Disclaimer: This is not financial advice. Anything stated in this article is for informational purposes only and should not be relied upon as a basis for investment decisions. Triton may maintain positions in any of the assets or projects discussed on this website.
Close readers of our posts will note that we have continuously shone a spotlight on both one-off events and general broader trends in the industry to tease apart changes in the macro supply-demand picture for digital assets. As a very brief and high-level summary, here are a few of these highlights:
Demand:
Supply:
We’ve been highlighting these dynamics piecemeal to provide a holistic view of what has been driving this cycle. In this post, we will zoom out and provide a high-level framework of how to contextualize all of this through some simple economics. This post is on the longer side, but by the end, it should provide clarity on the major factors at play and where things sit today. Time to brush off our ECON 101 textbooks and dive in.
Today: A Flat Total3 Definitionally Means Most Tokens are Down
Where are we in the market? Through much of 2H23 and 1Q24, digital asset markets performed incredibly well. From early September through late March, Bitcoin returned almost ~165% while Total3 (market cap of top 125 digital assets excluding BTC and ETH) was up ~130%. Since that peak, however, Bitcoin has since dipped below $54,000 after falling from a high of nearly $74,000. Total3 has seen a far more pronounced downturn, giving up more than half of the gains seen since September and essentially flat since the beginning of 2024, up just 11%.
Source: BTC and Total3 Marketcaps since September 2023 via TradingView
Here is the kicker – Total3 measures the aggregate market cap of the broader industry (top 125 assets), not the price – and thus this measly 11% expansion on the year is actually a function of the price of the top projects that existed adjusted for all new supply expansion and any new projects that have launched over the past few months into the top 125. Major new names such as Ondo ($1.3B), Celestia ($1.2B), Core ($1B), Pyth ($1B), Starknet ($900M), Ethena ($700M) and Safe ($600M) have all only released tokens in the past several months. Definitionally, that means that most ‘alt’ coins are actually down year to date, many 30-50% or more. For example, of the 10 assets ranked from 28-37 in terms of largest market cap, only 1 is positive on the year (Render, +34%) while the other 9 are down by an average of 33% (range: -7% to -58%).
So what gives? Aren’t we in a cyclical bull market? Well, yes – and ironically, that’s the problem. Somewhat paradoxically all of this is happening when the global backdrop for digital assets is the strongest it has been in years, perhaps ever, and the level of development and progress of the industry remains astounding. We at Triton are long-term investors and as such our posts are littered with optimistic perspectives about where we are and where we are going over the long run, but as we also pointed out in March, it will be a bumpy ride along the way. The current developing nature of digital asset markets essentially guarantees this.
Source: Idiosyncrasy in Market Volatility
Key Fundamental: The Public Market Capacity for Tokens is not Infinite
The public demand side of the digital asset market is minuscule compared to traditional markets. Galaxy Digital estimates that digital asset hedge funds account for less than $20B total. To put that in perspective, TradFi hedge funds manage a collective $4 trillion, and Bridgewater alone over $120B. Though largely driven by retail, the proportion and magnitude of retail involvement also remain far lower in digital assets than in traditional investing (e.g. most portfolios are still mostly stocks and bonds). That is to say, the aggregate market capacity remains tiny and can quickly become saturated without significant new inflows. This is important to remember in the context of the airdrop and TGE dynamics in digital assets that we have touched on in the last few posts.
Given the nature of digital asset cycles, the supply side of tokens hitting the market follows a strong S-curve. In the early stages of the cycle, new supply created from airdrops, TGEs, and unlocks is low and easily absorbed by the demand side. However, new supply starts to grow rapidly and eventually hits an inflection point, increasing far faster than the industry can sustain. This eventually leads to saturation and exhaustion on the buy side of the market, resulting in a local or cycle top. We will take a closer look at these dynamics, but this is the key takeaway: especially true in emerging internet-native industries, market equilibrium is incredibly difficult to find.
Source: TradingView – BTC and Total3 Marketcaps January-Aug 2023
In early 2023 the market was in fact in this state, even if it was temporary and precarious. Between January and August 2023, Total3 bounced around between -13% and +17%, a markedly narrow range for digital assets. By the summer of 2023, it was clear that much of this was changing, as we explore below (note: we ignore macro factors, e.g. rates, and instead focus on industry-specific changes).
