A monthly review of what's happening in the crypto markets. Enriched with institutional research on the most important topics in the industry. Written in cooperation with the Swiss digital asset specialist, 21Shares AG.

April brought a challenging landscape for Bitcoin. Geopolitical tensions flared in the Middle East when Israel targeted the Iranian Consulate in Syria on the 1st of April. In an unprecedented response, Iran retaliated directly with a drone strike against Israel, intensifying hostilities. The event contributed to a decline in the stock market and a temporary pullback in Bitcoin’s price. As mentioned two weeks ago, although Bitcoin historically served as a safe haven during crises like the Russian Invasion of Ukraine, its response to Iran-Israeli escalation may have been adverse.

An examination of the market provides a more nuanced perspective. Bitcoin's impact was most evident in the futures market, where open interest reached $35 billion on the day of the CPI release. This resulted in significant liquidation due to the fourth consecutive month of higher than expected inflation. Despite the Federal Reserve's best efforts, the resilient labor market and robust domestic demand suggest that the U.S. isn't yet ready to cut interest rates. This could lead to further instability for risky assets. Long-term holders proved resilient amid escalating tensions, increasing their supply by 0.1% for the first time since January, countering short-term market fears. The Israeli response coincided with a local bottom in long-term holder supply, signaling bullish sentiment and confidence in the asset despite recent market volatility. Nevertheless, the price of bitcoin is likely to remain in the $60,000 - $70,000 range until macroeconomic and geopolitical uncertainties are further clarified.

Macro Uncertainty, Geopolitical Headwinds, and Bitcoin’s Fourth Halving

Despite the macroeconomic headwinds, significant progress was made in the institutional adoption of Bitcoin. Despite a break in Blackrock’s Bitcoin ETF 71-day net inflow streak, the conclusion of the 90-day due diligence period for fund managers considering the spot ETFs revealed that over 100 institutions, such as BNY Mellon and Banco do Brazil, are exposed to Bitcoin. Morgan Stanley is also actively exploring allowing 15,000 brokers to provide this exposure to their clients. They also filed to broaden access to BTC ETFs by expanding it to 12 more funds. This move signifies the growing acceptance of Bitcoin by TradFi institutions. Finally, the launch of Bitcoin ETFs in Hong Kong marked a significant step towards adoption in Asia, potentially influencing other jurisdictions like South Korea, Japan, and Singapore to follow suit while expanding Bitcoin’s access to Hong Kong’s $1.15 trillion wealth management sector.

Figure 1: Bitcoin Short-Term Holder Supply vs. Long-Term Holder Supply / Source: Glassnode

April also marked a historic event for Bitcoin: the fourth halving. The halving reducing Bitcoin’s annual inflation rate to below 1%. This makes it even scarcer than Gold. Historically, Bitcoin trades 50% down from its peak leading up to the halving. This year, Bitcoin defied historical trends. It reached a new all-time high prior to the halving. The surge is attributed to the increase in demand from the aforementioned US Bitcoin ETFs, coupled with ongoing technical advancements within the Bitcoin ecosystem, such as Ordinals, BRC-20s, and Runes.

These advancements are transforming Bitcoin beyond its original vision as a purely decentralized payment network. The emergence of Ordinals and Runes has amplified on-chain activity, reflected in surging transaction fees. This is particularly beneficial for Bitcoin miners, who saw their block reward cut in half due to the halving. Higher transaction fees help compensate for this lost revenue, ensuring the continued security of the Bitcoin network. Notably, as shown in Figure 2, Bitcoin transaction fees made up 75% of Bitcoin miner revenue, soaring to $128 on the day of the halving. The surge might have been driven by the desire to have a historical inscription. It does underscore the potential impact on miners’ revenue as Bitcoin’s on-chain ecosystem matures.

Figure 2: Bitcoin Miners Revenue / Source: 21.co on Dune

Launched in April, Runes Protocol offers a novel approach to creating fungible tokens on the Bitcoin network. It addresses inefficiencies associated with the BRC-20 standard, which have burdened the Bitcoin blockchain due to its inefficient data handling. Ultimately, Runes presents a key innovation. The protocol bolsters Bitcoin’s security budget by offering miners an alternative source of revenue, while reducing their dependence on block rewards. Runes has already rewarded miners with almost $150 million. Impressively making up 80% of fees generated on the Bitcoin network on April 23 (see Figure 3).

Figure 3: Share of Bitcoin Transaction Fees / Source: CryptoKoryo on Dune

While Bitcoin's daily transaction volume surpassed 1 million, rivaling Ethereum's activity, the initial excitement surrounding Runes might recede before a more long-term, sustainable surge in the network's DeFi activity. The initial phase often focuses on meme-like tokens attracting rapid but fleeting interest. However, the development of sophisticated DeFi protocols like exchanges and Automated Market Makers (AMMs) will enhance Bitcoin's application layer. Streamlining token trading similar to what ERC-20/ERC-721 standards did for Ethereum. This paves the way for a more robust and mature DeFi ecosystem on Bitcoin.

Regulatory Crackdowns Fire Up in April

April saw the continued regulation-by-enforcement trend, cracking down on non-custodial infrastructure and the Ethereum ecosystem. On April 10, the Securities and Exchange Commission (SEC) sent Wells Notices to Uniswap and Consensys for alleged violation of federal securities law. Uniswap announced its intention to resolve this through court. The details of the SEC’s Wells Notice remain unclear. However, it could have been triggered by Uniswap’s pending revenue-sharing initiative, which has had a domino effect on the ecosystem. In the short term, the crackdown could dissuade protocols from following suit. This would have incentivized their users to stake and delegate their tokens for a share of the revenue.

