Grayscale Mid-Year Review and Outlook: Focus on Ethereum Ecosystem and AI Concept Projects in the Third Quarter

Original author: Grayscale

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Poin-poin penting:

• Our Crypto Sectors framework shows that despite the sharp rise in Bitcoin prices this year, the performance of the crypto asset class has been mixed so far. As with securities markets, this years cryptocurrency gains are mainly reflected in a small number of coins.

• We have launched the Grayscale Research Top 20, our pick of tokens with high potential for the next quarter. These crypto assets were selected based on the Grayscale Research team’s combined assessment of upcoming catalysts, market trends, and token-specific fundamentals. It is important to note that several assets in our Top 20 list have high price volatility and should be considered high-risk assets.

• Given the potential approval of a spot Ethereum ETP, we expect the Ethereum ecosystem to require significant attention in Q3.

Exploring the crypto asset class can be challenging, which is why Grayscale created the Crypto Industry Analysis Framework. It is a comprehensive framework for understanding the full range of investable crypto assets and their relationship to the underlying technology. The framework provides investors with common tools comparable to traditional markets to help investors better understand and explore the evolving crypto asset class.

Our crypto industry analysis framework divides the crypto asset space into five distinct sub-categories: (i) Currency, (ii) Smart Contract Platform, (iii) Financial, (iv) Consumer and Cultural, and (v) Utilities and Services (Figure 1). Tokens in these five categories are associated with unique use cases and investable risks. As a result, their valuations are subject to different fundamental and technical drivers.

Figure 1: The cryptocurrency industry analysis framework divides the digital asset market into five parts

Cryptocurrencies have seen modest gains so far this year

Since the beginning of 2024, despite the price of Bitcoin rising by about 50%, our Cryptocurrency Sector Market Index (CSMI) has actually fallen by about 3% (Exhibit 2). Assets in the five cryptocurrency sector categories and the total CSMI are weighted by the square root of their market capitalization to reduce Bitcoins dominance and better represent the overall performance of crypto assets. Weighted by market capitalization, the CSMI has increased by 30%, reflecting Bitcoins significant growth and its sizable share of total market capitalization (about 60%). Of the five segments, the best performer was the currency category (reflecting Bitcoins outperformance), while the worst performer was the consumer and cultural category, largely due to weakness in assets related to video game applications this year.

Figure 2: Despite Bitcoin’s huge gains, cryptocurrencies have had mixed performance so far this year

The large return gap between Bitcoin and the broader cryptocurrency market suggests that this year’s gains have lacked breadth. Much like the U.S. stock market, a handful of large technology companies have recently dominated index returns. Using the cryptocurrency industry analysis framework, we can create market breadth metrics similar to those used in other markets. For example, Exhibit 3 shows an “Up/Down” index, where we track the net percentage of price increases versus price decreases for tokens in our analysis framework on a daily basis; we then calculate the cumulative total over time. According to this metric, cryptocurrency market breadth peaked in late March/early April 2024 and has been declining since then. So far this year, despite Bitcoin’s huge gains, only about 30% of the cryptocurrencies in our analysis framework have actually risen in price.

Figure 3: Market breadth has declined since April

A relative bright spot is assets related to artificial intelligence (AI) technology, which are concentrated in five categories: smart contract platforms, utilities, and services. [2] These protocols attempt to solve AI-related problems (e.g., bots and deepfakes, privacy, model validation), provide resources critical to AI development (e.g., compute, storage, data), or provide a general platform for AI-related services (see our report for more details). Year-to-date, the equal-weighted AI-related cryptocurrencies are up 80%, compared with a modest decline in the overall cryptocurrency market (Exhibit 4).

Figure 4: AI-related tokens outperform

In addition to artificial intelligence, market participants are also paying attention to a number of other topics, which have to some extent influenced the relative performance of our five cryptocurrency categories. To help us understand market trends, Grayscale Research uses the narrative mindshare indicator from data provider Kaito. These data measure the relative frequency of social media mentions of specific crypto market themes or narratives, helping to evaluate crypto assets driven by communities of believers and supporters who frequently express their views on social media platforms. For example, over the past month, artificial intelligence has remained a dominant theme; followed by exchange-traded funds (ETFs), whose approval could become a short-term catalyst for the market; meme coins and blockchain-based games are also hot topics (Figure 5). While market focus may change, themes tend to be persistent, so indicators of narrative mindshare may provide clues to market performance in the coming months.

