Hashkey Capital Report: Why Are We Bullish on Altcoins?

Original Title: Why We Are Bullish on Altcoins

(Original report issued on October 22, 2024, this report is a translated version)

Author: Hashkey Capital

Compiled by: Mensh, ChainCatcher

Recent Market Overview

Market sentiment was generally bearish towards altcoins in the third quarter, with Bitcoin's market dominance rising to about 54%, the highest level since April 2021. The altcoin season index currently stands at 37, having previously reached a low point in mid-August. The HashKey top 20 token index and thematic index underperformed Bitcoin in the third quarter, a poor performance attributed to ongoing concerns about a U.S. economic recession, external shocks such as the German government and Mt Gox sell-offs, the unwinding of yen carry trades, and a lack of significant industry developments within the web3 sector.

Annualized returns of different cryptocurrency sectors

Altcoin Season Index

Despite a market recovery towards the end of the third quarter, according to Dune's industry classification, Layer 1 is the only sector that recorded positive returns in the third quarter and outperformed Bitcoin. Investor interest has shifted from DeFi and DePIN to AI and meme coins over the past quarter. This shift has led to poor performance for DeFi and infrastructure-related tokens, with the LRT sector down 15.77% and service infrastructure down 18.09%.

90-day relative strength of crypto tracks

L1 smart contract platforms. While Ethereum remains the leader in terms of the number of applications, developers, and total locked value (TVL), its market position is being challenged by several alternative platforms, including Solana, Tron, Ton, and the emerging Sui. These platforms compete by offering lower fees and attracting more users, leading to a decline in Ethereum's market share for transaction fees.

Active users of major public chains

The Dencun upgrade in March led to a significant decrease in Ethereum Layer 2 fees. Coupled with increased competition from other Layer 1 platforms, this has resulted in a drop in Ethereum's transaction fees. Consequently, Ethereum's deflationary status is being challenged, raising questions about the ETH "ultrasound money" narrative. Despite these challenges, the adoption trend within the Ethereum ecosystem remains strong, with 80% of tokenized assets still residing on its network. Additionally, large companies like Sony have announced plans to build their blockchain projects on Ethereum.

DePIN gained attention in early 2024, thanks to Solana's role in DePIN applications and the fusion of AI and cryptocurrency. Node sales help build communities and drive revenue. However, by the third quarter, momentum in this sector slowed due to the overall bearish sentiment in the crypto market and skepticism about real-world applications and business sustainability. Enthusiasm for DePIN assets also waned.

AI

Driven by OpenAI's ChatGPT, the demand for artificial intelligence is growing, increasing the need for storage, computing, and networking resources. Centralized AI infrastructure faces challenges such as high barriers to entry and data control. Blockchain offers solutions by providing token incentives to promote user and community participation. Bittensor (TAO) leads with its decentralized machine learning platform, while Fetch.ai (FET) stands out for optimizing transportation and supply chains using AI and autonomous agents.

RWA

TradFi participation has driven the growth of tokenized assets. Recent developments include Mantra's $500 million real estate tokenization, BlackRock's BUIDL fund exceeding $500 million, and investments in Securitize and Ironlight. WisdomTree has also expanded through its WisdomTree Connect platform, offering tokenized funds. Avalanche (AVAX) focuses on compliance and security, collaborating with Citi and JPMorgan to provide on-chain RWA solutions, while Ondo Finance (ONDO) offers DeFi users tokenized access to U.S. Treasury bonds. With regulatory improvements, more projects offering diversified tokenized securities are expected to emerge to attract a broader investor base.

DeFi

DeFi has made significant progress in various aspects, providing better scalability and clearer use cases. Throughout different market cycles, DeFi has demonstrated its ability to attract capital through competitive yield opportunities. Well-known DeFi projects from previous cycles, such as AAVE (2020), LIDO (2020), MakerDAO (2017), and Chainlink (2017), have become integral components of the ecosystem's infrastructure.

Major DeFi protocol LTV

From a blockchain perspective, Ethereum maintains its lead in total locked value (TVL), followed by Tron. However, capital inflows into the DeFi market are particularly driven by the TVL growth of Scroll and Sui.

Top blockchains TVL

Gaming and Entertainment

In the third quarter, the market value of Web3 games decreased by 8%. Nevertheless, Web3 gaming remains a strong player, accounting for 30% of all dApp activity, with daily active wallet numbers reaching 2.1 million. The release of new games is expected to have a positive impact on the future market. The Ronin and TON ecosystems are leading in the Web3 gaming space. Ronin benefits from the success of Axie Infinity, while TON reaches 900 million users through seamless integration with Telegram. Some TON mini-games, including Notcoin, Catizen, and Hamster Kombat, have become notable hits.

