Market
The crypto market in the past week has shown some encouraging signs of recovery. BTC (+2.94%) has outperformed both the equity market (SPY -0.50%) and the fixed income market (AGG -0.43%) over the 5-day period. ETH (+5.66%) has outperformed BTC, reversing the recent trend of declining ETH-BTC ratio back to the level last seen on September 11. A further +1.6% increase may help this ratio break the descending wedge pattern that has been present for the past year.
The outperformance of ETH is encouraged by the upcoming ETH futures ETF launch. In fact, Valkyrie has received approval from the SEC to convert their current BTC-only futures ETF to include ETH futures as soon as October 3. While ETH futures ETF might not significantly increase the mainstream adoption of BTC and ETH, considering the continued delay of the SEC approval of spot BTC ETF, as we previous mentioned, the ETH futures ETF approval could bolster the arguments against ETH as a security.
More encouragingly, a slew of bluechip altcoins have outperformed both BTC and ETH this week. With the LSD sector (LDO+RPL) and the DeFi sector (UNI+AAVE+MKR+LINK) returning more than 10% in the past 7 days. LDO (+13.03%), MKR(+14.55%) and LINK (+14.23%) have led the rally, indicating the market is willing to reprice these assets based on improved fundamentals and the prospect of growth opportunities ahead.
On the macro front, September has proven to be a down month for equities, fixed income and gold. Oil saw the biggest rally among macro assets (USO +12.11%) while the US dollar experienced moderate gains (DXY + 1.44%). The leading indicators are showing mixed signals, with both the manufacturing and non-manufacturing PMI indices up (bullish) and housing start and employment rate down (bearish). We are likely to enter a “higher rate for longer” environment as the futures are pricing in a 35% probability of at least one rate hike by year-end. The market is seeking more clarity on the directions as additional economic data rolls in for Q4. Although VIX remains relatively low, we anticipate more volatility ahead.
CeFi Update
It’s encouraging to witness select banks conducting trials on blockchains. What’s even more promising is when “hubs” of banks engage in DeFi experiments on a broader scale. Two of the most notable examples are the Bank for International Settlements (BIS) and SWIFT. BIS, the hub for central banks globally, successfully concluded Project Mariana last week, a 1-year trial demonstrating cross-border trading and settlement of wholesale CDBCs. SWIFT, the international financial transaction messaging network, also concluded their trial with Chainlink in August, aiming to use CCIP to facilitate the transfer of tokenized value across multiple public and private blockchains.
Both experiments represent TradFi’s confirmation on the benefit of bringing assets on chain through tokenization, whether it’s currency (CDBC) or broader asset classes. They took two different approaches though: BIS’s experiment requires central banks to use a common ledger for different CDBCs, and they were using Ethereum in this trial. SWIFT uses CCIP to connect different blockchains each bank uses to achieve interoperability. It would be ideal for all the banks to conduct transactions on the same common ledger, but given different regulatory regimes and tech implementations, interoperability is more likely the necessary approach. This positions Chainlink’s CCIP favorably for capturing more enterprise business.
BIS’s experiment using AMM for interbank CDBC settlement is also very revolutionary. Despite the regulatory headwinds many DeFi protocols face, the innovative AMM mechanism is being examined by TradFi giants for the benefits of efficiency and transparency. It’s exciting to imagine the $5 trillion trading volume per day FX market could run on AMMs, even if it doesn’t directly benefit Uniswap or Curve. The convergence of the DeFi and TradFi standards could bring more institutional business (or an exit path?) for bluechip Defi protocols.
While the future is bright, fundamental issues still exist for any TradFi institution to consider evolving their business on-chain, especially on a public one. Financial institutions are heavily regulated for many reasons. For example, if the chain is down, who is responsible for any monetary losses? Can customers contest a transaction if there is no intermediary to help investigate and revert?
