July 5, 2023

Insights and analysis for the professional investor

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Welcome to Crypto Long & Short!

This week, CoinDesk's Glenn Williams examines potential macro headwinds that could unravel BTC and ETH's big recent gains.

Then, Christopher Jensen and David Alderman of Franklin Templeton call for using a metric called years to profitability when examining crypto.

As always, get the latest crypto news and data from CoinDeskMarkets.com.

– Nick Baker

From the Analyst

Bitcoin Prices Are Hot, but Here's What Could Crush the Rally

We're starting today's column where we left the last, asking: Will macroeconomic narratives subside? The answer may ultimately be a bit nuanced. Macro factors will always play a role, but some key issues have been occurring in a relatively predictable fashion, especially as they relate to inflation.

Save for a few hiccups, inflation projections and the Federal Open Market Committee's (FOMC) expected response with interest rates have played out as expected.

Bitcoin (BTC) prices are up 87% year to date and seem to have found support near $30,000. Ether (ETH) has risen 64%, trailing BTC but still impressive nonetheless.

Both have largely shrugged off this perilous period for the overall crypto industry. Something called the Anchored Volume Weighted Average Price (AVWAP) of BTC helps show that.

Volume Weighted Average Price (VWAP) is a technical indicator that lets traders determine the average price of an asset, taking volume and price into account. AVWAP does the same thing but lets traders anchor their starting point to a customized date.

Bitcoin's AVWAP since the U.S. Securities and Exchange Commission's lawsuits against Binance and Coinbase is 9.1% lower than where BTC currently trades. The AVWAP taken from Nov. 9, 2022, the day Binance scrapped its proposed FTX takeover, is $22,632. Anchoring from when Celsius paused withdrawals in June 2022 shows an AVWAP of $21,400.

In other words, bitcoin has bounced back from a series of bad events. The latest industry catalyst appears to be BlackRock's recent filing for a spot bitcoin ETF.

The question now is, what could go wrong? What macroeconomic developments could send prices lower, eroding the aforementioned gains?

Reading through some of the more recent speeches by Federal Reserve Chairman Jerome Powell indicates that the FOMC is resigned to continuing its current course of action.

The market appears to be expecting at least two more rate hikes in 2023, topping out around 5.6%. If that occurs, it's difficult to imagine a significant shock to prices in either direction; it's likely already priced in.

But there are a few other macro factors that warrant attention in crypto markets:

Banks passed the most recent stress test with flying colors, so the FOMC will likely not hesitate to take a more hawkish stance if needed.

One of the largest news stories of the year was the collapse of Silvergate Bank and Silicon Valley Bank. Since both had ties to crypto, the news reverberated throughout the sector. Their failure led to thoughts that FOMC rate hikes had gone too far, creating too much stress among banks.

However, recent stress tests that were administered to 23 systemically important banks showed they appear to be well-positioned to weather a severe recession and continue lending to qualified households. The test assumed an unemployment rate of 10%, a 40% decline in commercial real estate and a 38% decline in housing prices.

The FOMC may feel that it has enough room to aggressively raise rates, despite the impact that may be felt. Subsequent weakness in the economy would be painful but would likely bring inflation down without cratering the banking system.

Consumer revolving debt continues to rise

Revolving debt is at all-time highs. This is an area that doesn't get a ton of attention, but is still significant.

Crypto investing continues to have a large retail component. Glassnode data show 1.3 million BTC held by investors with less than 1 bitcoin, and that population has grown 73% since 2021.

Increases in credit balances in conjunction with higher interest rates and potentially lower employment concern me as far as crypto investing is concerned.

That pesky yield curve is still inverted

The spread between 2- and 10-year U.S. Treasury yields is deeply inverted, with its -1.08% spread the largest since 1981:

Historically, inversions are often followed by recessions. However, the FOMC's most recent summary of economic projections does not appear to be forecasting a recession.

Still, this disconnect between economic history and economic forecast implies a degree of uncertainty that may not be priced in by markets.

As an investor with a bullish bias, it forces me to ask, "What if I'm wrong?" I don't think I'm alone. As more investors ask this question, a reluctance could grow when it comes to deploying capital to crypto assets.

That, in and of itself, could serve as a short-term hurdle for crypto prices.

— Glenn C. Williams Jr. CMT

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Institutional Outlook

A New Metric to Evaluate Crypto Ecosystem Fundamentals

When evaluating layer 1 (L1) blockchains, many fundamental investors focus on metrics such as price-to-earnings or price-to-sales ratios. While these metrics are important, they ignore the programmable aspect of a blockchain's token supply. Because a blockchain's emissions schedule (i.e., when new tokens will enter circulation due to staking rewards and token unlocks) is known, its cost structure into the future is essentially known as well.

