent macro uncertainty, the crypto market is still fundamentally strong and poised for the next leg up. Reaching our price targets for BTC and ETH of $100,000 and $10,500, respectively, by year-end is looking less likely. Still, we think that any prolonged periods of consolidation could provide a steadier floor off which Bitcoin and Ethereum could make their next jump and feel confident in each asset’s ability to reach these levels before the end of the current bull market. We view any sustained market chop as an opportunity to increase positions across major cryptoassets.

Black Friday Sale

Last Friday, investors were greeted with an unexpected black Friday sale, as the news of a potentially lethal COVID variant emerging from South Africa, coined “Omicron,” caused investors across all asset classes to go risk-off into the weekend. Bitcoin, Ethereum, and the rest of the crypto market sold off in concert with equities as the total crypto market cap dipped $200 billion by the time Friday was over (As an aside, it is crazy to think about the fact that the global crypto market cap totaled $200 billion a mere 18 months ago, and now we have days in which the market cap fluctuates by that amount). While there has been much speculation over whether BTC has transitioned into a safe haven asset, Friday’s price action suggests that it should still be considered a risk-on play, even if it is maturing rapidly.

When the dust settled on Saturday morning and investors had time to digest the preliminary reports on Omicron, markets rebounded significantly, recouping most of the losses incurred on Friday.
Fast forward to Tuesday, and crypto markets again ran into a bit of a speed bump as macro uncertainty clouded the picture. In testimony before a US Senate panel, Jerome Powell mentioned that he believes the Fed should eliminate the word “transitory” from the inflation lexicon and suggested initiating an expedited tapering process to mitigate the effects of recent price increases on the economy.

Is the Party Over?

On Tuesday, many investors found themselves asking each other whether a reduction in Fed purchases or a sooner-than-expected rate increase would hamper Bitcoin’s run at all-time highs. While we maintain that digital assets (including BTC) fare better during periods of monetary expansion, we have historical precedent to assuage our concerns over rates being the catalyst that sends crypto into a sustained bear market.

During the bull market in 2017, we experienced several rate hikes before the crypto market turned over. Considering that we are starting from a much lower base, we feel comfortable that the shock from any rate increases would take some time to be felt by Bitcoin and the wider crypto market.

Similarly, there is not much historical correlation between tightening the Fed balance sheet and near-term BTC performance. Below we map out the prior two bull market cycles for Bitcoin against total assets on the Fed balance sheet. In 2013, the balance sheet was still expanding when the leading cryptoasset started its decline into a bear market. Then in 2017, we see that the Fed’s balance sheet was quite steady for the several years leading into the crypto bull market. It wasn’t until the balance sheet actually started tightening (vs tapering) that BTC took a tumble.

Given that we are miles away from removing assets from the Fed balance sheet (latest estimates have the tapering ending within 4-8 months of starting), we don’t believe that a “taper tantrum” is a near-to-medium term risk for Bitcoin. Also, as one can quickly notice with a glance at the chart, our starting point is much higher than in prior cycles. Therefore, while we understand the concern, tapering is unlikely to be the straw that breaks Bitcoin’s back.
In other words, the party is still on.

Seems Quiet….Too Quiet

Despite the headline shocks from the past two weeks, Bitcoin volatility is still relatively muted compared to historical measures. Below is the Bitcoin “VIX,” as measured by data service provider T3 Index using the expected 30-day implied volatility of BTC option prices, displayed against BTC price. We can observe that as the index breaches the 80-85 range, the subsequent price action tends to be positive. This makes sense since derivates markets price risk via implied volatility. We will look to see if this pattern continues. If you are approaching things from a market-neutral perspective, this would probably be a good time to go long volatility.

Tis’ the Season

A theme that we have highlighted in several of our weekly notes is the apparent seasonality of Bitcoin. We noted to clients throughout the tumultuous month of September that, for some reason, Bitcoin performs poorly in September. However, the leading cryptoasset does favor the Q4 months quite a bit. These seasonal patterns essentially played out as expected in the past couple of months. We had a phenomenal October and eclipsed new all-time highs in November. Needless to say, the past few weeks have been mired in some profit-taking and sentiment-driven pullbacks. Still, looking ahead to December, we can see that Bitcoin historically performs well in the last month of the year, particularly during crypto bull markets.

In keeping with the theme of seasonality, we also observe that Bitcoin and Ethereum seemingly thrive on holiday spirit. During the bull markets of 2017 and 2020, both BTC and ETH outperformed in the weeks post-Thanksgiving through the end of the year as compared to the first few weeks of November. While the quantity of data points is limited, and admittedly the pre-thanksgiving period is about a week shorter, we do think that there is a case to be made that cryptoassets that perform well into Thanksgiving benefit from increased adoption following increased social gatherings.

