Bitcoin’s positive price momentum continued into 2Q, with bitcoin up 6.8% on the quarter and up 83.6% year to date.
Price was buoyed late in the quarter by a slew of new spot bitcoin ETF applications, most notably from ETF giant BlackRock.
Much of the quarter prior to the ETF filing was colored by enforcement action from the SEC, which sued Coinbase and Binance.
Much of the regulatory action is likely to take several years to play out, but we continue to watch important cases in the near term, such as the Ripple Labs and Grayscale cases, to understand how courts are interpreting securities laws.
All eyes are on the spot ETF filings, of which there are 8 in the running. We outline the road ahead.
Bitcoin’s correlations to other asset classes, chiefly US equities, have returned to long-term averages, reinforcing an important property of the asset, diversification capabilities.
Performance Review
Late Quarter Rally Propels Bitcoin to Another Gain
The bitcoin price rose 6.8% in the quarter, lifting its year-to-date return to 83.6%. Bitcoin was propelled by the recent spate of spot ETF applications that began in the middle of June, ultimately pushing the price over $30,000 for the second time this year. This reversed the heavy price action for much of the quarter. After the regional banking crisis propelled bitcoin to over $30,000 for the first time in mid-April, bitcoin had been trading down as regulatory enforcement actions, chiefly from the SEC which sued Binance and Coinbase, put a damper on investor enthusiasm for the digital asset industry.
Bitcoin was not the only asset that did well during the quarter. The rally continued for equities, with US Large Cap Growth leading the way, up 13.6% during the quarter. Bonds were mixed in the quarter, with bond categories exhibiting declines. Gold and precious metals showed declines during the quarter, weighed down by rising real yields. Commodities fell, as well, affected by the decline in precious metals and oil prices, which have been impacted by demand and supply imbalances.
While bitcoin was not the best-performing asset class during the quarter, its 83.6% return on a year-to-date basis places it well ahead of any other asset class. Other “risk-on” asset classes, such as equities, have had a banner year thus far, but have failed to keep pace with bitcoin. US equities have primarily been powered by large cap and growth stocks. For example, the tech-heavy Nasdaq-100 Index (not pictured) is up 40.1% on a year-to-date basis. Only commodities are down on a year-to-date basis, driven by lower oil prices.
Strong Performance Continues to Play Out
In our 1Q review, we pointed out that good first quarters were often signs of a good year ahead. That viewpoint continued to play out in 2Q. 2023 continues to shape up like the first year in the repeating 4-year cycle, one marked by bitcoin outperformance.
Correlations Back to Long-Term Averages
Bitcoin has two important financial properties for investors – high returns and low correlations with other asset classes. The second property, low correlations, enables bitcoin to be an effective diversifier, reducing the overall risk of portfolios. Unfortunately, bitcoin’s correlations with other asset classes, chiefly with US equities, jumped in response to the monetary and fiscal response to the COVID-19 healthcare crisis. However, those correlations peaked last summer, and today are back to the long historical average with US equities. Bitcoin’s rolling 3-month correlation with US equities ended June at 0.12, essentially the same as its average since 2011, 0.11. Bitcoin still may exhibit higher rolling correlations than it did prior to 2020, which averaged about 0.0, as the investor base is moving from retail to institutions. Still, we think it will primarily be driven by factors unique to the asset itself, such as adoption and usage.
Regulatory Enforcement Actions Were Front and Center
Without a doubt, the events that characterized most of the crypto markets in 2Q centered around actions from the SEC, which sued two of the industry's largest exchanges, Coinbase and Binance. The Binance suit, filed on June 5th, included charges against its founder Changpeng Zhao (CZ). The Coinbase suit was filed the next day on June 6th. Both were well-telegraphed and as a result, had less of an impact on the market than one might expect. The CFTC had already filed a lawsuit against Binance and CZ for violations of various commodities laws and regulations, and Coinbase had been public about a Wells Notice it had received from the SEC notifying them of pending regulatory action. As a result, the price of bitcoin had fallen from $27,250 on Sunday night (6/4) to a low of $25,350, but had retraced the entire loss by Tuesday night.
While it is difficult to judge the outcome of the lawsuits, one thing is sure – they are likely to take many years to resolve. As an example, the highly watched lawsuit between the SEC and Ripple Labs began over 2.5 years ago and still does not have a decision, even one was expected by the end of 2Q, and this does not take into account the appeals process or other avenues the case may ultimately take. It is our view that the outcome of these recently filed cases may not be known for many years and may span SEC Chairs (Gensler’s term ends on June 5th, 2026), changes in the legislature, and new digital asset legislation.
