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Now that Bitcoin has seen new all-time highs, institutional and retail investors alike are turning their attention back to the digital asset markets. Having fallen over 75% from its 2021 highs and trading at just $17,000 to begin 2023, Bitcoin was seemingly dead to those not involved in digital assets on a daily basis. However, Bitcoin has returned 182% over the past year and recently peaked at over $73,500, eclipsing the previous high watermark of ~$69,000. It’s easy to sigh “here we go again”, but for those of us deeply ingrained in the space, there’s a certain optimism that this time (at least so far) might be different.
New structural catalysts and legal clarity, in addition to the continued development of blockchain technology throughout the bear market, have opened the door for digital assets and blockchain technologies to take a much bigger step towards mainstream adoption as investment opportunities and valuable technology in real-world applications. In this post, we’ll explore some of the major developments that have gotten us to this point and highlight a few more on the horizon to keep an eye on.
(Note: Much of this is US-centric, but given its outsized impact on global capital markets, these are some of the largest drivers of recent movements.)
How did we get here?
Sandwiched between the sudden collapse of the $60B Terra ecosystem in May 2022 and the implosion of $32B exchange FTX in November 2022, the second largest digital asset, Ethereum, went through its biggest upgrade in its history, transitioning away from a Proof of Work consensus mechanism (similar to Bitcoin) to a more sustainable and efficient Proof of Stake mechanism, cutting its energy footprint by 99.95% overnight. Not only did this eliminate the chain’s reliance on miners, it opened the door to adopt more advanced scaling solutions, reduce fees and even turn Ether itself into a deflationary asset (1.5M ETH has been ‘burned’ since).
The new year brought legal clarity for some of the largest exchanges: Coinbase’s settlement for $100M in January 2023, followed shortly by Kraken’s $30M Settlement in February 2023, resolved major overhangs on the two largest exchanges in the US. The biggest legal overhang came in November 2023 when Binance agreed to a $4B settlement and its CEO Changpeng “CZ” Zhao stepped down.
Clarity around the FTX fallout and contagion throughout the market improved as well. Creditors and customers expected to be repaid in full as of January 2024, but crypto markets were expecting this in October 2023, buoyed in part by strength in the AI markets (read: Anthropic). This clarity extends to customers of other major centralized entities such as BlockFi, who is expected to receive $874M in repayment.
However, likely the most prognostic event of future market strength came in June 2023, when Blackrock, the $10T asset manager, filed its application for a spot Bitcoin ETF (more on this later). While other issuers had already applied, Blackrock’s track record essentially guaranteed the ultimate outcome: at the time, Blackrock had been successful in getting 575 of 576 ETF applications approved.
With all of that now in the rearview mirror, 2024 is already proving to be just as positive.
BTC Spot ETF Approval
Likely one of the biggest regulatory steps forward for Bitcoin and digital assets more broadly, the SEC finally approved the creation and trading of Bitcoin Spot ETFs in the US on January 10, 2024. Until this, only futures-based crypto ETFs or trusts, as in the case of Grayscale’s funds, existed for US investors (they have been available in markets overseen by other regulators). While Grayscale’s version did require holding spot Bitcoin, the vast majority of institutional exposure through ETFs did not touch Bitcoin the asset directly. This approval changed all of that.
Several of the largest traditional asset managers in the world representing $15T+ in AUM (i.e. Blackrock, Fidelity, Ark, Franklin Templeton, Invesco and VanEck) have jumped in, providing US-based institutional and retail investors simple onramps to owning spot Bitcoin. The ‘so-easy-your-Grandparents-could-do-it’ moment that digital assets had been waiting for. The flows into these products have exceeded even the wildest expectations over the first few months, frequently crossing $500M net new inflows in a single day. Currently, 6.25 BTC are produced with each new block, or roughly 900 new BTC per day – equivalent to $64M at current prices. That means this new structural buying pressure is almost 8-10x what the network is producing in new supply. In April, Bitcoin undergoes another ‘halving’ (more on this later), bringing new issuance per block down to just 3.125 BTC, or $32M per day – a 15-20x mismatch from what is demanded. These are only from 9 US ETFs, ignoring the rest of the world’s markets (again, more on this later). To date, these ETFs have seen over $110B in trading volume and over 4% of the entire bitcoin supply is already backing just this set of US products. Total flows into these ETFs in the 2 months since launching already exceed flows into all physical gold ETFs over the last 5 years combined.
But what of the rest of the 19,654,488 BTC in circulation? Bitcoin is a unique asset in that holders of Bitcoin do not sell Bitcoin. Roughly 70% of BTC in circulation has not been moved in over a year, and 31% of Bitcoin has not been moved in 5 years. This deep structural supply/demand mismatch has never been seen before in this market.