In simple economics parlance, this largely means that the aggregate supply and demand in the market were at equilibrium, thus resulting in a somewhat level market over this period. Note that the March 2023 wave of bank failures in the US and following uncertainty around the US stability/rate environment led to a pronounced increase in BTC price, but this largely failed to translate to the broader ‘alt’ market in the same way and didn’t shift the market out of equilibrium, remaining range bound over the following months. Rather, it was a nominal structural shift in BTC demand, moving the BTC-only curve out slightly. No one expects Uniswap to replace the NYSE, after all, but many do view BTC as a hedge against USD devaluation.
The Demand Side: Steepening and Shifting Out
Since then, several factors have (and are) impacted the demand curve for digital assets, all acting in concert to bring additional institutional capital into the market, and with that, more sophisticated actors, structural demand from stickier allocators, longer horizons and bigger checks.
The first major tailwind to demand is the increasingly accommodative regulatory environment in the US. While it is easy to look at the consistent barrage of lawsuits coming from the SEC and be skeptical, by and large, there has been increasing clarity resulting from a combination of regulatory action, lawmakers finally passing bills, and the judicial system weighing in.
Globally, other jurisdictions are far further ahead and are becoming increasingly aligned. The spot ETPs being approved around the world are just 1 example of this. As another: Circle, the issuer of the second largest stablecoin USDC with $34B outstanding was just granted a license to issue USDC and EURC in the EU in full compliance with MiCA. Switzerland has long had a clear and favorable legal framework that is accommodative to digital assets, while the UAE is increasingly becoming a go-to center for digital asset innovation by creating a proactive and common-sense regulatory framework.
The major benefit of this improving landscape is a general softening of the barriers that institutions face when considering allocating capital to digital assets. While there have always been (friction-heavy) avenues to do so, it is becoming increasingly derisked and viewed as a beneficial asset class to include in portfolio construction, with far smoother onboarding rails available now than ever before.
In economic terms, increasing institutional participation first and foremost changes the slope of the demand curve. The nature of institutional capital – longer-term allocators, structural buyers, stickier capital, mandated exposure, etc. – all serve to steepen the curve (chart below). Retail and hedge funds are relatively short-term and generally ‘weaker handed’, far more sensitive to price changes in digital assets (e.g. more elastic demand curves). Institutional allocators, meanwhile, are likely to be more price insensitive, commit flows in far more consistent levels, and given portfolio mandates, are far less likely to unwind positions/exit the market once entered. Importantly, it is still very early in this steepening process as institutions have yet to enter the market at scale. This is a longer-term dynamic playing out in the background. It is also a powerful one.
In July 2023, the first precursor to a discrete demand shock hit the market when it became clear that the BTC ETF approvals were likely imminent. Though it took several weeks to really impact the market, Bitcoin rose 27% in October and another ~20% before year-end as investors started to deploy capital in advance of the expected ETFs. Total3 over this time also ran over 50%, largely due to price appreciation (rather than new asset inclusion).
The ultimate ETF approval and live trading beginning in January was an additional demand shock. Though new net flows have moderated recently, these products combine for $15B in net new inflows to the market and represent the most successful ETF product launch in history. In economic terms, this represents a major shift outward of the demand curve (chart above). Remember, this $15B in net new inflows almost doubles the entire digital asset hedge fund industry in terms of size. Further and importantly, this is new capital above and beyond the flows entering the market outside of Bitcoin into the broader digital asset ecosystem, and much of this is going into retirement and other tax-advantaged accounts, tucked away off-chain into cold storage.
Taken together, the market demand curve looks far different today than it did just 12 months ago (chart above). Increasing global regulatory alignment and clarity, upcoming spot Ethereum ETFs in the US, and a potentially friendlier regime in the White House come January all point to these demand curve improvements continuing. Further, major platforms such as Morgan Stanley and Merrill Lynch have not yet turned on the BTC ETF spigots, nor have most RIA’s. Importantly though, these demand changes also happened very quickly, and the structural supply side did not change in lockstep. This misalignment resulted in a massive price run-up in digital assets to the highs seen in March.
