UTXO Management Quarterly Report
Deploying Institutional Liquidity on Bitcoin
This report intends to share the latest information available regarding UTXO Management activities and a brief overview of the Bitcoin ecosystem landscape over the quarter and provide updated data about our investments. Furthermore, each edition of this report will be accompanied by commentary from UTXO employees who will share exclusive insights based on their role within the fund.
This edition of the report will feature Henry Elder who will provide readers with an overview of how UTXO is pioneering on-chain capital deployment as an investment fund and describe how to evaluate yield-generating strategies within the Bitcoin L2 space.
The information contained herein has been provided to you by UTXO Management, LLC and its affiliates (“UTXO Management”) solely for informational purposes. Neither the information, nor any opinion contained herein, constitutes an offer to buy or sell, or a solicitation of an offer to buy or sell, any advisory services, securities, futures, options, coins or other financial instruments. Nothing contained herein constitutes investment, legal or tax advice or is an endorsement of any of the companies, digital currencies, or coins mentioned herein. You should make your own investigations and evaluations of the information herein, as it may not be independently verified by UTXO Management.
UTXO Management, its affiliates, funds and principals may have financial exposure to the companies, digital currencies and investment themes mentioned. Except where otherwise indicated, the information in this document is based on matters as they exist as of the date of preparation and not as of any future date, and will not be updated or otherwise revised to reflect information that subsequently becomes available, or circumstances existing or changes occurring after the date hereof.
Quarterly Macro State of Bitcoin Investing (L2s, Runes, and Crypto-Equities)
Frontrunning the future: A story about the rise of Bitcoin L2s and the stickiness of TVL.
While Q4 2023 and Q1 2024 were marked by a surge in interest for BitVM and the new possibilities it can enable, Q2 2024 has been a sobering quarter for most market participants. Valuations have cooled down and new research initiatives have helped make sense of what is happening on Bitcoin. Indeed, we are on the verge of a possible new bull market for Bitcoin coupled with a reinvigorated sense of purpose among many developers looking to build new, exciting applications on top of Bitcoin, which will undoubtedly lead to a reframing of Bitcoin itself. Like it or not, within the next 18 months, Bitcoin is going to become a competitor to ETH and Solana both in terms of programmability and ease of use. Many different teams are working on new ways to bring utility to BTC by creating new financial applications that will directly reward users and liquidity providers with native yield.
As with all disruptive changes, making sense of it all can be a daunting task. But that is precisely what is needed right now for Bitcoin to succeed in its transformation.
Despite being an incomplete and often misleading metric, Total Value Locked or TVL, can sometimes provide insight into the market’s appetite to put digital assets to use. Users stake, or lock, digital assets on a protocol or decentralized finance application in exchange for some reward or incentive being offered by the platform. While TVL across Bitcoin L2s skyrocketed in Q1 and even in the first few weeks of Q2, Q2 marked a dramatic downturn in the trend. The Q2 insight is abundantly clear - TVL across major Bitcoin L2s (with the caveat that most L2s haven’t even launched on mainnet yet) decreased from $1.32B on April 9th to $800M at the time of writing. So what went wrong?
Stickiness, or rather the lack thereof. Most projects have chosen to adopt incentive structures and go-to-market strategies that are common in other ecosystems, forgetting that building on Bitcoin is different. Most of the capital in crypto is mercenary capital, meaning that capital will readily be transferred from one protocol to the next with one goal: maximize returns. Thus, users target protocols offering the greatest amount of rewards to use their platform.
Does that mean that Bitcoin sidechains (looking to become L2s) are doomed to fail?
On the contrary, it means that early Bitcoin Sidechains that will have a first mover advantage and be able to attract more meaningful TVL because of their capacity to render BTC useful won’t have to rely so much on said incentives, and instead will be able to organically grow their userbase. What good is liquidity if no one wants to use it?
We are expecting this differentiation to happen between Q3 and Q4 of this year, as different teams continue to make technical progress on bridging architecture, UX (User Experience) design, and product match with bitcoiners looking to put their BTC to work.