The years-to-profitability (YTP) ratio is a useful new metric for analyzing an L1's profitability as it incorporates the blockchain's forward supply curve. It applies the traditional finance (TradFi) concepts of breakeven analysis and payback periods to crypto. The analysis views an L1 blockchain through the lens of a business that sells secured blockspace. Revenues are the fees that users pay to record transactions on the chain, and expenses are the costs needed to secure the network. YTP calculates a blockchain's profitability timeline by factoring in the protocol's current revenue and cost structure, a projected growth rate (CAGR) and future supply dynamics.

We find YTP compelling because it provides a comprehensive framework for evaluating an individual blockchain or comparing multiple blockchains.

We start our calculation with Token Terminal's definition of L1 profitability:

It is important to note that all revenues and costs are denominated in the L1's native token. And, while unlocks and staking rewards both increase the number of tokens in circulation, the difference between transaction fees and the portion of those fees paid to proof-of-stake validators is what is used to burn or reduce the number of tokens in circulation. In this sense, YTP measures the point at which an L1's circulating supply stabilizes at 0% inflation. Some broad assumptions we make are:

The percentage of the transaction fee burned remains constant.
The foundation takes 10 years to sell all its tokens.
For revenues, we use the L1's revenue for the last quarter annualized.

In comparing YTP across blockchains, it's helpful to group the L1s by whether they have an inflationary tokenomic model or a max supply model, because with the latter, an L1 might "break even" simply because the chain's fixed supply was reached (as modeled for SUI or ADA). Here's an analysis for multiple blockchains, with Ethereum and Binance Smart Chain excluded because they are already profitable:

Sources: The Tie, Token Terminal, Artemis, Franklin Templeton Estimates
On the Cardano blockchain, 20% of ADA fees are paid to the Cardano Foundation. Note, the foundation uses these funds to grow and develop the Cardano ecosystem but could burn the ADA if they wanted.

Then, by using the same set of growth rate assumptions for each chain (we calculated future CAGRs of 30%, 40% and 50%), we can make comparisons across chains and explore more deeply what drives YTP. For example, while APT has a high YTP, this is partially because the chain is relatively new and therefore its revenues are smaller than those of other more established chains. SOL has modest inflationary schedules compared to blockchains like NEAR or ICP. In all examples, a blockchain's ability to burn tokens (and provide some kind of offset to new emissions) is helpful for managing YTP.

In conclusion, YTP serves as a crucial metric in evaluating the profitability and sustainability of L1 blockchains. By carefully designing tokenomics (inflationary or max supply), balancing supply dynamics and incorporating burn mechanics, L1 blockchains can aim to reduce YTP and build a more sustainable blockchain economy.

– David Alderman and Christopher Jensen of

Franklin Templeton Digital Assets

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Takeaways

From CoinDesk Deputy Editor-in-Chief Nick Baker, here is some news worth reading:

BLOCK SCHOLES: It doesn't take too long hanging around finance before you hear the words "Black-Scholes," the famous options pricing model. I've even seen it argued that it's one of the most important math formulas of the past century. Anyway, when you spot a headline with "Block Scholes," you start wondering if that's a typo of Black-Scholes. But, no, it's a crypto data firm, and a recent CoinDesk story explains that the firm has determined that crypto prices have untethered from stocks. I'd argue this is either really good news for macro investors looking for uncorrelated assets or terrible news for crypto traders adrift in a sea of bad news.
PEPECOIN PLAGIARISTS: Not so long ago, pepecoin (PEPE) was the hottest thing on Planet Crypto. That's not so much the case anymore. Possibly trying to recapture the magic, though, some PEPE knockoffs have emerged, though ace CoinDesk reporter Shaurya Malwa argues in his coverage that past history shows any gains aren't likely to last long.
POOR APES: Another formerly hot area, Bored Ape Yacht Club NFTs, are getting hit hard lately, with the floor price of the BAYC collection sinking to a 20-month low. This fits with the recent trend in crypto: while the heavyweights, bitcoin and ether, are doing great, much of the rest of the industry is struggling.
BITCOIN WHALE: MicroStrategy, the software developer that Michael Saylor steered toward becoming a corporate bitcoin vault, recently bought more BTC. Here's a story on how MicroStrategy's past purchases have actually been followed by declines in bitcoin's price.