Source: BTC and Total3 from July’23 to March’24 via TradingView
Beyond the institutional allocators entering at scale, there is another near-term idiosyncratic demand shock that has the potential to shift the curve out even further. Come October and November, FTX creditors will finally recover funds that have been locked in the bankruptcy process since 2022, to the tune of ~$15B in cash. The vast majority of this is crypto-native capital, and as such, it is not unreasonable to assume a large portion of this cash will be put back into the market as demand-side buy pressure. Economically, this should push the aggregate price level up as the demand curve shifts out.
Source: Wintermute
The Supply Side: Flattening and Shifting…Way, Way Out
The supply side of the market is also undergoing significant structural changes, including a consistent flattening of the supply curve while being subject to major supply shocks in both directions. These changes are largely the result of a healthy and maturing industry that remains very early in its development cycle. Ironically, it is a long list of positive developments that have led to the supply glut causing short-term, “negative” impacts to the market.
Ceteris paribus, a flatter supply curve represents a more elastic supply. Producers of a service, e.g. block space in our case, in aggregate are often in a more competitive market with access to better technologies and adequate resources if there is elasticity in production. They are better able to adjust to price fluctuations and other demand changes as they occur.
Historically, digital assets have faced considerable supply constraints (e.g. inelastic supply curves). Technologically, blockchains have been incredibly difficult to build, requiring advanced skills in very niche programming languages and a strong grasp of cryptography, economics, game theory, and business development - a very small intersection indeed. A small organic user base and underdeveloped web3-specific advertising and acquisition software have also meant testing and iterating is more difficult than in web2. Available capital to fund development and hire programmers has mostly been limited relative to traditional industries. Regulatory uncertainty, perceived career risk, big-tech bull market from a low-rate environment, the list goes on. And it's new – Bitcoin is 15 years old, and Ethereum is less than 10. In short, there have been major structural obstacles on the supply side resulting in a fairly steep, inelastic supply curve. The market has either had adequate supply capacity to meet demand or not. There has been a very limited ability to adapt and respond based on market conditions historically.
Signs of change began to appear during the 2020-2022 cycle, beginning with Sushiswap in 2020. Blockchains and decentralized applications are mostly based on open-source code. As such, the entire code base of even the top protocols is free to anyone to fork (e.g. copy and paste) and launch a clone with minor, if any, changes. Sushiswap famously forked Uniswap’s code, added innovative new features like a ‘governance token’ and ‘staking’, and then conducted a vampire attack on Uniswap in an attempt to drain its liquidity and steal users. In defense, Uniswap created its own governance token and airdropped it to 250K users. Users received at least 400 UNI tokens each worth ~$1400 at the time. UNI peaked at almost $45 per token in May 2021, meaning any user that held had received $18,000 from that airdrop.
Why the history lesson? It is important to highlight several key aspects unique to digital assets:
For anyone active in digital assets today, none of these are surprising. But at the time (2020 and 2021), the industry was still coalescing around best practices and standard operating procedures and as a result, supply was relatively constrained. The general adoption of each of these factors provided the necessary foundation for the massive run-up in prices, especially in ‘alt’ coins. Interestingly, Total3 peaked far higher back in 2021 than it has reached in this cycle, despite BTC being at all-time highs now. Simply, this reflects the much more concentrated market in 2020/2021 than today. We cover this 2021 demand/supply imbalance later in this post, but importantly, most of the top digital assets in December 2020 were straight cryptocurrencies; there were essentially no smart contract platforms or DeFi applications of significant size at this point beyond Ethereum, Aave, and Uniswap.
Source: BTC and Total3 market cap growth since 2019 via TradingView
This price run-up and explosion in experimentation naturally attracted fresh capital to fund new projects and brought in thousands of new developers. At the same time, the success of Ethereum and Ethereum-based DeFi led to an explosion in ‘alt L1’ and L2 funding for projects such as Solana ($315M in 2021), Avalanche ($130M in 2020, $230M in 2021 and $350M in 2022), and Arbitrum ($120M in 2021). With funding and users also come developers. Having plateaued in 2019 and 2020, the active developer count almost tripled throughout 2021 and into 2022. Some of these new developers continued improving upon existing code bases while many more began building their own projects – new chains, new applications, and new infrastructure.
