Top Stories of the Week - 1/12

This week in the newsletter, we write about Bitcoin ETF launch day, Twitter removing NFT support, and Ethereum debating a block size increase.

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Bitcoin ETFs are Finally Here

On Wednesday, the Securities and Exchange Commission approved the first spot bitcoin ETFs in a historic decision. The approval concludes a more than decade long process to launch a spot bitcoin ETF that began in 2013. 11 applications were approved in total, including the Invesco Galaxy Bitcoin ETF.

In a note following the approval, SEC Chairman Gary Gensler pointed to recent court rulings as the driving force behind the decision, while reiterating his past criticisms of bitcoin. He described it as a "primarily speculative, volatile asset that's also used for illicit activities, including ransomware, money laundering, sanction evasion, and terrorist financing." SEC Commissioner Hester Peirce also published a statement opposing many of Gensler’s sentiments and commending the approval. Peirce said that prior ETF rejections and delays resulted in investors having less efficient access to bitcoin exposure while unnecessarily consuming the SEC's time. "The only material change since we last denied a similar application was a judicial rebuke," she stated.[TW1] Commissioner Mark Uyeda also criticized the Commission for relying on the “significant size” test, noting that the Commission’s use of this test “continues to be arbitrary and capricious” and calls the Commission’s reasoning “disingenuous.”

The process leading to the approval was chaotic. ETF issuers and the SEC worked up until the final days to finalize the details surrounding the launch and on Tuesday the SEC official Twitter account was hacked, posting a fake approval message.

Trading started Thursday morning when U.S. markets opened and the first day saw more than $4 billion in total volume (although a significant percentage of that appears to have been GBTC redemptions). Despite the approval, asset manager Vanguard blocked access for customers. A spokesperson for Vanguard was cited saying “high volatility runs counter to our goal of helping investors generate positive real returns over the long term.”

With the bitcoin ETF approved, crypto advocates are now focusing on potential other future crypto ETFs – particularly an ETH ETF – and the impending bitcoin halving in April.

OUR TAKE:

Today marks a significant victory for the crypto industry, and especially bitcoin advocates, who for more than a decade have relentlessly worked to make a spot ETF a reality. As highlighted by Commissioner Pierce, and many others, it never should have taken this long. Critics have noted the irony of an industry founded on the principles of a trustless, permissionless public network placing such importance on a vehicle like a bitcoin ETF, which seems to represent the opposite. This analysis misses the forest for the trees.

A spot bitcoin ETF fundamentally alters the crypto landscape in the United States. It enhances accessibility for both retail and institutional investors and paves the way for financial advisors to guide their clients towards investing in it. Moreover, it lends bitcoin greater legitimacy, both by addressing the regulatory and compliance concerns that previously deterred institutions from holding it and by solidifying its role as a genuine asset class that can offer portfolio diversification and enhanced returns. Spot bitcoin ETFs will also influence bitcoin culture by significantly growing the investor base, altering the way bitcoin is traded, and fostering a more committed holder base that should help stabilize volatility. Ultimately, the ETF further validates bitcoin and its geopolitical importance.

The next 3-12 months will be more important than the immediate 1-3. The access ramp will likely span several years across various U.S. wealth platforms (e.g., broker-dealers, banks & RIAs), which we view as the most addressable and direct market that would have the most net new accessibility from Bitcoin ETFs. In our report, Sizing the Market for a Bitcoin ETF, we estimated that only 30% of the $48T US wealth management will open access in the first year before ramping up each subsequent year. Based on these market size estimates, if we assume that BTC is adopted by 10% of total available assets in each wealth channel with an average allocation of 1%, we estimate $14bn of inflows into Bitcoin ETFs in the first year after launch.

