Tougher trends to follow

Returns on crypto trend-following strategies appear to be lagging discretionary long-only strategies to start the year, after outperforming in 4Q22. Such strategies often miss the first part of a regime change as it takes some time for a new signal to develop. Our own backtest suggests short positioning in November was responsible for the bulk of the appreciation, but covering those shorts in mid-January likely exacerbated the performance gap when these strategies were carried over into the new year.

Meanwhile, a new NFT protocol on bitcoin called Ordinals is expanding the assets that can be stored on the blockchain, sparking a debate that goes back as far as the BitDNS/Namecoin saga in 2010. Transaction fees on the network have doubled over the course of January since Ordinals was launched, although fees still averaged US$0.925 over the last 30 days. We discuss the competing views on the project in our report this week.

Finally, in our latest Monthly Outlook (Decoding the rally) published February 2nd, we think through some relevant on-chain market indicators that may help capture key fundamentals for digital assets. These include growth in on-chain activity, value locked in protocols, and respective adoption rates. For more, please see our full report here.

Weekly Market Call

View replays of our weekly crypto market analyses from our Americas, APAC and EMEA Coinbase Institutional teams, available here.

Market View

Our backtest of a simple trend-following strategy on cryptoassets suggests that this approach is currently lagging behind a long-only strategy to start the year. Such strategies often miss the first part of a regime change as it takes some time for a new signal to develop. For our purposes, we utilize a time-series momentum strategy (TSMOM) based on a 20-day rolling window of an asset’s own past returns, which was previously discussed in our report Trend following in uncertain times (September 2022). Based on a market cap weighted basket of BTC and ETH, this TSMOM strategy outperformed a long-only approach in 4Q22 mainly due to holding short positions in November, netting a gain of 6% that month – compared to an 18% loss for the alternative.

Comparatively, TSMOM’s return in January was 3.5pp below the 33.5% gain earned on a long-only approach. The sharp recovery last month likely meant that trending following funds that profited from their shorts at the end of last year would have needed to cover those positions in early-to-mid January – widening the gap relative to long-only funds. 

Chart 1: Monthly performance of TSMOM vs long only market strategy

Looking ahead, we should have a slightly calmer week as far as economic data releases and earnings reports are concerned. Central banks offered few surprises on policy during the week ended February 3rd. The US Federal Reserve pared back the pace of hikes to 25bps and didn’t take the opportunity to push a more hawkish tone, giving risk assets further room to rally. In our view, the implication of the Fed’s messaging is that they’re content with loosening financial conditions (signaled by indicators like the Chicago Fed National Financial Conditions Index – see our report from last week), perhaps because it supports their case of delivering a soft landing scenario. We think the most likely scenario is to see two additional rate hikes taking the terminal rate to 5.25%.

Meanwhile, the ECB delivered its 50bps hike as expected and signaled another 50bps on March 16. That would take rates to 3.00% compared to an implied terminal rate forecast of 3.25% priced into overnight index swaps by early 2H23. All things considered, the hawkish tone did little to significantly dent risk appetite. Even the multilateral USD index (DXY) retraced, after falling immediately after the central bank’s decision. 

We think market conditions should be relatively benign in the short term (next few weeks) barring any negative surprises in the economic data. In the US, that shouldn’t come until February 14 with the January inflation print, followed by retail sales and housing data. That said, something to keep in mind is that technical factors are starting to be less favorable with stablecoin dominance (of the total crypto market cap) having fallen from 17.9% at the start of the year to 13.4%.

NFTs & Web3

In recent weeks, a new NFT protocol on bitcoin called Ordinals (based around Inscriptions, a bitcoin-native mechanism) has sparked debates within the community about the fundamental nature of what deserves to be immutably stored on the digital ledger.

Taking advantage of functionality introduced in the SegWit (2017) and Taproot (2021) software upgrades for bitcoin, the Ordinals protocol allows individual satoshis (the smallest unit of bitcoin, 0.00000001 BTC) to be inscribed with data, effectively repurposing them as NFTs that can be transferred and stored on the bitcoin blockchain. While satoshis are fungible, Ordinal Theory is a convention that tracks these units sequentially and allows users to assign them non-fungible attributes.

