Research Round-Up: October 2023

Digital assets are quietly gaining legitimacy throughout the bear market

by Fidelity Digital Assets


The Research Round-Up On-Demand

Watch Now: Fidelity Digital Assets’ Director of Research Chris Kuiper and Research Analyst Daniel Gray provide additional commentary and market insights in this short on-demand video.

Market Commentary

Digital asset markets may have seen relatively uneventful price action month-over-month, but they were not entirely immune to fluctuations throughout September. Bitcoin saw a drawdown of as much as 9%, followed closely by a rally of 8%, before ultimately finishing down around 3.5% in September. Ether followed a similar path, declining as much as 10% before recovering around 7% off a monthly low of $1,549 to finish down around 4% for September. This leads to a year-to-date (YTD) price appreciation of 63% for bitcoin and 38% for ether.

Top headlines moving the markets this month include the Fed’s decision to leave the federal funds rate unchanged from a target range of 525 – 550 bps, while Fed Chairman Jerome Powell has remained steadfast in his hawkish stance towards fighting inflation. In other news, the Financial Accounting Standards Board (FASB) voted in favor of fair value accounting for digital assets, Citigroup announced expansions of their digital asset offerings, Ark and 21Shares filed for approval of the first spot ether ETF, and Ethereum’s Layer 1 transaction counts declined over Q3.

In this month’s newsletter, we will recap some observations from recent events that our research team attended, summarize the top developing news stories in the digital asset space, and highlight some data points that we are focused on.

Fidelity Digital Assets RRU 10-23 Bitcon and Ether Returns Compared Chart.png

Notes from the Field

Summaries and thoughts from the latest conferences and events attended by Fidelity Digital Assets Research.

Future Proof 2023, Huntington Beach, CA

Registered investment advisors are among those most likely to allocate to the digital asset space among U.S. institutions. Future Proof is a conference focused on preparing wealth managers for the inevitable change and evolution that technology will bring to financial markets and the interactions that they have with clients.

As a result, members of our Fidelity Digital Assets℠ team were in attendance to raise awareness and recognition for this emerging asset class. The perception of digital assets from these advisors was resoundingly intrigued and positive despite current market conditions. Many advisors recognized the need to educate themselves on where the digital asset ecosystem is going and understand that it is likely to play a key role in maintaining financial planning relationships with the next generation of clients.

While the conference focused on the entire investment landscape and topics pertaining to the challenges advisors face, there were a few discussions focused on digital assets, including a panel titled “Demystifying Crypto,” featuring representatives from Bitwise, VanEck, and Fidelity.

Permissionless II, Austin, TX

The Permissionless II conference, hosted by investing podcast Bankless and digital asset media and information platform Blockworks, was held September 11-13 in Austin, TX. The second conference of its kind, Permissionless II focused largely on the intersection of digital assets, decentralized finance (DeFi), Web3, technology, and the future of finance. Despite digital asset prices being in the midst of a prolonged bear market, sentiment and overall optimism from builders and investors alike was uplifted.

The event, attended by members of our Fidelity Digital Assets℠ Research team, began with an incendiary opening from private investor and ShapeShift Founder Erik Voorhees emphasizing the fundamentals of privacy, decentralization, economic empowerment, and the financial freedoms associated with the right to store one’s own wealth.

We particularly enjoyed panels on charting a regulatory path forward for digital assets, which called on members of the audience to contact their local representatives to push for appropriate legislation, while citing the need for consistent and extensive calls to elected officials to reiterate the desire for regulatory guidelines around digital assets.

The panelists specifically expressed interest in receiving clarity over which regulatory agency the jurisdiction would fall under and, resultingly, an interest in novel frameworks that would be native to digital assets. If such a framework is not designed specifically for digital assets under an existing regulatory body, the panelists expressed strong interest in the creation of a new regulatory agency unique to digital assets.

On a lighter note, the panelists discussed both the need and bipartisan desire for stablecoin legislation and digital asset regulation overall, highlighting the fact that legislative direction over this asset class is not a partisan issue.

