Coinbase Research Report: Lack of strong main narrative at this stage, Q3 will still be dominated by volatility

Original title: Weekly: 3Q24 Thoughts + EthCC

Original source: Coinbase

Original translation: Mary Liu, BitpushNews

Summary:

· According to Arkham data, the German government's Federal Criminal Investigation Bureau (BKA) may have completed its sell-off, with its holdings reduced from about 50,000 BTC ($3.55 billion) in mid-June to 0 BTC on July 12 (data as of 14:38 EST on the same day).

· There are concerns that if the United States falls into a recession later this year or early 2025 and the economic slowdown is greater, then interest rate cuts may be bad for the market.

· Panels and presentations at the 7th Ethereum Community Conference (EthCC), including a keynote by Ethereum co-founder Vitalik Buterin, reaffirmed Ethereum’s roadmap to provide the most decentralized and secure settlement layer 1 (L1) for various L2s.

Market View

The third quarter started off badly with oversupply as price-insensitive holders sold Bitcoin. This included the German government’s Federal Criminal Investigation Bureau (BKA), which began selling its seized Bitcoin on June 19. While the size of their Bitcoin sales ($85 million per day on average) was not particularly large relative to the $10.6 billion in daily BTC spot trading volume (on centralized exchanges worldwide since June 1), the BKA’s mindless selling unnerved the market, putting pressure on Bitcoin prices.

On the bright side, according to Arkham Intelligence, as of July 12, BKA may have almost completed sales as its holdings have dropped to zero (not sure whether some of it will be returned by CEX). But we think this shows that some of this market panic should dissipate soon.

At the same time, the repayment of the Mt.Gox Rehabilitation Trust that began on July 5 also had an impact on the market, but it is not clear how much of the repaid BTC was actually sold.

It is reported that the exchanges approved to process repayments include Bitbank, BitGo, Bistamp, Kraken and SBI VC Trade. But the repayment processing time may vary depending on the exchange and its internal verification procedures - from immediate (Bitstamp) to 90 days (Kraken).

We believe the uncertainty will hurt the market more than any actual sell-off, as the largest creditors (i.e., third parties who buy the claims of others) are likely to be hedged. Furthermore, we expect any sell-off that does occur to be gradual and orderly, with only a modest impact on the market.

But looking longer term, what does the rest of the quarter look like?

Recently, we have seen an increasing number of reports expressing concerns that the US could enter a recession later this year or early 2025.

We hold the opposite view, believing that productivity gains from accelerated post-pandemic technology adoption (including but not limited to generative AI models) will kick off a new multi-year economic cycle, possibly as early as the fourth quarter of 2024. (The timing is difficult to predict) However, the difference in economic views is not usually this large, and parsing the increasingly complex signals is a challenge.

That being said, the macro data has given plenty of evidence that the US economy has slowed (ISM manufacturing, unemployment, domestic demand, etc.), and we acknowledge that.

In fact, we think the US economy is likely to peak in the second quarter of 2024 - one of the reasons why we think the Fed will start cutting rates from September 18th (too early this month and there is no August meeting). In fact, the June CPI data released this week (-0.1% mom or -3.0% y/y) was below the median forecast of +0.1% and 3.1%, which may support a more dovish Fed stance.

The concern is that rate cuts could be bad for the market if the feared economic slowdown is deeper.

That said, retail investors may be reluctant to enter new equity or crypto positions if the US economy falls into a recession.

On the other hand, if the economy is still performing relatively well and the Fed cuts rates, then this could unlock more liquidity and attract more retail participation.

In addition, the US election will be held in November, and fiscal expansion seems likely regardless of who wins. In our view, this is a strong incentive to buy Bitcoin as an alternative to the traditional financial system.

For now, we expect price action to remain volatile in the third quarter of 2024, as the crypto market still lacks a strong narrative.

