VanEck Crypto Monthly Recap for February 2024

Please note that VanEck may have a position(s) in the digital asset(s) described below.

Bitcoin rallied 45%, its best monthly performance since December 2020 and its largest monthly candle ever in dollar terms. The new U.S. spot bitcoin ETFs have bought more than 5 times new Bitcoin supply since their January 10th launch and more than 10 times new supply in the last week of February. Even Marathon, the largest publicly traded U.S. miner, announced in an earnings call that the company bought the ETF with spare cash on a dip. The ETF wrapper, akin to an API connection from TradFi to Bitcoin, makes it much easier to purchase and custody the asset in an affordable and compliant fashion. Among new entrants to the space, Reddit announced it had bought Bitcoin and Ethereum for its balance sheet in an IPO filing, Ethiopia revealed its state-sponsored foray into bitcoin mining, and Merrill Lynch and Wells Fargo rolled out access to the bitcoin ETFs to select wealth management clients with brokerage accounts.

• Smart Contract Platforms: February Update
• Bitcoin L2s: February Update
• Notable Performer: February Update for Ethereum
• Notable Laggard: February Update for Arbitrum

We acknowledge that bitcoin is overbought on technical terms, with the 14-day Relative Strength Index (RSI) at 88 and funding rates above 100% for many altcoins. Still, we stay aggressively positioned to capitalize on the historic pattern for bitcoin, which may suggest the most significant gains during the halving year and subsequent 12 months. Our medium-term price target for BTC is $325k, half the market cap of gold, which also corresponds to the minimum trough-to-peak cycle for the asset, which was 16x in 2020-2021.

Source: Bloomberg, as of 2/29/2024. Past performance is no guarantee of future results. Not intended as a recommendation to buy or sell any securities named herein.

Smart Contract Platforms Updates

Smart Contract Platforms (SCP) Revenues vs. Daily Active Users

Source: Artemis XYZ as of 2/27/2024. Past performance is no guarantee of future results. Not intended as a recommendation to buy or sell any securities named herein.

After tepid price performance in January, February 2024 was an absolute blockbuster month for Smart Contract Platform (SCPs) tokens as the market capitalization of SCPs increased (+33%) from $1.27T to $1.72T were $829M, and as of writing, total revenues generated by SCPs was $829M and on pace to exceed December 2023’s revenue total of $838M. Unfortunately, we must dampen our excitement over the revenue figures because Starknet, who recently launched its native STRK token, accounted for over (47%) of February’s revenue total, or around $391M. Starknet’s total for February exceeded Ethereum’s by $100M and is very atypical as Starknet has only earned $36M in total revenues since June 2022. Regardless, if February 2024’s fee total crests that of January’s, it would make it the most profitable month for smart contract blockchains since January 2022.

One extremely positive trend for all SCPs is that the average daily active users of SCPs reached a new high in February 2024 with an average of 7.5M DAUs. Curiously, average daily DEX volumes across all SCPs were lower in February than in January or December. Thematically, February was characterized by jubilation over airdrops, new use cases for Bitcoin, and the potential of decentralized social media applications. In auspicious news for on-chain liquidity, stablecoin supply increased ~$10B in the month of February, moving from $131B to $141B.

As we noted in our last monthly, one of crypto's most interesting and useful attributes is the ability to market a project by giving users an ownership stake in that project’s network. This is called “airdropping” tokens because users’ addresses are sent tokens programmatically. In airdrops, applications hand out portions of their limited token allocation to users whose on-chain activity qualifies them as targeted future users of that application’s product or service. Often, the ideal type of activity that applications target is the usage of its application before it announces its token. However, other types of on-chain actions are also targeted, and these may include addresses that use a similar category of apps and even users of a direct competitor’s application. The most prominent airdrops in February were:

Source: Coingecko as of 2/28/2024. Past performance is no guarantee of future results. Not intended as a recommendation to buy or sell any securities named herein.

Many other projects are rumored to be considering airdrops, and these are Blast, Tensor, Wormhole, LayerZero, Magic Eden, Pixels, Drift Protocol, Saga, Aevo, Parcl, Bluefin, and Ethena.

