April 2022 Commentary


Chart of the month:

Figure 1: Time series of BTC daily prices in logarithmic scale, superimposed to the inverted dollar index DXY since early 2017. The chart shows how the two assets have been negatively correlated for the last few years and how recently the trend has rapidly accelerated for the dollar, which has appreciated now to levels never seen in crypto’s adult life. Source: TradingView


While the March price action gave some hope, April has been quite bearish, with most coins depreciating substantially over the month. Correlation with equity indices has been high throughout the period, with crypto surprisingly often displaying similar volatility to tech stocks.

With increasing inflation over the first quarter, the narrative has been dominated by the FED and its attempt to fight inflation via QT (quantitative tightening) already affecting the growth prospect in the US. In Figure 2 we show the FED fund rate over the last 10 years. Meanwhile, due to the war in Europe and zero-Covid policy in China, as displayed in Figure 1, the dollar index DXY is appreciating (despite its hegemony has been a matter of discussion due to the uncontrolled printing, and the freezing of Russia's foreign reserves), creating a physiological hurdle for USD denominated assets (which become more expensive in other currencies). The double whammy to the economy is setting the US on course for a textbook definition of recession, with two consecutive quarters of contraction.

Incentives are likely to provide some guidance on how to think about the months ahead, and if the FED can at least show some sign of the inflation cooling off, it will gladly avoid pushing the economy into a recession and probably consider reopening the taps and provide liquidity to the dry market, to allow asset prices to recover. If, on the other hand, due to a congested supply chain and scarce workforce, growth in salaries and inflation aliment each other, the FED will be forced to tighten further and, in the process, set the market for a hard landing.

Figure 2: Federal Reserve Funds rates since the most recent hike in late 2015 to the easing in late 2019, and until the most recent hike started in early 2022 in response to the rampant inflation. Expectations are to reach a level of rates seen in 2019 by early 2023. Source: tradingeconomics.com

Liquid crypto markets have behaved like tech stocks with drawdowns between 15% and 30%, while private funding has continued to flourish, with new multi-billion-dollar funds being closed this month. While public valuations follow the ebbs and flows of global liquidity, long term capital, like the one committed to private markets, has shown no lack of conviction in the space. Compared with the 2018 bear market, when many saw the industry as the remains of a burst bubble and private funding was scarce, this time no endogenous factors have caused the current drawdown, and the high institutionalisation and sheer size of the crypto market has driven correlations higher, as shown in Figure 3, forcing most coins to be highly influenced by the macroeconomic backdrop.

Figure 3: Rolling correlation between Bitcoin and Nasdaq 100 returns. While the correlation has been inexistent before 2020, since then the broader crypto market, as it reached higher levels of institutionalisation, has started trading more similarly to tech stock, causing correlation to move significantly higher. Most recently correlation has trended higher, as is often the case during market corrections. Source: Bloomberg

The trading environment has not drastically changed over the previous few months, with rare and short-lived bursts in the yield curve, followed by long periods of flatness. Open Interest remains relatively elevated, most likely an indication of wider participation in the market, rather than a pure indicator of leverage. As mentioned, the rates have remained compressed, and not shown signs of directional demand for leverage. See Figure 4 for the behaviour of rates over the last two years. A similar picture is painted by the private lending markets, where rates for dollars have remained relatively contained. Trading volume also remains in a long-term descending trend, with overall activity having decreased by more than 50% in USD notional over the last 12 months, as displayed in Figure 5.

Options markets have painted a similar picture, with increasing demand for downside protection, as demonstrated by the decreasing skew in Figure 6, which shows how the bid for Puts has been more consistent than on Calls. On absolute levels, the richness on Puts now is comparable to the highs of the year, in late January and February. Implied Volatility, on the other hand, has remained low throughout the month, and currently shows a flat term structure (displayed in Figure 7), towards the lowest percentiles, suggesting that we might be set for a burst in volatility, too often associated with downward price movements in this market environment.

Figure 4: The chart displays both funding rates and rolling 3-month Futures annualised basis. It can be noticed how since November 2021 both metrics have been shrinking, testifying to the decreasing demand for leverage on the market. Source: Delphi Digital
Figure 5: The chart shows BTC price superimposed to the 14-days moving average of Futures volumes since January 2020. An overall decline of approximately 50% can be identified since early 2021 when the market reached peak speculative behaviour. Source: Delphi Digital
Figure 6: Option skew for BTC options with 35% delta and maturity of 30 days (dark blue) and 90 days (light blue). During April we can observe a substantial repricing, with demand for puts increasing over the first two weeks of the month, to stabilise at levels seen at the highs in January and February. Source: Genesis Volatility
Figure 7: Volatility term structure from BTC Options from ATM options one week, one, two-, three- and six-months maturity compared with past distributions per maturity. It can be observed that the implied volatility is sitting near the lowest percentiles, leaving room for a sharp pick-up in volatility and, perhaps, a move on the downside for prices. Source: Genesis Volatility

DeFi activity has also slowed down, but remained relatively elevated, with capital ready to be deployed at a moment’s notice when new opportunities are available. Trading activity compared to centralised alternatives, displayed in Figure 8, has been in a downtrend since the beginning of the year, but it remains well above the average 2021 levels of between 5% and 10%. An increasing number of participants continue to join the market, while ever more sophisticated tools become available to increase the security of the assets and improve data availability and analytics, sustaining the exponential growth of the industry. Total Value Locked within the DeFi ecosystem, shown in Figure 9, has overall remained relatively stable since the beginning of the year, despite having seen an opportunistic shift of interest from the first wave of Ethereum killers (Binance smart chain, Avalanche, Solana) to the second (Terra, Near), according to the abundance of rewards available. Ethereum, meanwhile, with a dominance of over 60%, has defended its dominant position.

Figure 8: Percentage of trading volume on decentralised exchanges as a percentage of total activity on centralised exchanges. Despite a cool down over the last two months, volumes on DExes remain relatively elevated, above the 10% mark below which we spent the majority of 2021. Source: The Block
Figure 9: Total Value Locked in various DeFi ecosystems since early 2020. The trend YTD has been relatively flat, with a decrease in the first wave of Ethereum-killer chains like Binance, Solana and Avalanche and increasing adoption for newer entrants like Terra and Near (both native and EVM-compatible Aurora). Source: The Block

The metaverse, the place where a crypto economy really takes full shape, remains the focus of the investment community with, just this month, hundreds of millions of NFT lands sold for Otherside, the metaverse project by Yugalabs with Animoca Brands and Improbable, in less than an hour (as much as Ethereum blockchain could handle), as well as traditional corporations like Sony and Lego, which invested billions in the creation of a centralised walled garden metaverse for the youngest. The impact of NFT minting can also be seen in chains other than Ethereum. During the tail end of April, Solana suffered a 7-hour outage on the back of a frenzy of transactions from NFT minting bots. These bots contributed over 4 million transactions a second to the network or about 100 gigabits of data per second, causing validators to be knocked out of consensus. This is the seventh time this year that Solana has suffered either a complete or partial outage. Events like this highlight why Ethereum still remains the dominant chain for DeFi, it is battle-tested and has consistently remained online during stress events. The Otherside mint this month is a key example of this. During this minting event, the Ethereum network remained online, and the consensus was still achieved even if this came at the cost of incredibly high gas prices during this time, with transactions costing up to 3 Eth, as displayed in Figure 10.

Figure 10: Ethereum gas prices in gwei (10^-18 Ether). Otherside mint occurred on 30th April/ 1st May. Source: Dune