Economic jitters + a look at crvUSD

We saw an end to the bear market rally in traditional assets this week, impacting the performance of cryptocurrencies as well. Although the move higher in crypto during 1H January was driven mostly by technical factors, it showed that there is still appetite for these assets overall. Indeed, market players have mostly shrugged off news that Genesis Global Capital is filing for bankruptcy, suggesting much of the bad news may already be priced. 

Meanwhile, we think speculation about the potential release of Curve Finance’s new algorithmic stablecoin may have contributed to a rally in the Curve DAO token (CRV) recently. We take a look at the mechanics behind crvUSD and its implications for the Curve ecosystem.

Weekly Market Call

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Market View

The end of the previous week’s bear market rally has been accompanied by weaker US “hard” data like retail sales and building permits alongside mixed “soft” data on business sentiment. Retail sales contracted 1.1% MoM in December 2022, more than median Bloomberg survey expectations of -0.9% (although it still awaits to be seen how much of this was affected by poor weather conditions last month.) Building permits fell by -1.6% MoM in December compared to forecasts of 1% growth (and were revised lower in November as well), indicating slower housing activity going forward. We believe this is more important than looking at housing starts, which actually beat expectations.

Meanwhile, sentiment indicators like the Empire State Manufacturing Index and the Philadelphia Fed Business Outlook were less reliable. The former, which surveys manufacturing activity in New York State, saw a dramatic decline to -32.9 this month (vs a median survey forecast of -8.7). But the latter beat expectations rising from -13.7 in December 2022 to -8.9 in January (vs a -11 forecast). Overall, these give us little to go on with respect to forward looking recession indicators. Still, the multilateral USD Index (DXY) seems to be consolidating around current levels in our view, while the relative strength index continues to hover in oversold territory – albeit this has been ongoing since mid-November 2022.

Looking ahead, we’re entering a blackout period for the US Federal Reserve (starting January 21) ahead of the FOMC meeting (January 31 to February 1). Signals have indicated that the Fed will slow the pace of hikes to 25bps at this meeting with the latest Beige Book suggesting rising concerns among policymakers about domestic demand and a potential recession this year. The Fed funds futures are already fully pricing 25bps in, but have marginally lowered terminal rate expectations further below 5% by end-1H23. The Fed decision will likely matter much less than the commentary in our view, although the market seems less focused on forward looking guidance and more interested in the data at the moment.

Implied volatility in bitcoin and ether options picked up alongside the price action in spot with the 1m ATM levels increasing to 64% and 73% respectively, before retracing lower. Vols are now more in line with the levels observed three months prior. While the rally in crypto prices up to this week has mostly been driven by technicals in our view, it showed that there is still appetite for digital assets in the market. Plus there have been some supportive idiosyncratic developments as well.

Crypto market players mostly shrugged off news that Genesis Global Capital has filed for Chapter 11 bankruptcy (with an exit planned by May 19), which we think is a positive sign that this had already been mostly priced. Moreover, details of the prepackaged bankruptcy plan provided by The Block indicates that in exchange for a forbearance period, creditors could receive “cash payments and equity in Genesis parent company Digital Currency Group.” We view this as a potentially positive outcome that may help distance the asset class from further consolidation events.

Separately, there has been a 0.03% contraction in ETH supply month-to-date (annualized) which has been supportive for the cryptoasset. The pace with which ETH is being staked ahead of the Shanghai Fork (anticipated in March) has started to pick up at the margin, but overall, there hasn’t been a significant increase since December based on the 7-day average of rolling daily changes. Note that the first Shanghai/Capella community call will take place today (January 20 at 3pm UTC) to give an overview of the next upgrade. This may be helpful to correct some misconceptions around unstaking ETH, like the distinction between partial and full withdrawals. Partial withdrawals should happen automatically for any balances greater than 32 ETH (i.e. to claim any earned rewards), assuming the withdrawal credentials are set properly, whereas full withdrawals represent an exit from validator participation.

Chart 1. Daily growth in staked ETH (rolling 7d average)

Note that Electric Capital released its eagerly awaited Developers Report 2022 on January 17. It indicates that despite the drawdowns in crypto last year, there was an increase in new developers that joined in 2022 at 61,127 compared to 48,596 in 2021. Ethereum had 5,750 total developers as of December 2022 (of which 5,734 were active) and an average of 800 new developers joining per month. The network has 2.8x the number of total developers as Polkadot (2,034) which has the second largest developer community (growing 2% last year). Meanwhile, among the other 1000+ total developer ecosystems, Solana grew its developer community by 83%, Polygon by 40% and Cosmos by 25%.

Web3

Crypto Twitter has been speculating about the release of Curve Finance’s algorithmic stablecoin (crvUSD) as early as this month, following the release of its whitepaper back in November 2022. That said, there is not yet a firm timeline for the release, and Curve’s founder has played down expectations of an imminent release. Nevertheless, this may be contributing to the over 70% appreciation in Curve DAO token CRV month-to-date, as investors anticipate this could drive increased protocol revenue. (On a related note, we think a rally in the governance token of decentralized lending platform AAVE may also be partly related to this speculation. That is, there is now pressure on AAVE to release their GHO stablecoin because of a potentially imminent launch of crvUSD.)

Directionally similar to other overcollateralized algorithmic stablecoins, crvUSD will require users to create collateralized debt positions (CDPs) in order to mint the stablecoin. However, unlike other CDP platforms which can automatically liquidate the entirety of a user’s collateral if their loan-to-value (LTV) breaches a certain threshold, crvUSD is unique in that it introduces a specialized AMM (automated market maker) into the liquidation model that gradually liquidates (or “de-liquidates”) the user’s collateral based on price movements. Instead of having a singular liquidation threshold, users will have a range of liquidation levels (or bands) that determine the composition of their collateral. 

