On July 1, the price of Bitcoin was $63K. Today, as we write this in early October, the price of Bitcoin is still $63K. Sometimes the right move is no move at all, and that was certainly the case this summer. You could have logged off for 3 months and saved yourself a lot of time and money versus the traders who tried to play range breaks that never came.
In our last report, we suggested that forced selling from governments and Mt. Gox could hold down price in the short-term against an increasingly bullish macro setup. We also warned that bull markets routinely feature 20% drawdowns. We saw both play out in Q3, with the most notable moves being the unwind of the Japanese Yen carry trade (the big red candles in early August) and the expectation of Fed rate cuts (the grind up in late September). Speculation over the outcome of the presidential election was also a factor, though that correlation has since waned.
We were wary of overtrading summer chop and mostly content to observe in Q3. As expected, global liquidity has begun to increase (spurred by stimulus out of China) and the Fed rate cutting cycle has begun. We have positioned accordingly – 100% net long – and while our patience is being tested, recent price action has done little to change the shape of what we believe is to come. Who would bet against BTC when M2 (global liquidity) is rising?
Ethereum ETF disappoints as BTC dominance increases
While BTC held its own in Q3, Ethereum retraced the entirety of its gain following the ETF announcement. Alts have followed suit, with some top names down as much as 40% in Q3. Notable is the divergence among sectors, with some high-quality fundamental sectors we like (e.g. staking services, on-chain lending) badly underperforming while others (namely DePIN darling Helium) outperformed thanks to emerging PMF and narrative strength. We don’t want to make too much of short-term performance, but generally view dispersion as a positive trend because it shows that asset selection matters. In the long run, quality assets should benefit.
The real story here is the underperformance of Ethereum. Coming into the quarter, we were cautiously optimistic that ETFs would be constructive for ETH. The Bitcoin ETFs were an unprecedented success, and many believed ETH would see proportional if not outsized flows. Others were skeptical it would have the same appeal to institutional investors. Our view was somewhere in the middle, as expressed by similarly sized positions in BTC and ETH. A few months of data have vindicated the bears; flows have failed to meet even the lowest of expectations.
The explanation for this underperformance is up for debate, but likely some combination of:
Question marks about durability of revenues and broader market position; Fees were down in Q3 as activity moved to L2s, and Solana continued to gain share
ETH ETF coming quickly after the BTC ETF, at a time when managers were not prepared to allocate to another crypto asset
Sluggish market conditions, especially for growth tech
Of course flows could come later (and the last week of September has shown proof of life), but the thesis that ETFs alone would generate demand has been invalidated. So where does this leave us on ETH the asset? We continue to hold some ETH and view Ethereum’s existing network effects as a moat – it remains the largest smart contract platform by market cap, developer activity, and stablecoin volumes. It is also the most credible destination for serious institutional use cases (e.g. tokenized treasuries), as evidenced by Blackrock and others. But it’s becoming less clear that Ethereum network success will translate into ETH price appreciation.
Ethereum has successfully scaled to a network of L2s (90+% of activity), effectively decreasing transaction costs, but also raising a larger question about long-term value accrual and roadmap (Kyle Samani of Multicoin made this case at Token2049 recently and it’s worth watching). Despite these improvements, the user experience still lags Solana, which continues to gain in key usage metrics. The market reflects this reality, with ETH/BTC ratio sitting below .04, a multi-year low (down from .055 to start Q3). In crypto, you are usually rewarded for buying lows on sentiment, but it’s getting harder to hold ETH with so many questions about its future.
We would not necessarily endorse a rotation from ETH to BTC at this level (especially with cap gain considerations), but we have reduced our ETH holdings relative to BTC and SOL, and will continue to do so in order to access specific altcoin opportunities.
Framework: The token funnel
In Q2 we wrote about the underperformance of tokens with heavy unlock schedules. The below graphic (from anon McKenna) is a terrific mental model for the lifecycle of a crypto token, which also explains the opportunity for liquid funds.
