Author: Matt Hu, Blofin CEO, Griffin Ardern, Blofin Macro Trader

Wu said blockchain authorization release

"The Darling of Institutions": Why BTC?

In the contemporary financial system, central banks are the source of liquidity in the financial markets. When central banks start releasing/contracting liquidity, changes in liquidity are reflected in real-time changes in the prices of bonds, commodities, foreign exchange, and financial derivatives, as well as in the changes in stock indices. Bitcoin, as a newcomer to the "macro club," has not been around for long. However, the US government holds the most Bitcoin, and the inclusion of Bitcoin in investment portfolios is gradually increasing, with top asset management institutions like Fidelity among the issuers of these ETFs.

Bitcoin ETF list and holdings as of July 17, 2023. Source: Bitcoin Treasuries

Compared to other cryptocurrencies, BTC is truly decentralized. The achievements of Mr. Satoshi Nakamoto are well known, but no one knows "who he really is." However, "who he is" may no longer be important; the Bitcoin network has matured, and the influence of anyone on the Bitcoin network can be ignored—the attribute of "true decentralization" is also one of the characteristics of a qualified macro investment target. Gold and minerals are created in the universe; agricultural products are produced by nature; Bitcoin comes from the cyber universe composed of algorithms and information.

Because BTC is a product of the cyber universe, the magic of central bank liquidity control is ineffective. The USD price of BTC may change, but 1 BTC always equals 1 BTC. Native crypto investors use BTC as an investment and store of value to counter inflation under the fiat currency system.

For fund managers from traditional markets, they value the role of BTC in risk diversification. The price performance of BTC and gold has never reached a "strong correlation" level, and the correlation with US stock indices also fell to around 0 in 2023. At the same time, since BTC belongs to a completely different asset class, it means that BTC can to some extent diversify the overall risk of the portfolio. The compliance of BTC is also widely recognized, which greatly reduces the legal risks of investing in BTC.

BTC and gold price correlation changes in the last 90 days from July 2020. Source: CoinMetrics

BTC price and US stock index correlation changes from January 2021. Source: Block Scholes

Macro hedge fund managers are more concerned with liquidity. Their strategies usually invest in bonds, foreign exchange, commodities, stock indices, and prefer to trade through derivatives rather than spot-based. "Liquidity" is the core reason-macro trading requires accurately grasping the timing of liquidity changes and entering and exiting at the fastest speed and lowest cost. As an emerging asset, backed by the global liquidity in the Bitcoin network and abundant derivatives, the liquidity of BTC can be comparable to foreign exchange.

More importantly, due to the high speed and low transaction costs brought by the Bitcoin network and cryptographic infrastructure, traders can deploy and exit liquidity within seconds without having to constantly negotiate with numerous third-party institutions over the phone or wait for bids to be accepted in illiquid OTC trading systems. These advantages make BTC more sensitive to market sentiment and macroeconomic events, as reflected in its price fluctuations and volatility changes.

BTC price movements from January to July 2023. Source: blofin.com

Pay attention to the purple portions in the graph, which correspond respectively to the March banking crisis, the May Fed rate hike, and the submission of BTC spot ETF in July.

BTC DVOL volatility index compared to realized volatility levels from May 2021 to present. Source: Amberdata Derivatives

It's not difficult to see that BTC's volatility index is more sensitive to macroeconomic changes.

BTC DVOL volatility index compared to the level of "volatility of volatility" in August 2022. Source: Amberdata Derivatives

Compared to volatility, BTC's volatility changes are more rapid and sensitive.

In short, whether it's crypto enthusiasts, traditional market fund managers, or macro hedge fund traders, BTC fulfills the requirements of different types of investors in terms of functionality, compliance, risk management, liquidity, and trading. It's difficult to find a macro target that can meet all these needs at once; in other words, BTC is a natural macro trading target.

