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Reflections of the Past

The trading regime has become increasingly less certain as of late, but we think macro conditions are less of a headwind than some believe

March 9, 2023

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Key takeaways

  • Looking ahead, the disbursement of 142k BTC from the Mt. Gox rehabilitation plan and selling pressure from Ethereum’s Shanghai Fork represent the most visible technical risks for this space.
  • While global liquidity conditions look tighter due to central bank actions in China and Japan, overall demand remains supported by the drawdown in the US Treasury General Account.

Written by

  • David Duong, CFA, Head of Institutional Research


The macro environment still matters for crypto performance, even if the correlation between bitcoin and US stocks has come down from a coefficient of 65% at the end of 2022 to 28% as of early March (based on a 40-day rolling window). We do not believe macro is the headwind that some investors believe it to be, as the Federal Reserve’s hawkish forward guidance should become increasingly less relevant in 2Q23 due to the economic data. For example, in our view, the pace of disinflation should start to pick up once we factor in lower rent costs and base effects.

Liquidity conditions meanwhile are still favorable with the US government drawing down its Treasury General Account with no new debt issuance, offsetting the roll off in the Fed’s balance sheet. Nevertheless, the correlation trends have made it hard to isolate exactly what’s been driving the market here. For now, it seems like the price action in crypto reflects only a limited number of marginal sellers despite some of the idiosyncratic headline risks of late, which is keeping BTC and ETH range trading for now.

Looking ahead, we believe technical factors like the Mt. Gox disbursement of 141,686 BTC starting on April 6 (the registration deadline was delayed from March 10 and the distribution of assets is now set to begin on October 31) should have only a modest immediate impact on bitcoin performance. Meanwhile, it seems like investors are staying delta neutral heading into Ethereum’s Shanghai (+Capella) upgrade in early April as there doesn’t yet appear to be a clear consensus on the event risk and its implications for price action.

Performance recap

Historically, risk asset performance tends to drop off in the latter part of the first quarter, often starting in mid-February. By this point, much of the excess cash to start the year has already been deployed while bonus season flows have mostly dried up. Moreover, the trading regime has become increasingly less certain with Fed fund futures pricing in a higher terminal rate in the US and pushing out the likelihood of a Fed pivot to 2024. These same technical and macroeconomic factors affect cryptocurrencies and make it hard to interpret a sell off that has coincided with adverse headlines on industry regulations and contagion concerns.

Macro is neutral

That said, we don’t think the macro landscape is the headwind that some may believe it to be. In fact, we would argue that conditions are closer to neutral at the moment (at least in the US) given the still relatively strong economic data and the approaching end of the hiking cycle. While the probability of the Federal Reserve deviating from a 25bp tightening pace (to the upside) is higher than it was a month ago, we think chances of an overshoot will ultimately be limited by greater disinflation later this year. That is, there are still base effects that should take inflation lower but have yet to kick in, even if some core CPI elements are stickier than desired. Plus, fears of a reflationary China reopening have moderated.

On the downside, the People’s Bank of China (PBoC) has reduced its liquidity injections (reverse repurchase operations), and the pace of the Bank of Japan’s balance sheet expansion has slowed. However, we would argue that these flows have a less pronounced effect on global liquidity conditions as they tend to circulate more domestically than abroad.

More important to the digital asset class, in our view, is the drawdown in the US Treasury General Account (TGA) balance from US$568B at the end of January to $340B as of March 6. Because the debt ceiling limit has been breached, the US government is relying on the TGA to pay expenses without new debt issuance, thus offsetting the runoff in the Fed’s balance sheet. Given the current size of the TGA, we believe that support from this factor could last until early June. At that point, however, things could potentially become more volatile for the market, if the US experiences any economic slowdown.

1. Financial conditions in the US remain loose at the moment


Headline risks

There’s been no shortage of news stories on digital asset regulations and banking restrictions in recent weeks:

  • On February 9, US based crypto exchange Kraken agreed to pay the US Securities and Exchange Commission (SEC) a $30 million fine for allegedly violating securities laws related to its crypto-asset staking service. (Note: for more details, see Coinbase’s blog post on why Coinbase’s staking services are not securities under the US Securities Act.)
  • On February 12, Paxos disclosed that it had been ordered by the New York Department of Financial Services (NYDFS) to halt the minting of BUSD, and that the SEC had issued a Wells Notice to the firm. (Coinbase has published thoughts on stablecoins here.)
  • On February 15, Coinbase’s Chief Legal Officer Paul Grewal discussed the SEC’s new proposal on custody and why the firm is confident that Coinbase Custody Trust Co. is and will remain a qualified custodian.

