Forbes Interview with Grayscale Research Director: This Rate Cut is Different from the Past, Bitcoin's Outlook is Promising

Author: Steven Ehrlich, Forbes

Compiled by: Luffy, Foresight News

Zach Pandl is the head of research at Grayscale Investments, the world's largest cryptocurrency asset management company. Forbes recently had a conversation with Pandl, during which he provided important insights on the annual expectations for the cryptocurrency market. He shared some interesting thoughts on the market crash in August and the potential impact of future Federal Reserve policies. Additionally, he discussed his views on cryptocurrencies, which assets may stand out, and why other assets might struggle.

Forbes: Let's start with what happened in August. Initially, the yen carry trade was unwound, leading to panic in the market that lasted about a week. Then the market rebounded. How do you view all of this?

Zach Pandl: Last month was a turbulent month, but it can actually be divided into two phases. From the end of July to August 5, it was a phase of growing panic; then from August 6 to now, the market has returned to a recovery phase. Most major asset classes fell, but many of them have now returned to their early August levels. Some markets have not fully recovered, including the arbitrage strategies in the currency markets (which were a focus for investors at the beginning of the month), the Japanese stock market, and Ethereum.

Some markets performed well in early August and remained strong in the latter half of the month, such as the bond market and non-dollar currencies. The yen, Swiss franc, euro, and pound all appreciated this month. I believe the theme of the turbulent August market was declining interest rates and a weak dollar, which will affect Bitcoin in the coming months.

Forbes: Do you think this panic was a one-time event? If the market gets spooked again, will we see a similar situation?

Zach Pandl: First, I want to say that looking back at the market situation in early August, I strongly felt that the focus on events in Japan and the yen somewhat diverted attention. Even for professional macro investors, Japan is a challenging topic, and it often serves as a source of chaos. I believe the real driver behind the market crash was a gradually accumulating panic. Some U.S. economic data contributed to this panic, with the most significant being the rise in unemployment rates in the first week of August. The current rise in U.S. unemployment rates has only occurred during recessions. Economists refer to this as the Sam Rule, named after economist Claudia Sam. This does not mean we will necessarily enter a recession, but the data tells us some statistical patterns, such as an inverted yield curve and rising unemployment rates, which align with conditions during a recession. The reason it had such a significant impact on the market is that before August, the market generally believed the U.S. economy would achieve a soft landing. Last year, there were concerns about a recession, but the economy performed well, leading to increasing confidence in a soft landing, which the market increasingly accepted. Therefore, the rise in unemployment rates led many investors to believe the economy might enter a recession again. We need a few more months to observe the data to ensure the labor market does not deteriorate further. That said, some things happening in the market are still surprising, especially regarding stock volatility. The VIX index rose to levels close to those seen during past extreme market events, such as the COVID pandemic, the 2008 financial crisis, and the Lehman Brothers bankruptcy. The VIX index spiked above 65 during intraday trading in the first week of August and then fell to the 20s by the end of that week. Many other indicators, such as high-yield bond spreads, also experienced similar reversals. In summary, the market may have overreacted in the short term.

Forbes: Now let's talk about cryptocurrencies. I'm interested in whether there will be a divergence between Bitcoin and other cryptocurrencies. For example, Ethereum ETFs haven't achieved the same level of success as Bitcoin ETFs, and there are some concerns about Ethereum's prospects. What do you think?

Zach Pandl: First of all, it is indeed Bitcoin's dominant period right now. Bitcoin's dominance in the overall market is increasing, and the ETH/BTC price ratio is declining. Will this situation continue? I believe it will persist in the short term because Bitcoin has many positive factors, especially macroeconomic conditions, the Federal Reserve's interest rate cuts, the presidential election, and the growing demand for Bitcoin ETFs. I think all these factors together create a very positive macro environment for Bitcoin. Therefore, Bitcoin's dominance may further increase in the short term. However, altcoins performed well last week, and we are seeing some markets starting to recover.

Compared to the success of Bitcoin ETFs earlier this year, the performance of Ethereum ETFs has been disappointing. The trading volume of Ethereum ETFs is quite substantial, and aside from Grayscale's closed-end fund that upgraded to an ETF, other products have seen significant inflows. Therefore, I don't think the performance of Ethereum ETFs is too bad.

As for Ethereum's prospects, I certainly wouldn't give up on Ethereum. I believe the market's pessimism is mainly due to ETH's performance this month. In my view, ETH's performance this month is technical. In May, when the SEC approved the 19b4 application for ETF products, the leverage of Ethereum futures on the Chicago Mercantile Exchange (CME) and perpetual futures was rising, continuing until August. Coincidentally, under the influence of macro catalysts, namely panic sentiment and the triggering of the Sam Rule, all markets fell, and Ethereum was hit hard because it had accumulated a large number of long positions before this event occurred.

