Interpreting Market Indicators Where are we in the cycle?

I tend to think that the "wisdom of crowds" is mostly a farce.

Granted, it does matter in some ways, but humans often behave irrationally when it comes to money (especially when it comes to money) or they simply don’t understand that they are subject to cognitive biases.

More specifically, I mean this applies to smaller groups that are prone to overconfidence/irrationality.

For example, participants in financial markets.

After the FTX crash in November 2022, when the QQQ index fell about 30% from its all-time high, I was curious about what people thought about the possibility of a so-called "soft landing." Needless to say, only one in five people were reasonably confident in a soft landing.

A year later, with Bitcoin having doubled in price (to ~$35K) and in an undeniable uptrend, I was once again curious about how people were feeling. I typically use these types of polls to gauge market positioning. It’s just one data point, but I’ve found that most people respond based on what they hope will happen — especially on Twitter. So it’s not surprising to see that only half of people think a 30% rise is more likely than a 20% fall.

Fewer people expect prices to continue rising

At the time, I was pretty confident that Bitcoin would hit the $45k and $60k mark first for a number of reasons. Now, I am less confident about short-term price action, and to some extent, more cautious about what will happen over the next 6 months or so. However, a lot of people keep asking “where in the cycle are we?” This question itself is a bit of a trap because it presupposes something that is not necessarily true. But I will share my feelings anyway so that whenever I am inevitably asked this question again in the future, I can point them directly to this article.

The common view is that we are in the middle of the cycle. Anecdotally the most common answer people hear is inning 5 or 6. Even if that is true, it seems like a bit of a prevarication answer to me. It’s something you say when you don’t have an opinion and want to avoid taking one. It may be true, but I wouldn’t be writing this article if I really believed that.

So, where are we in the cycle? Which round? Is the cycle over or just beginning?

Let me bring up another tweet from November 2022. I bring it up to illustrate that in the context of “this cycle,” price and time are two very different things. If you look at them separately, purely from a time perspective, we are in about week 70 of this bull market. But I think that actually exaggerates the true length of this rally because I can count on my fingers how many people were 実際に(jitsu ni, actually) bullish on the market in November and December 2022. If I’m being very generous, most people didn’t start to realize what was going on until late Q1/early Q2 of last year. So, let’s say it’s been a little over a year.

From a price perspective, Bitcoin and Ethereum have risen approximately 3x and 2.5x respectively from their bottom.

My sense is that veterans of multiple crypto cycles think we are closer to the end than the beginning. This is largely because their usual playbooks are not working this time.

We wrote a little about this dynamic in our annual report…

Previous cryptocurrency cycles have experienced a logical flow where market participants believe in new narratives as money flows along the risk and speculation curve, BTC → ETH → long-tail crypto assets (where venture capital and token investing occur). The narratives often revolve around the fundamental transformation that cryptocurrencies can achieve, creating a wave of new believers who either convert for life or exit as prices fall back after the speculation subsides.

This cycle has been very different so far, and many people with the previous heuristics have been either slow to adapt or unwilling to adapt. To put it bluntly, this unwillingness leads to psychological defense mechanisms being activated. We are all human, so we can’t help but look around and judge our performance (the assets we hold) by relative standards - it’s not enough that the assets we hold are up 3-5x because the assets we don’t hold are up 10-20x. This is especially true when we don’t like the assets that are up 10-20x. This is the key to why many people feel that we are either in the middle of the cycle or in the back half in my opinion. They watched assets like Solana go from less than $10 to over $200. They saw a wave of meme coins soar 100-1000x and screamed inside but couldn’t do anything about it.

"This is not the correct order!"

“Why didn’t my assets skyrocket like this?!”

"This shouldn't be happening now!"

People simply don't like things not going the way they expect. It's not that they are necessarily wrong, but the market is not going the way they think it should. Maybe the cycle is compressing, or financial nihilism is being pushed to the extreme.

I’m not ruling out all of these possibilities, but there seems to be very little self-reflection going on.

Let me add some context, I know of many cases where junior analysts working at other funds recommended Solana at prices below $30 and they were repeatedly dismissed and ignored. It is almost laughable to see how many people rushed to buy the locked FTX tokens a few months later at a much higher price.