A post-mortem on Runes and the Ordinals Ecosystem:
Coming off all-time highs for Bitcoin and entering into the Halving month, the entire ecosystem was a fertile ground for euphoria and big expectations. Bitcoin was the talk of the town and the narrative around Runes was gaining traction everywhere. Blue chip Ordinal collections like Pups and NodeMonkes outperformed everything and became the main theme for Crypto Twitter. Before the halving, the pre-runes narrative allowed traders to express a view on the potential of Runes resulting in many tokens skyrocketing in value. However, the initial response to Runes didn't match pre-launch expectations, despite miners largely benefiting from the initial waves of people minting new tokens. As the market cooled down and expectations were leveled, the community realized that Runes was, at best, a marginal improvement upon the BRC-20 standard instead of the promised paradigm change. Consequently, Pre-Runes tokens faced heavy sell pressures while only a few select meme coins managed to outperform everything. Since then, most valuations for Runes and Ordinals have been in a downward spiral fueled by the continued decrease in bitcoin price and the waning interest in meme tokens.
Figure 1: Crypto Fear and Greed Index
In that sense, we started the quarter with Greed, and we’re ending this quarter with Fear. The Crypto Fear and Greed index which is typically used to gauge investor sentiment started around 80 at the beginning of Q2 2024 and ended around 30 at the end of the quarter, a level not seen since September 2023.
While the summer is typically a period of sideways price action for bitcoin and equities, the asymmetry of the Runes bet remains hard to ignore. As a reminder, the total market cap of Runes remains under $2B (with around 50% being DOG) and there are still no Runes listed on major exchanges (for reference, the marketcap of all meme tokens on Solana is around $6.2B, while the marketcap of frog themed tokens is around $5.2B). If history repeats itself, a wave of listings could spark a new Bull Run for the ecosystem, similar to what happened in 2023 with BRC-20s and Ordi on Binance. Moreover, as more analysts entertain the possibility of a Solana ETF, the narrative around meme coins could be reinforced, leading to a trickle-down effect for Runes. Therefore, UTXO will continue to make investments both into Runes and Runes infrastructure, as we believe that tokens on Bitcoin are here to stay. The On-Chain data is also here to support this, even as the price of most Runes has declined, they continue to represent close to 50% of all on-chain activity on Bitcoin in terms of transaction fees.
Figure 2: Runes vs Other Tx Fees on Bitcoin
Furthermore, data from GeniiData about Liquidium showcases that runes are slowly outpacing the number of ordinals being used as collateral on the Bitcoin native lending protocol. The backbone of the ecosystem is slowly moving to become one of the Runes standard.
Figure 3: Volume of Ordinals vs Runes backing collateral on Liquidium
The success of MetaPlanet - Running the MicroStrategy playbook
Early in the quarter, UTXO made an investment into Metaplanet. The success was immediate, with the stock price opening the quarter at 20 JPY and closing at 100 JPY by the end of Q2). UTXO is proud to support a renewed interest in Bitcoin as the ultimate treasury asset among public companies.
As of July 8, Metaplanet holds ~203.73 bitcoin acquired for ¥2.05 billion at an average price of ¥10,062,517 per $BTC.
As Metaplanet adopts its Bitcoin strategy, the goal is to enhance shareholder value through strategic, perpetual Bitcoin accumulation, aligned with a proven long-term, value-accretive vision. Through this approach, Metaplanet is able to develop business verticals that align with the overarching mission of adopting a corporate Bitcoin standard. The strategic roadmap encompasses various financial tactics, including equity financing considerations and long-dated fiat currency market arbitrage, all executed within a Bitcoin-centric framework.
Since then, UTXO has been approached by dozens of companies looking to replicate MetaPlanet’s strategy and adopt Bitcoin as a treasury asset. We’ll continue to monitor attractive opportunities with the goal of getting every company “off-zero” with their Bitcoin treasuries.
*Tyler Evans has been appointed to the Board of Directors of MetaPlanet as an Independent Director
Publicly Disclosed Investments in Q2 2024:
BitLayer: https://x.com/UTXOmgmt/status/1774754190704730300
Metaplanet: https://x.com/UTXOmgmt/status/1777795556561056045
Arch Network: https://x.com/UTXOmgmt/status/1778456304756875625
Ord.io: https://x.com/UTXOmgmt/status/1780979437917385070
SatScreener: https://x.com/SatScreener/status/1781466391205356017
SatRepublic: https://x.com/RunevoBTC/status/1782810008444457191
BotanixLabs: https://x.com/BotanixLabs/status/1787831600064897365
UXUY: https://x.com/uxuycom/status/1788584340860858553
Bitcoin Layers: https://x.com/UTXOmgmt/status/1795861978142916817
BAMK.fi: https://x.com/UTXOmgmt/status/1801004866195579080
Lava: https://x.com/UTXOmgmt/status/1803433002027889147
Ordinox: https://x.com/UTXOmgmt/status/1803519605995876724
Rebar Labs: https://x.com/UTXOmgmt/status/1806324153328324958
QED Protocol: https://x.com/UTXOmgmt/status/1808550490105417878
During the Quarter, we’ve also published our Investment thesis describing Bitcoin as the Settlement Chain for all economic activity: https://www.utxo.management/
Section 2 (Henry & GG):
Henry is a Principal at UTXO Management, managing the Bitcoin Decentralized Finance (DeFi/BTCFi) portfolio. He has been investing in Bitcoin since 2016 and was previously Head of DeFi at Wave Digital Assets, leading separate DeFi ecosystem funds for Polygon, Cardano, Horizen, and Hedera.
