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State of the Network’s 2024 Outlook

By: Kyle Waters & Tanay Ved

Digital assets rebounded sharply in 2023 as market conditions improved across the board and institutional interest accelerated alongside the impending launch of a spot Bitcoin ETF. Looking to 2024, there are a number of important developments on the horizon. In this issue of State of the Network, we offer our perspective on some of the biggest trends to watch in 2024 in the digital assets industry. 

The Arrival of Spot ETFs 

After a decade-long effort, the final steps to introduce a spot Bitcoin ETF to the US financial markets are underway, with products likely launching from a number of high-profile issuers like BlackRock and Fidelity Investments in 2024. The long-awaited approval of spot ETFs carries many implications that could shape the digital assets market for years to come. 

As the industry anticipates the SEC's decision on the ARK & 21Shares Bitcoin ETF, the issuer with the earliest final deadline of January 10th, the latest amended SEC filings from issuers appear to signal an impending green light from the SEC at the time of our writing. However, the specifics regarding the initial wave of approvals and the exact launch date remain uncertain. It's widely expected that the SEC will simultaneously approve multiple issuers to avoid perceived favoritism, as observed in the Ethereum futures ETF launch last fall. Currently, there are 11 major spot ETF filers that are prepared for a potential approval in the coming week. There are many different aspects to the launch such as the estimated magnitude of inflows to the ETFs, the competitive dynamics between ETF issuers, and Bitcoin’s maturing market structure. Some issuers have already begun a marketing push, while other issuers look to compete on having the lowest fees. How exactly this “Cointucky Derby” plays out at the onset is still uncertain.

We believe it’s also important to consider Bitcoin’s on-chain supply dynamics, which may evolve in the medium term, and where Coin Metrics’ data can help shed the most light. Bitcoin's supply, easily auditable and trackable on-chain, helps make it a unique financial asset. Anyone who runs a Bitcoin node can trace the whereabouts of all BTC and follow coins as they move. This allows us to deduce holder behavior, the dispersion of supply, active addresses, and many other on-chain metrics that would be impossible to compute for a more opaque asset. An important trend running parallel to ETF talks is an increasing percentage of bitcoin being held by long-term holders. As shown in the chart below, over 6 million BTC, or 30% of the total supply today, hasn't moved in over five years. We consider this dormant BTC as excluded from Bitcoin’s “free float” supply. For more on Bitcoin’s recent supply dynamics and free float vs. illiquid supply, see our joint report with Bitcoin Suisse from last fall.

Source: Coin Metrics Network Data Pro

Moreover, only 30% of all BTC was active on-chain in 2023, with the majority remaining untouched. Although it is important not to oversimplify the determinants of BTC’s price, a dynamic variable impacted by many unknowns, this growing illiquidity mixed with outsized inflows into the ETF could squeeze the market, thereby encouraging more supply to enter the liquid market. 

Many other factors will be interesting to watch. Counteracting forces will shake up the onshore crypto exchange landscape, with an ETF possibly enticing buyers away from spot exchanges through lower fees and less frictions. But at the same time, exchanges like Coinbase are set to gain as an ETF custodian (Coinbase is the named custodian in 8 of the 11 major filings including BlackRock’s iShares Bitcoin Trust). More broadly, the ETF is expected to enhance and affirm the legitimacy of digital assets, likely benefiting US exchanges down the road as the industry continues to mature. Average spot volume on Coinbase has already jumped above $2B per day on the back of improving market sentiment revolving around the ETF. Meanwhile, the jump in CME Bitcoin futures open interest is reflective of a shifting market structure focused on the US financial markets.

 With such a transformative development on the horizon, this year may mark the transition of digital assets from a niche to an emerging asset class. With BlackRock and others also filing for an Ethereum spot ETF, the potential approval of an ETH product will also be on industry participants’ minds in 2024. But BTC is set to go first in a year coinciding with another big supply event ready to dominate Bitcoin’s narrative in 2024: the next Bitcoin halving.

The 4th Bitcoin Halving

One of Bitcoin’s core value propositions lies in the programmatic nature of its monetary policy. Every 210,000 Bitcoin blocks, or about every four years, the amount of newly issued bitcoins cuts in half in an event known as a “halving.” Bitcoin block 840,000, expected to be mined this upcoming April, will reduce the reward for newly mined blocks from 6.25 BTC to 3.125, marking the 4th halving in Bitcoin’s history and a key milestone for the protocol as its issuance undergoes exponential decay on the path to Bitcoin’s end supply of 21M.

