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Hi readers, In today's newsletter, Andre Dragosch from Bitwise Investments looks at the implications of the Fed's interest rate cut for crypto. Then, Matthew Kimmel from CoinShares examines ETH's promise and risk for investors. Thanks for joining us. |
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The Fed Pivot is Finally Here
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"The time has come," stated Fed chairman Jerome Powell back in August at the Jackson Hole central bank symposium. Last week, the Fed cut its federal funds target rate by 50 bps to 5.00% p.a. (upper limit) which was slightly more than markets had priced in before the FOMC meeting. In other words, the Fed positively surprised markets with this rate cut. It is quite likely that the Fed is just getting started with rate cuts. At the time of writing, the market already expects 3 additional cuts (75 bps) by year-end and another 5 cuts (125 bps) next year through December 2025. The Fed has also telegraphed additional cuts via its latest Summary of Economic Projections (SEP) (aka "dot plot"). Nonetheless, despite this more-than-expected interest rate reduction of 50 bps, it is quite likely that the Fed still remains "behind the curve." For instance, a standard Taylor rule based on the unemployment rate and core PCE inflation implies that a fed funds target rate of around 3.6% p.a. is already warranted based on the underlying economic and inflationary momentum. In addition, the latest fund manager survey by Bank of America indicates that monetary policy was still "too restrictive" in September 2024 – in fact, the most restrictive since October 2008 according to this survey. There still remains an increased risk of a recession as several reliable indicators such as the prominent "Sahm rule" remain triggered. That being said, our quantitative analyses imply that global growth has become less relevant for the performance of bitcoin while other factors like monetary policy or the US dollar have become more important. |
In other words, a US recession might not be as negative as widely anticipated for bitcoin and other cryptoassets. To the contrary, it may lead to even more Fed rate cut expectations and US Dollar weakness which could provide even more tailwind. With the latest move by the Fed and other major central banks, the global liquidity tide is clearly turning; global money supply has already reached new all-time highs and is accelerating. Expansionary money supply growth periods are usually associated with bitcoin bull runs. |
The re-steepening of the US yield curve which tends to be a recessionary indicator is also an indicator for increasing liquidity and therefore bullish for scarce assets like bitcoin. |
What is more is that the increase in global liquidity is coinciding with the increasing supply scarcity of bitcoin which has been intensifying since the latest halving in April 2024. Our analyses have shown that there tends to be a significant lag between the halving event itself and the moment the supply shock starts to become significant, as the supply deficit only tends to accumulate gradually over time. So, it appears as if there is a perfect confluence between an increase in potential demand via global money supply and a simultaneous reduction in available supply via the halving. The market has been mired in "chopsolidation" – a choppy consolidating range-bound market – since the latest all-time high in March 2024. This was due to several factors such as government sales of bitcoin, Mt. Gox trustee's distribution of bitcoins, or the macro capitulation in early August 2024. In this context, the summer months have generally been one of the worst performing months for bitcoin historically with September being the worst month of the year. |
However, Q4 tends to be the best month for bitcoin from a pure performance seasonality perspective and we also expect bitcoin to break out of this chopsolidation in Q4. It seems as if the wait for a new break-out to the upside is finally over. The Fed pivot may have just delivered the perfect catalyst for that. |
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Ethereum's Changing Landscape |
Ethereum's ability to host a wide-range of applications and assets has been evident for years, but the investment case for its native token, ETH, has become increasingly complex. In the wake of key protocol changes, particularly the hardforks activating EIP-1559 and EIP-4844, investors are asking how Ethereum's adoption will translate into ETH's long-term value. While the platform has scaled, the relationship between its growth and ETH's supply and demand — and thus its price — is no longer as straightforward as it once seemed. The EIP-1559 revolution: linking utility to token value When Ethereum implemented EIP-1559 in 2021, it introduced a burn mechanism where the overwhelming majority of transaction fees (base fees) would be permanently removed from circulation. This created a direct relationship between Ethereum usage and ETH's supply. As users paid for transactions on the Ethereum network, the burn would act as a deflationary force, reducing ETH's supply and putting upwards pressure on its price. In 2023, our valuation model at CoinShares showed that under the right conditions, where Ethereum generated $10 billion annually in L1 transaction fees, something it achieved at its 2021 heights, ETH could reach a value near $8,000 by 2028. Since then, however, optimism has waned due to the Dencun hardfork and the rise of Layer-2s (L2), which have upended the fee burn and altered ETH's value potential. The rise of layer-2s: a double-edged sword L2 platforms were designed to scale Ethereum by moving transactions off the main chain (L1) and onto faster, cheaper networks. Initially, L2s complemented L1, helping the network handle more transactions without clogging the base chain — like a pressure release valve giving balance in times of high usage. |
But with the introduction of "blob space" in 2024, L2s could now settle transactions on L1 at much lower costs, reducing their requirement to pay expensive L1 fees. As more activity migrated to L2s, the supply burn that EIP-1559 was designed to instill began to drop, weakening the downward pressure on ETH's supply. The reality of Ethereum generating high L1 fees to support ETH's value is now looking bleak. L1 transaction fees have steadily collapsed, leading to questions about what differentiates the services offered at each layer, and what will drive the L1 fee landscape moving forward. A path forward: restoring the burn or adapting to new realities Despite these challenges, there are potential paths forward to restore demand for L1 transactions and, in turn, ETH valuation. One option is developing high-value use cases that rely on L1's security and reliability, yet, given current trends, this appears unlikely in the near future. Another possibility is that L2 adoption grows so rapidly that the sheer volume of transactions compensates for the discounted fees — but this would require extraordinary L2 growth, beyond near-term expectations. The most likely, and perhaps the most controversial, solution is repricing blob space to increase L2 settlement fees. While this would restore some of the L1 supply burn, it risks upsetting the economics of L2s that have been key to Ethereum's recent success and enhanced its ability to compete as an ecosystem with alternative platforms (like Solana, Binance Chain, etc.). The uncertain future of ETH While L2s have scaled Ethereum, they have also disoriented the mechanisms that tie ETH's value to its utility. For investors, this means that ETH's future depends on how Ethereum balances innovation with maintaining healthy economic policy. For now, ETH's investment case is unsettling, and risks remain high as the Ethereum community decides its path forward. |
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