Market update Q3 2023
Markets trended to lowest volatility in years | Regulatory scrutiny and catalysts around the potential spot Bitcoin ETF causes only notable price movements | The investment landscape for digital assets is starting to look brighter
In a quarter where the market trended towards the lowest volatility in years, news catalysts around the potential Bitcoin ETF and regulatory scenes caused the only notable price movements.
The past 18 months have seen several lawsuits against companies in the crypto sector by the SEC. The agency has sued Binance and Coinbase for running an unregistered securities exchange, Ripple for issuing unregistered securities, and it has prevented Grayscale from converting its Bitcoin trust into a spot ETF. The third quarter brought substantial movements in several of these cases. In early July, there was an unexpected outcome in the Ripple case against the SEC. The US District Judge decided that Ripple Labs Inc. did not violate federal securities law by selling its $XRP token on public exchanges, which meant a legal victory for the cryptocurrency industry. However, it also granted the SEC a partial victory on some other points in the lawsuit. The company's sales of $XRP of roughly $700 million to hedge funds were deemed unregistered securities sales. The decision that selling tokens on public exchanges does not constitute selling securities could serve as a precedent for other crypto companies facing challenges from the SEC regarding the categorization of their products. This is particularly relevant for firms like Coinbase and Binance, who offer crypto-assets on public platforms. Following the ruling, Coinbase resumed trading of $XRP, having previously delisted it from trading in 2020 due to the Ripple lawsuit. The broader crypto community has been closely observing this case, contesting the SEC's stance that a majority of crypto tokens should be classified as securities.
Despite the positive headlines on the regulatory front, July was one of the months with the lowest price volatility in Bitcoin's history. Part of the reason is that the positive headlines were offset by potential threats on the horizon. The market is still expecting the US Department of Justice to indict Binance, in addition to the ongoing SEC suit against them. The scope of this lawsuit is a significant unknown to the market. If it pertains to KYC/AML violations in Binance's early days, a settlement is likely. Some parts of the market anticipate a scenario more akin to the FTX situation, which could result in a more substantial sell-off. Due to these uncertainties, many market participants saw price increases in crypto as an opportunity to reduce their exposure, hence muting price upside.
The third quarter was not only filled with some cautiously optimistic news on the US regulation front but also showed green shoots regarding the adoption of public blockchain by large corporations. PayPal announced that it will be launching its own USD-pegged stablecoin on the Ethereum network called PYUSD. This move showcases confidence in the industry, even amidst the regulatory challenges faced by stablecoins over the past 6 months.
Image 1. Payment value comparison with stablecoins and other payment networks.
Source: Coinmetrics, Bloomberg
In addition, credit card giant Visa announced it will introduce settlement of the USDC stablecoin over the Solana network. The payments giant stated that this development could “improve the speed of cross-border settlements and provide a modern option for our clients to easily send or receive funds from Visa’s treasury.” Visa has been experimenting with USDC on the Ethereum Network since 2021. The significance of this became evident in 2022 when stablecoin payments processed a greater transaction value than both Mastercard and PayPal.
August marked further developments in another slow-moving legal case involving a crypto entity. Grayscale, a US-based asset management firm, first introduced and listed its Grayscale Bitcoin Trust in 2015. Since then, this trust has accumulated over 600,000 BTC (valued at $17 billion), which remains in the trust currently. However, the SEC never allowed for a redemption mechanism, causing the Grayscale Bitcoin Trust to trade at a large discount to its NAV—dipping as low as -45%. Although it has rebounded somewhat to -17%, the disparity remains. To address this, Grayscale has petitioned to transform its Bitcoin Trust into a spot Bitcoin ETF. This change would introduce redemptions, consequently bridging the gap between the trading value of the trust and its NAV, to the advantage of its investors.
However, the SEC continuously denied this motion (and any other Bitcoin ETF filing) with the argument that the proposals do not meet its bar for preventing market manipulation. In the US only Bitcoin futures are regulated, whereas the Bitcoin spot markets are not. The SEC claims there is no correlation between the futures price of Bitcoin & the spot price of Bitcoin (which is obviously false) and can therefore not monitor the Bitcoin market for price manipulation. This reasoning has led the SEC to decline spot Bitcoin ETF proposals for a decade. However, in a recent August decision, the DC Circuit contested the SEC's stance that Grayscale's ETF was not "designed to prevent fraudulent and manipulative acts and practices.". Judge Rao: "The Commission’s unexplained discounting of the obvious financial and mathematical relationship between the spot and futures markets falls short of the standard for reasoned decision making." While this doesn't guarantee Grayscale's transition from a Trust to an ETF, it inches them closer to that possibility. The court didn't instruct the SEC to endorse Grayscale's ETF, but indicated that their rationale on potential market manipulation was flawed. Consequently, the SEC must revisit Grayscale's proposal with the court's feedback in mind, which is expected to happen in October of this year. Even though this decision could pave the way for a spot Bitcoin ETF in the near future, the market was still very cautious on pricing this in. This sentiment was amplified when, two days later, news emerged that the SEC had postponed decisions on spot ETFs from Blackrock, Fidelity, and Valkyrie.
Another catalyst that led to the decline in market momentum was the shift from macro tailwinds in Q2 to headwinds in Q3. In the second quarter of 2023, we observed a significant rally in tech stocks, primarily driven by the AI-led surge following NVIDIA's quarterly results. Although the highly anticipated quarterly earnings from big tech companies remained positive in Q3, they were insufficient to propel the equity market forward, marking a local peak in stock prices for the remainder of the quarter. In addition to equities, many other risk assets also began to underperform in September. Historically, September exhibits the weakest seasonality for both stock and crypto prices.
Image 2. The average return per month for the S&P500 in the last 30 years.
Source: SentimentTrader. S8P 500 Index Seasonality: Average returns per month over last 30 years.
Monthly data as of January 2023.
This September began in much the same historical pattern. While at the start of the quarter, the consensus view was that the US would achieve a so-called 'soft landing' (bringing inflation back to the 2% target without hindering growth), this perspective underwent a complete reversal by the end of the quarter. Factors contributing to this shift included the persistence of US inflation, rising oil prices (which hinted at future inflation), and a decisive Federal Reserve press conference that firmly established the 'higher interest rates for longer' narrative. The US bond markets, in particular, saw a significant revaluation based on these developments, with long-end bond interest rates reaching levels not seen since the 2008 Great Financial Crisis. These elevated bond rates deterred equity investors, leading to a broad risk-off sentiment in traditional markets. This sentiment also spilled over to crypto-assets. As a result, any period of positive price momentum, especially in altcoins, was quickly met with selling pressure.
It's fair to say that we've entered the apathy phase of the bear market, characterized by low volatility, negative sentiment, limited inflow of new capital, and a virtually non-existent appetite for risk-taking. While this may be disheartening to some, there are budding signs of recovery within the industry, suggesting we might be nearer to the end than the beginning of this bear market. Crypto companies are beginning to win court cases in the US, pushing back against the strict regulatory environment. It's encouraging to observe the open-mindedness of US judges when ruling on cases involving the crypto industry and US regulatory bodies. With the potential approval of a spot Bitcoin ETF on the horizon and the possibility of a more accommodating macro environment in 2024, the future seems brighter than it has over the past 12 months.