Cryptocurrency valuation fell in early August due to concerns about the US economic outlook and broader financial market volatility. Ethereum performed poorly, possibly due to increasing positions in the futures market and the selling off of a few large holders. If the US economy continues to trend towards a "soft landing," Grayscale Research expects token valuation to rebound. However, even in a weaker economic environment, Grayscale Research has reason to believe that downside risks to prices may be more limited than in the past.
After a steep drop from August 2nd to 5th, both the crypto assets and the broader financial markets have become stable. Although the direct cause of the decline was the US employment report released on Friday, August 2nd. Especially, the report showed that the increase in unemployment rate was the same as during previous economic recessions. Despite the relatively good performance of Bitcoin after the risk adjustment, Ethereum's performance is not as good as other cryptos and many traditional markets. Despite Ethereums' higher volatility compared to Bitcoin, its performance was more significant than usual during the recent downward trend. Since 2020, during the steep drop in Bitcoin prices, Ethereum has typically fallen by about 1.2 times the Bitcoin price. The latest crypto bear market cycle has shown similar relative performance. In contrast, as of August 2024, the price of Ethereum has fallen by about 1.8 times that of Bitcoin, indicating additional, unique downward pressure on Ethereum. $Bitcoin (BTC.CC)$ $Ethereum (ETH.CC)$ Digital currency has its own cycle distinct from the macro economy and traditional financial markets. Considering that cryptocurrency markets trade 24/7, Bitcoin's cycle is shorter than that of the stock market. Although the history of digital currency is short - Bitcoin just celebrated its 15th birthday this year - it has already gone through three major cycles: 2011-2013, 2015-2017, and 2019-2021.
The direct reason for the decline in cryptocurrency prices, although the weather is good today, was the US employment report released on Friday, August 2nd. The report showed a higher than expected increase in the unemployment rate.
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Reasons for the drop
One of the reasons for the relatively large decline in Ethereum price seems to be the excessive long positions in perpetual futures. In May 2024, when the U.S. Securities and Exchange Commission (SEC) approved the issuer's 19b-4 application for ETP products traded on U.S. spot Ethereum exchanges, traders significantly increased their total positions in perpetual futures. Some long positions were liquidated during the recent decline, accelerating the price drop.
Another factor that may have contributed to Ethereum's underperformance is the actual and expected selling off of a few large holders, including market makers Jump Crypto, venture capitalists Paradigm and the Golem Network (a crypto protocol with a large Ethereum treasury).
Digital currency cycle rotation
Due to the 24/7 trading hours of the cryptocurrency market, Bitcoin's cycle is shorter than that of the stock market. Although the history of digital currency is short, Bitcoin just celebrated its 15th birthday this year, it has already gone through three major cycles: 2011-2013, 2015-2017, and 2019-2021.
The 2011-2013 cycle focused mainly on BTC, as altcoins (digital currencies other than BTC) represented by ETH were not launched until 2015. In the 2015-2017 and 2019-2021 cycles, Bitcoin led the market up at the start of the cycle, building confidence and laying the foundation for a broader rebound. With increased investor optimism, capital flowed into other digital currencies, driving a broad-based market rebound. The market value peaks of non-BTC digital currencies usually coincide with the bottoms of BTC's market value share, indicating capital rotation from BTC to these altcoins. Currently, BTC's dominance is still rising from the late 2022 FTX event low, indicating greater upside potential for BTC before ETH and other altcoins catch up.
Altcoins perform better in the latter half of the cycle.
In both major cycles, after the initial stage (when returns are roughly equivalent), Altcoins' performance was significantly better than Bitcoin's. This trend reflects investor increased risk preferences and the adaptability of the Altcoins market to increased venture capital. In the latter half of the 2015-2017 cycle, Altcoins had a return multiple of 344x, compared to BTC's 26x. Similarly, in the latter half of the 2019-2021 cycle, Altcoins had a return multiple of 21x, compared to BTC's 5x. After the FTX event, we are currently in the middle of the current cycle, and Altcoins are slightly lagging behind BTC. This trend suggests that ETH as well as other Altcoins may outperform in the next few years.
Although history won't repeat itself completely, we can summarize some characteristics of past cycles - Bitcoin dominance at the start of the cycle, followed by ETH and other Altcoins' excellent performance, and the impact of macro economies - BTC may break through the current range after halving in April, and ETH-led Altcoins may catch up in the mid-stage of the cycle.
The positive side is that Bitcoin and Ethereum have achieved mainstream adoption through ETFs, and the influx of funds from retail and institutional investors has reached historic highs. More numerous and diverse Altcoins may compete for investor capital injection into mainstream digital currencies such as BTC and ETH.
Where will cryptocurrencies go?
In the past week, the broader financial market has stabilized. $CBOE Volatility S&P 500 Index (.VIX.US)$ After a surge last Monday, it returned to around 20 this week. The stability of the future market depends on the Federal Reserve's policy decisions, the election, and subsequent macroeconomic indicators.
If the US economy avoids a recession and continues on a 'soft landing' path, Grayscale Research predicts that token valuations will rebound and Bitcoin will retest its historical high later this year. However, even in a weaker economic environment, Grayscale Research has reason to believe that the downside risk of the price may be more limited than in the past, including the relatively stable net demand from the new American listed ETP, the insufficient credit provided by centralized financial institutions during this cycle, and the relatively low returns of altcoins since the beginning of this year. Changes in the political landscape surrounding the cryptocurrency industry in the United States may also reduce the downside risk of valuations compared to past cycles.
Economic cycles are an inevitable feature of investing in almost all asset classes, and the uncertainty of macro prospects should be regarded as a short-term risk for cryptocurrency investors. At the same time, Grayscale Research believes that people can hardly tolerate serious economic recessions, and expects policy makers to start printing and consuming when problems arise. The irregularities in monetary and fiscal policies are one of the reasons why some investors choose to invest in Bitcoin; therefore, a period of economic weakness may strengthen the long-term investment argument for Bitcoin.
Edited by/Andreswang