Analysis of BTC, ETH, and SOL in the 2022 deep bear market
We’re now in the last quarter of 2022. Financial markets plunged deeper into a bear market as the Fed advocated more interest rate hikes despite a slowing economy. Crypto assets have started showing increasing correlation to traditional markets. A large part of this increase has been attributed to the escalation of crypto asset trading during the pandemic. The US is among the most technologically prepared for the adoption of crypto assets among advanced economies.
Bitcoin has always played a central role in the narratives that develop the crypto market. Historically, BTC hasn’t been closely correlated with traditional markets, but growth into mainstream adoption has changed this.
When comparing the price of BTC and QQQ (an ETF that tracks the Nasdaq 100 index), it’s evident that positive correlation has been apparent since 2019. BTC shows a strong relationship to the performance of the dollar and the bear or bull status of traditional markets. Over time, the relationship between crypto price swings and equity price movements has strengthened significantly. Many factors could contribute to this, including the increasing acceptance of crypto assets in retail and institutional investor portfolios, the outbreak of COVID-19, and crypto assets becoming increasingly accepted as payment methods.
While foreign interest rate policies have remained accommodating in this market, the Fed stepped up its fight against inflation by hiking up interest rates. This resulted in massive capital inflows to the US and increased outflows from other foreign nations. Dollar Currency Index (DXY) measures the value of the US Dollar against a basket of other major currencies. The Fed’s hawkishness makes the relative value of USD for investment increase over BTC. Investing in digital assets while USD is at its 14 year high of 3.25% means betting on lower rates, which investors are not likely to do.
Percentage of market capitalization is an indicator that measures a digital asset’s dominance within the crypto market. Using this data, we can identify how bullish investors are about Altcoins compared to Bitcoin. SOL started off the year with the highest dominance out of the three. This could be attributed to the rise of popularity for NFTs on the Solana chain as well as new protocols emerging after rounds of hackathons. ETH briefly took over BTC’s dominance during the merge in Q3, but declined when ETH price plummeted post-merge. Overall, BTC remains dominant amongst altcoins.
Bitcoin’s narrative leans into its role as the digital store of value, often compared to its counterpart, gold. Even though BTC has lost share relative to gold, what’s worth noting is its important differentiation to other crypto assets. While Bitcoin contributes to an insubstantial amount of yield in DeFi, this means it could potentially have a different regulatory position compared to other altcoins. This could remove US-based headwinds for investing. Combined with global fiat volatility, this could start painting BTC as a stable store of value that would increase investors’ appetite for it.
Ethereum’s narrative over the past year has been completely correlated to the anticipation of the merge. Post-merge, Bitcoin’s status of being the de-facto digital store of value has been widely challenged by the Ethereum community. PoS ETH is often referred to as ultrasound money, implying that it’s “better money” than BTC. One of the highlights of post-merge Ethereum points to it becoming a deflationary asset overtime. Those for Bitcoin argue that deflation is bad for the Ethereum economy because it incentives hoarding, and thus jeopardizes the market.
In an episode of Bankless, Justin Drake argues that this is a traditional economist thinking that deflation is bad. It’s important to distinguish two types of money, non-transactional money and transactional money. Non-transactional money is like collateral. Transactional money is like debt money. For example, everytime you take out a mortgage, you put your house as collateral. The collateral money is the house, and debt money is the mortgage. It’s true that you want your debt money to be inflationary, since it makes it easier for you to pay off the debt overtime and avoids defaults in the system. On the other hand, you want your collateral to be deflationary to grow overtime since it reduces the probability of liquidation.
In TradFi, we can think of gold as collateral money and fiat as debt money. Many within the Ethereum community argue that ETH is optimized to be collateral money. It’s used as collateral in the context of staking. Currently, around 12% of all ETH is being staked. Another use case of ETH as a collateral is in DeFi. A third case of ETH as a collateral is simply being a savings money, or store of value. This savings could be for housing, retirement or medical emergencies. In all cases, being a collateral means to be backing some sort of liability.
