February 28, 2024

Insights and analysis for the professional investor

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Welcome to Crypto Long & Short!

This week, Wilfred Daye, Co-founder of Samara Alpha Management, explains how the upcoming "Surge" is designed to improve Ethereum's network scalability, efficiency and security.

Then, Nathan McCauley, CEO of Anchorage Digital, argues that Separately Managed Accounts (SMAs) can help investors to get exposure efficiently to a range of digital assets.

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

– Benjamin Schiller, head of opinion and features at CoinDesk

From the Analyst

What to Expect From Ethereum's Cancun-Deneb Upgrade

The Ethereum blockchain has seen significant upgrades in recent times, enhancing its scalability, efficiency, and security. These improvements address the blockchain trilemma — the challenge of balancing security, decentralization and scalability. These ongoing enhancements are crucial for improving network performance while keeping costs low.

The upcoming Ethereum Cancun-Deneb ("Dencun") hard fork upgrade is set to be deployed on the mainnet on March 13. This upgrade will prioritize scalability, efficiency and security through various Ethereum Improvement Proposals (EIPs), notably EIP-4844 for proto-danksharding. This proposal aims to optimize gas fees and enhance network scalability.

The Dencun upgrade marks the beginning of "The Surge" era in Ethereum's roadmap, paving the way for achieving mass scalability through layer-two rollups. These rollups will make Ethereum more accessible and user-friendly, driving adoption and utility across various sectors, including DeFi 2.0.

The Benefits of Layer-2 Rollups

Layer-2 rollups enhance Ethereum's scalability and efficiency by processing transactions off-chain while preserving the security assurances of the main Ethereum blockchain (Layer-1). They have the following characteristics:

Off-Chain execution: Processing transactions off-chain enables quicker and more cost-effective throughput without competing for space on the Ethereum blockchain.
Transaction aggregation: Results of multiple transactions are aggregated or bundled into a single compressed form of transaction data after off-chain execution.
Posting to main chain: The compressed transaction data, or rollup, is then posted to the Ethereum main chain (Layer-1).
Data availability: Despite off-chain processing, the main Ethereum blockchain ensures that transaction-related data remains accessible and verifiable by all participants.
Security: Layer-2 rollups maintain the security guarantees of the Ethereum network through various cryptographic techniques.

Significance of EIP-4844 for Proto-Danksharding

EIP-4844, or Proto-Danksharding, aims to significantly enhance the network's scalability by introducing temporary data blobs attached to blocks. This innovation reduces processing costs and increases throughput by:

Temporary data blobs: These storage spaces attached to Ethereum blocks allow additional data to be included in transactions without directly interacting with the Ethereum Virtual Machine (EVM).
Lower processing costs: Efficient handling of transaction data via blobs leads to lower gas fees for users, potentially driving average transaction costs below $0.01.
Increased throughput: EIP-4844 enables higher transaction throughput, potentially reaching speeds of up to 100,000 transactions per second (TPS).
Facilitating Layer-2 solutions: The proposal is expected to benefit Layer 2 scaling solutions, such as rollups, by providing additional temporary storage space.

Trading Outlook around the Cancun-Deneb Upgrade

Ethereum's network transitioned from Proof-of-Stake to Proof-of-Work in 2022 (the "Merge"), with ether becoming a deflationary asset as a result. Currently, more than 25% of Ethereum's total supply is locked in staking platforms, significantly reducing the available supply for trading or investing. This shock coincides with a burning mechanism reducing ETH supply by 0.21% per year.

Dencun is expected to act as a positive catalyst for ETH. Ether holders have significantly reduced their exposure to exchanges by transferring more than $1.3 billion worth of ETH into private wallets. Recent data from Bloomberg shows the ETH/BTC spot ratio retracting to 0.5, reminiscent of post-Luna/Terra levels in 2022.

This presents a reasonable entry point for Ethereum enthusiasts. Moreover, there has been a surge in short-term call buying for ETH, with traders anticipating a move towards $4,000 by the end of March. Traders also favor buying March 2024 calls and selling April 2024 calendar strategies. Traders' bullish sentiment is evident in the market, with approximately $2.5 billion worth of ETH calls and $1 billion worth of ETH puts in notional value.

ETH/BTC Cross

Source: Bloomberg

As we look ahead, in addition to ether, other high beta names in Layer 2 are also poised to benefit from the Dencun upgrade. Layer 2 networks like Arbitrum (ARB) and Optimism (OP), which bundle transactions before posting them back to the main chain, are expected to reap significant advantages from the introduction of data blobs, for instance.

