Crypto’s Mid-Summer Comeback
Kaiko Research: August 2, 2021
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- Price Movements: Bitcoin is up 8% this week registering its largest weekly gain in months.
- Volume Dynamics: Ahead of Ethereum’s big upgrade, trade volume continues to surge relative to Bitcoin.
- Order Book Liquidity: Price slippage on FTX and Binance has fallen over the past 2 months despite the regulatory crackdown on exchanges.
- Macro Trends: Microstrategy shares are up 52% YTD and currently hold a .9 positive correlation with the price of Bitcoin.
- Derivatives Markets: Trends in open interest diverged across exchanges immediately following last week’s short squeeze.
Check out The Block’s webinar this Wednesday on the importance of digital assets market data to recap their new (extremely thorough) report on the state of the data industry.
Price Movements
Mid-summer bounce. Cryptocurrency markets finally came back to life following months of dismal returns and plummeting volumes. In the final week of July, Bitcoin and Ethereum surged +8% and +13% respectively, spurred by a massive short squeeze on perpetual futures markets. Cryptocurrency derivatives are the latest crypto sector to face the ire of global regulators. Last week, Binance and FTX, both unregulated, announced that they would be winding down derivatives trading in Europe and reduce maximum leverage from 100x to 20x. Derivatives markets frequently boast higher volumes than their underlying spot and have contributed to price volatility over the years, thus the new restrictions could significantly affect market structure.
The stablecoin regulatory showdown is here. This week, it was reported that several executives behind Tether are being investigated by the Department of Justice, just the latest saga in the largest stablecoin’s regulatory woes. This time, the controversy does not seem related to Tether’s reserves, but other stablecoin issuers have made recent efforts to appease regulators through increased transparency. The majority of stablecoins are designed to be backed 1:1 with the U.S. Dollar, but in practice reserves often take the form of other assets beyond simple cash. For years, the company behind Tether refused to release the makeup of its reserves which sparked speculation that the stablecoin did not have enough backing to justify its 1:1 USD peg.
Circle — issuer of the stablecoin USDC — and Paxos — issuer of the stablecoins Binance USD and Paxos Standard — are betting that transparency will win over regulators and help them gain market share. Last week, Paxos revealed that the reserves of both stablecoins it backs are made up by 96% cash or cash equivalents. This is far higher than reserves revealed by either Circle or Tether, which Paxos made no secret in pointing out.
Tether is still the highest volume stablecoin by far, but not the most stable. Above, we chart average hourly price of the four stablecoins versus USD (calculated by taking the volume-weighted average price for all stablecoin-USD pairs trading across exchanges) and can observe that BUSD wins the award for “most stable stablecoin,” just ahead of USDC. USDT is more volatile and consistently trades at a premium to the dollar.
Volume Dynamics
Volumes spike following slow start to summer. Last week’s short squeeze resulted in a surge in volume after more than a month of consistent daily declines. May 19th saw the highest volume of trades ever recorded, but since then volumes have plummeted into the summer months. Volume and volatility are directly correlated and most crypto assets have traded in a tight range over the past month with little directional bias, thus it is no surprise that volatility traders took a step back. However, Monday’s short squeeze kicked traders back into action as Bitcoin’s price broke $40k for the first time since early June. From one day to the next, BTC-USD and BTC-USDT volumes aggregated across 20 exchanges surged from $5 billion to more than $16 billion.
Ethereum trade volume continues to grow ahead of big upgrade. This week, Ethereum is set to undergo the long-awaited “London” hard fork upgrade which contains five Ethereum Improvement Proposals (EIP) that will alter the code of the second largest crypto asset by market cap. Upgrades are an important part of the blockchain lifecycle that enable improvements and optimizations to the network through consensus-backed code changes. The planned changes are set to improve transaction fee volatility and wait times and introduce a fee-burning mechanism that could transform Ethereum into a deflationary asset. The upgrade is not without controversy, with some fears that it could dampen incentives for miners (check out Coindesk’s Ethereum upgrade report to learn more).