He argues that the unlock cycle every project goes through (usually from years 1 to 4) is a test that few tokens pass. It is during this time that small circulating supplies approach larger fully diluted valuations as token emissions mount and investor and employee allocations vest. In far too many cases, holders dump tokens into a public market with few buyers interested in projects with little traction and lofty valuations. This is often still a winning trade for early investors and team, who have extremely low cost basis, and a loss for the retail investors on the other side.
In some cases, however, projects going through this adolescent phase are showing real PMF and revenue. Despite this fundamental difference, price action often looks the same as supply overwhelms demand – remember, there is vastly more capital allocated to VC than liquid. This offers a unique opportunity for liquid funds to select the assets that have fundamental value at a time when the price is structurally depressed. Of course early investors will hold onto their best performers, but there is still value to be had if you can separate the wheat from the chaff. You won’t find a 100x at the liquid stage nearly as often as you will at the VC stage, but it is much easier to identify the projects that can still 5x or 10x.
The one important footnote is that new money can squeeze up low float tokens, especially during bull markets. These coins will often look like the fastest horses for some period of time — and offer outsized returns to those that time it right (most do not). But when the dynamic inevitably shifts, these are the tokens that drop the most as money rotates and supply increases.
Q4 Outlook
Too many crypto observers miss the forest through the trees, as evidenced by persistent negativity on crypto twitter. But if you zoom out, it’s hard not to be optimistic about the next few hundred days. We don’t mean to suggest that history repeats and this “cycle” will look the same as previous. But as we have said before, we do believe BTC will reach new all time highs as liquidity increases and its narrative strengthens, just as it has in the past.
One question we do ask ourselves is whether this time could in fact be different in terms of market breadth. Or more specifically, could the presence of ETFs and institutional actors alter the historical progression from BTC to ETH to alts (as well as the volatility of the asset class as a whole). That’s always a dangerous bet to make in markets, but is part of the reason we still hold nearly half of the fund in majors (BTC, ETH, SOL).
That being said, our base case is that alts will rise again. The below chart shows the % of Top 200 assets that have outperformed BTC in the last 90 days (tl;dr: very few):
BTC was a great position this summer, but a risk-on environment should lead to altcoin outperformance as wealth effects increase and investors chase higher returns. One caveat here is that asset selection matters more than ever in the context of proliferating supply, and that’s where we will focus in Q4.
If there is a fly in the ointment of an otherwise promising setup, it’s the election in November. A Trump presidency is set to usher in a golden age of experimentation and speculation on crypto assets, while a Harris administration would likely maintain a more restrictive stance. We anticipate BTC strength in either scenario (neither is running on austerity), but Trump would surely create a more favorable environment for alts. We feel good about material alt exposure going into Q4 as a call option on the explosive upside of a Trump win – remember, an outsize portion of crypto returns generally occur in short periods of time. In the case that Harris wins, there is certainly downside risk, and we’ve considered her election futures as a hedge. But ultimately we view that downside as somewhat limited given how much progress crypto has made as an interest group (it remains the biggest spender this election cycle), along with the growing disapproval of Gensler’s SEC. Regardless of the Presidential winner, we should see some progress in congress (i.e. stablecoin legislation, changes to custodian rules) and a change in leadership at the SEC.
In Conclusion
All of this to say, we are re-underwriting our thesis that:
Crypto has reached escape velocity as a global asset class
Tokens that have PMF, revenue and mindshare will outperform
Liquid funds will offer the best risk-adjusted returns in the coming years
The sectors we continue to watch most closely are ETH defi (e.g. AAVE, MKR), L1 infrastructure (e.g. SOL, NEAR), and Solana apps (e.g. HNT, KMNO). We are positioned 1:1 between majors and alts (our highest concentration of alts yet) heading into the election. With a global cutting cycle, a resilient US economy, and plenty of spending initiatives - the next several quarters should favor growth assets.
Crypto markets will always have a soft spot for speculation (read: meme coins), and we do look at buzzy coins with more interest when the market is bullish. But with incremental capital in the hands of more professional investors, the best bets remain on utility and fundamental value. However you choose to play, it’s a good time to be in the game.