Smart Contracts Outperform Broad Digital Assets Amidst Overall Crypto Weakness

Bitcoin underperformed risk assets so far in September, down 7.3% through 23 September vs. the S&P 500 Index down 1.55%.¹ The broader digital assets universe, as represented by the MVIS CryptoCompare Digital Assets 100 Index (MVDA), returned -5.2% over the same period.² Though the impact was mild in market-cap weighted terms, strong price action among some smart contract protocol tokens helped mitigate the impact of continued regulatory headwinds for crypto in China, which tends to hurt Bitcoin disproportionately due to China’s history hosting large miners. Looming Federal Reserve policy normalization and additional regulatory uncertainty in Washington, D.C. also weighed on the asset class, whose returns correlate more closely with other risk assets during broad market selloffs.³The Crypto Fear & Greed Index, which incorporates volatility, social media sentiment and other factors, hit a low of 21 (scale of 0-100) on 22 September. For perspective, that index typically bottoms around 10 in oversold bear markets (March 2020, May/June 2021, much of 2018).⁴

Fig. 1: Digital Assets Still Exhibit High Correlation with S&P 500 During Market Selloffs

MVDA25 vs S&P: rolling 1 month correlation

Source: Bloomberg, rolling 30 day correlation as of 23/9/2021. MVDA25 = MVIS CryptoCompare Digital Assets 25 index.

While it is possible that September’s poor returns have something to do with market participants re-starting in-person activities⁵ and leaving their trading screens unattended—New York City hosted three major digital assets conferences in September, including Messari Mainnet, which claimed 2,000+ attendees at the Marriott Marquis in Times Square—the more likely culprit is the regulatory environment. At the Messari conference, for example, one DeFi (decentralized finance) entrepreneur was reportedly served a subpoena by the SEC before his keynote panel. In response, Messari’s founder Ryan Selkis teased a Senate run against crypto skeptic Senator Elizabeth Warren (D-MA).⁶ In more mainstream shows-of-force, SEC Chairman Gary Gensler testified before the Senate Banking Committee mid-month and hosted a livestream on cryptocurrencies with the Washington Post on 22 September. At both events Chairman Gensler reiterated that “many” cryptocurrencies are in fact securities and will face increased enforcement action from the securities regulator if the U.S. Congress cannot pass legislation clarifying the debate. Meanwhile, the crypto provisions in both the infrastructure and budget reconciliations remain troublesome to many bulls. Specifically, these provisions include changes to wash sale rules⁷, the definition of a “broker”, and additional tax reporting requirements—any of which could dampen the “velocity” of digital money, a defining feature of the asset class which underpins the revenue numbers and token performance of many decentralized protocols such as Uniswap (UNI, mkt cap $13B as of 23/9/2021).⁸

One specific legislative fix under debate in the U.S. infrastructure bill is a proposal to amend Section 6050I of the tax code so that “any person” who receives over $10,000 in digital assets must verify the sender’s personal information, including social security number, and sign and submit a report to the government within 15 days. Failure to comply would result in mandatory fines and could be a felony (up to 5 years in prison), according to the Proof of Stake Alliance who wrote a recent report on the topic.⁹ The proposal relies on a 1984 rule written to discourage in-person cash transfers and to encourage the use of financial institutions for large transactions. But the law may be difficult to apply to the transfer of digital assets, which are defined broadly as “any digital representation of value” using distributed ledger technology, including NFTs (non-fungible tokens). Miners, stakers, lenders, decentralized applications and marketplace users, traders, businesses and individuals are all at risk of being subject to this reporting requirement, even though in most situations the person or entity in receipt is not in a position to report the required information.¹⁰ The potential impact of this tax treatment on the market for NFTs can be seen in the price of $PUNK-BASIC, an ERC-20 token backed 1:1 with CryptoPunks in order to track the floor price of these “OG” NFT collectibles. $PUNK-BASIC price is now down 70% from its August high.¹¹ (See a recent VanEck report on NFTs and the “Jpeg economy” here.)

Fig. 2: NFT Prices Have Cratered Since the Market Peak in August

$PUNK-BASIC token price

Source: Coingecko, as of 15/9/2021.

Still, amidst the negative newsflow and overall market weakness, it is important to note that 4 of the top 5 best-performing digital assets (above $1B market cap) since the market peak in August have been “smart contract protocols”,¹² which we define as “open-source blockchain protocols designed to host a variety of self-developed and third party apps,” and which includes Ethereum. While the Ether price is down 30% from its peak, competing smart contract platforms such as Avalanche, Cosmos, Solana and Algorand all released a number of DeFi applications in September, which have attracted a combined $15B in additional deposits. In contrast, the value of ETH deposited in DeFi protocols fell $15B in September. Thus, ETH now accounts for 69% of the value locked in DeFi vs. 79% at the beginning of the month.¹³ And yet according to Messari, the data provider, the market-cap weighted last 30-day return among 82 smart contract platforms is 12% vs. the MVDA down 5%.¹⁴ While the competition between smart contract platforms may be fierce, the cost-advantage of these layer 1 protocols vs. traditional finance and web 2.0 platforms is becoming more evident to market participants. We see diversified exposure to this growing sector as an attractive linchpin of growth-oriented portfolios. Regulatory clarity – involving the potential watering-down of the above crypto-specific legislation in Washington – could be another powerful catalyst.

Fig. 3: Smart Contract Platforms Are Taking Share

Market Share by Category

Past performance is not a reliable indicator of future performance.

Source: Cryptocompare, VanEck, as of 23/8/2021.

Fig. 4: Ethereum Is Losing Share Among Smart Contract Platforms

Smart Contract Platform Market Share

Past performance is not a reliable indicator of future performance.

Source: VanEck analysis, based on data from CoinMetrics and Messari, as of 31/8/2021. Past performance is not a reliable indicator of future performance. *Algorand, EOS, Solana, TRON, Cardano, Polkadot, Internet Computer, Tezos, NEO, Waves, NEM.