Pantera Investment Guide: Invest in Bitcoin First in a Bull Market, Then in Altcoins

Original Title: "CRYPTO MARKET CORRELATIONS WITHIN BULL MARKETS"
Original Authors: Cosmo Jiang & Erik Lowe, Pantera Capital
Original Compilation: Shenchao TechFlow

Pantera Capital recently released a lengthy article that delves deeply into their outlook for the 2024 crypto market, investment strategies, areas of focus, and trend predictions.

Due to the length of the article, we have divided it into different sections based on thematic content for compilation.

This article is the first part of the full content, written by its portfolio managers Cosmo and content director Erik, providing an in-depth analysis of the bull market phase of the digital currency market, particularly the correlations between Bitcoin and other tokens (altcoins).

The authors point out that a bull market typically consists of two phases: the first phase where Bitcoin outperforms the rest of the market; and the second phase where altcoins outperform Bitcoin. The article also explores the reasons behind this phenomenon, such as Bitcoin's liquidity and notoriety, as well as investors' exploration of emerging tokens.

Here are some highlights from the Pantera Capital article:

Investors often ask us, "What is the correlation of various tokens during bull market cycles?"

To provide some perspective on this, we will analyze the last two cycles, during which the investable token space outside of Bitcoin held significant market share.

We observe that bull market cycles have two distinct phases. The first phase is the early stage of the bull market, during which Bitcoin tends to outperform other parts of the market. The second phase is the later stage, when altcoins often perform better.

We believe that Bitcoin's performance in the first phase may be attributed to several reasons. First, it is the most widely issued and liquid digital asset in the market. In 2023, Bitcoin's average daily trading volume was $18 billion, while Ethereum's was $8 billion. Second, first-time investors typically buy Bitcoin first before seeking investments in other tokens. Bitcoin has a 15-year history, and many people consider it synonymous with the industry.

While some investors' journeys are limited to investing in Bitcoin, many others delve deeper into the realm of cryptocurrencies. The number of investable tokens beyond Bitcoin is vast, and the bull market seems to accelerate the expansion of this space as more entrepreneurs and developers enter it. In the second phase, investors begin to look for higher-growth tokens that support different use cases, often driven by new innovations, such as the ICOs of 2017-18 and DeFi and NFTs of 2020-21.

Below is a chart of the two phases highlighted in gold shading. You will notice that in the first phase of the cycle, the market share of altcoins declines while the total market capitalization gradually rises, indicating that Bitcoin's performance exceeds that of the market. During 60%-70% of the bull market cycle, the market share of altcoins rises sharply.

Below are the actual returns in market capitalization growth for Bitcoin and altcoins, as well as the contribution of each currency to the overall growth of the cryptocurrency market.

Throughout these cycles, Bitcoin consistently outperformed altcoins in the first phase of the upward cycle. In the second phase, altcoins significantly surpassed Bitcoin. Interestingly, altcoins performed so well throughout the cycle that they outperformed Bitcoin in both complete cycles.

Historically, one of the highest sources of investment returns has come from perfectly timing the shift from investing in Bitcoin to altcoins at the beginning of the second phase, but this relationship does not always hold, and perfect timing is not realistic for any trader.

The most viable way to generate alpha in this field may be to maintain continuous investments in altcoins that have fundamental reasons to appreciate several times more than Bitcoin.

Our argument is that those protocol-based altcoins, which have product-market fit and are generating real revenue, will perform the best in the next cycle, just as one would expect in other asset classes (like stocks). Just as not all stocks are created equal, not all tokens are created equal. In the long run, the selection of tokens is crucial, as the best-performing tokens will depend on specific circumstances, not necessarily on tokens from a particular sector or based on fleeting, speculative hype.

So far in this cycle, Bitcoin has risen 2.8 times, while altcoins have risen 1.7 times.

So, what is the situation regarding VC investments in the crypto market cycles?

Since the first quarter of 2022, private financing in blockchain has been slowing down. According to data from The Block, both quarterly financing and the number of transactions have declined.

Average deal sizes have significantly decreased since peaking in early 2022.

It is important to note that this data is based on announcements of financing rounds released in the news, which I believe often lags behind the actual situation by one to two quarters.

Based on our observations at Pantera, we believe that the trough of financing and trading activity may have occurred last summer. Recently, we have seen a significant rebound in trading activity driven by entrepreneurs who entered during the last bull market, whose businesses have matured and are likely to find market-fit products, or who have been executing the right strategies and are now returning to raise funds at reasonable valuations.

This may take longer than most people expect, as many venture capital firms like ours advised companies to raise a year’s worth of operating funds during the bull market. Therefore, they did not raise funds for two years but rather for three years, and now we are starting to see them return to the market.

We believe this is a great time to invest, as trading activity has increased, and if the public market continues to rebound, I expect this trend to persist this year.