Cryptocurrencies Will Benefit from Global Monetary Easing Cycle

The global economy is currently in a monetary easing cycle. Major emerging market countries began cutting interest rates in the second half of 2023. Most developed market countries are expected to initiate a rate-cutting cycle in the second half of 2024, with Japan being the only exception.

According to the latest overnight index swap (OIS) pricing, the market expects the Federal Reserve to cut the benchmark rate by more than 160 basis points before the end of 2025, bringing it down to about 3.20%. Similar expectations exist for the Bank of England, European Central Bank, Bank of Canada, and Canadian banks, with rates expected to decline by about 100 to 200 basis points during this easing cycle.

U.S. Real Interest Rates and Pricing of Major Physical Assets

U.S. real interest rates are a key factor in pricing major physical assets, including gold and cryptocurrencies. Historically, there has been a strong correlation between the interest rate cycles of developed markets (DM) and U.S. real interest rates. However, due to quantitative tightening (QT) being conducted by major developed market central banks, real interest rates remain at elevated levels.

The Federal Reserve and European Central Bank (ECB) are expected to end their QT programs in the first half of 2025, potentially ending them earlier if recessionary pressures intensify.

Recent Pressure in the U.S. Repo Market

Recently, there has been increased pressure in the U.S. repo market, with SOFR rising sharply at the end of the quarter. This situation is reminiscent of the 2019 repo market crisis, when the Federal Reserve was forced to abruptly halt its balance sheet reduction. The end of quantitative tightening could lead to a significant decline in U.S. real yields, which would benefit the cryptocurrency industry.

Major central banks' balance sheets as a % of GDP

The surge in SOFR reminds us of the 2019 repo crisis

Cumulative rate cuts by major developed market central banks compared to 10-year U.S. real yields

Note: Based on cumulative rate cuts according to OIS futures pricing from the Federal Reserve, ECB, Bank of England, Bank of Australia, and Bank of Japan, weighted by central bank balance sheet size. Source: Bloomberg

Relationship between real yields and crypto assets

Rate Cut Space in Current Easing Cycle and Global Liquidity

In the current easing cycle, there is still ample room for rate cuts, and quantitative tightening may end before the year ends. We may see a dual effect of rising credit demand and expansion of the monetary base. These factors are expected to drive the global liquidity cycle into a new upward trajectory.

Cryptocurrencies have a high correlation with global liquidity. Here, we define global liquidity as the total M2 supply of major economies, specifically provided by BGeometrics. We used logarithmic linear regression analysis to examine how Bitcoin and Ether prices closely track global liquidity over time.

Relationship between global money supply and digital assets

Sensitivity Analysis of Cryptocurrencies to Global Liquidity Index

Analyzing the β factors of major asset classes over 10 years and 6 months against the global liquidity index, historical data shows that cryptocurrencies are the most sensitive to changes in global liquidity, with various crypto assets having β values exceeding 8.5. However, in the past 6 months, the sensitivity factor has turned negative. We believe these short-term deviations are due to idiosyncratic shocks, such as government sell-offs and previous valuation expansions.

β values of assets for a 1% increase in global money supply

Leading Role of Global Liquidity in Crypto Market

Global liquidity typically leads the crypto market by about three months. We compared the 8-week changes of Bitcoin and the HashKey top 20 index (as a proxy for altcoins) with global money supply. Notably, the global liquidity index has shown an upward trend in recent months.

Global M2 vs Bitcoin vs HashKey top 20 index (as a proxy for altcoins) 8-week changes

Impact of U.S. Elections on Crypto Market

The U.S. elections are a key external variable for the crypto market in the next 30 days. The volatility term structure of Bitcoin shows a clear inflection point near the expiration date of November 8, indicating increased market expectations. The election results and control of both houses of Congress will shape future U.S. economic policy, thereby affecting crypto regulation and investor confidence.

Probability of Trump winning and Bitcoin price

September's Polymarket data shows a divergence between perceived election chances for Trump and Bitcoin prices, indicating that the crypto market has partially priced in election risks. Historically, once short-term uncertainties surrounding elections diminish, the crypto market often experiences a significant rebound.

