The cottage season is coming and funds are rotating

Since October last year, our altcoin momentum indicator has shown a growing willingness among investors to move capital further up the risk curve.

While Bitcoin’s dominance remains significant, we are already seeing early signs of more capital beginning to move into the Ethereum, Solana, Polkadot, and Cosmos ecosystems.

Investigating Uniswap liquidity pools, we can see that the majority of capital remains in the most mature assets, and while total value locked (TVL) is moving outside the risk curve, trading volume has been slow to follow.

1. Anticipating an “Altcoin Season”

As new spot Bitcoin exchange-traded funds (ETFs) gain momentum, a bull run in the digital asset space may have begun. Against this backdrop, we continue to explore the question of whether capital will flow into altcoins, which we covered in our Week 4 On-Chain Weekly Report. This issue will focus on the performance of assets further up the risk curve.

The goal is to assess how capital rotates and flows in the altcoin market. We will again use our altcoin indicator as a macro indicator (see Week 41, 2023). This indicator assesses whether positive momentum is building within the total exchange coin market capitalization and is accompanied by continued capital inflows into Bitcoin, Ethereum, and stablecoins.

Our altcoin indicator has been showing positive momentum since October last year, despite a brief pause during the “sell the news” event following the Bitcoin ETF approval. It retriggered on February 4th.

In terms of market capitalization, Bitcoin continues to lead the total market capitalization of the entire digital asset market with a market share of over 52%. In comparison, Ethereum accounts for 17%, stablecoins account for 7%, and the remaining altcoins account for 24%.

In terms of asset performance, BTC and ETH lead the way, with year-to-date (YTD) gains of +17.6% and +18.2%, respectively. We note that after the approval of the Bitcoin ETF, ETH began to outperform BTC, a change from its relative underperformance since 2023.

However, overall, altcoin market capitalization has underperformed, with year-to-date growth less than half that of the two major currencies.

Another way to track performance is to use the realized market cap for each sector, which aggregates the cost basis value of all coins transferred on-chain. From this single chart, we can better assess the flow of capital within the digital asset market.

Bitcoin is once again the clear leader, currently seeing inflows of almost $20 billion per month.

Ethereum’s capital inflows tend to lag relatively behind Bitcoin, indicating that investors seek confidence and confirmation that the digital asset market is growing. In the 2021 cycle, the peak of new capital inflows into BTC occurred 20 days before the peak inflows into ETH.

Altcoins tend to see capital flows with a similar lag after ETH shows strength, with 46 days in mid-2021 and 14 days in late 2021.

Apparently, capital flows to altcoins have been slower than the rotation between the two major cryptocurrencies, a trend that appears to be repeating itself again.

2. Industry Rotation

With signs of capital flowing to the two major coins, the next question is to observe how it flows further up the risk curve over time. During the last cycle, several new layer-1 ecosystems emerged. Many of these ecosystems compete with Ethereum not only in terms of innovation and attracting users, but also in terms of investment capital.

Therefore, we examined the top five tokens of a few selected ecosystems: Ethereum, Cosmos, Polkadot, and Solana, to assess which ones are attracting the most investor interest.

Here we compare the weekly changes in the total market capitalization of the top five tokens in each ecosystem. Over the past 18 months, Solana has shown relatively high volatility, with an especially strong upside performance. Polkadot and Cosmos have similar volatility, but the Polkadot ecosystem has outperformed the latter.

Within the Ethereum ecosystem, we can specify three main sectors: DeFi, GameFi, and Staking. All three sectors have seen inflows since the beginning of the year, however the DeFi and GameFi sectors have seen relatively large outflows in 2022 and 2023.

The GameFi sector has reversed course this year, with significant inflows starting in October, coinciding with the timing of our altcoin indicator triggering. In contrast, staking tokens have been experiencing positive capital inflows, albeit in smaller absolute amounts.

3. Moving on the Risk Curve

To determine whether and to what extent investor interest has shifted outside the risk curve, we can refer to data from Uniswap liquidity pools. Since altcoins are often traded by more crypto-native traders through decentralized exchanges, activity on the oldest established DEXs can serve as a proxy for altcoin trading trends (note: this data reflects Uniswap transactions on the Ethereum mainnet).

Altcoin trading interest was very low during the 2022 bear market, but began to increase in mid-2023, mainly driven by the "meme coin craze". Currently, altcoin trading accounts for nearly 12% of Uniswap trading volume, close to 17.4% at the peak of the last bull market. In contrast, WBTC and WETH transactions account for 47% of trading volume, and stablecoins account for 40%.

Liquidity providers on Uniswap tend to monitor the market closely, and changes in the distribution of liquidity across pools can provide an indication of market trends. By examining the composition of the total locked value (TVL) on Uniswap, we observed that during the alt season, liquidity allocations for tokens outside the top 50 increased. This trend indicates that investors' interest in long-tail tokens is growing.

During the bear market, liquidity was primarily provided for the top 50 tokens as this is where most of the trading volume occurred. The top 10 tokens were mainly composed of WETH, WBTC, and stablecoins.

By looking at the percentage change in TVL per token category, we can detect an increase in liquidity provided to the top 10 (5.14%) and top 20 (10.9%) tokens, while liquidity was removed from tokens ranked 20 to 50. This suggests that market demand for long-tail assets has not yet grown significantly.

We will now examine the liquidity pools of the top tokens in each of the Ethereum space. This includes assessing the distribution of liquidity across various price ranges and observing the evolution of market depth (similar to the hypothesis we established in On-Chain Weekly Week 36).

The distribution between altcoins and WETH reserves is relatively balanced, with slightly higher expected upside volatility overall. This suggests that liquidity providers generally hold a bullish view on these tokens. The exception is GameFi Token IMX.

When looking at the rate of change in liquidity distribution, we see an increase in market depth in the -5% and +5% ranges, indicating that liquidity providers are preparing for a period of greater price volatility.

UNI is an exception, with market makers increasingly concentrating liquidity around the current price range. This suggests that UNI tokens are expected to have less price volatility, which is not surprising given that it is one of the most mature and stable tokens. Now comparing this to trader behavior, we can observe an increase in Uniswap volume since October 2023, including for tokens outside the top 10.

In contrast to this is trader behavior, where we can observe an increase in trading volume on Uniswap since October 2023, including for tokens outside the top 10. Trading activity for the top 10 to top 20 token pairs is also on the rise.

However, trading activity for the top 20-50 token pairs, as well as for 50+, remained unchanged, which reaffirms our previous hypothesis. While liquidity provision is moving towards higher risk curves, trading volumes have not yet caught up.

IV. Summary and Conclusion

Market momentum for the new Bitcoin ETF and expectations of a bull run for digital assets are beginning to cause a shift in capital flows toward altcoins. Our altcoin indicators suggest that the alternative coin market may be on the verge of a more mature and potentially sustained upswing, but currently remains relatively concentrated in higher market cap assets.

The digital asset landscape has changed significantly over the past cycle, with new ecosystems emerging to challenge Ethereum's dominance. Solana has been the strongest performer over the past year, but activity has also begun to emerge within the Polkadot and Cosmos ecosystems. Within the Ethereum ecosystem, the top tokens in the staking space have shown the most consistent capital inflows.

The resurgence of altcoin trading on Uniswap, along with liquidity and volume patterns, highlights a growing and cautious interest in long-tail assets. This was initially reflected in changing liquidity provision, as well as expectations of high volatility. However, this is particularly present within the TVL of the pool, and investor trading volume has yet to follow suit.