ETH: A "software company" with a P/E ratio of 312.58

Crypto market investors like to compare BTC and ETH; based on market capitalization, BTC and ETH rank first and second on the cryptocurrency market cap list, and every crypto trader will involve these two cryptocurrencies. However, investors from traditional markets have a different perspective. In fact, they are more cautious about ETH: leaving aside the potential compliance risks of ETH, considering the influence of Ethereum founders and developers on the development of the Ethereum blockchain, as well as Ethereum's "smart contract as a service" model, it is more like a "software company" similar to IT giants such as Amazon and Microsoft, rather than a "pure liquidity container" like the Bitcoin network.

In fact, some researchers and traders have been using a corporate finance framework to interpret ETH:

Ethereum profit and loss statement. Source: artemis.xyz

So, it seems reasonable to analyze ETH using a fundamental analysis framework used for stocks. Fortunately, due to the transparency of the blockchain itself, obtaining real-time supply and price of ETH is not difficult. Similarly, thanks to the efforts of researchers like Sam Andrew, we have also obtained the financial situation of the Ethereum network in a more feasible way. Let's estimate the current P/E ratio of Ethereum together:

Starting from when ETH officially introduces PoS, from the fourth quarter of 2022 to the second quarter of 2023, the total profit of the Ethereum network (in USD) is: (3,959 * 1,301) + (79,210 * 1,589) + (227,147 * 1,861) = $553,735,916, equivalent to an annualized income of approximately $738,314,555;

The spot average price of ETH (July 17th) is approximately $1,920;

The real-time supply of ETH (July 17th) is about 120,201,013;

Therefore, the P/E ratio of ETH = 1,920 / (738,314,555 / 120,201,013) = 312.58.

312.58! This is an amazing P/E ratio. We provide the P/E ratios of the Magnificent 7 (the seven largest tech stocks in the US market) for comparison *:

AAPL: 32.38

AMZN: 164.24

ETH: 312.58

GOOGL: 27.93

META: 38.32

MSFT: 36.92

NVDA: 207.62

TSLA: 82.76

*: All stock P/E ratios are based on the closing price on July 14th. The P/E ratio of ETH is based on the average price on July 17th.

Undoubtedly, Ethereum, as a "software company," has significantly exceeded our original expectations. Considering its non-dividend nature and its high growth phase after transitioning to PoS, the high P/E ratio is similar to that of NVDA with AI support. And compared to the P/E ratio of AMZN, as a provider of core infrastructure in the crypto industry, the high P/E ratio of ETH is not difficult to understand. Overall, investors have given a high valuation to ETH, expecting the unlimited possibilities of its future development.

However, when Ethereum can be fully self-consistent under the logic of a company, BTC and ETH have officially taken different paths.

Separate Paths

Under the narrative of "Crypto 3.0," where will BTC and ETH go?

BTC: Crypto Is Macro

Undoubtedly, the price of BTC will depend on the macroeconomic situation and the macro conditions within the crypto market. Therefore, for BTC, interest rates and market share will be important influencing factors. Interest rates affect expected returns, while market share affects market size.

• From the perspective of interest rates, the Federal Reserve is not likely to cut rates in the next six months, and the European Central Bank will also not show weakness under the threat of high inflation. These conditions mean that high interest rates will continue to suppress the performance of BTC. However, some potential positive factors are also supporting the price of BTC, such as the possible listing of BTC spot ETF.

Latest potential interest rate path of the Federal Reserve, as of July 17, 2023. Source: CME Group

• In addition, the internal allocation of liquidity in the cryptocurrency market will also affect the price and market value of BTC. From the beginning of 2021 to the end of 2022, influenced by the bull market and the "altcoin season," BTC's market dominance gradually declined from over 60% to between 40% and 45%. Subsequently, benefiting from institutional buying and liquidity returning, BTC's market dominance started to rebound from January 2023. By July 2023, BTC's market dominance was about 50%.

