Remaining OPtimistic

How We Got Here

Looking back over the past month, we found ourselves stuck in unusual stasis. Macro risks were escalating, and negative seasonality was taking effect, while at the same time, the potential for positive industry-specific tailwinds were knocking on the door. This strange equilibrium led to a decoupling from macro variables, with volatility approaching historical lows.

Our near-term bullish view was predicated on one or both of two things coming to fruition: either (1) liquidity conditions would bottom out (with rates rolling over, DXY declining, and central bank liquidity turning higher), or (2) industry-specific catalysts would emerge (such as a Grayscale verdict, official approval of an ETH ETF, or BTC ETH approval).

Unfortunately, last week the market broke free from its stasis, shifting to the downside. This move was spurred by an overleveraged market that had been waiting for one of the two possible relief scenarios to materialize.

The situation was exacerbated by $1 billion in liquidations. And although we received an article from Bloomberg suggesting that the SEC was set to greenlight an ETH futures ETF, it appears that confirmation from the regulatory body itself will be needed before this serves as an actual tailwind for prices.

Where We Go Next

The good news is that the market is now deleveraged. The catalysts we have highlighted previously still hold the potential to manifest, and there is a strong likelihood that we will see some relief (even if temporary) in both the rates and the DXY.

Below is an insightful visual illustrating the recent strength of the DXY as a wrecking force. The 30-day returns for the DXY are in the 87th percentile of all 30-day returns since 2014.

The DXY has followed a particularly reliable pattern so far this year, and Bitcoin’s relationship with the DXY has been similarly dependable (outside the brief period of stasis in August).

Below, we map the historical DXY returns against forward Bitcoin performance. As you can observe, each time DXY has produced a 30-day return exceeding 2%, it was followed by impressive performance by Bitcoin. This surge often occurred as the dollar encountered resistance, fueled by ongoing disinflationary trends, thereby benefiting risk assets.

There is the evident risk of the DXY continuing its upward trajectory for the remainder of this calendar year, a pattern that essentially unfolded in 2022. However, we believe this would necessitate a reversal of the current disinflationary trend.

In our view, the bond market appears highly concerned about the influx of long-term Treasuries anticipated to hit the market in Q4, leading to the recent spike at the long end of the curve. Yet, markets are forward-looking, and there is a reasonable probability that the effects of this supply are already priced in.

Some Positive Signs

Markets detest uncertainty, and the MOVE Index serves as an excellent gauge of that uncertainty. The MOVE Index, which measures bond volatility, has recently come down from its local peak—a positive sign and something we want to continue monitoring closely.

Lower risk in the bond market intuitively enhances the value of collateral in the banking system, consequently boosting lending and increasing the amount of liquidity in the markets. We hope to see this trend continue, with the index receding back toward the 100 mark.

Observing Gold catch a sustained bid for the first time since mid-July is potentially encouraging for the crypto market, including Bitcoin. Much like Bitcoin, gold serves as a reliable barometer of global liquidity conditions, often rallying alongside BTC at the beginning of most cycles. In fact, if one removes the period of low volatility over the past month in which bitcoin detached itself from macro variables, then it would have followed gold’s price levels quite closely this year. It’s conceivable that gold markets are detecting a local peak in interest rates and a local trough in central bank liquidity measures.

Big Day Tomorrow

Two reasons that tomorrow could be a big one for both crypto and traditional markets:

1. Jay Powell makes his annual speech at the Jackson Hole Economic Symposium, which was used last year to hammer markets and remind the market that there was a long way to go on inflation. We do not want to pretend to be Fed whisperers, but with the recent rout in bonds, coupled with rising concerns out of China and falling PMIs out of Europe, it is likely that JP toes the line carefully between declaring victory and promising more pain, and the market might view this as a dovish speech.

2. Around the same time, we may finally see a verdict in the Grayscale vs SEC case. As we highlighted in last week’s note, the case has already extended beyond the typical duration between oral arguments and a decision. It’s worth noting that most decisions are handed down by the end of August, as the court’s term ends at that time. Often, the court prefers to avoid having cases roll over into the new term. Also, of note are the importance of Tuesdays and Fridays – the days of the week on which case verdicts are delivered.

Trust Products Holding Up Well

Despite the weakness in the spot market, the discounts on the ETHE and GBTC trust products have not receded as we have historically observed during periods of drawdowns.

In fact, ETHE has experienced a relatively impressive week, with the discount rallying from -39% to -33%. This uptick is likely supported by the rising possibility of an ETH futures ETF launching in October.

Additionally, should Grayscale win its case against the SEC, a spot ETH ETF could potentially come to market in short order.

Staying Optimistic

One of the bright spots from the past week has been OP, which, as of today, is up 20% relative to BTC since being added to the Core Strategy last week following the market wipeout.

As the graph below illustrates, daily active users continue to climb, likely driving fundamental demand for the token. This increase in engagement is particularly evident in top projects currently active on the network, including Gnosis Safe, Layer Zero, Worldcoin, and Stargate.

Further aiding this rally is the impressive early traction of Base (Coinbase’s Layer 2), built on the OP stack. A portion of the fees earned on Base will be allocated to the Optimism Collective for future development, which likely contributes to OP’s success.

Below, you’ll find the daily user statistics for Base since its launch a month ago.

