Clear the fog, recharge your faith, and embark on the crypto journey in the second half of 2024
In 2024, the outlook for the digital asset market is promising, but regulation and liquidity remain major challenges.Author: FELIX HARTMANN
Compiled by: Kate, Mars Finance
Today, we will take a bird's-eye view of the digital asset landscape for the remainder of 2024, including a close examination of two major catalysts at the current juncture—regulation and liquidity. Insights from the portfolio level review of the second quarter will be shared with limited partners in a separate email.
The Rise of Cryptocurrency from Obscurity Over Six Years
Six years ago, the Hartmann Digital Assets Fund completed its first delivery. We (or more precisely, "I" at the time, as a 23-year-old solo act) entered a very novel scene where there were likely no more than 100 crypto funds in existence. It was easy to know everyone and everything. There were only a few over-the-counter trading platforms like Circle and Cumberland, a couple of custodians like Kingdom Trust, and one bank willing to support the space (Silvergate). In fact, I am serious when I say that aside from sending and receiving Bitcoin, there were no actual products or users. The industry was almost entirely built on vision and ideals. This was a time before DeFi, DePin, Web3 Gaming, and all the things that have emerged in recent years. In fact, most of the "basic" financial fundamentals that are taken for granted today, such as on-chain swaps, lending, and borrowing, simply did not exist—so much so that in that year, the total DeFi banking business globally was about $300,000. For context, that number has risen to over $100 billion.
In 2018, Larry Fink of BlackRock stated that he could not think of a single client globally who requested or wanted exposure to cryptocurrencies. Today, BlackRock's Bitcoin ETF has set the record for the most successful ETF launch in history, raising $20 billion in less than five months.
If we were to condense the entire trading history of Bitcoin and ETH into 10 days, I have traded and witnessed 5 days of Bitcoin and 8 days of ETH. Every candle and wick tells a story I miss. Similarly, as a young CIO/General Partner, I have six years of experience in digital assets, and this crypto journey has occupied 25% of my life and 64% of my adult life. Having spent so long in this emerging industry, I want to say that growing up in and around this industry has profoundly shaped my perspective.
The industry has gone through many phases on its path to maturity. A relatively homogeneous, ideal-driven libertarian community has splintered into many subcultures—from the suit-wearing digital asset crowd pushing for institutional adoption to the meme coin casino millennials living on Twitter, and finally to the original evangelists who pushed for ideals of privacy and decentralization while often becoming targets of government agencies. The first question became my job, the second question made me question my job, and the third question is why I can overcome the stench of the second question and remember what initially brought me here.
The Regulatory Bottleneck is Heating Up and About to Burst
While the industry continues to evolve, particularly in terms of scale, innovation and adoption have been hindered on the regulatory battlefield in the United States. It has been almost a year since I published that letter about the regulatory bottleneck. While Ripple and Grayscale have won their respective lawsuits and Bitcoin ETFs have finally been approved, as expected, the regulatory war has not been won. Just this April, the SEC continued its crackdown on the industry's most prominent players, issuing a Wells notice to the U.S.-based unicorn company Uniswap Labs. Uniswap Labs has millions of users and has never stolen a dime from anyone. They have not pursued the countless scams and fraudulent activities that are rampant in the financial and crypto space but have chosen to go to war with industry pillars like Coinbase, Kraken, and Uniswap. This is not a war to "protect investors"; it is a war against technology.
This war against technology has had real consequences. When considering how the current toxic regulatory environment has eroded the fundamentals of the industry, we think of several challenges:
Unless builders are willing to go to jail for their mission, many have shied away from cryptocurrency. Running a startup is hard enough; the last thing you need is the Federal Reserve threatening your freedom.
Regulatory pressure disproportionately leans towards legitimate products. In other words, if you scam someone with a meme coin that pumps and dumps, you might not face penalties from the SEC, but God forbid you develop a technology that could genuinely change the financial industry. Thus, we see more worthless junk being launched rather than truly valuable tokens that attempt to capture value and return it to holders.
DeFi has not seen real growth for three years. While we reached an astonishing $100 billion in assets on the decentralized track (down from $180 billion in 2021), significant growth requires institutional capital, which will not flow on-chain until there is regulatory clarity.
Digital asset trading does not need the support of regulators to climb from innovators to early adopters. However, the next phase of digital asset trading, from early adopters to early majority, desperately needs the support of regulators or the collapse of the old system.
