December 13, 2023

Insights and analysis for the professional investor

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Welcome to Crypto Long & Short!

This week, CoinDesk Indices' Todd Groth looks at previous crypto market cycles for indications of where the current market is headed (hint: it's good news).

Then, Greg Magadini, of Amberdata, argues that crypto derivatives show bullish positioning for next year.

As always, get the latest crypto news and data from CoinDeskMarkets.com.

– Benjamin Schiller, head of opinion and features at CoinDesk

From the Analyst

Bitcoin Has Gifts This Holiday Season

Welcome back to the days of $40k bitcoin. Ethereum is also back above $2k, while smaller tokens play catch up to the mega caps, and just in time for the holidays too.

Ah, the rollercoaster that is the crypto market. It's a wild ride that keeps us on our toes and glued to our screens, doesn't it? Protocols and projects are forged and refined in the fire of market cyclicality, with lesser ideas falling the wayside or exiting through the dramatic jumps and falls of the market.

These cycles are rooted in some tangible factors that stem from a mix of demand dynamics driven by investor psychology, regulatory developments, and technological advancements meeting the supply demands of halving schedules, protocol forks and ICOs. When these factors align favorably, demand skyrockets causing prices to rocket higher, often fueled further by hype and the ubiquitous propellent known as FOMO (fear of missing out). That's the halcyon days of the bull market where we bask in general euphoria, with the focus of fear being on further upside surprises.

But with every cycle there is a duality, a yin for every yang. Enter the infamous "crypto winter." This icy period kicks in when sentiment gets overly bullish and investors excessively leveraged, resulting in a self-correcting market — prices plummet, investors panic, and the mood gets frostier than a New York winter bomb cyclone. Indicators of this chilling season? Prolonged price declines, increased market volatility, reduced trading volumes, and a general feeling of despair among investors who bought in during the hype and try to ignore the stress of unrealized losses.

So, where in this cycle are we now, and why are we waving goodbye to crypto winter and stepping into warmer times?

(Source: CoinDesk Indices)

Bitcoin's up by a solid 18% month over month, while the broader CoinDesk Markets Index (CMI), which tracks the wider market, is up 21%. The outperformance of CMI over bitcoin shows the preference for lower cap altcoins, a positive cycle indicator due alongside positive Bitcoin and Ether Trend Indicator values and the buzz around spot exchange-traded funds (ETFs) continues to heat up. We're seeing a surge in inflows into crypto investment funds, and even meme-coins are making a comeback — yeah, they're back in the game. Plus, the end of Sam Bankman-Fried's trial gives the crypto world a fresh start.

Why are we out of the deep freeze? Well, it's all about a shift in the narrative. Wall Street is entering the scene big time, talking billions in investments through ETFs. They're spinning a tale of mainstream institutions swooping in to save the day, making crypto safer and more transparent for investors.

The focus now? More regulated crypto exchanges, building broader and more sustainable products like ETFs, tokenized securities, and stablecoins — not the frothy inside joke stuff of meme coins and overpriced NFTs we saw in the COVID frenzy.

This shift might ruffle some feathers, straying from crypto's original ethos as an alternative to mainstream finance. But, hey, it's what's revving up excitement again. And it's not just Wall Street driving this. Macro factors like the potential end of the U.S. interest rate hiking cycle, Middle East tensions and the specter of long-term inflation are nudging investors toward safer harbors, including crypto, as BlackRock's Larry Fink's "flight to quality," comment suggested. Funny how a former crypto-skeptic like Fink is now singing Bitcoin's praises on national TV, huh?

Assuming we're now out of the deep crypto freeze, where are we in this new cycle? From an analysis of previous Bitcoin cycles using the CoinDesk Bitcoin Price Index (XBX), we can see that we could be well on our way to the next cycle highs.

From an average of previous cycles, it takes about 700 days between previous cycle lows and new cycle highs, with drawdowns averaging some -80% across cycles. Assuming November 21, 2022 was the previous cycle low, this would imply a new cycle high sometime in Q3 of 2024, with new highs exceeding previous cycle highs (November 9, 2021 was Bitcoin all-time-high of $67k) by a multiple of 2-7 times, assuming the averages of a small sample size of Bitcoin cycles hold and history repeats itself.