Source: Coin Metrics Network Data Pro 

Although the halving is a predictable element of Bitcoin, it still carries some important implications. The first is the impact on Bitcoin miners, who are incentivized to invest capital and energy into securing the network in exchange for BTC. Miner revenue is derived from new BTC issuance, which is reduced through the halving, and fees paid by transactors, which are a function of demand for Bitcoin blockspace. The halving impacts miner economics by almost certainly reducing total aggregate miner revenues in dollar terms, while pressuring the margins of operators with high energy costs and/or inefficient hardware. 

Illustrated simply, if the halving had occurred in April of 2023, miners would have made $6.8B instead of the $10.3B in total revenue they received last year. However, the year-end boost in BTC’s price and the resurgent fee market helped miners in 2023, showing how the halving does not necessarily mean that yearly USD revenues will fall by 50% exactly. Nevertheless, with hashrate hitting an all-time high above 500 EH/s, miners are racing to achieve economies of scale and modernize their ASIC fleets to position themselves for continued success after the halving.

As in past halvings, there is likely to be renewed debate surrounding the halving’s impact on bitcoin’s supply and demand dynamics, and whether this reduction in issuance is already “priced in.” In one camp, there are those who believe that the Bitcoin halving, inherently programmed into the protocol's rules, is an event well-understood in advance—especially by the growing number of sophisticated institutions researching Bitcoin. On the other hand, some explain the halving through a flows-based lens, noting that sales from miners, who are natural sellers of BTC, will abate post-halving. More abstractly, they also believe the halving serves as a reinforcement of Bitcoin’s monetary properties and advances BTC as a reliable store of value, attracting new interest through the attention each halving brings.

The market will likely feel the effects of halving-related sentiment throughout 2024. Much of the attention will fall on miner profitability, and drive new discussion around Bitcoin's need to eventually shift towards a fee-based revenue model for miners. But the halving also corresponds to a pivotal moment in Bitcoin's history with the launch of spot ETFs in the US. Though future outcomes need not mirror past ones, the history of Bitcoin aligns neatly with its four-year halving epochs. This new epoch is poised to be just as momentous.

EIP-4844 & The Battle to Scale Smart Contract Platforms

Layer-2 (L2) solutions have been integral in tackling Ethereum's scalability challenges, including high gas fees and limited transaction throughput, which have affected user experiences especially during periods of high blockspace demand. L2 solutions, like Optimistic & ZK-rollups, bundle multiple transactions into a single "rollup" and process them off-chain, while leveraging the Layer-1 (L1) network as a "data availability layer" for settlement and security. This method has been instrumental in reducing average transaction fees from about $8 on the mainnet to roughly $0.01 on L2’s like Arbitrum. Nevertheless, with the rapid proliferation of rollups, the costs associated with storing data on-chain has emerged as a focal point of discussion and a crucial step forward in Ethereum’s evolution (see section on EIP-4844 below).

Bridges have played an important role in this transition, facilitating the movement of assets between Ethereum mainnet and various L2’s. As seen below, canonical Optimistic & ZK Rollup bridges have seen a large flow of ETH, and ERC-20 tokens such as USDC & USDT locked in their contracts—reflective of a growing demand to transact on layer-2 networks. While optimistic rollups such as Arbitrum and Optimism host the lion's share of assets with 1.3 Million and 330K ETH bridged, the L2 landscape continues to grow with the introduction of Coinbase’s Base, ZK-rollups (zero-knowledge) and application specific rollups optimized for particular use cases. 

Source: Coin Metrics ATLAS

A pivotal step in this transition is the ‘Dencun’ hard-fork, with its activation possibly arriving by Q2 2024. Through Ethereum Improvement Proposal (EIP) 4844 (“proto-danksharding”), this upgrade is set to introduce the concept of “blob-carrying transactions,” a new transaction type enabling rollups to store large amounts of data on Ethereum L1 (data availability) for shorter periods at lower costs. This is expected to reduce the operational overhead for rollups while further reducing transaction fees on L2s, ultimately enhancing the economic feasibility of using Ethereum and unlocking new use cases.