Over the past 30 days, both Base and the OP mainnet have accrued nearly $4 million in fees, surpassing the totals from any other Layer 2.

While it’s unlikely that OP will maintain the pace of its recent surge relative to Bitcoin, we believe this is a great asset to hold. The ecosystem’s development around the OP stack and the fundamental tailwind from the impending EIP 4844 update (expected in Q4) should enhance the profitability of operating a sequencer on an ETH Layer 2 and improve the overall user experience on the Layer 2 platform. Of note, we expect the 4844 catalyst to also benefit ARB as well over the next couple of quarters, but OP just happens to be outperforming now.

We Need to Talk About Rocket Pool

At the start of this year, we were quite constructive on liquid staking derivative platforms and their respective governance tokens. A major reason was simply narrative based. Given the Shapella upgrade and the value it would unlock for stakers, we viewed LSD governance tokens (LDO, RPL) as a perfect way to achieve exposure to this event. They performed very well in our Core Strategy through most of 1H. Once we viewed the narrative-driven portion of the Shapella upgrade as behind us, we removed LDO and kept RPL in our Core Strategy due to its fundamental advantages to its competitors.

The RPL token is the native token of the Rocket Pool protocol and, in our view, provides greater utility than Lido’s LDO token. It serves multiple functions within the ecosystem. Firstly, RPL is a governance token that enables holders to participate in the decision-making process and shape the future of Rocket Pool through voting on protocol upgrades and proposals.

Secondly (where the token differs from LDO), RPL is used as collateral by node operators within the protocol. Node operators stake RPL along with ETH to support the minipools and earn additional rewards. Consequently, RPL is subject to market dynamics as the value of the token is influenced by the adoption and usage of the liquid staking derivative token, rETH, within the Rocket Pool ecosystem. Further, as alluded to above, the network recently underwent a major upgrade, the Atlas Upgrade, which reduced the number of ETH required to spin up a minipools from 16 ETH to 8 ETH, and therefore increased the % of the Rocket Pool stake that is collateralized by RPL.

As you can observe in the chart below, there was a massive spike in minipools following the Atlas upgrade. This corresponded with outperformance in RPL price.

The post-Atlas increase in nodes has been followed by stagnation. Rocket Pool had been gaining significant ground on Lido in terms of market share. There was a particularly impressive landgrab following the Atlas upgrade. However, following this outperformance, this market share % has been moving sideways. Fewer mini pools means less incremental buy pressure for the token.

Price has certainly followed the decline in node growth. Since early June, RPL has underperformed BTC by a sizeable margin.

What is causing the selling and the lack of node growth relative to Lido? Well, to be clear, Lido is a great product. But, we viewed the leverage allowed to node operators via the RPL staking system to be a clever advantage for node operators who want to do more with less. It is likely that there were large holders who cashed out, and this volatility of RPL possibly caused potential node operators to pause before purchasing collateral worth 10% of their borrowed ETH in USD terms. This is obviously the double-edged sword of employing the collateral mechanism.

Despite the recent underperformance, we think it is early to write the project off, and still view it as an outperformer over the next cycle. And to be fair, LDO relative to BTC has not performed all that impressively in recent months either.

Some important positive factors to consider is the major upgrade informally scheduled for Q4, which should decentralize governance and broadly improve node operator experience. After discussions with the team, it also seems as if they are intent on developing a concerted marketing effort going forward.

Also, they recently acquired a key financial stakeholder in Coinbase Ventures, which invested in the RPL token. Coinbase is actively involved in Rocket Pool’s operations, participating in its Oracle DAO and running several hundred nodes. The strategic investment aligns with Coinbase’s emphasis on decentralization and its goals to scale Ethereum’s infrastructure.

In our assessment, Rocket Pool still presents a compelling long-term risk/reward opportunity, driven by its value proposition for node operators and the value-accruing nature of the RPL token. The performance of the RPL token remains closely tied to the growth of rETH supply and the appreciation of ETH’s price. An impending upgrade, improved marketing efforts, and a new strategic investor gives us confidence that we should see RPL rebound once ETH price action starts to improve.

Core Strategy

Despite the recent weakness in asset prices, the probability of near-term relief in the US dollar’s strength or the realization of various crypto-specific catalysts makes us believe that it’s wise to stay allocated and buy dips in anticipation.

We also found that some might benefit from us listing a brief summary of our theses behind each component of the Core Strategy. We will include in our strategy notes going forward:

• Bitcoin: 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 Grayscale vs. SEC, Spot ETF, the halving (April 2024), potential nation-state adoption (Argentina).
• Ethereum: 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 catalysts include Futures ETF, Grayscale vs. SEC, bitcoin halving (indirect catalyst).
• Solana: 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.
• Rocket Pool: An ETH liquid staking provider who we think stands to benefit from: (1) an increase in total % of ETH staked over time, (2) a relative increase in liquid staking relative to the overall amount of ETH staked, and (3) being the only (for now) LSD token with utility beyond governance. We think that over time, the token should outperform if Rocket Pool is able to gain even a semblance of market share on Lido. Key Catalyst: Protocol upgrade slated for Q4.
• Optimism & Arbitrum: 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.

Active Crypto Equities Recommendations

Tickers in this report: $BTC, $OP, $ETH, $RPL, $ARB, $SOL