In my view, the recent poor performance of ETH is mainly a technical issue rather than a problem with the Ethereum ecosystem. What I want to say is that Ethereum and Bitcoin are completely different assets that require different education for investors. Bitcoin and Ethereum ETFs provide a channel for a new series of investors and financial advisors to access crypto products. But they are completely different assets. They are both blockchains, but we categorize them differently within the Grayscale crypto industry framework. Bitcoin is primarily a currency, while Ethereum is mainly a smart contract platform. They are both blockchains, but their functions are different. I believe the educational process for Ethereum is longer than for Bitcoin. It is the foundation for smart contracts, decentralized applications, tokenization, stablecoins, and DeFi, which may be why the demand for Ethereum ETFs is growing more slowly than for Bitcoin.

Forbes: Another significant difference between Bitcoin and Ethereum is that Bitcoin does not have to face competition from networks like Arbitrum, Optimism, and Base. Especially after Dencun, the cost of using these networks has become very low. How does this relate to the current situation with Ethereum?

Zach Pandl: I think cryptocurrency investors should apply some investment principles from the securities market to the new market, such as the nature of competition, whether it is a monopoly market or a competitive market. Bitcoin holds a dominant position and no longer faces intense competition. In the smart contract platform space, while Ethereum also holds a dominant position, it faces much fiercer competition from numerous competitors. I believe there are significant investment opportunities among these competitors, and they are valuable. Perhaps in the more competitive segments where Ethereum faces more competition, a more diversified investment approach is better. That said, we firmly believe in the concept of network effects, and it is possible that a few very dominant blockchains will emerge in the future, rather than hundreds or thousands of small blockchains. Under network effects, investors and users benefit from networks that have the most capital, the most applications, and the most developers. Today, Ethereum is still that kind of network. Ethereum leads in network effects over other networks, and I believe that despite the fierce competition in this segment, Ethereum is likely to maintain its dominance in the long term.

Forbes: Why do you think now is the best time to launch Avalanche products?

Zach Pandl: All smart contract platform blockchains have their design choices, and it takes years to determine which blockchain's design is most effective in attracting users, generating fee revenue, etc. But I believe Avalanche has established itself as an effective platform, with a solid design and comprehensive functionality. It has matured enough, and we believe it is definitely a reasonable choice for investors to pay attention to. Regarding recent specific catalysts, Avalanche may find applications in the asset tokenization theme. Over the past few years, Avalanche has been used for various TradFi tokenization proof of concepts. In my view, the tokenization of real-world assets is just getting started. We have invested tens of millions of dollars in some of these products, with major financial institutions also participating, but we cannot predict how it will develop. I believe Avalanche's infrastructure, combining permissionless and permissioned structures, may be very suitable for certain tokenization projects, and now is a reasonable time to revisit this network.

Forbes: Solana has become the most popular blockchain after Bitcoin and Ethereum. However, it seems that many activities on Solana replicate those on Ethereum and other chains. What do you think?

Zach Pandl: Solana offers an excellent user experience. For newcomers to cryptocurrency, few experiences are as simple and enjoyable as downloading the Phantom wallet and starting to use Solana: it is fast and inexpensive. In this sense, it has been very successful in attracting new users. I also believe that Solana has established itself as the third-largest blockchain. At the same time, I think user experience does not necessarily create a lasting moat for projects. Ultimately, real value accumulation will occur in Layer 1, which can integrate the largest real-world use cases that major companies and industries can build on Layer 1 networks. For Solana, this is an open question: will tokenization happen on the Solana blockchain, and will large consumer goods companies (like Sony or Disney) build on Solana?

Forbes: What are your thoughts on DeFi?

Zach Pandl: It is hard to avoid the U.S. elections and the politics surrounding cryptocurrencies in this field. The Biden administration is taking steps to regulate this market. I believe it hinders innovation and adoption, and the Biden administration's attitude toward DeFi is obstructing the market's development. (Editor’s note: In April, the SEC issued a Wells notice to Uniswap, indicating potential enforcement action.)

For DeFi to continue to succeed, we may need to change the regulatory approach. If the Republicans win, especially in the Senate, it will give control of the Senate Banking Committee. This could affect the appointments of certain officials responsible for overseeing the industry. I believe DeFi is a core part of cryptocurrency. It is one of the core use cases for smart contracts, but to achieve greater success in the U.S., it needs to somehow integrate with traditional financial assets. And without clear regulatory guidelines, you cannot do that. So, we are waiting for more regulatory clarity for DeFi to thrive fully.

Forbes: Now, let's talk about artificial intelligence. For me, the connection between cryptocurrency and AI has always been somewhat unclear. The prices of many AI tokens often follow the ups and downs of Nvidia's stock, but the connection between the two seems shallow. What are your thoughts on this?

