Market Views
The year has kicked off on a promising note with the momentous approval of the Bitcoin ETFs. This milestone marks a significant step forward for the cryptocurrency market, drawing increased attention from both retail and institutional investors. As Bitcoin continues to gain legitimacy and recognition in traditional financial circles, it sets a bullish tone for the broader crypto ecosystem.
Ethereum Layer 2 (L2s) Update
In our previous letter, Ethereum: Post-Merge Looking Forward we discussed the Ethereum landscape. Now, we see additional catalysts aligning for Ethereum. The recent approval of Bitcoin ETFs has shifted the spotlight to the eagerly anticipated Ethereum ETF, which, like Bitcoin, is poised to attract institutional interest and generate broad market anticipation. This ETF approval holds the potential to be a game-changer for the Ethereum ecosystem. Furthermore, with ETH now having a deflationary supply and more ETH being staked than available on exchanges, the potential for a supply shock when demand surges is a significant consideration.
The L2 ecosystem on Ethereum is increasingly a dynamic arena for investors. The chart below displays the total value locked by ETH L2s, which has grown by over 500% in the past year.
Source: L2 Beat
Top 5 ETH L2s by Total Asset Value
Source: L2 Beat
Coinbase has launched an Ethereum L2 named Base. Base is an (L2) chain that offers a low-cost, centralized, developer-friendly platform to build on-chain. The economics of owning an L2 can be dramatically lucrative with meaningful adoption and growing network effects. Accordingly, we are keeping our eyes on an out of the money call, currently available for 80 cents on the dollar in the form of Coinbase convertible bonds.
We view L2s as an enhanced Ethereum play, with network activity and fundamentals improving everyday.
Options Abound
With the advent of Bitcoin ETFs launching in the past week, the crypto market has broadly “sold the news”. Apart from a downdraft of pricing, implied volatility of Bitcoin and Ethereum options has collapsed. The below chart reflects the nearly 33% drop in option implied volatility since earlier this month.
As a direct example, Bitcoin call options are currently pricing 63% implied volatility. That is quite low for an asset that has historically experienced dramatic price action.
The Bitcoin ETFs will imbue the digital asset class space with additional capital flowing through the options space in the coming months, growing the pie and opportunity set for derivative inclined practitioners.
Conclusion
We expect to largely outperform passive crypto bluechip portfolios in 2024 by allocating to high conviction L2 assets and employing an option overlay strategy while keeping dry powder for opportunistic placement throughout the year.
We believe that we are now in a bull market and we recommend an allocation to the digital asset class space.