(Source: CoinDesk Indices)

Massive cycle analysis caveats aside, it appears that we're out of another crypto winter, with the support of a broader institutional adoption narrative and a favorable macroeconomic backdrop.

Truly developments to be thankful for this holiday season.

– Todd Groth, Head of Research, CoinDesk Indices

Institutional Outlook

Why 2023 Is Like 2020 and Bitcoin Is Set to Head Towards $50k

Bitcoin has recently achieved new highs in 2023, but there's a question lingering: Is the market over-extended, and have we reached the pinnacle of enthusiasm? We can gain insight into these inquiries by examining the positioning of the crypto options market.

The most apt comparison to Q4 2023 is the rally we saw in Q4 2020. In fact, by superimposing BTC returns for both years, we can discern a strikingly similar narrative unfolding.

(BTC spot performance 2020 [green] and 2023 [orange])

At present, the implied volatility of options (which represents an investor's bet on BTC's future realized volatility) is hovering near its 2023 peak, primarily driven by the buying of call options. This could indicate the market is already factoring in the explosive upside potential we're all hoping for.

Nevertheless, when we look back at the implied volatility of BTC over the past four years, it remains relatively subdued, implying that BTC hasn't yet demonstrated the explosive rally it is historically capable of. When BTC surged in Q4 2020, the accompanying option volatility peaked at around 150%, whereas today it stands at approximately 50%.

(BTC implied volatility for "at-the-money" options)

We can also draw a comparison between the historical futures basis today and that of January 1, 2020. Back then, the futures basis on Deribit was 20% annualized, equivalent to 17 times the 10-year risk-free rate. Today, the futures basis is around 10% or 2.4 times the equivalent risk-free rate. These substantial disparities between now and 2020 don't necessarily forecast higher spot prices, but they do suggest that potential buying power is still largely on the sidelines.

Finally, it's crucial to note that the implied volatility option traders are willing to pay is closely tied to the actual volatility that BTC is experiencing (realized volatility), which has hit new lows in 2023. This connection is often referred to as the Variance Risk Premium (VRP), and it has been widening since mid-October. Recently option traders have consistently been willing to pay a significant premium over realized volatility in BTC, anticipating the possibility of explosive movements.

(BTC "at-the-money" implied volatility Term Structure)

We're currently witnessing an especially pronounced implied volatility "kink" higher for the January option expiration month. This reflects the anticipation that the Securities and Exchange Commission will approve/deny spot Bitcoin ETFs, causing markets to move.

The forward volatility (the actual implied volatility differential priced between the Dec. 29 expiration and the January contract) currently resides around 57%, a 12-point premium of about 30-day realized volatility of 45%.

This situation either suggests that option buyers are making incorrect and overpriced bets, or that substantial volatility in BTC will not only continue, but grow larger.

– Greg Magadini, director of derivatives at Amberdata.

Takeaways

From CoinDesk Deputy Editor-in-Chief Nick Baker, here is some news worth reading:

MINERS' DARWIN ERA: A thing to know about the Bitcoin blockchain is that every four years or so the amount of bitcoin (BTC) awarded to miners for creating new bitcoin gets cut in half. It would be like, I dunno, you're a gold miner and every so often a magical being shrinks your mine by half. In the crypto case, the core of your company, in the blink of a blockchain, dramatically worsens by 50%. Tough business! It's the kind of thing that would make any executive obsess about costs. And thinking about costs often begets thinking about industry consolidation, and that's where bitcoin mining appears to be today, as explained in this excellent CoinDesk article by Aoyon Ashraf. As he puts it: "Strong miners might be about to eat the weak ones as the reward for mining BTC gets cut in half, experts say."
SOLANA GETS HOT: As I argued last week, the recent crypto rally feels like a return to the old, bull market days, with bitcoin taking out round-number $1,000 thresholds very quickly. Another sign: highly lucrative airdrops. CoinDesk's Danny Nelson writes: "Solana-based crypto staking project Jito released its JTO token on Thursday, continuing the march of popular token airdrops into the newly resurgent Solana ecosystem." Many folks got tokens suddenly worth thousands of dollars. This helped lift other Solana-based projects. Risk appetites have grown.

Want more? For the latest news affecting the crypto markets, listen to CoinDesk's Markets Daily podcast.

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