The transactional part of ETH is what generates cash flow and income, and would take up a significantly smaller percentage of ETH’s total supply. When compared to gold, gold has roughly 10% of its supply that’s actively being used and generates cash flow through its role as an industrial metal (fyi, every single iPhone and electronic uses gold). Many predict that the same will happen to ETH, over the long term, the vast majority of ETH will be non-transactional and used as collateral.
This is in play right now, for an asset like DAI, the stablecoin is used as a medium of exchange, and it’s backed by USDC but also large amounts of ETH as collateral. In this sense, deflation is bad for the debt money narrative but it’s definitely good for the collateral money narrative. This distinction in fiat has been somewhat blurred but will be cleared in crypto.
Staking has become a popular form of investment for Ethereum in 2022. As we’ve mentioned from our previous report on the merge, validators are unable to unstake ETH post-merge just yet, and exactly 32 ETH is required per validator. However, we continue to see more liquid staking platforms offer the ability to easily partially stake, unstake, or even trade staked ETH. This and the successful merge to Proof of Stake has made staking a continuously favourable investment on Ethereum.
Prior to the merge, ETH prices fell as speculators doubted the possibility of a successful merge, or a revolt by crypto miners who wanted to keep the PoW system. As we approached closer and closer to the merge date and the possibility of a successful merge became more evident, ETH prices rebounded. Following a successful merge, prices fell sharply, depicting a “buy the rumour, sell the news” response from investors. Ethereum co-founder Vitalik shared his view on Bankless by saying the merge was “not going to be priced in pretty much until after it happens.”
ETH funding rates continue to be negative as we approach the date of the merge. On the day of the merge, funding rates hit the lowest in all of September. Funding rates are expected to gradually decline in the near future as concerns over failed mergers have proven uncorroborated. Although the merge happened without any technical hitches, there are still other undercurrents in place that could contribute to the volatility of ETH, namely the new ETHW network.
Crypto markets remain under impact of the crash earlier this year, and the overall deep bear market has shown unprecedented increase of correlation between mainstream altcoins like Ethereum and the Nasdaq 100 Index. On-chain data suggests that crypto and US equity markets have become more integrated since the onset of the pandemic.
Solana started the year off strong, it continued to grow in network usage, developer activity, network infrastructure, and overall ecosystem. Its TVL increased steadily as we headed into the bear market, and in Q2 it briefly became the largest protocol by secondary NFT sales volume, ahead of Ethereum. Solana was put to the challenge through several network outages, wallet exploits, and emerging L1 competitors like Aptos and Sui. The overall price performance of SOL remains consistent to the rest of the crypto market.
SOL shows increasing correlation to TradFi markets, even more so than ETH and BTC as the correlation coefficient remains positive for the vast majority of 2022. In Q3, Solana saw significant technological advancements in core platform optimization such as the Neon EVM layer, Nitro Solana VM, and the embedment of the Move programming language.
Much like Ethereum, the funding rates for SOL remain negative for the majority of the deep bear market. Rising interest rates in the US means on-chain activity and yield is lower than previous years. While projects and ecosystems continue to build and attempt to create value through new innovations.
One good thing to come out of this deep bear market is flushing out bad actors in the space. What’s left are builders who continue to realize the purpose of each chain and ecosystem. Building what’s useful for devs, helping projects migrate, and making things as easy as possible for the end user.
The interdependence of crypto assets and stock markets has increased significantly in the post-pandemic era, with BTC as well as other altcoins like ETH and SOL. The magnitude of spillovers from cryptocurrencies to equity markets tends to increase during periods of high market volatility, which is important for emerging markets, given their increased adoption of crypto assets in recent years. Key drivers of the increased interdependence could include growing acceptance of crypto-related platforms and investment vehicles in the stock market and OTC markets, or more generally growing BTC/altcoin adoption by retail and institutional investors, many of whom have positions in both the equity and crypto markets.
Not financial advise though, DYOR pls.