Changes in market dominance of mainstream cryptocurrencies, as of July 17, 2023. Source: Coinmarketcap

• When interest rates are at 0%, the total market value of the cryptocurrency market is approximately $30 trillion. When interest rates are at 5.25%, the total market value of the cryptocurrency market is approximately $1.2 trillion, about 40% of the peak. From November 2021 to March 2022, due to the Fed's expected management, the cryptocurrency market lost about $1 trillion in market value. In March, the Fed raised interest rates by 25 basis points, and at that time, the total market value of the cryptocurrency market was approximately $2 trillion, about 67% of the peak.

• Taking into account that the Federal Reserve is not expected to implement unlimited quantitative easing policies like those in 2020-2021 in the coming years, the largest expected change in the total market capitalization of the cryptocurrency market will not exceed $1 trillion.

Changes in the total market capitalization of the cryptocurrency market as of July 17, 2023. Source: Coinmarketcap

Let's develop the following logic based on the above:

• Considering the lack of external liquidity entering the cryptocurrency market, we assume that the future price of BTC will depend entirely on changes in interest rates and market expectations, reflected in changes in market share.

• Under the conditions of a high interest rate of 5.25% and a lack of external liquidity entering the market, it is difficult for the total market capitalization of the cryptocurrency market to increase significantly before January 2024. Even in the most optimistic scenario of "expectations leading," the growth of the internal market value brought by expectations will not exceed $500 billion.

• The total supply of BTC is about 19.43 million coins, and there will not be a significant change in the total supply by more than 5% within a year.

Let's consider three simple scenarios:

1. Investors have no further expectations, and the growth of the internal market value of the cryptocurrency market is limited. The total market capitalization of the cryptocurrency market will stabilize between $1.2 trillion and $1.4 trillion, and the market share of BTC will not undergo significant changes, remaining at around 50%. This means that the market value of BTC will fluctuate between $600 billion and $700 billion, and the price will fluctuate between $30,880 and $36,026;

2. Bitcoin spot ETF is approved, bringing favorable expectations to investors. The market capitalization of the cryptocurrency market rebounds to around $1.5 trillion to $1.6 trillion.

- If the market share of BTC does not increase, the market value of BTC will stabilize at around $750 billion to $800 billion, and the price may reach a maximum of $41,173; even if the rebound is not too strong, the price of BTC will still be higher than $38,500;

- If the spot ETF is approved and the market share of BTC rises to 60%. In the best case scenario, the market value of BTC will reach $960 billion, with a unit price exceeding $49,400; even if the overall rebound of the cryptocurrency market is not too strong, the market value of BTC will rise to $900 billion and the unit price will reach $46,300.

3. Expectations for interest rate cuts are combined with positive expectations such as spot ETFs and Bitcoin halving, which promote the overall return of liquidity to the crypto market, and the market value of the crypto market rebounds to over $1.7 trillion.

- If BTC's market share does not increase, the market value of BTC will reach over $850 billion, and the price will rebound to over $43,700;

- If BTC's market share reaches 60%, the market value of BTC will reach over $1.02 trillion, and the price will reach around $52,500.

In summary, macro factors are relatively favorable for BTC, and the ultimate level that BTC's price can reach depends on interest rates and market expectations.

ETH: "How to Build a More Profitable Company"

Considering that BTC has become the protagonist of the macro narrative, it may be wiser for ETH to make efforts in applications. Therefore, for ETH, the factors influencing its price mainly come from its own new narrative and whether it can be further widely used in the future. Since these factors will be reflected in Ethereum's net income, we can infer the possible price changes of ETH based on changes in the P/E ratio.

Similarly, let's consider three scenarios:

1. The significant upgrade of Cancun has greatly improved the speed of Ethereum's Layer 2 and reduced transaction costs, which has prompted the explosion of Ethereum's Layer 2 ecosystem. The profitability of the Ethereum network continues to grow, with quarterly revenues increasing by 50% before the Cancun upgrade and doubling after the Cancun upgrade.

