Why is it difficult for cryptocurrency liquidity to outperform Bitcoin in this cycle?

Source: Blockworks; Compiled by Deng Tong, Golden Finance

This is the first part of a series of articles about the current state of the cryptocurrency liquidity market, based on multiple conversations with liquidity funds.

It is an open secret that most cryptocurrency liquidity funds perform poorly.

The operation of a liquidity fund is similar to that of traditional hedge funds: selecting market direction, deploying capital, and outperforming the benchmark.

However, unlike hedge funds, the benchmark is not a composite benchmark like the S&P 500 index. The goal of cryptocurrency liquidity funds is to outperform Bitcoin.

For example, Bitcoin appreciated by about 110% in 2024. Any liquidity fund that performed below this benchmark was underperforming or at best could only be considered average.

So far this year, Bitcoin has remained stable overall, while the altcoin market has plunged to the bottom.

Taking Bitcoin (BTC.D) as an example, its dominance has steadily climbed over the past year, currently accounting for 63% of the total cryptocurrency market capitalization of $3.3 trillion.

In comparison, the peak market capitalization of the previous cycle occurred in November 2021, when BTC's share hovered between 40% and 45%.

Venture capitalists like Jon Charbonneau from DBA even question the value of BTC as a benchmark. Charbonneau stated in the 0xResearch podcast that a suitable benchmark might be a weighted average basket of altcoins such as ETH, SOL, and BNB.

This may explain why, despite Bitcoin hovering near its historical highs, there is a noticeable bearish sentiment in the cryptocurrency Twitter echo chamber. Many risk-seeking investors believe that altcoins will rise more significantly than Bitcoin, thus feeling "excluded" from the BTC rally.

Cosmo Jiang from Pantera told me, "The current situation is not very good. Most directional liquidity funds may have a negative view on BTC. For market-neutral liquidity funds, the industry average is irrelevant. However, their performance this year has also been poor, which means their overall performance is flat rather than positively trending."

Almost all the liquidity funds I have communicated with believe that Bitcoin has positioned itself as an institutional/macroeconomic asset, or "digital gold."

"We are at an interesting point on the S-curve of Bitcoin adoption, with penetration rapidly increasing due to ETFs and the U.S. government's strategic reserves. Last year, Bitcoin's inflows exceeded those of Nasdaq's QQQ, which is crazy," Jiang said. "Most players are still unaware of the significant differences in BTC's performance compared to other cryptocurrency markets."

This is not just a problem with Orange Coin; it has risen by 11% this week.

Most liquidity funds have performed poorly, affected by the clouds hanging over the altcoin market. Arthur Cheong from Defiance Capital told me that the oversupply of existing and soon-to-be-unlocked tokens such as L1/L2, DeFi, DePIN, AI, and meme coins signals a bleak outlook.

"It is expected that in the next two years, the unlocking plans for all altcoins, except for ETH, will reach 1 billion dollars per month. The demand for altcoins is fundamentally low. The total capital of all cryptocurrency liquidity funds is about 10 billion to 15 billion dollars," said Cheong.

These structural dynamics also affect liquidity funds focused on market-neutral strategies.

"Even if the project tries to sell its locked tokens at a discount of 30% to 40% on the OTC (, it is still difficult to find buyers. The market generally expects altcoin prices to plummet," said Presto research analyst Min Jung.

Presto wrote last year that it would take $60 billion in buying pressure to maintain the prices of the top ten tokens (STRK, ENA, JUP, ONDO, etc.) set to launch in 2024.

This mismatch between supply and demand means that liquidity funds must work harder to pick the "right" winners.

The phenomenon of "a rising tide lifts all boats (BTC)" is no longer present in the past cycles.

In the second part of this series, we will explore:

How can liquidity funds use fundamentals to adapt to market changes?

Which cryptocurrency sectors are liquidity funds paying attention to?

Has the four-year cycle ended?

Has the L1 valuation premium disappeared?

Please stay tuned for the second part of the 0xResearch newsletter later this week.