Compared to the heavily regulated financial industry, the adoption of blockchain in the gaming sector might be more feasible, except for challenges related to the technology itself. A leaked document from Microsoft unveiled their intentions to introduce crypto wallets to Xbox. Although not officially confirmed by Microsoft, this leak strongly suggests their efforts behind the scenes to integrate Web3 into their product strategy. Taking a step ahead, Sony has established a joint venture with Startale Labs, a Japanese web3 company. From my conversation with both parties at Token2049, it seems unlikely that Sony is transitioning their successful Web2 games to Web3. However, Sony is actively exploring ways to assist their network of creators and gamers in monetizing through Web3.
DeFi Update
While TradFi companies are accelerating their blockchain trials, CeDeFi companies are also striving to enter the TradFi domain. Kraken, for instance, has plans to offer trading for US-listed stocks and ETFs by 2024. This move could potentially attract younger investors who prefer a one-stop shop for trading both crypto and equites. However, they face fierce competitions from retail brokerage firms like Robinhood. The question remains as to how Kraken can effectively separate its exchange and broker-dealer business, especially after SEC rejected Coinbase’s application as a broker-dealer in the US.
In an encouraging development, Pudgy Penguins are now available at Walmart in addition to Amazon. The adorable penguin, donning a Hawaian shirt, has already sold out. The price is very reasonable compared to owning the underlying NFT, although the NFT holder stands to receive royalties from the associated toy sales. This IRL approach is a great attempt to address the NFT valuation challenge, especially when the IP can be effectively monetized. However, given the low price level of the toys, we may need more content to sustain the value of the Pudgy Penguin NFTs. Nevertheless, it’s not a bad time for some early holiday shopping.
Trends to Watch
With the shifting focus of investors from infrastructure to applications as observed in recent crypto conferences, I thought it’s a good time to revisit the “Fat Protocol Thesis”(FPT). Due to the rapid development of application-specific chains and rollups, one could argue that FTP no longer holds true. For example, dYdX moving to its own Cosmos-based chain has no value accrual to ATOM token at all. Even within the Ethereum ecosystem, we can observe how “value” is distributed among different layers.
Consider L2s as specialized applications on Ethereum that provide wholesale blockspaces. They batch transactions and submit the bundle to Ethereum for settlement, charging a fee for this service. This fee essentially constitutes the sequencer revenue, from which they pay the gas fee to ethereum for data and settlement. The chart below illustrates the L2 profit margin, representing the percent of total revenue allocated to L2s. Currently, this falls between the 30-50% range, which is certainly promising for a wholesale business. After the Dencun upgrade, we anticipate more room for L2s to increase their profit margin as the cost is reduced by 10 times.
Source: Token Terminal, Decentral Park Capital. Profit Margin = 1 - Gas Fee Paid to Ethereum/Total Fee Earned by L2
So does Fat Protocol Thesis still hold? From a revenue-sharing perspective, the above-mentioned numbers suggest it may not be the case. In fact, as we continue to achieve breakthroughs in modular blockchain technology, blockchains should be so cheap to use that more apps would prefer to build on them rather than on the traditional infrastructure. This represents the end game we are aiming for. However, it doesn’t necessarily diminish the value of Ethereum. As we discussed in our previous weekly, Ethereum would function more like a nation-state currency, necessary to pay for public goods. In fact, the market has already begun to price ETH in that way. The P/S ratio for ETH has been increasing, which is atypical for a “maturing” business. This suggests the market is valuing ETH’s function as a form of money, rather than just a business that earns fees.
Source: Token Terminal, Decentral Park Capital
Top Gainers and Losers
Top 100 MCAP Winners
Maker (+20.56%)
GMX (+19.57%)
Pepe (+18.96%)
Compound (+17.78%)
Lido (+15.90%)
Top 100 MCAP Losers
Toncoin (-7.25%)
UNUS SED LEO (-5.09%)
Immutable (-4.51%)
Tether Gold (-3.72%)
GateToken (-3.71%)
About Decentral Park
Decentral Park is a founder-led cryptoasset investment firm comprised of team members who’ve honed their skills as technology entrepreneurs, operators, venture capitalists, researchers, and advisors.
Decentral Park applies a principled digital asset investment strategy and partners with founders to enable their token-based decentralized networks to scale globally.
The information above does not constitute an offer to sell digital assets or a solicitation of an offer to buy digital assets. None of the information here is a recommendation to invest in any securities.