Last December, in a piece titled “Crypto Risk vs. Reward”, we shared our view that the start of 2023 would prove to be a good entry point. As of this writing, Bitcoin has returned 150% YTD, and the CCI 30 (large cap crypto index) 90%.
The thesis at that time was more technical (capitulation and deleveraging complete, reduced impact from macro headwinds, innovation carrying on) which created a positive risk/reward for inflows. This December, we again have an optimistic outlook for the year ahead, supported by more fundamental catalysts:
Macro: The business cycle is rebounding, global liquidity is rising, and Fed tightening is likely over
Flows: Imminent approval of the first US spot crypto ETFs in the face of constrained supply
Technology: Function, efficiency, and ease of access have never been greater
Participants: Many bad actors of the prior cycle have been replaced by “adults in the room”
Policy: Anti-crypto US regulators are losing in courts (even sanctioned), there are multiple pro-crypto candidates in the upcoming Presidential election, and the rest of the world is pushing forward
Exposure: Investors (including those currently in crypto) are underexposed
While we believe the above to be objectively true, the reality is that it will only take some of the above to be right for crypto markets to have a very strong 2024. Investors should position accordingly. In the below we dive into each area in detail.
Macro – The Four Year Cycle
Crypto cycles tend to play out over four-year periods, with many attributing this phenomenon to Bitcoin’s “halving” where every four years the inflation schedule of Bitcoin cuts in half, historically leading to higher BTC price as new supply is reduced. The next halving is scheduled to occur in May 2024.
While we believe the halving has an impact on Bitcoin and crypto generally, there are also broader macro cycles that show high correlations with crypto prices – the overall business cycle and global liquidity. Both of which appear to have bottomed and are trending upward.
Business Cycle
Both crypto market bottoms and tops have historically aligned with inflections in the business cycle (measured by US ISM PMI).
Cycle Bottoms – US ISM PMI YoY (White) vs. BTC YoY% (Orange)
Cycle Tops – US ISM PMI YoY (White) vs. BTC YoY% (Orange)
Business cycle reversals also happen to line up with Bitcoin halvings.
US ISM PMI YoY (Green) vs. BTC YoY% (Blue) vs. Bitcoin Halvings (Orange)
Source: Delphi Digital as of November 2023
Global Liquidity
Throughout 2022 and into 2023, Central Banks around the world tightened liquidity in order to contain high inflation which negatively impacted risk assets.
Global liquidity appears to have bottomed and has recently started to trend upwards. The impact of rising global liquidity should be constructive for all risk assets.
The important part is to recognize that even a small amount of increased liquidity can have an outsized impact on crypto markets relative to say equity markets. For example, $100B of inflows to “traditional assets” equates to a 0.2% increase. For crypto, that would be 10% of the total market. With an ETF likely to be approved (more on that below) you will likely see large traditional participants (hedge funds) take this view.
Last, recent FOMC minutes and commentary from Fed Chair Jerome Powell support this view of easier liquidity conditions ahead.
Flows – Spot ETFs are Finally Here (but supply isn’t)
There are currently 12 applications to the SEC for the approval of spot Bitcoin ETFs, including the largest ETF providers in the industry. Thus far, all applications have been delayed, with the closest final decision deadline being January 10, 2024.
All indications are that the SEC is actively engaging with these ETF providers to address concerns in their applications and standardize how these products will function. Additionally, recent delays have aligned the comment period for January 5th with the expectation that all applications will be approved on January 10th to not give any providers an advantage over the others.
Additionally, there are 7 Ethereum spot ETF applications with the SEC. Given the facts and circumstances of BTC and ETH are very similar, it is assumed that the approval of a BTC ETF will pave the way for ETH shortly thereafter.
We believe the potential size of new inflows from a spot ETF is in the billions within the first year or two. For reference, we estimate that the Registered Investment Advisory (RIA) market alone covers roughly $5-6 trillion in assets under management.
A recent survey showed that 12% of financial advisors are currently recommending that clients invest in Bitcoin, while 47% personally own Bitcoin and 77% say they are waiting for a spot Bitcoin ETF to become available so they can offer it to their clients. Just a few basis points of portfolio allocation from this segment of the market can be enough to move Bitcoin significantly higher.
Galaxy Research also put a few numbers for reference below.
