Grayscale: Crypto fundamentals are improving, BTC or will it continue to rise?

Original article by Grayscale Research

Original compilation: Felix, PANews

Essentials

• BTC prices continued to rise in November, with the cryptocurrency’s recovery expanding to a wider market segment.
• Some macro risks to financial markets have declined, including geopolitical conflicts in the Middle East and the risk of a “hard landing” for the U.S. economy.
• The combination of “tight” token supply, mitigated macro risks, and the U.S. presidential election will focus on excessive government borrowing could benefit valuations in the 2024 BTC.

BTC rebounded 130% in 2023 after a “losing ground” in 2022 and is poised to be one of the best-performing mainstream assets this year. The crypto market continued to recover in November as various macro risks in the financial markets declined. In the digital asset market, this has led to a shift in market leadership from BTC to an increasingly broad crypto segment. Grayscale believes that the fundamentals of cryptocurrencies are gradually improving, and the supply of major tokens is relatively tight (e.g. due to BTC current ownership structure). This could be in line with the rise in crypto valuations in the coming year, especially if the Fed has ended its tightening and the US economy can avoid a “hard landing” (recession).

Over the past month, various tail risks in financial markets appear to have declined, helping assets that had previously underperformed to rebound. For example, positive signs of conflict in the Middle East appear to have reduced fears of broader regional chaos, and assets tied to the Israeli economy have rebounded as a result (Figure 1). Similarly, the price of long-term government bonds rose (yields fell) after the Ministry of Finance announced that the growth in borrowing demand was less than expected. The Consumer Price Index (CPI) also continued to fall, which increased market hopes for a Fed rate cut and a possible “soft landing” for the US economy. On a volatility-adjusted basis, BTC underperformed this month (outperforming since the end of August) but still up 9% (ETH was up 13% in November).

Chart 1: Tail Risk Reduction Drives November Asset Market Recovery

A broader recovery in the crypto market

BTC has been outperforming other crypto assets lately due to the demand for BTC as a digital alternative to gold and optimism about the approval of BTC spot ETFs. However, the leadership of the crypto market changed in November as the rally extended beyond the BTC.

According to the New Framework Index for Crypto Asset Class Criteria (Note: Grayscale’s crypto index product in partnership with FTSE Russell, a subsidiary of the London Stock Exchange and London index provider FTSE Russell, which has five different crypto sector indices: currencies, smart contract platforms, financials, consumer and culture, utilities and services, and more than 150 protocols), the best-performing segments last month were financial indices, utilities and services, and consumers and culture (Table 2). Among the financial sectors stood out was the 131% increase in the Thorchain (RUNE) token; Thorchain runs the decentralized exchange ThorSwap, which has seen an increase in trading activity recently. In the consumer and culture sectors, the growth of gaming-related tokens ImmutableX and Illuvium stood out. On November 28, Illuvium (up 119%) listed its eponymous game on the Epic Games Store, while ImmutableX, a Layer 2 blockchain for crypto gaming apps on ETH Square (up 87%), announced a partnership with Ubisoft.

Chart 2: Financials, Consumer & Culture Crypto Sectors Outperformed

In addition to the latest price movement, the market is once again focusing on the combination between cryptocurrency and AI technology after the turmoil in OpenAI’s leadership. In Grayscale’s view, there may be synergies between public chains and AI technology. Specifically, blockchain can combat or address potential societal risks posed by AI, such as deepfakes, bots, and the proliferation of misinformation. In addition, decentralized computing protocols can counter the centralized control of AI models that hold sensitive personal information. Grayscale believes that the main crypto projects related to the topic of AI include Akash and Render (GPU sharing), Worldcoin (identity), and Bittensor (open architecture AI development).

As valuations have moved higher, the fundamentals of the crypto industry have also improved. For example, BTC’s hash rate, a measure of the total amount of computing power used to secure the network, reached an all-time high in November (Table 3). This trend can be attributed to the upgrading of miners ahead of next year’s BTC halving, higher token prices (which make older machines profitable), and an oversupply of relatively new machines operated by miner equipment manufacturers. In addition, the increase in stablecoin activity is also responsible for the improvement in crypto fundamentals. Over the past month, the total market capitalization of stablecoins has increased by $4 billion, and the amount of gas used in stablecoin transactions has also increased.

Exhibit 3: BTC hash rate hits all-time high

The fundamental factors that drive BTC prices

After a period of sharp rises, position active crypto traders as relatively “long”. For example, open interest in BTC futures listed on the Chicago Mercantile Exchange (CME) hit an all-time high in November, which may indicate that institutional activity is increasing in the market (Figure 4). Meanwhile, exchange-traded products (ETPs), including futures products in the U.S. and spot products overseas, saw net inflows in November. Grayscale estimates that global crypto ETP net inflows totaled $1.3 billion in November and $2.2 billion for the year.

Chart 4: CME BTC futures open interest hits all-time high

In terms of the short-term outlook for the market, the position of a “long” trader means that it may be difficult for the price to rise further. The prices of major crypto tokens have risen sharply, and the benefits have been consumed in advance. In addition, there are some risks to the economic outlook that could undermine the positive trend this year. These include a “hard landing” (recession) for the U.S. economy, a resumption of interest rate hikes or lower-than-expected rate cuts by the Federal Reserve, and/or a prolonged delay in approving BTC spot ETFs for the U.S. market. All of these risks could hinder crypto recovery, at least in the short term.

That being said, in Grayscale’s view, financial markets and macroeconomic conditions may be favorable for BTC and other crypto assets. The supply of BTC was relatively “tight” before potential investors poured into US spot ETF products. For example, the share of BTC supply held by short-term speculators reached record lows, according to Glassnode data (Table 5). Similarly, Grayscale’s analysis also shows that a large portion of the BTC is held by long-term holders (related reading: Grayscale Revealed BTC Holder Pattern: Owning more than 1 BTC accounts for only 2.3%). The BTC halving next year will also limit the growth of the new token supply. In Grayscale’s view, the combination of inelastic BTC supply and potential new investor inflows should have a positive impact on valuations.

Chart 5: Long-term holders hold a large share of BTC supply

However, more important than the technical background is the fundamental outlook for BTC. BTC is a macro asset that is seen by many as a digital alternative to physical gold. As a result, the price of BTC is likely to be influenced by the factors driving demand for digital gold, including the Federal Reserve’s monetary policy, the health of the U.S. economy, and the soundness of the fiat monetary system. The market’s reaction to Javier Milei’s (BTC-friendly) election as Argentina’s president is the latest example of the impact these factors can have (related reading: A quick look at Argentina’s new president’s past and key takeaways: breaking parental ties, supporting BTC). While there is uncertainty about the macro outlook, economists unanimously expect the Fed to cut interest rates next year and the U.S. economy to avoid a recession. There will also be a U.S. presidential election next year, which is expected to focus on excessive government borrowing, the independence of the Federal Reserve, and other issues that affect the long-term value of the dollar. Grayscale expects this combination to have a positive impact on demand for physical and digital gold and is likely to coincide with rising BTC valuations.