Source: Electric Capital’s Developer Report. Expect to see these developer counts pick up significantly again in 2024.
Though the crash following FTX and all of the bankruptcies that rang through the market in 2022 were painful, many of the majorly positive developments from the boom have resulted in permanent, significant changes to industry aggregate supply. More money and more developers lead to far more innovation and experimentation, better code bases, and improved DevOps. Newly rich crypto-native users were trained to be early test subjects for new projects launching, incentivized by extensively engineered airdrop campaigns. Expanded tooling and infrastructure improvements pave the way for new primitives such as staking and restaking, Rollups-as-a-Service, oracle expansion, improved user experience, and expanded use cases beyond finance to gaming, DePin, RWAs, and NFTs/metaverse applications. In short, the 2020-2022 cycle served as jet fuel in terms of industry development. It is still very nascent today but miles ahead of where it would be without that cycle having taken place.
Economically, this means that the supply curve for the industry is structurally far different today, constantly evolving towards a more mature, elastic curve typically seen in more established industries. This is all a very healthy development path for an emerging industry.
Whether funded during the strong 2020-2022 cycle or started during the ensuing bear market, teams never stopped building and almost all of them had tokens in mind.
Following the market crash in 2022, very few teams were conducting airdrops/TGEs throughout late 2022 and early 2023 and instead holding off for the next risk-on cycle where they could better capitalize on market conditions. Also during this time, many investors that had written checks in 2020-2022 did not have liquidity on their tokens, subject to the common 12-month cliff and 2-4-year vesting schedules, or from teams generally holding off from any TGE at all. Most of the major protocols (BTC, ETH, LTC, BCH, SOL, DeFi blue chips, etc.) that were live throughout 2020 and 2021 largely had close-to-fully circulating supplies. Altogether, this meant that very little new token supply was hitting the market, and the industry was in a very organic, albeit depressed, winter-like equilibrium.
But as attention turned back to digital assets and market capacity began to increase throughout late 2023 and into 2024, teams and investors began to look back at airdrops and TGEs. A common refrain we repeatedly heard from teams: “We’re targeting the end of 1Q for TGE”. Two major factors are primarily at play:
Together, these two pieces have resulted in an overwhelming deluge of new token supplies hitting the market. Referring back to that S-curve inflection point in token supply and exponential growth we mentioned at the top: scaling analytics site L2 Beat now tracks 61 Ethereum-based layer-2 networks, 18 layer-3 networks, with 79 more in the pipeline. Alone, these Ethereum-only scaling solutions represent ~160 well-funded, mostly venture-backed networks, the majority of which already do or are likely to have their own tokens. Further, each of these has its own ecosystem of applications, almost all of which will have their own tokens as well. For example, Blast, a major L2 that recently held its own $2.5B TGE in June, has almost 120 different projects building on its chain, the vast majority of which have released tokens or are running points campaigns. This doesn’t account for the dozens of teams building on Bitcoin and hundreds more in the Cosmos, Polkadot, and other base-layer ecosystems.
Source: L2Beat
Meanwhile, on Solana, the next largest smart contract ecosystem outside of Ethereum, token creation is going parabolic. Metaplex is the de facto fungible and non-fungible token creation protocol on Solana. In May 2024 alone, Metaplex had almost 900K create instructions called – an enormous jump from the previous month and orders of magnitude larger than what was occurring throughout most of 2023:
Source: Metaplex
To make matters worse, many of the TGEs happen at valuations completely detached from reality with 90%+ of the supply continuously dripped into the market, or are struggling/failed projects that are taking advantage of the embedded crypto put to salvage some value from the project. There is no way else to put this: the industry is currently being drowned in a massive supply shock from the magnitude and quantity of these token launches. To quantify this - there is an estimated $58B of unlocks across 120 projects coming between now and the end of 2024. Economically, this is reflected in a massive shift outward in the supply curve. This is happening at a far greater pace than the structural changes in demand are occurring thus leading to lower price levels across most of the market (shown below). This also highlights the importance of deep fundamental research in navigating this new market environment.