ETF Filings Boosts Price
The surprise event, and one that provided a significant boost to price, was the filing of a spot bitcoin ETF application by investment giant BlackRock on June 15th. The main wrinkle with the BlackRock filing, and the primary differentiator from previous filings, all of which had been denied, was a surveillance sharing agreement (SSA) with a spot exchange, Coinbase. The news of the filing resulted in a slew of competitive filings and there are now 8 potential ETFs in the works, including one from Ark 21Shares which was already in process before BlackRock filed.
As mentioned, the news of the filing caused bitcoin's price trajectory to change completely, pushing the price through the $30K ceiling. Before the filing, regulatory actions had weighed on the price of bitcoin, sending it under $26K after the banking crisis pushed the price above $30K early in the quarter.
Banking Crisis Abated. For Now.
The regional banking crisis that engulfed several banks in the US was one of the most important events during the first quarter. While headlines seem to have receded into the distance at this point, it was just over 60 days ago, May 1st, that the last explosive event of the crisis occurred, JP Morgan’s last-minute takeover of embattled First Republic. The regional banking crisis was very much a 2Q event, as well.
While the crisis may be out of the headlines, it may not be completely out of the picture. Total draws on the Fed’s discount window (primary credit) plus the bank term funding program (BTFP) created to address the crisis, are down from the crisis highs, but banks continue to rely heavily on the BTFP. Fed data from this week indicates that draws on just the BTFP are still hovering at an all-time high. And with investors eyeing 3 more 25bs rate increases throughout the rest of the year, the root cause of the banking crisis, rising rates, and the failure of banks to hedge interest rate exposure may still be at play.
Debt Ceiling: Kicking the Can Down the Road
The much-ballyhooed raising of the $31.4T debt ceiling got resolved with little drama, aside from constant back and forth negotiating that seemed to play out in the media. But the “resolution” that legislators came to was simply to suspend the debt ceiling until January 2025. And while a suspension has happened five times in the past (2013 twice, 2015, 2017, and 2019), these are relatively new occurrences in the 106-year history of debt ceilings. By not raising the debt ceiling, legislators will once again have to come to the table to hammer out a deal. While we’re grateful there was no market volatility associated with the outcome, such as in 2011 when S&P downgraded the US’s credit rating, we are likely going to be subjected to the same media-driven drama again in a few short months. The events did not shine a light on bitcoin like we might have hoped, but we think the political spectacle associated with the US’s financial states that unfolded paints a non-sovereign issued money, one with well-understood economic parameters, such as bitcoin, in a positive light.
Transaction Fees Rise, Fall
With the rise of Ordinals in 1Q which gave way to BRC-20s in 2Q, transaction fees and the backlog of unconfirmed transactions waiting in Bitcoin’s mempool were highly topical. As a refresher, Ordinals allows users to embed much more data in Bitcoin’s blockchain than previously thought, unleashing a wave of NFT creation, and BRC-20s build on top of Ordinals, allowing unique digital assets to be issued on top of the Bitcoin’s blockchain. While few if any BRC-20s have any explicit utility, and thus should be categorized as “meme coins,” their sudden rise in collective value created significant demand for blockchain space, as users deployed, minted, and transferred BRC-20 tokens.
With the meme coin craze mainly behind us, the demand for blockchain space and thus transaction fees have declined. Prior to the launch of Ordinals, transaction fees accounted for 1-2% of total miner revenue, with 98-99% coming from the block subsidy, newly created bitcoins created by the protocol for creating new blocks. The share of miner revenue from transaction fees peaked at over 40% on a daily basis with some individual blocks breaking the 50% level. After peaking at over $1B in total value, the collective value of BRC-20s is down significantly, resulting in cooling transactional demand and fees. While fees might be down, the entrepreneurial spirit is still soaring on Bitcoin, and we are excited to see what the technical community builds next.
Bitcoin Dominance Continues to Rise
Bitcoin’s dominance, its share of the total digital asset industry market cap, has been on the rise throughout 2023. Bitcoin’s dominance has tended to bottom at cycle peaks but then rise through drawdowns and in the first part of a new bull cycle. We saw this in the previous cycle, which peaked in 2017 and troughed at the end of 2018, and the same trend appears to be playing out again following the 2021 peak and 2022 trough.
Part of the growth in dominance has to do with bitcoin’s place as the least risky digital asset, from a legal, technical, economic, and product-market fit perspective. It has fallen less in drawdowns on a percentage basis than more risky assets (BTC fell 77.6% in the last drawdown while ETH was down 81.9%). Once the trough is reached, bitcoin has tended to be the asset that gets underwritten most easily. Hence, bitcoin has tended to gain dominance in the first part of a bull market cycle. However, in the most speculative phase, bitcoin has tended to cede dominance as the most risky and speculative assets outperform. We are still a ways from that part of the market cycle.
