October 6, 2023
Greg Cipolaro

Research Weekly - 3Q23 Review and Look Ahead


  • Bitcoin's value experienced a drop of 11.1% during challenging third quarter, as numerous asset classes grappled with the impact of rising interest rates and concerns about an economic downturn.
  • Bitcoin is still up 63.3% on a year-to-date basis, far exceeding returns for every other asset class.
  • Spot bitcoin ETFs were highly topical with investors, with anticipation building given some key deadlines early next year.
  • The SEC has until next Friday, October 13th to appeal the ruling the Grayscale case, the outcome of which could be pivotal in approving or denying the current cohort of ETF applications.
  • Bitcoin continues to trace a familiar pattern exhibited by previous cycles, with all eyes on the reward halving in April 2024 as an important economic and price cycle marker.

Performance Review

Bitcoin Post a Decline as Rangebound Trading Continues

The price of bitcoin fell 11.1% during the quarter, bringing its year-to-date return to 63.3%. Interestingly, the past few months have seen bitcoin trading within a relatively narrow range, despite various significant events and developments in the financial landscape. The price of bitcoin has remained confined between $25K and $31K, defying attempts to break out in either direction. This has been the case even with the impact of court rulings, macroeconomic changes, the potential threat of a government shutdown, debates surrounding the debt ceiling, and the ongoing efforts to secure approval for a spot bitcoin ETF in the US.

However, bitcoin wasn’t the only asset down on the quarter. Nearly every other asset class, including stocks, bonds, gold, and real estate, was down during 3Q. Persistently high inflation, rising rates, and recession worries weighed on returns, with commodities being the one exception. For commodities, production cuts by OPEC+ countries drove oil prices from $70/bbl to over $90/bbl during the quarter before falling back the past days.

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Despite the performance in the third quarter, bitcoin continues to maintain its position as the top-performing asset/asset class for the year, with an impressive 63.3% year-to-date increase. While stock market indices have dipped from their July highs, equities are still solidly up year-to-date . On the other hand, bonds have faced challenges due to higher interest rates and inflation, resulting in some bond asset classes seeing gains while most experiencing losses for the year. The asset class with the poorest performance on a year-to-date basis is long-term US Treasuries. Not only are these US Treasuries exposed to duration risk as rates rise, but downgrades and credit warnings have likely impacted their performance.

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Seasonality a Factor as Well for 3Q

In the past, the third quarter has consistently shown to be bitcoin's weakest period, and this year is no exception. Typically, returns start to decline during the summer months, hitting a low point in September before rebounding in October. The lack of catalysts, coupled with investor apathy and the "sell in May and go away" mentality that characterizes seasonal trends in equity markets, all contribute to this pattern during the third quarter. However, the silver lining is that the lackluster performance in 3Q may pave the way for a strong 4Q, historically one of bitcoin's best quarters.

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Correlations Perk Up with Equities, Decline with USD

Bitcoin's correlations with other asset classes, especially equities, are a topic of frequent discussion. With its historically low correlations with other assets, bitcoin has the potential to diversify portfolios, reducing risk and increasing returns. In the third quarter, as macroeconomic factors impacted both bitcoin and equities, their rolling 3-month correlations saw an uptick. The great news is that these correlations, while slightly higher, remain well below their peak in mid-2022.

Despite the widespread belief on social media that a strong dollar is hindering bitcoin returns, its correlation with the US dollar continues to weaken on an absolute basis. Ultimately, we believe that the strength or weakness of the US dollar in comparison to other fiat currencies is determined by macroeconomic factors such as real interest rate differentials and current account deficits or surpluses, which may be the more interesting factors to focus on.

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The Events that Shaped the Quarter

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ETFs Continue to be Top of Mind

Ever since BlackRock filed for a spot bitcoin ETF on June 15th, the entire industry has been buzzing with excitement about the possibility of a spot bitcoin ETF finally trading in the US. However, despite several other companies following suit and filing for similar listings, it seems like there hasn't been much progress on the surface. The SEC has been continuously delaying their final decisions on all existing products throughout the quarter, and they even expedited the decision to postpone some deadlines in November, potentially due to a looming government shutdown which never materialized.

