The past six months have been challenging for digital asset markets, with volatile prices and supply imbalances dominating the landscape. However, beneath the surface, smart contract platforms (SCP), which form the backbone of the digital asset ecosystem, are seeing quiet growth in adoption and capital inflows. Despite potential political challenges that could affect market sentiment, such as a Harris administration or a fiscally conservative government, the momentum behind Blockchain technology and its adoption appears to be steadily building.

Key questions for the market include: Is the digital economy expanding? By how much? And what metrics should be used to define this growth? These questions are critical for shaping decisions about exposure to digital assets.

This report provides an update on the state of digital markets, focusing on the SCP sector. It also introduces the beta versions of the SCP Network and Asset Pulse dashboards, which are expected to play a crucial role in future analyses.

Key Takeaways

• Nearing Market Bottom: The significant market correction shows signs of exhaustion, with most metrics reaching extremes and fewer assets hitting new lows.

• Bullish Liquidity Setup: Weakness in the U.S. dollar and central bank balance sheet expansions are creating a favorable liquidity environment, with signals indicating a potential reversal.

• Robust Network Growth: Despite weak price action, active addresses have increased during the correction, and total value locked (TVL) remains resilient, showing continued capital inflows.

• Fee Decline Explained: Updates in protocols and market dynamics have contributed to a decrease in fee revenue for Layer 1 blockchains.

• Ethereum Dominance: Ethereum (ETH) is at a pivotal moment within the SCP sector, either primed for a breakdown or poised for a strong recovery.

Market Update

The mid-cycle downturn, which began in March/April, has extended its downward trend into the current period. This ongoing correction has been characterized by significant volatility and price declines across the digital asset markets, especially in the broader cryptocurrency space. A 55% pullback from the Q1 peak in the Top 200 equal-weighted index is certainly notable, but it is essential to understand that such corrections are not unusual in the context of historical market behaviour within this asset class.

In fact, these kinds of substantial price retracements have been a hallmark of previous market cycles in the crypto space, especially in mid-cycle periods. The volatility and rapid price swings that characterize digital assets make them more prone to sharp corrections, but these corrections are often followed by periods of recovery and growth. Let’s break down why this 55% pullback, while severe, aligns with historical trends:

1. Historical Precedent of Mid-Cycle Corrections:

In previous market cycles, particularly in 2018 and 2022, similar corrections occurred during mid-cycle periods. For instance, during the 2017-2018 bull market, Bitcoin and other digital assets experienced multiple corrections exceeding 40% before the market reached its peak. Likewise, in 2022, following the highs of 2021, the market went through several steep corrections, some as deep as 50-60%, before eventually stabilizing and recovering.

The current 55% decline from the Q1 peak fits within this historical context. It signals a natural ebb in the market cycle, where exuberance is often followed by profit-taking, reallocation of capital, and, in some cases, market-wide deleveraging.

2. Cyclical Nature of Digital Asset Markets:

The cryptocurrency market has shown itself to be highly cyclical, with periods of rapid expansion typically followed by contraction phases. These contraction phases are necessary for markets to consolidate, shake out weak hands, and reset expectations before the next phase of growth can occur. The 55% pullback from Q1 is consistent with this cyclical nature, indicating a period of consolidation rather than the onset of a long-term bear market.

In this case, the mid-cycle correction could be viewed as a healthy realignment, where market excesses are tempered, liquidity is reallocated, and speculative positions are unwound. These processes often pave the way for a more sustainable rally in subsequent months, setting the stage for the next upward leg of the market cycle.

3. Technical and Sentiment-Based Factors:

Beyond macroeconomic influences, technical indicators and market sentiment often play a crucial role in triggering and exacerbating such corrections. In the case of this 55% pullback, the market was likely reacting to a combination of factors, including overextended valuations, profit-taking after the Q1 run-up, and concerns over tightening global liquidity.

Sentiment indicators, such as market breadth and the advance/decline ratio, have been signaling a weakening market position since the downturn began. However, this type of technical exhaustion often precedes market recoveries, as seen in previous cycles. In the past, once the market completes its downward consolidation phase, these technical indicators tend to reverse, signaling the beginning of a new uptrend.

4. Macro Factors and Global Liquidity:

Macro-level factors also contribute to these mid-cycle corrections. In recent months, concerns over rising interest rates, global economic instability, and a strong U.S. dollar have weighed heavily on risk assets, including cryptocurrencies. These factors have added pressure to the market, amplifying the magnitude of the correction.

That said, the macro environment is also fluid, and liquidity conditions can change rapidly. Historically, when central banks adopt more accommodative policies, or when the U.S. dollar weakens, markets have rebounded from such corrections. Should liquidity conditions improve in the coming months, the current 55% pullback could mark the beginning of a recovery phase, much like we’ve seen in previous cycles when external pressures began to ease.

5. Long-Term Structural Growth:

It’s also important to view this pullback within the broader context of the digital asset market’s long-term growth. Despite short-term price fluctuations, the underlying adoption and infrastructure development in the cryptocurrency ecosystem continue to expand. Institutional interest in blockchain technology, decentralized finance (DeFi), and smart contract platforms (SCPs) remains robust, even amid market volatility. These structural drivers of long-term growth tend to remain intact, regardless of mid-cycle corrections.