We estimate that Bitcoin is still in the mid-cycle of a three-year bull market. Improvements in liquidity and resolution of uncertainties surrounding the U.S. elections are expected to drive the market further upward, potentially reaching new all-time highs in the next 3-6 months.

Additionally, Bitcoin has historically performed strongly in the fourth quarter, with an average return of 40% over the past decade. These factors, combined with a favorable macroeconomic environment, suggest that the bull market may continue its upward trajectory.

Bitcoin's monthly price changes over the past decade

Performance of altcoins before Bitcoin's new highs

We have observed that altcoins tend to exhibit high β characteristics in the three months leading up to Bitcoin reaching a new all-time high. Since 2016, in four instances where Bitcoin reached new cycle highs, the altcoin index outperformed Bitcoin in the three months prior, with the only exception occurring in the second quarter of 2016.

The current derivatives market has priced the terminal rate of the U.S. easing cycle slightly above 3%. As U.S. monetary easing extends into next year, we believe that relatively high-yielding altcoins, such as ETH and SOL, may benefit. Additionally, staking protocols (e.g., STETH) and delta-neutral DeFi protocols (e.g., ENA) are expected to benefit from the increased pursuit of yield behavior in a low-interest-rate environment.

However, altcoins still face risks in this cycle. As more projects launch with low circulating supplies, a total of $155 billion in funds will be unlocked. Price trends may decouple from Bitcoin as capital inflows struggle to absorb the growing supply. Therefore, identifying fundamentally and technically strong altcoin assets is more important than ever.

Performance of Bitcoin and Altcoins in the 3 Months Before Bitcoin Cycle Highs

Token unlocks over the past few years

Timing: When and How to Navigate the Altcoin Market

Bitcoin Dominance

Historically, altcoins perform well after Bitcoin dominance peaks. When Bitcoin occupies market share at the beginning of a cycle, capital tends to shift to altcoins after Bitcoin's dominance wanes. This cycle benefits altcoins as investors seek higher-risk, higher-return assets.

Bitcoin Dominance

History of Altcoin Seasons

• 2013-2014 Altcoin Season

Start Date: November 2013

End Date: January 2014

Bitcoin Dominance: Approximately 95% in November 2013; about 85% in January 2014

Triggering Factors: The launch of various new cryptocurrencies following Bitcoin's initial success.

Key Events: Introduction of Litecoin (LTC), Ripple (XRP), and Dogecoin (DOGE). Bitcoin's price surged to over $1000 by the end of 2013, followed by a correction.

• 2017-2018 Altcoin Season

Start Date: December 2017

End Date: January 2018

Bitcoin Dominance: Approximately 62% in December 2017; about 33% in January 2018

Triggering Factors: The ICO (Initial Coin Offering) boom.

Key Events: Ethereum facilitated the creation of ERC-20 tokens, promoting numerous ICOs. A large influx of retail investors followed media reports of FOMO. Bitcoin reached nearly $20,000 in December 2017.

• 2020-2021 Altcoin Season

Start Date: December 2020

End Date: April 2021

Bitcoin Dominance: Approximately 70% in December 2020; about 40% in April 2021

Triggering Factors: The boom of DeFi and NFTs.

Key Events: Growth of DeFi platforms such as Uniswap, Aave, and Compound. The popularity of NFTs surged with projects like CryptoPunks and the rise of Bored Ape Yacht Club. Institutional interest in cryptocurrencies, including investments from Tesla and MicroStrategy.

From a static perspective, BTC dominance (BTC.D) may need to reach levels of 62%-70% to trigger an altcoin season. Currently, BTC.D is around 57%, which means Bitcoin's market cap would need to grow by about $280 billion.

This implies that Bitcoin's price needs to exceed $76,000. For BTC.D to reach 70%, the price must hit $108,000, with an average estimate of around $92,000. In an optimistic scenario, an altcoin season is more likely to occur when Bitcoin's price exceeds $100,000. In a more optimistic scenario, an altcoin season is more likely when Bitcoin's price surpasses $80,000.

Another factor is the correlation between Bitcoin's price surge and ETFs. While this is generally seen as positive, if crypto-native funds drive the rally, capital may shift from Bitcoin to altcoins.

However, when ETFs lead the market, funds are less likely to shift to altcoins, as mainstream investors typically cannot access them directly. Instead, funds are more likely to flow into other crypto-related stocks, which belong to two different worlds.

