August 23 Commentary

News Highlights

1. Europe’s first spot bitcoin ETF is going live
2. US court says SEC wrong to deny Grayscale’s spot bitcoin ETF proposal
3. Balancer exploited in nearly $900k after vulnerability warning
4. PayPal Launches PYUSD Stablecoin
5. Sam Bankman-Fried’s Bail Revoked, Sent to Jail Until October Trial
6. Prime Trust Files for Chapter 11 Bankruptcy, Top 50 Creditors Owed $145mm
7. WSJ Claims Binance Is Committing Massive US Sanctions Violations with Russian Banks
8. Coinbase and Circle End USDC Consortium, Coinbase Buys Stake in Circle
9. Coinbase wins approval to offer crypto futures trading in the US
10. Genesis and DCG Reach In-Principle Agreement with Creditors

Chart of the month:

Figure 1: 15-min frequency time series of the price of the Ripple inverse perpetual swap contract on Bybit (candles) superimposed to the spot price of XRP on Coinbase (orange line). On the bottom panel, we additionally show the liquidations on the perpetual swap (red for long positions being liquidated). It can be observed how during the sell-off on August 17th the intense flow of liquidations pushed the price to a considerable discount, creating a trading opportunity that lasted just less than an hour. The reason for such inefficiency is that Ripple inverse contracts need to be collateralised with XRP itself, requiring market participants to first source the coin, before being able to buy the perpetual. source: Coinalyze

Commentary:

For a month that is the pinnacle of Summer in Europe, August showed us more volatility than we might have liked to see. Overall a negative month for most asset classes, the crypto markets have not distinguished themselves in positive, with Bitcoin more than decimated during the last two weeks of the month. In fact, the month was poised for better performance with positive news on the regulatory front. The approval of Europe’s first spot Bitcoin ETF and the U.S. court ruling in favor of Grayscale’s ETF proposal are significant markers of regulatory acceptance. These developments could serve as catalysts for more institutional money to flow into the crypto market. The ETFs provide a regulated investment vehicle, making it easier for institutional investors to gain exposure to cryptocurrencies without the complexities of direct ownership. With the new ruling, the SEC will have to be more imaginative next time to reject the spot ETF applications, given it has already approved the Futures-based one. Additionally, PayPal’s launch of the PYUSD stablecoin signals that traditional finance companies are making significant strides in the crypto space. These companies bring with them a level of credibility and regulatory compliance that could attract more mainstream users to crypto. However, their entry also raises questions about the decentralization ethos of cryptocurrencies. Will the involvement of these giants lead to a more centralized crypto ecosystem?

While crypto players have their heads spinning around these questions, traditional market participants get their fair share of spinning, evaluating equity indices close to their all-time high, while we are, from certain points of view, in one of the most severe tightening environments in the last 50 years. Rates climbed fast, and, for the first time, the actual supply of money is not only rising more slowly, but it’s actually contracting, as shown in Figure 2. The medium-to-long-term repercussions of the current environment are difficult to predict, however, some consensus is forming around the notion that things will get ugly before we can forget about the turmoil of the last few years, and initiate a new path, free of the inherited problems developed during and before the Covid crisis.

It should be expected that large movements in traditional markets will propagate, and often be amplified in the crypto markets, as we witnessed this month (see Figure 3).

Figure 2: Monthly time series of the one-year change in M2 as a proxy for the money supply in the US. It should be noted how we are currently experiencing the first instance of contraction of quantity of money readily spendable, in more than 50 years. source: Board of Governors of the Federal Reserve System

Figure 3: August monthly performance for major equity indices (SP500 and Nasdaq), Gold, 10Y US rates, and Bitcoin. Not surprisingly BTC showed higher volatility than other asset classes, while also being in the red for the month, together with Equities, gold, and bonds. source: Fasanara Digital

Figure 4: hourly time series of the price of Bitcoin (orange) and Nasdaq (blue) over the month of August. In the bottom panel, we show the discount on NAV for Grayscale Bitcoin (GBTC) trust. It can be noticed how both Bitcoin appreciated, and the discount to NAV for GBTC contracted on the news that Grayscale won against the SEC in its case claiming the unfairness of the rejection of conversion in spot ETF from the current trust structure. All gains associated with the news have been given back by Bitcoin, but the discount has not widened. source: TradingView

Zooming more specifically on the performance of crypto markets, this month we observed a period of high market dislocations during the market sell-off on the 17th, as well as more contained volatility towards month-end, in response to the ruling in favor of Grayscale against the SEC. These latter gains were not however long-lasting, with everything given away within 48 hours. As shown in Figure 4 on the other hand, the Grayscale Bitcoin Trust (GBTC) discount to NAV has narrowed considerably in response to the ruling and has remained relatively stable since. On the same picture, more concerningly, we can observe how Nasdaq has recovered most of the ground lost during the first half of the month over the last two weeks, while Bitcoin has failed to recover the losses of the 17th. Late to come and, so far, late to leave.

