‘Mission-Accomplished’ Rate Cuts From The Fed Will Boost Bitcoin, Weaken Dollar

Zach Pandl is head of research at Grayscale Investments, the world’s largest crypto asset manager. In this discsussion, he provides an important perspective on what to expect throughout the year. He also had some very interesting insights into the market dive that happened in August and whether something similar could happen again as the Fed tries to remove its restrictive posture on the economy. We also move into his thoughts on crypto, which assets are poised to outperform, and why others may struggle.

Forbes: Let’s talk about the last month. In the beginning, there was the unwinding of the yen carry and panic in markets that followed for about a week. Then markets rebounded. How do you process all that?

Zach Pandl: It was a volatile month, but it really needs to be divided into two periods. One from the end of July to August 5, which was a period of growth scare. Then the period from August 6 to the present, which was a kind of recovery. Most major asset classes declined, but many of them ended up approximately where we were when we started the month. Now some things declined and didn’t fully recover, including carry trade strategies in currency markets–which was a big focus for investors at the start of the month–Japanese stocks and Ethereum.

Then, there were some things that performed well in early August and then continued to perform well in the second part of the month. Those were bond markets, high-quality bonds as a whole, like U.S. Treasuries and closely related assets, and non-dollar currencies. So the yen, Swiss franc, euro and British pound had gains during the month. The lasting themes, I think, coming out of a volatile August are lower rates and dollar weakness. I think that has implications for Bitcoin in the months ahead.

Forbes: Do you think this scare was a one-off or will the market experience something similar if it gets spooked again?

Pandl: I’d like to say first that I feel fairly strongly that the focus on events in Japan and the yen is a bit of a red herring when we’re looking at what happened in markets at the beginning of August. Japan is a challenging subject even for professional macro investors, and I think often the source of confusion. What I think really happened was a true growth scare. There were a few pieces of U.S. economic data that caused that, but the most important was the increase in the unemployment rate in the first week of August. The U.S. unemployment rate has now increased by a magnitude that has never occurred outside the context of recessions. This is something that economists call the Sahm rule after economist Claudia Sahm, who labeled that statistical regularity. That doesn’t mean we necessarily will have a recession, but the data are telling us that we are seeing some of the statistical regularities like an inverted yield curve and a rising unemployment rate that are consistent with recession.Why that had such a big effect on markets is that a soft landing was a very strong consensus prior to this month. There were fears about recession last year, but the economy held up well and so it became an increased consensus and increasingly priced into markets that soft landing was assured. So the rise of the unemployment rate increased the perceived odds of recession again for many investors. It will take a few months of watching the data to ensure that the labor market isn’t deteriorating further. That being said, some of the things that happened in markets were surprising, particularly in equity volatility. The VIX index increased to a level associated with really extreme market events in the past like Covid, the 2008 financial crisis and Lehman Brothers bankruptcy. That probably tells us something about market microstructure—the ability of broker-dealers to manage inventory of equity volatility and manage their client’s demands around a period like that. But it was remarkable. The VIX index rose above 65 intraday in the first week of August and then ended the same week in the 20s. Many other indicators, like high-yield bond spreads, had a similar reversal. So in summary, we had substantive economic news, but probably a market overreaction to that news in the short run.

Forbes: Let’s turn to crypto. I’m interested in whether there’s a bifurcation coming between bitcoin and the rest of the market. We haven’t seen the same type of runaway success in ether ETFs that we did with bitcoin ETFs, and there are some concerns about trends on Ethereum, like lower usage numbers, lower fees, and it’s becoming inflationary again. What are you seeing?

Pandl: First off, in some ways it really has been a bitcoin-dominant period for a while now. Bitcoin dominance is rising across the market, the ETH/BTC ratio is falling. I think it is fair to say that we’ve been in a bitcoin-led period. Will that continue? I think over the very short run, it may because there are so many positives lining up for bitcoin. In particular, the broader macro thesis, the Fed rate cuts, a contentious presidential election in which one of the major party candidates may call for dollar weakness, where both parties have not had a record of fiscal sustainability, and where we’ve seen all this demand for the bitcoin ETFs. All those things together I think, are a very positive macro environment for bitcoin. So bitcoin’s dominance is running relatively high, and I think could increase somewhat further over the short run. Although, as you know, altcoins had a great week last week, and we’ve started to see some of that market come back as well.