- Assuming that the P/E ratio of ETH does not change significantly, investors' strong expectations push the P/E ratio to remain around 300. The net income for Q2 2023 is $423 million, Q3 net income is $635 million, and Q4 net income is $953 million. In this scenario, Ethereum's total revenue for 2023 will reach $2.137 billion. Considering that ETH deflation will reduce the total supply of ETH to 120 million, the average price of ETH in early 2024 may exceed $5,300, and in the first quarter after the Cancun upgrade, it may exceed $9,700.

- Assuming investors have a relatively neutral expectation, causing the PE ratio of ETH to fall to around 150 (close to the level of comparable companies like AMZN), under this scenario, the average price of ETH will reach around $2,670 in early 2024 and approach $4,900 in the first quarter after the Cancun upgrade.

2. The profitability of the Ethereum network is relatively stable, with quarterly revenue increasing by 25%, and revenue in the first quarter after the Cancun upgrade increasing by 50% compared to Q4 2023.

- Assuming no significant change in the PE ratio of ETH, strong investor expectations drive the PE ratio to remain around 300. The net income for Q2 2023 is $423 million, Q3 net income is $529 million, and Q4 net income is $661 million. Under this scenario, the total revenue of the ETH network in 2023 will reach $1.739 billion, and the average price of ETH in early 2024 may exceed $4,300 and surpass $6,500 in the first quarter of 2024. If the PE ratio falls to around 150, then the average price of ETH in early 2024 may be around $2,150 and surpass $3,200 in the first quarter of 2024.

3. The profitability of the Ethereum network shows marginal decline, with revenue growth rates of 20% and 15% for Q3 and Q4 respectively. The positive impact of the Cancun upgrade only temporarily halts the decline in profitability.

- Assuming no significant change in the PE ratio of ETH, strong investor expectations drive the PE ratio to remain around 300. The net income for Q2 2023 is $423 million, Q3 net income is $508 million, and Q4 net income is $584 million. Under this scenario, the total revenue of the ETH network in 2023 will reach $1.641 billion, and the average price of ETH in early 2024 may exceed $4,100 and surpass $5,400 in the first quarter of 2024. If the PE ratio falls to around 150, then the average price of ETH in early 2024 may be around $2,050 and surpass $2,700 in the first quarter of 2024.

In summary, the development of ETH is highly related to its own profitability. The combination of narrative support and sustainable and growing profitability is key to driving the increase in ETH price - which sets it apart from BTC.

Junction

In fact, the "divergence" in the encryption market is no longer just theoretical, nor is it limited to BTC and ETH. According to statistics, in 2023, not only has the correlation between BTC and ETH significantly decreased, but the correlation between BTC and mainstream altcoins has also significantly decreased. BTC seems to be going its own way, while the correlation between ETH and XRP, LTC, BNB, and other different types of coins is also weakening. However, there is still a strong correlation between ETH and public chain coins like ADA, as well as project tokens like CRV that are deeply rooted in the Ethereum public chain.

With the continuous weakening of correlations between different cryptocurrencies, previously fully or partially reusable analytical logic and trading strategies are no longer effective. Pair trading no longer exhibits ideal correlation regression, and general investment frameworks based on market value and sectors are also somewhat inapplicable - this means that further analysis based on the fundamental aspects of projects becomes more important.

Correlation changes between BTC and major cryptocurrencies excluding ETH, as of June 2023. Source: Kaiko

Correlation changes between ETH and major cryptocurrencies excluding BTC, as of July 2023. Source: CoinMetrics

Now is the time to adopt completely different logics to look at the cryptocurrency market. Cryptocurrency 3.0 has already arrived; the era is moving forward. Bitcoin will be more closely integrated with the macroeconomy and traditional markets, while Ethereum needs to become a "great company"; other cryptocurrencies also need to find their own paths. In the rapidly changing cryptocurrency market, we need to keep up with the times.