The most enlightening panels of the event were centered around the macro environment and its effect on digital asset markets coupled with institutional sentiment and adoption of the asset class. Jurrien Timmer of Fidelity Investments℠ highlighted how positive real rates are currently a headwind for digital assets during this market cycle with expectations that quantitative easing (QE) and a low interest rate environment could reverse this trend in the next cycle.

To emphasize the second order effects of currency devaluation in a credit-driven economy, Mark Yusko of Morgan Creek Capital Management pointed out that stock market returns have been flat since 1977 if denominated in gold.

Matt Hougan of Bitwise Asset Management pontificated on how the approval of a spot bitcoin ETF has the potential to take bitcoin from a niche asset class to a mainstream one, underscoring how it would remove all logistical obstacles for investors to invest in the asset class, while pointing out that institutions are already adopting digital assets in geographies with established regulatory environments, such as Asia and Europe.

Overall, Permissionless II was packed with informative content and great panels, and underpinned the continued perseverance of industry participants and community members who are diligently working toward bringing to market the products and services that mainstream audiences are increasingly demanding.

News and Editorial

A curated list of the most relevant news and developments along with our two Sats.

Financial Accounting Standards Board (FASB) Votes in Favor of Fair Value Accounting for Digital Assets

The FASB has voted to implement new rules that will allow entities that hold bitcoin or other digital assets to report the value of those assets at market value, which will reflect a more accurate and timely valuation.1 Once implemented, companies will no longer be required to report the value of their digital asset holdings as intangible assets using an impairment calculation, which reflects the lowest valuation mark since the asset has been held. Non-fungible tokens, or NFTs, as well as stablecoins and wrapped tokens, will not be covered by the new valuation measure. The new rules are expected to be implemented in 2025, although companies will have the ability to apply them early.

Our Two Sats:

The approved fair valuation model further exemplifies that bitcoin and other digital assets, such as ether, are receiving mainstream acceptance as investable assets. Elimination of the requirement to record the asset at the lowest valuation point allows for a more accurate accounting and these new rules should improve transparency; however, it may take some time for consistent implementation to be applied.

Fair Valuation models do not come without their own unique set of challenges because they can be complex and incorporate volatility and other market risk factors. Companies will need to develop vigorous valuation methods and procedures to ensure accuracy in their financial reporting and auditors alike will require expertise in assessing the fair market value of these assets, which can be a complex task.

Despite these challenges, the introduction of fair value accounting rules for bitcoin and other digital assets is a significant step forward for the industry. As the bitcoin market continues to grow and evolve, having a standardized accounting framework in place is crucial to maintain trust and ensure the responsible integration of bitcoin into the global financial system.

Financial Powerhouse Citigroup Announces Expansion of Digital Asset Offerings

Citigroup is broadening its digital asset services through an expanded custodial partnership with BondbloX Bond Exchange (BBX) and the launch of a pilot tokenizing client deposits.2 BBX’s platform enables the trading of $1,000 increments of fractionalized wholesale bonds using atomic settlement and distributed ledger technology for asset trading and settlement.

Through the partnership, Citi, which began providing custody for BBX’s traditionally-issued bonds in 2021, will become the first digital custodian for the exchange’s tokenized, fractionalized bonds. The partnership will give the bank’s clients access to trade these bonds and give BBX clients greater access to global bond markets. Citi will manage the settlement and custodial services for the digital assets, using what the bank says is highly scalable infrastructure that can be used to custody client assets on other permissioned networks.

The bank is also launching a pilot program, called “Citi Token Services,” which will enable the tokenization of customer deposits on a private blockchain controlled by the bank. The goal of the pilot is to provide a 24/7 cross-border payment system, enabling clients to instantly transfer funds using blockchain rails.

