A Gateway to Digital Asset Insights

The saying "sell in May and go away" captures typical seasonal patterns in global equity markets. Historically, returns from the end of May through November are significantly lower than the rest of the year. But in an era marked by profound change, relying solely on past patterns is unwise. What’s the most significant change? We are transitioning from a period of abundance to one of scarcity. As policymakers strive for a soft economic landing, indicators like the surging price of copper – a crucial global resource – signal that changes are in motion, contradicting the deflationary trends that defined previous global growth cycles. In digital asset markets, there are also marked shifts in the dynamics of investor sentiment before and after Bitcoin halvings. Consider the Bitcoin cyclical indicator of unrealized profits as a ratio to unrealized losses. Before the Bitcoin halving in 2020, investor sentiment rose to "euphoric" levels only eight months after the event. During the 2024 halving, in contrast, extreme sentiment emerged more than six months beforehand. While it's easy to view these shifts as outliers, they underscore a broader trend. As Jeff Bezos once suggested, "When the data and the anecdotes disagree, the anecdotes are usually right." The transition from abundance to scarcity remains a narrative, an anecdote. But markets are signaling that it deserves our attention. “Sell in May and…wait a minute, get back here,” isn’t quite as catchy, but you get the idea.

Gold is an industrial powerhouse – top of its class in conducting electricity because it doesn’t rust. It can be spun into wires so thin that all of the gold ever mined would loop around Earth over 11 million times. Yet, we barely use it industrially. It’s only ~5% of gold demand in the past decade. Why? Because the costs are too high for industrialists to foot the bill. Gold’s long monetary history and durability define its value – a vehicle for storing wealth. Energy is spent digging gold out of the ground, impurities are added to harden it, and most of it ends up back underground in vaults. Even Costco is on the bandwagon, selling ~$200 million in gold bars monthly. Now, let’s parallel that with Bitcoin. At Bitcoin’s block 840,000, the reward for mining service providers halved. But it started a drama. When this block hit, transactors paid tens of millions in fees in the following days to get a chance to buy Bitcoin branded with art. Many had juvenile labels. But analyze, don’t judge. The NFT frenzy dilutes Bitcoin's use as a money system. If the scene steers more toward art than function, other tech will take over as the financial conduit of the blockchain monetary system just as copper took over for gold despite being inferior. It’s the sequel to the bitcoin blocksize war . Investors need to analyze. The outcome may confine Bitcoin to its most narrow case – digital gold.

On October 19, 1987, the US stock market suffered one of its steepest one-day plunges, reminiscent of the severe declines of October 1929. Yet, there was no trigger, no singular event to point to. Surveys conducted shortly after emphasized the role of market psychology. Despite the ensuing chaos, no systemic risk materialized. Major financial intermediaries, including clearinghouses that were at the center of the storm, remained solvent. It was a liquidity crisis where the system functioned as intended – transferring risk effectively, thus marking a win for the system. But there were policy pressures to act, leading to the implementation of "circuit breakers" to curb excessive volatility. Unlike traditional markets, crypto asset markets operate without such pauses, functioning 24/7 with a focus on efficient risk transfer rather than smoothing market prices. April 13, 2024 serves as another example where crypto markets experienced significant liquidations . It underscores that leverage can amplify financial risks and distort market signals. Both historical and recent events teach us that investor sentiment deeply influences market stability – the resultant volatility imposes discipline on investors. Such periods also test systemic resilience – core infrastructure like Bitcoin, Ethereum, and stablecoins demonstrate their ability to operate non-stop, maintaining order throughout.

There are more than two million unique crypto assets with a market size of $2.7 trillion and trading volumes in the top ten of global exchange activity. But big investors need to put big dollars to work – and today those dollars need to be concentrated. The top five crypto assets account for 84% of the total market. It’s a macro allocation – one that can dynamically cover a spectrum from digital gold to the digital oil that keeps the wheels turning in the crypto economy. But there’s more going on. Bitcoin, Ethereum, and US dollar stablecoin are entering mainstream finance – institutional adoption reflects maturing industry standards. It’s also increasing dispersion. More dispersion means more differentiation and more opportunity for professional capital. Take Friday’s market volatility. Snapped just past the US payroll witching hour of 09:00 ET, crypto asset markets were seeing red mirroring the job reports. It was subtle. The median performance of the top 100 assets by market capitalization were down 14% – a big move (the expected one daily standard deviation for a 100-vol asset on 365 trading days is 5.23% - CBAM calculations). The overall market was down only 1.5% with assets like bitcoin holding firm. Memecoins and everything in their orbit were walloped, and assets outside of that gravitational pull carried on unalarmed. It’s exactly the type of dispersion that will bring more depth of capital to crypto markets, like long-short strategies that aim to lift fundamental winners and cull weak links. A signal? It’s only one observation that demands more…please. Stay tuned.

What does it mean when a central bank is losing money? Unlike typical businesses, central banks don’t need capital to operate. Operations can continue by printing more money or asking their bosses for federal support. Take the US Federal Reserve. Their weekly balance sheet report, detailed in H.4.1 tables, shows their obligations to the federal government. It has accumulated to $159.473 billion and is growing at ~$1.6 billion a week. This rising debt may not impact operations, but it’s certainly awkward. It makes fiscal and monetary policy increasingly joined by the hip, with less policy independence. With a $7.5 trillion balance sheet run on a sliver of $43 billion of capital, the only monetary anchor is prudent policymakers. And as central bankers queue for rate cuts, wavering market confidence becomes evident in rising commodity markets like gold, copper, and bitcoin. Central bankers themselves contribute to this narrative, with their record gold purchases in the latter half of 2022 signaling a new trend. It’s the opposite of the deflationary shocks of the past three decades. Today’s imbalances have inflationary consequences, and that’s a “melt-up” shock, a vicious cycle where scarce assets are hoarded, only adding to their premium. In the end, money is illusory, a lesson often learned when bad fiscal policy prevails. That’s now (ish).

Better, cheaper, faster – that’s the promise of crypto technologies. We get better at doing everything over time. Productivity trends higher, eliminating friction at each step, flattening the middleman on its way. Bitcoin has sparked a technological evolution unprecedented in the realm of intermediation. It will drive the marginal cost of financial transactions to zero, ushering in profound changes in organizational structures. The middleman is dead. Yet, it is the middleman who must accommodate crypto technologies to achieve their potential scale. Long live the middleman!?! Think of exchange-traded products – it blunts the best features of Bitcoin. But it unlocked enormous pent-up demand for a simple reason – familiarity. It tells us a lot about adoption. Bringing familiarity to crypto technologies will spur adoption. Like the internet, the middleman may monetize the technology with tools that captivate users’ imagination. The old middle operators are still crushed in that world – just as Amazon flattened retail distribution. Net profit margins were slashed to ~5% with a focus on efficiency and scale. Users still won. An institutional cycle for crypto brings the technology to companies that adapt to it. Many may be new. Some can be old. Where’s the crypto in your portfolio? It may be names like Blackrock, PayPal…and the Lightning Labs. This isn’t an 'us versus them' situation; rather, institutional convergence is the overarching theme.

Artists appreciated the value of the Internet long before experts did. Those active in internet supply chains took their cues from market signals, much like semiconductor manufacturers are today. It functions more like an ant colony than an orchestra. Speculation is a natural byproduct, not a random outbreak of enthusiasm. It targets scarce assets that hint at a potential extraordinary future value. Crypto assets are prime candidates for such speculation. Are we in the middle of a period of excess? The market microstructure suggests otherwise. The colony of option traders provides the richest information on speculative patterns. There is demand for downside protection in the shorter term, with 7-day bitcoin put options trading at a premium to calls. But this looks nothing like periods that defined tops, with a premium less than one-tenth past signals of price peaks. It’s an observation confirmed by broader volatility metrics. When shorter-term volatility expectations jump above their long-term counterparts, it's a “bad vol” sign – bearish. It happened over the weekend – but timidly and briefly. One-week expected volatility rose to 80% annualized , far from the 125-150% leaps seen during market tops. In the meantime, longer-term volatility expectations are creeping higher with demand for unimaginable upside. What we’ve seen in the past week is good vol, a healthy two-sided market. The trend remains.

The Fed sees real interest rates as too high, a bold stance amidst record-low unemployment and eased financial conditions. In a world captivated by inflation and technology, digital assets are seizing their moment, being perfectly poised to harness both themes. This week is Ethereum’s time to shine, unveiling key upgrades that underscore its technological prowess. The journey began in December 2020 with the Beacon Chain, setting the stage for a proof-of-stake transition – a daring endeavor without a set end. Fast forward to September 2022, Ethereum flawlessly merged its consensus and transaction mechanisms. Come April 2023; a pivotal upgrade allowed investors to withdraw from staking pools, a significant milestone. This week brings the “Dencun” upgrade, promising to turbocharge transaction speeds and slash costs, all while bolstering security through smarter off-chain computations. Enter Base Layer2, eyeing transactions under a penny and in less than a second as their north star. Yet, it's crucial to remember – blockchain isn't the panacea. Traditionalists have critiqued base layers for their inefficiency, a challenge Bitcoin pioneers anticipated. They envisioned a future dominated by institutional-led, high-value transactions. In this new world, Bitcoin and Ether have emerged as the gold standard of reserves of the digital economy, propelling the technology that's redefining intermediation. A decade on, the institutional embrace is evident. A wave of innovative applications will follow. While not all will revolutionize the market, Ethereum's role in where the future is constructed is clear.

Interest rates are too low. That’s the market’s loud whisper. It isn’t obvious by conventional metrics. The expected dip in US inflation to 2.1% over the next year is a drastic change from the peak of 9%. It’s the root of the Fed’s “we've-done-enough” stance. Real rates? Too high. Fed projections aim to reduce them down to 0.5% over time, and the bond market is nodding in agreement. Where is the market whisper clearest? Low velocity assets that don’t have yield – the definition of safe haven portfolio tools. Like gold and bitcoin. Both are supposed to suffer when real rates are high and inflation is falling – the consensus narrative. Both are racing to new highs. Price stability may be the right objective. But targeting a narrow measure like consumer prices has been ineffective. Asset prices have experienced the most pronounced boom-busts during the period of inflation targeting. And markets are now testing those limits at the fringes, where things always start. It's beyond bitcoin and gold hitting new highs. It's about the rush to monetize scarcity, with equity markets riding the wave. Fringe markets are skeptical about the potential return of policy orthodoxy – a push for higher real interest rates aimed at normalizing government deficits. And they are leading indicators, pressing the need to reassess our approach to economic stability and growth. Pay attention – when traditional policy metrics miss the beat, the rhythms of fringe markets speak volumes.

Are you integrating AI into your workflow? This integration signifies the commoditization of everything. That’s a great thing for consumers but not for producers. Think of a product becoming a commodity when the outputs produced are roughly the same, no matter who makes them. How does one differentiate? The artist, the philosopher, the baker – how the ingredients are brought together becomes the differentiator. The introduction of text-to-video is a powerful reminder that even at the first stage, the creation of content will soon be a commodity. Your skills are irreplaceable, but they just need to adapt to the new world. Physical experiences become dearer as virtual ones that mirror them turn ubiquitous. Virtual experiences have become the new reality, representing one of the most powerful macro megatrends. The ability for policy to adapt will define the winners and losers as much as the advancements themselves. Consider intellectual property, which now constitutes a 31% share of all private fixed investment in the US, including critical infrastructure like roads, power grids, buildings, and subways. While ChatGPT may not be quite ready to build infrastructure, robots directed by AI are undoubtedly a part of that future. Intellectual property is the new oil, the toll road to the new decentralized super-highway. Protecting intellectual property will be a growing priority. Blockchains are designed to provide that digital footprint. A solution to a problem. Welcome to the future.

