Grayscale Review of July Market: Cryptocurrencies and Soft Landing Dreams
Original author: Zach Pandl
Translated by: Luffy, Foresight News
Since the end of 2022, there has been a noticeable recovery in the digital asset market, and the cryptocurrency industry is benefiting from technological and legislative progress.
Macroeconomic factors may be the biggest risk to the current cryptocurrency market. Recent economic data has shown low inflation and stable growth, which greatly reduces the possibility of an economic recession. Market expectations of a "soft landing" have propelled previously lagging risk assets such as crude oil and regional bank stocks.
If the US economy can achieve a soft landing, the rebound in the cryptocurrency market can continue. However, if the economy falters or the Federal Reserve further raises interest rates, the cryptocurrency recovery may temporarily pause.
While Bitcoin briefly consolidated in July, the rally in other risk assets has further expanded on the expectation of a "soft landing" in the US economy: that is, gradually bringing inflation back to target levels without a recession (Chart 1). We believe that the cryptocurrency market may benefit due to the correlation between mainstream tokens and risk assets, as well as various favorable factors in the industry. However, a soft landing is not a certainty, and it has increasingly become a consensus, so the market has already partially priced in the benefits of a soft landing.
In addition to regulatory progress, the near-term outlook for cryptocurrency may largely depend on whether the expectation of a soft landing can continue. If the upcoming economic data continues to support the argument for a soft landing, the rebound in mainstream tokens may persist. But if the economy falters or the Federal Reserve further raises interest rates, the cryptocurrency recovery may temporarily pause. Until the outcome is certain, the cryptocurrency market may experience significant volatility in altcoins, as happened in the past month.
Chart 1: Recent optimism about a "soft landing"
Last month's data and the signals from the Federal Reserve supported the view that the economy could achieve a rebalancing without falling into recession. Inflation is further slowing down, especially for "core" indicators that exclude volatile food and energy prices. Despite low unemployment, strong job growth, and a decline in unemployment claims, there are signs of an economic slowdown. In the press conference after the FOMC meeting on July 25th to 26th, Fed Chair Powell stated that the Federal Reserve staff predicts that the economy will not experience further decline.
In the financial markets, the prospect of a soft landing has led to the emergence of new outperforming stock portfolios. Over the past year as of June 1st, the performance of Bitcoin, the Nasdaq Composite Index, and AI-related assets has been better than the overall market, benefiting from the introduction of AI tools including ChatGPT (public blockchain technology may provide solutions to some AI challenges). However, in July, the leadership shifted to previous laggards, including US regional bank stocks and crude oil (Chart 2). It is noteworthy that many of the best-performing stocks in the US stock market are heavily shorted, indicating that many active investors are not betting on a soft landing.
Chart 2: Assets that lagged at the beginning of the year performed better in July
Bitcoin and Ethereum have fluctuated within a small range, with a slight decline compared to the previous period, as the dominant force in the market has shifted from tech-related themes to other areas. Compared to earlier this year, there are fewer driving factors for Bitcoin, such as concerns about regional banks (March 2023) and optimism about the approval of spot ETFs (June 2023). The actual and implied volatilities of cryptocurrencies have both dropped to historical lows (Chart 3). At the same time, their correlation with the S&P 500 index has rebounded after experiencing a decline in the first half of the year. Bitcoin's on-chain transaction fees decreased again in July, and steadily decreased after a surge in interest around ordinals in May. In contrast, Ethereum's transaction fees increased in July, and gas prices and maximum extractable value (MEV) rewards skyrocketed on July 30th after an attack on the Curve protocol.
Chart 3: BTC and ETH volatility decline
In July, the dominance of "altcoins" increased, and their volatility was higher than that of Bitcoin and Ethereum. We believe that the main catalyst was the court ruling on July 13th in the SEC v. Ripple Labs case in the United States. In the case, the judge ruled that certain sales to institutional investors met the securities trading standards and should be registered with the SEC, while certain sales to the public did not. It is worth noting that the court stated that Ripple's native token XRP "is not itself an investment contract as a digital token." The price of XRP rose in response, roughly doubling, although it declined towards the end of the month, it still grew by 48% compared to June. The clarification of XRP's legal status has driven the prices of other tokens, including XLM, SOL, OP, and MATIC. In addition to the XRP ruling, the bipartisan group of lawmakers continues to make progress on legislation related to cryptocurrency market structure and stablecoins.
The performance of other digital assets is closely related to the fundamental changes in the protocols, highlighting how progressive technological advancements are driving the development of the crypto industry. For example, after the proposal was put forward at the end of June, the governance token MKR of MakerDAO rose by 50% within a month. Additionally, the profitability of the protocol has increased by about 4 times since last quarter due to the rising interest rates, and this trend may continue with the Andromeda treasury of Blocktower (a real-world asset lending tool). Similarly, the prices of UNI and LINK tokens have also risen with the advancement of technology, which are respectively associated with the UniswapX protocol and Chainlink's new cross-chain interoperability protocol. Dogecoin also experienced an increase in late July, possibly due to Elon Musk changing his Twitter name to "X". Finally, Worldcoin (WLD) was listed on cryptocurrency exchanges at the end of this month, and its fully circulating market value has exceeded $20 billion.
Figure 4: Price increases of certain tokens driven by XRP court ruling and fundamental improvements
Since the end of 2022, the cryptocurrency market has made significant progress in its recovery, and we have reasons to be optimistic about recent technological advancements as well as legal and legislative developments. Therefore, we believe that the macro outlook is now the biggest risk facing the cryptocurrency market. An economic soft landing may benefit risk assets, including cryptocurrencies, as it could prompt the Federal Reserve to lower real interest rates. Considering Bitcoin's role as an alternative non-sovereign currency system and a hedge against inflation, if the Fed decides to tolerate persistently higher inflation than its target, Bitcoin may also appreciate. However, if central banks decide to further raise real interest rates, or if the economy falls into a recession, the cryptocurrency recovery may pause in the short term.