Zach Pandl: Blockchain technology can establish connections with the AI industry through several specific channels. The first is providing infrastructure. I think shared computing networks are a great example; they are working and are just getting started. Intellectual property and deep fakes are another important issue and one of the most challenging problems facing this new technology. I often use generative AI tools in my work, and with them, I no longer need research assistants. At the same time, I know that when I query these tools and pay clients, that income does not all flow to the original creators of the materials used. Therefore, protecting intellectual property is a very important issue, and public blockchain technology can provide us with detailed information about specific data sources. Again, these projects are just getting started, but I believe they have potential synergies.

Finally, there are broader categories, including Bittensor, which aims to leverage blockchain technology to build AI projects from the ground up. I find this vision impressive. Bitcoin demonstrates the value of developing monetary systems using decentralized computer networks. What projects like Bittensor are trying to do is leverage the same idea: the power of decentralized communities to build machine intelligence or AI on the internet and create an open system where anyone can add or use the technology without going through a central authority. Anyone living in an environment where the monetary system is restricted, capital controls exist, banks fail, or hyperinflation occurs understands the value of having an independent open monetary system like Bitcoin.

I believe that in the future, as more people use generative AI tools, they will realize the need for an open structure that is not controlled by any government or company. This is what projects like Bittensor are trying to achieve.

Our broader perspective is that as more investors closely monitor the fundamentals of AI tokens and try to understand them, their correlation with AI will gradually decrease. Worldcoin rose because of Nvidia, but there isn't much fundamental reasoning behind it. In some ways, cryptocurrency remains an immature market, and I think the high cross-correlation between assets is an example of this, which will decrease as the market matures.

Forbes: What are your expectations for the remainder of this year?

Zach Pandl: We believe the core outlook for Bitcoin is quite optimistic, as three positive factors are at play. 1. Bitcoin ETFs are attracting new funds. 2. The political landscape regarding cryptocurrencies in the U.S. has improved. There are still unknowns, especially regarding the Democratic Party's stance. But in my view, things are moving in a favorable direction. 3. The Federal Reserve is cutting interest rates, and the economic environment is healthy. I think the last point is very important. This may be something people overlook. Typically, the Federal Reserve cuts rates due to an economic recession. This time, the Fed is cutting rates because it has won a long battle against inflation. Therefore, these rate cuts are the result of a job well done, which is quite different from the past.

In the context of a soft landing, rate cuts are quite unfavorable for the dollar but beneficial for assets like Bitcoin. Considering these factors, I believe we will retest historical highs in the coming months. The main risk now is the health of the U.S. economy and whether it can achieve a soft landing. I think this is the view of most economists today, but we need to closely monitor labor market data. If unemployment continues to rise and signs of layoffs begin to appear, we may see a period of economic weakness, during which many assets, including Bitcoin and tech stocks, will weaken in a typical cyclical manner. My point is that a recession period will be an excellent opportunity to accumulate Bitcoin because you are likely to see loose monetary policy and fiscal policy afterward, similar to what happened during the COVID pandemic. But if the U.S. labor market continues to deteriorate and the economy enters a brief recession, we may face downside price risks. This is the main risk we face in the next 6 to 12 months.

Forbes: Do you have any contrarian views or other projects and tokens that are worth our attention?

Pandl: First of all, cryptocurrencies are an indispensable asset in most investors' portfolios. Most of my time at Grayscale has been spent educating investors on how to understand this asset class, the fundamental principles of blockchain technology, and the statistical characteristics of the assets themselves. This is a contrarian view in the broader financial market: aside from the most conservative investors, cryptocurrencies should have a place in almost every investor's portfolio. Just in terms of short-term liquidity, I think cryptocurrencies can serve as a diversification asset.

The second thing I want to say, which may be a contrarian view in the cryptocurrency world, is that in some ways, the risks of blockchain tokens are lower than those of stocks. Cryptocurrencies have different volatility factors, but at least in one aspect, their risks are lower than stocks because they have no liabilities. Public companies can disappear because they have liabilities. Their revenues need to support those liabilities. Blockchains mostly have no liabilities. They have revenue, they have activity, they have a community of users around them, but they do not have liabilities that need to be continuously paid. So I think when many people talk about the risk of public blockchain tokens going to zero, there is some misleading information. We would be surprised to find that even some less successful projects can exist for a long time.

I want to emphasize that our analysis of public chain tokens is still in its early stages, and there are not many traditional financial analysts publishing research on evaluating these assets. Moreover, some very basic things, such as the liability structure of crypto projects, are still not well understood. So, I feel fortunate to be writing about these topics in what I believe is still a very early-stage market.