Will Alts Survive?
In this post, we seek to answer the often asked question “when will altcoins outperform Bitcoin?” We look at current uses cases and narratives, macro trends, and past Bitcoin cycles for clues to when altcoins may rally.
When Will Alts Outperform?
One of the most common questions we get asked by clients and partners is “when will alts outperform?” This is in reference to price returns of Bitcoin, which year to date have significantly outpaced most altcoins (digital assets which simply aren’t Bitcoin). This divergence in performance has Bitcoin today at over 70% dominance, or network value share of the digital asset class, a level not seen since early 2017. We believe there are several factors at play here, including Bitcoin halving cycles, a favorable macroeconomic backdrop for Bitcoin, and a current lack of fundamental drivers for many utility tokens and dapps.
A Look at Bitcoin Cycles
We’ve mentioned this numerous times in client research and in public posts, but it bears repeating: Bitcoin’s parabolic rise and subsequent fall has coincided with halving cycles. This is something we tried to quantify in our Stock-to-Flow (SF) post, which replicated the statistical log-log relationship with Bitcoin’s market cap and its SF ratio (inverse of the inflation rate), originally created by the pseudonymous PlanB.
Why does this happen? After all, Bitcoin’s programmatic block reward schedule and fixed supply are both well-known and easy to forecast. The first answer, which is entirely valid in our opinion, is the price action around the past two halvings were mere coincidences. Statistically speaking, a sample size of 2 with a total population of 34 is too small for a reasonable confidence level and margin of error. This is why we are so interested to see what happens next May — it’s the next out of sample test.
The other answer and one that resonates with us given our long history in the space and observations of price reactions to fundamental news is that digital asset prices may not accurately reflect all information correctly. This would be a blow to the efficient market hypothesis (EMH), at least in its strongest forms. We know, we almost dropped our Faberge Egg too, but our best guess is that digital assets at best exhibit the weak form of the EMH. This is great news for active managers, who can utilize their skills to generate excess returns for clients. As to how this explains returns for Bitcoin, our theory is that reward halving signals increasing scarcity that creates a buying frenzy. This buying frenzy eventually fails to take in more and more capital to sustain it and results in a price correction down to a level higher than where Bitcoin was before the halving.
Macro Backdrop Suits Gold (and Possibly Digital Gold)
It should be no surprise to multi-asset class investors that gold has found bid in this market, particularly since the beginning of June. While it’s tough to pinpoint the exact reason, several new items come to mind: heightening trade tensions between China and the US, devaluation of the renminbi, increasing complexity around a Brexit resolution, and decelerating global economic growth. In our opinion, all of these headlines combined with a slowdown in global growth has resulted in declining real yields, risk-free returns excluding the impact of inflation. Most of the headlines in the financial press are about nominal yields (ex: the $17T of negative-yielding bonds). Nominal rates are what you’ll see in just about every interest rate, policy setting measure, and yield calculation. But in our opinion, the most important metric for gold at the moment is real yields, which recently turned negative in the US. 10y TIPS are one measure of real yields:
We’ll expound on this in future posts but think of it like this: cash and gold are both sitting on a seesaw. When cash has a positive real rate of return, it is advantageous to hold it vs non-productive (non-income producing) assets. Gold and Bitcoin are both non-productive assets — owning gold or Bitcoin does not confer more gold or Bitcoin over time (unless you consider chain splits). In this situation with positive real rates, cash is sitting high up in the air on the seesaw with its feet up in the air.
When the real rate of return for cash falls to zero, investors should be indifferent to holding the two assets. Cash and gold (or Bitcoin) are now even on the seesaw, with falling preference to hold cash and increasing preference to hold gold. The seesaw is now horizontal.
When real rates turn negative, investor preference should be for gold (or Bitcoin) over cash as now holding cash now confers negative real returns (losses in real terms). Gold (or Bitcoin) is now high up in the air screaming for joy, while cash is planted on the ground. Granted this doesn’t happen all at once, but this is the situation which we’ve found ourselves in now.