All of this suggests that how people collectively experience rising markets affects what phase they think we are in. Most people entered this cycle overexposed to the Ethereum ecosystem and underexposed to everything else. This positioning distorted the overall perception of cryptocurrencies during this cycle and distracted many people from assessing where we actually are.

Now let’s weigh the arguments for either end of the cycle – early versus late.

Only 100 days until Bitcoin ETF is approved for trading Ethereum ETF has not yet been approved (likely in late 2024/early 2025)

I often talk, write, and tweet about crypto market structure, and why such a boring concept actually has major consequences. It’s a bit of an exaggeration, but I think of it somewhat similar to plate tectonics — huge, slow-moving plates that form the base of the market. It’s hard to comprehend how much of a seismic effect these plates moving can have, and what kind of impact the aftershocks will have. But imagine being in crypto for 8, 9, 10+ years and reaching this pivotal moment…

Bitcoin ETF approved. Large new pools of institutional capital can now legally enter the asset class. Initial inflows were significantly stronger than the market expected.

Then you predict the cycle top will come in 100 days.

“But the market is forward-looking, the ETF has been approved, and the inflows are already priced in!”

Markets are forward-looking, yes. But they are not omnipotent. They just got ETF inflows wrong. People who understand crypto simply don’t understand how traditional market structure works, and people who understand traditional market structure rarely have time to study crypto. Ethereum ETF approval was inevitable, and the time lag between Bitcoin ETF approval and Ethereum ETF approval was actually very healthy in my opinion. This allowed some time for digestion, learning, and post-election clarity. The structural changes in the cryptocurrency market cannot be overstated.

Bitcoin has just maintained its 7th consecutive month of gains, and Bitcoin does not provide an opportunity to enter the market: 16 of the 21 weeks from mid-October last year to early March this year were green

Bitcoin has been going up for almost nothing over the past year and a half. Prior to April, it had been up 12 of the past 15 months, and up 16 of 21 weeks from the middle of last year to the beginning of this year. It's been pretty unstoppable. Though to be fair, few expected this to happen in the first half of 2023. Would it be shocking if we were to oscillate for a while now? I don't think so. Markets will trend, but it feels like people are still reeling from the crash of the last cycle.

I also feel more and more like I’m repeating the conversation I had in late 2022/early 2023, only now Bitcoin is around $60k instead of $18k. Not exactly the same, of course, but the skepticism is centered around the fact that Bitcoin has already risen so much, there is no new narrative driving it further up, and that memecoins have already gone crazy.

But I think none of these are real reasons why Bitcoin should fall.

BTC ETF has not yet entered the offline trading center

Now let’s get into some deep banking stuff. When I talk about financial advisors not being fully exposed to Bitcoin ETFs, I mean they don’t have the incentive to recommend such products to their clients yet.

When financial advisors recommend trades, they are categorized as “unsolicited” and “unsolicited.” Unsolicited sales are trades that the broker recommends to the client (“you should buy ABC”), while unsolicited sales are trades that the client proposes to the broker (“I want to buy XYZ”). The main difference here is that commissions are only paid on unsolicited trades.

Currently, no major financial management company allows active allocation of Bitcoin ETFs in its client portfolios. In short, these advisors don't really have any incentive to recommend these products to their clients. But it's only a matter of time - all these companies are waiting and watching, and once one company starts to act, others will quickly follow.

13F reports are also coming in. One important point Eric Balchunas made a week or two ago is that IBIT reports about 60 holders (a number that will increase as more reports are filed), but they only represent about 0.4% of the total outstanding shares. This means that " most buyers are small buyers, but there are a lot of buyers ." The highest record so far belongs to a financial advisor in Kansas who put $20 million, or about 5% of his portfolio, into Fidelity's Bitcoin ETF.

The last halving had a substantial impact on supply (currently 94% in circulation)

To be honest, these two metaphors feel like we repeat them every cycle. But they are worth mentioning regardless - with ~94% of Bitcoin’s supply currently in circulation, the recent halving will likely be the last meaningful halving. On the other hand, the market continues to be waterboarded by new token supply - new L2s, the Solana ecosystem, bridges, LRT, SocialFi, carry trade arbitrage. The list goes on and the total FDV of these projects is both astounding and unimaginable. As with every cycle, most tokens will trend towards zero as insiders unlock and sell . Enough has been written and discussed about this issue, though.