More Supply Being Held for Longer
The percentage of bitcoins outstanding that have been held for a year or more hit a new high at the end of the quarterly, 69.0%. Bitcoin is well known for its short-term price movement and volatility, but based on blockchain data, it appears that bitcoin investors are increasingly becoming long-term holders. This may play out to be an important factor in a continued bullish market. As fewer coins are available for purchase, new buyers may be required to bid up the price of coins.
Crypto-Related Equities Continue to Perform Well
Crypto-related businesses, chiefly mining companies, continued to perform well during the second quarter. Returns for the publicly traded miners handily beat bitcoin during the second quarter and on a year-to-date basis. Our belief has been that crypto-related businesses have inherent leverage in their business models that should allow them to act as high beta trades relative to spot prices of digital assets, such as bitcoin.
With a new race kicking off for a spot bitcoin ETF, all eyes are on the competing applications and the SEC’s response to the applications. At odds are BlackRock’s near-perfect record in getting ETFs approved and the SEC’s perfect record in denying spot bitcoin ETFs. Only one of these records can come through intact. The SEC will set a tone for how we can expect them to react to the bitcoin ETF filings, Blackrock’s being only one of them, with their response to the ETF from Ark 21Shares, which is expected to receive feedback first. Despite all the headlines, only the Ark 21Shares Bitcoin ETF has a definite deadline by which the SEC needs to approve, deny, or delay a decision on its application, August 13th. The other ETFs have yet to hit the Federal Register, which starts the countdown of the first 45-day window on which the SEC needs to respond. Based on the typical timing from when an exchange files a 19b-4 to when the SEC publishes a Notice of Filing (14 days), to when the proposed rule change hits the Federal Register (6 days), we would expect the first 45-day response deadline from the SEC to land in the beginning of September.
While the final outcomes of the SEC cases against Coinbase and Binance are not likely to be known for several years, there are some important cases in the short-term that investors should continue to watch. The SEC’s case against Ripple Labs for the unregistered offering of digital asset securities could have a decision any day. And while any decision is likely to be appealed, it could inform us as to how courts are interpreting securities laws in the case of digital assets. While not directly impactful for bitcoin, as bitcoin is squarely defined as a commodity by regulators, it may have a bearing on other digital assets as well as service providers, such as exchanges.
The other case that investors should watch for is the case between the SEC and Grayscale. In October of last year, Grayscale, the sponsor of the Grayscale Bitcoin Trust (GBTC), the single largest bitcoin fund ($19.4B in AUM), sued the regulator for rejecting its application to convert into an ETF. Oral arguments, which were interpreted positively for Grayscale by the market, were heard before a 3-judge panel in the D.C. Circuit Court of Appeals on March 7th. A verdict is expected sometime this fall, so possibly in 3Q. The ruling may have implications for existing ETF applications as well.
Valuation Still a Discount to Metcalfe’s Law
Nearly 3 years ago, we published a piece outlining the connection between the square of the number of Bitcoin addresses that held balances, a proxy for Bitcoin’s user base, and its market cap. Since publishing, the model has lost some of its predictive abilities, with R Squared dropping from 90.4% at the end of 2020 to 78.7% at the end of June. Still, we think the model is a useful tool to detect under/overvaluation in the context of price cycles. Bitcoin has tended to trade below model valuation in drawdown and the early stages of a bull market but has traded at a premium near market peaks. Since 2022, bitcoin has traded at a significant discount to the model price, and at the end of June, bitcoin’s valuation was 30% below the model price of $43,535. To us, this is an indication that we are still early in what could be a new price cycle for bitcoin.
Cycles Keep Playing Out
Bitcoin's 4-year repeating price cycles are one of the great mysteries in digital asset models. These repeating patterns, centered on reward halvings, are seemingly violations of even the weakest form of the efficient market hypothesis (EMH). While the facts, players, and circumstances surrounding each of these cycles differ, the shape and duration of these patterns have continued to repeat. One explanation is that the axis of bitcoin growth is up and to the right, but that human nature, a cycle of fear and greed, leads to under and overvaluation. Another explanation is that lacking fundamental valuation tools for bitcoin, like a discounted cash flow model, investors are using historical price patterns as price guides for the future. Whatever the reason may be, this cycle, with all its idiosyncrasies, has continued to follow a similar path to the cycles before it.
Final Thoughts
Bitcoin's positive momentum from 1Q continued into 2Q largely driven by the enthusiasm for a spot ETF. This positive price performance comes despite regulatory headwinds faced by some of the industry's biggest exchanges. While the outcome of these cases will likely be settled far down the road, we find it encouraging that bitcoin continues to "climb a wall of worry." Bitcoin's repeating price cycles appear to be intact, an amazing fact considering the facts, players, and events all have changed from cycle to cycle. All eyes are on the spot ETF applications, and we are certain we'll have more information about them next quarter.
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