Research Round-Up: September 2023

The Research Round-Up On-Demand

Watch Now: Fidelity Digital Assets’ Director of Research Chris Kuiper and Research Analyst Daniel Gray provide additional commentary and market insights in this short on-demand video.

Market Commentary

While the digital asset community seems to be celebrating the court’s decision favoring Grayscale’s ETF case, this past month’s overall price action was dull. Bitcoin fell just over 6%, while ether fell roughly 8% from the beginning of the month. Year-to-date returns, however, remain positive, with bitcoin’s YTD at roughly 65% and ether’s at just under 43%.

Other top headlines affecting the markets this month include the Treasury and IRS’s proposing new digital asset tax reporting rules, the first spot bitcoin ETF launching in Europe, PayPal’s launch of a U.S. dollar stablecoin, the Friend.Tech social app’s polarizing rollout, and Bitcoin exchange balances’ fall to a 5-year low.

In this month’s newsletter, we digest the top developing news stories in digital assets, highlight some data points, and explore what they could mean going forward.

News and Editorial

A curated list of the most relevant news and developments along with our Two Sats.

Grayscale Wins Landmark Case Against SEC

A high-profile court case involving Grayscale Investments ruled in favor of the digital asset trust issuer over the SEC regarding Grayscale’s application for a spot bitcoin ETF.¹ Bitcoin's price appreciated by 5.4% to $27,450 immediately following the court's decision, as the Grayscale Bitcoin Trust (GBTC) discount to net asset value narrowed from -25% to -17%.² The court criticized the SEC's inconsistent treatment of spot and futures-based bitcoin ETFs, comparing Grayscale's proposed bitcoin ETF to already approved bitcoin futures ETFs in both the underlying assets and in surveillance sharing agreements. While the court explicitly opined that the SEC's denial of Grayscale's proposal was "arbitrary and capricious," the agency does have 45 days to request a rehearing. After this time passes, the court will issue a final mandate along with further directives.

Our Two Sats:

Is a spot bitcoin ETF approval now one step closer or is this just another round of false hope? While only time will tell, it is no secret that this decision could have broader implications for pending spot bitcoin ETF applications. Grayscale's victory might make it harder for the SEC to deny future spot bitcoin ETFs because the agency can now approve the conversion of GBTC into an ETF, deny it for a reason not yet mentioned, or force the closure of existing futures-based bitcoin ETFs. With more spot bitcoin ETF application deadlines fast approaching, we will be closely monitoring SEC judgements in these filings.

First Spot Bitcoin ETF Goes Live in Europe

Jacobi Asset Management has launched Europe’s first spot bitcoin ETF on the Euronext Amsterdam Stock Exchange.³ The Jacobi FT Wilshire Bitcoin ETF is trading under the ticker BCOIN and is regulated by the Guernsey Financial Services Commission. Jacobi claims that the ETF is "the first digital asset fund compliant with SFDR Article 8 through its decarbonization strategy," leveraging Renewable Energy Certificates (RECs) to offset the fund’s bitcoin holdings, enabling investors to gain exposure to bitcoin while meeting their ESG mandates. The fund was originally approved in October 2021, but Jacobi delayed its listing due to market headwinds from the collapse of the Terra ecosystem and a slew of high-profile industry bankruptcies. Fidelity Digital Assets^SM is providing custodial services for the fund, Flow Traders is the market maker, and Jane Street and DRW are Authorized Participants. The listing comes amid increased speculation around the approval of a spot bitcoin ETF in the U.S., following a wave of applications from major incumbent financial institutions.

Our Two Sats:

While most U.S. spot bitcoin ETF filings are homogeneous in nature, it is worth calling attention to Jacobi’s unique approach in the use of Renewable Energy Certificates (RECs) to offset the carbon emissions associated with bitcoin’s energy consumption. ESG mandates are becoming increasingly common among retail and institutional investors, especially in Europe, and the inclusion of RECs suggests Jacobi is attempting to proactively address any environmental concerns tied to Bitcoin and help align the fund with investors’ ESG objectives. Despite this approach’s allure, few products have gone to market with this strategy, probably because it is cumbersome to estimate the emissions associated with a single bitcoin and any existing methodologies that might be used to attempt to measure this are controversial at best.

PayPal Launches U.S. Dollar Stablecoin PYUSD for Payments and Transfers

Digital payment service provider PayPal is launching a U.S. dollar stablecoin, dubbed PayPal USD, (PYUSD) in partnership with blockchain infrastructure firm Paxos.⁴ The token will be issued on Ethereum as an ERC-20 token and is backed by U.S. dollar deposits, short-term Treasuries, and similar assets. PayPal initially plans to offer PYUSD to its U.S. customers, allowing them to transfer the stablecoin, use it for purchases, and convert it to other digital assets.