How we’re pioneering on-chain capital deployment as an investment fund
Throughout the entire history of digital assets, Bitcoin has held the distinction of being the most desirable of the asset class. And yet, Bitcoin holders wishing to generate yield were typically required to pursue one of two custodial (trusted) options:
- Lend BTC to counterparties via centralized entities such as Genesis or Galaxy.
- Wrap BTC into an ERC-20 token (a fungible token standard on Ethereum) via depositing the BTC at Bitgo.
During this time, Ethereum developed a sprawling decentralized finance ecosystem that enabled the creation of sophisticated financial products that minimized counterparty risk. Wrapped BTC was adopted early in this ecosystem, but it did not find significant product market fit with Bitcoin holders, leading to less than 0.01% of all bitcoin being wrapped. This period coincided with an entrenched conservative mindset within the bitcoin ecosystem that eschewed innovation or cooperation with other chains.
Bitcoin began to emerge from this innovation “Dark Age” in mid-2023, and by 2024 had a nascent, but flourishing, ecosystem of decentralized finance (“BTCfi”) and Layer-2 blockchains anchored in the Bitcoin ethos and ecosystem. This new BTCfi ecosystem ports over many of the trustless models for financial products developed on Ethereum, giving Bitcoiners access to native yield opportunities for the first time.
DOMINATING THE LEADERBOARDS
UTXO has been at the forefront of this BTCfi Renaissance, testing blockchains, applications, and strategies. The fund has become the most recognizable institution in BTCfi, drawing deal flow and new opportunities. We are operating a validator for Core Chain, and supplying liquidity to Core, BoB, and Mezo.
\Figure 6: CoreDAO Ecosystem Rewards Leaderboard
Figure 7: BOB (Building on Bitcoin) Rewards Leaderboard
Figure 9: BAMK Leaderboard with UTXO occupying the Number 1 and 2 spots
Understanding Yield-generating strategies in the Bitcoin L2 Space
Henry previously managed a series of funds that were dedicated to providing liquidity (LP) to specific blockchain DeFi ecosystems. Investing in DeFi is a unique process that requires new tools and heuristics to analyze value, execute trades, manage positions, and evaluate risks.
In our experience, the culture of the chain can have a significant impact on the long-term viability and corresponding value of its DeFi ecosystem. Bitcoin has an inherent benefit in this regard as a chain with a long-established cultural preference for security and careful evaluation of technology. UTXO is committed to furthering those values in recognition of the competitive edge they will provide BTCfi as it grows and moves into direct competition with the more mature DeFi ecosystems on other chains.
BTCfi is in its infancy and can be broadly organized into 3 categories: sidechains, Layer-2 chains and metaprotocols.
Sidechains
Sidechains were built on top of or alongside bitcoin with a focus on cultural commitment to bitcoin but not a strong technological or security link. The Bitcoin sidechains that exist today mostly draw inspiration from existing Ethereum L2 defi ecosystems such as Blast or Polygon. Rootstock, Core, BoB, BSquared, and Merlin fall into this camp, with each having tenuous technological and security links to bitcoin, instead opting for an Ethereum Virtual Machine (EVM) approach, integrating Ethereum assets and Ethereum tools such as Metamask.
Sidechains are currently much simpler to launch than true Layer 2s, so it’s no surprise that the sidechain landscape is the most developed and mature BTCfi ecosystem, as the products and tools have already been developed over the past several years on Ethereum. These ecosystems also benefit from the highly developed security auditing infrastructure that already exists for Ethereum and its associated L2s,easily enabling developers to fork code from battle-tested applications that exist on those chains.
Stacks is a notable exception in this category - a sidechain that does not use an EVM and is not a rollup on top of Ethereum or Ethereum technologies. Stacks is a sidechain that uses a Proof-of-Stake model leveraging a native token, STX. The virtual machine is called Clarity. Stacks is moving towards a security model that more closely ties the chain to Bitcoin, but the full rollout of this Nakamoto upgrade isn’t expected until later this year.
