The first half of 2024 has started a new cycle for the crypto’s adoption. The long awaited approval of Bitcoin ETFs was a decisive factor for this new cycle, along with strong price momentum that led to bitcoin reaching a new all-time high. This not only pushed bitcoin to the doorstep of institutional adoption again, but it also positioned the market for another potential bull market cycle. 

These cycles have been marked not only by the introduction of new projects, from Bittensor and ZKSync, to Bonk and Dogwifhat, but also by strong price appreciation of many digital assets. With a higher beta compared to bitcoin, assets of varying sizes and sectors often experience greater volatility, reflecting investors' expectations of higher returns.

Several trends are shaping the altcoin market in 2024 that signify a focus on innovation, sustainability, and exploration of new use cases, driving growth among altcoins.  

Re-staking has emerged as a notable vertical for this new cycle, which involves continuously staking the rewards earned from staking tokens, compounding the returns over time. Projects  like EigenLayer (EIGEN), EtherFi (ETHFI), and Renzo (REZ) have implemented mechanisms that encourage users to restake their staking rewards, thereby increasing their stake in the network and contributing to its security and stability. 

Altcoins are increasingly adopting Layer2 scaling solutions such as Optimistic Rollups, zkRollups and side-chains to improve transaction speeds and reduce fees. Projects in this category include Arbitrum (ARB), Optimism (OP), Polygon (MATIC), Starknet (STRK), among many others. This trend aims to enhance user experience and attract more users to these projects’ platforms.

Interoperability between blockchain networks is also a growing trend. Some projects are collaborating and building bridges to enable asset transfers and communication across disparate blockchains. This trend aims to create a more interconnected and efficient blockchain ecosystem instead of many different siloed blockchains. Examples of such projects include Axelar (AXL), Across (ACX) and Stargate (STG).

With the rise of Layer 2 solutions and interoperability, modular blockchains represent the next phase of digital assets’ evolution. With their adaptable and customizable design, these offer a flexible framework where developers can plug-and-play modules like consensus mechanisms, token standards and governance models. Blockchains such as Celestia (TIA) and Dymension (DYM) are using this modularity to enhance scalability, interoperability and security. 

Parallelized Ethereum Virtual Machines (EVMs) break down smart contract execution into parallel tasks, harnessing the power of multiple nodes simultaneously. The most popular parallelized EVMs, such as Sei (SEI), Canto (CANTO), Nomad, and NeonEVM (NEON), are attempting to do this by processing transactions off-chain, then aggregating them back onto the Ethereum mainnet. This approach drastically improves transaction throughput and reduces latency, addressing Ethereum's historic limitations.

Current crypto market prices seem to indicate that a bull market is underway, mega caps may still have room to grow before smaller coins outperform the rest of the market. However, this phase may not be far off and, once it begins, being under-positioned could be difficult and potentially costly, especially as institutional adoption grows and the need to generate alpha increases.

- Santiago Velasco, senior trader, Nonco

Digital assets may be one of the few markets where diversification still seems underappreciated. Bitcoin and Ethereum remain dominant by market cap despite a growing number of innovative new projects, and many investment products provide only a handful of concentrated positions. 

At Outerlands Capital we have written about the benefit to risk-adjusted returns from diversification. Individually, smaller projects may carry higher risk, but investing across a broad mix of projects can reduce volatility and improve risk-return metrics like the Sharpe ratio (returns normalized for volatility). However, there’s more to diversification than higher Sharpe ratios. 

In a market as dynamic as crypto, diversification is essential to gain exposure to the varied and evolving mix of themes and sectors built around blockchain technology. Diversification is about solving for the power law distribution of returns, whereby a portfolio’s return is driven by a small number of highly positive outcomes against a larger number of investments that deliver lower, or negative, returns. This phenomenon is well documented in venture capital (VC) investing, and the concept carries over to digital asset investments, which are akin to investments in disruptive tech startups. Diversifying makes sure your portfolio has enough shots-on-goal to capture the biggest winners over time.

A concentrated portfolio of just a handful of tokens will struggle to capture the range of exciting crypto use-cases being developed today. Take, for example, the 10 largest cryptocurrencies by market capitalization – a popular take on a ready-made “diversified” portfolio. You have here, essentially, a mix of currencies and Layer 1s. While these larger tokens are sometimes seen as less risky on account of scale, such a selection fails to capture much of the current innovation happening in crypto. 

Expand to an actively managed portfolio encompassing tokens from the Top 150 by market cap and you start to see a much more dynamic picture, spanning Layer 1s and related infrastructure (like scaling solutions and interoperability), DeFi (from trading and lending to asset management), entertainment (including gaming and the metaverse), decentralized physical infrastructure networks (DePIN, including projects for distributed compute power with tie-ins to AI), real-world-assets (RWAs), and more. While some of these projects may carry greater risk on their own, diversification helps manage the risk of the overall portfolio.

Portfolios should be positioned to capture emerging themes and new directions as projects across the space continue to innovate, searching for product-market-fit. Even in the more developed parts of the crypto ecosystem, such as payments or Layer 1s, we believe it is still much too early to call winners. The pace of innovation means disruption will continue to be the norm.

The nascency of the market and its fast-paced evolution also mean that an active approach to portfolio management is imperative: Diversified is not equal to passive. Building a well diversified portfolio does not mean just buying more, smaller assets. It means taking a long-term perspective on the scale and scope of the digital assets ecosystem, and positioning a portfolio to take advantage of the many different potential outcomes.

Coming out of crypto conferences like Consensus, AIMA Digital Assets, Token2049, and DAS, we are again emboldened in our assessment that the average institutional crypto portfolio is simply not exposed to enough of the disruptive use-cases being tested in digital assets today. Budding themes such as DePIN, innovative scaling solutions for Ethereum and also Bitcoin, and bringing real-world-assets on-chain all require a deep look past the largest tokens, and should encourage portfolios of digital assets spanning many sectors and project sizes. 

Remember that diversifying doesn’t make a portfolio less potent - it actually gives investors more opportunities to capture winners, while still providing time-tested risk benefits. In essence, diversification gives you more for less.

Disclosure: The information herein is for general information purposes only and is not investment advice. An investment involves a high degree of risk. Past performance is not necessarily indicative of future results.

– Felix Stratmann, head of research at Outerlands Capital

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