While Paxos labeled PYUSD the "world’s safest dollar-backed digital asset," some industry observers expressed concerns over the stablecoin’s design. Notably, the new stablecoin reportedly operates on an outdated version of Solidity from 2018, and some are criticizing the decision to issue the stablecoin on the Ethereum mainnet because of the network’s historically high transaction fees (although it seems most transfers will be free for users). Like other centralized stablecoins, concerns also arose regarding the token's potential control mechanisms, with some noting that PYUSD allows for a high degree of centralization, including the abilities to pause transfers, freeze addresses, and increase the token’s total supply.⁵ The launch of PYUSD also caught the attention of lawmakers. Congressman Patrick McHenry (R-NC-10) supported the announcement, emphasizing the potential of regulated stablecoins in modern payment systems,⁶ while House Democrat Maxine Waters (D-CA-43) expressed deep concerns over the token’s launch, including concerns over the lack of a federal framework to regulate stablecoins like PYUSD, PayPal's enormous global reach, and the token’s widespread implications relative to consumer protection and financial stability.⁷

Our Two Sats:

The launch of PayPal’s stablecoin indicates larger financial institutions’ increasing acceptance of and interest in digital assets. PYUSD’s value proposition is being questioned by some, and its centralized design potentially makes significant tradeoffs when it comes to user control. However, the development signifies a milestone for a major payments provider and could motivate others to adopt the technology. The announcement has also reinvigorated the debate on stablecoin regulation. While the House of Representatives disagrees over the legislation’s intricacies, there seems to be a consensus among lawmakers that a regulatory framework is necessary and long overdue. PayPal's move is likely to accelerate the development of such a framework, which could pave the way for large-scale stablecoin adoption among financial institutions and their customers.

Treasury and IRS Propose New Digital Asset Tax Reporting Rules

The U.S. Treasury and IRS have released newly proposed tax reporting rules for digital asset brokers, exchanges, and potentially decentralized exchanges to increase taxpayer compliance in the next few years, with expectations of generating approximately $28 billion over a decade.⁸ The proposed rules would require digital asset brokers to report certain digital asset sales ranging from bitcoin to NFTs—with an aim to close the tax gap by treating them similarly to traditional firms and "avoid[ing] preferential treatment between different types of assets." Under the proposal, digital asset brokers would need to begin reporting on digital sales starting in 2025. The news has been met with mixed reactions from the industry. The proposed regulations are open for public comment and may be modified or withdrawn prior to finalization. We are actively digesting the information and how it will impact our clients.

News Quick Hits

• Two founders of Tornado Cash, the polarizing digital asset mixer, have been charged with laundering more than $1 billion, including millions for North Korea.⁹
• The SEC brought its first NFT enforcement action against the Impact Theory podcast studio for allegedly conducting an unregistered offering of digital asset securities.¹⁰
• Bitcoin payments firm Block Inc. reported $2.4 billion in bitcoin sales for Q2 2023, a 34% year-over-year increase.¹¹
• A wave of Ethereum futures ETF applications have been filed with the SEC as a renewed sense of optimism surrounding ETF approvals surges through the industry.¹²
• Solana’s payment tool Solana Pay has integrated with one of the largest e-commerce platforms, Shopify, for digital dollar currency payments.¹³
• Circle CEO Jeremy Allaire says the firm is banking on $1 billion in cash reserves to weather decreasing market share and fresh competition from other stablecoins.¹⁴
• The Federal Reserve has new guidelines for state-chartered banks, ordering them to get a written “non objection” before engaging with stablecoins, but Congress may overrule them.¹⁵

What We Are Reading Lately

A brief synopsis of research we have been consuming and our interpretation of it.

Ark Invest Partners with Glassnode to Introduce Cointime Economics

A new form of data analysis for the Bitcoin network has been released by Ark Invest and Glassnode. The two companies came together to research, develop, and launch a new data analysis tool on Glassnode known as Cointime Economics. This tool puts a larger emphasis on the factor of time in relation to bitcoin unspent transaction outputs (UTXOs), the main takeaway being that the longer bitcoin is held in a wallet, the more valuable it becomes. Each new block in the Bitcoin network creates what is referred to as a coinblock. A coinblock can be simply explained as the number of bitcoin held multiplied by the number of blocks held. So, the more blocks mined on top of the last spent UTXO, the more coinblocks created for that bitcoin. Once a UTXO is spent, its coinblock count resets.