Despite progress towards Ethereum’s rollup-centric roadmap and the anticipated Dencun hard-fork, lingering questions about the long term efficiency and user experience within the ecosystem remain. Complexities in asset bridging and the need for standardization, coupled with the rapid proliferation of rollups fragmenting users and liquidity, underscore the importance of interoperability among these ecosystems. As Ethereum adopts a modular approach to alleviate its limitations, it also contends with the potential re-distribution of certain activities away from its layer-1, a shift that could influence the trajectory of Ethereum mainnet and the utility of ETH. Despite some valid critiques, the Ethereum ecosystem will still head into 2024 holding a significant lead in a number of important categories including stablecoin liquidity, DeFi activity, total fees spent by users, and several other measures.

However, in parallel to Ethereum’s L2 roadmap, the resurgence of alternative layer-1 blockchains like Solana and Avalanche—achieving returns of 975% and 300% respectively over the year—is refocusing attention on their architectural trade-offs. The core of this discussion juxtaposes the monolithic approach, like that of Solana, which unifies execution, data availability, and consensus in a single layer against Ethereum's modular approach, which splits some of these functions. This contrast is central to the discourse around smart contract platforms and will continue to influence the debate around their relative dominance, ultimately trickling into discussions around trade offs of scalability, user experience, security, and the ecosystem of applications.

It’s clear that there are a number of competing efforts underway to scale smart contract platforms; however, it’s still unclear if a single winner will emerge or if a multitude of solutions will exist alongside each other. It is unlikely 2024 will yield a definitive answer. Yet, it’s apparent that there is significant demand for blockspace, and as we’ll see in the next section, there are plenty of emerging applications that will seek out reliable and cheap blockspace in 2024.

Stablecoins, RWA’s & Emerging Applications

Stablecoins & CBDC’s

Stablecoins have been a central theme throughout the past year, which we believe will continue to persist into 2024. Over 2023, the $120+ billion stablecoin market saw a major re-shuffling as the market grappled with events such as Silicon Valley Banks collapse. This influenced the trajectory of the two largest fiat backed stablecoins, Tether and the onshore issued USDC with their supply trending in opposite directions. Yet despite losing some market share in 2023, USDC issuer Circle is considering going public in the US in 2024, its business boosted heavily by rising rates in 2023, while it plans an expansion abroad in places like Japan and Brazil. Meanwhile, the stablecoin sector in aggregate has continued its expansion going into 2024, cementing its value proposition and strong product market fit within the digital asset ecosystem. 

This expansion is exemplified by newer stablecoins gaining adoption, such as PayPal's PYUSD, the Euro-backed EURCV issued by Société Générale, and protocol-native stablecoins like Aave's GHO. This trend is evident not only in the variety of stablecoins—ranging from fiat-backed to crypto-backed—but also in the diversity of issuers, including payments and financial institutions. Moreover, interest-bearing stablecoins, backed by off-chain assets like tokenized treasuries and on-chain collateral such as ETH and liquid staking tokens (LSTs), are gaining traction. While these developments are still emerging and carry distinct risk profiles, they hold the promise of enriching the evolving stablecoin ecosystem.

 Source: Coin Metrics ATLAS

Running parallel to the rapid rise of stablecoins on public blockchains is the ongoing research and development around Central Bank Digital Currencies (CBDCs). With some countries like Brazil hoping to launch a CBDC in the new year, 2024 may provide a new lens for comparing permissionless vs. centralized digital financial infrastructure.

Real World Assets (RWA’s)

As we anticipated in 2023, the real world asset (RWA) ecosystem has seen substantial growth over the past year. This has been fueled by two major categories in the space, namely the tokenization of public securities and private credit, with both themes bridging the gap between the traditional finance and the digital asset economy. While tokenization of public securities has brought the vast market of traditional financial assets such as US Treasuries to public blockchains, globalizing their access, private credit projects have served the needs of emerging economies through vehicles to access cheap credit. The market for tokenized treasuries surpassed $500 million in 2023, in part fueled by the Federal Reserve’s rate hiking cycle increasing the attractiveness of yield offered through the “risk-free” rate—buoying projects like Ondo’s OUSG to $175 million in market capitalization and providing a boost to MakerDAO’s revenues. Faster settlement times, enhanced transparency and cheaper operational costs are some of the value propositions brought by blockchains that are helping accelerate this trend as the opportunity expands to other financial instruments like equities, private market funds and real estate. 

