Market Update — Great Newsflow, Terrible Prices

Sector newsflow has been strong for most of 2018 with improving regulatory clarity, accelerating entry of new market participants and, most importantly, the continued inflow of key global development and tech management expertise. Unfortunately digital asset prices have disconnected from this and their year-to-date performance has been what can only be described as terrible. With encouraging, tangible newsflow and falling prices fundamental value has to be improving but at what point it starts to attract sizeable, new investors remains the key question.

With this in mind, over the last fortnight we have travelled extensively meeting with a number of investors (some invested in the sector, some not) to discuss market conditions — discussing both our views and to hear their feedback. The below summarises the main market themes we discussed and how we believe these are driving short-term prices. Whilst these short-term themes are an interesting discussion (for us at least!) its critical to keep perspective on the longer-term outlook — our short-form view on which we also share below.

Summary

In our view, the key thematics currently driving the market are:

  • Volatility remains high and is a key issue deterring new potential investors;
  • Retail investors continue to be a key driver of digital asset prices but this is being diluted as the range of market participants broadens;
  • Mining issuance is finely balanced with investor inflows which is creating a weak supply/demand backdrop;
  • Regulatory uncertainty is slowly clearing but there is still some way to go -a potential ETF approval remains the most visible short-term catalyst;
  • Established Wall Street players entering the sector will increase market liquidity/sophistication — whilst their entry will take some time its a clear positive in terms of liquidity and potential improvements in the volatility backdrop; and
  • ICO issuance volumes remain high but we are seeing accelerating signs of it slowing — ether selling by 2017/earlier-2018 ICO projects continues to weigh on the market but this is dissipating and with an increasing trend to cash contributions this should help to mitigate this going forward.

Each of these is discussed in more detail below.

Volatility remains high and a significant deterrent to new investors

Whilst bitcoin’s volatility has fallen from late-2017/early-2018 levels it still remains high relative to almost all traditional assets — as illustrated by the chart below of bitcoin’s volatility against the relatively volatile oil and gold:

DACM analysis, *1 month rolling standard deviation of daily log returns

From our discussions volatility remains a key deterrent for potential new investors. With inflated volatility, new investors, many of which measure returns in a volatility-adjusted manner, require high conviction of bitcoin’s short-term recovery to justify a new or incremental investment — it is evident from ongoing price weakness that they do not yet have this conviction.

Will volatility fall in the short-term? Whilst the chart above shows volatility falling, unfortunately, at this point, we believe this is more related to falling bitcoin prices (bitcoin prices and volatility remain positively correlated). Longer-term however with increasing futures volumes (and derivative products in general) and an increasing, institutional-biased investor base we would expect volatility to fall which will help to broaden the sectors investment appeal.

Retail investors still a key driver…but its changing

We think this is best illustrated in the relationship between Google searches for bitcoin (a measure, albeit far from perfect, of retail investor interest) and bitcoin’s price movements — a relationship that has historically shown a very high correlation but has shown signs of breaking down over the last six months:

As-at 27 August, 2018 Source: www.coinmarketcap.com, Google Analytics

As shown in the chart, the correlation between these data sets is 0.63 over the last six months against 0.82 for the previous six months and 0.84 over bitcoin’s trading history.

Mining issuance finely balanced (probably unbalanced) with inflows

Mining issuance, through block rewards, a significant portion of which we believe are currently coming directly to the secondary market, necessitates inflows (new demand) to maintain a balanced secondary market. Bitcoin and ethereum alone are minting around $490m of new coins/tokens monthly and we believe the portion of these assets that find their way to the secondary market are currently outweighing new investor inflows:

DACM estimates — as-at 27 August, 2018

Ethereum’s falling rewards, and eventual move to POS, will help reduce this ongoing supply, as will bitcoin’s next halving, but the combination of these events are some way away and mean this incremental supply is here to stay (and weigh on the market) for the short to medium-term.

Regulatory uncertainty slowly clearing but some way to go — a potential ETF approval remains the most visible short-term catalyst

Key regulatory catalysts are inherently difficult (read impossible) to predict however regulatory approvals relating to a US-based bitcoin ETF are probably the most transparent process and most straight forward potential regulatory-driven price catalyst. As we have previously published we believe the addition of US-based ETF(s) for bitcoin are a clear positive but likely a medium-term event (and then will take some time to build scale). With regard to market impact, to recap, we see, based of the historical growth of the gold ETF market, net incremental demand of around 787,000 coins or around $5bn at current prices which is clearly material:

Established Wall Street players entering the sector will increase market liquidity/sophistication

Key traditional players across exchange, banking, custody and settlement solutions are committing to the sector. Again, their entry and growth to scale will take some time but introducing traditionally accepted services like broking, custody and insurance to the digital asset space will materially increase the universe of potential market participants.

In addition to increasing the pool of potential investors increased institutional ownership is likely, over time, to reduce the sectors overall volatility as a more balanced distribution of owners is achieved.

ICO issuance/project selldown continues to weigh on the market but we expect it to dissipate

There has been over $14bn raised year-to-date through ICOs or around $10bn if adjusting for the booking of EOS’s total raise in June. Whilst volumes remain robust we would expect them to fall in the coming months and in particular have seen, unsurprisingly, a significant slowing in marketing activity by smaller, utility-token offerings. Having said this, larger, more sophisticated raisings are still closing and attracting quality investors but the aggregate capital being raised is likely to fall back below the $1bn monthly level.

Source: CoinDesk, as-at 31 July, 2018

The selling of ether by ICOs completed in late-2017/1H18 has clearly impacted its price and had a flow-on impact across much of the market- particularly alt-coins. With falling volumes and with the level of selling already seen (both through our counterparty feedback and wallet data) we would expect this to abate over the next month or so. Recent ICO rounds we have seen and participated in, at the seed/institutional round stage, are also strongly biased to cash contributions and those that are accepting ether are monetising it immediately (we recently contributed directly to an OTC account that immediately sold the ether and provided guaranteed cash funding to the ICO issuer). We therefore expect the relationship of ICO issuance and ether selling to weaken over the coming months as new issuers, particularly those unrelated to ether, focus on cash-proceeds. Whilst this is positive for ether’s price performance, the other side of the equation (less ether being used in the funding of ICOs) also reduces demand so ether’s overall outlook remains clouded as long as ICO activity remains a key driver of it’s price.

Outlook — Keeping Perspective

Its important to remember that most of the themes mentioned above are short-term in nature. Whilst its necessary to follow and understand these themes its critical not to lose sight of the longer-term picture for this asset class — namely:

  • Ownership remains nascent — it’s still early days in this asset class’ development with both institutional and high-net-worth retail ownership close to non-existent — we remain convinced this will not remain the case;
  • Somewhat related to the above, market infrastructure is developing and making it easier for a broader set of investors to access digital asset but a lot more upside remains in this area;
  • Use cases for blockchain are exploding as more and more innovators turn their minds to the disruptive potential of this new technology and “business model” — in our experience, key developers that are driving innovation, are not distracted by short-term market prices; and
  • The sector continues to attract the most outstanding tech talent globally which in our opinion makes the asset classes success all the more inevitable — this sector remains the most exciting opportunity for developers and tech entrepreneurs alike and we continue to see significant inflows of high-quality leadership teams to existing and new projects