One last point to keep in mind regarding seasonality is tax-loss harvesting. The interesting thing with crypto is that in a bull market, most assets generally end up in the black. However, those who invested late or in the wrong projects often harvest tax losses before year-end by selling losing assets and rolling liquidation proceeds into their winners. This is likely a dynamic that we have seen benefit BTC and ETH in the past and would perhaps benefit other strong layer 1 protocols during this bull market.

The Reports of Ethereum’s Death Were Greatly Exaggerated

If you hang in certain crypto circles, you might be accustomed to hearing investors rant about how Ethereum is the “boomer” smart contract platform – how it is slow, crowded, and everyone hates it. While there are certainly valid criticisms worth flinging in Vitalik’s direction, we are here to tell you that developers and users are still flocking in droves to the Ethereum network, and there is fee data to show for it.

As depicted in the chart below, we can observe that fees paid on the Ethereum network have steadily climbed from their YTD trough in June to approach all-time monthly highs in November. This level of “revenue” paid to the network points toward a persistent level of demand for blockspace, regardless of apparent scalability concerns.

Of course, this raises the question of where the demand is coming from. While it is easy to forget, Ethereum still has a vibrant DeFi ecosystem, and users are proving that to be that case.

Below we leverage a chart from the Block displaying a recent increase in the decentralized exchange (DEX) volume to centralized exchange (CEX) volume ratio. To be clear, we are referencing the increase from September through November, and ignoring the parabolic increase at the end of the chart – this is comprised of 1 day of partial data. We have returned to relative levels last witnessed during the summer months.

When coupled with the chart below, we can see that both nominal and relative usage of decentralized exchanges has risen steadily and indicates that DeFi activity is driving a lot of the usage levels on the network.

However, DeFi is not the lone causation for rising ETH fees. Below we observe impressively consistent NFT sales volume throughout recent months. As many of these NFT projects are built on Ethereum, we can ascertain that NFTs are also driving demand for Ethereum blockspace.

Interestingly, we would also like to point out the relative volume of gaming NFTs. At the onset of “NFT-mania,” art and collectible NFTs were the first to gain widespread traction. Since that time, a burgeoning ecosystem of decentralized games has also spun up. These dApps secure native non-fungible gaming assets to the blockchain, allowing users to achieve ownership of any in-game assets. Many of the gaming assets below are likely the product of Axie Infinity (AXS), a play-to-earn game built on Ethereum’s Ronin sidechain.

With these exemplary usage metrics in mind, we can see below that ETH is trading at a relatively modest multiple compared to historical measures. If we calculate an annualized revenue based on the previous 30 days, the current EV/Revenue multiple for the Ethereum network is 24.9x. This pales in comparison to the 48.4x multiple a few short months ago, when the price was lower than its current level. Thus, if macro conditions hold up through the balance of the year, we think that ETH is fundamentally positioned to outperform.

Our Altcoin Baskets

We hope that many of you tuned into our annual conference a couple of weeks ago, in which we did our best to provide a lay of the current crypto landscape and offer some context surrounding why we like certain assets during this bull market. We usually try to focus the lion’s share of our weekly market coverage on BTC and ETH, given that these assets are where the majority of our clients’ capital is parked and generally lead the market in any cyclical changes.

If you recall, we highlighted two key areas to roll gains into, should one be inclined to move further out on the risk curve:

• Emerging layer 1 platforms
• The crypto ecosystem’s application layer – particularly within the emerging verticals of Web3, Metaverse, and Gaming

Below are the emerging layer 1 tokens that many on our team are users of. We believe they possess long-term viability as providers of blockspace in a modern crypto economy. Each of the following has some or all of the following attributes:

• Robust and dedicated developer communities
• A growing ecosystem of applications
• Proven demand from users
• Unique technical advantages

Additionally, most of these projects are favored by the leading crypto funds. We were able to retrieve the data below from Messari. The chart displays the number of funds that hold Avalanche, Terra, Polkadot, and Solana. Any project with institutional skin in the game is more likely to fare well in a bull market and perform more robustly during downturns.

In a similar vein, these platforms have allocated a significant amount of treasury capital towards incentivizing development and usage within their respective platforms. The numbers below represent funds allocated by each separate protocol’s treasury or foundation toward development funds and incentive programs over just the previous four months. These figures exclude any additional external capital invested in projects built on the platforms.

If a client of ours wishes to move even further out on the risk spectrum, we highlight several decentralized applications (dApps) below that share similar characteristics to the layer 1 tokens (strong community, technical advantage, etc.), and have ample liquidity sources.

Bottom Line

Despite recent macro uncertainty, the crypto market is still fundamentally strong and poised for the next leg up. Reaching our price targets for BTC and ETH of $100,000 and $10,500, respectively, by year-end is looking less likely. Still, we think that any prolonged periods of consolidation could provide a steadier floor off which Bitcoin and Ethereum could make their next jump and feel confident in each asset’s ability to reach these levels before the end of the current bull market. We view any sustained market chop as an opportunity to increase positions across major cryptoassets.