Bulls and Bears Face Off

Aug 13

July/mid-Aug 2024 Commentary

The approval and launch of Ethereum spot ETFs in the US in the second half of July was a major milestone for the broad adoption of digital assets. The volatility that ensued a week later in early August was a reminder that crypto markets trade 24/7/365 and constantly price in new information. Not paying attention is a source of risk and missed opportunities.

New(ish) Era of Spot Cryptoasset ETFs

2024 is shaping up to be a seminal year for the broad adoption of digital assets by a broader range of investors. After spot BTC ETFs were approved in early January, there was much handwringing over the next set of approvals for the suite of spot ETH ETFs. Whereas BTC was squarely deemed a commodity, the ability to stake ETH to help secure the blockchain and receive a staking yield (approximately 3% in additional ETH tokens) risked ETH being deemed a security and throwing a wrench in the ETF approval process. ETF sponsors quickly revised their SEC applications, and after their approval, nine ETH ETFs began trading on July 23.

Not unlike the start of the BTC ETFs trading in early January, uptake in the ETH ETFs has been slow and characterized by rotation out of the expensive Grayscale Ethereum Trust which has management fees of 250 bps compared to its competitors with fees of only one-tenth of that.

As of August 9, there has been a cumulative net outflow of US$ 406M, almost all of which can be attributed to withdrawals from the pricy Grayscale Ethereum Trust, ETHE. According to sosovalue.xyz, net assets in the US spot ETH ETFs total $7.28B, just about 13% compared to their BTC ETF counterparts of $55.11B in net assets. Given that the market capitalization ratio of ETH to BTC is just over 27%, this is an indicator that so far, the ETH ETFs have not captured as broadly the attention from the non- crypto-native investor cohort.

Early August Shakeout and Recovery

The high note from the July ETF approvals was to be short lived. For context,

On July 31, the Bank of Japan (BoJ) raised interest rates to 25 bps, from effectively 0%, a level that had been in place for 15 years;
The Yen started to appreciate against the USD from 152.7 to what would be a recent high of 144.7 on August 6;
On August 2, the US unemployment rate increased unexpectedly to 4.3%;
Fears of a weaker economy led the S&P 500 to drop by 1.8% that Friday;
On August 5, the Nikkei 225 dropped 12.4%. The US market followed suit with the S&P 500 dropping 3%;
Compared to Friday afternoon, BTC dropped 12% while ETH lost 19% on August 5.

The ferocity of the market pullback has been blamed on the yen carry trade, effectively shorting and borrowing in yen (at 0% borrow costs and in a depreciating currency) and investing the proceeds in higher yielding, higher risk assets using leverage to amplify those returns. A BNN Bloomberg article cited a value of $1.1 trillion had been placed into this strategy.

Deleveraging has a pro-cyclical vicious effect on liquid risk assets as investors seek to reduce risk to meet margin calls and conform to internal risk guidelines. It is no wonder that as cryptoassets gain broader adoption, it will behave similarly to other risk assets during these drawdown periods. The fact that ETH’s drawdown was more severe than that of BTC’s was quite likely due to the additional selling reported to be associated with Jump Trading, a crypto-trading firm.

And then it was over. Those who blinked or were on vacation over the past week would’ve missed a tremendous opportunity to buy quality assets at a decent price. The BoJ’s comment that it would not raise rates while the markets were unstable and the increased expectations for at least a 50 bps rate cut by the US Federal Reserve in September, according to the CME Fed Watch, helped to bring in investors who were hunting for bargains.

Volatility is So, Short-Term

This short-term volatility we just experienced is important to pay attention to but investors need to prioritize it consistently with their respective investment horizons. Leveraged investors need to be mindful of stop-loss breakpoints before margin calls are demanded. Long-term investors, such as us, use these opportunities to assess whether their investment thesis remains intact and what re-allocation, if any, needs to be made.

Our opinion is that the fundamental thesis for continued cryptoasset and blockchain adoption remains strongly intact. In our June commentary, we focused on the growing value of real world assets being tokenized and growing number of transactions on-chain. As we draw closer to the US November elections, we thought it would only be fitting to highlight the shift in attitudes of US’ two major political parties towards the crypto markets.

Republicans and Democrats, Like Oil and Water

It is not an exaggeration to expect major cryptoasset and market policy reforms in the US over the next one to two years. Europe passed its Markets in Crypto Assets (MiCA) regulations in June 2023 and is underway with its implementation. Dubai’s Virtual Assets Regulatory Authority (VARA) in the UAE provides a clear and compelling jurisdiction for businesses that are looking to build digital assets platforms. Meanwhile, the US lags woefully behind, still mired in regulatory opaqueness for the crypto markets and turf battles between the SEC and the CFTC. The approval of spot ETFs for the two largest cryptoassets does foretell a future of friendlier policies towards crypto market development in the US.

Republicans have generally been far warmer to the digital asset community than the Democrats. After maligning crypto in 2021, President Trump started to warm up to the asset class with the issuance of his first NFTs in late 2022. Fast forward to Bitcoin 2024 held towards the end of last month in Nashville, TN, Trump reportedly promised to create a “strategic national bitcoin stockpile”. Around the same time, Wyoming Senator Cynthia Lummis proposed the BITCOIN Act of 2024, cleverly crafting the legislation’s name to spell out BITCOIN as the acronym. The proposal would allow US and her states to buy and hold BTC as part of their reserves.

After a disastrous presidential debate on June 27 between Biden and Trump, President Biden stepped down from the 2024 ticket. The Democrats rebooted their campaign by positioning current Vice President Kamala Harris as the Democratic presidential nominee. So far, neither Harris nor her vice-presidential running mate, Tim Walz, have clarified their policy stance on digital assets. However, anecdotes have surfaced that Harris’ campaign has been speaking to influential persons affiliated with the cryptoasset industry, and with Harris herself having strong ties to Silicon Valley prior to 2017, her administration may weigh favorably on policies towards technology development, innovation, and the crypto markets.

Broader real-world applications, stronger name recognition, easier-to-invest vehicles paving the way for broader adoption, and a warming political climate in the US – so much has shifted positively over the first half of 2024. Yet we still see crypto-market valuations, on average and adjusting for risk, barely above that at the beginning of the year. What’s there not to like?

S. Jim Hwang