- Wilfred Daye, Chief Executive Officer at Samara Alpha Management

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Institutional Outlook

Bitcoin ETFs and Crypto Separately Managed Accounts: What RIAs Need to Know

The recent approval by the SEC of spot Bitcoin ETFs was nothing short of historic, offering a new avenue for safe and compliant access to the largest cryptocurrency. Since January 10, there have been over $10 billion in inflows, helping drive a favorable outlook for Bitcoin and the broader market. For retail investors especially, spot Bitcoin ETFs simplify access to Bitcoin backed by secure custody while removing the complexity of managing private keys themselves.

With rising interest in crypto, Bitcoin ETFs raise new questions for institutions managing client assets: How should we meet client demand for digital asset exposure? What investment vehicles are best?

If the new ETFs are part of the answer, so is the complementary investment vehicle of crypto separately managed accounts (SMAs). Crypto SMAs, or portfolios of digital assets, are quickly gaining ground with wealth managers, family offices and registered investment advisors (RIAs).

Why Crypto SMAs?

SMAs have long been a key investment vehicle across a variety of traditional asset classes, from equities to fixed income. The SMA structure allows for direct ownership of — not just direct exposure to — the underlying asset.

Crypto SMAs give access to a wide range of assets beyond bitcoin. Multi-asset support allows institutions to meet client demand for a greater depth of exposure to crypto, especially novel protocols or tokenized RWAs.

In addition, crypto SMAs are easy-to-tailor to different client types and strategies. If, for example, a family office wanted to allocate 60% of a portfolio to Bitcoin and 40% to Ethereum, an SMA could be tailored to this allocation as a streamlined avenue for crypto exposure.

Much like spot Bitcoin ETFs, crypto SMAs provide institutions with the regulatory and security profile they need to engage in the asset class. To safeguard assets, a qualified custodian should serve as the base layer of a compliant-crypto SMA.

Qualified custodians are required to segregate accounts and cannot commingle assets. And a recent SEC proposal has emphasized the importance of qualified custodians across asset classes, including crypto.

Flexibility and tax advantages

An SMA approach enables investors to customize their portfolio to include many digital assets, enabling diversification and the ability to adjust risk. Additionally, an investor may benefit from professional management that tailors their portfolio based on market analysis and their individual goals. Such flexibility may allow for sophisticated tax management strategies, such as tax-loss harvesting on an individual basis.

Wealth managers, family offices, and RIAs should consider both spot Bitcoin ETFs and crypto SMAs side-by-side as safe, secure and compliant investment vehicles.

Focusing on key areas — such as asset support, portfolio allocation, and tax status — will allow institutions to make the best decision when selecting a spot ETF, a crypto SMA, or some combination of the two.

At the end of the day, having more choices for participation in the digital asset class is a major net positive for consumers and institutions — and the ecosystem is stronger as a result.

- Nathan McCauley, Co-Founder and CEO of Anchorage Digital

Takeaways

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

DON'T SLEEP ON ETHER: Bitcoin (BTC) has captured headline writers' attention in recent months given the spot bitcoin ETF excitement. And BTC's price has rallied commensurately, topping $60,000 this week for the first time since November 2021 (around the peak of the last bull market). And, yet, its younger sibling, the second-largest cryptocurrency – Ethereum's ether (ETH) – has done even better year-to-date. There might be a similar theme at work: There's some optimism U.S. regulators, after approving spot bitcoin ETFs, will do the same for ether ETFs. However, according to Bernstein, that's not all. The brokerage firm sees five catalysts fueling recent ETH gains. Ether's supply has not increased since the late 2022 shift to the proof-of-stake mechanism for running the blockchain, something Bernstein argues is underappreciated. Decentralized finance, or DeFi, is showing increased signs of life on Ethereum, the analysts noted. Bottom line, though: The two biggest cryptocurrencies by market cap are quite hot at the moment – and the bitcoin halving that optimists believe will fuel more bitcoin gains won't arrive until April.
MATIC MALAISE: Speaking of 2021, Polygon's MATIC token was, in the words of CoinDesk's Omkar Godbole, a "market darling during the 2021 bull run." In the latest market run-up, though, its price is falling, putting it way behind bitcoin, ether and the coins of other layer-2 blockchains that, like Polygon, seek to scale up Ethereum's capabilities. Those other layer 2s pose real competition for Polygon, as Godbole explains in his excellent story. The question for traders is whether MATIC has fallen too much and represents good relative value.