March 23 Commentary

News Highlights

1. Gary Gensler: SEC Needs New Tools, Expertise, and Resources to Regulate Crypto Industry
2. USDC depegs as Circle confirms $3.3B stuck with Silicon Valley Bank
3. After SVB failure, regulators close crypto-friendly bank Signature Bank
4. New York AG Alleges ETH is a Security in KuCoin Lawsuit
5. Sam Bankman-Fried pleads not guilty to paying $40M bribe to Chinese officials
6. Crypto fugitive Do Kwon arrested in Montenegro after $40B TerraUSD collapse
7. Tron Founder Justin Sun Sued by U.S. SEC on Securities, Market Manipulation Charges
8. Binance and founder CZ violated compliance rules to attract U.S. users, CFTC alleges
9. Coinbase warned by SEC of potential securities charges
10. US Government Plans to Sell Over 41,000 Bitcoins Confiscated from Silk Road Hacker
11. Amazon NFT Marketplace Could Feature Beeple, Pudgy Penguins
12. Nasdaq Eyes Crypto Custody Launch by End of Second Quarter

Chart of the month:

Figure 1: Price time series for the four major stablecoins during the banking debacle in mid-March: USDC (blue), DAI (orange), BUSD (yellow), USDT (green). It can be observed how USDT, in particular, absorbed the demand for stablecoin exposure stemming from the run on USDC, having traded at a considerable premium ever since. Meanwhile, the discount on USDC, which reached more than 10% at the peak, closed shortly after the end of the weekend as Circle started again to process redemptions of USDC into USD. Source: Trading View

Commentary:

This month’s commentary focuses on recent events in the traditional financial sector and their impact on the crypto markets, in particular the impact of increasing interest rates and mark-to-market losses on banks’ balance sheets. Many banks have invested heavily in long-term maturity treasuries during an environment of zero interest rates and are now suffering from a decline in price due to the rising interest rates. As a result, these banks are now facing significant mark-to-market losses, which can negatively impact their profitability and balance sheets. This has caused concern among investors and regulators alike, as the stability of the financial sector is crucial for the overall health of the economy.

The recent actions taken by the US government against Silicon Valley Bank (SVB) and Signature Bank highlight the severity of the situation. The regulatory scrutiny of these banks’ risk management practices and ability to weather the economic climate has led to shutdowns, raising questions about the resilience of the traditional banking sector.

Figure 2: Time series of the interest rate on three reference maturities for Treasuries: 2 years in black, 5 years in orange, and 10 years in blue. After more than a year of rock-bottom rates, the 2 years contracts started climbing sharply towards the end of 2021 and entered a slightly decreasing trend over the past few months. Particularly noticeable was the reaction to the banking crisis on the second weekend of March, resuming the downward trend forming over the first quarter. Source: Trading View

Despite the challenges faced by the traditional banking sector, cryptocurrencies have demonstrated their resilience to economic turbulence. Even amid a bear market, the crypto markets have proven to be remarkably robust, with prices recovering from temporary dips and showing signs of stability throughout the banking crisis. Circle however, the issuer of USDC, suffered from the situation as part of its reserves were held in custody with Silicon Valley Bank (SVB), and for a short amount of time it was uncertain whether the losses of the bank would have impacted the clients’ deposits.

Moreover, while institutional investors may be exhibiting a cautious approach to cryptocurrencies at the moment, their growing interest and adoption of blockchain technology suggest that the appeal of cryptocurrencies may continue to increase in the long run. This is particularly relevant given the ongoing issues faced by traditional banks, which have highlighted the need for alternative and secure financial systems.

Figure 3: Price time series for the major Layer-1 currencies since the beginning of March. Excluded from the graph are BNB and OKB coins, closely linked with the Binance and OKX exchanges. It should be noted that performance has been dispersed, with the best-performing assets (XRP and BTC) returning more than 20%, while the worst performers (ALGO, SOL, and DOT) with up to 10% losses. Source: Trading View

The recent incident with Circle and SVB has raised concerns about the stability of the USDC peg and the overall resilience of the stablecoin market. Circle, the issuer of USDC, had approximately 3.3 billion USD of the reserves backing USDC deposited with SVB, which was shut down by the US government. As these events took place during the weekend, Circle was only able to provide limited conversion services between USDC and USD, causing panic among investors which resulted in a drop in the price of USDC below its peg of 1 USD. While the situation has since returned to normal, there have been considerable outflows from USDC and into other stablecoins such as Tether USDT, which has seen an increase in market capitalization since the incident with SVB Bank in mid-March.

These events follow the regulatory action against Paxos BUSD last month, further strengthening the position of Tether USDT in the stablecoin market. It is important to note that the incidents with both Circle and Paxos were not a result of a lack of transparency on the part of the stablecoin issuers, but rather a lack of clear regulations and structures to support private stablecoin issuers.

As the stablecoin market continues to grow and evolve, it is crucial for regulators and market participants to work together to establish clear standards and best practices for stablecoin issuers, in order to ensure the stability and resilience of the market as a whole. Despite the challenges faced by the stablecoin market, the growing adoption of cryptocurrencies and blockchain technology more broadly suggests that stablecoins and other alternative financial systems may play an increasingly important role in the years to come. As we continue to monitor the developments in the stablecoin market and beyond, it will be interesting to see how issuers and investors adapt to the evolving regulatory landscape and the changing needs of consumers and businesses alike.