Risk Appetite - Not Yet Achieved

Another key factor is risk appetite. Currently, two critical risk appetite issues must be addressed:

1. Investors prioritize profitability. Given the negligible profits generated by crypto institutions, there is an increasing reliance on Bitcoin.
2. The altcoin sector is underperforming, with almost no projects worth noting.

To address these issues, Bitcoin needs to rise first. Current price levels are insufficient, as altcoin losses need to be offset by Bitcoin returns. This is why Bitcoin's price needs to break above $80,000.

Additionally, emerging sectors such as ETH, SOL, RWA, AI, and DePIN must perform strongly. Fortunately, recent quantitative easing measures in the U.S. and China have somewhat boosted risk appetite.

Risk appetite remains the biggest challenge, and we must wait for further improvements. Although Bitcoin performed excellently in the first quarter, its momentum has slowed. Despite being hailed as a store of value and digital currency, its ratio to gold has dropped from 33.6 in the first quarter to 23 in early October, down from 20.5 at the beginning of the year. While gold has reached new highs due to rate cuts and geopolitical tensions, Bitcoin has stagnated. This indicates that the broader market's risk appetite for cryptocurrencies remains low, and significant capital has yet to flow into Bitcoin as a digital gold alternative.

Bitcoin and Gold Ratio

Historically, the upward movement of the Bitcoin/gold ratio generally coincides with altcoin seasons. Therefore, a decline in risk appetite can adversely affect the performance of new coins. Thus, it is necessary to wait for the Bitcoin/gold ratio to enter an upward trend to send a more favorable signal.

Since 2012, the S&P 500 index has significantly outperformed its performance in non-election years in the years following U.S. presidential elections. On average, the S&P 500 index has risen about 6.6% in the three months following an election. Six months later, the increase rises to 13.8%, and one year later, the average increase is 24.8%. In contrast, in non-election years, the S&P 500 index typically experiences a minimal decline of 0.03% three months later, a slight increase of 1.8% six months later, and a modest increase of 6.9% one year later. Bitcoin's price movements have also followed this trend, showing significant strength in the months and year following U.S. elections.

U.S. equities and Bitcoin performance during elections

Global liquidity and Bitcoin

From the perspective of the Korean exchange, the premium for altcoins remains relatively low. According to Kaiko, the discount has reached its lowest point since the FTX collapse, indicating that Korean traders may have realized profits after two months of price declines. The peak season is only likely to reappear when the market transitions to a premium phase.

New coin premiums/discounts in the Korean market

Several altcoins have already surpassed the 360-day moving average, which is a typical trend at the beginning of a bull market. As the broader cryptocurrency market re-enters a bull market, this ratio is expected to rise further.

Altcoin Breadth Indicators

Ethereum - A Struggling Game

As mentioned earlier, Ethereum's underperformance can be attributed to several factors:

Increased competition - Users are increasingly migrating to faster, more scalable high-throughput blockchains.

Lower transaction fees - The reliance on second-layer scaling solutions has significantly reduced transaction fees on the Ethereum network. While this benefits users, it negatively impacts the network's overall revenue.

Value transfer - The development of second-layer solutions, data availability services, alternative blockchains, and mechanisms such as monitoring and re-monitoring has shifted value away from the Ethereum core network.

Ethereum's TVL since January 2023

According to VanEck, since January 2023, the share of ETH in the value of Ethereum ecosystem tokens has dropped from 97% to 89%. After Ethereum transitioned to a proof-of-stake consensus mechanism in September 2022, Ethereum's comprehensive staking rate (CESR) was divided into consensus rewards and transaction fees, along with the effective federal funds rate (EFFR). Since June 2023, the spread between the federal funds rate and CESR has remained negative. However, this gap is narrowing and is currently at its highest level since December 2023. Driven by expectations of Federal Reserve rate cuts and increased network usage, this spread is expected to continue narrowing and may turn positive in the coming quarters.

Comparison of Ethereum staking compound yield with EFFR

Based on existing data, Ethereum's performance is expected to remain sluggish until it enters a deflationary phase. The recent decrease in network usage has led to about 1.5 million tokens returning to supply levels seen at the time of the Merge.

ETH supply since the Merge in September 2022

Vitalik Buterin recently commented on "consistency," noting that "the main challenge is to ensure that all projects collaborate to build an Ethereum ecosystem rather than 138 incompatible territories."

The concept of Ethereum consistency proposed by various ecosystems emphasizes a positive-sum approach. As Vitalik Buterin pointed out, "The success of one project should benefit the entire Ethereum community (such as ETH holders, Ethereum users), even if they are not part of the project's own ecosystem." This initiative represents the beginning of a broader movement to strengthen Ethereum.