Chocolate is almost universally loved by all – and it’s about to get a lot more expensive, with cocoa prices surging to 46-year highs. Cocoa production is dominated by two regions – Cote d’Ivoire and Ghana. The two account for 40% of world exports. Like so many commodities, efficiency drove concentrated points of production for global distribution. It’s especially true for commodities that are not complex – like cocoa. Cote d’Ivoire and Ghana rank 110 and 112 out of 131 countries in the complexity of exports, respectively. The cardinal rule of investing says never short innovation. Simple inputs to production are most vulnerable to innovation – not interesting long-term investments. Markets are built to make things better, faster, and cheaper. But consumers take it for granted. Cycles matter. Between climate and politics, concentrated points of production have left consumers vulnerable to centralized risks and severe price spikes. Cocoa is merely a lesson, a market microcosm. When supply is constrained, prices rise until demand is rationed or investment leads to more production. Are there lessons for crypto assets? The world is moving to decentralized, diversified production. It is a critical feature of crypto markets. Be it the location of bitcoin miners or network nodes for Ethereum staking – incentivize decentralization or risk the wrath of markets.

People like stability. Security, predictability, and controllability are comforting features. These are also characteristics best managed by machines, providing feedback to people who can spend more time preparing for the unpredictable. One of our machines, our macro pulse tells us the stage of the economic cycle each month, leaving us to hunt for differences from the norm. Both activity and capacity turned late-cycle on the latest reading. It’s unusual. In the past 16 months, the global cycle transitioned from a downturn that usually creates excess capacity, to a recovery that absorbs capacity, and a later stage where capacity is constrained. The trend in the unemployment rate was materially higher during the downturn on all past cycles. But not this time. No matter what lagging and nagging data suggest, it tells us the inflationary cycle reignites much sooner than the past. Scarcity is already showing up powerfully in financial assets. Companies with dominant market positions were not threatened in the downturn, and stand to become even more dominant. Activity in the digital economy sends a similar message. As crypto technologies integrate into the mainstream, there is rising demand for infrastructure that supports communication across blockchains and real assets. Chainlink is a powerful oracle to solve that problem. And markets signal it will be able to capture scarcity value – $LINK is up nearly 30% for the year compared to median performance of –4.75% for the top-twenty tokens. The machine is telling investors to hunt for scarcity – markets are too.

Micro factors dominated crypto assets so far this year. Shorter-term volatility expectations surged from 40% to 86% as investors digested ETF flows. Option markets have settled since – seven-day vol expectations are back below 40%, and the bitcoin skew is leaning bullish as attention shifts back to macro forces. Is it all about the Fed again? It feels that way into this week’s FOMC meeting, with prospects for rate cuts. Well, it never really was. Liquidity policy deserves more attention. Yes, the surge in real interest rates mattered and battered global markets. But inflation assets recovered mightily despite real interest rates holding near 15-year highs. Something else is going on – and that something else is liquidity policy. Tools that allowed money funds to lend to the Fed are being rapidly phased out. The bank lending program introduced during last year’s turmoil is also being eliminated. It’s a simpler Fed balance sheet and message. Bond markets are focused on the timing of rate cuts. But inflation-linked assets more broadly are monitoring the end of quantitative tightening, expecting excess reserves in the banking system to hold at more than $3 trillion. That’s greater than the height of the previous quantitative easing cycle. Attention is shifting back to macro trends. The Fed will talk tough on inflation. But easy liquidity policy and the end of QT ending may be the headline action. Inflation assets are attentive to actions over words.

Fat Application Revenues: Joel Monegro's 'Fat Protocol Thesis' piques our curiosity, exploring how value accrues in the blockchain ecosystem. Monegro's model posits that native tokens and shared data enable blockchain protocols to claim a majority of value within our digital technology stack. When assessing this thesis using the market value of token assets, it appears to hold true with Bitcoin and Ethereum alone accounting for two-thirds of the total crypto market value. But revenues tell a different story. There’s roughly a 1:1 ratio of revenue earned by applications on Ethereum versus the Ethereum network. Applications dominate revenues in the Solana ecosystem, with a ratio of ~7:1. The gap is even wider extending into layer-two blockchains. Application revenues on Arbitrum, the largest Ethereum layer 2, are ~17x the blockchain rails they ride. It’s a natural response. As application activity grows, high base layer costs are quickly addressed with efficiency gains, a declining cost of compute, and the integration of cheaper alternatives wherever high security is unnecessary. The same evolution eventually delivered internet video streaming and cloud computing from a starting point of the dial-up modem. Joel’s Fat Protocol Thesis is right and wrong. Consider the internet. Investors could not add TCP/IP and HTTP to their portfolios – utility giants that captured no value. Native tokens of base layer blockchains like Bitcoin and Ethereum are built for value. However, the trend is a growing share of revenues captured by the applications that connect directly to users – that’s how adoption rises as productivity drives down prices. The protocols might be fat; applications are fatter.

Diversification: Investors seek to add assets that are uncorrelated with existing positions to avoid redundancy. It is the art of diversification. The challenge is particularly apparent when dealing with nascent assets with unstable correlations – cryptos are no exception. Interestingly, the case for crypto as a diversifier is gaining strength. It’s the silver-lining in this year’s performance, down 3% having risen by more than 10% earlier this month. That’s uncorrelated with broader financial markets – even riskier frontier markets have managed a 1.5% gain so far this year. The strength of the US dollar plays a role in this equation, evident in the sharp decline of emerging market currencies during this crypto slump. And it’s the US dollar, more than equities and bonds, that holds the most significant importance to the digital ecosystem. Stablecoins pegged to the USD emerged as the asset of choice for those within the crypto ecosystem in the 2021-2022 downturn. It was the safe-haven of choice. Currently, the top three stablecoins are USD-based, comprising 94% market share. But the landscape is evolving. First Digital USD has risen to become the fourth-largest stablecoin, partly due to its responsiveness to Hong Kong regulations. Small, but mighty. Integrating with exchanges, it now trades at 1.5-times its $2.7 billion in assets. That pace would support ~$1.5 trillion in annual transaction volumes. USD stablecoin dominance may be natural. After all, nearly 90% of fiat FX trading volumes involved the US dollar. Whether for now or forever – that’s for new US stablecoin laws to decide. 

Disclaimer:

This communication may contain statements of opinion, including but not limited to, the author’s analysis and views with respect to: digital assets, projected inflation, macroeconomic policy, and the market in general. Statements of opinion herein have been formulated using the author’s experience, research, and/or analysis, however, such statements also contain elements of subjectivity and are often subjective in nature. In addition, when conducting the analyses on which it bases statements of opinion, the author(s) will incorporate assumptions, which in some cases may be shown to be inaccurate in the future, including in certain material respects.  Nothing in this presentation represents a guarantee of any future outcome. The author(s) are under no obligation to update this document, notify any recipients, or re-publish the content contained herein in the event that any factual assertions, assumptions, forward-looking statements, or opinions are subsequently shown to be inaccurate.

This communication contains information about the Coinbase indices. It is not intended as a means to market or advertise the investment advisory services of Coinbase Asset Management (“Coinbase AM”) and should not be construed as investment adviser advertising material.

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Past performance not indicative of future results.

Volatility gets a bad rap, synonymous with “crises” in recent history. And “crises” have been used to justify all sorts of policy intervention. It’s also usually cast in the name of resolving market dysfunction. But spikes in volatility are more likely the market doing its job than dysfunction. Consider the 3-month rolling volatility of S&P 500 daily returns. There are four jumps above 30% annualized since 2007, with the greatest to 72% in 2008. Each was met with a policy response that expanded central bank balance sheets. Too US-centric, you say? Global stocks share the same profile – MSCI World volatility correlates 98.7% to the US since 2007. Policy responses are a choice and unique to recent history. Take the 1987 stock market crash. The rise in volatility rivaled that of the 2008 financial crisis. Yet, policy was attentive to the micro financial plumbing, not macro bailouts. The change in policy behavior is clearest in central bank balance sheets. Circulating currency dominated policy balance sheets in 1987, accounting for 77% of total Fed liabilities. It’s 28% today, dominated by excess liquidity parked in the banking system. Critically, most of the unconventional expansion is tied to policy after the chronic phase of the 2008 crisis, not during. And now commercial banks mandated to fund these policies are captive to central bank largess. The entry of crypto technologies into traditional finance poses an added disruptive dynamic as a result. It’s only natural they are met with greater resistance in regions with concentrated unconventional policy. But time waits for no one – and neither does change. Volatility is the signal, not the noise.

AaaA: Bitcoin’s developer ecosystem is reactivated. A year ago, most experimentation on the network was heretical; today, developers are solving orthodox problems. Inscriptions, for example, is a protocol that uses Bitcoin as universal, permanent data storage. Flattery by imitation – copy-cat Ethscriptions have spread across smart contract chains quickly. Inscriptions are high-cost, to be sure. But with an estimated million-plus miners storing an independent copy of the blockchain, Bitcoin is one of the most robust data storage systems ever invented. Redundant, decentralized digital data available for 15 years with no downtime. So what? Groups like Pizza Ninjas are exploring new use cases – as usual, it starts with play. The team inscribed code for a Super Nintendo emulator on Bitcoin, allowing players to build a virtual version of the video game console on-the-fly directly in a web browser. It demonstrates what open source software delivered as a public good could look like without reliance on a centralized server. No shutting it off or deleting it. These programs aren’t limited to a single onchain location either. Several can be stitched together to assemble more complex systems. If we extrapolate from play to pragmatic, open source tooling for the internet is possible, assembled on-the-fly supplying basic computing services to any human with a web connection. Direct from Bitcoin on a million or more servers. Always on. It starts with nostalgic video games. It’s called Art as an Application (AaaA).

Details, details. Mysterious complexities emerge in the details. Accept it. Respect it. Investors can be wrong – but they can’t be stubborn and survive. Staying curious about details allows investors to take a differentiated journey, a pathway to identifying new megatrends. Take our Macro Pulse, a tool that systematizes the stage of the cycle. It says that economic activity is in an early-stage recovery – the best regime for risk assets. It’s also a stage reserved for periods after a deep recession. Only, we didn’t have one. Rate cuts are also the norm at this stage. The US, Europe, and China are following the script, soon to be cutting policy rates in concert. More good news for risk? It’s complicated. US S&P 500 forward equity multiples are starting from the 85th percentile, double the lows of the past two early-cycle recoveries. Passive investment strategies that won in the past are unlikely to repeat. Details matter more at higher valuations — even for nascent crypto assets. Like specifics around Bitcoin ETFs and its futures’ strategies. The ETF league tables are unchanged from last week’s approvals – the largest futures’ strategy still holds second place. Yet, the approach is vulnerable. It incurs an added cost to maintain bitcoin exposure, selling futures that are approaching expiration to buy the next month forward. Today, the cost in the shortest horizon is low, half of its peak in the past year. But the toll migrated, it didn’t disappear. Exposure to bitcoin moved to the more distant future. The cost of maintaining that exposure rose to new highs in the past three months, ~13% annualized. Volatility is masking investor interest in these details. After all, bitcoin has traded in an 18% range so far this year compared to 3% for gold. That’s for now, details are forever.

Shared Resources: In a competition to do one thing well, general purpose machines lose to specialization. Bitcoin mining migrated naturally from dorm-room laptops to industrial warehouses filled with application-specific integrated circuits (“ASICs”) because of competition. Want to win? Focus. Ethereum, on the other hand, is general purpose – a world computer running smart contracts that can execute anything you dream up. In conflict, the core of this general purpose machine requires high-performance specialization to run a few critical cryptographic algorithms that are poorly suited to its smart contracts. They need to be run constantly, efficiently, and at a predictable price. To cut the tension between high performance and general purpose, “precompiles” were introduced – optimized cryptographic utilities installed at carefully reserved addresses onchain. Each runs at a fixed, low price regardless of demand and without a smart contract. Now, a new range of addresses are being staked out where layer 2s can park their own expanding set of precompiles, installing new utilities and leaving room for future growth. History repeats. Formed in 1934, the Federal Communications Commission (“FCC”) has been tasked with allocating the US wireless spectrum for nearly a century, rebalancing a public resource across an ever-expanding set of industries and demands. The wireless spectrum map plots the path of a century of innovation. It gave birth to many new industries. The map of decentralized blockchain addresses could tell a similar story as global networks are partitioned like shared resources, breeding new industries we cannot yet foresee. It is worth paying attention.