The halving just happened

The halving did just happen, supply was reduced, simple as that. Personally, I don’t find these last two reasons very compelling on their own, but they are interesting in that they are different from what people think we are in. If we look at the well-known Google Trends data for BTC, ETH, SOL, NFT, etc., there is a commonality.

We are still far from the true bull market peaks we have experienced in the past.

The same goes for the Coinbase App Store ranking (currently ranked #270). I’ll get to the controversial issue of retail investor participation later, but suffice it to say that there is a lot of room for growth in the usage of crypto-native apps.

AI narrative saves the market, unemployment will only rise, and traditional financial market breadth is weakening

I subscribe to the AI ​​narrative that saves traditional financial markets in Q4 2022 and Q1 2023. Without the launch of ChatGPT at that time, traditional markets may have collapsed instead of finding solace in new innovative models. But there is no way to prove the counterfactual, so we can only face the present situation. It is true that the labor market is showing incredible strength and unemployment can only rise. It is also true that the overall breadth of traditional markets is shrinking...

I don't think we've seen the kind of jaw-dropping run we saw when we broke out to new all-time highs. During my long bull run, people have been trying to convince me of all the reasons why it will take a long time to repair the damage in 2022. Now, most of the same people are trying to tell me all the reasons why we can't go any higher. That doesn't mean they're wrong this time, but the evidence I'm reading today suggests we have a lot more room to go.

I also think the delay in the Ethereum ETF is good for the extended cycle both from a timing and price perspective. This is another counterfactual, but I think if it had been approved in May(15), it would have been too close to Bitcoin’s approval. Market participants have short attention spans, and if the approval and subsequent trading of these products are tied together, it will lead to cannibalization of market share. To what extent, no one can say. But it is important that BTC funds continue to flow into the market as the only cryptocurrency ETF. It is the gateway drug. Ethereum ETFs will have their moment to shine, and in fact, Bitcoin’s performance will be their best marketing campaign. Baby boomer managers are being forced to consider Bitcoin as an asset class. They can no longer ignore it, and if they are lagging behind competitors with Bitcoin exposure, they need answers. Calling it a scam is no longer a legitimate view.

This is what a healthy market looks like. An asset gets oversold, then slowly rises as more and more people realize they can't buy it any lower. There's a period of consolidation as the market digests that, then the asset continues to climb higher. That kind of pump-and-dump top is not what you want to see if you expect the bull market to continue.

This time is different

“This time is different” – these are terrifying words.

You can occasionally say this to yourself, or you can privately discuss “what ifs” with your friends. However, if you say it in public, be prepared to be laughed at.

We've all been there. When someone says this, we can self-righteously parrot "this time is different" to show how smart and mean we are. We mock them on Twitter, call them stupid, and suggest that this might be their first time going through a cycle, as if it matters.

However, if you are still here, it means that deep down you actually believe vaguely that "sometimes things will be different."

If you say this and it ends up being wrong, everyone will laugh at you and call you a fool for thinking it would be different.

That's not a big deal. These people are rarely able to form independent opinions anyway, so why expect them to react differently?

But if you see enough evidence that “this time might be different” and do nothing, then who is the real fool?

Capital flows are growing, but where are they going?

The big question in my mind is how much of these passive flows will end up on-chain. The most boring scenario for crypto is that Bitcoin is a new asset class that is incorporated into a small part of the portfolio by institutional investors, while all other cryptocurrencies are relegated to a niche of online subculture. However, it is difficult to determine how much of the ETF inflows will end up on-chain, either directly or indirectly.

You might be thinking - Smac, how dumb are you, nobody buying into a Bitcoin ETF is going to use their Bitcoin for on-chain activities. Of course, that is true today, but that is not the point. We all know that the wealth effect is real in crypto, and that ETFs are going to be a gateway drug for some. The question is just scale, and I don’t think we’ll probably have a good answer to that in the short to medium term. But we can try to find directional clues…

If we look at stablecoin activity, we find some interesting data. The chart below shows that last November was the first time in about 18 months that stablecoin supply turned positive. The continued net capital inflows through stablecoins suggest that we are earlier in the cycle than people realize. This is particularly telling given the magnitude of the inflows in the last cycle.

