In the first quarter of 2024, we saw Bitcoin surge to a new all-time high, reaching $73,800 on March 14th. Much of this significant price move was the result of the entry of institutional capital into Bitcoin through the spot ETFs launched in early January. The price surge also spilled over to the wider crypto market, leading to substantial gains in the altcoin market. In retrospect, the market might have gotten a bit ahead of itself, as the second quarter of this year was quite the opposite of Q1. Large idiosyncratic sellers of Bitcoin distributed their holdings over the market, causing a sharp correction.
While we started April with a new surge towards the previous all-time high, with Bitcoin trading well above $70,000 for several days, the market was shaken by an unexpected geopolitical event. On Friday the 12th of April tensions started to increase between Israel & Iran. This eventually resulted in Iran's attack on Saturday which sent around 170 drones, over 30 cruise missiles, and more than 120 ballistic missiles toward Israel. Although the attack caused limited damage, the markets took a major hit. As the events unfolded over the weekend, Bitcoin and other digital assets were the only tradable assets to express any view as traditional markets were closed. Bitcoin saw a sharp drop as investors de-risked in fear of global escalation, and many altcoins fell by more than 20% in a single day. The downturn in altcoins was further amplified by the cascading effect due to the high amount of leverage in the altcoin markets. When the traditional markets opened on Monday, we saw further downside risk-off behavior among all assets as crude oil surged in price, causing fears of renewed increases in the already sticky worldwide inflation. Within a week after the geopolitical events started, Bitcoin traded roughly 15% lower, and many altcoins saw much heavier losses.
Image 1. The Bitcoin price reaction to Israel/Iran conflict escalation.
Despite the volatile start of the quarter, April 20th marked a pivotal moment with the Bitcoin halving event. This event, which occurs every four years, halves the daily emission of Bitcoin, reducing the inflation rate from 900 BTC per day ($53 million) to 450 BTC per day ($27.5 million). The anticipated supply shift is likely to distort long-term supply and demand dynamics and has historically resulted in upward price pressure as the daily supply of BTC is reduced by 50%. However, as we briefly described in our previous quarterly update, Bitcoin halvings usually result in short-term price volatility:
“While this scenario is likely to unfold favorably in the long term, the event may also introduce short-term price fluctuations. Historically, Bitcoin halvings have reduced the profitability of Bitcoin miners, prompting some of the least efficient mining participants to sell their Bitcoin reserves to cover losses, which could suppress the Bitcoin price in the short term following the halving event.”
Following the halving, the reduction in block rewards from 6.25 BTC to 3.125 BTC squeezed miner profitability. As a result of this squeeze, we experienced a major capitulation event in May and June that was much more severe than the market anticipated. This quarter, many miners were forced to sell their reserves to cover operational costs, pushing Bitcoin prices lower. This huge overhang of more than $2 billion worth of Bitcoin being sold on the markets was too much to digest, causing a constant wave of relentless selling in all crypto assets.
Image 2. The reduction of BTC balance sheets of miners in Q2 .
In addition to the Bitcoin selling pressure from miners after the halving, the market faced more overhang from several fronts in Q2. In June, after 10 years of legal battles, the infamous Mt. Gox announced it would be distributing 140,000 BTC (worth about $8.6 billion) back to its rightful owners. Mt. Gox was an infamous crypto exchange that collapsed in 2014 after being hacked. In this incident, the hackers stole up to 950,000 BTC, of which 140,000 BTC were recovered after many years. After the announcement that Mt. Gox would start distributing the BTC, the market saw another sharp downturn due to fear of this supply being sold off in the market.
Meanwhile, the German and US governments also began offloading their Bitcoin holdings, which they acquired in several lawsuits. The German government started to offload 50,000 BTC ($3 billion) over the last two weeks of June. The US government's amount was relatively small but added to the cumulative selling narrative. At the time of writing, the market has chewed through the majority of the 50,000 BTC from the German government, and they have around 10,000 BTC left to sell. These continuous sales created a challenging environment for Bitcoin prices and caused bearish sentiment to spill over to the wider crypto market. The combined idiosyncratic supply overhangs from miners, Mt. Gox, and the German and US governments resulted in a negative decoupling from worldwide risk markets in Q2.
Image 3. German government’s 50.000 BTC stack getting sold off in a matter of weeks. Source: Arkham.