This communication may contain statements of opinion, including but not limited to, the author’s analysis and views with respect to: digital assets, projected inflation, macroeconomic policy, and the market in general. Statements of opinion herein have been formulated using the author’s experience, research, and/or analysis, however, such statements also contain elements of subjectivity and are often subjective in nature. In addition, when conducting the analyses on which it bases statements of opinion, the author(s) will incorporate assumptions, which in some cases may be shown to be inaccurate in the future, including in certain material respects.  Nothing in this presentation represents a guarantee of any future outcome. The author(s) are under no obligation to update this document, notify any recipients, or re-publish the content contained herein in the event that any factual assertions, assumptions, forward-looking statements, or opinions are subsequently shown to be inaccurate.

This communication may contain statements of opinion, including but not limited to, Coinbase AM’s analysis and views with respect to: digital assets, projected inflation, macroeconomic policy, the market adoption of digital assets, and the market in general. Statements of opinion herein have been formulated using Coinbase AM’s experience, research, and/or analysis, however, such statements also contain elements of subjectivity and are often subjective in nature. In addition, when conducting the analyses on which it bases statements of opinion, Coinbase AM will incorporate assumptions, which in some cases may be shown to be inaccurate in the future, including in certain material respects. Information provided reflects Coinbase AM’s views as of the date of this communication and are subject to change without notice. Coinbase AM is under no obligation to update this communication, notify any recipients, or re-publish the content contained herein in the event that any factual assertions, assumptions, forward-looking statements, or opinions are subsequently shown to be inaccurate.

We see the future more clearly by standing on the shoulders of past giants. Hal Finney was one of them. We commemorate his legacy with the Running Bitcoin Challenge, where participants run at least 21.1 kilometers in the first ten days of the year. 

Finney was among the original cypherpunks, advocating for privacy-enhancing technologies to drive social and political change. He confronted tired criticisms of Bitcoin over a decade ago, openly and precisely addressing issues like its compatibility with banking. 

The financial system, he argued, couldn't operate on a singular crypto rail – too slow and too deflationary given Bitcoin's limited supply in a fractional reserve banking system. 

Finney astutely contended that Bitcoin would scale through an efficient secondary layer, an observation made five years before the introduction of the Lightning Network. And as the technology integrated with the payment system, Bitcoin private transactions would become less frequent, serving more as an institutional reserve asset than a substitute for bank money.

Ironically, the integration of crypto technologies into the financial mainstream has transformed the cypherpunk into a corporate figure.

But the ideals of cypherpunk persist in non-financial applications, influencing consumer-driven innovations within the financial world. The friction between financiers and industrialists endures, even within crypto circles. 

Let’s pay tribute to Hal by going for a run before tomorrow as a token of our gratitude.

Open markets are terrific psychologists. No need for couches and probing conversation. The market will expose your greatest weakness and test your strength to overcome it. Repeatedly. Like any great psychologist, it is nothing more than a mirror. The issue is what the subject is willing to see. Take lessons from last year. It started with nobody foreseeing a rise in risk assets. It ended with material gains – and now nobody can imagine a decline. Lower inflation. Rate cuts. US soft landing. China’s industrial recovery. Bitcoin ETF approval. With expectations like these, what’s not to like? Investors had very long cash positions a year ago, guarding against recession. Fed intervention prevented those risks from being realized. Cash became trash (again). An abundance of liquidity followed despite higher rates. It helped everything – especially crypto. Now? All eyes are on the launch of US Bitcoin ETFs. It will validate centralized institutions, defining the next cycle. Bullish. But all know it. It can’t be so simple…can it? The market psychologist asks whether you would buy BTC at $37,653 after having just bought at $44,125. “That can’t happen” is not an accepted answer. Markets write the stories, investors narrate after the fact. Always be alert to the pain trade. Short-term traders are sitting on healthy gains at a cost basis of $37,653. This fast-twitch cohort is most responsive to price. But they also aren’t big enough to reverse the trend, especially as leverage has been limited by higher rates. The market mirror tells you it won’t be a straight line – it never is.

Everyone loves a good comeback story – DeFi and Solana are it. Capital in Solana DeFi applications has more than tripled in a month. Applications like Jupyter, Jito, MarginFi, Kamino promise nextgen financial applications. New and improved? The user experience is far more compelling. But the functionality hews closely to past applications – borrow-lend pools, swaps, perps, and staking. Much of the enthusiasm stems from spikes in trading volume as players fight for position in league tables, with “Airdrop farming” a focus. Jupyter and almost every other hot DeFi app is farming-focused as users try to increase forward rewards in assets that might surge in value. It is one area of rising speculative sentiment – BONK and $WIF memecoins to prove it. But behind the shiny toys is legitimate innovation. The upcoming release of Solana’s next client software, Firedancer, could multiply both its throughput and resilience. Investors should ask the simplest of questions: How do SOL token holders benefit? After all, Solana runs more like a utility with the expressed goal of being fast, reliable, and cheap. It is not designed to maximize network valuation. Solana’s blockchain has generated a paltry average revenue of ~$80k a day during this DeFi boom versus Ethereum’s ~$15mn per day. Service providers could be the big winners. Like Pyth, nurturing a better model for onchain price feeds on Solana. It’s a service in demand that can be monetized at scale. This DeFi wave could be a meaningful step forward or another round of trapped crypto capital playing zero-sum games. Crypto markets will be running the experiment at least one more time.

Crypto asset markets self-selected the US dollar as its base currency. It’s a peculiar choice. Many of the most ardent proponents saw crypto as a replacement to the global monetary system, not a complement. So why not build on gold? After all, it has a long monetary history. And its digital transformation would turn a slow-moving physical commodity into an asset that can move around the financial system with ease. Global central banks are quietly making the case, hoovering gold. The pace of buying in the past three years is 1.7x that of the prior decade. Something’s up. Yet, gold in its digital stablecoin form today has less than a 2% market share and is a tiny fraction of digital US dollars. Strange, but true. A bit of history explains a lot. In fact, crypto started with gold – e-gold, discovered in 1996. Its founders had the US Constitution in their corner: “no state shall make any thing but gold and silver coin a tender in payment of debts.” And it worked! E-gold had more than five million accounts by 2009. But it was shuttered for not doing enough to prevent unlawful behavior. The dream of e-gold replacing central banks didn’t die there. Bit Gold, led by Nick Szabo, was revealed to the public in 2005. But it never launched, presumably for fear of the same fate as e-gold and its founders. It was all a precursor to the birth of bitcoin. Satoshi is anonymous for a reason – bitcoin created the digital gold standard from scratch. And the US dollar is its ecosystem’s digital money of choice. The best laid plans lead to the strangest of bedfellows.

Service professionals hear it all and see even more. They say nothing, and they execute their jobs quietly. Open the door for a conversation and you will learn. “Do you think the US should be cutting rates?” the driver asked softly. Less than 48 hours after the Fed signaling as much, the taxi driver caught us off guard, overhearing a conversation. It doesn’t matter what you think the Fed ought to do. Understanding the consequences is what matters. Unsatisfied, the next observation strikes at the heart of societal friction. “Well, prices are still high. I still can’t buy an apartment even if inflation stops.” Of course, he’s right. We were waiting for the fellow to quote the probability density of June 2024 bitcoin at $30k versus an all-time high of $70k to show that selling the downside to buy 1:1 ratio of upside is interesting. And he would be right…again. Because policy lives on the rule of bygones, allowing asset prices to race higher. It doesn’t try to reverse past inflation. Policy is geared to bring inflation under control, accepting higher price levels. It’s a permanent devaluation, leaving the masses disgruntled as asset prices – the income for the rich – surge while wages lag…again. Financial assets were nearly 5 times wages in the early 1980s before the secular rise; it’s nearly 10 times now, even after the correction lower. Crypto assets aren’t immune to these dynamics, also challenged by a narrow ownership distribution. But there’s nobody to protect the downside in crypto markets. Holders are punished in downturns, clearing the way for new owners at lower prices. We’ve lost that in traditional assets. It’s the great divide – the taxi drivers lament, and the bankers rejoice.

Tokenization is on the map – literally. Google searches for tokenization show rising engagement rates led by Singapore, China, and the UAE. It is a big step for an irreversible process – a migration to more efficient and effective infrastructure. As that happens, the term “tokenized” will disappear. As technologies mature, so too will every application that uses them to create value, enhance productivity, or delight users – the “how” becomes invisible. It is a sign of success. Recent estimates project a multi-trillion dollar wave of real world asset tokenization. Superpowers of near-free, near-instant transfer, and fractionalization. But tokenizing current assets does little to remove the frictions of legacy infrastructure. Old systems, networks of intermediaries, and operating models designed for business hours and bank holidays limit the productivity of underlying assets. It also retains old costs while adding new ones. That’s why digital natives like MakerDAO buy debt offchain – the economics of tokenized versions don’t work today. The long-term solution goes a step further. It lets go of the old operating model and creates digitally native assets – the DNA of crypto. These new financial instruments will be born onchain and use crypto infrastructure to automate their full life cycles. It is the natural endpoint that completes a transition to modern infrastructure. Our marketplace platform, beginning with Project Diamond, was created to offer digitally native assets to the world. An “appstore” built for all assets – even non-financial ones we can’t imagine today. Project Diamond offers our partners a home to remake their financial businesses with clear regulations and the help of an old friend – the internet. We started in November 2023, issuing digitally native debt. More groundbreaking activity is on the way. The world will transition to rails built on the DNA of crypto – we’re thrilled to share our contribution with Project Diamond. 

Periods of profound change impose humility. The most brilliant are the most susceptible, so used to being right that the prospects of being horribly wrong are unthinkable. Like the story of Irving Fisher. An everything mind, Fisher’s lecture on the applications of mathematics to social sciences forever changed the field of economics. He was also bankrupt by the Great Depression, never recovering financially but still able to use his beautiful mind to frame the proximate cause of a downturn without precedent. It’s not that this time is different – every time is different. Principles matter more than rules. Principles like leverage. Adding leverage turns your relationship with an asset from an owner to a renter. No matter how seemingly unlikely, there is a price and circumstance where the asset is repossessed. And the behavior is highly procyclical – greed trumps fear. So, anytime an asset price rockets, be alert for signs of increased leverage. Is today’s bitcoin cycle at risk? Leverage indicators say no, not even close. In the past cycle of rapid price gains, an indicator spanning futures, options, and physical bitcoin raced ahead with prices. It was speculator fervor. Today, the price rise hasn’t seen any advance in leverage sentiment. Price reversals like the ones in recent days can be safely interpreted as an interruption to the trend, not a reversal. And what a trend it has been. Traditional markets have been whipsawed. The SG trend benchmark is down 15% for the year versus strong gains in digital asset strategies. Even in common designs, crypto can play the role of diversifier. Principles are paramount.

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Surveys are in hot demand, especially in an election cycle. They capture sentiment with simple questions – anger, frustration, hope. But there is no stronger signal than voting with your feet, the ultimate sign of conviction. It’s also where an intersection of climate change and banking emerges. Nearly 70% of Americans see carbon neutrality by 2050 as a worthy goal. Nearly 90% of Democrat and Independent voters favor alternative energy sources as a national priority. The stakes are high, even if medium term. One billion people can be displaced by climate change over the next decade. A mass migration to higher ground must be happening, right? Au contraire mes amis. Americas are leaving California for Texas and New York for Florida. Mobility is being defined more by economics than climate – surveys say that migration is driven by lower taxes, cheaper houses, and a low regulation lifestyle. There’s an interesting twist on the plumbing of banking, too – as always. Narrow banking. It is the safest of depositories. They take your money and buy short-term liquid assets. There’s almost no duration mismatch. Narrow banking is perfect for the cash people need to pay the bills. And Texas has one of the most interesting ones – the Texas Bullion Depository. It’s America’s first state-run depository, holding commodities from gold to rhodium. Five years since its creation, the crypto application is in motion – a fully reserved gold and silver crypto currency backed by State of Texas. You see, stablecoin in all its forms is the narrow bank of the future. That’s no small feat.

