In August 2024, crypto asset valuations saw a decline as market volatility spiked temporarily. While Bitcoin showed stronger performance relative to the broader crypto market, Ethereum lagged behind.
Federal Reserve Chair Powell indicated that interest rate reductions are on the horizon, which could positively impact Bitcoin and other assets that rival the U.S. Dollar, such as physical gold. Despite increased activity on Ethereum's Layer 2 networks, concerns about its scalability have led to uncertainty about its future outlook.
While global equity markets remained relatively unchanged in August, significant volatility within the month followed a disappointing jobs report on August 2, which led to a dip in riskier assets and a surge in equity volatility. The VIX Index, a measure of market volatility, briefly soared above 65%. However, as further economic data revealed no immediate risks, many market segments recovered, and the VIX dropped back below 20%.
The softer labor market conditions seemed to have influenced the views of Fed policymakers. During the annual Jackson Hole conference on August 23, Chair Powell announced that the time had come to lower rates, citing increased risks to employment. Interest rate futures now suggest a 100 basis point (b.p.) cut across the remaining three Federal Open Market Committee (FOMC) meetings this year.
Market Changes in Response to Volatility and Rate Cut Signals
The brief period of volatility, along with the prospect of rate cuts, has led to several shifts in the market. Returns on strategies that were heavily impacted, such as short volatility strategies and FX carry trades, experienced significant declines. The U.S. Dollar weakened against major currencies and gold, while defensive assets like high-quality bonds and consumer staples stocks outperformed. In the crypto space, Bitcoin dropped 8.5%, while Ethereum saw a larger decline of 21.8%, underperforming on a risk-adjusted basis. The broader crypto market, as measured by our Crypto Sectors Market Index (CSMI), fell by 13.2% during the month.
Dollar Weakness and Bitcoin's Prospects
The continued weakening of the U.S. Dollar and the possibility of lower interest rates could work in Bitcoin's favor. Like physical gold, Bitcoin operates as an alternative monetary system that challenges the U.S. Dollar in international markets. A reduction in U.S. interest rates diminishes the Dollar's competitive edge, which benefits assets like other fiat currencies, gold, and Bitcoin. Over recent years, Bitcoin's value has shown an inverse relationship with both real interest rates and the strength of the U.S. Dollar. Investors looking to hedge against Dollar weakness may consider Bitcoin for diversification.
Ethereum's Underperformance and the Layer 2 Transition
Ethereum significantly underperformed in early August and struggled to rebound later in the month. This performance was partly attributed to high positions in both CME-listed and perpetual futures. In May 2024, following the approval of U.S. spot Ethereum exchange-traded products (ETPs) by the SEC, traders increased their positioning in perpetual futures, anticipating further price gains. However, the speculative overhang led to a sharp drop in Ethereum's price and hampered its subsequent recovery.
On a more fundamental level, Ethereum is undergoing a major transition, moving transactions to Layer 2 networks that settle periodically on the main Layer 1 network. While this strategy is yielding results, with activity on Layer 2s increasing significantly, it has also resulted in reduced fee revenue for the Layer 1 network, potentially affecting the value of Ether. Furthermore, uncertainty surrounding the transition may explain the low inflows into spot Ethereum ETPs launched in July. Although Grayscale Research views the current pessimism as unwarranted, it could take time for the market's outlook to improve.
Other Developments in the Crypto Market
While Ethereum underperformed, certain sectors of the crypto market saw positive developments. ZCash (ZEC), a privacy-preserving asset, rose 29.5% in mid-August before pulling back. ZCash's upcoming transition to a hybrid consensus mechanism and the second halving event scheduled for November 2024 have fueled investor interest. The Aave protocol, part of the Financials Crypto Sector, hit a record high in weekly active borrowers, and its governance token, AAVE, gained 21%. A new proposal could introduce a buy-and-distribute model for AAVE tokens, similar to Maker's Smart Burn Engine.
The stablecoin market capitalization continued to rise, approaching its previous all-time high. An upcoming Apple software update may drive further stablecoin adoption, enabling Circle’s USDC to be used for tap-to-pay payments on iPhones. Meanwhile, Tether announced the creation of a stablecoin tied to the UAE's Dirham, and Latin American platform Mercado Libre launched its own USD-linked stablecoin.
Privacy and Blockchain Technology
Toward the end of the month, attention shifted to the intersection of blockchain technology and digital privacy following the arrest of Telegram founder Pavel Durov in France. Durov was charged with failing to mitigate the misuse of Telegram for criminal activity. Following the news, The Open Network (TON), a platform integrated with Telegram, saw a 20% drop before recovering slightly. Other developments included the Near protocol launching Nightshade 2.0 and the long-awaited Nakamoto upgrade by Stacks protocol.
Bitcoin's Potential Future
Bitcoin has traded within a narrow range since Q1 2024. Despite positive fundamentals, selling pressures from sources such as the German government and Mt. Gox estate have weighed on the market. Grayscale Research believes that these pressures are easing, and improving fundamentals should soon be reflected in Bitcoin's price. Should the U.S. labor market remain resilient and Fed rate cuts proceed, Bitcoin prices could potentially retest their all-time highs by the end of the year. However, the main risk remains a potential rise in unemployment and recession.
Investors are advised to keep an eye on upcoming labor market data, including the next employment report due on September 6.
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