Longer-term, the addressable market for bitcoin investment products could extend even further across all third-party managed assets (~$126T in AUM according to McKinsey) or even more broadly across global wealth ($454T according to UBS). Some believe that as Bitcoin monetizes, it will systematically reduce the monetary premium applied to other assets like real estate or precious metals, dramatically expanding Bitcoin’s TAM. Inflows from ETFs, market narratives about the forthcoming Bitcoin halving (April 2024), and the possibility that global interest rates have peaked or will peak in the near term, all suggest that 2024 could be a big year for Bitcoin. - Lucas Tcheyan

Elon Musk Nukes NFTs on X

Social media giant X quietly discontinues support for NFTs as profile pictures. Prior to this change, premium users were able to feature their NFTs in their profile pictures, with Twitter implementing a verification system by allowing users to connect their wallets to the platform. This shift follows a broader trend, as in March 2023, Meta also withdrew support for NFT profile pictures.

Elon Musk's lack of enthusiasm for expanding NFTs on Twitter coincides with X’s current emphasis on peer-to-peer payments and advancements in its AI large language model, "Grok." Although X will no longer verify NFT ownership, users are continuing to use their NFTs as profile pictures.

OUR TAKE:

X's decision to withdraw support for NFTs aligns with Elon Musk's recent critique during his Joe Rogan interview, where he dismissed NFTs as nothing more than a "URL to a JPEG" not truly on the blockchain. Musk has been vocal about his belief that both Web3 and NFTs are overrated, a sentiment likely influenced by the broader collapse of the NFT market in 2023, with volumes still down 70% from their all-time highs. This decline in NFT transaction volumes indicates a significant reduction in NFT user activity, with no influx of new users entering the ecosystem.

The NFT market's slow recovery, paired with major social media platforms distancing themselves from NFTs, highlights a shift in perspective. Web2 giants now seem less enamored with Web3 as an imminent, attractive feature. Instead, their focus is turning towards developing features for the everyday user, such as AI.

Despite the divergence of Web2 and Web3 synergy for social applications, this scenario positions Web3-native social media platforms, also known as DeSoc, to emerge as leaders in Web3 social media development. Meanwhile, whether X adopts Web3 features or not, the platform will remain a central hub for the crypto/Web3 community. As X introduces a new peer-to-peer payment platform, the inclusion of crypto remains speculative. Elon's vision, however, is evident—X's resources will prioritize features offering substantial value to everyday users, deeming NFT profile pictures inconsequential in the broader context. - Gabe Parker

Ethereum Community Debates Merits of Another Gas Limit Increase

On January 10, 2024, the Ethereum Foundation Research team conducted their 11th Ask Me Anything (AMA) session on Reddit. One Reddit user asked about the Ethereum gas limit and the extent to which it could be safely raised by validators today, as well as after the Verkle upgrade. Creator of Ethereum Vitalik Buterin responded to the question and said, “Honestly, I think doing a modest gas limit increase even today is reasonable. The gas limit has not been increased for nearly three years, which is the longest time ever in the protocol's history.” Buterin went on to suggest a 33% increase to the gas limit from 30mn gas to 40mn gas.

As background, Verkle is an upgrade on Ethereum's roadmap that will introduce a new, more efficient data structure for storing and retrieving data about Ethereum state. Developers are currently debating the merits of focusing on Verkle for the next immediate upgrade after Cancun/Deneb. The gas limit referenced in the question refers to the block gas limit, which restricts the number of transactions and smart contract operations that can be included in a block. Since the genesis of Ethereum, there have been seven major gas limit increases, which is akin to an increase in the block size as they effectively allow for more transactions to be processed and finalized on the network at once.

The first six gas limit increases between 2015 and 2021 were initiated by miners, who were the original block producers on Ethereum when the blockchain was still a proof-of-work consensus protocol. These gas limit increases did not require a hard fork upgrade but rather, the coordination of a majority of miners. Individual miners could adjust the gas limit by 0.1% per block and collectively, miners could then coordinate to incrementally increase or decrease the gas limit to a new threshold without requiring any code changes to the Ethereum protocol.

These increases initiated by miners occurred six times on Ethereum during periods of network congestion and high transaction volumes. The seventh and most recent gas limit increase on Ethereum occurred in August 2021 and unlike the others, it was initiated through a hard fork upgrade dubbed the “London” upgrade. The London upgrade most notably implemented Ethereum Improvement Proposal (EIP) 1559, which introduced a fee burning mechanism to Ethereum. It also doubled the block gas limit from 15mn gas to 30mn gas. For more information about EIP 1559 and its impact on Ethereum blocks, read this Galaxy Research report.