Crypto-friendly bank Silvergate has also been a focus for investors, announcing on March 8 that it intends to "wind down operations and voluntarily liquidate the bank." It previously notified the SEC on March 2 that it will not be able file its annual financial report (Form 10K) before the extension date of March 16, 2023. Silvergate then discontinued operation of its Silvergate Exchange Network on March 3. Form 12b-25 suggests that both Silvergate Capital Corporation and Silvergate Bank could be “less than well-capitalized” due to impairments on the securities portfolio.

Many of Silvergate's issues were connected to the collapse of FTX late last year, but not because the bank was holding bad assets. Rather, Silvergate was forced to liquidate its US Treasury, mortgage bond, and municipal bond holdings amid a run on the bank in 4Q22, and those assets had declined in value amid the Fed’s tightening cycle. (The assets that banks buy tend to have a longer duration than the deposits they receive, i.e. a classic maturity mismatch.) This led Silvergate to realize a $949M loss last quarter ($886M from its bond portfolio). The issue for the industry now is that many crypto firms will need to find alternative onramps for the asset class. In light of these developments, we would characterize the performance of cryptocurrencies as relatively resilient over the last six weeks, with bitcoin and ether trading inside narrow ranges -- albeit the story on banks is still in flux. Moreover, on a risk-adjusted basis, bitcoin has continued to outperform the S&P 500 US equity index, trading 0.63 standard deviations above its 65-day rolling average (vs 0.07 standard deviations for the S&P 500).

We think that’s partly because some of the recent developments may have already been priced in by markets. For example, Silvergate announced as early as January 5 in its preliminary 4Q22 financial metrics that total deposits from its digital asset clients fell 68% to US$3.8B in 4Q22. Meanwhile, the open interest on bitcoin futures declined by 29k BTC (to 453k BTC or $1.05B as of March 7) since end-January, suggesting fuel for a sharp squeeze higher may be gone for now. Open interest on ETH futures have been stable at 3.6M ETH ($5.7B) ahead of the Shanghai Fork (also known as the Shapella upgrade), but total open interest across global futures for all coins dropped by $3B (to $34.1B) in the first week of March.

2. BTC is outperforming US stocks on risk-adjusted basis


Relative value

Overall, the momentum in activity seems to be tapering off for many layer-1 smart contract enabled networks. While total value locked on Ethereum increased 0.96% in February, the TVL for other top ten alternative L1s (by market cap) were either flat or falling with the exception of Cardano. Of course, Cardano’s TVL also rose from a much lower base than its peers. We did however see a sharp rise in transaction volume on the network, but that was partially offset by sizable ADA inflation in February. Its velocity is the highest among L1s at 16.38, compared to low levels of 1.11 and 0.50 for bitcoin and ether respectively. The latter reflects less supply circulating in the market for those large caps (as we previously discussed last month) providing technical support for these assets.

An alternate measure of activity is the number of transactions per capita, which also showed large declines for many L1s last month. This was most severe for Avalanche which saw the ratio of transactions to unique active addresses fall by 15.5%. However, there were notable increases as well, particularly for Solana (8.2%) and Tron (34.1%). Lastly, transaction fees on bitcoin in February were 1.16 standard deviations above the preceding 365d average, the only L1 on our table which reflected any substantive increase. The higher network fees most likely reflect earnings related to the Ordinals (NFT or digital artifacts) project, which debuted earlier this year.

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Bitcoin. The disbursement of bitcoin and other funds from the Mt. Gox rehabilitation plan is slated to begin on April 6 (the registration deadline was delayed from March 10 with the distribution of assets now to begin on October 31).  It should distribute up to 141,686 BTC to creditors whose funds were lost by the defunct exchange, though we believe this process could potentially be dragged out. Creditors can receive a lump sum payment, bank remittance or register with an exchange to receive funds. On the latter however, some of these exchanges have said they can take anywhere from 20 to 90 days to process payments. Moreover, the notification from Mt. Gox in July 2022 stipulated that any movement of creditors’ funds will be restricted “until all or part of the repayments made as initial repayments is completed.” That suggests that not all the repayments will be distributed at once. 

Consequently, we do not believe these Mt. Gox payments will be a relevant technical factor for markets until closer to 3Q23. Importantly, the two largest creditors (representing 20% of all claims) have opted for a crypto payout, and others may yet join them. That should limit upfront redemptions and help smooth out the flows against a daily average trusted BTC spot volume of $11.1B YTD (according to CoinMetrics).

Ethereum. The deadline for the Shanghai Fork (enabling staked ETH withdrawals) has been delayed from March to the first half of April, according to the latest core developers’ call. Futures and options positioning suggest investors are staying delta neutral heading into this event, as the implications on ETH performance are still uncertain. (We previously laid out our case on why we believe the selling pressure should be limited -- with ETH performance dependent more on what risk does at the time withdrawals are enabled. See our report dated February 14.) Meanwhile, ETH supply growth was deflationary for a second consecutive month in February at -0.34% annualized, as activity on the network was sufficient to meet the ETH burn threshold.


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