February 22 Commentary
News Highlights
- U.S. Treasury Signals that Cryptocurrency Miners & Stakers Will Not Be Subject to Broker Information Reporting Tax Requirements
- Canada Sanctions 34 Crypto Wallets Tied to Trucker ‘Freedom Convoy’
- U.S. lawmakers push Treasury to ensure Russia cannot use cryptocurrency to avoid sanctions
- DOJ Seizes $3.6 Billion in Bitcoin Stolen in Bitfinex Hack
- Wormhole replenishes its blockchain bridge after $325 million exploit
- BNY Mellon joins State Street in crypto trading push
- Crypto Lender BlockFi To Pay $100M in Fines to US Regulators
- Circle revises SPAC merger deal with Concord at $9bn valuation
Chart of the month:
Commentary:
February was expected to be a month of stabilisation, after the highly uncertain weeks in December and January, when signals and indications of the extent of the FED’s tightening policy monopolised the market activity. Unfortunately, more gasoline was thrown on the fire of uncertainty, with dreadful news coming from Eastern Europe, where an armed conflict in Ukraine caused most western countries and private multinationals to impose sanctions and terminate services in Russia. As a result of the economic sanctions and the threat of escalation of war, the macroeconomic and geopolitical landscape is quickly evolving, challenging long-standing norms and beliefs. As international reserves are frozen, and wealthy individuals see their domestic assets plummet in value, the need for a supernational, uncensorable asset becomes apparent, igniting the conversation about Bitcoin’s role in society. Bitcoin might be used to escape sanctions or to circumvent capital controls that imprison one’s wealth in an inflating system, or to fund popular initiatives, which might be forbidden by the ruling power. February did display multiple examples of the role of cryptocurrencies in society, driving direct donations to the Ukrainian government, helping Russians to shield themselves from sanctions, allowing Canadians to circumvent the government’s ban on supporting the protests of the “Freedom Convoy”. These events however have also exposed the high degree of centralisation of the crypto market, with authorities being able to force custodial wallets and exchanges to freeze the assets of selected individuals. Broader calls for bans of entire countries/nationalities have instead been rejected by exchanges that remain true to the decentralised and permissionless cryptocurrency ethos. As displayed in Figure 1 however, current events have also shown the high degree of speculation and self-interest permeating the crypto markets. While crypto donations to the Ukrainian government were open for days, as soon as a potential airdrop to donors was announced by the Twitter account of the Ukrainian government, the number of unique wallets sending (small) donations spiked by a few orders of magnitude, and remained sustained until a few days later, when the airdrop was cancelled.
The reaction of the market to the current events has been relatively unremarkable, with the correlation between Bitcoin and the SP500 index remaining high throughout February, granted the higher beta and higher volatility. In Figure 2 we display the YTD price action of BTC and the SP500 Futures (rolling front month) with 1-hour resolution. The chart clearly shows a similar price action, reinforcing the idea that Bitcoin trades like a risk asset, and leaving some to wonder whether its permissionless nature has been fully priced-in, in the context of the recent events. It should be mentioned however that in times of considerable geopolitical instability, financial assets can become targets of severe restrictions, sanctions and seizing, putting incredible pressure on the price of such assets. The US government has already mentioned how cryptocurrencies might be used to circumvent sanctions on cross-border payments, which, if it takes place in a meaningful manner, could attract severe restrictions and bans.
In Figure 3 we take a step back and look at the long-term behaviour of the crypto market since early 2017. We display the total value of all liquid circulating cryptocurrencies and superimpose Bitcoin dominance as well as the sum of Bitcoin, Ethereum and stablecoins market cap as a share of the total. It can be observed that over time the composition of the market has broadened, with the share of alternative crypto projects consolidating and remaining a meaningful percentage of the market, despite the already non-negligible drawdowns. A sign that the market has matured and is now more resilient to temporary downturns.
Focusing back on February market dynamics, we observe in Figure 4 the behaviour of open interest (OI) for linear and inverse BTC derivative contracts (measured in coins) and the downward slope of the trendline during the month of February. Similar behaviour to previous months. Funding rates, also shown in Figure 4 and marked on the left axis, have exhibited an uncertain behaviour, with positive and negative rates alternating throughout the month, indicating low demand for leverage. The options market, on the other hand, shows a more decisive bearish sentiment, with the Call-Put skew, displayed in Figure 5, decisively negative throughout the month. OI, as we approach the March maturity, is lower than for previous quarterly maturities, confirming the lower demand for leverage observed through the funding rates.
On-chain data, typically offering indications of more fundamental and longer-term shifts in investors sentiment compared to derivative markets, show some reassuring signs, indicating that long term holders might be starting to accumulate, and that selling pressure seems to be diminishing since the peak in exchange deposits that followed the ATH in BTC price. We display in Figure 6 the deposits and withdrawals from exchanges superimposed to the price of Bitcoin since late 2018. As indicated, a persistent decline in deposits has been observed since late November 2021, reaching levels observed last in October 2020, just before the face-melting rally above the 2017 ATH. Throughout the last few months, withdrawals have not followed the downward trend of deposits, demonstrating that fewer deposits are not only due to reduced market activity, but also to a reduced selling pressure. Another interesting indicator showing the behaviour of long-term investors is displayed in Figure 7, where the quantity of coins that have not been moved for a certain amount of time are represented as different cohorts with different colours. From the chart, we can observe how BTC price tends to find a bottom supported by the buying pressure coming from longer-term investors, which tend to sell those coins during strong positive market action. Recently the number of coins older than 3 months is increasing, showing that long term investors find current prices interesting to start accumulating more coins, despite having already accumulated a considerable amount during the drawdown in Summer 2021. As it should be expected, fundamental accumulation patterns of long-term investors precede speculative and retail activity that usually manifests itself in derivative markets, and via shorter-term accumulation patterns, in the days-to-weeks’ timescale.
DeFi activity, and more broadly on-chain activity and demand for blockspace, the ultimate indicator of the fortunes of a base-layer protocol, have reduced considerably over the last few weeks. We display in Figure 8, as an example, the average transaction cost on the Ethereum network as a proxy of the value of on-chain activity and demand for block-space, since early December. During the last three months the overall trend has been downward, with February demand for blockspace having reached levels last observed in September 2021, but still higher than the 4$ reached a few weeks earlier, in July. Diminished activity this month is mostly due to the cooldown of the NFT market, which was previously leading network usage with daily mints raising millions of dollars, as well as secondary trading activity pushing prices of profile picture collection to tens of thousands of dollars per piece (where usually collections are comprised of 8–10k items).
In the current market dynamics and broader geopolitical situation, speculations on short term price performance are difficult. It is also difficult to assign probabilities to each of the possible scenarios, due to the high number of exogenous factors that can affect crypto markets over the coming weeks. In the medium term, we also see potential disruptions to distributed ledger technology adoption, and roadblocks to the development of mature crypto markets. With the exceptional powers government around the world are entrusting themselves to deal with various economic, political and military threats, legislative actions limiting cryptocurrency usage might be introduced, or enforced as temporary measures. In the longer term, however, in a world that is increasingly becoming digital, cryptocurrencies will keep demonstrating their role in society as uncensorable platforms that foster financial freedom and permissionless p2p interactions, alternatives to the financial and tech incumbents’ walled gardens where interactions need to be authorised by a centralised authority, before taking place.
