Q4–23 Commentary

News Highlights

1. Spot bitcoin ETF approval may be coming in January
2. Binance and CEO Plead Guilty to Federal Charges in $4B Resolution
3. US FASB Updates Crypto Regulation Allowing Firms To Use Fair-Value Accounting
4. S&P Global Ratings Launches Stablecoin Stability Assessment
5. France’s 3rd-largest bank, Société Générale, launches euro-pegged stablecoin
6. Nigerian central bank lifts ban on crypto trading
7. Billionaire Druckenmiller calls Bitcoin a ‘brand’ he should probably own
8. BlackRock CEO Larry Fink Says Bitcoin and Crypto Will Play a Role in Investors’ Flight to Quality
9. BlackRock files for spot Ethereum ETF with SEC
10. JPMorgan, Apollo Tokenize Funds in ‘Proof of Concept’
11. Sam Bankman-Fried found guilty of seven counts of fraud
12. Tether announces wallet-freezing policy for OFAC-sanctioned persons
13. SEC Drops Charges Against Ripple CEO Garlinghouse
14. Barry Silbert and Mark Murphy resign from Grayscale’s board
15. MicroStrategy buys bitcoin worth $615.7 mln ahead of SEC’s spot ETF decision

Chart of the quarter:

Figure 1: Long-term historical time series of Bitcoin price since late 2017. The chart, using a logarithmic scale, shows three major cycles of Bitcoin price, and a projection of the 2017 (red) and 2021 (blue) bull runs onto the current price action. In green we highlight the Q4 price action. source: TradingView

Commentary:

The past year, starting from a low point in the cycle, witnessed a swift turnaround, culminating in a significant recovery by the fourth quarter. Bitcoin soared over 150%, Ethereum nearly doubled its price, and Solana achieved an impressive tenfold increase. These figures are remarkable, yet it’s important to note that the broader market trends, including the Nasdaq’s over 50% annual gains, significantly influenced this upswing. The anticipation of interest rate cuts in 2024 played a crucial role in driving these macroeconomic forces. In Figure 2, we see the correlation between the weakening dollar and stabilizing interest rates, which helped Bitcoin make a substantial recovery from its 2022 losses. A major development was the long-awaited Bitcoin spot ETF, which garnered significant support from Wall Street giants. The filing of Blackrock’s spot ETF on June 15th marked a turning point, leading to a consistent appreciation in Bitcoin’s value. Institutional applications and tokenisation of real-world assets remain among the most exciting segments, with few other killer apps having gained notoriety in the past 12 months. Some infrastructure upgrades have been introduced on some blockchains; however overall adoption still lags behind. Regulatory developments across various nations have become more stringent, with enhanced AML requirements and increased disclosure obligations, shaping a more structured and secure trading environment.

Figure 2: Superimposition of the time series of the inverted dollar index (green) the interest rate on 2-years US treasuries (blue), and the Bitcoin price (orange). The effect of macroeconomic forces on Bitcoin prices is rather evident from the picture. source: TradingView

The SEC’s historically tough stance against cryptocurrencies has softened, shifting the discussion from the possibility of an ETF to its imminent arrival. The growing interest in products like Blackrock’s ETF, which is voiced to have attracted over $2 billion in interest, along with others like Invesco, Valkyrie, Ark, and Fidelity, signals a significant shift. The winners so far, however, have been holders of Grayscale GBTC shares, which appreciated considerably, and recovered the deep discount to NAV they were trading at, less than a year ago. While jumping from 0.2 to 0.5 after the Blackrock filing, the discount tightened consistently during Q4, as the prospect for the SEC approval grew more certain, finally reaching more than 0.9 cents on the dollar by year-end, as displayed in Figure 3.

Where Q4 has certainly shined however, was in the institutional participation in the Bitcoin price action, as exemplified by the impressive growth of the Open Interest (OI) on the CME Bitcoin Future, as shown in Figure 4. The impressive growth, which started in mid-October, saw the OI more than double in just over a month, surpassing 5 billion and claiming the title of the largest Bitcoin Future market.