Figure 5: Artificial intelligence remains the most important topic

Looking to the future: Focus on the Ethereum ecosystem

For the next quarter, Grayscale Research expects crypto markets to be impacted by the approval of spot Ethereum exchange-traded products (ETPs) in the U.S. market. In late May, the U.S. Securities and Exchange Commission (SEC) approved Form 19b-4 applications from multiple issuers to list these products on U.S. exchanges. Furthermore, SEC Chairman Gensler recently stated that the regulator could approve the remaining applications “sometime this summer.” Therefore, while the timing remains uncertain, for the purposes of market analysis, Grayscale Research assumes that these products will begin trading in the third quarter of 2024. As with the spot Bitcoin ETP that launched in January 2024, the Grayscale Research team expects these new Ethereum products to bring meaningful net inflows (albeit less than the Bitcoin ETP), potentially supporting the valuation of Ethereum and tokens within its ecosystem (for more details, see our report, The State of Ethereum ).

The Ethereum ecosystem has several unique features that the launch of a spot Ethereum ETP could highlight. For example, the Ethereum network is pursuing a modular design philosophy where different components of the blockchain infrastructure work together to provide a more optimized end-user experience and reduce costs. Additionally, Ethereum is home to the largest decentralized finance (DeFi) ecosystem in the crypto space and is home to the majority of tokenized projects (see our report Public Blockchains and the Tokenization Revolution for more details). If the approval of an ETP spurs interest and adoption of Ethereum, we may also see an uptick in activity and valuations for some Layer 2 project tokens (such as Mantle), Ethereum DeFi protocols (such as Uniswap, Maker, and Aave), and other assets that are critical to the operation of the Ethereum network (such as Lido, a staking protocol).

In addition to the approval of the US spot Ethereum ETP, Grayscale Research expects that various current market themes will continue to receive attention in the coming quarter, especially the potential intersection between blockchain technology and artificial intelligence. One asset in this category is Near, whose founder is the co-founder of the Transformer architecture, which powers artificial intelligence systems such as ChatGPT. Near is one of the top smart contract platforms in terms of daily active users and has gained widespread practical application in non-financial use cases. Recently, however, Near relied on its artificial intelligence expertise to announce the development of user-owned AGI through a research and development department led by a former OpenAI research engineer consultant. The markets continued preference for artificial intelligence may also benefit decentralized GPU markets such as Render and Akash.

Outside of the main market themes, various projects appear to be benefiting from their own unique adoption trends, whether due to innovative technology or integration with platforms that provide room for user growth. Two notable examples are Toncoin and Pendle. The TON blockchain, a smart contract platform tied to the Telegram messaging platform, has seen significant growth in users, transactions, and fee revenue. Pendle Finance is a relatively new DeFi protocol that allows users to customize the yield profile of their strategies. While this is not a new trend, we also believe that the Solana network is experiencing organic adoption growth thanks to a compelling user experience.

Finally, the cryptocurrency market will likely continue to distinguish between tokens with relatively low and relatively high supply inflation. While Bitcoin has a maximum total supply and fairly low annual inflation, many of the tokens in our analytical framework do not have this structure. In fact, many tokens have relatively low circulating supply and relatively large monthly or annual supply inflation (“unlocks”). In these cases, supply growth can dilute existing token holders even if the project is experiencing user adoption and revenue growth. Examples of this include well-known Ethereum Layer 2 networks such as Arbitrum and Optimism, which have experienced relatively poor returns on their native tokens despite high user adoption, likely due to rapidly growing circulating supply.

Introducing the Grayscale Research Top 20

To highlight high potential tokens in specific crypto sectors, we have launched the Grayscale Research Top 20 (Figure 6). The Top 20 represents a diversified portfolio of crypto assets that we believe have high potential in the coming quarter due to a combination of (i) direct catalysts or trending themes, (ii) favorable protocol adoption trends, and (iii) low or moderate token supply inflation. The selection of these assets represents the near-term market outlook and may therefore exclude higher market cap assets that do not have direct catalysts or sustained improvement in fundamentals. We intend to update the Grayscale Research Top 20 list on a quarterly basis. Please note that several assets on the list are highly volatile (as shown in the rightmost column of Figure 6) and should be considered high risk assets.

Figure 6: High potential assets in Q3 2024

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