April 17, 2023

March 2023 Market Commentary

Galaxy Asset Management

April 17, 2023

Market Commentary

Crypto markets experienced a bounce-back performance in March after February’s skid as bitcoin (“BTC”) outperformed finishing up 23% on the month. Major themes impacting both traditional and crypto markets stemmed from the banking crisis led by closures of Silvergate Bank, Silicon Valley Bank and Signature Bank. Concerns over banking viability continue and depositors are fleeing en masse to larger systematically important banks, money market funds with higher yields, and non-sovereign reserve assets, such as gold and bitcoin.

The recent surge in value of BTC serves is a reminder of its true purpose – to establish autonomy away from the risks to the traditional banking system and be liberated from the influence of central banks. Recall, Bitcoin was created partially as a response to the Global Finance Crisis and its first block was embedded with the text: “Chancellor on the brink of second bailout for banks.” This was Satoshi Nakamoto’s comment on the alleged instability caused by the fractional-reserve banking system. The current banking crisis boosted the confidence of investors who view Bitcoin as an alternative to the traditional banking system, resulting in BTC outperforming almost all other digital assets in March.

In efforts to reduce further banking panic, the Fed implemented new loan facilities to help banks meet depositor needs. In doing so, the Fed expanded its balance sheet up to levels not seen since last November, effectively undoing much of the recent quantitative tightening. As a result, a weaker dollar was another contributing factor in propelling BTC higher. BTC saw a reduced correlation with equites while its correlation to gold trended higher. We’re beginning to see examples of BTC’s long term use case as a store of value and risk mitigation during volatility markets.

Earlier this week, Ethereum successfully implemented its Shapella upgrade, enabling withdrawals of staked ETH positions for the first time since the Beacon Chain’s launch in December 2020. Following the upgrade, open interest rotated from BTC into ETH. The regional banking crisis drove focus and capital into BTC leading to its recent relative outperformance, though this is now reversing with clarity on asset flows following the Shapella upgrade's success.

In addition, March unfortunately saw the ongoing regulatory crackdown continue:

On 3/3, an SEC official accused Binance.US of operating an unregistered securities exchange
On 3/9, the NY Attorney General filed a lawsuit against Kucoin for being an unregistered securities broker
On 3/21, decentralized exchange Sushiswap and its “head chef” Jared Grey were served with SEC subpoenas
On 3/22, Coinbase received a “Wells notice” from the SEC focused on staking and asset listings
On 3/22, crypto entrepreneur Justin Sun and his companies were charged by the SEC for fraud and other securities law violations
On 3/27, the CFTC sued Binance and its founder Changpeng Zhao (CZ) for regulatory violations

Portfolio Considerations

March was a significant month for Ethereum scaling solutions, specifically for Layer 2 (L2) roll-up ecosystems, as it saw the launch of the Arbitrum (ARB) token. L2s are built on top of Layer 1 (L1) blockchains like Ethereum and facilitate faster and cheaper transitions by grouping multiple transactions on the L2 and periodically batching them to be submitted back to the L1 where they are validated as one large transaction and added to the next block on the L1 chain. The ARB airdrop occurred on 3/23, distributing just over one billion tokens to more than 600,000 wallet addresses, including early users, communities, investors and towards future development of the ecosystem. Presently, Arbitrum and Optimism (OP) are the leading L2 blockchains on Ethereum with over 80% of the L2 market share. Optimism is planning to release their Bedrock upgrade in the coming weeks. The demand for Ethereum blockspace from L2s continues to rise and is currently utilizing around 16% of each block.

Notably, the L2 ecosystem is flourishing not just because of the ARB token launch but also with new types of roll-ups. Arbitrum and Optimism are both optimistic roll-ups and the next iteration of roll-ups to be released will be zero-knowledge roll-ups, specifically zkEVMs (see recent Galaxy research piece). zkEVMs are based on zero-knowledge (zk) proofs that are Ethereum Virtual Machine (EVM) compatible. These include zkEVM from Polygon and Era from zkSync which recently launched public alpha and beta versions. The founder of Ethereum Vitalik Buterin’s opinion is that zero-knowledge roll-ups will eventually win-out over optimistic rollups even though optimistic had a head start. However, there is no reason why Arbitrum or Optimism can’t also remain sustainable in their current form or switch over from being an optimistic roll-up to a zero-knowledge roll-up themselves.

Institutional Adoption Highlights

Crypto Performance and Volatility Data<br>