Market Byte: Late Summer Storms

• Crypto valuations declined at the start of August, amid worries about the U.S. economic outlook and broader financial market volatility. Ethereum underperformed, potentially due to elevated futures market positioning and selling from a few large holders.
• If the U.S. economy remains on a path to a “soft landing” Grayscale Research expects token valuations to rebound.
• However, even in a weaker economic environment, Grayscale Research has reason to believe that downside risk to prices may be more limited than in the past.

Crypto assets and broader financial markets stabilized midweek after sharp declines from Friday, August 2, through Monday, August 5 (Exhibit 1). Although major token prices typically have a low correlation with other asset classes, volatility in traditional markets can affect crypto valuations.

Exhibit 1: Bitcoin and Ethereum declined at the start of August

The proximate cause of the drawdown was a weaker-than-expected U.S. employment report for July, published Friday, August 2. In particular, the report showed that the unemployment rate had increased by a magnitude typical of past recessions.[1] Fears of a cyclical downturn contributed to weaker performance from cyclical assets like equities, and strength in traditional safe havens like U.S. Treasury bonds, the Japanese Yen, and the Swiss Franc (Exhibit 2). Non-U.S. stocks and strategies that short U.S. equity volatility performed especially poorly. Bitcoin and Ethereum both declined; while Bitcoin held up relatively well on a risk-adjusted basis, Ethereum underperformed both other crypto assets and many traditional market segments, which we explore further below. Among major crypto assets, Solana was a notable outperformer.

Exhibit 2: Ethereum among underperforming market segments

Although Ethereum has higher volatility than Bitcoin, its underperformance during the latest drawdown was more pronounced than normal. For example, Exhibit 3 shows the largest percent declines in Bitcoin’s price since 2020 and compares them to the declines in Ethereum’s price over the same period. During these events, Ethereum’s price typically fell about 1.2x as much as Bitcoin’s price. The latest “crypto winter” (i.e., bear market episode) showed similar relative performance.[2] In contrast, August 2024 month-to-date, Ethereum’s price has declined about 1.8x as much as Bitcoin’s price, suggesting additional, unique downward pressures on Ethereum.

Exhibit 3: On average, Ethereum typically falls 1.2x as much as Bitcoin in drawdowns

One reason for Ethereum’s comparatively large price drop seems to have been outsized long positioning in perpetual futures. In May 2024, around the time that the Securities and Exchange Commission (SEC) approved issuers’ 19b-4 filings for U.S. spot Ethereum exchange-traded products (ETPs), traders significantly increased gross positioning in perpetual futures (Exhibit 4), perhaps in anticipation of further price increases upon full regulatory approval; this approval occurred in July 2024, and U.S. spot Ethereum ETPs began trading shortly thereafter. A portion of the long positions were then liquidated during the recent drawdown, accelerating the price decline. On August 4, Ethereum’s price fell by 7.6% over just a three-minute window, and liquidations of perpetual futures totaled $340 million just on that day alone.[3] Because the sell-off occurred during the U.S. overnight session and involved a meaningful spot price discount on Binance vs. Coinbase[4], the liquidations seem to have been dominated by leveraged traders in Asia.[5]

Exhibit 4: Ethereum futures leverage increased in May 2024

Another factor possibly contributing to Ethereum’s underperformance has been actual and anticipated selling from a few large holders, including market maker Jump Crypto; venture capital investor Paradigm; and the Golem Network — a crypto protocol with sizable Ethereum treasury holdings.[6] While the exact amount of selling cannot be determined, based on data from analytics platform Arkham Intelligence, Grayscale Research estimates that these entities collectively held about $1.5 billion worth of Ethereum before they began moving tokens (based on Ethereum prices at that time[7]). A decline in the number of active validators and an increase in Ethereum’s staking reward rate also point to movement in relatively sticky token supply, which may be weighing on market sentiment.[8]

Broader financial markets settled down over the course of the past week. Perhaps most dramatically, the VIX index, a measure of implied volatility for U.S. equities, fell to 26% by Thursday’s close, after reaching an intraday high of more than 60% on Monday (Exhibit 5). Whether the market’s stability continues will depend on the upcoming macroeconomic and corporate earnings data, as well as any policy response from the Federal Reserve or other central banks. In terms of economic data, key upcoming reports include the weekly unemployment claims reports (which is published every Thursday), the Consumer Price Index report (which will be published August 14), and the next employment report (which will be published September 6). The Federal Reserve appears very likely to reduce interest rates at its September 18 meeting, but markets are more focused on what the path for policy will look like thereafter. Policymakers may offer additional guidance at the upcoming Jackson Hole Symposium, which takes place August 22-24. Grayscale Research is monitoring these events closely, and will share insights via our newsletter and on @Grayscale’s X account.  

Exhibit 5: Market volatility declined over past week

If the U.S. economy avoids recession and remains on a path to a “soft landing,” Grayscale Research expects token valuations to rebound and Bitcoin to retest its all-time high price later this year. However, even in a weaker economic environment, Grayscale Research has reason to believe that the downside risk to prices may be more limited than in past drawdowns. These include relatively steady net demand from the new U.S.-listed ETPs, a lack of credit provided by centralized financial institutions during this cycle[9], and relatively subdued altcoin returns since the start of the year. Shifts in the U.S. political landscape around the crypto industry may also reduce downside risks to valuations compared to past cycles (see July 2024: Bitcoin Goes to Washington).

The economic cycle is an unavoidable feature of investing in virtually every asset class, and uncertainty about the macro outlook should be considered a short-term risk for crypto investors. At the same time, Grayscale Research believes that there is very little tolerance for a deep economic downturn, and is expecting policymakers to print and spend at the first sign of trouble. The undisciplined approach to monetary and fiscal policy is one reason why some investors choose to invest in Bitcoin; a period of economic weakness could therefore reinforce the longer-term Bitcoin investment thesis.

[1] Economists often refer to this statistical regularity as the “Sahm Rule”.

[2] For example, during the peak-to-trough period in Bitcoin’s price during the last cycle, both Bitcoin and Ethereum declined by identical amounts. During the “bear market” period from March 2022 through October 2023, Ethereum declined 1.3x as much as Bitcoin. Source: Artemis, Grayscale Research.

[3] Source: Trading View, Coinglass.

[4] Source: Coinglass

[5] On-chain liquidations may also have contributed to the sharp decline in Ethereum’s price. For example, lending platform Aave reported liquidations of $239mn on August 5. Source: Dune Analytics. Data as of August 8, 2024. For illustrative purposes only.

[6] Source: The Defiant, CoinDesk, Arkham Intelligence data.

[7] Specifics dates are 6/21/24 for Paradigm, 7/8/2024 for Golem, and 7/24/2024 for Jump.

[8] Source: validatorqueue.com. 

[9] Several centralized lending businesses went through bankruptcy in recent years. Source: Blockworks.