As witnessed in prior market downturns, these corrections often represent opportunities for long-term investors to re-enter the market at more favorable valuations. Once the market stabilises, the same long-term trends that have driven the digital asset ecosystem’s growth — increased adoption, technological innovation, and institutional participation — are likely to fuel the next upward cycle.

While the 55% pullback from the Q1 peak in the Top 200 equal-weighted index is substantial, it remains within the boundaries of what can be expected during a mid-cycle correction in the volatile digital asset markets. This decline mirrors similar corrections seen in previous market cycles, which often serve as a healthy realignment phase before the next growth period. With historical precedent, cyclical behavior, and improving liquidity prospects, the market may be setting up for a recovery, much like it has done following other deep corrections in the past.

Market Breadth

A review of the equal-weight index reveals that market breadth remains weak. Large-cap assets like Bitcoin (down 21%), Ethereum (down 41%), and Solana (down 35%) have performed better than smaller altcoins, keeping the market cap-weighted Top 200 positive year-to-date, outperforming the equal-weighted index.

The Altseason indicator, which tracks how many of the Top 200 assets have outperformed Bitcoin in the last 90 days, remains low. Historically, this indicator bottoms out during extreme bearish phases, suggesting that the market may be approaching the final stages of this correction.

Three key breadth indicators offer insights into market positioning:

1. Advance/Decline Line (ADL): The ADL, tracking the net daily advances across the Top 40 assets, remains in a downtrend. However, the ADL momentum oscillator shows a bullish divergence, indicating potential exhaustion in the downward trend.

2. Top 20 Assets Above their 200-Day Moving Average: Only 6% of the Top 20 assets remain above this key moving average, a low not seen since previous market downturns.

3. 180-Day Lows: A surge in assets hitting 180-day lows indicates significant market stress, though fewer assets are making new lows compared to earlier in the downturn, suggesting the market may be nearing a bottom.

Seasonality

September has been a challenging month for Bitcoin, with data showing weaker price performance compared to other months. This can be attributed to a range of factors, including lower market participation due to the end of the summer season, broader macroeconomic uncertainty, and sometimes increased regulatory scrutiny as governments and institutions prepare for the final quarter of the year.

However, despite these seasonal headwinds, Bitcoin typically experiences a turnaround as it enters the fourth quarter. This trend has been particularly evident during Bitcoin’s “halving years” — the years when Bitcoin’s mining reward is halved, an event that occurs roughly every four years. Since 2016, Q4 in halving years has demonstrated especially strong performance for Bitcoin. This phenomenon can be linked to a combination of factors, including:

1. Supply Shock: After a halving event, the rate at which new Bitcoin is created is reduced by half. This reduction in new supply typically leads to a supply-demand imbalance over time, as demand either remains steady or increases while the new supply decreases. This supply shock tends to become more noticeable towards the end of the year following a halving, often sparking significant price rallies in Q4 as investors anticipate reduced supply.

2. Increased Institutional Participation: Q4 is often marked by higher institutional trading activity as large investors rebalance portfolios, make year-end adjustments, and look for opportunities to generate returns. Since Bitcoin has matured into an asset class of interest to hedge funds, asset managers, and even corporations, this increased participation can provide a boost in liquidity and demand.

3. Market Sentiment and Historical Precedent: Bitcoin has developed a reputation for experiencing strong price movements in the latter part of the year, especially in halving cycles. This historical precedent can create a self-fulfilling prophecy, as traders and investors position themselves in anticipation of a Q4 rally, further fueling upward price pressure.

4. Holiday Season Effect: The holiday season tends to bring increased consumer and retail interest in Bitcoin and cryptocurrencies. As people become more involved in digital assets, whether as investments or gifts, the demand for Bitcoin rises. This retail interest adds a layer of support to the price during Q4.

5. Macro Factors: Q4 often coincides with pivotal macroeconomic decisions, such as central banks’ fiscal year-end strategies or tax-related market movements. A favourable macro environment, including potential stimulus packages, dovish monetary policy, or an easing of liquidity constraints, can provide additional momentum to Bitcoin’s Q4 performance.

While September often presents hurdles for Bitcoin, the fourth quarter is typically a period of recovery and growth. Halving cycles in particular create conditions where Bitcoin experiences amplified gains, as the combination of reduced supply, heightened institutional and retail demand, and favorable macro conditions converge to push the price higher. If historical patterns hold, Bitcoin’s upcoming Q4 could once again see significant upward momentum, driven by these recurring factors.

Liquidity Outlook

The liquidity environment has become increasingly supportive of digital assets since August. The U.S. Dollar has weakened, signaling potential increases in global liquidity. A weaker dollar historically benefits assets like Bitcoin, which may indicate a forthcoming market reversal.

Global money supply is also rising, with central banks, such as China and Japan, coordinating liquidity injections. This has led to the first bullish signal in the Macro State Indicator (MSI) since November 2023, suggesting that a favorable liquidity regime could persist into 2025.

Historically, when liquidity is abundant, altcoins have outperformed. This pattern may repeat, with a strong Bitcoin move potentially followed by a rally in select altcoins. The liquidity landscape indicates the potential for a sustained recovery in the digital asset markets over the coming quarters.