As a final friendly reminder, while the preceding analogy is a way to think about cash vs non-productive assets, the observed price correlation ratio between gold and Bitcoin is quite low (90-day rolling correlation of 0.3 by our last check).
Fundamental Drivers for Many Alts Currently Lacking
Against the positive cyclical and macro backdrop for Bitcoin, we find that many alts are struggling to find product-market fit. The ICO craze of 2017 proved that platforms like Ethereum could be effective substrates on which to raise money (albeit not always in compliance with existing securities laws), but dapps and dapp platforms largely failed to transition from capital formation use cases to material dapp usage. Yes, Ethereum has DeFi, which is still nascent and rapidly changing, but growing. This area shouldn’t be underestimated. Other popular dapps are either stablecoin transactions (a growing use case perhaps should be classified under DeFi) or gaming (gambling) or video game applications. Unfortunately, many of the gaming and video games have most a few thousand daily active users. Exchange tokens certainly have found a niche, with trading and speculation a tried and true use case within crypto. This isn’t to ignore the fact that Bitcoin went through ups and downs over the years of trying to find product-market fit before mostly landing on digital gold today.
If we are to offer a piece of advice, it is to think of Ethereum as a tech platform rather than ether as being competitive with Bitcoin as a form of digital gold. The idea of a programmable SoV is antithetical in our view, plus ether doesn’t currently have a fixed supply, which may be one of the killer features of Bitcoin. Instead, we’d try the pitch like this: Ethereum is the world’s largest decentralized platform for the development of permissionless applications. Its ecosystem of developers, 5.5x larger than the next leading dapp platform, continually build new open source functionality, enhancing value to other users and the platform as a whole. Ethereum’s competitive moat and one that is hard to supplant is its ecosystem of open source developers. Any traditional startup with one of the words “platform”, “network effects”, or “user-generated content” would be enough to have VCs tripping over themselves to fund. To have all three is something special.
A Look at Past Cycles
A look at past crypto cycles may be instructive to how they fare in the future. Unfortunately, most tokens didn’t survive the last parabolic rise (2013) and subsequent crash (2014), which should be the first takeaway — most of alts will never return to their former glory. While it’s tough to completely kill a digital asset, we expect the asset class to exhibit venture style returns where 80% are nearly worthless, 15% have some value, and 5% really hit it big.
For the alts that did survive from the 2013 time frame, chiefly Litecoin (LTC) and XRP/Ripple (XRP), they didn’t rally until AFTER Bitcoin regained its previous high. After that, LTC and XRP quickly went back to their previous highs. For example, on February 23, 2017, when Bitcoin made a new high (from 2013), Litecoin was still at 10% of its previous peak price and XRP was at 8.6%. That’s down 90.0% and 93.4% respectively from their all-time highs. If history is to repeat itself, alts won’t rally until Bitcoin approaches the $20,000 number again.
Pay Attention to Events
Our final recommendation is to pay attention to catalytic events for alts. Hard forks, halvings, chain splits, airdrops, developer conferences, feature announcements, and partnerships all drive returns in a way that should make traditional securities investors jealous. Our previous event studies showed 26% (full percentage points) of alpha over Bitcoin (on median, average was even higher) for these types of events. Luckily we have a product for that, our Crypto Catalyst Calendar, so get in touch with us if you’re interested.
Conclusion
In summary, we believe Bitcoin has been having its moment because of the current macro and geopolitical climate coupled with asset-specific drivers, its upcoming halving. While alts as a broad category may be on their heels due to lack of use cases, we would be surprised for that to continue indefinitely. We recommend being objective about the trends in the market and discerning about the information consumed. We help financial institutions and digital asset investors make sense of this complex and fast-moving industry. To find out how we can help your organization, reach out to us here.
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