Crypto beta trades: how well do they actually work?

The crypto markets are considered to be extremely volatile, as illustrated by a comparison of the 120-day volatility of Bitcoin relative to various equity indices over the past five years (31 March 2019 to 31 March 2024): 

Source: Bloomberg

Within the crypto world, Bitcoin and Ether have already established a reputation as stoic blue chips. This is due to the fact that the volatility of other crypto assets is much higher still. For instance, if you compare the 120-day volatility of Solana with that of Bitcoin in the period since August 2021, it is almost twice as high at 95. For other crypto assets in the top 100, the difference relative to Bitcoin and Ether is even more marked. 

Due to this higher volatility, it is reasonable to assume that various crypto assets can therefore serve as so-called “higher beta” trades for Bitcoin or Ether. This is especially the case when these beta trades go hand in hand with a coherent narrative that fits well with either Bitcoin or Ether.

Ethereum as a practical example

A long-only strategy with crypto assets involves speculating on rising prices. One option is to turn to beta trades. This is appropriate if you expect that these beta trades will perform better than the underlying reference crypto asset during the course of a current narrative.

A recent illustrative example that saw this theory put to the test was provided by Ethereum and its various Layer 2s. The so-called Dencun upgrade for Ethereum was implemented on 13 March. Above all else, the implementation of EIP-4844 has now made it possible for Ethereum Layers 2s to operate rollups more cheaply. The term rollups refers to a method of compressing transactions and securing them as compressed files on the Ethereum blockchain. Until now, rollups have been considered the only viable scaling solution for Ethereum in the short to medium term (possibly also in the long term).

The success of the Dencun update is reflected in the transaction fees of various Layer 2s after 13 March (see graphic below). For this article, however, our main interest lies in the price development of the tokens of various Layer 2 solutions relative to Ether up to the time at which the update was implemented.

Source: Dune Analytics

The general market expectation had been that the tokens of Layer 2s such as Polygon (MATIC), Optimism (OP), Arbitrum (ARB), Skale (SKL) and Metis (METIS) would outperform Ethereum as “higher beta plays” up until the actual launch of EIP-4844¹. If the market were to be believed in the run-up to the Dencun upgrade, it was the prices of Layer 2s that were likely to benefit most from this narrative. Ethereum ecosystem projects such as Lido (LDO, Ethereum’s most prominent liquid staking solution) or Ethereum Name Service (ENS, the decentralised identity protocol on Ethereum) would likewise have benefited. But has this turned out to be the case?

A look at the figures

To answer this question, we at Maerki Baumann Investment Management chose the period between 10 January and 13 March as the basis for the performance comparison. The reasoning behind this choice was as follows:

with the approval of Bitcoin spot ETFs in the US on 10 January 2024, general sentiment appeared to have shifted from Bitcoin to Ethereum and the crypto community seemed to have found a new target narrative in the form of the upcoming Dencun update on 13 March. The performance of the individual crypto assets measured in US dollars during the selected period is shown in the table below.

Source: Messari

As can be seen, what were supposed to have been beta trades did not turn out as such. From our selection, Ether put in the best performance with 55.03%. ENS and Polygon came closest to keeping pace with Ether with performances of 46.08% and 41.30%, respectively. However, ENS is not a Layer 2 and should thus have been the least appropriate in terms of the narrative.

Of the Layer 2s, Arbitrum was the biggest disappointment, posting a negative performance of -4.94%. These Layer 2s not only underperformed Ether by a considerable margin, but also had a greater maximum drawdown as well as a longer time to recovery thereafter. Both of these measures are important and have to be viewed for an asset in relation to its performance. 

Source: Messari

Conclusion and outlook

The various Ethereum beta trades therefore failed to outperform Ethereum in US dollar terms. Of all of the assets analysed, Ether posted the best price performance. At the same time, ETH recorded the second lowest maximum drawdown (-14.20%) and also had the second shortest time to recovery from this drawdown (18 days). Only ENS had a lower maximum drawdown at -6.27% and a much shorter time to recovery (1 day). A beta trade strategy with Ethereum Layer 2s would thus not have proven very successful.

A further interesting insight is that crypto blue chips such as Bitcoin and Ether are not only more stable during slumps, but are also among the strongest crypto assets during recovery phases. At Maerki Baumann, we are ultimately also endeavouring to keep the “Crypto” focus module as stable as possible despite the high level of volatility exhibited by crypto assets.

What does this mean for crypto investors?

It is interesting to observe that a similar narrative is currently also playing out for Bitcoin. Until recently, Bitcoin was considered to only have limited scalability and programmability on its base layer (Bitcoin blockchain). This changed with the Taproot upgrade in 2021. Taproot made the Ordinals protocol possible, allowing for Bitcoin NFTs and BRC-20 tokens to be created. With the Bitcoin halving on 20 April, an updated version of the Ordinals protocol called Runes has gone live. Progress is also being observed in the area of Bitcoin Layer 2s. In 2023, for example, 40% of all Bitcoin developers turned their focus to Bitcoin Layer 2s in order to increase the scaling potential of Bitcoin.

If we now look at the period from 10 January to 20 April (time of the Bitcoin halving), the bet on Bitcoin beta trades worked out better compared to the Ethereum beta trades. This may also be because there are fewer investment candidates relative to the Ethereum ecosystem and the narrative surrounding the Bitcoin ecosystem is generally more entrenched at present.

ORDI, a token that can be viewed as a representative of Ordinals development, enjoyed less success. Its price performance of -30.28% in US dollar terms fell far short of that of Bitcoin. The upcoming introduction of the Runes standard with the halving block (840,000 Bitcoin block) could, however, once again provide a boost in the Ordinals segment.

The coin of the Layer 2 protocol Stacks (STX) has performed better. As at the end of March, STX had recorded a price performance of 98%, almost twice as high as that of Bitcoin. Looking at the almost twice as high maximum drawdown (with almost the same time to recovery), an investment in Stacks does not necessarily appear to a sure-fire success when compared to Bitcoin. The performance of Stacks can also likely primarily be attributed to the upcoming Nakamoto upgrade at the end of April, with implementation taking place between 15 and 29 April. This will result in technical improvements for Stacks and a closer connection to the Bitcoin blockchain.

In retrospect, Bitcoin Cash was an outstanding beta play. Since the launch of the Bitcoin ETFs, BCH has significantly outperformed BTH with a gain of 102.47%. At -9.92%, the maximum drawdown was almost half as severe, while the time to recovery was pretty much identical at 19 days. This outperformance is likely due to the halving that had already taken place and which historically occurs a few weeks prior to the Bitcoin halving.

 ¹ Alternative Layer 2 scaling solutions such as Zora, StarkNet, zkSync and Base were not taken into account as they either do not yet have tokens or these have only just been launched.

Important legal information:
 

This publication is intended for information and marketing purposes only, and does not constitute investment advice or a specific individual investment recommendation. It is not a sales prospectus and does not constitute a request, an offer, or a recommendation to buy or sell investment instruments or investment services, or to engage in any other transaction. Maerki Baumann & Co. AG does not provide legal or tax advice. Investors are therefore advised to obtain independent legal or tax advice concerning the suitability of such investments, since their tax treatment depends on the personal circumstances of the investor in question and is subject to change at any time. ­Maerki Baumann & Co. AG holds a Swiss banking licence issued by the Financial Market Supervisory Authority (FINMA).

This publication is expressly not intended for persons resident in Germany.

Editorial deadline: April 2024

Maerki Baumann & Co. AG
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T +41 44 286 25 25, info@maerki-baumann.ch
www.maerki-baumann.ch