Who is behind the crypto market’s surge in February?

• In February, Bitcoin prices rose 45%, surpassing $60,000 for the first time since Q4 2021, and ended the month just 9% below their all-time high. We believe the price increase likely reflects significant inflows into new U.S.-listed ETFs and anticipation of the Bitcoin halving in April.

• From the perspective of the crypto industry, the utility and service crypto industry dominates other market segments. This field includes many projects that may have synergies with artificial intelligence technology, including Filecoin. The decentralized file storage service has expanded to computing functions and announced integration with Solana.

• Macro factors could be the main obstacle to higher cryptocurrency valuations in the short term. Inflation accelerated in February, casting some doubt on the likelihood of a rate cut by the Federal Reserve.

In a mixed month for traditional assets, the cryptocurrency market generated solid returns in February 2024, helped by steady inflows into new spot Bitcoin ETFs and a variety of positive fundamental developments. The main risk to digital asset valuations right now is likely to be the Federal Reserve’s monetary policy: inflation picked up again in February, and any further acceleration could delay rate cuts until later this year or longer.

Bitcoin and Ethereum were among the best performing assets in both crypto and traditional finance in February, both in absolute terms and in risk-adjusted terms (returns relative to volatility) (Exhibit 1). Global bond markets fell this month as a resurgence in inflation dampened hopes of rate cuts by U.S. and European central banks. Equities were mostly higher, led by Chinese and other emerging market stocks. While cryptocurrencies have become increasingly correlated with traditional markets in recent years, the performance of major tokens in February once again highlighted the diversification benefits of the crypto asset class.

Chart 1: Bitcoin and Ethereum outperform many other major assets

For Bitcoin, solid returns likely reflect, at least in part, steady inflows into the new U.S.-listed spot Bitcoin ETFs. From their launch on January 11 through the end of the month, the ten spot Bitcoin ETFs saw net inflows totaling $1.46 billion. [1] In February, net inflows accelerated sharply, totaling $6 billion for the month. For the entire cryptocurrency exchange-traded product (ETP) universe, we estimate total net inflows of $6.2 billion in February, more than double the monthly record since October 2021 (Exhibit 2). Notably, U.S.-listed gold ETFs have experienced net outflows since the launch of their Bitcoin ETFs, as investors switch from one “store of value” asset to another. [2]

Chart 2: Crypto ETP net inflow records

From the perspective of spot Bitcoin ETF inflows, at the current block reward rate, the Bitcoin network produces about 900 new Bitcoins per day, or about $54 million worth of Bitcoin (assuming an average price of $60,000 per coin). In April 2024, Bitcoin issuance will be cut in half (which occurs every four years, called a "halving"), at which time daily issuance will drop to 450 Bitcoins. In February, net inflows into U.S.-listed spot Bitcoin ETFs averaged $208 million per day, far exceeding the rate of new supply even before the halving. We believe that the imbalance between new demand and limited new issuance may have led to the increase in valuations.

Despite Bitcoin’s solid returns in February, it was outperformed by the second-largest crypto asset by market cap, Ethereum (ETH), which gained 47% on the month. [3] The market appears to be anticipating a major upgrade to the Ethereum network scheduled for March 13. Ethereum is pursuing a modular design philosophy that will see more activity on Layer 2 blockchains connected to the Layer 1 mainnet over time. The upcoming upgrade will accommodate this growth by providing Layer 2 with designated storage space on Ethereum, aiming to reduce their data costs and, hopefully, improve their operating margins. Ethereum could also benefit from other tailwinds, including interest in “restaking” technology [4] — Eigenlayer, a leader in the space, raised $100 million from venture capital firm a16z this month[5] — as well as interest in the ETH Denver conference (February 29-March 3), and the prospect of regulatory approval for an ETH ETF.

The best performing segment in February was utilities and services cryptocurrencies—up 53% (Exhibit 3). This category includes tokens related to artificial intelligence (AI) technologies , some of which have seen outsized gains. [6] While not originally designed with AI applications in mind, we expect Filecoin (FIL) to have benefited from the market’s interest in this topic. The project initially focused on decentralized storage but now includes smart contracts and compute infrastructure, which could bring synergies with blockchain-based AI applications. On February 16, Filecoin announced an integration with Solana to provide a decentralized block history for the network. [7] Filecoin currently has a dominant market share (~99%) in the decentralized data storage space. [8]

Chart 3: Utilities and Services Crypto sectors outperformed in AI

The crypto-finance category grew by 34%. [9] Part of the reason for the growth was a surge in the governance token of decentralized exchange (DEX) Uniswap. The platform generates revenue through trading fees, a portion of which goes to the Uniswap Foundation when users visit the front-end website. However, no revenue currently flows directly to holders of the UNI governance token. On February 23, the head of governance at the Uniswap Foundation proposed distributing fee revenue directly to UNI holders who stake tokens on the platform and delegate voting rights. [10] If implemented, the UNI token would receive a portion of the trading fees from one of the most traded decentralized financial applications.

February’s rise in valuations was accompanied by an increase in trading volume and a rise in various on-chain metrics, particularly for Ethereum. For example, average daily spot trading volume for ETH reached $5.8 billion in February, the highest level since September 2021, according to Coin Metrics data. The value of all transfers on the Ethereum network also increased to its highest level since June 2022 (Chart 4). Finally, the total stablecoin market capitalization increased by another $5.5 billion this month. [11] In related news, stablecoin issuer Circle announced that it would stop supporting USDC on the Tron blockchain. [12] About 80% of all USDC in circulation is on the Ethereum network, with only about 1% on Tron (where Tether is the primary stablecoin). [13]

Chart 4: Ethereum’s on-chain transfers continue to increase

The cryptocurrency market has performed strongly this year, supported by Bitcoin ETF inflows and various fundamental positive factors. However, an important lesson from the last crypto cycle is that macro factors such as the Federal Reserve's monetary policy and economic conditions can have a significant impact on crypto asset valuations. If the macro market outlook remains positive, many aspects of the industry, including the Bitcoin halving and Ethereum's upgrades, may point to further gains in token prices throughout the year. Now, the price of Bitcoin is only 9% above its all-time high, so new records may be reached later this year.

In contrast, a less favorable macro outlook could dampen valuations. Bitcoin could benefit from an eventual shift by the Federal Reserve from rate cuts to rate cuts in the fourth quarter of 2023. If the central bank does cut rates in the coming months, it could weaken the dollar and support valuations of assets that compete with the dollar, including Bitcoin. But during January (when February data was reported), the steady decline in U.S. inflation appeared to be slowing or pausing in some measures[14], and markets began to discount a higher inflation outlook (Figure 5). If inflation remains stubborn, Fed officials could consider delaying cuts until later this year or until 2025. In general, higher U.S. interest rates[15] are likely to be positive for the value of the dollar and potentially negative for Bitcoin.

We believe the most likely outcome is that US consumer price inflation will continue to decline, facilitating an eventual rate cut by the Fed. However, crypto investors should focus on upcoming inflation reports (particularly the CPI report on March 12 and the PPI report on March 14) as well as the Fed’s updated policy rate guidance at its next meeting on March 20.

Chart 5: Markets pricing in higher US inflation