November 22, 2023

Insights and analysis for the professional investor

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Welcome to Crypto Long & Short!

This week, Todd Groth, Head of Research at CoinDesk Indices, anoints the king of blockchain metrics: on-chain transaction volume, a reliable proxy for a network's future prospects.

Then, Peter Gaffney, Head of Research at Security Token Advisors, explains why a range of blue-chip institutions are beginning to tokenize "real world assets," starting with U.S. treasuries.

As always, get the latest crypto news and data from CoinDeskMarkets.com.

– Ben Schiller

From the Analyst

Why On-Chain Transaction Is the Key Blockchain Indicator

On-chain transaction volume is the pulse of blockchain networks. For digital asset investors, monitoring these flows within the network and comparing them across protocols is a way to ascertain adoption rates and utility of the protocol, and determine whether a project is further developing, or an obsolete relic of the previous market cycle.

This perspective gives us valuable insights into user activity, network utility, and the overall health of the crypto ecosystem. A surge in transaction volume often signifies increased network usage, adoption and trading activity. It could indicate growing interest, new protocol utility, or even speculative fervor. Conversely, a decline in on-chain transaction volumes might signal reduced network development, protocol stagnation or loss in market share to other competitors.

Several factors drive blockchain trading volume, and understanding these nuances helps us navigate the ever-evolving crypto market cycle. During bullish phases, when the crypto market resembles a bullish festival of excess, trading volumes tend to surge. Positive news, like regulatory clarity, institutional adoption or significant protocol upgrades, can spark heightened trading activity.

Additionally, market sentiment plays a crucial role. Bullish sentiment often drives traders and investors to flock to decentralized exchanges, causing a surge in transactions on-chain. There, they tend to be more focused on trading newer innovative products such as NFTs and smaller token launches, which have a greater impact on on-chain activity than major tokens traded within centralized exchanges. This contributes to increased trading volumes during bullish cycles.

Conversely, during bearish periods, trading volumes start to dwindle, with bursts of activity around periods of deleveraging. Uncertainty, negative news, regulatory crackdowns, or market corrections often lead to a decline in trading. Investors might adopt a wait-and-see approach, leading to decreased transaction volumes, and they might move their assets to cold storage or stablecoins, reducing the overall trading activity on exchanges.

To better dig into the usefulness of on-chain transaction volume data, we use data provided by SonarVerse, which provides OnChain Trading Dollar Volume by protocol, and compare volume across Bitcoin, Ethereum and Polygon protocols.

To normalize the volume across these protocols, we divide the transaction volume by market capitalization of the protocol. (see Figure 1 below)

Figure 1: On-Chain Trading Volume / Market Capitalization, by protocol, 30d smoothed, Source: SonarVerse, CoinDesk Indices Research

Here, we can see the relatively low and steady transaction volume of bitcoin, with Ethereum and Polygon having peaky and relatively offsetting activity, which makes sense given that Polygon is an EVM scaling solution for Ethereum based protocols.

To further highlight the investment benefits of this data, we run a very simple backtest, where we rotate across Ethereum and Polygon protocols based on recent normalized on-chain volume activity with the simple rule that when normalized Polygon trading activity is greater than Ethereum we rotate into Polygon, otherwise we hold Ether token (see Figure 2 below for hypothetical backtest strategy).

The rotation strategy improves absolute and risk-adjusted returns over a crypto market cycle when compared to separate allocations to Ether and Polygon tokens. This outperformance could be due to the information contained within the on-chain trading volume metric, which tilts the hypothetical strategy towards protocols with greater recent activity, and by association, greater blockchain protocol demand.

Figure 2: Ether / Polygon Rotation Strategy, Long-Only. Source: SonarVerse, CoinDesk Indices Research

By understanding the dynamics of on-chain activity, we can better gauge market sentiment, and make more informed trading decisions by assessing underlying protocol health. During bullish phases, high trading volumes can signal potential profit-taking opportunities or heightened volatility. In bearish cycles, low volumes might indicate potential market bottoms or opportunities for accumulation.

Keeping an eye on on-chain transaction volumes and other blockchain metrics like TVL is like listening to the heartbeat of the crypto market, allowing investors to navigate its twists and turns caused by industry developments.

– Todd Groth, Head of Research at CoinDesk Indices

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Institutional Outlook

Tokenization and Real-World Assets Take Center Stage

The asset tokenization and real-world asset (RWA) space caught the eye of retail and institutional capital investors in 2023 for its favorable blend of professionally-managed products and digital asset mechanics. Having advised 40-plus clients on tokenization strategies and issuances to date, we see the following key themes emerging in these markets in Q3 2023.