Layer-2 Chains
Layer-2 chains, built on top of bitcoin, attempt to directly benefit from bitcoin protocol security using various technologies, such as ZK rollups. They may use bitcoin-native assets, Ethereum-native assets, or a mix of the two. Lightning network, Botanix, Citrea, and Alpen are examples of this cohort.
- Other than Lightning Network, these products are largely still in the development stage and each implement unique and novel technical solutions to link security to Bitcoin.
- Botanix and Citrea will use EVM and inherit the benefits of doing so. Lightning Network does not have a virtual machine as it’s a simple peer-to-peer transaction settlement network.
Bitcoin Metaprotocols
Bitcoin metaprotocols that use the bitcoin chain directly and are the most bitcoin-native classification. They use bitcoin-native assets and the relevant details of their operations are encoded directly into bitcoin blocks, although they must be decoded using custom indexers. Arch Network is an example of a metaprotocol that supports BTCfi applications, but Ordinals, BRC-20s, and Runes are also metaprotocols, they simply support BTCfi assets.
Quantifying the opportunity size for true native Bitcoin Yield
Bitcoin is the only crypto asset with universal appeal. It is now recognized, understood, and trusted throughout the crypto world, retail tradfi world, and institutional tradfi world. This drives great demand for usage as a collateral asset, trade settlement asset, and money. However, the lack of programmability and lack of a native financial ecosystem has relegated Bitcoin to primarily meeting that demand through centralized entities, which have been hesitant to facilitate such activity due to a hostile regulatory environment for most of the past 15 years.
ETH has historically dominated demand for on-chain crypto asset financialization, with $115 billion worth of ETH staked to secure the Ethereum network and $35 billion further restaked to secure other networks. ETH is also the most widely-used collateral asset on chain, collateralizing a large portion of the $35 billion on-chain lending markets and $10 billion crypto-collateralized stablecoin market.
ETH staking and restaking provide the equivalent “risk-free rate” for crypto. This rate, at 3%, is currently lower than the real-world risk-free rate due to the high volatility of the base asset. As volatility dampens over time we should see this rate rise to meet and eventually exceed the real-world risk-free rate. This entire use case will likely be subsumed by bitcoin, which is a superior collateral asset and is rapidly catching up on relevant technological metrics.
Bitcoin also has a superior cultural component: it hasn’t historically been viewed as a competitor to most smart-contracting blockchains. Therefore, the deeply partisan relationships between Ethereum, Solana, Cardano, Tron, and others do not exist to the same degree with Bitcoin. This partisanship limits the ability to which an individual chain can interact with a competing chain at the base layer.
As a result, each chain uses its own base asset to bootstrap security and continually dilutes holders through high inflation. This security subsidy is a massive cost for the chain, and means that the vast majority of blockchains are unprofitable the majority of the time. This is completely unnecessary. Layer 2 technologies demonstrate that a chain with a unique asset and technology can exist on top of a far more secure Layer 1 and reduce security costs by 10-100x.
The only real Layer 1 option to build on has been Ethereum, which is culturally impossible for legacy competitors like Cardano, Polkadot, Cosmos, Avalanche, Tron, BNB, and Solana. Bitcoin now offers an alternative that is economically more secure, credibly neutral, and potentially offers superior technological security, as well, by dint of a lower attack surface than Ethereum. Legacy projects can remove billions of dollars of annual expenses and/or inflation by moving to a proof-of-stake model using BTC or an L2 directly on top of Bitcoin, while getting better security and maintaining a high degree of technological and cultural independence.
Managing risk when you’re early
DeFi is similar to traditional lending in that the biggest single risk is usually your counterparty, or in this case, the decentralized application itself. History shows that a hack of the application often results in the total loss of principal. Diversification can be a useful tool to counter this risk, but DeFi requires other, new frameworks to evaluate risks as well. The underlying technology is usually more relevant than the balance sheet. Your returns can be denominated in a range of cryptocurrencies that each come with unique risks, such as tokenomics, tech risks, and founder/product quality. Custody solutions are highly fragmented, with best practices defined by the capability and product availability on each blockchain. Crisis situations can happen in a literal instant, forcing asset managers to react instinctively. The risk/reward for vanilla liquidity provisioning is often unattractive compared to the additional incentives that a large LP can extract. Together, these factors have led to a decline in retail LP as efficiencies in risk management and incentive extraction accrue to institutional investors.