But amidst all this, there was one significant development on the ETF front - the legal case between Grayscale and the SEC. In early September, the DC Circuit Court of Appeals ruled in favor of Grayscale and against the SEC, strongly criticizing the SEC's stance for rejecting spot ETFs. What the SEC's next move will be remains unclear, but they have until October 13th to appeal the Grayscale decision.

While the industry did see some new ETFs approved, they were primarily in the form of ETFs backed by Ethereum futures. However, even though these products are still in their infancy, their performance has been lackluster so far, accumulating only $16.8M in AUM. This could be seen as a critique of the disadvantages of futures-based crypto ETFs, but it also highlights the lack of investor appetite for the asset class at the current juncture.

Legal Proceedings Go Against the SEC

The SEC faced a legal setback during the quarter with the Grayscale case, but that wasn't the only blow it experienced this quarter. The highly anticipated litigation with Ripple also went partially against the agency, causing a stir in the industry. Certain offers and sales of XRP, in particular secondary sales, were deemed not in violation of securities laws by the judge. This partial victory, although subject to appeal, dealt a temporary blow to the agency's regulatory efforts. The conclusion of this case is still uncertain, so stay tuned for updates.

In addition to Ripple, we are closely monitoring the SEC's cases against Binance and Coinbase. However, it is still too early to draw any significant conclusions. It took over two and a half years for the SEC's case against Ripple to reach a judgment, and even then, it was only a judgment on some of the charges. Given that the SEC's cases against Binance and Coinbase are only four months old, it may take several years before a final decision is reached.

Bitcoin Related Equities Struggle

With bitcoin falling during the quarter, it comes as no surprise that crypto related public equities struggled in the quarter as well. On a market cap weighted basis, crypto companies, which include exchanges, entities that hold large amounts of bitcoin, like MicroStrategy, and ASIC miner manufactures, fared better than bitcoin miners. Crypto companies were up 1.6%, buoyed by Coinbase’s quarterly return, while miners fell 22.4%. Given the leverage in their business models, it is not surprising to see bitcoin miners underperform spot bitcoin in a falling price environment.

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Look Ahead

ETFs at a Critical Juncture

The upcoming fourth quarter will be a crucial period for the potential approval or rejection of spot bitcoin ETFs. The SEC has until January 10th, 2024, to reach a final decision on the Ark 21Shares application, which is currently at the forefront of the approval process. While the final decision deadline for ETFs like BlackRock's extends to March 2024, it seems possible that the SEC will adopt a consistent approach for all ETFs, either granting approval or denying many of them simultaneously. Although the actual approval or denial may not occur in the fourth quarter, it could happen in early 2024 given the looming Ark 21Shares deadline. The possibility of a government shutdown on November 15th, given the recent 45-day reprieve granted by Congress, might also prompt the SEC to expedite its final decision. In anticipation of a potential shutdown on October 1st, the agency preemptively postponed decisions on all ETFs in the pipeline. It may choose to make decisions again ahead of the November 15th budget date.

Regarding the Grayscale litigation, the SEC has until August 13th to file for an appeal. It may try to push the case to the Supreme Court, but that seems less likely given the nature of the case, or it may request an "en banc" panel review from the DC Circuit Court, which would result in further examination of the case. If the SEC decides not to appeal, the ball will be in the SEC’s court to decide Grayscale’s petition within the parameters set forth by the DC Circuit’s decision reversing the SEC’s previous denial of the petition.

More Civil and Criminal Charges to Come?

Let us start this section by saying that it is impossible to predict the actions of legal or regulatory authorities in the future. However, the head of the SEC's crypto enforcement division recently made comments suggesting that it may continue to take action against crypto exchanges and DeFi projects. While we can't speculate on which specific companies or protocols might come under scrutiny, it seems likely that the SEC will be taking more actions in the future. Additionally, the CFTC settled charges with three DeFi platforms this quarter, and it would not surprise us if more charges were to come from that agency as well.

