Leading institutions move into crypto
Starting in 2020, the crypto market witnessed a wave of institutional interest, and the expected institutional flows were a key driver of the 2021 bull market.
However, the flows had not materialised by the time the market peaked, and the 2022 bear market delayed meaningful institutional investment. Still, most institutions expressed their continued confidence in the crypto market’s long term potential, continued building teams and systems, and launched numerous initiatives throughout the bear market.
In this regard, the recent news of BlackRock’s spot Bitcoin ETF filing is highly significant, not only because of the potentially substantial fund flows it would unlock, but also because it was accompanied by positive statements about crypto by CEO Larry Fink, and by moves by other major financial institutions. Fidelity, Charles Schwab and Citadel announced the launch of a crypto exchange, EDX, and various crypto licences were granted in European jurisdictions to Société Générale, Credit Agricole and Santander, with Deutsche Bank also applying for a licence. BlackRock’s ETF filing was quickly followed by similar applications from numerous other institutions including Fidelity, Invesco, VanEck.
Although the final decision on Bitcoin spot ETFs may be somewhat delayed, the probability of an approval is reasonably high based on their track record and regulatory connections, and this may serve as the catalyst for the next bull market phase.
How regulators are shaping the market
Although the US regulatory newsflow has been mostly negative throughout 2023 so far, the recent institutional moves and a ruling in favour of XRP in their case vs. SEC suggest that US regulatory efforts may have been less about attempts to stamp out crypto (which some referred to as “operation chokepoint”) and possibly more about reshaping the crypto market.
Binance’s overwhelming market share has been a concern for regulators – as well as for the crypto market. Regulatory actions against Binance have resulted in a decline in their market share. As major institutions are launching crypto offerings, the US crypto landscape is changing rather than disappearing.
Stablecoins, however, do appear to be under constant attack – from regulatory action to vanishing bank accounts, to fiat onramps (Signet and SEN networks) shut down, to rumours and large one-sided trading flows dislocating prices. As stablecoins are in direct competition with the fiat rails, there may be an “operation stablecoin chokepoint”.
At the same time, regulators in other jurisdictions have been more proactive in clarifying the rules for crypto businesses. As regulation in Asian jurisdictions (in Hong Kong in particular) has been especially crypto friendly while numerous crypto businesses were announcing that they were reducing their US presence, this has led to speculations about an “East/West Crypto Flippening” and Hong Kong’s potential role in shaping Greater China’s crypto markets.
Bitcoin vs. the rest of the market
Bitcoin’s dominance surged from 40 to 50 percent year-to-date, with the token outperforming the rest of the market significantly. This is consistent with the early stages of previous crypto bull markets, with bitcoin leading the recovery and the rest of the market following in the next phase. This has been exacerbated by macro instability inspired safe haven flows into bitcoin that have accelerated since the start of the banking crisis, the potential for a Bitcoin spot ETF, and a revival of developer activity and growth in transaction volumes on the Bitcoin network.
The focus on Bitcoin left Ethereum underperforming, despite its own strong fundamental drivers, including its sustained deflationary supply dynamics, the strong demand for staking ether which led to a long staking queue forming, and Ethereum’s currently implemented scalability upgrades.
The underperformance of the rest of the market was partly due to the SEC naming a large number of tokens securities in various court filings. The recent XRP ruling has calmed concerns in this regard – although certainty on this issue is still some way off.
Correlation and volatility
The correlation between crypto and traditional asset classes was historically always low, however, the period between the 2021 bull market’s peak and the FTX collapse saw an unusual surge in correlation, particularly with the NASDAQ and the S&P500. This shift was initially interpreted as “institutional investors entering the market” but in reality, it is likely that it was mostly driven by the trading activities of macro hedge funds, alongside certain crypto hedge funds and traders such as FTX’s sister company Alameda. Since the failure of FTX, this temporary correlation has dissipated and decreased to historically low levels.
Crypto’s high volatility has been in a structural decline as the market matures. The volatility year-to-date has been running at only half of historic levels. However, the recent decline in liquidity, partly driven by some US based market makers cutting or reducing their crypto activities has primed the market for a potential spike in volatility on strong catalysts.
- Layer 1 blockchains have strongly outperformed other sectors so far this year, in a large part driven by Bitcoin’s outperformance.
- After very strong Q1 performance, Layer 2 scalability protocols have underperformed recently despite tremendous user growth and a lot of important innovation.
- DeFi protocols are geared to benefit from a new bull market, while the subsectors of tokenised real world assets and liquid staking are experiencing fast growth.
- Interoperability solutions are in focus again, while several Web3 projects are posting all time high user numbers.
- Gaming continues to struggle with sluggish user numbers as investment and innovation target improving the gaming experience and finetuning the economic models.
- Metaverse projects continue to see low adoption as the user experience remains limited; major corporations and VC investment, however, continue targeting the sector.
- CeFi (centralised finance entities serving the crypto market) remains under pressure from regulators.
The global macro landscape remains precarious and fragile, underscoring the investment case for crypto assets as alternative money, safe haven asset, and as alternative business models.
Although global financial markets may benefit as the rate hike cycle nears an end, the broader picture of macro instability remains with unpayable levels of debt, declining competitiveness for many Western industries with the loss of access to cheap energy, fiscal and monetary policies that lead to a misallocation of capital and undermine productivity, and ever increasing concentration and centralisation. Geopolitical tensions and the ongoing realignment of the global economic and political structures remain further points of instability. In the face of this uncertainty, the fundamental case for crypto assets remains intact.
Meanwhile the entry of major financial institutions into crypto signals that funds flows are likely to turn positive and suggests that we may be in the early stages of the next structural bull cycle.
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