One would not expect it by purely looking at the price performance in Q2, but the quarter actually brought a wide stream of positive headlines that will have a lasting positive impact in the quarters to come. Most of the positive developments came from the US regulatory landscape. Whereas in the past years the United States has increasingly tightened their crypto regulation spurred by the SEC, a fresh wind started to blow in Washington starting in May. Although there was a wide range of crypto-related bills and notes that took center stage, the most notable was the so-called ‘FIT21’ bill. The goal of this bill is to provide a clear regulatory framework for the issuance, trading, and management of digital assets. The bill clarifies the roles of the SEC and the Commodity Futures Trading Commission (CFTC), determining whether digital assets are classified as securities or commodities. Under the bill, the vast majority of crypto assets would be qualified as commodities, taking them out of the jurisdiction of the restrictive SEC. This move is widely seen as very positive for the crypto industry, as the SEC has opted to “regulate by enforcement” in recent years instead of providing a clear regulatory framework.
As the Democrats have been mostly supportive of the anti-crypto policy by the SEC, it came as quite a surprise that FIT21 saw a shift in the Democratic party’s voting behavior. In the days prior to the House vote, rumors were swirling that a group of Democrats swung in favor of the bill. In the end, the U.S. House voted 279-136 to approve FIT21 with a very strong showing from House Democrats, breaking with the SEC’s anti-crypto approach. The passage of the crypto market-structure bill marks the industry's most significant legislative accomplishment in Congress. It is quite likely that the Democrats started to realize that being anti-crypto was losing votes from a big group of younger voters, as Donald Trump announced in the same week that he would be fully supportive of the digital asset industry if he won the election. In one of his rallies, Trump proclaimed: “We will defend the right to mine bitcoin, and ensure every American has the right to self-custody their digital assets, and transact free from government surveillance and control.” Although the words of Trump should be taken with a grain of salt, after years of a restrictive stance from the US government towards digital assets, it is very supportive for the industry to see this change of tone.
High-profile applicants such as BlackRock, Fidelity, and VanEck, who successfully launched Bitcoin ETFs, applied for their Ethereum ETFs at the end of 2023. In our Q1 update, we noted that the chances of a May approval for the spot Ethereum ETF were unlikely due to the non-existent public communication between the SEC and the ETF filers. However, this changed on May 20th, when Bloomberg journalists Eric Balchunas and James Seyffart raised the odds of a spot Ether ETF approval to 75%, up from 25%. They cited chatter indicating that the SEC might be reversing its stance due to increasing political pressure from high-ranking members of the Democratic Party. The SEC’s unexpected request for an accelerated update on filings for spot Ether ETFs suggested that approval would be imminent. On May 23rd, the final word came: the SEC approved the 19B-4 form of the spot Ethereum ETF. Form 19B-4 refers to the filing that a national securities exchange, such as the NYSE or Nasdaq, submits to the SEC when proposing to change rules or introduce new products. However, for the Ethereum ETFs to officially start trading, the approval of the S-1 form is still required. These forms are being submitted by the filers (BlackRock, Fidelity, VanEck, and others) and also need final approval from the SEC
For the remainder of the quarter, we saw back-and-forth communication between the SEC and the filers to finalize the Ethereum ETF products. The final approval is not yet in, but is expected to arrive in the back half of July. One interesting statistic to monitor is the dynamics around the Grayscale Ethereum Trust. Similarly to what we described in the previous quarterly update regarding the Grayscale Bitcoin Trust, Grayscale has accumulated slightly under 3 million Ethereum over the past six years in a trust that has not allowed for redemptions. As a result, many investors have been locked into the Grayscale Ethereum Trust for multiple years. Once the final approval for the Ethereum ETFs is obtained, this trust will convert into an ETF, which will finally allow investors to exit. This could potentially lead to a significant supply overhang of Ethereum in the market that will need to be digested, resulting in price volatility. While the initial trading weeks will likely be volatile, a final approval would be a major milestone, signaling further institutional acceptance and potentially driving significant inflows of new capital into the industry.
The second quarter of 2024 was an extremely challenging market environment due to the constant addition of more idiosyncratic supply overhang in the Bitcoin markets. Although we have chewed through the majority of capitulated miner supply and the German government sales, the Mt. Gox distribution is only just starting. However, one should note that markets are generally forward-looking and will probably start repricing before the final Bitcoin is sold off in the markets. Due to the widespread bearish sentiment after the relentless selling in Q2, the market has priced out any form of success that the Ethereum ETF might bring. Due to the very low expectations in the market, this product could potentially bring a large surprise to the upside and spark upward price momentum. In addition to the Ethereum ETF, it should not be understated how positive it is that crypto is now an active issue in the US elections with Trump’s active support and the apparent shift in the Democratic Party. Finally, it is likely the back half of 2024 will bring a more favorable monetary policy for risk assets as inflation is waning and central banks around the world are starting to lower interest rates.