Catalysts for Digital Asset Growth

Bitcoin recently exited its longest bear market ever on June 12, shortly after the S&P 500. We evaluate this idea through analysis of YoY returns, which were negative for 490 days. The previously longest bear market of 2014-2015 was 353 days. The longest bear market in history followed shortly after. In hindsight, we find that the longest bear market in history was caused by the increasingly intertwining correlations between digital assets and the global equity market. However, there is opportunity in ruin.

We speculate that 2024 will serve as an immense catalyst and birth of the longest bull market in digital asset history. The growth of the market will be supported by the conjunction of potentially bullish events in Q2 2024: the slow and cautious easing of the Federal Funds Rate, decisions of notable spot ETF applications, and the Bitcoin Halving Event.

Catalyst 1: Easing of the Federal Funds Rate

We have witnessed the first sample size of a hawkish Federal Reserve, where Bitcoin is treated as a risk asset, and its effects on the digital assets in 2022 and 2023. Between Bitcoin’s inception and 2020, rates had little effect on Bitcoin. This first sample is showing us that increasing institutional involvement since 2020 is leading digital assets to be classified in the high-risk category (which is not a big surprise), wherein equities also lie.

“We can expect Bitcoin to behave as a risk asset from the perspective of volatility for years to come.”

- March 2022

It’s reasonable to assume that the growing correlation between the two markets was a key driver of a bear market that, from a discretionary standpoint, the vast majority of digital asset managers got wrong in terms of timing and predicted peak value. We believe that this correlation will continue to grow over the long term as institutional capital continues to penetrate the market.

The breakdown of 2022 was a mass risk-off event by institutions. Asset allocations of institutional investors were clearly defensive with a risk-off posture. The reasoning derived from the speculation of increased and sustained inflation, which would consequently cause the Federal Reserve to increase the Federal Funds Rate.

The monetary breakdown was a step function of increased risk in the global financial markets. Institutions treat digital assets and equities in the same aggregate risk profile, leading to reductions in allocated capital to these markets and additions to macro-friendly assets with low risk, such as money market funds and bond yields.

Federal Funds Rate (red) vs. Bitcoin (blue) during 2016-2020, Source: Aboura, Sofiane. (2022). A note on the Bitcoin and Fed Funds Rate. Empirical Economics.

We expect a similar, but inverse, effect when it is time for the Federal Reserve to return to a low interest rate environment, enabling greater estimated length in time for the growth cycle. It won’t take getting all the way to a low interest rate environment. These markets usually move before the information is disseminated in a reflexive fashion. In this scenario, we will see the market have strong resemblance with the behavior in the 2016-2017 bull market - something most digital assets have never seen before. All of this is possible due to the increased institutional involvement relative to retail value. Institutions now account for 85% of trading volume on notable centralized exchanges, whereas retail is a mere 15%.

Share of On-Chain Trading Volumes (left). Source: Chainalysis / Trading Volumes ($bn) on Coinbase (right). Source: Coinbase Quarterly Report

Many digital asset shamans who were making predictions for further gains in late 2021 or early 2022 used the argument that, historically, the Federal Funds rate has had little correlation to the price of Bitcoin and Altcoins. For much of history before these statements, that was the case, but the final conclusion was wrong. Yes, the Federal Funds Rate had little correlation to the digital asset market before 2020, but the initiation of exponential quantitative easing and timely entrance of institutions to the market completely changed the game. The market was not correlated because it was limited to the behaviors of retail traders and few small institutions. Now, that category of market participants have nearly no impact the direction of the broader market.

As the Federal Funds Rate stalls and eventually declines, the upwards step function for renewed risk allocation will benefit equities and digital assets, but it will favor the low market capitalization assets. Bitcoin lies on the high risk end of the risk spectrum, but a low market capitalization digital asset presents even greater risk. In an environment where the assets with the highest market risk have been completely depleted from capital involvement, these assets have suffered the most. As a result, they have the most to gain after the largest trough of risk assets has been endured. Opportunity in ruin.

BTCUSD, Federal Funds Rate, and NASDAQ Composite Correlation

Goldman Sachs predicts the start of rate cuts will begin in Q2 2024. JP Morgan predicts it will begin in Q3 2024. BlackRock notes that “in the five previous hiking cycles since 1990, the Fed paused an average of 10 months between its last hike and its first cut.”

Interest Rate Forecasts, Source: Morningstar

Rate cuts are on the horizon, which we believe will drive the U.S. monetary step function of ease for risk assets. Once we return to low interest rate environments, it’s possible we continue to see growth until completion of the parabolic, hype-driven peaks that are so characteristic to the digital asset market.

Catalyst 2: Decisions on spot ETF applications

The month of September is historically the worst performing month for digital assets, yet it ended in the green this year. High-caps showed strength despite dwindling on-chain volumes. Many market participants appeared to support the underlying weakness on hopes of a spot Bitcoin ETF approval. This likely explains BTC outperformance of ETH and other digital assets in September.

The spot Bitcoin ETF could unleash a large amount of capital potential into the BTC market. Dozens of asset managers, some of which have assets under management of 20x BTC’s current market capitalization, are aiming to offer their investors access to the digital asset market. The potential injection of liquidity has investors on edge and the demand is clear enough.

The ETF is highly anticipated by both the crypto and traditional finance communities. Growth is expected with this anticipation, as players bet on the odds of approval and subsequent further growth. ETF approval can spur strong emotions and impulses in the moment, but it is more likely that future marketing campaigns by competing institutions facilitates long-term growth rather than the approval announcement itself. That’s not to say that the event isn’t massively bullish, but rather that it’s a long-term game, not a short-term one.

Approval of the ETF is likely to stimulate volatility amid speculation. However, the market cycle must commence. It’s possible that we see an impulse in BTC.D, which represents BTC’s market capitalization share of the broader market.