(majorly positive developments) * (industry dynamics) = severe short run chop
Ironically, due to these dynamics – all positive – we find ourselves in an oddly depressed market environment. And it makes sense. We have seen strong structural demand shifts happen followed shortly thereafter by a counter-shock of massive supply curve shifting. Volatility should be the outcome. And it is.
Further, both curves are currently undergoing changes in their slopes as well. The demand curve is growing increasingly steep as accessible products reach a larger set of investors, including never-before-involved institutional allocators. The supply curve is growing increasingly flat as developer frictions are minimized, codebases and libraries are standardized, use cases proliferate and supply-focused infrastructure such as Rollup-as-a-Service providers come to market. These latter supply changes are further along than the changes happening on the demand side. However, the long-term demand changes are likely to be more significant at maturity. In the short term, it is difficult to gauge where all of this finds an equilibrium, but a range-bound or down market is not surprising despite all of the positive catalysts happening.
In the long run (e.g. 12+ months), it is much easier to be optimistic about where things will all ultimately find balance. Because all of this is permanent, structural change, and reversion to previous equilibria seem far less likely than establishing new ones. And given that the net positive developments far, far outweigh any short-term negative changes, any new future equilibria are likely to situate the market in a much stronger position than before. The new shapes of the curves should also reflect the lowered volatility that comes with a more mature industry, growing beyond its severe boom-bust chop cycles.
Why is this time different?
We saw similar, but far simpler dynamics play out over the 2020-2022 cycle. There was a surge in supply from DeFi summer and the resulting proliferation of projects that spun out from those experiments. However, that list was relatively short compared to what we are seeing today. There are more Ethereum L2s now than there were even serious DeFi protocols back then. More importantly, the demand shock that hit the market was massive – billions of people around the world were suddenly flush with cash and had nothing to do besides be on the internet. That demand shift swamped the new supply and resulted in the massive bull market over that period. Naturally there was a substantial lagged increase in new supply that was permanent, but much of it was blunted to a degree by investors’ and teams’ vesting schedules. The demand shock was largely temporary. Once the world started normalizing and the industry was rocked by bankruptcy after bankruptcy, most of that capital left the market. Very little of it represented a permanent structural change.
This time feels different. The demand side is undergoing long-lasting structural changes that fundamentally impact where the market will reach equilibrium moving forward. In the short term, however, the shifts in aggregate supply are overwhelming the market’s capacity to absorb them. This is why Bitcoin has held up so well relative to the rest of the market: its post-halving supply and post-ETF demand both represent fundamentally positive and long-lasting shifts in Bitcoin’s aggregate curves, pushing it to a higher and more stable equilibrium.
The ‘alt’ market is still finding its footing. The Ethereum ETFs are a strong first step towards creating structural demand changes, and the improving regulatory environment around the world is laying a solid foundation for future improvement. Continued technological developments, improvements around user experience and accessibility, and generally improved understanding and appetite for digital assets all point towards long-term positive developments that will further push out and steepen the demand curve while continuing to flatten supply.
Conclusion
The double-edged sword of digital assets is this all happens very fast, precisely because of all these dynamics. The same feature that means code can literally be copy and pasted (e.g. forked) with minor tweaks that leads to unparalleled speed in development also leads to massive oversupply in the market short term and suppressed prices. We are witnessing the clash of programmatic and cryptographically ensured scarcity vs. infinitely scalable internet technology with near-zero marginal cost of production and distribution. The ultimate showdown of an unstoppable force vs. an immovable object. This is why we have such massive swings in digital assets, why this current market is not unsurprising, and while we await a winner, this ironically all points to a stronger industry moving forward.
Is this a short-term transformation? Definitely not. But digital assets are a young and incredibly dynamic industry, seemingly speed running the years-long cycles other industries go through in just a few months. As we have said all along, there will most assuredly be periods of extreme volatility as all of this plays out, but if one takes a step back and looks at all of this in a broader context, it is impossible to not be excited and optimistic about where the industry will be in the next few years:
Onchain Ethereum ecosystem transactions (top) and L2 active addresses (bottom)
Source: growthepie.xyz
