Web3 Breakdowns Ep 84 - Jack Neureuter - Bitcoin, Ethereum, and an Institutional Perspective

Primer: How do large institutions view Bitcoin and Ethereum? What does Bitcoin’s on-chain data show? Where does crypto belong in a diversified portfolio? Let’s find out from Jack Neureuter of Fidelity Digital Assets in this episode of Web3 Breakdowns.

Background

• Senior research analyst at Fidelity Digital Assets

The Bitcoin Cycle

• Everyone in the crypto space is familiar with the Bitcoin halving schedule — every 4 years, its issuance rate gets cut in half

• The price of Bitcoin has moved in roughly 4-year cycles, 6 - 18 months after the halving

• There’s a large run-up in prices followed by extreme drawdowns

• Everyone is asking whether the same cycle is playing out

• What gives him pause is the positive real interest rates on a forward-looking basis

• This year is going to continue consolidating and be boring with no narratives

Is There A Catalyst Triggering Price Moves In Previous Cycles?

• People who subscribe to these price runs would say that there is less Bitcoin being issued and, as a result, an imbalance between supply and demand

• The marginal changes at each halving are a lot smaller

• Hence, it’s a little more narrative this time around rather than in terms of material impact on miners’ bottom lines

• Might head into a slowdown at the end of the year, with liquidity being added and central bank balance sheet expanding next year

His On-Chain Data Analysis Reports

• Bitcoin and Ethereum are structurally different with core trade-offs and drivers

• Bitcoin makes explicit trade-offs toward security and decentralization, at the cost of scalability and complexity

“What are the key KPIs that matter to a monetary asset that's trying to be an alternative store of value, digital gold? I would think it's people accumulating that asset and wanting to hold on to it.”

- Jack Neureuter

Bitcoin

• When we look at accumulation addresses (addresses that have 2 or more inputs and 0 historical outputs), these addresses are breaking new all-time highs

• There’s a million+ addresses having this type of activity

• If we look at the liquid vs illiquid supply, 70% of the Bitcoin supply is illiquid (has not moved in the past 365 days or more). This is at an all-time high

• There’s also cyclical behaviour — people taking profit when the price rises and less on-chain liquidity during drawdowns

• There’s a group of Bitcoin accumulators that appear to be exhibiting Gresham’s Law type of behaviour on-chain

• Gresham’s Law: Viewing Bitcoin as the better monetary asset by buying and holding it and viewing fiat money as a worse version of money

Ethereum

• After Proof-of-Stake, Ethereum became a yield-bearing asset whose value or tokenomics is derived from useful applications that people are willing to pay to use

• Those fees trickle down as value accrual for people who choose to stake their ETH or even just hold ETH since a portion of those fees are burnt

Big Money Buying Ethereum VS Bitcoin’s Decentralization

• They are fundamentally different

• Bitcoin’s use of Proof-of-Work is to abstract away the correlation between wealth and power

• There’s an argument about buying more ASICs to mine Bitcoin. However, the actual energy supply and token wealth are two different currencies in theory

• Bitcoin node operators are able to serve as a counterbalance against mining entities

• In contrast, Ethereum node operators are themselves both the staker and the validator, combining their power into one

The Ability To Scale Bitcoin Relative To Ethereum

• Most people talk about the Lightning Network that makes peer-to-peer payments cheaper

• There are issues of liquidity fragmentation where channels have to be pre-funded

• If you want to truly use it in a peer-to-peer fashion, then you should run your own node

• However, this is not how most people use the Lightning Network. Instead, they use a custodial solution

On Bitcoin Ordinals

“That's one of the things about Bitcoin is it's always just been unwilling to change.”

- Jack Neureuter

• Ordinals are one of the roundabout things that got invented because of inscriptions

• Ordinals felt like a mini-bubble

• Making small upgrades on the chain has been the framework for a lot of Bitcoin’s growth:

  • SegWit increased transaction malleability

  • Taproot led to people minting Ordinals

His View On A Bitcoin ETF In 2023

• The wildcard is what comes out of the Grayscale lawsuit

• Seems that the ball is moving forward with surveillance-sharing agreements

Crypto Merging With Traditional Finance

• It is inevitable from an investment perspective

• This is why Fidelity Digital Assets got involved in the space

• There are security and custody risks associated with large institutions owning crypto

• However, just because one large entity owns Bitcoin does not mean that they have more governance or voting rights over the network

• In contrast, if there was a spot ETH ETF in the future, and those assets are staked, then there is a governance component to those tokens

Institutions Reaction: BTC/ETH Are Not Securities

• The ruling and the outcome took a lot of people by surprise

• Have not seen a response from institutions changing their allocation based on one specific court ruling

“It's a positive sign to see, especially that judges and lawyers are able and willing to wrap their head around the complexity of this space rather than just shove it into a singular mould of existing securities that we already have.” 

- Jack Neureuter

Role Of Bitcoin In Client’sPortfolio

• Bitcoin’s price action in the previous month tends to form the current narrative that allocators have

• It’s a form of recency bias

• In 2022, Bitcoin was correlated to the S&P and risk assets. The narrative during that period was that Bitcoin was similar to leveraged equity exposure

• The narrative depends on the investor type

• Those who look at things from a macro perspective want to own a bit of Bitcoin because it is a digital scarce asset

• Ethereum is more for the tech-minded investor

Institutional Investor Survey

• They conduct an institutional investor survey each year. The highest rates of adoption tend to be registered investment advisors and family offices that are directly connected to the end client

• Often, it’s the end client that says that they want to get exposure to the digital asset space, with Fidelity or other companies helping them to get that exposure

• Conversations with the end client tend to be on education

• Allocations from large institutions are sparse. Often, they will go through a traditional venture wrapper rather than take direct token exposure

US VS International Adoption

• Every single year, it goes from east to west in terms of rates of adoption, understanding, interests in DeFi, and yield opportunities

• Asia is always the furthest up the curve, followed by Europe, with the US in the last spot across 90% of the categories each year

• In Asia, the concept of a multi-currency world is more normal

• Asia is also the first to digital payments, where it has become more normalized

Portfolio Weight Theory: Crypto In A Diversified Portfolio

• Have written a number of different pieces using historical data

• Even with historical data, it is hard because the dataset is small and everyone knows the returns were incredible before

• Need to have a framework and investment thesis for the future

• This is why a lot of people end up saying 1-3% because if it blows up, it will be only a small percentage of your portfolio

• If it goes 10x, it would contribute meaningfully to your portfolio

• Allocators that make these decisions tend to use mean-variance optimization, which Bitcoin does not fit perfectly inside

The Lack Of A Valuation System: A Severe Disadvantage 

• If you think of Bitcoin as a monetary asset, you would view it in terms of its value accrual

• Ethereum could be viewed as a business that sells block space:

  • It has cash flows that come from fees being paid

  • It has an automated share buyback through the burn portion of those fees

• They are going to release an ETH investment piece using a discounted cash flow model with tons of assumptions

• To get a valuation perspective, you need to have an outlook on it or have a multiple associated with its current cash flow or revenue

• With Bitcoin, it looks more like gold. Hence, it should have a relationship to some other macro variables

• Have written a piece called Valuing Bitcoin

Areas Of Interest

• The introduction of real-world assets on-chain

• Need more regulatory clarity to bring assets on-chain

• Scaling Ethereum from millions to billions of people across the globe

Most Excited To See

Over The Next 6 Months

• Ethereum pushing through EIP-4844

Over The Next 6 Years

• Real-world assets finding their way on-chain

• Real-world use cases being enabled

• Getting regulatory clarity

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