This novel approach to liquidation dynamics – called LLAMMA (Lending-Liquidating AMM Algorithm) – is the core concept of Curve’s proposal:

• When users deposit collateral (such as ETH) to mint crvUSD, the LLAMMA smart contract determines the liquidation bands for the collateral.
• In our example, if the price of ETH declines, the liquidation model would sell ETH for stablecoins.
• If the price of ETH rises, the model would sell stablecoins for ETH.

Notably, this is different from traditional AMM pools where ETH would typically be removed from the pool if the price were increasing, and vice versa. LLAMMA’s rebalancing method, therefore, could present instances of permanent loss in periods of outsized volatility (by virtue of effectively buying high and selling low). That said, Curve suggests in the whitepaper that given a hypothetical price drop of 10% below the liquidation threshold over a three day period, only 1% of the user’s collateral would be lost.  

Other concepts discussed in the whitepaper include the PegKeeper, an automated smart contract that aims to stabilize the price of crvUSD at US$1. Curve will utilize a stablecoin pool in order to maintain the dollar-peg for crvUSD, wherein:

• the PegKeeper contract will mint uncollateralized crvUSD to this pool when the price is greater than $1
• conversely, it will withdraw crvUSD from the pool and burn it if the price is less than $1

Further, the whitepaper suggests that borrowing rates on crvUSD will dynamically adjust depending on the variance of crvUSD around its peg (rates decrease as crvUSD moves above $1 to incentivize users to borrow and in turn increase the supply of crvUSD, and vice versa).

Despite the negative market sentiment surrounding algorithmic stablecoins, which manifested in the wake of the Terra/LUNA collapse in May 2022, Curve has forged ahead with a relatively novel approach to the concept. Enthusiasm from Curve users and the broader crypto community stems from the potential of these mechanisms to minimize (or at least “smooth out”) the liquidation risks associated with stablecoin minting and borrowing. Further, if successful, these mechanisms could enhance the overall liquidity of the Curve ecosystem and in turn increase the fees generated by the platform.

Crypto & Traditional Overview

(as of 4pm EST, January 19)

Coinbase Exchange and CES Insights

Volumes on exchange have continued to be strong over the past seven days and are trending well above average. We are now seeing more activity outside of BTC and ETH as traders look to move into higher beta assets as a way to capture further upside. Bearish positioning has diminished. Over $500M in liquidations are said to have gone through on perpetual swap and future exchanges. 

While the move was seen as technical in nature, there are some underlying fundamentals that CES clients are focused on. We are closing in on the Shanghai Fork upgrade for ETH. That upgrade will be an important factor for liquid staking tokens. Additionally, Ethereum transaction activity has picked up, making ETH deflationary again, and daily active users on SOL have increased. Coinbase Institutional saw buying from traditional and crypto focused hedge funds, corporates and traditional asset managers. Meanwhile, miners took advantage of the higher prices and became slightly more aggressive in their sales. 

Bitcoin Technicals

BTC broke out of the US$15,900 – $17,800 range where it has been trading since the implosion of FTX in early November 2022 and has been consolidating around the $21,000 level. This level coincides with a strong resistance around the $21,500 level where the market has been topping out from August to November 2022 as well as a TD Sequential sell signal on January 18. While it is an impressive rally, momentum has clearly started to fade over the last few days after the RSI on the daily chart had reached the highest level in over two years during the move higher. Continued consolidation around current levels seems like a probable scenario in the absence of a further move higher across risk assets more broadly and the next range to watch could be $18,500 – $21,500 similar to August to November last year. Alternatively, if risk assets continue to trade well and if momentum rebuilds, then a break of the $21,500 level could set the next target for BTC at $25,000.

Financing Rates

Notable Crypto News

• ETH staking draw increasing institutional interest (TC)
• Binance to let institutions store crypto with cold custody (Cointelegraph)  

• Dutch Central Bank Chief takes aim at jurisdictions that attract bad actors (Coindesk)
• Nexo pays $45 million to settle SEC and state charges (The Block)
• McHenry Announces Subcommittee on Digital Assets, Financial Technology and Inclusion for 118th Congress (House.gov)

• China launches smart contract functionality on Digital CNY (Coindesk) 
• Crypto is back – in Davos at least – as redemption tour rolls on (WaPo) 
• FTT jumps on the back of possible exchange restart (WSJ) 
• OKX declares $7.5B in liquid assets in proof of assets report (Cointelegraph) 

• Coinbase halts operations in Japan (Coinbase)

View From Around the World

National Australia Bank has created a stablecoin called AUDN. The stablecoin, launched on the Ethereum network and backed one-to-one with Australian fiat held by the bank, allows business customers to settle transactions in Australian dollars, according to the Block. Transactions are targeted to launch by mid-year, including carbon credit trading and remittances. (The Block)

“The European Union’s landmark crypto legislation, the Markets in Crypto Assets regulation, or MiCA, has been delayed until April because of issues in translating the rules into the 24 official languages in the EU. ‘MiCA is tabled to be voted by the plenary in April and to my knowledge, the delay is technical, caused by translating issues,’ an official familiar with the matter said. EU procedures require legal acts such as MiCA, which was negotiated in English, to be available in all the bloc's 24 official languages.” (Coindesk)

The Week Ahead