On April 25, Consensys filed a lawsuit against the SEC for “unlawful seizure of authority”. The lawsuit argues that Ethereum is not a security nor that MetaMask is a securities broker. The recent crackdown could put a strain on the crypto infrastructure industry in the short term. It could severely disrupt the ecosystem while encouraging companies to explore alternative jurisdictions aside from the U.S. market.

Earlier in February, the SEC adopted rules that widened its interpretation of a dealer to include “as part of a regular business”. This is in addition to the initial definition, “any person engaged in the business of buying and selling securities . . . for such person’s own account through a broker or otherwise.” The newly adopted rules have triggered an outcry in the crypto community, deeming the legislation too broad. It includes average market participants in cryptoasset liquidity pools (liquidity providers). Even though they essentially have a very different role than a broker.

For example, anyone can be a liquidity providers on Uniswap. The only requirement is that they have the capital to deposit and earn yield. This is unlike professional market makers in traditional finance whose responsibilities extend beyond this. Providing liquidity on Uniswap is open to anyone to enable permissionless markets. Making this an important characterization due to the impact it could have on how DeFi functions in the US. While the ongoing crackdown could cause uncertainty in the short term within the Ethereum ecosystem, regulatory clarity will ultimately be reached in the long run. We’ve seen this play out on several counts of hurdles over the past few years.

Ethereum’s Most Anticipated Application of the Year is Live

EigenLayer is finally live on Ethereum’s mainnet. It’s a new primitive that allows ETH users to “re-stake” their existing staked ETH to validate the security of external networks. EigenLayer has been eagerly anticipated. It optimizes capital efficiency by allowing users to earn additional yield on top of their native staking rewards. Further, it allows younger protocols to borrow the security assurances of Ethereum, circumventing the need to bootstrap their own security from scratch. This translates to a more cost-efficient approach while simultaneously bolstering their decentralization. Nevertheless, the protocol comes with inherent risks.

By opting to earn additional yield, users, and validators subject themselves to heightened smart contract risks. They become exposed to the vulnerabilities of both Ethereum and the additional protocols relying on its security. Moreover, a large portion of ETH could end up being “re-staked” in EigenLayer instead of just validating the security of Ethereum, as usually typical for Proof-of-Stake (PoS) Blockchains. This creates a problem of misalignment. Validators might opt to maximize their profits by pursuing strategies that prioritize short-term gains over the long-term security of the network. Additionally, the growing enthusiasm for the protocol suggests that a significant portion of the crypto economy might rely on Ethereum's security. Currently, 15% of all staked ETH is allocated towards Eigen’s re-staking strategy. The continuation of this trend could lead to centralization, posing a risk as Ethereum might inadvertently become a single point of failure over a longer time horizon.

Wide-spread slashing is another concern. In essence, if a substantial amount of ETH is re-staked in a singular protocol, then a slashing event due to unintended or malicious behavior could significantly impact honest ETH stakers. Thus, Eigen proposed a slashing committee comprising esteemed ETH developers and trusted community members. The members are empowered to veto such occurrences and safeguard Ethereum's integrity.

The final risk concerns a new breed of tokens known as Liquid re-staking Tokens (LRTs), which operate atop EigenLayer. LRTs, akin to Liquid Staking Tokens (LSTs) issued by the established Lido Protocol in 2021, aim to unlock similar capital efficiency by allowing users to use their re-staked ETH as collateral for lending and borrowing. Given that re-staked ETH in Eigen can't be used across DeFi platforms, users have turned to LRT protocols like Ether.fi and Renzo to seek higher levels of capital flexibility, with their re-staked assets. For context, LRTs grew exponentially by a factor of 28 throughout Q1. Increasing from nearly 100K units to the current figure of 2.8M, as shown in Figure 4, illustrating its soaring demand.

Figure 4: Growth of Liquid re-staking Tokens (LRTs) on EigenLayer / Source: @hahahash on Dune

While LRTs can offer amplified gains through leveraged lending, they can also exacerbate losses, increasing systemic risk in market downturns. Since some LRT protocols can't offer withdrawals yet, users may be forced to swap their LRT tokens on thinly traded secondary markets, intensifying their decline. Last week, we saw an instance of this risk manifest when Renzo's ezETH lost its peg. This happened as the ETH derivative experienced heavy selling on various exchanges, causing it to trade at over a 75% discount compared to ETH. This coincided with the company facing scrutiny over its controversial token distribution plan, scheduled for April 30.

All in all, the impact of EigenLayer is not to be understated. The excitement surrounding the new primitive has propelled it to become the second-largest protocol on Ethereum by Total Value Locked (TVL), boasting an impressive $15.6B. This already eclipses the TVL of established players like Solana by fourfold. This massive TVL highlights the immense adoption that EigenLayer is witnessing despite its brief existence. Further, the excitement building up to its launch since it unveiled its roadmap in March has propelled the Ethereum validator entry queue to its highest level since October. The queue now necessitates a minimum waiting period of 8 days before new validators can join the network (see Figure 5). Nevertheless, stay tuned as we prepare to release a more in-depth exploration of EigenLayer risks over the coming weeks.