The second quarter of 2023 in the digital assets market was eventful. Digital assets initially rode the momentum from the previous quarter, before excitement waned as alt-season never arrived, leading to concerns about where the marginal buyer would be to drive asset prices higher. However, the quarter also witnessed growing institutional interest, particularly after the flurry of Bitcoin ETF-related news. Additionally, excitement about the convergence of artificial intelligence (AI) and blockchain helped frame the discussion about how a more decentralized and inclusive financial ecosystem might look.
Here are the four key takeaways from Q2 2023 in the world of crypto:
1. Regulatory Impact and Alt-Season Miss
Q2 began on a promising note, with digital assets riding high after the sharp rebound in the first quarter. However, as April progressed, enthusiasm waned alongside the continuing shift in market structure, leading to a lack of buying pressure, which ultimately resulted in fading volumes and prices.
Central banks consistently tightened monetary policy, but the full impact of their actions is yet to be fully felt. A notable theme emerged - the "survival of the largest." In Traditional Finance, Market-weighted equity indices significantly diverged from their equal-weighted counterparts as a handful of tech giants drove headline performance. The concentration of the top stocks within major indices increased, while the implied correlation between members reached record lows, creating an unusual market environment.
In crypto, the anticipated 'alt-season'– a period during which altcoins “moon” (sudden increase in price) – failed to materialize. Moreover, regulatory actions taken against exchanges hit “long-tail” assets particularly hard, leading to significant underperformance. The market quickly learned that regulatory decisions and actions have a powerful influence on crypto prices, emphasizing the need for caution and awareness of regulatory developments, especially for altcoins. In place of ‘alt-season’ we saw ‘memecoin mania’ as buyers chased newly launched tokens that captured the zeitgeist pulling capital from across both altcoins and NFTs further weighing on prices of those sectors.
2. Credit Conditions and Labor Market
The quarter saw credit conditions tightening in the broader economy as banks faced continuing pressure on their deposit bases. Customers migrated to higher-paying money market accounts or sought refuge in the largest institutions to avoid headline risk. Regional bank stock prices recovered from the lows but remain significantly weaker overall for the year. The rise in uncertainty, coupled with higher interest rates and potential capital requirements from the looming 'Basel III endgame' rules for larger banks, created a challenging credit environment. The impact was evident in the ~68% increase in commercial Chapter 11 bankruptcies in H1 2023 compared to H1 2022 and the ~23% rise in Individual Chapter 13 filings during the same period. With the future implying even tighter credit conditions, we anticipate a tougher market backdrop that could influence crypto markets and investor sentiment.
Labor market strength remains the most conspicuous positive, although there are signs the clock is ticking. Overtime hours are contracting, temporary staff are being cut, and overall hours worked are trimmed, leading to an increase in job loss as shown by the initial claims figures that appear to have inflected higher. Consumers are already being squeezed, as evidenced by credit card balances not being paid down in 1Q for the first time since the GFC, and delinquency rates on consumer lending are shifting sharply higher. This matters for digital assets as retail is often the marginal buyer for the "long-tail” of altcoins, so the deterioration bodes poorly for liquidity in that segment specifically.
3. Bitcoin ETF – Inflection Point of Institutional Adoption?
Digital asset prices received a welcome boost in the second half of June. A flurry of positive news stories hit the tape, suggesting that digital assets are gaining more acceptance and adoption by mainstream investors and institutions. The launch of EDX Markets, a non-custodial crypto exchange supported by prominent financial institutions, coincided with the approval of the 2x Bitcoin Strategy Futures ETF (ticker BITX) from Volatility Shares Trust. Additionally, several reputable and influential investment firms filed applications for spot Bitcoin ETFs, signaling a shift in market sentiment.
The quality and diversity of ETF applicants reflected a strong belief in the longevity of digital assets, particularly Bitcoin. Notably, BlackRock's 575-1 approval/rejection ratio indicated a favorable stance, with Nasdaq partnering to ensure pricing data oversight for a potential physical BTC ETF. Such an ETF would enable direct ownership of bitcoins through a regulated and liquid vehicle which in turn has the potential to open the sector to fresh pools of capital. This institutional adoption could act as a catalyst for broader market participation and growth.
4. AI x Blockchain - a Financial Ecosystem for Web3
The web3 paradigm seeks to create a more decentralized, open, and inclusive web, emphasizing user control over data, identity, and assets. It is well understood that Blockchain technology plays a central role in web3, but more recently, artificial intelligence (AI) has gained attention as a complementary technology that can enhance the ecosystem. AI applications can leverage blockchain's trustless and transparent nature to access data and services, transforming transactions, specifically financial ones. As the original and most popular cryptocurrency, Bitcoin has several advantages over traditional fiat currencies, such as being global, scarce, and censorship resistant. However, it also faces challenges like scalability and fees that are too high to enable microtransactions natively. Solutions like the Layer 2 Lightning Network have worked to combat this by offering faster and cheaper transactions, which is a necessary pillar for a new financial system.
We envision AI agents as the driving force of the next generation of users. These autonomous software programs interact with humans and other agents, powered by NLP, computer vision, and machine learning. Integrating AI agents with blockchain and cryptocurrencies enables decentralized access to data and peer-to-peer payments. The realm of DeFi opens exciting possibilities where AI agents conduct 24/7 Bitcoin and Lightning Network transactions, paying for services like cloud computing or streaming content. Projects like LangChainBitcoin pave the way for AI agents to interact with Bitcoin and the Lightning Network, unlocking their potential in various AI applications. The future of web3 finance, shaped by the convergence of AI and blockchain, holds immense promise and is closer than we might think.