In other words, the increasing prevalence of tokenization and blockchain is technically inevitable. But whether we start using this technology today or wait until the ashes of authoritarianism and currency devaluation settle is a power that lies with regulators (and voters).
Remove the time frame, and there is only one correct trade: long-term decentralization, shorting the fiat system, institutional inertia, and any country suffocated by bureaucracy.
However, managing a liquid fund makes the time span important. For example, while the AI industry has clearly broken records in terms of adoption speed, it experienced two winters in the 1970s and 1990s. In recent months, as Bitcoin struggled to defend its historical highs, I spent a lot of time pondering whether this industry would win the regulatory war in the West or be sidelined until a more friendly (or what the media likes to call radical) government takes over.
But in the past three weeks, things have started to change… with former President Donald Trump publicly expressing support for the digital asset industry, we began to see a sudden shift in tone from Washington:
Contrary to everyone's expectations, the SEC hastily approved the Ethereum ETF.
Congress opposed the SEC's strict cryptocurrency custody rules under SAB 121, with countless previously hostile Democrats voting in favor.
The Financial Innovation and Technology Act has been widely welcomed by the digital asset community as it provides more regulatory clarity and limits the SEC's jurisdiction over this asset class; the bill has passed the House and has been submitted to the Senate.
Noticing the sudden influx of support from the digital asset community for Trump's campaign, the Biden campaign suddenly began its own community outreach efforts. But just days later, Biden vetoed Congress's repeal of the SAB 121 bill, losing all support from the community.
Ending Gensler's Ambitions
To better understand the situation, two weeks ago, at the annual CoinCenter Gala in Austin, Texas, I found myself in a room with most of the industry policy and/or leadership teams. The atmosphere at the conference was quite excited, with speakers acknowledging that given the recent victories in Washington, "we are finally starting to win." House Majority Whip Tom Emmer also addressed the audience, warning SEC Chairman Gary Gensler: "Hear my voice, Gary—your days are numbered." As I sat there, I asked myself, "Is it really time?"
The presidential election could be the hammer that breaks the regulatory bottleneck. If Trump wins, the worst-case scenario is Gensler resigning, and the best-case scenario is him going to prison. Besides his authoritarian abuse of power during his tenure as SEC chairman (a point that is now being pointed out more frequently by the courts), Gensler also served as the CFO of Hillary Clinton's campaign, which has painted him as an enemy of the Trump administration.
If Biden wants to win, getting rid of Gensler could be the most direct way for him to win the cryptocurrency vote while distancing himself from the radical left, especially Elizabeth Warren, whose mission is to "build an anti-crypto army." Warren has effectively been the spokesperson for the Democrats on all cryptocurrency issues, and his dissent was evident in the voting on FIT 21, where even former House Speaker Nancy Pelosi voted in favor alongside Republicans.
I now believe there is a 70% to 80% chance that Gensler's era will end in the next six months. By that day, I expect the global digital asset market cap to appreciate by over 30%, in other words, about $1 trillion.
If the dice fall on the remaining 20-30% (or my estimates are completely off), and we have four more years of Biden and another two years of Gensler before the end of Biden's term, I would bet on the continued erosion of what Capo Gensler likes to call "crypto asset securities." The good guys will lose, and the only winners will be law firms that will cash checks from crypto companies and U.S. taxpayers as they face off in the next four years.
However, there are two classes of assets that have essentially not been affected by this onslaught: one is Bitcoin, officially recognized as a crypto commodity, and the other is meme coins, which have not even attempted to create value but have evolved into proxy trades of the spirit of the cultural era. Due to the fiscal irresponsibility of central banks and the financial nihilism of Gen Z and millennials, these two asset camps will continue to grow. Monographs exploring these markets are also being written, but that will have to wait until next time.
A New Era for Digital Assets
Beyond the digital gold theory of Bitcoin, the most significant shift for the broader digital asset space occurs at the moment when tokens can accumulate value without conflicting with regulators. While part of the debate is whether digital assets are commodities or securities, another meaningful debate is how crypto assets can comply without violating the underlying technology. For example, when the fundamental principles are privacy and permissionlessness, requiring KYC for every holder is impossible.