Ethereum layer 2s (“L2s) are multiplying, with almost 20 different chains doing a million transactions a month. And more L2s are on the way! Chaos. Application builders find some L2s are identical to Ethereum, and others are distinct, requiring their own languages. Why be different? Because L2 teams are searching for product-market fit. One L2 could include an upgrade that won’t go live on Ethereum for years, another could add features and data that make the developer’s job easier. It’s a great example of organic and incremental change that drives technology forward. It’s also a mess that the team at LimeChain are cleaning up with rollup.codes, a site dedicated to organizing the chaos of L2 progress. Most of us will never need the site. But it will save countless developer hours, especially as the trickle of Web2 talent connecting applications to blockchains turns into a tsunami. The website explains how each L2 is set up, how to connect, how fees are charged, and what specific changes have been made to each L2 blockchain computer. Imagine a public website maintained to clearly explain how driver’s registration or property title works in every state, province, or country and how to bridge between them. A map to navigate public infrastructure. It is not glamorous, yet inspirational. Invisible teams putting in the extra effort to share hard-won knowledge to the benefit of a broader community. Sometimes, the most valuable thing we can do is organize the chaos.

Periods of profound change impose humility. The most brilliant are the most susceptible, so used to being right that the prospects of being horribly wrong are unthinkable. Like the story of Irving Fisher. An everything mind, Fisher’s lecture on the applications of mathematics to social sciences forever changed the field of economics. He was also bankrupt by the Great Depression, never recovering financially but still able to use his beautiful mind to frame the proximate cause of a downturn without precedent. It’s not that this time is different – every time is different. Principles matter more than rules. Principles like leverage. Adding leverage turns your relationship with an asset from an owner to a renter. No matter how seemingly unlikely, there is a price and circumstance where the asset is repossessed. And the behavior is highly procyclical – greed trumps fear. So, anytime an asset price rockets, be alert for signs of increased leverage. Is today’s bitcoin cycle at risk? Leverage indicators say no, not even close. In the past cycle of rapid price gains, an indicator spanning futures, options, and physical bitcoin raced ahead with prices. It was speculator fervor. Today, the price rise hasn’t seen any advance in leverage sentiment. Price reversals like the ones in recent days can be safely interpreted as an interruption to the trend, not a reversal. And what a trend it has been. Traditional markets have been whipsawed. The SG trend benchmark is down 15% for the year versus strong gains in digital asset strategies. Even in common designs, crypto can play the role of diversifier. Principles are paramount.

Price stability will forever be the main objective for any central bank. And rightly so. Steady short-term purchasing power keeps people happy. But translating price stability into a target is a problem – and a big one. The period of low and stable consumer price inflation accompanied unprecedented boom-bust cycles in global asset prices – from tech to housing to bonds and crypto. And the distortion from inflated asset valuations is an imbalance crushing the spirits of the younger generation and the working class. It feels unfair to them – because it is. Market signals are screaming that central banks need to broaden their perspective now-ish. Gold prices are at all-time highs and crypto markets are up nearly 20% in the past month. These assets aren’t supposed to be surging. Inflation expectations are anchored to the 2% target and real interest rates at 2% are near the highest in more than a decade. Inflation assets with no yield should be in the ho-hum phase of their cyclical tour, not their rock-and-roll segment. It’s the wisdom of the crowd, identifying the scope for policy easing long before the peak in rates. Lower for longer inflation is giving central banks the green light to take their foot off the breaks of the economy. And rate cuts are coming from elevated cycle lows in asset prices – ~$70 for oil prices, ~3,500 in the S&P 500 Index, ~$1,600 for gold, and bitcoin of ~$15k. These are multiples above previous cycle lows. It sets the table for an asset inflation moonshot in anticipation of the real thing down the road – a sea of forward inflation. You’re going to need a bigger boat to navigate your portfolio.

Countersteering is a racing skill – the art of steering left to turn right. It’s happening in public sentiment, too. Politics veered left after the 2008 financial crisis. Notable movements included Occupy Wall Street in the United States and radical left coalitions like Syriza in Greece. They mattered – but were battered. Now, the wind is shifting to the right. Last week, the Netherlands far-right Freedom Party won the most seats and Argentina elected its first libertarian president. Frustrations of electorates are global and inescapable, led by a chasm of economic outcomes across workers and generations. Economic models calibrated to recent history won’t help investors through these times of rapid change. Signals from market prices deserve the most attention – the kryptonite to the world’s super-investors who are accustomed to telling the market why it is wrong. It’s also where crypto asset markets shine. Take Argentina. The peso has depreciated by 51% in the past year based on the official foreign exchange rate. Yet, crypto asset markets tell a vastly different story. One dollar buys you nearly 1,000 Argentine pesos in crypto markets, nearly three times that of the official rate. In the old days, such price discovery was confined to swapping cash in street markets. Decentralized finance brings clarity to the disparity. And who loses from the difference? Those forced to sell US dollars at greatly inflated peso valuations – to the benefit of the government. No wonder people are frustrated.

Pull from the Ethereum ecosystem is heavy, like gravity from a planet many times the size of its moons. Other smart contract blockchains like Celo are gradually drawn in by network effects, opting to become Ethereum layer-2s after struggling to reach escape velocity. But as each smaller chain collides with the larger body, its shape and direction changes. Case in point, NEAR recently partnered with Polygon to develop a zero-knowledge connection to Ethereum, aiming to provide blockchains built on other computing languages a clear trajectory to layer-2 status. By connecting an open source technology called WebAssembly, the NEAR-Polygon system enables complex programs running in your web browser to prove their computations directly on the blockchain. If successful, this connection could push many more chains and applications onto a collision course with the growing Ethereum cluster. It could also entice talent from browser apps and industrial-grade software with familiar tools. The strategy reflects a broader shift – competitive tech stacks are breaking apart and recombining with complementary partners. Tribal ideology is giving way to commercial reality: better developer and user experience wins. It also highlights that “Web3” is often misunderstood as a rewrite of the internet. Blockchains introduce digital property rights to an increasingly digital world. Those rights must connect wherever information flows on the internet to unleash the Web3 vision. As they connect, clusters combine. Gravity compounds. The end result is a Big Bang.

Last year’s crypto descent will go down as one of the greatest all-time financial destructions for its speed and efficiency. It’s exactly what you hope for from market-based outcomes – distribute loss in a brutal manner and cull bad operators. On the other side of this is a more resilient crypto ecosystem, one narrowly dominated by Bitcoin, Ethereum and US dollar stablecoin. Yet, US lawmakers and regulators continue to fight yesterday’s war with all their might. Common ground will emerge. “The crypto markets should not be allowed to harm investors,” SEC Gary Gensler offers. “Crypto is enabling rogue nations, drug lords, ransomware gangs, and fraudsters to launder billions in stolen funds etc,” Senator Warren reasons. However, Chainalysis offers a much deeper analysis of illicit financing. We learn that the transmission of illicit activity is traceable, and shuttering network nodes of bad operators is effective. They offer a detailed case study. Known terror-affiliated wallets that transacted on the Garantex exchange were sanctioned by the Treasury’s Office of Foreign Assets Control (OFAC) for illicit laundering, analyzed using Chainalysis tools. What about the bad guys who can’t be immediately identified? Say hello to Heather Morgan and Ilya Lichtenstein. Ilya was smart enough to figure out how to steal ~120,000 bitcoins from Bitfinex – but not smart enough to execute it. The two lived in a prison long before their 2022 conviction, knowing the immutability of the blockchain would eventually catch up to them. It was the US Department of Justice's largest-ever financial recovery. Cash Is King for illicit activity – and the recovery rate from bad guys is near zero. 

There’s a word for everything in German. Its language and culture live in harmony, built around precision. Zeit being “spirit” plus geist for “time” captures the intellectual, moral, and cultural climate of an era. Meet the “Silent Depression,” this cycle’s candidate zeitgeist. The cost of living is worse today than in the Great Depression. The older generation refutes the data. Averages don’t tell the story, they cry. The younger generation keep it a viral sensation – on TikTok, no less, with its one billion active users that boomers see as a fad. It's a division by age. Average US household assets for those aged 60 to 74 is $1,871K. It is $290K for those under the age of 35. That may not seem odd. After all, older people have had more time to mature the monetary value of their skills. But the younger generation ain’t buying it – rightly. Average assets for the older cohort have risen 1.6 times the pace of the younger one in the past three decades. Yet, average debt between the younger and older cohorts has been roughly the same, rising with the secular decline in interest rates. It turns out higher asset valuations aren’t a skill – it’s generational theft when funded with profligate debt. It’s also an illusion – financial wealth is infamous for being vaporized when unsustainable. Enter Bitcoin and its German-like precision on how it defines money and security. It’s also generationally corrective – 69% of those aged 25-34 have used bitcoin compared to 3% for those older than 55 years of age. Yet, not even the German language dares precision on the timing of the generational rebalancing – it’s “boom-bust.”

Problem solving is a strength for decentralized organizations. The best ones have on-demand access to wide ranging expertise – ideas aplenty. But ideas aren’t enough, solutions are built on execution. Today’s problem belongs to Ethereum’s next upgrade, Dencun, delayed into 2024. Adding unstructured “blob” data to an always-on, global computer has proven unwieldy. A new approach is needed. A few clever developers are channeling Elon Musk’s engineering minimalism: “the best part, is no part.” Reduce complexity. In that spirit, they have released a fix called “Prove It” that focuses on removing unnecessary code instead of adding something new. Execution is under way. Coordination in the Ethereum community is fluid. Teams of pseudo-volunteers operating without a clear leader or the benefit of consistent legal framing. How are decentralized teams allowed to incentivise members? Do they need physical presence to gain legal rights? Bank accounts? How do they defend in court? Clear answers to these questions would put decentralized organizations on a level playing field with their centralized competitors, unleashing competition from a new way of solving problems at scale. And those answers are coming. Abu Dhabi Global Markets (“ADGM”) has just released rules governing rights for decentralized organizations. Other jurisdictions hope to fast follow. So, for those that think execution belongs only to command-and-control, you’ll soon have a chance to prove it.

The FedNow Service went live on July 20, 2023. It’s available to US depository institutions and lets individuals and businesses send instant payments. The success of crypto rails sharpened the focus of the Fed to deliver the service. And the efficiency of crypto rails can no longer be ignored. In the past 24 hours, for instance, the volume of Circle’s USD stablecoin was roughly $4 billion. That means $25 billion of assets in USDC, its current supply, can support annual activity of $1.5 trillion at that pace, or roughly 10% of annual VISA activity. Traders came to stablecoin for a banking alternative – they stayed for efficiency. But cryptos will have to enter the regulatory mainstream to achieve scale. Regulators can add friction to the use of USD stablecoin for simple payments as they grow – as with the PayPal subpoena the day before earnings. If the recipient of stablecoin can’t engage with the banking system, its use is greatly constrained. After all, I need to buy food and the farmer needs to pay her people. FedNow is trying to position itself as the mainstream application. But there are devilish details. Would you like to try FedNow? Silly rabbit, FedNow is institutional-only. No ordinary user can simply download and engage with the application. It’s a service provided through the banking system and banks have little incentive to accelerate adoption. There are more than 10,000 depositor institutions in the United States, and fewer than 400 have adopted FedNow. Not to worry, the researcher argues, banks make up two-thirds of payments. That is solid advertising for consolidation of financial services. Most of the energy around FedNow is explaining what it’s not. It’s not a tool to monitor your transactions. It’s not a risk to financial stability because banks can turn off money outflows. It’s not a central bank digital currency because…because. These features leave FedNow tied up in knots – and it cannot scale. What is it? Validation that payments are moving to instant settlement because it’s better for users. The time is now-ish.