It is also reasonable to expect approved ETF providers to spend significant marketing time and dollars to win market share for their product. The below figure shows the largest US ETFs by annual revenues. The Grayscale Bitcoin Trust (a closed-end fund) already ranks 3rd, with GLD ranking 4th despite having significantly lower AUM than other widely held ETFs.
Like GLD, we expect a passive Bitcoin ETF to be a “winner take most” product, with the ability to charge higher fees given the volatility of the underlying and the increased access it provides investors. We also believe it is reasonable to put higher return potential on Bitcoin relative to Gold, meaning AUM could grow meaningfully absent new flows. When you add these together it equals a very attractive product for the issuer.
This is also at a time when BTC held on exchanges is already near an all-time low (most BTC are held in self-custodial wallets), and the four-year inflation halving is just six months away.
Bitcoin Reserves held on Coinbase (blue) vs. Bitcoin price (black)
To recap, Bitcoin spot ETFs should be approved in a little under a month, issuers are incentivized to dominate market share, and the underlying is in short supply.
The ongoing debate has been if the Bitcoin ETF is “priced in”. Our view is that the announcement may be priced as the ETF will not start trading for a few weeks to a month later (based on similar prior approvals). In this scenario it is likely we see positioning move to an Ethereum in anticipation of a spot ETH ETF.
The reality is that it is impossible to price in actual flows, which by definition will increase price, particularly in the face of limited supply. We (and others) believe these flows will be meaningful.
The Tech is Ahead of Price
In August we wrote a piece titled “The Start of the Next Cycle” where we highlighted that there have been two major technology (and price) cycles for crypto (2014 – 2018, 2019 – 2022). From one to the next we ended with better applications, more users, and strong returns. We believe we are at the start of the next cycle, where the improvements in technology already being used and further upgrades coming soon are head and shoulders above where they were in prior cycles. Prices have only started to reflect this.
You can read in more detail here, but to summarize:
The areas of innovation that are here, and we believe will drive this cycle accomplish 4 objectives:
Improve scalability
Increase capital efficiency
Increase the composability of assets
Make blockchain user friendly
The result of each is the following:
In just the last 18 months, interacting with blockchain has become materially faster and cheaper. Speed and cost should continue to improve, and we favor applications that are now possible with improved scalability.
Capital within crypto is now the most efficient it has ever been and will increasingly become more efficient in the future. This means that as capital begins to re-enter this space, we should expect to surpass 2021 highs in activity on a much lower capital base, and deliver multiples of activity relative to 2021 when we return to similar capital levels. Providers of liquidity and assets that accrue value based on volume should benefit.
Composability increases the productivity of assets. This leads to monetary expansion within crypto regardless of new inflows, and highlights another benefit of tokenization that traditional markets do not provide. Monetary expansion should act as a near-term tailwind, while tokenization benefits should drive longer-term adoption trends. Borrow/lend platforms are the likely near-term beneficiaries.
The highest hurdle to crypto adoption has been the technical know-how required to access it. The abstraction of the underlying tech, driven by companies such as Coinbase and decentralized applications will remove this hurdle. This is a major catalyst for broad adoption, and consumer focused applications should stand to benefit.
To summarize, during the past year and a half we have had advancements that will bring in more users, make capital more efficient, make assets more productive, and in a faster, more scalable way. This will inevitability lead to activity and value created that surpasses prior highs.
Market Participants
As with many new technologies, there is an adoption curve. However, when it comes to a new financial technology that started outside of existing regulated walls and offers globally instant trade, there were bound to be misaligned interests amongst various participants in this new market.
From the early days up to the fraud-induced collapse of FTX, we have finally arrived at a point where the technology is both understood and structured enough for the traditional players to get involved in a regulated fashion.
Similar to the early wild west of emerging market equities, we believe crypto will reach an inflection point of maturity and become an official asset class amongst stocks and bonds with the arrival of traditional asset managers, ETF issuers, and derivatives exchanges.
Crypto Market Structure Has Come A Long Way
The crypto market went through a mass deleveraging over 2022 into 2023. This will build back up, but on the foundation of regulated and experienced companies. This will be far healthier and should be welcomed by all participants.
Political Football
Over the past year we have been forced to monitor regulatory developments impacting crypto.