Our Two Sats:

Citi is no stranger to this space and has been actively developing blockchain-based applications and digital asset products and services for its clients. This announcement reaffirms the bank’s commitment to the technology, while enabling greater accessibility to bond markets for more investors and driving operational efficiencies in asset trading and settlement. As the tokenization of traditional financial assets increases and investor demand grows, it is likely that traditional financial services firms will continue to develop the capabilities to support the budding sector.

Riot Platforms Receives Hefty Credit for Shutting Down Miners Amid Summer Heatwave

Riot Platforms, one of the largest bitcoin miners in the U.S. and operator of the largest mining datacenter in North America, received a record $31.7 million in energy credits in August for reducing their power consumption amid a record-breaking heatwave in Texas.3 The payment surpasses the total credits the firm received in all of 2022. Despite cutting its energy consumption by over 95% during periods of peak demand, Riot still mined 333 bitcoin in August, worth about $8.5 million using average prices over the period, bringing total revenue to $40.2 million.

Riot CEO Jason Les emphasized that the credits reduce the company’s cost to mine bitcoin and offer a significant competitive edge at a time when the industry is struggling with margin compression and bracing for the upcoming “halving” event expected in April 2024 when Bitcoin’s block subsidy will be cut in half. The Electric Reliability Council of Texas (ERCOT) has embraced the mining industry, positioning the state as one of the largest mining centers in the world and, in some cases, compensating miners for participating in demand response programs where they agree to reduce their power consumption during periods of peak demand in exchange for energy credits.

Our Two Sats:

The harmonious relationship between ERCOT and bitcoin miners in Texas is perhaps the most palpable example of how, contrary to common misconception, bitcoin mining can play a crucial role in helping to stabilize the energy grid. Riot, among other miners, has embraced demand response programs because energy credits can help to diversify their revenue streams and reduce their overall cost of power, the largest cost input in proof-of-work mining.

ERCOT, which is isolated from the rest of the U.S. grid and operates as a deregulated power market, faces unique challenges in balancing supply and demand, particularly during extreme weather events when demand spikes or supply is limited, as evidenced by frozen wind turbines last winter. Large, flexible loads from bitcoin mining can help to stabilize the grid by consuming power when there is excess supply and reducing power consumption when there is a risk of demand exceeding supply.

Moving forward, it is likely that there will continue to be increased cooperation between miners and grid operators as mining loads become systemically important to the grid. In the meantime, miners in Texas are likely to continue enjoying the benefits of operating within the state’s unique power market structure and ERCOT can take comfort in being able to call on them to push power back to the grid when it is needed. Investors should take note because this means that bitcoin miners, particularly in Texas, can be profitable and sustainable investments by providing a valuable service to their local communities.

News Quick Hits

  • Japanese financial services group Nomura launched a “long-only” bitcoin exposure fund, dubbed the Bitcoin Adoption Fund, through its Laser Digital crypto arm and will use custodian Komainu to store the fund’s assets.4
  • CFTC Commissioner Caroline Pham has proposed a pilot program to regulate digital assets that would set up a roundtable with stakeholders, propose rules, and result in the agency considering whether a permanent change would be made to its rules.5
  • The London Stock Exchange Group has revealed plans to build an end-to-end blockchain-based digital marketplace that will use blockchain technology to enhance the trading of traditional financial assets.6
  • Asset managers ARK Invest and 21Shares have applied for regulatory approval for the first spot ether ETF.7
  • The defunct digital asset exchange FTX received judge approval to sell billions of its digital asset holdings to be distributed to creditors.8
  • Digital asset issuer Tether Holdings resumed lending out its own stablecoins to customers less than a year after it said it would discontinue the practice.9
  • Coinbase CEO Brian Armstrong said that bitcoin is the “most important asset in crypto” and announced the exchange’s decision to integrate the Layer 2 Lightning Network.10

Data to Watch

Data we are currently keeping an eye on and our commentary.

Are Users Leaving Ethereum?

