This week we look at the concept of benchmark rates in the crypto ecosystem as well as discuss some important announcements from Circle (the issuer of USDC) and the new Cosmos whitepaper.
Also, please take a look at our recently published Monthly Outlook titled “Post Merge Metrics,” where we evaluate some lingering questions about Ethereum following the Merge. These pertain to ETH’s updated tokenomics, the schedule for further upgrades and the competitive landscape surrounding alternative layer 1 networks. The full report is available here.
Finally, the institutional research team is hosting their next ask-me-anything webinar on October 20 at 11am ET. Please register here to listen to “Ask Coinbase Research” and submit your questions.
Weekly Market Call
View replays of our weekly crypto market analyses from our Americas, APAC and EMEA Coinbase Institutional teams, available here.
Market View
Risk free rates in crypto?
With Ethereum’s Merge complete, we believe the community is turning its attention towards building more complex financial products on the network based on the staking rewards earned by validators. Already we have seen the broader crypto industry explore the idea of having benchmark rates for DeFi. For example, Chainlink and CF Benchmarks recently announced a Bitcoin Interest Rate Curve (from overnight to 5 months) on September 28. This is akin to traditional finance’s LIBOR (London Interbank Offered Rate) or its successor SOFR (Secured Overnight Financing Rate).
In our view, having a benchmark rate for lending and borrowing could eventually become integral for the asset class, although we think there is something of a flywheel effect that may take place over time. That is, crypto markets are still relatively nascent compared to the rates markets in traditional finance, which is precisely why this gap in the ecosystem exists. But as this space develops, we believe that some of the attributes of certain digital assets may become more currency-like.
What the ultimate benchmark rate should be is another matter. According to Token Terminal, Ethereum’s share of the revenues generated across blockchains is 87.8%, suggesting activity in the crypto economy tends to be concentrated in one network. As such, it seems like Ethereum’s staking yield - earned via inflationary base rewards and net transaction fees paid to validators - could be more closely aligned with the capital actually being deployed in the broader crypto economy.
Chart: Top blockchains by cumulative 1y revenue (US$)
The idea is appealing as ETH staking yields have a self correcting mechanism to reduce rewards during periods of economic expansion - whether propagated idiosyncratically or due to exogenous macro forces - and raise rewards during periods of economic contraction. That is, when staking demand increases (presumably in periods of economic strength), the base reward declines in favor of capturing higher transaction fee earnings. Conversely, when staking demand declines, base rewards programmatically rise while income from fees is potentially lower.
But while SOFR is the theoretical risk-free rate for traditional investments, the same cannot be said for Ethereum staking rewards. For one, earning the staking yield is not riskless. It requires positive action on the part of the validator to earn it. Moreover, block proposers can be slashed for malicious behavior, implying risk. To use the staking yield as a benchmark, we would likely need to make adjustments to the rate - adjustments which may be inherently variable.
Resolving this is important, particularly since staking yields feature in futures pricing. If investors treat ETH as equivalent to a traditional currency with a risk-free rate, that could translate into a persistent negative basis for the term structure with important ramifications for hedging. Already the front end annualized futures basis post-Merge has been in negative territory over the last two weeks with the 1m and 3m currently near -2.0% on Deribit. Regardless, staking rewards may offer a good starting point for exploring more complex financial engineering in this space.
USDC and cross-chain interoperability
At its Converge22 conference, Circle (issuer of USD Coin) unveiled their new Cross-Chain Transfer Protocol (CCTP), which is a permissionless protocol that facilitates a mint/burn mechanism allowing USDC to be sent natively across ecosystems, aiming to improve liquidity, enhance multichain interoperability and reduce the broader fragmentation of bridged assets. At a very basic level, a user looking to move USDC from one chain to another can use the CCTP to destroy (burn) the transferred amount on the original chain and create (mint) the same amount on the destination chain, assuming Circle has attested the transaction. The CCTP is expected to go live on Ethereum and Avalanche mainnet later this year and will eventually expand to the rest of the chains where USDC circulates– which will include five new blockchains in the future: Arbitrum, NEAR, Optimism, Polkadot (expected before the end of 2022) and Cosmos (expected in early 2023).
This enhanced capacity for cross-chain native USDC transactions should allow developers to more seamlessly build wallets, bridges, payments apps and financial services tools that will benefit from a more simplified user experience. This will likely improve the capital efficiency of USDC across varying ecosystems and enable more DeFi composability, particularly as developers use Circle APIs to build fiat on/off-ramps to and from USDC in their products.
