CoinWorld reported:
Source: Grayscale; Translation: Bai Shui
Summary
Concerns about the U.S. economic outlook and broader financial market volatility led to a decline in cryptocurrency valuations in early August. Ethereum’s underperformance may be attributed to increased futures market positions and the sell-off by a few large holders.
If the U.S. economy continues on a “soft landing” path, Grayscale Research anticipates a rebound in token valuations. However, even in a weaker economic environment, Grayscale Research believes that the downside risk to prices may be more limited than in the past.
Cryptocurrency assets and broader financial markets stabilized in the middle of the week after experiencing a significant drop from August 2 (Friday) to August 5 (Monday) (Figure 1). Although the prices of major tokens typically have low correlation with other asset classes, volatility in traditional markets may impact cryptocurrency valuations.
Figure 1: Bitcoin and Ethereum Decline in Early August
The direct cause of the decline was the weaker-than-expected U.S. employment report for July, released on August 2 (Friday). Specifically, the report showed an increase in the unemployment rate comparable to previous economic downturns. Concerns about a cyclical recession led to weak performance in cyclical assets like stocks, while traditional safe-haven assets such as U.S. Treasuries, the Japanese yen, and the Swiss franc showed strong performance (Figure 2). Non-U.S. stocks and strategies that short U.S. stocks performed particularly poorly. Both Bitcoin and Ethereum declined; while Bitcoin performed relatively better on a risk-adjusted basis, Ethereum lagged behind other cryptocurrency assets and many segments of traditional markets, which we will explore further below. Among major cryptocurrencies, Solana significantly outperformed other assets.
Figure 2: Ethereum’s Poor Performance
Despite Ethereum’s volatility being higher than that of Bitcoin, its performance during the recent downturn was more pronounced than usual. For example, Chart 3 compares the maximum percentage declines in Bitcoin prices since 2020 with those of Ethereum over the same period. In these events, Ethereum’s price typically fell about 1.2 times that of Bitcoin. The latest “crypto winter” (i.e., bear market) exhibited similar relative performance. As of August 2024, Ethereum’s price has dropped approximately 1.8 times that of Bitcoin, indicating additional unique downward pressure on Ethereum.
Figure 3: On Average, Ethereum’s Decline is Typically 1.2 Times That of Bitcoin
One reason for Ethereum’s relatively large price drop appears to be excessive long positions in perpetual futures. In May 2024, as the U.S. Securities and Exchange Commission (SEC) approved issuers’ 19b-4 applications for U.S. spot Ethereum exchange-traded products (ETPs), traders significantly increased total positions in perpetual futures (Chart 4), possibly anticipating further price increases upon receiving full regulatory approval; this approval was granted in July 2024, and U.S. spot Ethereum ETPs began trading shortly thereafter. Subsequently, some long positions were liquidated during the recent downturn, accelerating the price decline. On August 4, Ethereum’s price fell 7.6% in just three minutes, with a total liquidation amount of $340 million in perpetual futures that day. As the sell-off occurred during U.S. overnight trading hours, and due to a significant discount in Binance’s spot price compared to Coinbase, the liquidation appeared to be primarily driven by leveraged traders in Asia.
Chart 4: Increase in Ethereum Futures Leverage in May 2024
Another potential factor contributing to Ethereum’s underperformance is the actual and anticipated sell-off by a few large holders, including market makers Jump Crypto, venture capitalist Paradigm, and Golem Network (a cryptocurrency protocol holding substantial Ethereum treasury assets). Although the exact amount of sell-off is difficult to determine, Grayscale Research estimates, based on data from analytics platform Arkham Intelligence, that these entities collectively held approximately $1.5 billion worth of Ethereum before they began transferring tokens (based on Ethereum’s price at that time).
The decline in the number of active validators and the increase in Ethereum staking reward rates also suggest that the relatively sticky token supply has undergone changes, which may affect market sentiment.
Over the past week, broader financial markets have stabilized. Perhaps most notably, the VIX index, which measures implied volatility in the U.S. stock market, reached an intraday high of over 60% on Monday before closing at 26% on Thursday (Chart 5). Whether the market can maintain this stability will depend on upcoming macroeconomic and corporate earnings data, as well as any policy responses from the Federal Reserve or other central banks. Key reports to be released include weekly unemployment claims (released every Thursday), the Consumer Price Index report (scheduled for August 14), and the next employment report (scheduled for September 6). The Federal Reserve is likely to cut interest rates at its meeting on September 18, but the market is more focused on the policy path that follows. Policymakers may provide further guidance at the Jackson Hole symposium, taking place from August 22 to 24.
Figure 5: Decline in Market Volatility Over the Past Week
If the U.S. economy avoids recession and continues on a “soft landing” path, Grayscale Research expects token valuations to rebound, with Bitcoin potentially retesting its historical highs later this year. However, even in a weaker economic environment, Grayscale Research has reason to believe that the downside risk to prices may be more limited than in previous downturns.
Factors contributing to this include relatively stable net demand from newly listed U.S. ETPs, insufficient credit provided by centralized financial institutions during this cycle, and the relatively lackluster returns of altcoins since the beginning of the year. Changes in the political landscape surrounding the U.S. cryptocurrency industry compared to past cycles may also reduce the downside risk to valuations.
Economic cycles are an inevitable characteristic of investing in nearly all asset classes, and the uncertainty of the macro outlook should be viewed as a short-term risk for cryptocurrency investors. Meanwhile, Grayscale Research believes that the tolerance for a severe economic recession is nearly nonexistent, and policymakers are expected to begin printing money and spending as soon as issues arise. Irregularities in monetary and fiscal policy are among the reasons some investors choose to invest in Bitcoin; thus, a period of economic weakness may reinforce the long-term investment thesis for Bitcoin.
References
[1] Economists often refer to this statistical pattern as the “Sam’s Rule.”
[2] For instance, during the last cycle from Bitcoin’s peak to trough, both Bitcoin and Ethereum experienced similar declines. During the bear market from March 2022 to October 2023, Ethereum’s decline was 1.3 times that of Bitcoin. Source: Artemis, Grayscale Research.
[3] Source: Trading View, Coinglass.
[4] Source: Coinglass.
[5] On-chain liquidations may also be one of the reasons for Ethereum’s significant price drop. For example, the lending platform Aave reported $239 million in liquidations on August 5. Source: Dune Analytics. Data as of August 8, 2024. For illustrative purposes only.
[6] Source: The Defiant, CoinDesk, Arkham Intelligence data.
[7] Specific dates are June 21, 2024, for Paradigm; July 8, 2024, for Golem; and July 24, 2024, for Jump.
[8] Source: validatorqueue.com.
[9] In recent years, several centralized lending companies have gone bankrupt. Source: Blockworks.
