Valuations in the cryptocurrency market have dropped significantly from their all-time highs, with the total market capitalization losing around $2.2 trillion – a decline of around 73%.
Many altcoins, including some from the large caps, have lost over 90% of their value since their all-time highs, and industry participants are scrambling to time the bottom.
In light of the above, crypto analytics resource Nansen released a report that identifies systematic patterns in crypto derivative markets and traditional spot markets, analyzing what they mean for the current market environment. In short, they are attempting to answer the question if the crypto bear market is coming to an end.
Nansen outlines three key takeaways.
The US Dollar
As of the time of writing these lines, the USD has started to lose strength against other major currencies such as the JPY and the CNY.
Nansen argues that one of the drivers for this could be the pricing of the peak Fed interest rates by future bond markets.
Bond futures currently forecast that the Fed policy rate will peak at ~4.84% in May 2023 and will be cut by +40bps in H2 2023. Admittedly, US CPI releases have been surprised to the downside for the second month in a row, which can account for Part of the pricing out of rate hikes. Read the report.
Nevertheless, rate cuts can take place if there’s a serious weakness on behalf of the US on a macro level, with their real growth slowing down significantly. The Chairman of the Federal Reserve – Jerome Powell – has outlined on multiple occasions that the “risks of under-tightening outweighed the risk of over-tightening” and that the labor market was too high and needed rebalancing.
Using complex indicators to assess relative growth between the US and other considerations, Nansen came to the conclusion that:
“…it is probably too early to call for a transition to easier global financial conditions, and, therefore, that the fundamental case for bottoming of crypto assets is likely not there yet.”
With this, the analysts change their focus to the derivative markets.
Calls vs. Puts for BTC and ETH
The question that Nansen aims to answer here is if option investors in BTC and ETH have capitulated yet, and to address it, they take a look at the open-interest-weighted implied volatility of call vs. put options (CPIV).
The data they examine covers the period between January 2021 through November 2022, with the assumption that the derivative market is going to evolve in future cycles.
The conclusions that they came to can be summarized as follows:
- The CPIV indicator managed to generate more frequent risk-on and risk-off signals compared to the stablecoin indicator.
- Both of them flagged the multi-month BTC decline that started in November of last year.
- The stablecoin indicator came back to risk-on in May 2022, while the CPIV indicator was risk-off as of November 20, 2022.
*Note: the stablecoin indicator mentioned above is the Nansen Smart Money Stablecoin risk appetite indicator.
Crypto Risk Premium
In the last section of the report, the analysts conceptualize and calculate a risk premium for crypto, called Crypto Risk Premium or CRP. It is linked to the fundamental value of the crypto assets held by investors.
The methodology the analysts adopt is developed by Ian Martin in a paper published in April 2015 called What is the Expected Return on the Market? Nansen also uses historical options data of Deribit with consideration of the intra-day bid and ask prices of calls and puts on BTC, ETH, and SOL.
However, when pinning crypto and equity markets, the analysts make the caveat that crypto derivative markets are young and not as well-studied as equity options markets, meaning it’s necessary to keep an open mind when analyzing CRP estimates.
With that said, the conclusion (rather speculation) is that:
“…in the eventuality of a US recession and US equity sell-off (our main scenario for 2023 given the Fed’s determination to maintain tight financing conditions for longer), the ERP is likely to go much higher, and conversely, the CRP or crypto risk premium will probably also jump. It is therefore possible that crypto prices experience a further (and “last” ?) leg down in this cycle before financing conditions turn more favorable to both equity and crypto assets.”
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