The Ethereum ETF launches are only disappointing in contrast to the success of the Bitcoin products earlier this year. The Ethereum products are seeing healthy volumes and, excluding the Grayscale closed-end fund, which uplisted to an ETF, are seeing healthy inflows. So in the context of a standard ETF launch, I think the ether products are doing relatively well.

What about the outlook for Ethereum? I’m definitely not ready to count out Ethereum, and I think there is pessimism in the market largely because of its performance this month. And the performance this month, in my view, is mostly technical in nature. We had rising leverage in Ethereum futures in both the CME and in crypto products, perpetual futures during the month of May, when the SEC approved the 19b4 filings for the ETF products. Leverage positioning seemed to pick up in May in anticipation of eventual approval, and those positions were maintained into August. We had a macro catalyst, the growth scare and triggering of the Sahm rule that caused all markets to fall and Ethereum suffered worse because it had a significant long positioning going into that event.

In my view, the recent underperformance is mostly technical and not something substantive about the health of the Ethereum ecosystem. I will say that Ethereum and Bitcoin are completely different assets and require different education processes for investors. Bitcoin and Ethereum ETFs are giving a new range of investors and financial advisors access to crypto products. But as you and your readers know, these are completely different assets. They’re both blockchains, but we would put them in different categories in the Grayscale crypto sectors framework, for example. Bitcoin is primarily a currency and Ethereum is primarily a smart contract platform. They’re both blockchains, but they serve different functions. And I do think that the education process for Ethereum is taking longer than it did with Bitcoin. It is smart contracts, decentralized applications, tokenization, stablecoins, and DeFi. And I think that’s why demand has been slower to pick up for the Ethereum products compared to the Bitcoin launch earlier this year.

Forbes: One other big difference between the two is that Bitcoin doesn’t have to deal with competitors like Arbitrum, Optimism and Base. You could even throw Polygon into the ring and plenty of others, especially post-Dencun when the cost of using those networks is so low. How does that fit into all this?

Pandl: I think these principles that come from investing in equity markets are the type of things that investors should be bringing to crypto markets, like the nature of competition, whether it is monopolistic or more competitive markets. Bitcoin is dominant and does not face strong competition anymore. Whereas in the smart contract platforms blockchain segment, while Ethereum is also dominant, it faces stiffer competition from a wide range of competitors. Grayscale offers investors access to many of those competitors in single-asset products and in multi-asset products. So we certainly think that there are important investment themes among those competitors. Most recently we launched an Avalanche product just last week. So we think that there is value in the competitors. This may mean something about how investors should approach the smart contract platform crypto sector. Maybe a more diversified approach makes sense in that market segment where Ethereum faces more competition. All that being said, we are strong believers in the idea of network effects, as it relates to these technologies, that bigger is better. In the future there will more likely be a small number of very dominant blockchains rather than hundreds or thousands of small blockchains. That is because of the economics of network effects. Investors and users benefit from the networks that have the most capital, the most applications and the most developers. Today that is still Ethereum. So Ethereum leads others in terms of network effects, and therefore I think it has the ability to maintain its dominant position over time despite fierce competition in that market segment.

Forbes: What made you believe that now is the right time to launch an Avalanche product?

Pandl: All the smart contract platform blockchains of course have their own design choices and it’s going to take several years to determine which of those has the most effective design to bring in users, generate fee revenue, etc. But I think Avalanche has established itself as an effective platform with a solid, well-functioning design. It’s mature and tested enough that we think it is certainly a reasonable place for investors to look. In terms of specific recent catalysts, I do think that Avalanche potentially has applications in the tokenization theme. The Avalanche chain was used in various TradFi tokenization proofs-of-concept in the last couple of years and benefits from a hybrid permissionless and permissioned chain architecture. Tokenization of real-world assets, in my view, is something that is just getting started and should be considered at the experimental stage. We have tens of millions of dollars in some of these products with major financial institutions involved, but I don’t think we can say how this will play out. I think there is potential that the Avalanche infrastructure, which marries permissionless…