Bitcoin Dominance (BTC.D) Analysis

Further growth is foreseen after approval relative to the broader market, but that will end in due time. The spot Bitcoin ETF is merely a precedent for what is to come. The rest of the market is likely to catch up.

Catalyst 3: The Bitcoin Halving supply shock

The Bitcoin Halving is a supply shock that is programmed into the asset. Everyone who has kept up in this industry knows this. For those who are less familiar, the Bitcoin market cycle is tied to the halving of block rewards and occurs roughly every four years. Block rewards are how miners introduce supply to circulation. After each four years, the difficulty doubles.

The next Bitcoin Halving is expected to be in May 2024. Once the last block is mined, the issuance halving immediately goes into effect. This supply shock causes an inevitable appreciation in the price of Bitcoin, so long as demand either remains the same or increases.

Bitcoin Halvings Modeled with Fibonacci Time Cycles

Given that the supply rate is programmed to decrease in May 2024, our variable input is demand. This presents three scenarios:

1. Supply issuance rate decreases, demand decreases (price decreases)

2. Supply issuance rate decreases, demand remains unchanged (price increases)

3. Supply issuance rate decreases, demand increases (price parabolically increases)

As price rises, you get more demand with a supply that is rigidly fixed. This becomes a positive feedback loop that turns into speculative mania. Each halving shows a clear reaction to the supply shock, subsequent growth, a hype-driven blow off top, return to the mean, accumulation, then repeat.

Altcoins are Poised for Greater Opportunity

The interesting thing about Bitcoin’s Halving is that the broader digital asset market grows far more than BTC itself. Bitcoin is not the only asset in the digital asset universe. It isn’t even close to being the best asset for profit potential. Every halving, the potential of price appreciation is lesser than the halving before. The rate at which Bitcoin grows is less, with respect to supply. This is why each Bitcoin bull run has grown less than the one preceding it.

Historically, Altcoins are also tied heavily to the Bitcoin Halving. The reasoning behind this can vary. There are arguments that claim that, because Bitcoin serves as the denominator for many Altcoins, interconnection causes investors to diversify into Altcoins when Bitcoin outperforms. Contradictions exist arguing that most Altcoins operate under their own supply schedules and have different definitions of demand. It is a complex web of reasoning and the point is, rather, that the phenomena exists.

Prior Bitcoin Halvings put an end to the Altcoin accumulation phases. The event spurs growth across the asset class and resembles a reflexive, herd-driven mania. After the period of mania, there was a notable decline of over 90% in the value of many of these assets.

Total Market Capitalization Excluding Bitcoin

The same phenomena of Altcoin parabolic growth is foreshadowing itself in this cycle. A feature in previous cycles is the dampened performance of Altcoins with respect to Bitcoin. Bitcoin dominance rises in bear markets. Altcoins bleed more by an order of magnitude and are incapable of relief until the Halving Event.

Year-to-date, the total market capitalization of all digital assets (TOTAL) has risen 32.94%. If you exclude BTC and ETH from the equation (TOTAL3), growth was limited to 8.60%. The lagging effect is no stranger because we find it in every bear market.

Total Market Capitalization (TOTAL) vs. Total Market Capitalization Excluding BTC and ETH (TOTAL3) Lag Effect

The lag effect and underperformance of Altcoins with respect to Bitcoin, in addition to the historical Altcoin outperformance during bull markets following the Halving Event, lead us to speculate that there is strong risk/reward opportunity found in digital assets that are not Bitcoin for the coming years.

Our Thesis

Digital assets are coming to an end of their contractionary period. The ideas that support this claim have been rationalized through analysis and show the following conclusion:

1. Equities and digital assets are becoming increasingly correlated in their behavior pertaining to the U.S. monetary policy and its effects on global markets.

2. The Federal Reserve is predicted to begin cutting rates in Q2 2024, which would begin a step function leniency spring to risk assets such as equities and digital assets.

3. The SEC is speculated to approve the spot ETFs of large institutions such as BlackRock, Fidelity, and Invesco by Q2 2024.

4. Spot ETFs are predicted to boost liquidity and credibility of digital assets by allowing institutions further access to exposure.

5. Boosted liquidity from institutions further reinforces digital assets as a risk asset in the financial cycle.

6. Bitcoin is scheduled to have a supply shock in Q2 2024 by halving the rate at which miners can issue new supply.

7. The halving has historically spurred exponential growth in Bitcoin and the broader altcoin market for an average of roughly 500 days following the Halving Event.

8. Altcoins have historically outperformed Bitcoin during this time period due to mere infancy, capital potential, market patterns.

9. Bitcoin has been able to relieve its 2022 losses in 2023, whereas Altcoins have lagged behind.

10. The Altcoin market poses high reward with relatively medium-low risk, but only with professional management that is capable of evaluating narrative, network effects, and intellectual property.

If the Bitcoin Halving is the runway, approved spot ETFs and Federal Funds Rate cuts are the thrust of the plane. If Q2 is when the Fed starts cutting rates, institutional spot ETFs are approved, and Bitcoin Halving occurs, it could be a massively bullish conjunction for the broader digital asset market. Could it be possible that, after the longest bear market in crypto history, we witness the longest bull market?

It would be in interest to look outside of the largest market capitalization, since the Altcoin lag effect has signaled a mean-reverting dislocation with Bitcoin and this has typically lead to outperformance following Halving Events. Infancy, capital potential, and historical patterns favor the new.

The scheduled supply shock will give us a runway for demand to take the wheel. Demand will be reinforced through an incremental decrease in the Federal Funds Rate and renewed accessibility through approved spot ETFs. We speculate that Bitcoin will rise and Altcoins will follow suit in a powerful way.