The “Goldilocks economy” became the moniker for the long period of stability and prosperity. The US economy was neither too hot nor too cold for extended stretches of time. Now, economic and financial models built around those periods are breaking down in spectacular fashion. We see it in our macro pulse that translates business conditions into the stage of the cycle, and their expected future transitions. Things that never happened over more than six decades are now the norm. After eight months of “too cold” recessionary signals, the cycle moved to a “just right” expansion, then shifted to “too hot” for a month, and back to “just right” in the latest data – never happens. It’s the reverse Goldilocks. You see it in the jobs data, too. US GDP is 26% higher than the previous cycle peak; payroll employment is only 3% greater – also never happens. Only it’s happening. This makes investing harder. Just ask Charlie Munger: “In my lifetime, a guy who just bought the best common stocks and sat on his a– would have made about 10% per round before inflation, maybe 8% after inflation. That is not the standard return that someone can expect from an investment.” Equilibrium concepts that breed return-to-mean investing won’t make the cut. Everyone is an active investor now and uncorrelated assets – currencies, commodities, and, yes, cryptos – are taking center stage. Trend models don’t care about what you think about equilibrium prices. It’s their time to shine. 

‘Tis the season to be scared. What’s the scariest thing about digital financial rails? Bridges. Bridging data between networks is commonplace, but when that data is also cryptographic digital property rights for bearer instruments, the cost of error can be very high. To date, most bridges have used a “wrapped-assets” model, with tokens collected in a smart contract on their native chain and an equivalent “wrapped” token printed at the destination. Want to return home? Submit your wrapped token and unlock its twin on the original chain. The problem? One-way demand builds up huge token pools, daring creative thieves. Headline-worthy hacks left many users with the impression that bridging is fundamentally unsafe. Today, in a builder’s market, bridges are evolving. Circle’s Cross-Chain Transfer Protocol (“CCTP”) takes a different path. They take temporary ownership by burning your digital dollars at the source and minting them again, natively, at the destination. Another example is Chainlink’s new Cross-Chain Interoperability Protocol (“CCIP”), a network of offchain oracles to watch over token transfers, ideally making them more resilient than a single smart contract. The Ethereum community has also introduced a new proposal that puts the token issuer in control of bridge activity, and offers rate limits so no hacker could make off with the whole stash at once. Applications are already being built to take advantage of these cross-chain capabilities. Maybe it’s time to look past the vampire attacks, zombie protocols, and hack horror stories that strike fear into your heart. Halloween’s over.

Central banking is hyper-transparent – offering false precision on future guidance under the guise that all would be lost without it. Hubris may be the deadliest of deadly sins. Once we all have the same information and agree on how it should be used, it becomes useless. Like bitcoin halving, when the rate of new bitcoin supply is cut in half based on a known algorithm. In the past three halving events, the price of bitcoin rose more than 60% three months later (Source: Coin Metrics). It’s tempting to see causality. The stock-to-flow model is the explanation of choice. Stock-to-flow measures the time that takes to replenish the capital stock based on the incremental flow of supply. It’s a model known for valuing assets like housing. In the case of bitcoin, stock-to-flow asymptotes to infinity – tempting the imagination of those religiously long. It can’t be that easy. Bitcoin’s cousin, Litecoin, also has a halving function. Only its value cratered since the August 6, 2023 event. There’s more to it than supply. After all, 93% of all bitcoin that will ever be produced are already in circulation. Supply is already tight. The constraint in the price of litecoin or bitcoin or happycoin is its demand – its use-cases. Other factors also cannot be overlooked. US interest rates were falling sharply into each of the past three bitcoin halving cycles, for instance. Could we be witnessing a happy coincidence now? Sure. But if that lessens the drive to create use-cases, history will judge the proponents fairly – and harshly. Extreme pride is a bug, not a feature. 

Broad participation is the distinguishing feature of decentralized networks from current computer architecture. For proof-of-stake networks, like Ethereum, that participation comes in two forms: doers and financiers. The doers run hardware and take operational risk – the “sweat equity” to network consensus. The financiers delegate duties, which is much more scalable. On Ethereum, the participation of financiers has ballooned, expanding the set of validators past 863,000, and driving staking yield down below 4%. More money, more problems – checking all 863,000 signatures is now stressing computational limits. Over 30% of those validators are concentrated in Lido’s liquid staking protocol, a hair’s breadth away from one-third control that could halt the network if there were a bug. Ethereum’s co-founder proposed mitigants as a cure to the threat. Top of mind is carving the validator set in two groups – an “always-on” set of high effort participants, the core doers, and a second tier with no rewards or risk of capital loss who rotate randomly to watch over the paid operators. The idea is just a starting point, a nudge to a broad developer community to consider improvements. Changes like it would clear computing overhead and also significantly lower new issuance to pay validators. Computer networks are always driving towards max efficiency. Is that good in this case? As decentralized networks integrate into essential global infrastructure, many investors hope to scale their exposure and harvest digital yield. Overpaying to incentivize broad participation could be the cost of entry, reinforcing network effects. In the end, efficiency matters. But broad adoption is everything. 

It’s the simplest children’s game with terrific life lessons. Some people are faster, more attentive, and fiercely competitive. But all can play – just like crypto. Traffic signals are more complicated in financial markets. There’s no centralized decision-maker telling you when to move. It’s the collective judgment of its players – and crypto markets are the purest form. Rules without intervention. Prices equilibrate demand and supply, indifferent to emotions. Analysts are charged with the task of inferring the traffic lights from a mountain of data. What’s the signal for bitcoin? The light has been bright green, indicated by a flat forward curve, low volatility expectations, option pricing skewed to downside risk, and smaller trades in CME futures’ markets nowhere to be seen. The contrarian nature of these indicators was emphatic – the next shock would be a crash up, not down. Now, there’s a mad dash to explain this move. Bitcoin is a safe-haven, an inflation hedge, a guardian from bank risks, an ETF. Resist the temptation of false precision – timing is always elusive. Focus on what we know. We know that long-term holders of bitcoin rose to record highs through the period of low volatility. So, when short-term traders engage, prices would need to rise to encourage long-term holders to sell. Now, think of the mindset of the long-term holder – that cohort survived one of the most brutal market dynamics in the history of all assets. Naturally, they are reluctant to sell as their patience is rewarded – especially when our traffic light is still green.

Look at the stars tonight. They cluster. Our solar system is only one out of billions in our galaxy. Billions. We see them with the naked eye in two dimensions, lines that lend themselves to stories. Images created by our imagination. And from dippers to demons, the simple stories stick – just as they do with macro investing. “The buildings stay, but the owners change,” Charlie Munger observed to describe defenseless commercial real estate. Those active in the market are the root of the conviction – office space loans are being recapitalized with a 50% write-down, and that’s with a strong economy. Exposure is stuffed in small banks that constitute only one-third of US banking by assets but more than two-thirds of commercial real estate lending. The decline in collateral values means borrowers either find equity capital or default, the latter being the only realistic option. Looking through a narrow lens, words like “small” and “contained '' come to mind. And just as central bankers declare a soft landing for the economy, harder risks arise. Markets are punishing fiscal irresponsibility with a surge in real interest rates, hammering plans for private capital spending. Comfortable historical correlations are breaking. Typically, a sharp rise in real interest rates strengthens the dollar, weakens commodity markets, and exposes instability risks. Not now. Gold is bid and bitcoin with it – their correlation propelling to 47% in the past month (Bloomberg, Coinbase Asset Management calculations). New stories are being written. Don’t forget to tell yours along the journey.

“Africa has been forgotten by Europe. Nearly all of the incremental growth in trade for the last 10 years has been with China, India, and the Middle East.” Said the former PM of an African nation. It wasn’t an admonishment, but a call to re-engage or miss out on growth. We are at SuperBridge in Dubai, a conference that feels deeply international. The assembled group engages with the pragmatism of competing, cooperating nations. Frictions are depersonalized. Commerce is enabled. It is economic magic. I spoke with a Kurdish entrepreneur about payments infrastructure. Their problems mirror those of many other nations – trust is held locally because governments are untrustworthy. US hundred dollar bills are stored at home. Banks are a risk. So is having your family’s life savings in your house. We discussed enabling local entrepreneurs with distributed, decentralized payment technology and how to embed businesses in a community context and serve customers directly, earning their trust through accountability. I met a woman from Europe who returned to Dubai after spending her teens years here. This country grew from something small into something amazing as the world turned around it. She has been a part of that story, and now leans into the next wave of growth. And I met an interpreter for nations, enabling communication between world leaders over decades, abating conflict. He splits his brain in two to process language and convey empathy. To this audience, we presented Project Diamond, our platform to deliver digitally efficient capital markets within a regulatory envelope. The feedback? A different use case in every region. Opportunity everywhere. The blessing and curse of platform technology is that you need many partners to be successful. SuperBridge taught us they are out there, waiting. 

One word captures the breadth and depth of content at the SuperBridge conference. Lines between disciplines are blurring. The future imagines a world where the marginal cost of intelligence, energy, and financial transactions converges to zero. Where we build into abundance. Specialization has defined professional progress in the past five decades. There are hundreds of medical doctors, for instance. Have a health issue? You are almost certain to see a specialist who aims to solve one specific problem, potentially creating new ones for other specialists to tackle. It isn’t malicious, obviously. It’s a matter of capacity. No individual can manage all your details, nor do they have effective tools to do so. Until now. Will we see a revival of polymaths? Like al-Kindi – philosopher, physician, mathematician, musician…and father of cryptanalysis. The generalist becomes an expert user of tools. Artists are the natural starting point. They push creative boundaries as a matter of professional survival. Artists like cellist Dana Leong who argue that collaboration across sectors will define his future. It’s evident in his GAIA compositions, sharing the name of Dr Lovelock’s theory that everything evolves with its environment – even inorganic objects. Artists like Sean Moss-Pultz, whose engineering background allows him to appreciate the mathematical elegance of digital art. His collaborations were popular enough in MoMA that they bought the algorithm, demanding careful definitions of digital property rights. Skepticism is everywhere. Type in “NFTs are” into a Google search, and all but one will encourage you to run and hide. To counter-consensus investors, this is the signal to lean in. Need somebody to lean on? We’re here.

“We may not live for hundreds of years, but the products of our creativity can leave a legacy long after we are gone.” Mattar Bin Lahej’s Arabic calligraphy compels you to wonder, to dream. “The future belongs to those who can imagine it, design it, and execute it,” reads the second set of scripts defining the Museum of the Future here in Dubai. In preparation for a conference at the Museum, we brainstormed with a trusted partner. “SuperBridge themes will cover global communication, sustainability, lifestyles, and investing,” it was explained. “Are there ways for us to collaborate?” A question asked like a statement. Zoom screens nodded enthusiastically. “Which theme?” There was a pause. We imagined the future. We were also designing it. But as Mattar observes, execution is everything. Without it, commitment means nothing. “Our project connects all four themes” we offered, daring to be bold. And so, Project Hamilton turned Onebridge, now Project Diamond, built by Canadians to refine digital regulatory perimeters in the United States, will launch in the UAE – a global hub. We committed to delivering digital “Clean Energy Credits” with direct integration into “Green Bonds” at the SuperBridge conference. It went from a napkin sketch to a permanent transaction record on Ethereum’s global network in a few months. Dubai’s SuperBridge welcomes an audience that seeks playful discovery with a serious message. Nearly two billion people are unbanked. More than 200 million companies are, too. They all require solutions. Project Diamond scales finance like software. And there is no better setting to showcase it than a museum that respects the past, but demands you to think bigger into the future. 