Another sign of what’s to come, Fidelity Canada now, by default, allocates 1-3% of its all-in-one ETF products to crypto (read: Bitcoin ETFs). Being piloted here, this model will likely become the de facto standard for portfolio construction going forward, as dictated by modern portfolio theory. It takes several months for these issuers to engage all their distribution channels, and advisors/investment managers take time to review new products before recommending them to clients. Likely, only a fraction (e.g. <25%) of these channels are fully turned on. All of that is to say: we likely haven’t even scratched the surface of demand for these products compared to what we will see once the trillions of capital overseen by investment advisors in the US is finally opened up fully to BTC exposure.
What’s next?
While most of the market is still picking our jaws up from the floor after seeing these ETF flows, there are multiple new developments on the horizon that are potentially equally as positive for digital asset markets.
ETF Approvals Keep Coming (maybe?)
Following in the steps of SEC regulators, on March 11, the UK’s FCA approved the launch of crypto ETPs for institutional investors (though not for retail), opening the door to another massive capital market to move into spot Bitcoin. Flows from these have not yet started but will run into the same structural mismatch that the US ETFs are facing.
While exciting, most eyes are now on May 23, 2024: the potential approval of Ethereum Spot ETFs in the US. Not only would this open up another $500B digital asset to the investing public, this would greenlight an entirely different form of asset: a Proof of Stake asset (refer back to the Proof-of-Work to Proof-of-Stake upgrade to Ethereum mentioned earlier in this post). Bitcoin is essentially the only major digital asset still using PoW (exceptions apply), almost all other major blockchains use the PoS mechanism. If this is approved by US regulators, that opens the door for all others in the future while majorly derisking Ethereum the chain, and the billions of dollars of blockchain-enabled protocols and assets that have been built on top of it. In short, if this approval goes through, we expect a massive rerating to occur for most digital assets similar to the one demonstrated by Bitcoin.
What’s the catch? Approval this time is far from certain. While Bitcoin has been viewed as a commodity for many years, the SEC has avoided answering whether or not PoS Ethereum is a commodity too, or if it’s a security. This, plus several other idiosyncratic differences, have put the odds at approval closer to 50/50 by this deadline. Some major banks expect approval, while top ETF analysts and blockchain-focused lawyers are less optimistic, putting odds closer to just 30%. Top firms such as Blackrock, Fidelity and CBOE have asserted that the same arguments that led to the Bitcoin ETF approval apply to Ethereum as well. We’re watching to see if these issuers start making updates to their filings throughout April, a sign that they are actively engaging with the SEC and potentially moving towards approval.
Proto-Danksharding (EIP4844/Dencun) and Eigenlayer
Following the transition to proof of stake and the resultant “Merge”, Ethereum is now in the colloquially named “Surge” part of its development roadmap. The Dencun upgrade, the largest upgrade since the move to PoS introduces “Proto-Danksharding” via EIP-4844. In essence, this vastly reduces the costs of layer 2 blockchains that use Ethereum for settlement and security. The impact? Fees on these L2s have dropped dramatically. For example, Base (Coinbase’s own L2) saw medium transaction fees of roughly $0.50 historically. Post-upgrade, median fees are just $0.03. On Zora, median fees dropped from $0.60 historically to $0.009. While the long-term equilibrium of this is yet to play out, this is a massive step forward towards scaling and user friendliness.
Perhaps the biggest impact to Ethereum economics is coming in the form of Eigenlayer, expected to go live this spring. At a very high level, Eigenlayer allows users to deposit their Ether to help secure other blockchains (in addition to Ethereum) in exchange for additional fees, through what is called ‘restaking’. No one is quite certain about what the long-term equilibrium yields look like for ETH holders once these ‘Actively Validated Services’ go live, but this will likely add an extra 3-8% on top of the current 3-5% ETH stakers receive, resulting in ETH becoming a deflationary asset yielding 6-13% annually if staked appropriately. Eigenlayer and restaking have dominated Ethereum conversation over the past several months, but in case that wasn’t enough, a16z invested $100M in Eigenlayer in February as a further kickstart to this entire new system.
US Macro Environment
There are also favorable developments on the US macro level that have the potential to provide even more tailwinds for digital assets. Primarily, we’re watching two core pieces: the Fed Rate cuts, now largely expected to begin in June, and the US election in November. Regarding the rate cuts – given many major digital assets are non-yield generating and are obviously far further out on the risk spectrum – higher rate environments are less conducive to capital flows into digital assets. We saw an increase in activity once the rapid hikes to rates stabilized in the Summer of 2023, and expect additional interest once rates start coming back down over the next 12 months.
While the US elections in November are still many months away (and there are ahem…certain legal issues yet to be resolved), Republicans winning control of the Senate or White House is largely expected to result in a more digital-asset-friendly stance by US regulators and lawmakers. Should this be the case, expect a more friendly SEC to be reviewing blockchain products for the next few years, helping progress the US digital asset market forward. As of right now, on-chain prediction markets (backed by $93M in wagers) expect Republicans to prevail.
MEV (Maximum Extractable Value) is the value captured by third parties on blockchain networks