Time has always been a pivotal variable in the Bitcoin network. Satoshi mentioned the word “timestamp” 13 times in the 2008 Bitcoin whitepaper, never referring to it as what has become known as blockchain. With time being so important, one would think Bitcoin data analysis would use this variable regularly. However, one could argue that the time factor has been significantly underused, discounted even. However, there is light at the end of the tunnel, and it may be coming from the headlights of a DeLorean. Fear not, Doc Brown enthusiasts, the novel concept of Cointime is upon us. Cointime Economics is an interesting concept, and further exploration will be needed. Many have long said that time is money, and it is about time to put that theory into practice. You can find the entire Cointime paper here.

Data to Watch

Data we are currently keeping an eye on and our commentary.

Easy Come, Easy Go – Friend.Tech

Friend.Tech, a social app that launched on August 10 on top of Coinbase’s Layer 2 protocol, “Base,” quickly caught our attention in August. The protocol allows its users to buy and sell tokenized shares of another user’s profile, granting the shareholder exclusive access to the personality through exclusive content and chat rooms. On an invite-only basis, users can connect their X (formerly Twitter) profiles to the new app. This allows users to verify their identities. In mid-August, the daily transactions and fees began to rise. Friend.Tech’s cumulative fees reached $1.4 million on its 10^th day of trading, averaging daily total fees of $700,000, including the next two days. Those fees topped out at just under $850,000 on the 21^st trading day. However, August 22 experienced less than half of the fees of the previous day and has since sunk to a quarter of the average since the protocol’s release. We will be watching to see if the network experiences another resurgence once invites are open to the broader community.

Bitcoin Exchange Balances Fall to 5-Year Low

Bitcoin held by exchanges have been in a steady decline since March 13, 2020. At its peak, digital asset exchanges held approximately 3.2 million bitcoin. Today, exchanges hold roughly 2.3 million bitcoin, representing an approximate 30% decrease from the peak. Since the 2020 halving, bitcoin’s price has risen over 200%. This is important to note because halving events are preprogrammed into the network’s issuance schedule, and the next one happens to be less than a year away. The halving event, which reduces the newly minted supply of bitcoin, is estimated to occur sometime around April 2024. The change in exchange balance levels could be written off as nothing more than users learning from historical exchange fallouts, as has been experienced over the last few years. However, users might also be studying the historical effects of halving events and preparing for any upcoming volatility by holding their bitcoin in cold storage.

Note: Each epoch is measured from each halving event date; these dates occur roughly four years apart. The first halving occurred in November 2012, the second in July 2016, the third in May 2020, and the fourth is estimated for April 2024. The first epoch is not pictured here because the asset was too young to have a meaningful presence on exchanges.

Cointime Economics – A Closer Look at a Long-Term Holder Signal

One of the metrics produced by Ark and Glassnode in their report mentioned earlier is the Coinblock metric. This metric provides a time variable for bitcoin UTXOs by assigning the coinblock value derived from multiplying the number of bitcoin held by the number of blocks mined while held. Put simply, if someone held one bitcoin for six blocks, their bitcoin would be valued at six coinblocks. If someone held the same bitcoin for 210,000 blocks, then their bitcoin would be valued at 210,000 coinblocks. More specifically, this will allow analysts to weigh UTXOs in coinblocks instead of in the standard Boolean measurement system. Shown here is the number of cumulative coinblocks stored, which is comparable to the unmoved supply, up roughly 10% year-to-date, which aligns with other metrics showing that users have increased their savings rates.

In Case You Missed It

While users may get technological utility from the Ethereum network by accessing the various applications in the ecosystem, some may wonder, “How does utility translate into value for ether the token?” In other words, why would an investor buy and hold the ether token, rather than just use it to interact with the Ethereum network? In our previous paper introducing the Ethereum network, we only briefly considered how or why the ether token may accrue value. In our latest paper, we examine this question more deeply on an investment thesis level and include some of the technical aspects related to the various investment theses. 

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Contributors:

Christopher Kuiper, CFA, Director of Research, Fidelity Digital Assets^SM

Jack Neureuter, Senior Research Analyst, Fidelity Digital Assets^SM

Matthew Hogan, Research Analyst, Fidelity Digital Assets^SM

Daniel Gray, Research Analyst, Fidelity Digital Assets^SM

Max Wadington, Research Analyst, Fidelity Digital Assets^SM

Zack Wainwright, Analyst, Fidelity Digital Assets^SM