The line up to stake your ETH is gone. Yesterday, the entry queue for new validators, once 46 days long, worked its way down to zero. You can now earn a staking yield at a moment’s notice – and it pays a paltry 4%. In early April, speculation swirled around the Shapella upgrade enabling long-time stakers to withdraw for the first time. Investors feared a rush for the exits and downward pressure on ETH. It never materialized. Instead, clarity around staking liquidity unlocked demand. The number of validators securing Ethereum’s network rose from ~600k at the time of the upgrade to ~850k today, and staking yield came down with the increase in participation. With US Treasury bills yielding more than 5% and ETH prices moving sideways, the reward for staking is under scrutiny. Markets are generally in tension. Macro uncertainty is rising with renewed conflict in the Middle East, the tech growth premium for crypto has collapsed, and concerns about a lagged recession are limiting capital deployment. Investors are flocking to money markets, earning a positive real rate, and waiting for a compelling entry point. Outsmarting the market is the consensus view. Why watch the Ethereum validator queue? Because it’s a new investor metric combining a digital risk-free rate, the technology growth premium, and liquidity risk in one. Will a line form at the exit queue next? Or could a change in interest rates create renewed demand for more staking in 2024? Watch closely.

The line up to stake your ETH is gone. Yesterday, the entry queue for new validators, once 46 days long, worked its way down to zero. You can now earn a staking yield at a moment’s notice – and it pays a paltry 4%. In early April, speculation swirled around the Shapella upgrade enabling long-time stakers to withdraw for the first time. Investors feared a rush for the exits and downward pressure on ETH. It never materialized. Instead, clarity around staking liquidity unlocked demand. The number of validators securing Ethereum’s network rose from ~600k at the time of the upgrade to ~850k today, and staking yield came down with the increase in participation. With US Treasury bills yielding more than 5% and ETH prices moving sideways, the reward for staking is under scrutiny. Markets are generally in tension. Macro uncertainty is rising with renewed conflict in the Middle East, the tech growth premium for crypto has collapsed, and concerns about a lagged recession are limiting capital deployment. Investors are flocking to money markets, earning a positive real rate, and waiting for a compelling entry point. Outsmarting the market is the consensus view. Why watch the Ethereum validator queue? Because it’s a new investor metric combining a digital risk-free rate, the technology growth premium, and liquidity risk in one. Will a line form at the exit queue next? Or could a change in interest rates create renewed demand for more staking in 2024? Watch closely.

Blockchain technologies are often observed as a solution looking for a problem, mostly by those at risk of being disrupted. Effective use-cases are quietly growing. Buenos Aires just rolled out blockchain-based digital wallets to its 2.5 million citizens. Initially, the wallets will provide access to birth certificates, marriage licenses, and academic credentials. The tools used? Ethereum is the baselayer. zkSync is the scaling solution that maintains the security integrity of Ethereum. And QuarkID is the Web3 digital identification protocol. It’s another data point showing that cryptographic tools are pressing ahead, and being led by emerging markets. The program will expand quickly to include other commonly-checked information like income, driving, and health records. What does this ID system improve? First, ease of access. No more carrying around a folder of critical documents that are costly to replace. A government office or service provider can triangulate your credentials onchain. Second, systems like QuarkID limit access to only necessary information. This is one of the core principles of self-sovereign identity – “minimization.” Instead of handing over a driver’s license with name, birthdate, address, height, a car rental agency can ask the blockchain: “Do you have a valid driver’s license?” Or a bar can ask: “Are you of legal age?” Yes or no comes back. Only you and the government have your details. Most companies don’t want your data anyway. Everytime they receive personally identifiable information they’re subject to complex, and costly, compliance mandates. And storing your information is a hacker honeypot, with legal liability when breached. Congrats to Buenos Aires for pushing digital adoption to streamline its bureaucracy. It’s a clear use case. There could be many fast-followers.

“Be humble. Be teachable.” Professor Richard Feynman’s philosophy lives in a Twitter feed, thanks to a magical curator. It’s especially useful for investors searching for a truth that isn’t out there. ETF-Monday was one of those humbling moments. Nine new ETH ETFs went live, all tied to futures. There was less than $2 million in trading volume by late Monday morning. It’s not so unusual. Derivative-based ETFs are typically built for shorter-term traders – a very quiet bunch these days. Leveraged ETFs is the extreme example, relying on futures for gearing, and underperforming because of linear rebalancing versus compounding returns. As a matter of math, leveraged ETFs promise convergence to zero over longer time horizons – they get there faster with more leverage and more volatility. The SEC documents those risks, too. But the slippage to long-term holders is relevant even without leverage. Approaching its second anniversary, the BTC futures-based ETF has underperformed “physical” by nearly ten percentage points. Investors are cautious in response. This may actually help the case for a spot-based ETF – the lack of investor frenzy makes it easier on the regulator. And you are seeing shifts in the SEC approach. Two bitcoin ETFs were denied well ahead of their next deadlines – but with unique feedback more geared to plumbing and legal issues. Spot ETFs are coming. The signaling is relevant. But remember ETH-ETF Mega-Monday. It could be a yawner.

Work is a privilege. I was reminded of this lesson while helping out on a farm last week. “We could use stairs to the upper fields,” it was explained. It demanded sweat-equity and creativity. I estimated a few hours. It turned out to be a couple more and a few extra after that. Solving problems clears your mind to solve more of them. And the problems you have lodged in the back of your head keep churning for creative solutions while at work. Problems like the investment classification of crypto assets. A commodity, a technology, a currency, a bond proxy – all can be true, none need to be. And recent memories are hard to shake. Policy rates surged, equities plunged, and crypto went into crisis. That period says bitcoin was a speculative asset burst by the rise in interest rates. At its peak in April 2022, the weekly return correlation between bitcoin, US one-year interest-rate expectations, and the S&P 500 averaged more than 60%. All assets were driven by the same factor – the policy response to inflation. And now that inflation is falling sharply, running less than 2% annualized in August, nobody is sure what to do. So, they do nothing. Bitcoin’s return correlation to bonds and stocks has averaged near-zero in the past three months. It’s clear to the naked-eye. Hawkish Fed, dovish Fed, stocks down, stocks up – crypto asset markets are shunning the volatility of other markets. Today, it tells us that crypto may work best in a portfolio as an uncorrelated asset after all. If you want to figure out tomorrow, there’s always “work” to do and there’s never “nothing” going on. 

Ethereum now has over 820k validator nodes – a dramatic rise. That’s the “more.” But it also needs to be “better”. Diversity, not abundance, is key to longevity. Think bananas and a specific image comes to mind. Because 99% of bananas are the Cavendish yellow boomerang. Even though bountiful, “the banana” is highly vulnerable to extinction because they are all the same. More isn’t necessarily better – a point not lost on the Ethereum community. There is concern that Ethereum’s decentralized network isn’t decentralized enough. Why? Concentration risk. If more than a third of computers operate identically, a bug could shut out users from the blockchain – a “liveness failure,” where blocks stop being produced. No blocks, no blockchain. If more than half of computers stumble in unison, two versions of truth can emerge. This would require coordinated human interference to pick a single path forward. It’s the kind of intervention that runs counter to the mission of trustless computing. Network watchdogs recently discovered that Ethereum’s diversification is much less than previously thought. A failure in the dominant program used for execution management, known as “geth,” could result in major network malfunction. Developers are on it – risk mitigation is refreshingly forward looking. A recent call aimed to address centralization sore spots. Self-coordinated contributors are working on solutions before the problem is realized. It demonstrates an unwavering commitment to decentralized global infrastructure, aligned by longer-term investment incentives. Amazing. And Ethereum is not alone. The same values drove Bitcoin to diversified nodes long ago. They are also driving Solana’s next validator. Building something robust isn’t just about having more. It’s also about being better.

“Nothing in the world is worth having or worth doing unless it means effort, pain, difficulty.” The Teddy Roosevelt era of leadership wasn’t all sunshine and unicorns – it was sincere. Struggle because it’s worth it. Just ask Graham Tuckwell, who orchestrated the launch of the first gold ETF in 2003. No marketing. Limited support. No press coverage until four years after the launch. $3 million of AUM to start. A $20 million order that provided a big boost. An ETF wasn’t obvious. The price of gold peaked in 1980. Policy orthodoxy, central bank selling, and taxation of gold purchases all contributed to the multi-decade slump. Gold was prohibited in most investment mandates. It took until 2008 for gold to recover its 1980s highs. Forget about winter, commodity markets experienced deep hibernation. We can look back with nostalgia. The gold ETF was the catalyst. Or was it? Gold ETFs are ~$200 billion today, or ~1.7% of all the value of gold in the world. It’s mostly chasing prices. ETF gold flows have declined in each of the past five quarters, when gold prices failed to hold cycle highs. Investment growth is strong because of physical demand – people want their coins and bars. A lesson for crypto? Exchange traded products hold ~820k bitcoin, or 4% of the fully-diluted 21 million supply. That’s already greater than the penetration of gold, for an asset that is easier to own. The bitcoin ETF is still a very relevant signal. Institutions now see crypto technologies as a permanent part of financial infrastructure. The ETF planted a flag in the ground – a statement that institutions have landed. It’s no magic wand. Getting blockchain into the mainstream will be a struggle. As it should be – it's worth it.

It’s never boring. Periods of low market volatility, like now, give time to figure out the next surprise. Like banking. “The U.S. banking system is sound and resilient.” This phrase has opened the second paragraph of the FOMC Statement since March, when banking strains emerged. Words ring hollow. In May 2007, Bernanke declared that “the effect of the troubles in the subprime sector on the broader housing market will be limited and we do not expect significant spillovers.” It was an expectation – the Fed was ready to respond if wrong. And boy did they. Like the rest of us, policymakers get plenty wrong. In 2022, for instance, policy rates ended up rising nearly 300 basis points more than planned when the year started. Today, the FOMC feels compelled to declare the resilience of the banking system. What does it mean? The FOMC is prepared to ensure banking resilience if needed. And it may be needed. Markets signal caution. US regional banking ETF, IAT, is quietly approaching March lows, down 50% from its cycle peak. Fed data reinforce a challenged sector. Small banks have $5.7 trillion in assets, 33% of the total US banking system. But small banks are far more exposed to commercial loans, at $1.9 trillion or 66% of the US total. Those commercial loans are nearly 3-times the equity of small banks. Banking strains aren’t over. And March is an excellent case study for the impact on digital asset markets. Bitcoin played the role of banking safe-haven – expect a repeat performance.

Sometimes I anglicize badly, as I did with “hole sky,” Ethereum’s newest test network. It’s actually pronounced “holesky,” named after a train station in Prague. But today’s note is all about mistakes – so let’s run with it. Scheduled to debut on the first anniversary of Ethereum’s transition to proof-of-stake, the new testnet includes a very large set of validators so developers can accurately simulate mainnet behavior. But things didn’t go as planned. Software that runs transaction execution was out of sync with its sibling program handling network consensus. The launch, billed as an anniversary victory lap for “The Merge,” came to a screeching halt. The network failed, and developers were forced to postpone – testing further before a second attempt. The public failure opens “a hole in the sky,” meaning it forces a shift in perspective. Ethereum’s development process is fallible, even if the last few upgrades have been flawless. Changing the open-source software that runs decentralized networks is bound to produce mistakes. Those mistakes are a sign that we’re attempting something ambitious enough. They are also humbling. Whether we focus on Solana’s downtime, a failed Ethereum testnet launch, or a compiler error that exposes gaps in hardened protocols, each event highlights the difficulty of building new digital public infrastructure. It’s a struggle that will wind through several generations, mostly to benefit those that follow. A foundation for the future, built one failure at a time. If you aren’t failing, you aren’t trying hard enough. 