For example, the market cannot decide whether potential spot ETH ETF flows (experts expect to launch soon) are bullish or bearish, although we believe this is not necessarily a bad thing from a positioning perspective. Even if flows take time to materialize, this could leave room for unexpected performance and provide more support for ETH. But overall, we think the next two months are likely to produce more volatility until the situation starts to improve more clearly in late September.

EthCC Highlights

The 7th Ethereum Community Conference focused on key technical topics, including Layer 2 (L2) scaling and differentiation, ETH staking issuance, cross-chain interoperability, and more. Conference panels and discussions, including a keynote by Ethereum co-founder Vitalik Buterin, reiterated Ethereum’s roadmap to provide the most decentralized and secure settlement Layer 1 (L1) for a variety of L2s.

Ethereum’s continued focus on becoming a settlement layer L1 suggests that its execution layer is unlikely to scale significantly (measured in gas per second) in the short term. Instead, it is more focused on increasing the data availability bandwidth of L2 storage. However, this does not mean that ETH’s utility is stagnant.

On the contrary, the diversity of L2s allows different technical approaches to compete quickly. L2 platforms such as Optimism, Base, Arbitrum, and Starknet demonstrated their unique technical and ecosystem advantages on EthCC. The ability of L2 to quickly iterate on competing technologies is a unique advantage of the modular approach and one of the advantages of Ethereum that we have highlighted before.

That being said, universal interoperability between L2s remains a controversial issue. While many solutions appear to be technically feasible (with different trade-offs), there is currently no top winner across all chains. Communication standards tend to be a "winner takes all" market due to network effects, but crypto interoperability faces additional challenges in resolving conflicts of interest. That is, the ability of interoperability protocols to monetize the adoption of their standards makes this space a near zero-sum game. In our view, full interoperability remains an open challenge that may take months or even years to coalesce into a clear standard.

However, we do not believe that barriers to interoperability mean that crypto user experience (UX) will hinder user onboarding.

Account abstraction and Smart Account adoption are gaining momentum. Beyond the core infrastructure layer, it seems more decentralized application (dApp) developers are looking to leverage gas abstraction and bundled transactions to simplify the dApp experience. Additionally, session key technology (which enables automatic transaction approval under certain conditions) is expected to be a means to further reduce dApp UX friction, especially in DeFi (swap) and gaming.

Staking and re-staking are also related issues.

The rise in the staking rate (currently 28% of total ETH supply) and the resulting reduction in net staked APY could pose long-term challenges to the economic viability of independent stakers. Similarly, concerns have been expressed about the growth and centralization of Liquid Staking Tokens (LSTs). While no firm conclusions have been reached, suggestions include lowering the base issuance curve (which should theoretically moderate staking growth) and establishing LST standards to enable more LST diversity and competition. Meanwhile, restaking faces challenges in terms of implementation timelines. Payout and slashing functionality is not yet enabled for any shared security layer. Additionally, uncertainty has been expressed about the importance of Active Validation Service (AVS)-based yields relative to the size of ETH being re-staked in the short to medium term (a risk we highlighted earlier this year).

For the most part, discussion at the main EthCC event focused on the infrastructure layer, although a number of consumer-facing applications were demonstrated at many of the peripheral events. Applications ranged from AI-parsed blockchain data, perpetual on-chain gaming, novel prediction markets, and more. That being said, in our view, the infrastructure to application ratio still seems to be more heavily skewed toward infrastructure projects than might be thought.

Overview of Crypto and Traditional Currencies (data as of 4 p.m. ET, July 11)

Coinbase Exchange and CES Insights

This week, Bitcoin has consolidated below its 200-day moving average. Lower-than-expected CPI data failed to propel the coin higher as supply concerns continue to weigh on the market. Ethereum has also been trading in a tight range around $3,000 as traders await the launch of a spot ETF in the U.S. Positioning on the coin is thin, but we have begun to see a rotation from altcoins into ETH. Elsewhere in the market, SOL has held up relatively well during this month’s sell-off, suggesting to some traders that it could outperform if the broader crypto market rebounds.

Coinbase trading volume (USD)

Coinbase trading volume by asset

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