What factors will support the strength of BTC and ETH?

summary

• The Federal Reserve is likely to stick with its plan to cut interest rates this year despite evidence of a strong economy because short-term rates are well above policymakers’ estimates of “neutral.”

• Grayscale Research believes that this macro backdrop, along with favorable supply and demand technicals from the halving, could be consistent with further gains in Bitcoin prices this year.

• There has been increasing discussion in the cryptocurrency market about Ethereum, which faces competition from other smart contract platform blockchains and the U.S. market’s decision on spot ETF approval is also pending.

Since reaching its all-time high on March 13, the price of Bitcoin has been consolidating in a relatively narrow range (Chart 1). Despite the increase in certain macro risks, Grayscale Research remains optimistic that Bitcoin prices may rise further this year.

Chart 1: Bitcoin price consolidates after reaching all-time high

Since Bitcoin’s March 13 high, the evolution of traditional asset valuations looks consistent with a more positive outlook for global growth and higher inflation risks. On a risk-adjusted basis (i.e., taking into account the volatility of each asset), physical commodities, Western European and emerging market equity markets, and assets tied to U.S. consumer price inflation have led gains (Exhibit 2). Long-term Treasuries have lagged significantly, perhaps reflecting elevated medium-term inflation risks. Certain technology-oriented segments (e.g., the Nasdaq 100, biotech stocks, and recent IPOs) are flat or down. Since the start of the year, Bitcoin, and especially Ethereum, has outperformed most other assets, but has underperformed both in absolute terms and on a risk-adjusted basis.

Chart 2: Commodities and inflation indicators have dominated the market since mid-March

We believe that a lower probability of a Fed rate cut may be one reason for Bitcoin’s recent pullback. Since mid-March 2024, U.S. economic indicators have continued to surprise on the upside. For example, the March jobs report released on Friday, April 5, 2024, showed a monthly increase in payrolls of about 300,000, an increase in the labor force participation rate, and higher average weekly work hours. [1] Strong economic and moderately higher inflation data have led to lower expectations for Fed rate cuts. At one point in January 2024, the market was pricing in as many as seven 25 basis point rate cuts this year. As of Monday, April 8, 2024, the rate cuts have been pared back to nearly three 25 basis point cuts (Exhibit 3). All else being equal, rising short-term interest rates tend to support the value of the U.S. dollar and weigh on the value of Bitcoin .

Chart 3: Markets have priced in a reduction in the Fed’s rate cuts

Still, the main outlook remains lower short-term interest rates—both in the United States and in all other major markets except Japan. As recently as the March 19-20 meeting, most Fed officials expected three rate cuts this year, despite forecasting stronger GDP growth and higher core inflation.[2]

Furthermore, even if recent data continue to show strong nominal growth, the Fed’s framework is likely to continue to steer policy toward lower interest rates. Based on their latest projections, Fed officials appear to believe that short-term interest rates will be 2.5-3.0% over the long term, which can be interpreted as their estimate of the “neutral” policy rate. [3] Since the current policy rate of 5.25-5.50% is well above their “neutral” expectations, the central bank believes that monetary policy has become unnecessarily tight in the context of slowing inflation. While there is debate in the policy community about the level of the neutral interest rate, the Fed’s thinking is likely to continue to consider rate cuts. We believe that a Fed rate cut should be viewed as positive for Bitcoin in the context of strong economic growth and above-target inflation.

Additionally, Bitcoin’s supply and demand technicals are likely to tighten in response to the upcoming halving event (which will occur at block 840,000; at current block production rates, this will likely occur at midnight EST on April 20). At the halving, the issuance of new Bitcoins will drop in half, from about 900 Bitcoins per day to about 450 Bitcoins per day, or $31.5 million at an average Bitcoin price of $70,000. While net inflows into U.S.-listed spot Bitcoin ETFs have slowed since February and March 2024, they still averaged about $80 million per calendar day over the past two weeks. [4] Taken together, we believe that a strong economy, the potential for central bank rate cuts, and favorable supply and demand technicals should support Bitcoin’s price. After a period of consolidation in Bitcoin’s price, measures of active trader positioning (such as the funding rate) now appear more balanced [5], which may also indicate a positive market outlook in the short term.

There has been increasing discussion in the cryptocurrency market about the prospects of Ethereum, the second largest blockchain network by market cap. Since the crypto market high in mid-March, Ethereum’s Ethereum (ETH) has underperformed Bitcoin (BTC) by about 6 percentage points (Chart 4).

Chart 4: Ethereum underperforms Bitcoin

Unlike Bitcoin, which dominates the crypto space, ETH faces meaningful competition in the smart contract platform crypto space. While the ETH ecosystem has seen a significant increase in active users this year, the network’s modular architecture means this has not translated into a corresponding increase in fee revenue, as new activity has primarily occurred on Layer 2 and sidechains (Exhibit 5). ETH may also be held back by the low likelihood of spot ETF approval. According to decentralized prediction platform Polymarket, consensus expectations for spot Ethereum ETF approval have fallen by about 20% from around 80% in January. The SEC is expected to make a decision to approve or reject the proposal in late May 2024.

Chart 5: Ethereum ecosystem activity does not translate into mainnet fee revenue

From a bigger picture perspective, Grayscale Research remains optimistic about Ethereum's prospects. Accumulation of token value ultimately derives from network adoption for sustainable (i.e., non-speculative) use cases. Ethereum continues to have the most users, developers, and applications compared to other smart contract platform blockchains. Therefore, Ethereum should be in a good position to compete for users over time. That being said, there are still risks to ETH valuation in the short term related to Ethereum ETF spot approval, and competition with the smart contract platform cryptocurrency industry is likely to remain fierce. To maintain its leading position, Ethereum's ecosystem needs to continue to work hard in the direction of deployment and adoption of decentralized applications over time.