In a scenario with regulatory clarity, the digital asset market could undergo a transformation, unlocking the largest bull market to date. Here are some prominent predictions:
1. The Shift from Narrative to Product-Market Fit
Currently, there is no compliant pathway for crypto assets to appreciate in value, so most crypto asset issuers are even reluctant to create products that can capture value. Ironically, the ability to capture value is a great litmus test that can determine whether a product itself truly has enough demand to make consumers willing to part with their hard-earned money. Instead, crypto founders often build things that consumers care little about, and they have to pay users tokens to use them. So something has happened. The quality of construction has improved, and…
2. Projects Will Have Clearer Metrics for Success
Currently, many digital assets' valuations seem to be completely based on market sentiment and competitive free-floating numbers. While most markets are certainly not efficient, as even stock trading often diverges from earnings, the stock market does a good job of elevating the essence to the highest levels. Therefore, tokens that align most closely with actual product-market fit and revenue may begin to dominate conversations and portfolios more frequently. This, in turn, leads to…
3. A More Convenient Digital Asset Financing Environment
Funding for digital assets is primarily skewed towards private markets, and the ability to raise funds post-token issuance often turns into a dice roll depending on the market mechanisms the founders are in. This has led to the cyclical rise and fall of "alternative investments," with each new cycle bringing a batch of new projects that have raised impressive funding while unlisted but often run out of funds or fail to capitalize adequately in the next bear market, sometimes even if they have actually developed a great product. Then, the private market rotates to the next queue. There is a considerable amount of redundant costs and value discarded in this cycle. Thus, a stronger foundation will make it easier for protocols to raise funds while also…
4. A Booming M&A Market
During the 2022-23 period, we witnessed many DeFi projects being shelved that could have become prime acquisition targets for better-funded DeFi projects. For example, well-funded Uniswap or well-funded AAVE could expand their product range by acquiring some well-performing but underfunded participants in the on-chain trading and options market, becoming DeFi super applications, or more substantively entering the real-world asset (RWA) space by facilitating token swaps with one of the leading RWA protocols (the trading price of RWA protocols could be 1% of Uniswap's market cap). The maturation of crypto assets and the entire market may open doors for truly savvy dealmakers and operators to create value in ways we have not seen before in digital assets, significantly accelerating product development and innovation, bringing us closer to adoption. For example, some Layer 1 blockchains may leverage M&A to acquire urgently needed products and turn them into public goods. This will lower user costs while increasing the usage and gas expenditure of the chain itself, thereby driving the value of network tokens.
From the day we entered this industry, we have been trading the catalysts and fundamentals of digital assets, which may be the most promising era for this market's future. This structural change could also bring the largest capital inflows into the market, as institutional allocators can apply similar models to seek true value, just as they have done in other asset classes for a century.
At Hartmann Capital, our core digital asset thesis is that "most assets will be tokenized in the next decade." While this is a contrarian view, the fat protocol argument expresses its greetings, but Larry Fink and even Jamie Dimon (who cannot stand Bitcoin) are both staunch supporters of tokenization. While most of these leaders focus on the assets wrapped in tokens and the opportunities and savings they will unleash, we want to focus on the infrastructure that powers the entire process, owning its share, and potentially capturing all market fees in the final stages—from finance to physical assets to intellectual property and personal data.
Igniting the Fuse
The timing of the U.S. presidential election and the regulatory fate of the digital asset space coincides perfectly with the upcoming central bank pivot. While the European Central Bank has taken the first step towards rate cuts, the Federal Reserve has yet to take its first rate cut, and it is now expected to cut rates once in 2024, with rates projected to fall to around 4% by 2025 according to June's economic forecasts.
So far, about $6.44 trillion of this money supply has been funneled into money market funds, yielding around 5% annually. As rates decline, not only do risk assets become more attractive as capital becomes easier to obtain, but also risk-free alternatives will become less appealing. When $2-3 trillion of idle funds re-enters the market, we may see digital asset prices soar, whether in the early stages of easing or throughout a low-rate environment.
Conclusion
Regardless of the political outcome, rate cuts are imminent. This will allow capital to flow. The direction of this capital largely depends on whether there will be a change in leadership or authority at the SEC or whether it will lose jurisdiction over digital assets through the courts and Congress. However, the outcome remains binary; under the current regime, Bitcoin and memes thrive, while under a more constructive regulatory framework, true innovation in digital assets can begin to serve trillions of dollars in financial value and capture hundreds of billions in value.
Trading remains dualistic, tightly gripping the key, choosing the right regime. Regardless of the outcome, over the next four years, these two teams can serve as a trading space with immense potential.
Finally, I will quote a segment from digital asset pioneer Erik Voorhees' keynote speech at the annual CoinCenter gala, discussing the prospects of crypto and why it is essential to win the battle for digital sovereignty in the U.S.—a nation built on the principles that most closely reflect this industry.