But perhaps the biggest question on everyone's mind is Binance. Despite a recent decline in volume and market share, Binance remains the largest spot and derivatives exchange in the crypto industry (assuming their self-reported volumes are accurate). There have been media reports of an ongoing criminal investigation by the DOJ, although no charges have been filed yet, so any speculation on our part would be pure conjecture. However, it is worth noting that several key executives have left Binance's US subsidiary, Binance.US. If charges were to be filed against Binance or its executives, it would undoubtedly have a significant impact on the market. But until that day comes, it is best for us to reserve judgment.

The Cycle Remains the Remain

What's remarkable about the drawdown since the peak of the cycle in November 2021 is how uncannily similar it appears to the previous two cycles. Bitcoin has experienced four significant price cycles, all culminating in a sharp decline of 75% or more from peak to trough. The previous two cycles, including the drawdown and subsequent recovery, mirror the current one in terms of both depth and duration. If investors cast their minds back to the last cycle, they'll find that 2019 bore a striking resemblance to 2023. In December 2018, Bitcoin hit its price bottom (similarly, it bottomed in November 2021 this cycle) and then rebounded in 2019 (just like it is doing now in 2023). The only difference was that by mid-2019, Bitcoin had quadrupled from its low point, only to fall again through the second half of the year. It didn't hit another bottom until March 2020, plummeting from the mid-2019 high by 72%. While 2023 looks a lot like 2019, it hasn't experienced such a significant retracement. Nevertheless, it is important to emphasize the repetitive cyclical nature because Bitcoin appears to follow the path set by the previous two cycles.

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Halving Looms Large

In the middle of April 2024, specifically at block 840,000, Bitcoin will go through a significant change. The block reward, which is the number of new bitcoins given to miners for recording transactions on the blockchain, will be reduced by 50%. This event, commonly known as a "halving" or "the halvening," marks the fourth time in Bitcoin's history that such a reduction has occurred.

The halving will bring the block reward down from 6.25 bitcoins per block to 3.125 bitcoins per block. Additionally, the daily production of new bitcoins will be reduced from 900 bitcoins (equivalent to $24.3 million at the current price of $27,000 per bitcoin) to 450 bitcoins (equivalent to $12.2 million at the same price).

Although the supply reduction resulting from the halving may seem significant, we believe that investors often overweight its impact. The $12.2 million reduction in daily supply is overshadowed by the immense size of the spot trading markets, which still measure in the billions of dollars per day despite the current downturn.

However, the halving holds great significance from an economic perspective. It is a crucial mechanism through which Bitcoin ensures a capped supply of around 21 million coins. By repeatedly halving the supply function, Bitcoin will eventually reach a point in 2140 where it can no longer be divided in half. This will effectively halt the growth in the number of bitcoins, an important part of Bitcoin's "controlled supply" function.

Furthermore, halvings have historically served as important indicators in bitcoin price cycles. They have approximately marked the midpoint between two cyclical peaks. Although the future continuation of this pattern is still a topic of debate, it is worth noting that price patterns tend to repeat themselves, as we mentioned in the previous section.

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Final Thoughts

Bitcoin ceded some price gains during the third quarter; however, it is important to note that bitcoin continues to show significant performance on a year-to-date basis. With trading rangebound in recent months, it is essential not to overanalyze the quarter's price decline. As we head into the fourth quarter, all eyes are focused on legal proceedings and the industry's concerted efforts to gain approval for spot bitcoin trading in the US. We remain hopeful that by our next quarterly update, we will have more clarity on this topic and potentially witness a cessation of the current sideways market.

In the larger economic context, stubborn inflation and rising interest rates have posed challenges for various financial assets, including bitcoin. Nevertheless, it is important to acknowledge that bitcoin is largely driven by unique idiosyncratic factors. Looking ahead, we are optimistic that significant industry developments, such as the potential introduction of a spot ETF and the upcoming halving, will play a more prominent role in driving bitcoin's value in the future.

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