Bitcoin L2 Updates

An emerging narrative that re-surfaced in February is the creation of protocols that make Bitcoin more useful. Since Bitcoin’s scripting language is Non-Turing complete by design, it lacks the runtime logic to allow smart contract applications to function on Bitcoin. The result is that Bitcoin has long been considered to be a payments-only application chain. That understanding of Bitcoin changed with the emergence of ordinals, enabled through upgrading the Bitcoin core software that allows users to post arbitrary data to Bitcoin. Thereafter, once pioneering “hackers” called the Taproot Wizards began uploading NFTs, others rushed to create token standards for NFTs on Bitcoin. The interest in doing more with the Bitcoin blockchain has orthogonally catalyzed renewed interest in also doing more with Bitcoin’s value.

Currently, Bitcoin’s value can be “bridged” off Bitcoin by varying means that rely upon different levels of trust. For example, on Ethereum, you can create WBTC or “wrapped Bitcoin” by sending Bitcoin, on the Bitcoin blockchain, to a trusted third party who mints a representation of the escrowed Bitcoin as the WBTC token. By contrast, a bridging protocol called LayerZero creates a representation of “locked” Bitcoin on the Avalanche blockchain called BTC.B by locking the value of BTC on Bitcoin’s blockchain through a consensus network of validators. Other schemes, like Stacks, allow Bitcoin to be “trustlessly” used on the Stacks network because Stacks posts proof of its transactions to Bitcoin’s blockchain. Each of these solutions has tradeoffs with respect to safety, convenience, and functionality. More recently, in February, the Bitcoin L2 roll-up Citrea launched what it claims to be the first Bitcoin zero-knowledge L2 that will use zero-knowledge cryptography to secure its Bitcoin interactions.

In February, there was a strong bid in the private markets for Bitcoin L2 solutions, which carried over into the public markets. For example, the token powering the Stacks blockchain saw its value increase (+98%) in the month of February. Additionally, glomming on to the airdrop narrative, a shadowy Bitcoin L2 called Merlin’s Seal was launched and, by the end of the month, had amassed nearly $1.6B in TVL.

Merlin Seal Total Value Locked (TVL) by Blockchain

Source: Defillama as of 2/28/2024. Past performance is no guarantee of future results. Not intended as a recommendation to buy or sell any securities named herein.

One interesting Bitcoin project to watch is Babylon by Standford professor David Tse. In February, Babylon announced a partnership with the Cosmos Hub (ATOM) to bring trustless BTC security to Cosmos blockchains. The stated purpose of this endeavor is to allow Bitcoin holders to receive a yield on their Bitcoin by non-custodial staking of Cosmos blockchain validators. Essentially, this means that a Bitcoin holder can lock his BTC on Bitcoin through a Babylon blockchain smart contract to lend out the value of the BTC. Babylon claims that this is all made possible through a series of cryptographic primitives that allow native “slashing” of BTC in the event a BTC-backed validator acts maliciously. If Babylon is thriving and widely adopted, it could be a powerful competitor to both WBTC and the other BTC L2s due to its more trustless reliance on cryptography for security. The result is that Babylon, and by extension, the Cosmos Hub, could prove to be a competitor to Ethereum’s Eigenlayer for securing Actively Validated Services.

Smart Contract Platform (SCP) Share of Crypto Market Cap

Source: Coingecko, Artemis XYZ as of 2/27/2024. Past performance is no guarantee of future results. Not intended as a recommendation to buy or sell any securities named herein.

One of the forgotten topics of crypto that began to re-emerge in February is a discussion over the long-term value split between applications launched on smart contract blockchains and the smart contract blockchains themselves. This debate was typified by the posts Fat Protocols in 2016 and the follow-up post Thin Applications in 2020. The basic idea is that smart contract blockchains should take most of the value in Web 3.0 because open-source smart contract code, the shared data layer, and the difficulty in differentiation would prevent applications from combining networks with business moats. The result would be that infrastructure rather than applications would accrue most of the business value in contrast to internet Web 2.0 companies.