Figure 3: Time series of the GBTC discount to NAV since early 2020. After a sharp drop to less than 20% of the value of the Bitcoin held in the Trust, the Grayscale shares have recovered to a discount of less than 10% to the NAV. source: TradingView

Figure 4: Time series of the total Open Interest (OI) on the CME Bitcoin Future expressed in dollars since early 2020. The impressive growth in Q4 2023 reflects the increase institutional interest in the asset class due to the upcoming Spot ETF listing. source: TradingView

This period also saw a shift in market share, with Binance’s dominance waning, as highlighted in Figure 5, and culminating with a change of leadership, and a fine of 4.3bn, largest of this type yet. Despite indicating wrongdoing in the past, with allegations on their AML procedures, and allowing access to US institutions as well as sanctioned jurisdictions to the exchange, Binance has not received any inquiry on the safety of client funds. Binance risk in the ecosystem seems to have subsided as a result, similar to the long-discussed Tether risk. The stablecoin issuer completed the year without scandals, increasing clarity on its reserves (nowadays mostly invested in US Treasuries), and collaborating with US authorities to freeze sanctioned wallets — strengthening the ties with the US government.

Figure 5: Time series of the derivatives market share of CME (blue) vs. Binance (orange) superimposed to the price of Bitcoin (grey). Since the end of Q1 there has been a significant shift in market structure culminating in the CME taking the role of largest Bitcoin derivative market. source: Glassnode

Figure 6: Time series of the price of Bitcoin during the quarter (orange) superimposed to the average premia of perpetual swap over spot prices. With a thicker line we indicate the long-term four-week average, with a thinner line we display the daily average. The chart shows how the demand for leverage has considerably picked-up during Q4, causing the price of perpetual swaps to rise above spot at levels last seen during the previous bull market. source: TradingView

This quarter, the trading activity on the market finally picked up some steam and consistently increased, reaching just recently the highs seen in 2022 with around 40bn daily volume. A figure still shy of the 100bn+ seen in 2021, but a trend that points to a renewed interest in the asset class from speculators and larger investors.

As discussed in previous paragraphs and shown in Figures 4 and 5, the derivatives market has not lagged behind, and for the first time in the last couple of years, has dominated the price action. OI on exchanges has increased consistently throughout the year, but it is in Q4 that the market has shown a more consistent demand for leverage.

Perpetual swap funding rates, as well as the basis on term futures, clearly show a shift in sentiment and more speculative behaviour, with market participants willing to pay higher and higher rates to be able to maintain leverage long positions on Bitcoin and other tokens. We show in Figure 6 the average funding rate on Bitcoin perpetual swaps on Binance, Bitmex, Bybit, Deribit, and OKX. It can be observed the sharp regime change associated with the strong price action at the end of October, and the higher funding rates that persisted since. While a common occurrence during the 2021 Bull market, such persistence in the cost of leverage was not seen in a long time.

Figure 7: Time series of the market cap of the three largest stablecoins, Tether USDT (green), Circle USDC (blue), and Maker DAI (yellow). The total market cap of stablecoins is indicated in purple and superimposed, showing the relative variation from the all-time high in May 2022. source: TradingView

It should be noted that presently the availability of capital in the system is considerably lower than it used to be, implying that a similar cost of leverage to the previous cycle could result from significantly weaker demand, now that the supply no longer enjoys the backing of various institutions like BlockFi, Celsius, etc. On the other hand, a strong demand and higher retail participation could cause even larger dislocations than previously observed, until more capital is deployed in the market.

Stablecoin supply is often used as an indicator of new capital being deployed in the market since fluctuations in supply are due to the conversion of dollars into tokens and vice versa. As shown in Figure 7, throughout the quarter, total supply has increased by 10%, showing 10 bn USD being deployed into the ecosystem.

