October 2, 2024

Insights and analysis for the professional investor

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Hi readers,

In today's newsletter, David Lawant from FalconX points out two catalysts that could ignite the next bull run.

Then, Julien Vallet from Finst proposes a risk-managed approach for professional investors looking to capitalize on the crypto market's growth.

Thanks for joining us.

– Alexandra Levis

From the Analyst

Crypto at a Pivotal Moment

Seismic events often trigger crypto-asset market cycle transitions. The 2016-2017 cycle was largely industry-driven, expanding crypto's reach beyond early adopters. In contrast, the 2020-2021 surge was propelled by unprecedented COVID-era interest rate cuts.

Now, two powerful catalysts converge: the looming 2024 U.S. elections and a nascent global liquidity cycle for risk assets. This potent combination could shatter bitcoin's $58,000 to $70,000 trading range, where it has largely remained since late March, potentially igniting the next major market movement.

2024 U.S. elections likely to gain importance as election day nears

This election cycle marks several firsts for crypto, primarily how the industry emerged as a relevant topic in political discourse and campaign financing. Another interesting trend is how Polymarket, a breakthrough crypto application, now provides real-time estimates of consensus on election results, with over $1 billion at stake.

The chart below shows the relationship between two factors over 3-day periods: changes in Republican win odds on Polymarket and changes in bitcoin prices as a proxy for overall crypto market performance. Different election phases are color-coded: gray for the initial phase (before June 26), red for the period of Republican momentum (between the end of June and the end of July), blue for Democratic gains (between the end of July and mid-August), and black for the final stretch (since mid-August).

If the market linked crypto prices directly to Republican win odds, the dots in the chart above would form an upward-sloping 45-degree line. Conversely, a direct link to Democratic win odds would show a similar, but downward-sloping, line. Instead, we see a scattered cloud of dots, indicating no clear, consistent trend between election outcomes and crypto prices so far.

This dynamic is evident across all phases highlighted in different colors throughout the scatterplot. Although the relationship is stronger during the phase of Republican momentum, it still explains less than 20% of bitcoin price movements.

This doesn't mean the elections are unimportant for crypto price action. It is possible, if not likely, that this relationship strengthens as we approach Election Day, now less than one month away. But this inconsistent relationship suggests that other critical factors have also been dominating crypto market price action.

Interest rate outlook hints at novel regime for crypto prices

Recent global liquidity shifts have driven markets worldwide, including crypto. The Federal Reserve's strong start to this rate-cut cycle, coupled with China's surprising market-lifting measures, likely fueled crypto's recent price surge.

Unlike equities, crypto lacks extensive historical data for gauging returns across different interest rate regimes.

Nevertheless, examining crypto prices against rate environments remains instructive. The chart below shows the effective federal funds rate alongside Treasury constant-maturity yields from 1-year to 30-year tenors. For context, the lower chart displays bitcoin's USD price (in log scale for perspective), with color-coded market cycles: green for the 2016-2017 and 2020-2021 bull markets, red for the 2018 and 2022 bear markets.

This chart suggests that a soft landing with lower rates — the current investor consensus — would create an unprecedented macro backdrop for crypto. This scenario differs from both the industry-driven 2016-2017 cycle and the COVID era, rate-cut-fueled, 2020-2021 surge.

Consequently, macroeconomic factors are expected to significantly influence crypto prices in the near term, as evidenced by strengthening correlations between crypto and broader risk assets.

Looking ahead

Low crypto liquidity following Labor Day indicates a market in wait-and-see mode. While factors such as geopolitical tensions and supply/demand imbalances can still influence the market, two primary drivers most likely to define market direction into 2025 are still the upcoming election and global liquidity conditions. The next one to three months will be crucial in revealing how these trends will unfold.

- David Lawant, head of research, FalconX

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Institutional Outlook

The Rise of Index Investing in Crypto

Cryptocurrency has evolved as a global asset class with significant implications for modern investment portfolios. Despite undeniable growth, crypto remains volatile, posing challenges for even seasoned investors. An increasingly popular solution to navigating these risks is crypto index investing. Crypto index funds are products that bundle multiple cryptocurrencies into a single vehicle, offering a diversified, systematic approach to gaining exposure to the digital asset market while mitigating some of its inherent risks.

The value of crypto index investing

1. Risk diversification

Crypto index-investing reduces reliance on the performance of any single digital asset, balancing exposure across a range of tokens with different risk profiles and use cases. This approach helps hedge against the volatility of individual cryptocurrencies, ensuring that portfolio performance is not overly reliant on the unpredictable price movements of one asset.

2. Strategic exposure

Many institutional investors are looking to incorporate digital assets as part of their broader diversification strategy. Crypto index funds offer a streamlined way to gain access to this rapidly evolving sector while avoiding the steep learning curve associated with understanding and selecting individual cryptocurrencies. For investors seeking exposure to crypto as an asset class, this approach provides both simplicity and strategic depth.

3. Reduced operational complexity

Managing a portfolio of cryptocurrencies can be resource-intensive. Factors like liquidity, custody, regulatory compliance, and security create significant operational challenges. Index products offer a solution by packaging a diverse selection of digital assets into a single investment vehicle. This reduces the need for active portfolio management, complex due diligence on individual tokens, and the overhead costs of custody and security for a variety of digital assets.

Increasing popularity among institutional investors

An increasing number of institutional investors are looking for ways to participate in crypto without taking on unnecessary risk. Index funds and exchange-traded funds (ETFs) that focus on digital assets have emerged as a compelling option. We've experienced this trend as well with 30% of our retail and institutional clients opting to diversify their portfolios through a crypto index bundle.

Tailoring the index to investor goals

Crypto index funds have the ability to tailor exposure based on specific investment goals and risk tolerance. Some indexes focus exclusively on large-cap cryptocurrencies like bitcoin and ether, providing a stable base of well-established assets. Others may prioritize high-growth sectors like decentralized finance or newer blockchain protocols, offering higher potential upside alongside increased risk.

Selecting the right index strategy depends on a detailed understanding of the underlying assets and market dynamics. Diversified exposure can enhance the risk-adjusted return profile of a portfolio, but the nuances of index composition should align with an investor's broader strategy.

Index investing offers a strategic, risk-managed approach for professional investors looking to capitalize on the crypto market's growth. By offering diversified exposure, reducing operational complexity, and providing a controlled entry into the crypto ecosystem, index funds and ETFs are becoming valuable tools for those navigating the digital asset landscape.

- Julien Vallet, CEO, Finst