While numerous second-layer solutions have improved Ethereum's speed and efficiency, they have also led to fragmentation, reducing the cohesion seen during the DeFi and NFT boom in 2020. Nevertheless, due to relatively low capital expenditures, Ethereum is unlikely to become a low-margin operator. While competitors will emerge in each cycle, this will not undermine Ethereum's strong position.

Currently, the Ethereum community is developing metrics to measure "Ethereum consistency," and these efforts are expected to yield best practices that further solidify Ethereum's ecosystem and ensure long-term success.

Solid Fundamentals - Solana, Chainlink, DeFi

We view Solana as a major fundamental play.

No MEV, no second layer - Solana operates without miner extractable value (MEV) and second-layer solutions. Thus, all value is concentrated in its first-layer tokens.

Increased activity - The rise in network usage has led to increased transaction fees, indicating greater activity and adoption rates.

Accelerated institutional adoption - Solana continues to solidify its position in the cryptocurrency space, particularly in the meme community, focusing on high activity and institutional trust.

• Partnerships with major institutions: In the past year, Solana has accelerated institutional adoption. First, Visa utilized the Solana blockchain for stablecoin settlements.
• PayPal's PYUSD launch: In May 2024, PayPal launched the PYUSD stablecoin on Solana.
• Franklin Templeton: Franklin Templeton, managing $1.4 trillion in assets, announced plans to tokenize mutual funds on the Solana blockchain.
• Citibank: Citibank is exploring Solana's capabilities for cross-border financial transactions and smart contract usage.

Community and popularity - Solana's strong community engagement, combined with its lower transaction costs, greatly enhances the success of its meme coins. Discussions, promotions, and collaborations around these tokens on platforms like Telegram and Discord are very active.

Performance - According to CoinMarketCap data, the average return of meme coins based on Solana has been 8,469%, while the average return of meme coins based on Ethereum has been 962%. Notable meme coins on Solana include Dogwifhat (WIF), Bonk (BONK), and Popcat (POPCAT).

Market dynamics - Solana has become the preferred platform for launching new meme coins due to its high throughput and user-friendly tools. The network sees a large number of token issuances daily, reflecting a vibrant and evolving ecosystem.

Chainlink

Chainlink has made significant progress, securing approximately $25 billion in total value secured (TVS), about half of its peak. Meanwhile, LINK's price is only 25% of its historical high, indicating considerable potential value. As the largest oracle provider, Chainlink is well-positioned to benefit from the rapid growth of RWA projects across the industry.

Chainlink TVS

Chainlink's business model on Swift

Early entry - Chainlink entered the market early and established partnerships with institutions, solidifying its position as the leading oracle network and giving it a competitive edge over other networks.

Business model - Chainlink focuses on providing data support for dApps, smart contracts, and RWA services. This enables the network to benefit from the growing demand for these blockchain-based services.

Banking integration - Banks and financial institutions are leveraging standards like SWIFT and ISO 20022 to layer their existing infrastructure on top of blockchain technology, accelerating blockchain integration without replacing traditional systems.

DeFi

DeFi protocols have made breakthrough progress, achieving scalability and providing clear use cases.

The Federal Reserve has entered an easing phase, significantly lowering interest rates to stimulate the economy. This has led to ample liquidity within the system and encouraged people to seek more emerging yield opportunities, as traditional risk-free rates are very low.

Many DeFi projects from the previous cycle have gradually become foundational infrastructure, crossing cycles to form a "must-have" landscape.

DeFi is beginning to expand into a multi-chain ecosystem, with the industry's leading position becoming increasingly solidified, unaffected by inter-chain competition.

Institutional Interest

In 2024, the ETF market has seen significant growth, particularly in the realm of cryptocurrency-related products. According to ETFstore data:

Of the 525 ETFs launched in 2024, 13 of the top 25 are directly related to Bitcoin or Ether. If we include the MSTR options strategy ETF, which carries cryptocurrency risk, this number increases to 14. The top four performing ETFs are all spot Bitcoin ETFs. Additionally, among the top 7 cryptocurrency-related ETFs, 5 are the strongest performing ETFs in the market. These trends highlight the growing institutional interest in cryptocurrency investments through ETFs, with Bitcoin and Ether still dominating the field.

Ranking of inflows for newly established ETFs in 2024