The number of transactions happening on Ethereum’s base layer (L1) has barely changed during the past few months. Ethereum L1 transaction count, up 33% YTD, but down 2% over Q3, was enough to cause daily net issuance to flip back from deflationary to an inflationary supply change. While this has not affected the overall trend since The Merge (net deflationary) in September 2022, it is important to uncover any nuance behind the change. In our August Research Round-Up, we explained the churn limit and the acceleration of staking validators joining the network. This new staking demand could arguably be responsible for the inflationary supply change because more validators mean higher issuance. During Q3, Ethereum experienced both a higher demand for staking and decreased transactions on layer one. While this alone does not indicate the future state of Ethereum’s supply, it is an example of how quickly supply dynamics can change.

Fidelity Digital Assets RRU 10-23 Ethereum Daily Net Issuance Chart.png

Or are Users Embracing Layer Two Protocols?

While transaction count has fallen slightly on the base layer, layer 2 usage is increasing. The layer 2 transaction count has continued to rise and account for a growing percentage of layer 1 fees. This means that, while the layer 1 metrics may not be changing, layer 2 protocols are clearly being utilized more.

Taking a closer look at a comparison between layer 1 and layer 2 daily transaction count, one can begin to realize the growth of the underlying protocols. While layer 1 transactions grew 33% YTD, layer 2 transactions, comprised of Arbitrum, Optimism, and Base, have grown more than 180% YTD. In addition, after the quick spike in both layer 1 and layer 2 transactions in mid-September, the final count of layer 2 transactions ended Q3 at a more sustainable growth rate of 18%. In comparison, layer 1 transactions fell 2% over the same period. This is a prime example of the nuance hidden behind the layer 1 metrics.

Fidelity Digital Assets RRU 10-23 Ethereum Daily Transaction Count by Layer Chart.png

Surge in Bitcoin Address Count

Bitcoin saw an uptick in active addresses over the past month, representing an upward trend in active addresses after a drop-off in May. That drop-off was the result of an increase in fees, which may have caused fewer users to transact, but growth has since reignited in September. The 7-day moving average of the daily average transaction fee has stayed below $2 since July, which could potentially incentivize more users to interact.

There has also been a large increase in new addresses on the network as it is standard to see new addresses grow alongside active addresses due to transactions generating change addresses. These change addresses receive any leftover funds not sent in a transaction to a different address that is still controlled by the sender, akin to receiving change back during cash transactions.

On average for the past 30 days, around 550,000 new bitcoin addresses have been created each day, which is an unprecedented amount of on-chain activity during a bear market and rivals levels not seen since the peak of the 2021 bull market cycle. Because of the market drawdown, users may be willing to wait to have their transactions included in blocks in return for lower fees (also known as having a low time preference).

In a bull market, this same investor psychology may not apply because users are trying to move money quickly to arbitrage elsewhere, meaning they have a high time preference. Therefore, if block space demand stays the same and time preference rises, fees will also rise. It is fair to assume that blockspace demand should increase in a bull market, in which case fees could go even higher.

Fidelity Digital Assets RRU 10-23 Bitcoin New Address Momentum Chart.png

In Case You Missed It

In January 2020, we described the origins of the omnibus custody model in traditional finance and its application to digital assets. Over three years later, the omnibus model remains a compelling and beneficial model for digital asset custodians (and investors). While the omnibus model has remained consistent, the digital asset market has evolved rapidly in recent years, with various innovations to custody models and technologies. While we encourage those seeking a detailed understanding of omnibus custody to read the earlier overview, we aim to reiterate many of the benefits of the omnibus model for digital asset custody in a revisited viewpoint here while contextualizing the approach within today’s current digital asset market. 

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Christopher Kuiper, CFA, Director of Research, Fidelity Digital Assets

Matthew Hogan, Research Analyst, Fidelity Digital Assets

Daniel Gray, Research Analyst, Fidelity Digital Assets

Max Wadington, Research Analyst, Fidelity Digital Assets

Zack Wainwright, Analyst, Fidelity Digital Assets











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