Looking ahead, initiatives like Coinbase's layer-2 network Base are set to propel the RWA sector's growth. “Project Diamond”, leveraging Base's scaling capabilities, Coinbase's wallet and custody services, and Circle’s USDC stablecoin aims to create a regulated capital marketplace for digital financial instruments. Similarly, “Project Guardian”, a collaboration involving JP Morgan, Apollo, and the Monetary Authority of Singapore, reflects a growing interest in tokenization among financial institutions. Although some RWA initiatives have occurred on permissioned blockchains, limiting their full potential, the expansion of this sector on public blockchains holds great promise.

Staking & Decentralized Finance (DeFi)

In the Ethereum DeFi ecosystem, liquid staking has surged post the Shapella upgrade, with nearly 29 million ETH staked on the Beacon chain and Lido managing close to 32% of this total (9 million ETH). This existence of an on-chain yield, rewarded for validating the network, has boosted ETH's appeal as a productive capital asset. Layer-2s bridges like Blast, staking idle ETH for yield generation, further accentuates this trend. The 2024 launch of EigenLayer mainnet will introduce restaking, enabling the use of staked ETH to bootstrap economic security for other networks like data availability layers, oracles, or bridges, essentially re-using Ethereum’s security model. While restaking would provide greater incentives through higher yields, it could also amplify smart contract, operator, and slashing associated risks, making it a key theme to follow in 2024.

Within the larger DeFi ecosystem we anticipate decentralized exchanges (DEX’s) and lending protocols to play a crucial role in 2024, particularly with Uniswap v4 expected to enter the scene. The new iteration will enable the creation of customized pools and trading strategies via “hooks” along with gas cost reductions enhanced by the Dencun upgrade. As protocols become more generalized, they will offer greater flexibility and control over risk management which may externalize some complexities, but also cater to a broader audience and variety of use cases.

Convergence of AI & Crypto, DePIN & Consumer Applications

Blockchains are increasingly impacting non-financial applications, as seen with decentralized physical infrastructure (DePIN). By facilitating resource sharing in areas like storage (Filecoin), networking infrastructure (Helium), and compute (Akash) through token incentives, access to these essential resources is being democratized. This is also crucial in the realm of artificial intelligence, enabling global, permissionless participation in compute markets currently dominated by major technology firms, while also making AI generated content or data more secure and trustworthy through blockchain privacy solutions. The convergence of these groundbreaking technologies offers an exciting development to follow. 

Gaming and social media will also likely see a boost, driven by advancements in account abstraction—streamlining wallet interactions and transaction processes, thereby improving user experience. Layer-2 enhancements, particularly in gaming-specific L2’s like Immutable, are making frequent, low-value transactions, including in-game item purchases and NFT usage, more feasible. While the NFT landscape has witnessed a trough and changing dynamics with marketplaces like Blur overtaking Opensea and the growth of inscriptions on Bitcoin, the area holds great potential in enhancing engagement between brand or artist communities. The bull market is poised to bring renewed interest in the consumer application ecosystem, facilitating the mainstream adoption of blockchain technology. 

Regulatory & Policy Outlook

With an onslaught of regulatory challenges over the past year in the US, the materialization of a more optimistic political environment would be a welcomed change. However, there are several developments on the policy front that digital asset market participants will be looking to seek clarity from before that becomes a reality. One promising development in the US is a more politically active crypto base, with the Fairshake super PAC raising $78M to advocate for candidates in the 2024 US election who support blockchain technology. The ongoing legal proceeding between Coinbase and the SEC will also be an important area to watch, with Coinbase’s oral arguments on its motion for judgment to be heard in the courts on January 17th. Just like the Ripple and Grayscale proceedings, the outcome of this battle could have far reaching implications for the industry, potentially influencing international regulations. While several jurisdictions globally have made significant strides in crypto policy, such as the UAE, and the EU—with its MiCA regulations set to come into effect in 2024—others have a lot of catching up to do.

Conclusion

The digital assets market is poised for maturation in 2024. The anticipated launch of a spot ETF stands as a milestone in Bitcoin's relatively brief but impactful history, a mere 15 years ago today since its genesis block was mined, unleashing a new concept of money upon the world.

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