Curiously, as the above chart demonstrates, this thesis began to sag as a bevy of new applications launched on Ethereum and other SCPs beginning in 2020 and 2021. While DeFi summer unleashed a new category of applications to take advantage of crypto speculation, the market cap of those apps eventually sank relative to SCPs in the bear market. This is because most crypto apps, as Fat Protocols asserts, were non-differentiated and mostly forked copies of one another. The result has been that after reaching a low in the mid-60s, the percentage of crypto market cap that is SCPs has risen during this latest bull market to float in the mid-70s. While February saw this trend of Fat Protocol continue, there was a renewed interest in applications that may reverse that trend.

Currently, there are few applications in crypto that have substantial value relative to SCPs, and, quite frankly, there are few applications that are interesting enough to attract the interest to give them higher valuations. While the category of DePIN holds substantial potential, particularly in apps like DIMO, Hivemapper, and Helium, outside of this area, there are few applications with the potential to attract 50M+ users.

However, many speculated that this dynamic was changing quickly in February with the rekindled interest in Farcaster. Hosted on Optimism, Farcaster is a decentralized social media platform that allows anyone to create their own social media application that taps into the open-source social media graph hosted on Farcaster. The most important application on Farcaster was a Twitter clone called Warpcast. At the time of writing, Farcaster had reached nearly 375k total users and around 16k DAUs after peaking at 40k DAUs on February 7. The aspect of Farcaster that attracted particular interest was a core part of its application called “Frames.”

Frames allow anyone to turn any “cast” or social media post into an interactive application. People are excited about Frames because it enables application creators the ability to cut down on the number of steps for someone to use their application. In essence, you can create applications and posts that can compose with each other. Frames and Farcaster also enable a better attribution engine that allows people to monetize their content better while creating an open-source, immutable graph that allows any party to analyze that user behavior. By contrast, it is challenging to allow applications to coordinate with each other on Web 2.0 platforms like Facebook. Facebook must approve the creation and deployment of applications to Facebook, and Facebook owns and hoards all the collected data.

Farcaster Revenue and Casts

Source: Dune @pixelhack as of 2/27/2024. Past performance is no guarantee of future results. Not intended as a recommendation to buy or sell any securities named herein.

Decentralized Exchange (DEX) Updates

Outside of the major themes of the month, we saw renewed interest in DEXes and value accrual to their tokens. This is due to a proposal being posted to the Uniswap governance forum that would grant Uniswap token holders a portion of the fees from trading on Uniswap’s DEX. Long rumored to be non-desirable to pass due to legal issues, the fact that a value accrual proposal was posted led many to contend that the legal environment for crypto was on the cusp of rapidly changing. Some even attributed the perception of this legal shift to the late February push of the BTC price from the low 50s towards the ~63.6K peak it reached on February 28. Another major news item for the month was the 5-hour outage of Solana on February 6th that was caused by an issue with Solana BPF. While Solana secured 100k pre-orders for its Chapter 2 mobile phone, the outage and its outsized rally over the preceding months kept its price appreciation somewhat subdued compared to other chains (+28%).

Continuing around the horn of notable events, Blast, an NFT-focused L2 by the famous developer named “Pacman,” reached $2B in TVL amid airdrop rumors. Avalanche’s long-awaited FPS game Shrapnel was listed on the Epic Games store. Meanwhile, Polygon laid off 19% of its staff while announcing the Elderberry upgrade to its zkEVM, which sets it on the path to becoming a Type I Prover that can prove any EVM chain. Polygon also unveiled more details surrounding its Aggregation Layer roadmap, where it would act as a unified settlement and proof layer to make L2 bridging more efficient and settlement cheaper. Open AI launched a preview of its video rendering generative AI, spurring a rally in AI names, including WorldCoin, whose WLD coin increased 236% in the month of February. Meanwhile, the highly controversial “stablecoin” project, Ethena, which can be more accurately characterized as a basis trade yield-bearing strategy, raised its vault size to $200M. Finally, outside of the echo chamber of crypto Twitter, the fork of Ripple called Stellar has announced the phased rollout of smart contracts through its Sorobon upgrade.

February’s Notable Winner

Ethereum (+48%)

Ethereum Revenues vs. Market Share of SCP Revenues

Source: Artemis XYZ as of 2/28/2024. Past performance is no guarantee of future results. Not intended as a recommendation to buy or sell any securities named herein.