Throughout 2021, Ethereum has become an increasingly attractive crypto asset and this is best evidenced by comparing its volume relative to Bitcoin. At its peak in May, ETH-USD volumes were 51% of total volume, a record high. June and July has seen ETH-USD volumes fall 10% relative to BTC-USD, but overall market share is still near all time highs. Coinbase recently revealed that the exchange’s institutional clients increased their exposure to Ethereum throughout H1 of 2021.
Order Book Liquidity
Slippage falls on unregulated exchanges. Despite the past month’s regulatory crackdown that has threatened the world’s largest exchanges, price slippage has fallen for their highly-liquid BTC-USDT markets. The four exchanges charted above contain some of the most liquid cryptocurrency markets in the world. Binance’s BTC-USDT market boasts billions in volume every day while Huobi and Okex average just below $1 billion. Over the past few months, FTX has slowly claimed market share, although the exchange processes only a fraction of the volume that the others do.
Price slippage measures the cost of executing a trade and is calculated by taking the difference between the expected price and actual price once the order has been fully executed. Kaiko calculates slippage by simulating a sell order size of $50k on the bid side of an order book snapshot. We can observe that slippage has fallen over the past two months on all four exchanges, likely due to the lack of overall market volatility. Slippage fell most sharply on FTX, from .03% to .02%.
Market depth stays flat despite BTC gains. Over the past two weeks, Bitcoin has rapidly surged from $30k to $40k, resulting in higher all-around trade volumes. Despite the gains, market depth remains unchanged. During Bitcoin’s run-up from November to January of this year, market depth (as quoted in Bitcoin) plummeted. It was difficult to identify a single reason for the declines, but some explanations could be overwhelmingly large volumes, fixed budgets for market makers, and a shortage of Bitcoin all around. Market depth frequently shifts along with increases/decreases in the price of Bitcoin. However, market depth has stayed flat over the past two weeks which suggests market makers are able to keep up with the volatility.
Last week’s short squeeze on July 26th barely made a dent in market depth, a positive sign for Bitcoin liquidity.
Macro Trends
Public tech companies re-affirm interest in crypto. Crypto market sentiment has improved following another round of bullish affirmations by public tech companies. Microstrategy, up 52% YTD, announced that the company plans to continue amassing bitcoin. The company’s share price is tightly correlated to Bitcoin (.9 positive correlation) which suggests investors view the investment as a means to gain indirect exposure to crypto. Tesla also committed to holding the company’s Bitcoin reserves, despite negative YTD share price returns. Square, up 16% YTD, also recently announced plans to build Bitcoin hardware wallets.
The U.S. Dollar closes July in the red. The U.S. Dollar Index (DXY), which tracks the dollar relative to a basket of foreign currencies, closed the month down 0.5% as dovish comments by the Fed and lower than expected growth figures in the U.S weighed on the greenback’s performance. Bitcoin kept its gains from last week, breaking $39K and closing July up 4%. For much of the past year, Bitcoin and the U.S. Dollar have trended in opposite directions as loose monetary policy put the dollar under pressure while risk-on assets surged to all time highs. Throughout 2021, the DXY has made slow gains as the U.S. economy reverts to pre-pandemic levels of growth. The dollar lost steam in the second quarter of the year as the Fed kept its monetary policy stimulus unchanged despite rising inflation
Derivatives
Short squeeze rattles markets. On July 25–26th, Bitcoin gained 9% over the span of just three hours following a massive short squeeze on Asian derivatives markets. More than $960 million in short positions were liquidated, the largest amount ever recorded. Short selling involves selling borrowed shares of an asset, betting that the price will drop. However, if the price increases instead of declining, short sellers are forced to cash-settle their contract or buy the underlying asset. This could contribute to a rapid increase in the asset’s price known as a “short squeeze”.
Above, we chart the aggregated open interest across seven exchanges during the short squeeze and can observe that open interest climbed half a billion dollars in the days preceding the squeeze while volumes stayed low. This suggests traders were heavily leveraged, which led several analysts to predict the coming squeeze.
We noticed a diverging trends in open interest after the squeeze when diving into the exchange-level data.
For example, on Bybit open interest fell while on FTX, open interest increased on the day following the squeeze. This could be partly explained by differences in trading strategies, the level of experience of market participants and margin requirements across exchanges.
Thanks for reading and see you next week!
Written by Clara Medalie with contributions by Dessislava Aubert and Arun Vignesh