Buterin’s comments about another increase to the block gas limit, this time initiated by validators, who are the new block proposers of the network since the network’s transition to a proof-of-stake consensus protocol, have sparked controversy and debate in the Ethereum community. Long-time Geth developer Péter Szilágyi warned on Twitter about the downsides of a gas limit increase, saying, “State will grow faster, sync time will get slower quicker, DoS potential will grow.” Ethereum validator node operator and investor at Framework Ventures Joe Coll said in a tweet that while he’s open to the idea, initiating an increase before the activation of the Cancun/Deneb upgrade is too risky. Ethereum Foundation Researcher Ansgar Dietrichs also noted that the Cancun/Deneb upgrade will effectively increase the gas limit already by 10mn gas, though this additional block space will be reserved for use by Layer-2 rollups.

OUR TAKE:

A 33% increase to the Ethereum block gas limit is indeed a risky move for three main reasons. The first reason as pointed out by Dietrichs is due to the Cancun/Deneb upgrade which will place higher networking and bandwidth requirements on nodes. The creation of 768kB of additional block space for Layer-2 rollups if coupled with a separate gas limit increase of roughly 33% would result in the largest possible block on Ethereum being 1MB in size. Based on experiments analyzing the impacts of large blocks on Ethereum, larger blocks would certainly increase block propagation latency and potentially result in a higher number of missed blocks. Both are outcomes that would negatively impact network health and the user experience on Ethereum.

Second, as pointed out by Geth developer Marius van der Wijden, increases to the block gas limit, present challenges to “accessing and modifying” Ethereum state over time. Ethereum state refers to the historical record of Ethereum accounts, transactions, and smart contracts that grow as the blockchain continues to progress and finalize blocks. Operating a full Ethereum node is becoming progressively more resource-intensive and nearing requirements of close to 1TB of storage. An increase to the gas limit today would mean even faster growth in state that makes it difficult for users to spin up and operate Ethereum nodes. While an ever-growing state is an unavoidable problem for many highly used public blockchains, there are long-term solutions to the issue that Ethereum developers are currently weighing including state expiry. Without a long-term plan for addressing the issue of state growth, a 33% increase to the gas limit in the short-term may be premature.

Finally, in light of the code changes that are upcoming in Ethereum’s near and long-term future to enhance the network’s scalability through Layer-2 rollups, an increase to the gas limit that offers a short-term boost to scalability on Ethereum directly is not beneficial for promoting Ethereum’s use as a data availability layer and may even make future upgrades that improve Ethereum state like Verkle harder to roll out. For these three reasons, a 33% increase in the gas limit is ill-advised and unlikely in the near term. However, as noted, gas limit increases are one of the few aspects of the Ethereum protocol that can be changed without input from Ethereum core developers and the broader Ethereum community. As the new block producers of Ethereum, validators hold the power to change the gas limit based on factors external to the Ethereum protocol, such as the price of hardware and bandwidth. Therefore, if a gas limit increase does occur on Ethereum, it will at the very least be a positive signal indicating the ability for validators to coordinate and enable changes to the Ethereum protocol independently of involvement from other stakeholders in the Ethereum ecosystem. - Christine Kim

Charts of the Week

In our December 22, 2023 newsletter, we covered the flippening of DAI collateral from majority off-chain/RWA sources towards on-chain sources. This trend has accelerated since the coverage. As of January 11, 2024 55% of DAI collateral is from on-chain sources, representing a 4% change from 51% in the last newsletter. Over the same period, the number of DAI collateralized by on-chain assets grew by 190m DAI (6.98%) from 2.718bn DAI to 2.908bn DAI.

The next significant flippening lies on MakerDAO revenue, which is currently rooted in 50% on-chain sources and 50% off-chain sources. Off-chain sources have dominated MakerDAO revenue since November 2022, capturing as much as 77% of revenue at their peak. Now, for the first time in 415 days, on-chain sources of collateral are set to generate more revenue for the protocol than their off-chain counterparts.

The culmination of the collateral and revenue flippenings highlights the growing attractiveness of on-chain native assets in the frameworks of protocols and the growing demand for on-chain assets from end users.