 “The most powerful person in the world is the storyteller.” Steve Jobs was pretty good at it. Like all of us, he learned by adjusting to failure. The Apple Lisa computer didn’t have a story. It was technically superior to competing products. And its architects overwhelmed the audience with technical features. It was lost in translation. Lisa 2.0 struck a different chord. “Soon, there will be two types of people…those who use computers, and those who use Apples.” With its 1983 vintage in mind, the v2.0 story was visionary – the personal computer was nowhere, nor was Kevin Costner who starred in it. Crypto is searching for its v2.0 story. Chainalysis brilliant Crypto Adoption Index informs the narrative. Rich developed countries are not defining the narrative. India, Nigeria, and Vietnam are on the adoption podium. Crypto has found use at the grassroots - banking the unbanked, hedging inflation, and creating new businesses. “You’d get into a pedicab and see that the driver had his phone mounted at the top of the windshield playing Axie,” observed Donald Lim, president of the Philippines Blockchain Association. Axie Infinity has fallen out of favor with its token down 97% from its highs. But wallet infrastructure is now in the mainstream, used to deliver NFTs rewards by airlines. Demand for inflation hedges drives Pakistan adoption. The surge in trading volumes of crypto assets against the Turkish lira points in the same direction. Adoption needs a story that resonates with users. And the tech needs to deliver on the experience.

$5.583 trillion. That’s the dollar value of assets in money market funds. It’s a big number by any standard. The 2020 COVID peak was $4.79 trillion. The 2009 GFC peak was $3.92 trillion. What’s interesting – cash holdings peaked *after* rate cuts by the Fed in those two periods. Investors were defensive, markets rallied, and cash holdings collapsed as they were penalized by low rates. It’s different now. Global equity markets are within spitting distance of all-time highs. That would normally accompany a sharp decline in cash holdings. But it didn’t. Why? Bonds. Nobody wants them. 30-year US real yields are trading at 2.09%, around the 2004-2010 average. That’s the yield paid above CPI inflation – guaranteed. Investors worry even inflation-protected bonds will get cheaper. Belief in higher real rates is a vote for the house of orthodoxy. Possible, but it’s not today’s reality. The Fed’s weekly balance sheet is a reminder of how far away we are from home. The H.4.1 weekly tables include a terrific breakdown of balances by district banks. Earnings remittances due to the U.S. Treasury is a line-item. It reads –100,218 million in the latest week. The remittance line-item is like a negative amortization to the government – it’s their debt. It’s also small. The Fed is paying money market rates on its liabilities. Banks and money funds are only too happy to take the yield. Today, it doesn’t matter. Monetary policy operates normally under abnormal circumstances. The New York Fed has negative remittances of $66 billion against paid-in capital of $12 billion. Cash is only cheap in an orthodox world. This isn’t one. And when that inflection point hits, bitcoin becomes much less boring.

A paper detailing privacy pools has stirred quiet waters. One direct application would transform Tornado Cash into an OFAC-compliant tool. Blowback ensues. There is a group that believes compliance with any centralized authority runs counter to the ideals of a decentralized, permissionless financial system. But does it? Most people favor the stability created by nations, and their laws. Privacy, not anonymity, is paramount. Meeting regulatory compliance is also an enabler of coordination – a foundation that makes US capital markets the most desirable home to global financial activity. Are the rules perfect? Certainly not. But even freedom-focused advocates of decentralized infrastructure should be agreeable to proving they are not depositing from a known address of North Korea’s infamous Lazarus Group. Privacy pools could grant total privacy for users who prove they are not on a list of bad actors. If the centralized entities that run compliance lists become corrupt or large groups of users disagree with their implementation, they can change – without affecting privacy. And deploying them on decentralized networks means you retain the right to make direct transactions without the pool. It’s vote with your feet – technology edition. So let’s not confuse efforts to introduce compliant privacy with a war on freedom. It’s a pool, not the ocean. 

Once a year, the Group of Twenty (G20) leaders gather informally to coordinate on global economic and financial matters. This year marked a milestone - India hosted its first G20 Summit at Bharat Mandapam. The event served as a timely reminder to get away from our Western priors. Like the wisdom of a diverse market, the G20 crowd is worth hearing. India is critically important to the proliferation of financial technologies. Nearly 200 million people are unbanked, a number poised to collapse with the proliferation of satellite internet and digital wallets. Chainalysis ranks India fourth in the world on crypto adoption, one spot higher than the United States and miles ahead of most developed countries. Under India’s G20 leadership, a rational, pragmatic tone on regulations emerged, focused on the Crypto Asset Reporting Framework (CARF). The goal? Information sharing to ensure “holistic tax coverage” of digital assets. Sovereigns reserve the right to tax. Those are paid in local currency. International organizations have recognized that crypto isn’t going anywhere, nor can it derail sovereign monetary systems. It can complement them. Did India’s G20 Presidency really make a difference? Sure did. It requested frameworks from the IMF and BIS, presented ahead of the Summit. Officials declared the taming of “wild” crypto asset markets – don’t blame the technology; it’s just tame math. 

Innovation is all about scale. Doing more with less. Crypto assets demonstrate that potential. How they are monetized is less clear. Established financial companies are demonstrating execution savvy. Blackrock established an information-sharing agreement with its Bitcoin ETF application, a critical new ingredient. PayPal introduced a stablecoin and Visa digital settlement rails, both disintermediating banks. The crypto ecosystem is showcasing its utility – but not its value, which must be an investors’ focus. And mainstream finance is now in the race. Will the same be true for central banks with CBDCs displacing other payment tools? No. CBDCs have a scaling problem. Take the Fed’s balance sheet. Currency liabilities of $2.2 trillion fund $8.1 trillion of assets. Think of the gap as central bank activities in markets. It’s massive and looks nothing like the “old days” of policy. Before 2008 interventions, currency funded 90% of central bank assets. Now, let’s imagine a CBDC entering the equation. The first response is a collapse in currency demand. To prevent asset sales, excess reserves at banks would have to rise. Impose a March-2023-styled bank run. Where do you run? The safest asset – a CBDC. The yield is secondary. Central bank currency liabilities would rapidly rise, draining deposits from the private banking system, and becoming an engine of instability. Naturally, this is not an outcome any central bank would target. And there is a simple way around it – cap individual holdings of CBDCs. So, central bank digital currencies don’t scale. Private stablecoins are the value capture for payment solutions. That’s one value proposition you can take to the bank.

Markets have settled into a no-man’s land. Bitcoin volatility is low, futures’ curves are flat, and positive headlines on regulation or institutional adoption are met with a shrug. Inflation and central bankers’ response defined the boom-bust cycle in broader markets. Now, it’s a waiting game. Waiting for the next “shock.” Investor conviction is high that central bankers won the battle against inflation – it’s a skirmish, not a precursor to war. Inflation swaps are near 2% for the next year and expected to stay there over the next decade. All with a real interest rate of a bit less than 2%. Boring, shockingly so. Bitcoin, the loyal empath, is reflecting the energy of its macro surroundings. Cautious. Dull. True, an air pocket led to a sharp decline in August. But nothing else moved outside of butterflies in the bellies of those long. Everyone loves 24/7 trading until there’s a liquidity vacuum. Market indicators lean to negative sentiment. Fear over greed. Bitcoin puts are trading at a premium to the delta-equivalent calls –  a rarity. It shows concerns of a “shock” linger. Bullish sentiment would leave bitcoin vulnerable to negative macro surprise. That’s not now. Today looks more like March, when bitcoin responded favorably to banking strains after inflationary policy responses. Boring banking is built on crypto rails, it scales, and it is disruptive to incumbents. Just ask Visa and @cuysheffield, who announced yesterday that instant payment authorization is being matched to instant settlement using stablecoin. So long clunky bank intermediation.

OnFi as in Onchain Finance. It was an onchain summer, after all. Games are good simulators. When it’s time to ply a craft in the “real world”, you are ready to go. Our monkeying around led to the acquisition of the “cyber ape” NFT readying for Mars. It was made available on BASE, the new Ethereum Layer 2 incubated by Coinbase. BASE is the most successful protocol launch on several key metrics – more than one million users and over 18 million transactions in a one-month period. It shines a bright light on the solution to a problem exposed by a viral sensation – CryptoKitties, circa 2017-2018. True, those NFTs let some college students repay their debts in short order. Oh, and it clogged Ethereum. Skeptics rejoiced. Digital cats made the cost of using Ethereum impossibly high. Only, like any bottleneck, the market signal was met with a response – layer 2s. Not everything should clear through a base layer. Imagine if all financial transactions went through Fedwire? Senseless. Layer 2s are normal in internet use. So, too, they should be in the crypto asset ecosystem. And now they are. While Ethereum clocks its boring one million transactions per day, layer 2s have become the fast-twitch, low-cost sibling. From nothing last year, layer 2s routinely surpassed Ethereum in daily transactions volumes this year. Pics of apes preparing for a Mars expedition are merely proof of concept. Engage. It accelerates feedback. It improves user experience. And playing keeps you young.

Global policy rates are approaching a pause as inflation falls. Crypto asset markets have taken a breather, too. The Coinbase Core Index traded in a narrow 11% range in July, and the market is extrapolating lower volatility. One-month expected volatility has dropped to an all-time low of 32%, mirroring the compression of volatility across most markets. There’s an exception – commodity markets, where prices surged ahead and quietly drove medium-term inflation expectations to one-year highs. Traded goods' prices don’t tell us that policy is too tight; they signal it is time to build. Crypto asset markets had a head-start on building in the background during last year’s slump, with Ethereum taking the lead. The Ethereum ecosystem has further advanced on its modular approach with the rapid growth of Layer 2s. It’s the differentiator from previous cycles. These advancements are innovating with a dual focus: one eye on institutional operational norms and meeting the needs of the average person. US legislative icebergs are also thawing. Two bills made their way through the House Finance Committee for the first time. Steady strides. Regulatory clarity is on the horizon. Our formal notes will take a summer break, but our attention won’t wane. Periods of low volatility are most tempting to find ways of selling volatility – the root of tomorrow’s volatility.

Web 3.0 is here. But is the crowd attentive? A recent ConsenSys survey revealed a stark disconnect – 92% of people are aware of cryptocurrencies, but only 8% are alert to Web 3.0. It extends beyond a naming issue for Web 3.0. It points to a poor operational grasp of blockchain’s core value. Disinterest in Web 3.0’s value proposition is also not the problem. The survey shows that 95% want to own their internet content, 83% value data privacy, and 77% yearn for increased control over their digital identity. Satisfying this demand starts by reducing friction between Web 3.0 and incumbent systems. Web 3.0 must penetrate inescapably, like the relentless beat of a drum to a listener. Threads, an app launched by Meta to compete with Twitter, offers a noteworthy example. Its ability to deliver seamless interconnectivity with existing networks and applications propelled initial interest in the application. Even more interestingly, the swift migration exposed user dissatisfaction with current Web 2.0 offerings. Be it Web 2.0 or Web 3.0, users want better. Demand beats even louder when broader socio-economic challenges trigger a desperate call for change. This is evident in Southeast Asia and Africa’s growing adoption of Web 3.0. Be it quiet or loud, the drumbeats are for change. Web 3.0 will have to dance to the tune.

Staked ETH is ~$50 billion. It’s enough to notice as it nears the bond capitalization of household names like General Motors. Ether has better USD yields, too. And without the duration risk. It’s easy to exit stake ETH. The wait time is six minutes. But like any bond, the duration risk is subtle. The long wait time in entering ETH staking pools, 34 days now, is a signal for future exit times. After all, the technical features of entry and exit are symmetric – it’s all about the “churn.” Churn was designed with the security and stability of the ecosystem in mind, not finance bros. It sets the limit of validators that can join and leave each 6 minute, 24 second interval – true on the way in and out. Those with a longer-term view of Ether won’t be fussed by days added to the exit queue – they aren’t leaving. Short-term speculators will be. “Liquid staking” – an ETH staking derivative – is positioned as a solution. An investor exchanges Ether for a smart contract that commits to staking. The derivative token can be “burned” by the investor with ETH returned, inclusive of rewards. It’s the darling of DeFi – Lido’s liquid staking has enjoyed an 80% market share, or $15.6 billion since April. But it’s dilutive to investors. Ether reserves on the Curve protocol are currently 49.9% in spot ether, not staked – the dilution is material. There is also the issue of the exit queue. When the exit line gets long, liquid ether will trade at a discount if traders urgently want out. And they will. That doesn’t negate liquid staking. Its value? Making it easy for users. Built for speed, not duration.

