Grayscale interprets the follow-up trend of the encryption market in July depends on the United States

Written by: Zach Pandl Compiled by: Luffy, Foresight News

Since the end of 2022, the digital asset market has shown clear signs of recovery, and the encryption industry is benefiting from technological and legislative progress.

Macro factors are probably the biggest risk to the cryptocurrency market right now. Recent economic data point to low inflation and steady growth, a favorable combination that makes a recession much less likely. Anticipation of a "soft landing" lifted crude oil and regional bank stocks, which had previously lagged behind a rally in risky assets.

If the U.S. economy can achieve a soft landing, the rally in the cryptocurrency market can continue. However, the cryptocurrency recovery could pause in the short-term if the economy struggles or the Federal Reserve raises interest rates further.

While Bitcoin briefly consolidated in July, the rally in other risky assets extended on the back of expectations of a “soft landing” for the U.S. economy: a gradual return of inflation to target without a recession (Exhibit 1) . We believe that the cryptocurrency market could benefit due to the correlation of mainstream tokens to risky assets and various current favorable factors in the industry. However, a soft landing is not a certainty, and it has become more and more a consensus now, so the market has digested the benefits of a soft landing to a certain extent.

Beyond regulatory progress, the near-term outlook for cryptocurrencies may depend largely on whether soft-landing expectations persist. If upcoming economic data continues to support the soft landing thesis, the rally in major tokens may continue. But if the economy falters or the Federal Reserve raises interest rates further, the cryptocurrency recovery could pause in the short term. Until the outcome is confirmed, the cryptocurrency market could experience wild swings in altcoins, as has happened over the past month.

Chart 1: Near-term optimism for a 'soft landing'

Last month's data and Fed policy signals supported the view that the economy is likely to rebalance without slipping into recession. Inflation slowed further, and more so for "core" measures (excluding volatile food and energy prices). Despite low unemployment, strong job growth and declining jobless claims, the recovery is showing signs of slowing. At a press conference after the July 25-26 FOMC meeting (Federal Reserve interest rate meeting), Powell said that Fed board staff do not expect another recession.

In financial markets, the prospect of a soft landing has spawned a new portfolio of outperforming stocks. Bitcoin, the Nasdaq Composite and AI-related assets outperformed the broader market in the year to June 1, benefiting from the launch of AI tools including ChatGPT (public blockchain technology may offer solutions to some of AI's challenges). During July, however, the lead shifted to previous laggards, including US regional bank stocks and crude oil (Chart 2). Notably, the best-performing stocks in the U.S. stock market include a large number of shorted stocks, suggesting that many active investors are not buying a soft landing.

Chart 2: Assets that lagged at the beginning of the year performed better in July

Bitcoin and Ethereum fluctuated within a small range, and fell slightly month-on-month, as the dominant force in the market has shifted from technology-related topics to other areas. There are also fewer drivers for Bitcoin than earlier this year, such as concerns about regional banks (March 2023) and optimism about spot ETF approvals (June 2023). Both realized and implied volatility of cryptocurrencies have fallen to historically low levels (Exhibit 3). Meanwhile, their correlation with the S&P 500 has rebounded after a first-half decline. Bitcoin on-chain transaction fees dropped again in July and have steadily declined after a surge in interest around ordinals in May. In contrast, Ethereum transaction fees rose in July, and gas prices and maximum extractable value (MEV) rewards spiked on July 30 after the Curve protocol was hacked.

Chart 3: BTC and ETH Volatility Declines

“Altcoin dominance” increased throughout July, with their volatility higher than Bitcoin and Ethereum. We see the main catalyst being the July 13th US District Court decision in SEC v. Ripple Labs. In that case, the judge ruled that certain sales to institutional investors qualify as securities exchanges and should be registered with the SEC, while certain sales to the public do not. Notably, the court said that Ripple's native token XRP "is not, as a digital token, an investment contract per se." Monthly still increased by 48%. The clarification of XRP's legal status has boosted the prices of several other tokens, including XLM, SOL, OP and MATIC. In addition to the XRP ruling, a bipartisan group of lawmakers continues to make progress on bills related to cryptocurrency market structure and stablecoins.

The performance of other digital assets is closely related to changes in the fundamentals of the protocol, highlighting how incremental technological advancements can move the crypto industry forward. Example: MakerDAO governance token MKR rallied 50% in a month after a proposal was made in late June. Additionally, rising interest rates have boosted the protocol’s profitability by roughly 4x since last quarter, a trend likely to continue thanks to Blocktower’s Andromeda vault, a lending facility for real-world assets. Likewise, the value of UNI and LINK tokens has risen as technology has advanced — the UniswapX protocol and Chainlink’s new cross-chain interoperability protocol, respectively. Dogecoin also rallied in late July, likely fueled by Elon Musk changing his Twitter name to "X." Finally, Worldcoin (WLD), listed on cryptocurrency exchanges at the end of the month, has a fully circulated market cap of over $20 billion.

Chart 4: XRP Court Judgments and Improving Fundamentals Drive Some Token Prices Up

Since the end of 2022, the recovery of cryptocurrencies has clearly achieved results, and there is reason to be optimistic about recent technological advancements and legal and legislative progress. Therefore, we believe that the macro outlook is now the biggest risk facing the cryptocurrency market. A soft landing for the economy could be beneficial for risk assets, including cryptocurrencies, as it could prompt the Federal Reserve to lower real interest rates. Given Bitcoin's anti-inflationary role as an alternative non-sovereign monetary system and an alternative to gold, Bitcoin could also appreciate if the Federal Reserve decides to tolerate prolonged inflation above target. However, if the central bank decides to raise real interest rates further, or the economy slips into recession, the cryptocurrency recovery could pause in the short term.