Blockchain Savings and Bottom-Line Improvements

For investors entering this space, the greatest efficiencies will come through end-to-end digital systems – meaning an on-chain lifecycle. That means savings in dollars or manual labor time relative to traditional processes. For example:

Goldman Sachs Digital Asset Platform (GS DAP) achieved 15 basis points in savings for its €100M digital bond issuance, resulting in €150K of added return passed onto Union Investment as the sole buyer.
J.P. Morgan's Onyx Digital Assets (ODA) is projecting $20 million in savings on an expected $1 trillion in tokenized repo volume by the end of 2023.
Broadridge's Distributed Ledger Repo (DLR) is saving sell-side clients like Societe Generale $1 million per 100,000 repo transactions.
Equilend launched 1Source as a distributed ledger-based securities lending solution to save the securities lending industry an estimated $100 million in collective costs.
Structured finance servicing platform Intain reports 100 basis points in savings by reducing SME loan lifecycle fees from 150 bps to 50 bps through Hyperledger and Avalanche blockchain solutions.
Vanguard is leveraging R3's Corda through Grow Inc. to achieve straight-through processing saving 100 hours a week in labor.
Liquid Mortgage has reduced Mortgage-Backed Securities (MBS) reporting from 55 days to 30 minutes on the Stellar blockchain.

Money Markets and Treasuries as the Low-Hanging Fruit

Asset managers and issuers are familiarizing themselves with tokenization workflows by trialing money market and treasury products. These tokenized assets generate a yield that can be passed on to clients, fully on-chain.

While alternative product strategies, like Hamilton Lane's digitally-native private equity share classes, are in the works, money markets yield ~5% annually in low risk segments. This asset class accumulated almost $700 million in on-chain capital by the end of Q3 2023, up almost 520% YTD.

Tokenized Product Distribution through Institutional Client Bases

One of the weak points in the tokenization industry to date is actual product distribution and capital syndication. Institutions are beginning to move beyond just tokenizing assets for operational uses and savings (repo, collateral management) and are now placing tokenized products with their own client bases as buyers.

Citi is one name leading the charge here, offering digital corporate bonds through Singapore's BondbloX to its Southeast Asia private banking and wealth management clients. UBS built upon its previous $400+ million digital bond issue to high-net-worth clients with an Ethereum-based money market fund, also in Singapore.

As blue-chips like JP Morgan and Goldman Sachs continue to develop their digital suites, expect their private banking, wealth & asset management, and alternatives teams to act as distribution channels unlocking serious capital that retail broker-dealers struggle to access.

- Peter Gaffney, Head of Research at Security Token Advisors

Takeaways

From CoinDesk Deputy Editor-in-Chief Nick Baker, here is some news worth reading:

BINANCE: Michael Lewis originally seemed to plan to do a glowing profile of Sam Bankman-Fried before SBF's fall from grace. (Though some say he ended up doing the glowing profile anyway …) Binance CEO Changpeng "CZ" Zhao was evidently going to be the villain of that story – Lewis described that duo as being like Luke Skywalker vs. Darth Vader. But a jury didn't see much Luke in SBF when it just convicted him on fraud and conspiracy charges. And now CZ pleaded guilty. Two of the biggest figures in crypto have fallen, in the span of a year. What's it mean for crypto? Wall Street firms are ascendant in the industry, so new leadership is asserting itself. Crypto prices roared higher during SBF's trial, and bitcoin (BTC) initially rallied Tuesday as word spread that a Binance settlement with the U.S. might be near. People – be they crypto-natives or relative TradFi newcomers – seem very ready to put the past behind them. No more Luke vs. Darth situations is the hope, maybe.
KRAKEN: The U.S. got tough on more than just Binance this week. Kraken, which already had to shut its staking service early this year, was sued by the U.S. Securities and Exchange Commission for allegedly running an unregistered platform and improperly commingling up to $33 billion in customer crypto with its own corporate assets. The FTX case, of course, highlighted the issues of letting customer and corporate money mix together, though there's no indication this is anything like an FTX situation on that front. Nonetheless, the 2023 dynamic remains in play: Crypto prices are soaring, even as the U.S. clamps down on exchanges. It's a hard one to figure out.
BULLISH: This very publication you're reading has come under new ownership. CoinDesk was just purchased by Bullish, a crypto exchange owned by Block.one, from Digital Currency Group. This is worth mentioning not just for the sake of transparency, though transparency is something we cherish here. This newsletter is geared toward a professional audience from traditional finance or elsewhere. And the CEO of our new owner, Tom Farley, once ran the New York Stock Exchange. This is a theme we've explored before in this newsletter: that crypto and TradFi are intersecting. The question is how does that affect both sides. Whatever the answer is, things are changing. Something that is not, however, is our commitment to journalistic independence. As reported by The Wall Street Journal, the former editor-in-chief of that newspaper will run a committee tasked with ensuring CoinDesk journalists can pursue whatever stories they need to pursue.

Want more? For the latest news affecting the crypto markets, listen to CoinDesk's Markets Daily podcast.

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