The dynamics within the sector during the quarter have remained consistent with the trend initiated in March 2023 with the collapse of SVB, Silvergate, and Signature, with the latter holding some of Circle reserves and causing a temporary depeg of USDC. Tether continues to dominate the market and at the same time improves its relationship with the US government, further solidifying its leading position.

The large influx of dollars in the system has contributed to the growth in DeFi Total Value Locked (TVL), or, in other words, the assets custodied in smart contracts and deployed in credit and trading markets. Since the end of October, as shown in Figure 8, the TVL increased by more than 20bn and the trading volume on decentralised exchanges more than doubled, from less than 2bn per day to more than 4bn per day.

Figure 8: Time series of total DeFi TVL (blue) superimposed to DeFi daily trading volumes (green). source: DeFiLlama

A sector that experienced significant growth over the year was the tokenisation of Real-World Assets (RWA), primarily led by US Treasuries, with a long tail of private credit, and other case study implementations. Starting the year with less than 1bn in assets, by the start of Q4 more than 5bn of new assets have been brought on-chain, as shown in Figure 9. Interestingly, while the rest of the industry shined in Q4, RWA stagnated, with a high in mid-October, and a contraction ever since, showing a rotation away from those lower-yielding products and into crypto-native alternatives.

The Solana ecosystem and its SOL token emerged as definitive winners in Q4. SOL’s price surged almost 10x over the year, with the majority of this growth occurring in the last quarter. This rise was fuelled by a resurgence in the DeFi ecosystem, with trading volumes surpassing those on Ethereum for the first time, as illustrated in Figure 10.

Figure 9: Time series of the Total Value Locked (TVL) in tokenised Real World Assets (RWA) protocols. Most of the assets represent tokenised versions of US Treasuries, however private credit and tokenised funds have also seen growing interest. source: DeFiLlama

Figure 10: Time series of the daily trading volume on Solana DeFi ecosystem. After a near-death experience post FTX, Solana has recovered the trust of traders and investors, causing the activity on the network to surpass the activity on Ethereum for the first time. source: DeFiLlama

Due to the high concentration in the Solana ecosystem of the Alameda balance sheet, as well as several winners identified within their VC portfolio, the FTX estate has also enjoyed a profitable Q4, and, along with them, the millions of customers to which it owes money. While the recovery process has proceeded consistently throughout the year, it is in the last quarter that most action has been seen in the secondary market for claims. Such a market gives a pulse on the expected recovery value and has seen considerable activity over the past few months. Claims have traded between 0.1 and 0.3 over the first three quarters of the year, with a stable increase as more information became available, and crypto prices recovered. During Q4, along with a strong recovery in crypto prices, claims have moved considerably higher, with the higher quality and larger claims trading up to 75% of the value of the assets held on the exchange on the day FTX filed for bankruptcy, as shown in Figure 11.

Figure 11: Time series of the secondary price for FTX claims since the bankruptcy of the exchange. Prices have consistently moved higher as new information became available. Claim prices now reached 0.75c on the dollar for the largest and cleaner claims. source: Cherokee claims-market.com

While the overall sentiment and price action over the quarter suggest a comeback of the bull market, an optimistic view broadly shared by most market participants, a note of caution is warranted. Potential adverse macroeconomic developments and regulatory changes could temporarily disrupt this positive trajectory. On the other hand, we are just a few months away from the Bitcoin halving, which despite not possessing any objective characteristics that should justify positive price action, has been historically a catalyst for new interest and resulted in large positive price movements.

Looking at the coming quarters, we anticipate continued volatility. While we remain hopeful for upward movement, a significant retracement, similar to what was observed on January 3rd, should not be ruled out. Nonetheless, we found the market in the past couple of months the strongest since Q3 2021, which is a promising sign, potentially indicating better conditions in the upcoming quarters.