From our vantage point, it appeared the SEC, and maybe the entire administration, wanted to maximally deter crypto usage and investment. However, their tactics of confusion have not held up well in court or in Congress, and they do not compare favorably to other global regulators who are making meaningful good-faith progress.
July 13 – Federal district court judge sided with Ripple that sales of tokens in the open market were not investment contracts, and the underlying tokens themselves are not securities.
August 10 – a Southern District of New York judge ruled that the XRP (Ripple) token was not a security when sold to the general public.
August 29 – US Court of Appeals for the DC Circuit unanimously ruled that the SEC prohibition of GBTC’s conversion to a spot ETF (after approving BTC futures ETFs) was “arbitrary and capricious”.
November 30 – A federal judge warned SEC attorneys that they may be sanctioned for requesting a crypto firm’s assets be frozen under “false and misleading” pretenses. Continuing to say that the SEC’s “misrepresentations… undermined the integrity of the case’s proceedings”.
Within Congress, Elizabeth Warren has been the most outspoken critic of crypto and the need to “crack down” on the decentralized nature of it. This week she released a new bill to do so. For those keeping score, below are the lifetime stats for Warren Bills:
305 bills introduced, 1 became law (a law about flags…seriously)
1766 Co-sponsored, 45 became law
Senator Warren’s view may have appeared to receive a boost during a recent hearing with bank CEOs, when Jamie Dimon proclaimed “If I was the government, I’d close it down”. While Jamie Dimon is one of the most successful executives of all time, this is a bit like asking taxi medallion owners what they would do to Uber.
On the flip side, multiple congresspeople have put forth good-faith and bi-partisan legislation that attempts to clarify some of what the SEC refuses to opine on. Perhaps Congress will make progress before the courts do.
Additionally, in the upcoming US Presidential election, the majority of current candidates have put forth pro-crypto policy stances. Why? Likely because it is increasingly popular, particularly with younger voters.
Regardless, the rest of the world is not waiting for the U.S. Years in the making, the European Union’s landmark Markets in Crypto Assets (MiCA) legislation is an earnest attempt to begin to regulate with both industry and consumers in mind.
In short, there have been great strides in reducing the regulatory ambiguity in the US, pro-crypto policy has become bi-partisan, and the rest of the world are putting in frameworks to be a leader in this space.
Exposure Remains Low
Most individuals simply don’t own crypto, and even amongst the few who do, they don’t seem to think they own enough.
A study by Morning Consult (a business intelligence firm unrelated to crypto) surveyed 2200 of American adults, and 80% own no crypto. While 20% do, 29% say they are likely or somewhat likely to own it in the next 12 months. That’s 25MM Americans currently on the sidelines who don’t own crypto but likely want exposure.
In another survey of 400 individual investors (conducted by crypto news/investment firm Unchained), both current bitcoin owners and non-owners who would consider ownership cited likelihood to buy more bitcoin if there is increased regulatory clarity, a spot ETF approval, or a buy recommendation from a financial advisor.
One interpretation of this is that as these events come to pass, no one feels they have enough exposure.
This is echoed in surveys of Institutional Investors, too. Trackinsight and JP Morgan surveyed 550 Institutional Investors, and 76% own no crypto, yet 50% will consider it once there’s an ETF. Even if only a fraction follow through, again you have a huge number of underexposed investors.
On-chain data helps explain why. Amongst BTC holders, just 2.3% own a whole BTC or more:
Most institutions and most individuals don’t own crypto. Many who don’t are likely to, and even among current and expected future owners, few feel they have the exposure they want. No one owns enough crypto.
Conclusion
Throughout 2022 and into 2023, the crypto market faced a number of headwinds. Some were self-induced (leverage, poor risk management, etc.), and others external such as regulatory overhang, global liquidity conditions, and high interest rates.
These overhangs have been largely removed or at a minimum materially improved. This coupled with imminent significant inflows via ETFs creates ideal conditions to get invested in this market.
Please do not hesitate to reach out with questions, comments, or feedback!
Sincerely,
Motus Capital Management
Past performance is not indicative of future results. This communication does not constitute an offer to sell or solicitation of an offer to buy the Interests in any jurisdiction where, or to any person to whom, it is unlawful to make such offer or solicitation in such jurisdiction. This communication is being provided solely as a high-level overview and is not intended to be relied on for the terms of any offering.