What past cycles say about which digital assets are likely to be around for the peak of the next cycle
Network difficulty undergoes a negative revision giving miners a short reprieve
The Persistence of Top Digital Assets is Fleeting
We are going to let you in on a little secret about crypto markets; we are not all going to make it. Yes, we know this is in opposition to the crypto ethos of WAGMI, “we’re all gonna make it”, a memetic show of solidarity. But unfortunately, this ethos belies facts about digital asset markets and the cyclical nature of the industry.
The reality is that there has been very little stability in the composition of top projects over time. Part of that has to do with the high growth and experimental nature of the industry. The digital asset industry is still young, and experiments abound in technology, economic design, and application development. Crypto native investor attention can often be short-lived, rotating from one theme to another, often in dizzying and rapid succession. In the past 4 years, we have experienced waves of interest in stablecoins, exchange tokens, DeFi, NFTs, layer 1 Ethereum competitors, and layer 2 scaling solutions, just to name a few. While some of these technologies and themes are most likely here to stay, the exact form of these markets is likely to evolve and change.
The following chart ranks the top 10 digital assets by market cap (excluding stablecoins) over the past 3 market cycle peaks: 2013, 2017, and 2021. Aside from Bitcoin being the largest asset and Ethereum a consistent number 2 (it did lose that crown to XRP briefly in 2017 and 2018 and did not launch until 2015), there is very little consistency in the make-up of the rest of the market.
On top of that, some of the largest digital assets, ones with some of the best returns, had no staying power. Even just looking at some of the top digital assets from the 2017 peak, we see that many of them have fallen in terms of rank and in absolute size. What from the 2021 leader board is unlikely to be around in the next cycle peak? We already know that Terra will certainly not be there.
There are a few reasons Bitcoin has had staying power. Certainly, brand recognition, regulatory clarity, deep trading markets, and a developed derivatives infrastructure are part of that. It also might be that an open-source monetary platform, one with a finite supply, is a bigger idea than dapp platforms, privacy coins, or dog-inspired meme coins, no matter how cute they might be. We cannot predict the hot new digital asset or application that springs forth in the next cycle, but we are confident that Bitcoin and the benefits it brings to society are likely here to stay.
Miner Profitability Gets Some Respite in Difficulty Change
This week, the Bitcoin network difficulty decreased by 4.3%. This is an acknowledgment by the network that blocks over the preceding 2,016 blocks were taking too long to produce versus an expectation of 10 minutes. This means an increase in expected daily profitability of 4.3% for miners, keeping all else equal.
Unfortunately, all else has not been equal, with one key input, the price of bitcoin, falling -36.0% year to date. One common measure of miner revenue that we have mentioned before in this newsletter is called hash price. Hash price measures the expected revenue of a miner per hash, or one guess at creating a valid block. This value decreases when bitcoin prices decrease since blocks are worth less in dollar terms. Hash price also decreases difficulty increases, since it is harder to mine a block. As a result, the level of hash price now is at fall 2020 levels, down -48.6% from the start of year levels and -70.7% from its recent peak in 2021.
What does this mean for an average miner? Even with these factors, prices are still nowhere near their marginal cost of production or breakeven prices for the latest machines, which are currently just under $10K (assuming $0.05/kWh for electricity). That does not mean, however, that miners are resting easily. The rising cost of capital, need to cover operating expenses, and the requirement to service debt mean that miners are likely in a tighter pinch than simple breakevens would indicate.
Market Update
The price of bitcoin slumped 1.9% on the week, falling to $29,365. This makes it the 8th consecutive week of negative performance, a record-losing stretch for the asset. Bitcoin’s fall this week deviates from equity performance, breaking rank from the tight correlations we have seen for several months. The S&P 500 rose 4.0% and the Nasdaq Composite rose 3.1%. Bonds also bounced on the week as forward rate expectations leveled off. Investment Grade Corporate Bonds were up 2.5%, High Yield Corporate Bonds were up 3.9%, and Long-Term Treasuries were up 1.4%. Gold was up slightly on the week, 0.8%, while real yields dipped, and inflation expectations remained largely unchanged.
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