December 21 Commentary
By: Fasanara Digital
Tags: Bitcoin, Cryptocurrency, Investing, Trading, Market Research Reports

Commentary:

Perhaps we were all expecting a different end of the year, with some fitting fireworks. The market, however, after the welcomed Christmas rally, has delivered the harsh truth with a correction on the 27th that brought us back to the lowest prices since the September lows. Low liquidity seems to blame, however looking closely at the price performance of Bitcoin over the year, and comparing it with the S&P500, as displayed in Figure 2, we observe that twice this year we had periods of inverse correlation in the performance trend. After the Summer correction, the two time-series began to diverge again around mid-November, when crypto markets initiated their downward trajectory, while the equity market, despite some short-lived correction, has kept pushing to new highs. Whether this continued behaviour hides more significance than just end of the year lack of liquidity shall be seen over the coming weeks when institutional players are expected to deploy more capital in the crypto markets.

Figure 2: Comparison of the yearly price performance of Bitcoin and S&P500. It can be noticed without the aid of correlation measures, how we had two instances of diametrically opposite behaviour. First in the Summer, with the May crash, then the current period, after the December crash. Historically such a difference in behaviour has been resolved in a few months. Source: Trading View

Looking closely at the chart in Figure 2, it can be noticed that most of the divergence in performance is due to the market crash on December 3rd, ultimately a reaction to the FED tapering plans and the spreading of the Omicron variant. Both caused continued downward pressure throughout the month and should be expected to produce headwinds into the new year.

In the meantime, Derivative markets paid the price with an Open Interest (OI) wash-out in the region of 20%-30% triggered by the liquidations on the 3rd of December, as well as the unwinding of directional longs and cash-and-carry shorts, set to profit from the demand for leverage products that characterises neutral and in particular bullish market regimes. As displayed in Figure 3, the OI of Bitcoin products crashed for both linear and inverse contracts, however, while the former has found new footing and recovered the interest of buyers and sellers, the latter, crypto-native products, struggled to recover. A theme that has characterised the last couple of years, with every crash providing an opportunity for linear derivatives to gain market share. Lower OI and a lack of demand in the past few weeks has not only characterised Future products but also Option Markets, with a monster expiry on December 31st that has halved the size of the market overnight. As displayed in Figure 4, the uncertainty has caused traders to be cautious with only a small percentage of the OI being rolled into farther maturities. The low demand, as well as the increasing influence of DeFi on the markets, has pushed Implied Volatility (IV) below the levels to be historically considered normal. With the increasing popularity of yield generation via passive option-selling strategies by decentralised protocols, we can expect the IV to remain compressed on the shorter maturities, as well as pinning the whole curve down.

Figure 3: Open interest time series for Bitcoin contracts, both linear (BTC denominated — green) and inverse (USD denominated — purple) since late November. It can be easily identified the drop due to the liquidations and position unwinding on December 3rd. Since then, linear instruments Open Interest has recovered the pre-crash levels (partially thanks to the price appreciation), while inverse instruments struggle to recover their popularity Source: Coinalyze

Figure 4: Monster Option expiry on December 31st has halved the size of the market overnight, with only a timid recovery due to rolling into the next available maturity. Market participants seem to be taking an approach of wait and see, as liquidity slowly comes back from the Winter Holidays. Source: Deribit

Rates across the curve for Futures products have also been compressed, as discussed earlier, with Perpetual contracts (Figure 5) and Fix Maturity contracts (Figure 6) demonstrating a lack of demand with low rates and a flat behaviour during the second half of the month, after the initial volatility post-crash dissipated. After a few weeks of discounts on the Perpetual contracts, following the crash at the beginning of December, funding rates seems to have stabilised, with all contracts exhibiting neutral premia, the first sign that traders’ confidence in the market is increasing and sentiment improving.

Figure 5: Average Funding Rates for linear and inverse BTC contracts, grouped by collateralisation currency (USD — green, USDT — blue, BTC — red). It can be noticed how the rates have remained subdued during the second half of November and the majority of December, with a slow and painful recovery from the depths caused by the crash on December 3rd. Source: Trading View

Figure 6: Annualised premia of March Future contracts over the last two months. Notice how the volatile trend, albeit downward, has died down in December, with rates barely moving from their baseline return of 8%-10%. Source: Trading View

Looking away from the short-term price performance of the majors, a thriving ecosystem can be found in microcap coins and projects oriented towards the creator economy, gamified DeFi, p2e games (play to earn) and similar. In Figure 1 we show an assortment of “Flippenings” that happened in the few prior weeks and, albeit their scope is limited, they offer some insight into the transformational trends that we are experiencing. NFTs are more popular than Ethereum itself, Metaverse is more clicked than Cryptocurrency, the most expensive art piece from a living artist is now a digital image minted as NFT, Bored Apes are more expensive than CryptoPunks (read as “a vibrant community takes over the establishment”).

The old guard should watch its back, the incumbents are being displaced and a new reality is taking shape. Despite this warning, in Figure 7 we show the ranking over time in the app store of a number of retail crypto platforms. It can be observed how the sentiment has actually cooled down during December, with Coinbase and Crypto.com apps tumbling down the rankings below the 100th and the 50th place respectively.

The headwind for most crypto assets is partially due to the tightening in financial conditions that are expected over the coming months, as the FED slows down its bond purchase program and increases the rates, on the back of rising inflation and normalisation of economic conditions. As Crypto was born from the ashes of the 2008 Financial Crisis it has historically been focused on payments and financial disintermediation, tying the fortunes of the market with the ebbs and flows of the overarching financial system, a system from which the crypto community wants to break apart. Enters Web3, NFTs and social tokens that offer a compelling use case beyond finance, onboarding millions of people to the Blockchain ecosystem, and reaching a crowd that had no interest in trading and speculative investments.

Figure 7: Popularity of retail-oriented Crypto apps in the US Google play store. Representative of the sentiment over the last few weeks, we observe the popularity of those that used to be top-ranking apps at the beginning of November crashing down to sub 50th and sub 100th ranking (Coinbase and Crypto.com respectively). Source: The Block

Despite the increasing institutionalisation of DeFi and the growing interests of the traditional financial industry towards decentralised investments products (loans, swaps and derivatives) as well as improved settlement channels, the sector has lagged the market over the last few months, with infrastructure plays, Web3 and games decisively outperforming as they enter the spotlight for the first time (the latter two in particular). With major fashion brands (Dolce and Gabbana, Burberry, Hermes), sports brands (Adidas, Nike), tech companies (Facebook), artists (Kings of Leon, Eminem, Jay-Z, Snoop Dog, Ice Cube) and many other businesses and celebrities betting on the space, the industry can thrive during times of adverse macroeconomic conditions.

In Figure 8 we show the historic active developer count over the last 8 years, highlighting the positive trend and the increasing participation resulting from the newly found interest in the Metaverse and, more generally, non-financial applications of decentralised protocols. Expect network effects to transform the landscape in the years to come, with the most talented software engineers, researchers and designers joining the space and fuelling exponential growth in user adoption with improved interfaces and compelling use-cases.