Investments in Virtual Currencies, Virtual Currency Derivatives, or Digital Assets are speculative and have unique risks including but not limited to, (i) that they are not legal tender in the United States and as such the value is based on the agreement of the parties in the transaction, (ii) the price of a virtual currency is based on the perceived value of the virtual currency and subject to changes in sentiment, which make these products highly volatile potentially subject to rapid and substantial price movements which could result in significant losses, (iii) the lack of a centralized pricing source poses valuation challenges for market participants trying to exit a position, particularly during periods of stress, (iv) a cybersecurity event which could result in a substantial, immediate, and irreversible loss for market participants that trade virtual currencies, (v) virtual currency balances are generally maintained as an address on the blockchain and are accessed through private keys, which may be held by a market participant or a custodian, (vi) the lack of regulatory oversight creates a risk that a virtual currency exchange may not hold sufficient virtual currencies and funds to satisfy its obligations and that such deficiency may not be easily identified or discovered resulting in significant losses, (vii) currently virtual currencies face an uncertain regulatory landscape in the United States and many foreign jurisdictions and laws, these changing regulations or directives may impact the price of virtual currencies, (viii) the new and rapidly evolving technology underlying virtual currencies could also have adverse implications for investors, (ix) many virtual currencies allow market participants to introduce fees which may not be defined or known adding to the cost on a pass through basis to investors.

It’s live. 12 Federal Reserve District Banks are offering the FedNow service with instant settlement, 24/7/365. There will be expectations for network expansion. Vendors should love it. Their cash positions will be better known at any moment in time, and holding less cash means more profit. But there is an interesting history with FedNow. A trademark application was filed on October 15, 2008. In 2013, the application was deemed to have been “abandoned,” as there was no use case filed. It is the type of detail that tells you to dig a little. The technology is old. Japan started its real-time settlement system in 1973; it went 24/7 in 2018. India’s instant payment system started in 2007. Yet, the growth in the two networks is vastly different. In Japan, more than 90% of people still use cash for day-to-day transactions. Why? Concerns over information leakage. India designed its system to be mobile-first, a bold move. PhonePe is a payment application built on India’s instant payment rails. It boasts 450 million users and is expanding into Wealth Management. In the case of FedNow, there are 17 certified, centralized service providers. These are the engines that app developers will build upon…subject to the Fed’s permission. And that’s a big “if”. You must bank with the Fed, after all. Decentralized systems are a client and competitor. Stablecoin issuers would surely find the service useful. Will they be allowed? Building the payment rails is not enough (see Japan).

How do you generate security in the digital ecosystem? Scale. Scale gives you redundancy and overwhelms the incentives to cheat. But how does a new protocol get to scale? In the early days of blockchain, several protocols resorted to "merged mining," a process where smaller networks offered proof of work miners the opportunity to run another copy of their software on the same mining machine for a second network and collect token rewards. They borrowed scale. That was how Dogecoin built network stability – merged mining with Litecoin. In the Ethereum ecosystem, a new protocol called Eigenlayer presents a similar opportunity. Nascent protocols offer rewards on a marketplace to entice Ethereum validators to lend them security by 'restaking' their staked ETH – securing both networks simultaneously. The fledgling protocol avoids the capital expenses of community building and paying validators to bring a network to life from scratch. Re-staking through Eigenlayer also satisfies a market yearning for higher yield as ETH staking returns decrease with more validators. But it's not without risk. Validator problems on either protocol can now cause a loss of the same principal. Higher reward, higher risk. The final stage of the Eigenlayer's three-staged launch will come later this year. Will the Eigenlayer efficiently bootstrap the next generation of protocols? Or will it expose a new form of correlation risk in the digital ecosystem? TBD. 

Customer Service. It’s the dreaded call. And the most frustrating element – it is usually something you’ve done wrong. The wrong form. The wrong number on a file. And then the clinical response: “your wait time is 35 days, and two hours.” That’s the current wait time to activate an Ethereum validator – and it’s down from 45 days a week ago. If patience is virtuous, the Ethereum community is striving for sainthood. Yet, the exit queue is nonexistent, with same day service on withdrawals. It is the precise opposite of the dynamic feared on the April 12 upgrade that gave ether holders exit liquidity. The explanations are simple enough. Ethereum’s staking yield is running around 4% net of inflation, on par with the average of the top ten staking protocols by market cap. But the rate of staking is still relatively low, at 20% versus an average of 50% for the top ten. There is room to run higher. True, this is a terrific signal for the ecosystem. But put your investor hat on. Anticipating a surge in staking after April 12, one might have surmised a rise in prices, too. It hasn’t happened. Instead, the price of ether has been largely unchanged from the fateful April date. Why? Well, the lineup to get into the party is long because everyone already had a ticket; they just need it to be scanned. It’s about vintage. Ether holders for longer than a year have risen to the highest since 2015. The new staking is from investors already long. It’s better than the alternative, to be sure. But it’s also dynamic. We won’t really appreciate investor staking behavior until we live through a cycle.

 “The truth is rarely pure and never simple,” observed the radical liberal Wilde, a pretzel of contradiction. Greatness demands obsession, a willingness to sacrifice all for the unattainable – truth, like money. It was created from necessity, allowing easier exchange by cutting middleman frictions. Gold won. Because it was better? Heck no. Electrum was money, too – a naturally occurring element in gold and silver and more durable. Gold won for the reason provided when even the best parents are stuck…because. Electrum demanded that gold innovate – refined gold provided its durability. And it’s the durability of crypto assets that is demanding change. Yes, the judgment of the US District Court matters. And, yes, it is not simple. But it is an interpretation of messy laws. Laws around securities were built to protect retail investors. The judgment said they failed to do so for sophisticated institutional ones, which have easy fixes. Rejoice! But the point is far more direct. Policy is set by lawmakers. Europe is moving. Hong Kong, and by extension China, is moving. Singapore is moving. UAE is moving. Brazil is moving. The pressure building in the US is tied to policy more than legal scholars. Sensing the opportunity for change, Lummis and Gillibrand rebooted their crypto bill in the Senate last week with many common factors to the House proposal. That’s the macro moment, which is tedious and obsessive in micro detail. Detail like stablecoin issuers – they would have to be banks, with existing issuers able to jump the line. Not pure. Not simple. The pragmatic truth is what we define the rules to be.

Network congestion is Ethereum’s high-class problem. Demand is so strong at times that the lineup is costly to clear. But it’s also a necessarily evil because it motivates the investment in scaling solutions. Ethereum’s challenge is the simultaneous handling of three crucial functions – making data available, performing transaction execution, and forming consensus. When network traffic increases, competition for the limited space in each block intensifies, causing fees to rise. Layer-2s are an engine of compression, bundling multiple transactions into one before uploading them to the Ethereum Mainnet for final record keeping. Transaction costs average 23 cents for Layer 2 protocols versus the $5 in Ethereum’s Mainnet this year. But what happens when Layer-2s get congested? Even more investment in scaling solutions, naturally. Solutions like “proto-danksharding” (EIP-4844). Danksharding isn’t only fun to say – it’s functional, easing transaction processing by creating a new space in the Ethereum execution layer called "blobs” that aren’t stored forever, so they are much cheaper. Transaction records pushed to these blobs are assigned to a group of validators and executed independently. It should bring costs for Layer 2s down by 10-100x. While this proto-upgrade is set for later this year, the endgame of full danksharding is even more exciting. More than 100,000 transactions will be processed at near-zero costs on the Ethereum network – the big theme of the ETH Community Conference in Paris next week.

Think of the Bank of International Settlements (BIS) as the central bank for central bankers. They don't make the rules – they shape them through international cooperation attentive to monetary and financial stability. Yet, they have quietly been strong proponents of decentralized digital asset innovations. When the policy world got disturbed by FTX last year, the BIS could have postponed its work on prudential policies for crypto assets. Instead, they led from the front, following the age-old provision that regulation must be agnostic to technology to spur innovation. The BIS' Dec 2022 report proposed crypto be treated no differently than others for bank capital provision. And the BIS Innovation Hub is pushing down an ambitious path with that in mind – like the CBDC pilot dubbed "Project Mariana." Park your judgment on the need for CBDC; the technology stack is the interesting bit. The wholesale CBDC is designed based on the "best practices in the public blockchain space" (emphasis added). Uniform technical standards across EUR, CHF, and SGD are achieved with the ERC-20 smart contract standard. A governance layer is used to regulate currency issuance and whitelist banks eligible to engage with the central banks. Ethereum is the base layer. Permissioning is achieved with Quorum, a fork of Ethereum run by ConsenSys and built in concert with JP Morgan. Automated market making? The BIS doesn't openly endorse Curve V2, but perhaps they use it because it's the right tool for the job – there's no better endorsement! Don't confuse the soft-spoken nature of the BIS. Their actions are loud.

Macro went from obvious last year to subtle now. Higher inflation and rising real rates were bad for everything. Now, beauty is in the eye of the beholder. Europe’s recession is being led by the North with the South enjoying an equity renaissance – Greece is outperforming the NASDAQ this year. China’s demand surge from reopening didn’t materialize, one of the few markets in the red. Emerging markets that were ahead of the Fed, like Brazil, are readying for monster rate cuts. It’s all about the US dollar and the Fed – only it’s not. One-year inflation swaps have collapsed to less than 4% from last year’s peak of 9%. Large growth companies are outperforming in response. Yet, real interest rates are quietly back to cycle highs. The tightening in capital markets has constrained leverage, tempering enthusiasm. This is clearest in crypto-asset markets where the trend is still safety-first – bitcoin. Dispersion is the featured dish on the macro menu, and it’s more difficult to digest. We see unusual features in our Macro Pulse, too. The cyclicality of global goods usually dominates macro. Not now. Our Macro Pulse is stuck in a low-and-falling recession regime for its longest stretch. The difference? There’s no fracture. The current Macro Pulse most resembles the 1995 downturn, started by the Asia crisis. Only back then oil prices fell to the cost of a McDonald’s family outing. Cycles rhyme – the key is to appreciate their differences. The greater the difference, the greater the need for flexibility. After all, even the mirror changed its mind for the fairest of them all.  

Solana ended the year on a weak note. Whereas leading digital assets recovered from the November FTX crash, Solana fell to fresh lows. A new beginning? Solana has surged to two-month highs, led by Vitalik’s support and an NFT meme-coin launch. The airdrop of the Solana-based, Bonk, served as a reminder of Solana’s potential to support NFT activities, re-igniting community interest. Are we right back to a cycle of excess speculation? Inflows into Solana’s ecosystem are massive, and Bonk token yields went bonkers. But market capitalization is down nearly 90% from a year earlier, even after this resurgence. Recovery is more about Solana fighting for relevance. And broader network fundamentals demonstrate resiliency. Solana continues to have the highest volume of daily transactions. In active users, it trails only the Binance Smart Chain and Ethereum. Network validators remain strong, having recovered to pre-FTX levels, and installations of development kits are trending higher. Network activity is concentrated in NFT marketplaces, with Magic Eden drawing the most share. Can the NFT market support a stronger valuation of the Solana network? The announced departure of the top two NFT projects on Magic Eden casts doubt. Solana’s future may lie in innovative, decentralized infrastructure. For now, the Solana mobile phone and integrations with the decentralized wireless network, Helium, are the highest-profile applications. Use cases will be the differentiator for blockchains coming out of this bear market. Solana’s resilience keeps it alive to play a role in that trend.