Coinbase Exchange and CES Insights
Exchange
Volumes on exchange were around average last week. With heightened volatility in financial markets, traders sought the relative safety of BTC. It regained the top spot as the most traded asset on exchange. Interest in altcoins outside of ETH remained low as there was a lack of token specific narratives for the market to latch on to.
Coinbase Execution Services
Crypto continues to hold up well when compared to traditional risk markets, though correlations remain high at north of 0.70. With positioning in traditional markets at extremes, and the pain trade higher, there is the potential for a melt up that could drag crypto along with it. Medium term momentum signals are beginning to flash Buy for a subset of tokens and so we have seen momentum traders begin to leg into fresh longs. Meanwhile, crypto native funds continue to add to favorite projects in the identity and scaling spaces. UHNW investors have been notably absent recently, likely tending to their portfolios in other areas.
Bitcoin Technicals
Despite trading range bound over the last month, the BTC chart remains in a bearish formation. BTC is currently rejecting the EMA50 on the daily timeframe and the multi month downtrend line (black line) formed on May 31 of this year. The same time this happened was September 12 and September 13 when BTC rejected the EMA70, downtrend line, and cross rejected the EMA9 and EMA20. BTC fell from US$22.5k to US$19.8k on a single candle. This is the current setup for BTC. Given that the StochRsi is about to cross downward with this setup, BTC may retest the US$18.9k level within a week. BTC would need to close above US$21.3k to invalidate this bearish setup which is unlikely given the last 3 candles rejecting the EMA50. We now have a triple top formation on the StochRsi. BTC may retest the lows of US$17.5k very soon.
DeFi
The Cosmos network represents a critical infrastructure stack of tools (Tendermint, IBC, and Cosmos SDK) that have enabled a network of interoperable application-specific blockchains (appchains) and Proof-of-Stake (PoS) networks. Historically, however, very little of the revenues generated by the growing ecosystem have accrued to holders of the native token, ATOM. This dynamic could soon change by virtue of several fundamental proposals announced at the Cosmoverse conference held in Colombia last week. Cosmos released a new whitepaper that articulates the revamped vision for the Cosmos Hub (the blockchain sitting at the center of the Cosmos blockchain ecosystem) focused on interchain security, allowing other Cosmos chains to borrow or “rent” validator capacity from the Cosmos Hub in order to better secure their own networks (while also allowing Cosmos to more directly monetize the security assurances of the Cosmos Hub).
Further, the whitepaper proposes key changes to the issuance schedule of ATOM and aims to enhance the utility of the native token through the introduction of liquid staking. Unlike the current issuance schedule which dynamically adjusts based on the supply and demand of staking, the newly proposed monetary policy would temporarily increase issuance (relative to the historical issuance rate which has ranged from ~7% to ~20% annualized) for the first 9 months. That will be used to bootstrap the funding of a new Cosmos Hub Treasury before falling below current issuance levels and continuing to decline over the subsequent 27 months, eventually arriving at a steady state issuance of ~300k ATOM per month (or ~0.1% of the current outstanding supply).
Other proposals announced by the Cosmos team include the Interchain Scheduler, which facilitates an interchain MEV marketplace on-chain, and the Interchain Allocator, which allows the Cosmos Hub Treasury to fund new Cosmos chains through on-chain agreements. At a high level, the combined effect of these proposals (if passed via governance voting) promises to more concretely position the Cosmos Hub and ATOM at the heart of the growing Cosmos ecosystem by enhancing the utility of ATOM and allowing the token to accrue value in tandem with the broader growth of the network.
View From Around the World
Asia
The Prime Minister of Japan has announced in his State of the Union address on October 3 that the government plans to promote the use of Web3 services that utilize the Metaverse and nonfungible tokens. NFTs are already a part of the country’s digital transformation - with the Prime Minister also hinting at the possibility of digitized national identity cards. (Coin Telegraph)
Europe
The European Union is getting ready to regulate the digital assets sector after agreeing on the final wording for its landmark crypto legislation known as the Markets in Crypto Assets Regulation (MiCA). Subject to European Parliament approval MiCA is on track to come into force in 2024. Whilst a step forward in the right direction, questions remain around crucial areas such as NFT’s, DeFi and capital requirements for stablecoins. (Coindesk, Decrypt)
