July 2021 Commentary
News Highlights
1. PayPal to expand crypto capabilities including CBDC and smart contracts
2. Goldman Sachs files to create an ETF dedicated to DeFi and blockchain stocks
3. Stablecoin issuer Circle to go public in $4.5 billion SPAC merger
4. Hedge Fund Marshall Wace Looking to Enter Crypto Space
5. Fidelity’s Digital Assets Division Reportedly Plans to Boost Staff
6. SEC Chair Hints Some Stablecoins Are Securities
7. Bitcoin, Ethereum hash rates start recovering as Chinese miners redeploy overseas
8. FTX closes $900 million Series B at an $18 billion valuation
9. Fireblocks scores $2 billion valuation with $310 million Series D
Aave plans to build a protocol for decentralized social media
Chart of the month
Commentary
The Theatre is packed, and Act-two has started. As anticipated last month, regulators worldwide are trying to tighten their control on crypto (encouraged, if not coordinated, by financial industry lobbyists), often using deception as their main strategy. National security, shadowy super-coders, terrorism financing: “please regulator, save us from crypto!”.
Over the past few weeks, we have seen a number of measures and proposals being discussed by governments worldwide, from the dreaded travel rule in the EU, and the bipartisan $1 trillion US infrastructure plan (which contains some wording to extend the definition of “brokers” — that need to report transactions to the IRS — to miners, node operators, non-custodial services and DeFi applications, in order to raise up to 28b in taxes from crypto investors), to a number of investigations on key individuals and institutions in the space: Binance, BlockFi and a group of Tether Executives among the most noticeable.
Binance, the biggest crypto exchange in the world by daily trading volume, has suffered the most from the regulatory crackdown around the world: India, Malaysia, the United Kingdom, Japan, Thailand, Cayman Islands, Hong Kong, have all tightened the screws on the exchange. They responded to these pressures by accommodating numerous changes, winding down derivative trading in a few EU countries, shutting down regional subsidiaries in UK and Malaysia, lowering maximum leverage on the platform from 100x to 20x (quickly followed by FTX), reducing the daily withdrawal limits for accounts without KYC checks, and even Changpeng Zhao (CZ — Binance founder and CEO) suggesting that he is considering stepping down from his current role in favour of someone with a stronger regulatory background.
This is surely not the first time we see this trend taking place. BitMex, then Huobi and OKEx, have perhaps been the first to pay their toll. The Chinese exchanges, with a combined market share of approximately 38% a year ago, have suffered the increasing pressure from Chinese authorities causing their share of trading volume to drop to 28% at the beginning of the year, and, more recently, to 17%. Where has the capital moved? Binance, FTX, and Bybit.
Meanwhile, the investor community is well set to ignore regulatory pressures in a spree of funding activity that has culminated with FTX raising $900m at an $18b valuation. Sam Bankman-Fried, the exchange CEO and majority owner, used the opportunity to buy out CZ’s stake in the exchange. A move seen by many as a way to distance FTX from the exchange, and the man, in the middle of the regulatory crossfire.
The exodus of miners from China, despite causing turmoil on the market, has actually turned around one of the most negative narratives surrounding Bitcoin: its energy consumption and carbon footprint. This month, one of the biggest proponents for eco-sustainability, Elon Musk, has met with Twitter Jack Dorsey and Ark Cathy Wood to discuss the state of the industry and serve as a platform for the Tesla Billionaire to set the records straight on his stance on Bitcoin (His biggest holdings after Tesla and SpaceX). The outcome of the conference has been extremely positive for the market, that rebounded almost 40% since then as Elon Musk states “There appears to be a positive trend in the energy usage of Bitcoin”, perhaps easing the ESG concerns holding back more institutional money joining the space.
A noticeable corner of the market that has wildly exceeded the most optimistic expectations is the NFT space. Completely unconcerned by the events in the real world, a community of mostly anonymous developers and investors have slowly attracted the general public to crypto through Rolex-priced unique profile pictures for social media and a multitude of play-to-earn/engage-to-earn models surrounding some artistic digital items or video games. This month, two new unicorns were born in the space: Sorare, the fantasy football platform, raised $532m at a $3.8b valuation; OpenSea, the leader p2p NFT marketplace, raised $100m at a $1.5b valuation. In Figure 2, we display weekly sales of Art and Collectibles NFTs, where the bulk of the activity is due to CryptoPunks and Art Blocks. For reference, Axie Infinity, a strategic fight-and-collect game featuring cartoonish-looking monsters, has generated more than $170m in revenues. Overall, Ethereum ranks first among revenue-generating crypto projects with $185m, followed by Axie, Uniswap ($70m), Binance Smart Chain ($46m), PancakeSwap ($38m), and, finally, Bitcoin ($28m) — Notice that for Layer-1 we report transaction fees only and not block rewards.
Considering the wide scope of regulatory scrutiny, markets have reacted well and prices for the time being seemed to have bottomed between June and July, with the maximum drawdown this month ranging from -10% for exchange tokens, -14% for Bitcoin, -20% for the DeFi sector to -33% for small-cap tokens. Overall, however, the worst-performing sector, the small-cap tokens, as represented by FTX: SHITPERP, has closed July with a positive 8% appreciation. Bitcoin, Exchange tokens, and DeFi are instead up 20% or more on a monthly basis, igniting positive sentiment for a new bull run.
On-Chain fundamentals however remain weak, and despite some signs of recovery, the number of transactions is at levels last seen in 2018, while the number of active addresses is just slightly higher than where it has been for the majority of 2019 and the beginning of 2020. See Figure 3 for further details.
Some recent research from Crypto.com, however, estimates that over the last six months the number of crypto users has doubled from 100m to 200m, as indicated with monthly rates of change in Figure 4. Notice the difference between on-chain activity, and the metric reported by Crypto.com, which includes users on centralized venues and suggests increasing levels of adoption/speculation. In particular, looking at June data, we notice a much stronger growth in the number of Ethereum users, suggesting that the increased utility provided by DeFi protocols and NFT marketplaces drives adoption during times when price action discourages speculation. More specifically to the Ethereum network, however, there is the incumbent London Hard Fork, taking place on August 4th, and introducing new dynamics in the transaction fee market and potentially reducing the inflation rate for ETH (as the fees will be burned). For comparison, ETH issuance schedule is approximately 4.27% per year, while Bitcoin stands at around 1.78%.
As demonstrated by Figure 5, usage metrics for DeFi protocols have not shown significant weakening despite being charted in USD. Lending protocols in particular control as many assets as ever, and the demand for borrowing is still consistent. DEX volumes instead remain still low, being more correlated with speculative activity which has remained low through the Summer.
Funding rates and premia on Future contracts have remained low with only a moderate steepening during the last ten days of the month, as the market appreciated between 40% and 50%. As mentioned, the strong spot demand has only marginally raised the demand for leverage, just enough for rates to adjust to more healthy levels.
Positive sentiment can however be read in the Options market, with the demand for Call options exceeding Puts for the first time in months. The monthly timeseries for OTM contracts expiring within the next three months are shown in Figure 6.
More structurally, as displayed in Figure 7, most option writings took place outside the range where the market has traded over the last two months, creating potential opportunities for strong Gamma effects, as the price wonders around the upper bound of the $30000-$40000 price range.