• Opponents of Ordinals believe that non-financial transactions could ultimately become an expensive form of spam in a future state of the network where scarce blockspace drives a robust fee market. They believe that bitcoin blockspace should be solely reserved for financial transactions. (Note however that transaction fees on bitcoin are relatively inexpensive at the moment – averaging ~US$0.925 during January 2023.)
• Proponents on the other hand believe that incremental sources of demand for blockspace – such as non-financial data like domain names, text, images, or videos – represent positive competitive forces that ultimately increase fees paid to miners, further incentivizing them to secure the network. 

In our view, Ordinals represents a possible path forward for bitcoin where new constructs can be built on the network. That could potentially be beneficial for bitcoin’s usage and adoption. However, it remains to be seen whether the project will gain any meaningful traction, considering the current technical requirement of running a full bitcoin node to inscribe satoshis. There’s also a general lack of infrastructure to support the trading/display of the NFTs (or “digital artifacts” as creator Casey Rodarmor calls them).

Still, it’s possible that NFTs or other types of assets will eventually be brought to bitcoin through other potentially more blockspace-efficient means still in development, such as Taro. Even opponents of Ordinals – including Andrew Poelstra, the head of research at Blockstream – recognize the difficulty in dissauding users from engaging with the network in a manner that is in fact permitted, technically speaking.

Crypto & Traditional Overview

(as of 4pm EST, February 2)

Coinbase Exchange & CES Insights

On exchange volumes continue to be elevated and trend higher. Post the FOMC on Wednesday we saw crypto markets rally across the board. The ETH/BTC cross, which generally performs during risk rallies but was left out in January, led the move higher breaking above 0.07. That wasn’t for lack of price action from BTC which was up 3.2% on the day. Both BTC and ETH have bullish narratives making the rounds. BTC is under owned, and with much of it going to self custody the liquidity likely won’t be there when allocations are dialed up. ETH has the upcoming Shanghai upgrade and the proliferation of liquid staking derivatives.

Altcoins rallied as well on Wednesday and into Thursday. Coinbase Institutional saw buyers in SOL, MATIC, AVAX, CVX, and LDO, among others. With the broad based risk rally traders also began to look at market neutral opportunities with basis and perp funding trades.

Bitcoin Technicals

BTC has been consolidating below the US$23,175 level after a brief correction on Monday (January 30) which saw the total market cap of crypto fall below $1T. After the Fed’s statement on Wednesday, BTC finally broke out above this resistance level and is currently trading around $23,800. The 4-hour MACD is still showing bullish signals on this rally – with the MACD line finally crossing back into positive territory on the rally.

It is worth noting though that while BTC did break above the psychologically significant resistance level of $24K post FOMC, it only briefly held that level before closing below $24K again. The 4-hour RSI is currently at 66, approaching overbought levels of 70 – suggesting that the rally could be losing steam and we might see a brief pullback given the velocity of the move overnight (commentary as of Thursday, February 2).

Financing Rates

Notable Crypto News

• Silvergate Capital shares jump after BlackRock reports increased stake in the crypto bank (CNBC)
• Highlights from the court report detailing Celsius' Ponzi-like downfall (The Block)

• Senate Banking Committee to Release Priorities for Developing Crypto Regulatory Framework (Coindesk)
• The UK finally reveals plan to regulate crypto trading and lending (The Block)

• What Is the Ethereum Blockchain’s Shanghai Hard Fork, and Why Does It Matter? (Coindesk)
• ARK Invest Maintains Prediction Bitcoin Price Will Hit $1M by 2030 (Coindesk)

• Making web3 exploration more secure with Coinbase Wallet (Coinbase Blog)

View From Around the World

Hong Kong is planning to set up a regime to supervise stablecoins. Entities conducting regulated activity in Hong Kong will have to obtain a license to operate stablecoin services, while issuers must maintain reserves matching the amount of the crypto in circulation. Algorithmic stablecoins will not be accepted. (Coindesk)

The UK government is pressing ahead with its plans to bring the cryptocurrency industry under the umbrella of mainstream financial services regulation. The Treasury said it would unveil a series of proposals to “regulate a broad suite of crypto asset activities, consistent with its approach to traditional finance”. As reported by the FT – the aim of the reforms is to move Britain’s crypto regulatory regime to a more “neutral” position following suggestions that its rules were previously too lax. (Financial Times)

The Week Ahead