Figure 4: Time series of stablecoin market cap over the last 12 months. It can be observed how during last year the overall stablecoin market cap dropped, while seeing BUSD gaining ground on its competitors. The environment mutated since the regulator went after Paxos for its ties with Binance, and the banking crisis weakened USDC, ultimately prompting USDT to approach its all-time high in May 2022. Source: The Tie

As we shift our focus to the broader cryptocurrency market, it is worth considering the latest market fundamentals such as spot and derivative volumes, open interest of derivative contracts, and prevailing interest rates. In recent months, we have seen a downward trend in spot volume, which reached a low point following the bankruptcy of FTX in late 2022. However, since the beginning of this year, spot volumes have started to increase again and have reached the average levels observed over the second half of last year.

When it comes to derivative volumes and open interest, we have observed a steady increase in recent months, indicating growing confidence from investors that stepped out of the market after the FTX crisis.

Taking a closer look at the cryptocurrency market, we can see that the ratio of spot to future volume was on an upward trend until mid-January, indicating lower levels of speculative activity in the markets. However, since then, we have observed a sharp correction in the ratio, with levels approaching those observed more than six months ago. This trend highlights the shifting dynamics between spot and derivatives markets, with the current trend highlighting the positive shift in sentiment for traders and investors.

Figure 5: Monthly spot volume on the major crypto exchanges over the last 12 months. Since the beginning of the year, we observed a positive trend with volumes increasing month on month and have now reached the highs registered since the Terra collapse in May 2022. Source: The Block

Figure 6: Time series of the Spot to Future trading volume ratio. The curve represents the level of speculation in the market, with lower values indicating higher activity on derivative markets than spot. Since the collapse of Luna in May 2022 this ratio has constantly climbed until mid-January 2023, when sentiment started to improve as demonstrated by increasing activity on derivative markets. Source: The Block

Furthermore, we have observed increasing activity in regulated options markets, particularly on the CME exchange. Both volume and open interest have reached all-time highs over the last three months, indicating growing interest from institutional investors. Overall, despite the ongoing bear market and lower institutional investor appetite, the cryptocurrency market has proven to be surprisingly resilient in the face of economic turbulence and regulatory uncertainty.

As we continue to observe the shifting dynamics in the cryptocurrency market, it is worth noting the growing interest in decentralized finance (DeFi). In recent months, we have seen a considerable increase in activity in this space, driven in part by the failures of centralised institutions, such as large lenders, exchanges like FTX, and even banks like SVB and Signature. These events have highlighted the potential vulnerabilities of centralised systems, increasing interest in decentralised alternatives.

Figure 7: Time series of Volume and Open Interest (OI) for BTC options traded on the CME. It can be noticed that both measures have exploded over the last three months reaching an all-time high. Volumes in March have approached 2x the monthly average for 2022, while OI is three times larger than it was last year, on average. Source: The Block

In the DeFi space, we have seen a considerable increase in activity over the last three months. Decentralised exchanges (DEXes) like Uniswap have been particularly active, with total trading volumes surging by almost three times since the December lows.

This growth in DEX trading volumes can be attributed to various factors, including the failures of centralised institutions such as large lenders and exchanges. The increasing demand for decentralised platforms stems from the need for greater transparency, security, and control over one’s assets.

Figure 8: Monthly trading volumes on decentralised exchanges over the last 12 months. Similarly, to centralised spot volumes, we can observe a positive trend over the last three months, with volumes having recovered to levels last observed before the collapse of Luna, signalling the preference for investors to shift some flows towards decentralised alternatives. Source: DeFi Llama

Figure 9: Time series of DeFi Total Value Locked (TVL) since the Terra-quake in Spring 2022. It can be observed how assets flow back into the ecosystem after a considerable drawdown following the FTX collapse and, despite the short-term distress linked with the USDC situation, assets were recovered quickly. Source: DeFi Llama

Moreover, it should be considered that the latest March figures have shown particularly high trading volumes, largely due to the USDC de-peg event. This event caused abnormal volatility and trading activity, leading to a surge in demand for stablecoins and DEXes as a means of hedging risk and capitalising on market opportunities. While the March numbers may be somewhat inflated due to this event, the broader trend of increasing DeFi adoption and usage is a positive sign for the long-term growth and sustainability of the space.

In addition to the increase in DEX trading volumes, we have also observed resiliency in Total Value Locked (TVL) in the DeFi space. Despite the sharp drop in TVL during the USDC de-pegging event, it has since recovered, and we have seen substantial growth since the beginning of this year. The TVL in DeFi has increased by over 20% or $10 billion, and it is now approaching pre-FTX levels.

In conclusion, the cryptocurrency market has shown remarkable resilience in recent months, however, it is worth noting that crypto’s correlation to traditional markets and overall interest rate policy remains strong, and macroeconomic conditions will continue to play a central role in assessing future market conditions.

Furthermore, the industry is currently facing various regulatory issues, particularly in the US, which could have a deep impact on the market. The recent regulatory actions against major players in the industry have created sources of idiosyncratic risk for the market, and it will be essential to monitor these developments closely.