We can also observe the total supply of stablecoins on exchanges, which has more than halved since its peak to trough, but is now clearly beginning to trend upward.

The hardest thing to translate is if and how this activity moves on-chain. Take the following with a pinch of salt, the chart below shows total active addresses (blue line) and stablecoins on exchanges. Depending on your own sentiment, you may come to some different conclusions, but here’s how I interpret this:

During the last bull run, we saw a huge increase in active addresses and then a big drop as people rage-exited, and activity levels have remained relatively stable since Q3 2021. We have yet to see a new wave of activity, which in my opinion suggests that retail activity is far from recovering.

It’s also worth mentioning here that retail activity is likely coming from Solana. There has been a noticeable increase in activity on Solana over the past 6-9 months, and I personally expect this trend to continue.

SOLs with a DAU of 0 or less than 1 are not worth paying attention to (Source: hellomoon)

What about more off-chain data? From Coinbase’s 10-Q last week, we actually saw a decrease in monthly transacting users (MTUs) from 8.4 million to 8 million. But both retail and institutional volumes more than doubled. Interestingly, while BTC’s volume share remained the same, ETH’s share shrank significantly, which could indicate increased demand for a wider range of crypto assets (i.e. altcoins) going forward, which is also very healthy in the long run as broader distribution across crypto assets is the desired end state. Haters and losers will say everything in crypto is a wash and people just arrived at the hyper-gambling end state. I would say this indicates there are more interesting early stage projects/protocols worth exploring.

First quarter of 2024

First quarter of 2024

How does this compare to what we’ve seen from Coinbase users over the past few years? First, we’re still over 40% below the 2021 high in MTUs (11.4 million) and below where we were at the end of 2022. For all the talk of memes and retail metamorphosis, I just don’t see a credible argument that this is happening on a large scale. Is this happening on a small scale for users who are very familiar with crypto? Of course, this again suggests that people are getting caught up in the crypto bubble and missing the broader picture. If you log on to Twitter to see what’s happening about crypto and treat the discourse there as a kind of gospel, you’re going to have a bad time.

End of 2021

End of 2023

The last point I want to make here is about altcoins outside of BTC and ETH. As early crypto investors, we obviously have strong convictions that this space will continue to grow, beyond just the majors. The simplest way to measure that activity is to use TOTAL3, which tracks the top 150 altcoins outside of BTC and ETH. I think it’s instructive to look at the cycles from highs to lows that we’ve seen before. Looking at the 2017 cycle and the recent cycle, it’s clear that the relative upside is compressing (although still astronomical), which is what we expect as the space expands. The base is larger, so high-speed upside is intuitively more difficult. But even if there’s plenty of room for further compression, I don’t think enough people realize there’s a lot of upside left in this space. TOTAL3 is only $640 billion, which may sound like a big number, but is almost insignificant in the grand scheme of financial markets. If we believe this is a $10 trillion space in the next 24 months, and BTC accounts for 40%-50% of that, there’s a ton of value left to be created.

2017-18

2020-21

2024-25?

I myself don’t think the space will be dominated by memecoins. Some people I admire disagree, and that’s okay. I think memecoins have their place and will continue to be a relevant part of crypto (and traditional finance, to be honest), but I’m also optimistic about a new wave of founders emerging. They’re thinking deeply about solving real problems, and they care about 10-year outcomes. Those are the types of founders we’re interested in working with.

If you haven’t figured it out yet, I still think we’re in the early stages of this cycle.

My guess is that we are only about a third of the way there. While many people cynically think it’s all about memecoins, there are actually other areas that are developing and building as well. Social Finance (SocialFi) is starting to see more creativity, the ERC-404 standard is still underexplored, the use cases of DeFi lending protocols are expanding outside the crypto circle, real world assets (RWA) are slowly being put on the chain, and we are also seeing more exploration of how distributed systems can affect the "real world". We are still adding new arguments to the public database and are always happy to talk to builders who are experimenting with strange, novel and ambitious intersections.

Despite the many problems, I remain extremely optimistic about this field.