Figure 5: Time series of the open interest (OI) weighted Funding rate for Bitcoin perpetual swaps on the major derivative exchanges. As it can be observed the cost of leverage was quite healthy over the first half of the month and collapsed with the market crash on August 17th. source: Laevitas

Looking past Bitcoin price action, the situation becomes grimmer, with most altcoins (and in particular excluding ETH) having had a rather suboptimal first half of the year, failing, in the aggregate, to recover any of the ground lost since the Luna collapse more than one year ago. Even looking at the fundamentals the outlook for many projects is less than promising, with many competing Layer 1 blockchains having failed to see any adoption, and with the case for new chains outside of the established ecosystems (which is unclear if it includes anything other than Ethereum and its Layer 2s). Decentralised Applications (DApps) are suffering from the astronomical valuations they have been trading at in 2021, which are extremely difficult to justify even in the more rosy scenarios. Widespread usage has been dropping consistently in the last few quarters, as outsized token rewards have dried up or lost their attractiveness in light of the depressed prices. Some niche activity remains on-chain and the overall sophistication of the space has grown considerably even in these last few months, however, volumes are far from anything impressive. Confirmation of this trend can also be found in centralised exchanges, and Coinbase, in particular, offers transparent data due to its disclosure obligations as a public company. We display in Figure 6 the quarterly trading volumes of the US exchange, as well as the share of retail participation, and we can see how the trend is negative, despite looking like it bottomed up a couple of quarters ago for what concerns the retail participation.

Meanwhile, derivative markets have shown us two faces during the month, with a relatively rich premium on long-leveraged exposure during the first half of the month, and a more muted profile during the second, more in line with the market we had in Spring. Figure 5 shows the aggregated fundings OI-weighted for Bitcoin on the major derivative venues. Figure 7 and Figure 8 however remind us that OI-weighted measures often represent a relatively balanced average of Binance, Bybit, Bitget, and OKX, with the latter three representing just over half of the total OI. Smaller derivative exchanges like Deribit, Bitfinex, Bitmex, Huobi, and Kraken, represent just over 10% of the total crypto derivative market, making them more niche venues than the former (Deribit is specialised and has a near-monopoly in Options, for example).

Figure 6: Quarterly time series data for Coinbase comparing total quarterly volume with the share of participation to the volume from retail traders. It can be observed how, together with decreasing volumes over the last two quarters of 2022, the participation of retail has decreased. Since then, while volume has continued to decrease, retail activity seems to have bottomed up and slowly increased over the last two quarters. source: TheBlock

Figure 7: Time series of the aggregated open interest (OI) for all perpetual swaps on the largest four derivative venues (Binance, Bybit, Bitget, and OKX). source: Laevitas

While trading activity almost entirely mimics the distribution of the open interest, as shown in Figure 9, it is interesting to notice how OKX volume ranking is higher than its relative size and, conversely, Bitget is less active than expected. Generally, we notice a full OI turnover in less than half a day for the largest exchanges, and in one day or more for the smaller ones, highlighting the different role these exchanges play in the ecosystem.

Figure 8: Time series of the aggregated open interest (OI) for all perpetual swaps on the longer tail of derivative exchanges (Deribit, Bitfinex, Bitmex, Huobi, and Kraken). It is interesting to note how these exchanges, together, represent a smaller share of the market than the smaller of the large four (Binance, Bybit, Bitget, and OKX). source: Laevitas

Figure 9: Time series of the aggregated average daily volume (ADV) for all perpetual swaps on the main derivative exchanges. We can notice spikes in activity corresponding with the largest market moves during the month, as well as how the largest venues are also the most active, despite OKX being considerably more active than sizable in relative terms. source: Laevitas

Turning our attention to the stablecoins market instead, we can identify a clear winner, after multiple changes of weather in Tether land, it seems that now the pioneer of stablecoins has reached a position of complete dominance, with increasing market capitalization since the beginning of the year (and not only gains in market share) in an environment where other issuers have seen a contraction in demand and a shrinking supply, as shown in Figure 10.

Figure 10: Time series of the stablecoin supply since the beginning. It can be observed how the overall supply has been constantly contracting, as well as how Tether has been gaining market share consistently, at the expense of BUSD and USDC, mostly. source: TheBlock

Further to that, Tether is generating astronomical gains on its 60bn+ of cash on which it pays no interest, and it can generate non-negligible rates just by investing in short-term Treasuries, allowing the issuer to accumulate considerable reserves (more than 3bn as of the latest disclosures) fostering the confidence of the market on the peg to the dollars and alimenting the flywheel that has got USDT to the size it has today.

Overall, August showed us more volatility than we expected, but it did not really surprise us in character. Nothing substantial has really happened, and our outlook for the coming months remains unchanged. ETF-related news is poised to move the market, as well as larger swings on other asset classes. Idiosyncratic catalysts are nowhere to be seen, with a relatively dry event calendar from here until the halving next year. The compounding of the listing of a spot ETF and a reminder that Bitcoin inflation is decreasing over time might just be what we need to reignite the next bull run, but more likely we would need renewed demand for Bitcoin and an uptick in DeFi activity (with large institutions scaling up their test programs) to more confidently expect higher prices.