Finally in February, Ethereum broke its curse of always being the bridesmaid during the crypto rally and never the bride, as it became the belle of the February’s crypto ball with returns of (+48%). This made it the second most performant SCP token in the month of February behind Stacks. While Ethereum did not generate enough revenues to exceed its December figures ($284M in February), it was able to continue to take market share of the SCP market (once removing Starknet’s highly aberrant surges in revenue). This could mark a turning point for Ethereum as it would represent the highest revenue market share, (65.1%), since July 2023. With respect to Ethereum fundamental metrics, Ethereum’s DAU was up only 1%. Over the past 12 months, Ethereum’s DAU count is up only 12% and has been mostly flat on a month-to-month basis. Perhaps Ethereum has reached the limit of its daily active users due to gas constraints?

We attribute Ethereum’s outperformance in February to several factors. First, Solana’s outage redirected attention towards more reliable chains like Ethereum who have never experienced downtime. Second, the creation of the ERC-404 standard, which allows for divisible NFTs, resulted in renewed interest in Ethereum NFTs in February. Additionally, speculation over a potential spot ETH ETF as well as enthusiasm around Ethereum’s important ETH Denver Conference beginning at the end of February also boosted ETH’s price. Another interesting narrative contributing to the ETH rally is the idea of gaining yield on re-staked ETH by backing Eigenlayer’s AVS and even decentralized sequencers. On the first point, many ETH holders are participating in ETH restaking as Eigenlayer’s TVL sits at 2.78M ETH worth $9.8B. With respect to decentralized sequencers, referred to as Based Sequencers, ETH would be used to guarantee the honesty of a set of sequencers that would operate on Ethereum L2s. In return, those ETH holders backing those sequencers would receive transaction fees. Finally, there is a good deal of anticipation in the Ethereum community around the upcoming Dencun upgrade with the key Ethereum software improvement to allow data blobs on Ethereum. These data blobs will help Ethereum scale by making L2 transactions cheaper.

February’s Notable Laggard

Arbitrum (+13.3%)

Arbitrum Market Share of L2 Daily Active Users

Source: Artemis XYZ s of 2/28/2024. Past performance is no guarantee of future results. Not intended as a recommendation to buy or sell any securities named herein.

In February, Arbitrum’s ARB token was a victim of its competitors, generating more excitement combined with Arbitrum’s token unlocks. Currently, the most powerful force fueling token price appreciation is narrative, and Arbitrum seems to have lost the plot as Bitcoin L2s, Blast, Optimism (through Farcaster and Worldcoin), and Polygon gain attention for each’s respective vision. This narrative fumble bled into fundamental metrics for Arbitrum as its market share of usership amongst L2s declined from (13%) at the start of 2024 to roughly (9%) at the end of February. While Arbitrum was able to maintain its market share of revenues amongst L2s, its relative DEX volumes status, and Arbitrum’s its TVL, its average DAU actually declined (-0.91%) in February compared to January.

The most bearish news facing Arbitrum is that 1.1B ARB ($2.2B) tokens will be unlocked to investors and the Arbitrum team on March 16. This would increase Arbitrum’s circulating supply of ARB tokens by (+74%). Additionally, as other L2s for Bitcoin gain traction and purpose-built blockchains like Blast and Optimism’s OP stack chains promise innovative new applications, Arbitrum appears to be simply treading water as its competitors advance. Likewise, there remain unanswered questions with the viability of Arbitrum’s L3 scaling strategy given capital inefficiency of 14-day challenge periods as well as dependability concerns given Arbitrum’s reliance on a sole sequencer. Finally, security concerns persist around Arbitrum’s fraud proofs because currently only 14 whitelisted entities are enabled to spot on-chain malicious activity by Arbitrum’s sequencer. While any one of these entities could prevent fraud, until fraud proofs are opened to the broader crypto community, concerns over security will endure. While Arbitrum’s fraud-proof system is vastly superior to that of its optimistic L2 roll-up (ORUs) competitors, it lags behind the stronger trust assumptions of zk L2 roll-ups (ZKUs). As it stands right now, while Arbitrum and other ORUs have a “trust me” approach to preventing fraud by each of their sequencers, ZKUs provide direct evidence through cryptography of untampered activity.

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