- The Good, the Bad, and the Ugly
- Upcoming Risk Events
- Trade Ideas Update
1. The Good, the Bad and the Ugly
The unraveling of LUNA and UST was a blackswan event that shocked an already weak crypto market. How has the market taken it and where do we go from here?
As a whole, crypto markets have been relatively resilient in the face of this market shock. More importantly, unlike previous crashes, liquidity in spot and options was consistent with no disruptions at major trading venues.
To put things in perspective, a top 10 coin went to zero within a week! At its peak, LUNA was the 8th largest token with a market capitalization of $41 billion, in addition to TerraUSD’s (UST) $18.7 billion. In spite of such a massive wipe-out, the market remained robust. This is clearly a mark of maturity for crypto as a trading and investment asset class.
LUNA is not the first and will certainly not be the last to face collapse or obscurity. The chart below shows the composition of the top 15 coins over the years. Many have come and gone over the various cycles.
The good news is that the top names; BTC, ETH and the collateralised stablecoins (USDT and USDC), have remained sturdy and provide a confident foundation for the market.
The decimation of LUNA and UST has also forced many to reassess the economics around tokens. If a ‘blue-chip’ token can become worthless so quickly, do tokens have any intrinsic value or proper value accrual?
This line of questioning has inevitably led to the decline in valuations in both private and listed token markets. If the market continues to price out ‘fundamentals’, what other factors could support token prices?
We’ve previously explained in Fiat & Crypto that the primary macro driver of token prices is money supply. We have seen this play out with the exponential increase in the crypto market capitalisation on the back of unprecedented money supply expansion in 2020 and 2021.
The bad news is that US money supply (M2) recorded its first monthly contraction in 12 years last month. This is only the 3rd time it has contracted in close to 20 years! (Chart below)
This contraction in M2 has been a result of Fed hikes and forward guidance which drove a surge in reverse repos (RRP) to all-time record levels. Banks and money market funds withdrew money from the financial system in order to park it with the Fed to take advantage of high overnight interest rates.
This draining of liquidity will only be exacerbated by the upcoming QT balance sheet unwind as well, beginning 1 June. We expect these factors to weigh on crypto prices.
We’ve already started to see the effect of monetary tightening on crypto with BTC and ETH down 9 consecutive weeks and counting, a record since they began trading. We examine the overall decline in the crypto space in two different tables below:
i. The impact has been felt across the space. Nothing has been spared from this drawdown.
ii. DeFi and Meme coins have had the largest drawdowns. When the easy money dries
up, coins with poorest utility and highest multiples suffer the most.
i. For BTC and ETH, the current drawdown is now identical to the 2020 Covid drawdown. It is possible that we see a short-term bounce from these oversold levels.
ii. For BTC and ETH, if we match the 2017 drawdowns of 85% and 95% respectively, we will be looking at levels of 10,000 for BTC and 250 for ETH. While we think this is unlikely, the deep negative skew in the vol markets is reflecting some fear of this happening.
iii. In 2017, it took roughly 1 year to find the bottom for BTC and ETH. We are potentially still some time away from the absolute bottom.
iv. NASDAQ has now matched its 2020 Covid drawdown. However, there is still room on the downside compared to its prior drawdowns.
v. S&P 500 on the other hand, has not even come close to the extent of its historical drawdowns.
i. USD (DXY Index)
● Our call last month was for a false topside break of the 6-year trendline followed by a monthly TD 9 reversal. This has played out nicely.
● However, for the USD to keep moving lower, the narrative has to shift away from inflation towards an impending recession in the US. This would force the Fed to slow down the hiking cycle.
● For the USD, Bonds and Equities, we are now therefore entering into a “bad news is good news” phase with regard to growth and employment data. The market would trade positive on negative news as that would reduce Fed hawkishness.
ii. 5-year and 10-year Treasury Yields
● In-line with the USD story, US Treasury yields have fallen this month, off a double-top at 3.22% in the 10-year, and 3.1% in the 5-year.
● This is due to certain Fed members acknowledging that the Fed would potentially be forced to cut rates sometime next year in the face of slowing growth (after hiking this year to combat inflation).
● The 28,742 level (61.8% Fibonacci retracement from the Mar 2020 lows at 3,858 to last year’s 69,000 all-time highs) has proven to be a pivotal closing support.
● The 25,000-28,742 support area could provide the base for a move higher to retest the 36,500 level (50% Fibonnaci support turned resistance
● By wave count, it is possible that with the UST-led capitulation this month, we have now completed the 3rd wave lower and will embark on a 4th wave higher.
● Following the conclusion of this 4th wave, we could have a 5th wave lower that breaks the 25,000 wave 3 low to test the key 20,000 major long-term support.
● ETHBTC has finally broken below its 1-year consolidation triangle.
● The cross is currently holding to the very key 0.06 level, a break below would be bearish towards the 0.03 support level.
● We have broken below the upward trend channel formed in the 2020-21 rally. However the extremely key 1,700 support level has held firm.
● A break below 1,700 would be bearish towards the 1,000 support level.
● It is likely that ETH trades higher from here in an extended 4th wave towards the 3,000 level. However, we might eventually see a final 5th wave that breaks the 1,700 level.
● It is possible that the market was positioned heavily long in ETH in anticipation of the ETH 2.0 merge. Further unwinds would place significant downside pressure. For this reason, we prefer BTC over ETH until we get more certainty on the ETH 2.0 merge.
3. Upcoming Event Risk
4. Trade Ideas Update
We’ve taken profit on the positions that we put on in December 2021. The only positions that remain open are a short 60,000 call (December 2022 expiry) as well as our exotic option structures.
1. Long Jun BTC 40k Call w/ 50k ERKO (European Reverse Knock-Out)
Similar to buying a 40k call option except the structure is knocked out (eliminated) if spot expires above 50k at expiry [cheapens option buying]
We had the right view but wrong timing on this as BTC topped at 48,240 on 28 March.
Fortunately, the ERKO made this much cheaper than a typical call option. The cost of this structure was only 3.9% vs. 14% for a vanilla 40k call.
2. Short Sep ETH 2k Put w/ 1.5k ERKI (European Reverse Knock-In)
Similar to selling a 2k put option except the structure only knocks in (becomes live) if spot expires below 1.5k at expiry [reduces risk on option selling]
This structure would already be in the money if not for the insurance provided by the ERKI.
Giving up 1.3% in premiums collected (4.5% for the ERKI structure vs. 5.8% for the outright 2k put) allows us to lean on the 1,700 support level in ETH. If the level holds till expiry, we would be able to earn the premiums without the option being exercised.
*Please reach out to the QCP option desk if you would like to put on similar structures.
New Position – Short BTC Spot vs Long GBTC at >30% spread.
This is a non-directional, delta-neutral trade that aims to monetise the large pricing difference between BTC spot and Grayscale Bitcoin. 6 July is the SEC’s date for GBTC’s ETF conversion. While the probability of approval is low, the pricing gap would likely close up if it goes through. This would allow us to unwind the spread at a profit.
The risk for this trade is if the spread fails to close up or widens into perpetuity. There is also a 2% management fee to hold a long GBTC position.