At the end of last week, bitcoin experienced a swift and sharp drop in price resulting in hundreds of millions of dollars of futures liquidations in a short period. While we did not have the time to analyze it for last week’s note, given the magnitude and the amount of ensuing head-scratching, we think it is worthwhile to review the set of events that transpired.
Heading into last Thursday’s sell, price action could have been described as rangebound, unable to convincingly break through $30,000 and hold the price level. Bitcoin had already broken through the $30K ceiling twice, once in April following the regional bank crisis and once in June following the filing of a spot ETF application by Blackrock. Unfortunately, these moves were unable to hold the $30K level. The first break above $30K was subsequently dampened by a slew of regulatory enforcement actions, including lawsuits from the SEC against Binance and Coinbase. The second break above $30K was longer lived but eventually succumbed to profit-taking and perhaps the gradual realization that a spot ETF, while still a possibility, would take longer than the price action would lead investors to believe.
On July 13th, a long-awaited decision in the case between Ripple Labs and the SEC was handed down, resulting in a partial win for Ripple sending the price of XRP and many other coins soaring. Bitcoin rallied to a yearly high, but the moment was short-lived, as bitcoin quickly traded back down while many alts continued to rally.
We don’t have much to add on this topic as we’ve discussed it several times in the recent past, but it bears repeating - the summer is typically a weak period for bitcoin returns. Average monthly returns have declined beginning in May and have tended not to perk up again until October. While 2023 monthly returns throughout the summer have been a bit bumpy, it’s clear the seasonal effect is still at play.
Declining USD spot volume has been a trend we have noticed all year, and August is a continuation of that trend. While the month isn’t over yet, August is on track for the weakest month yet of declining spot volume. And this is amidst a resurgence in price this year – bitcoin is still up nearly 57% year to date, even if it may be off the yearly highs.
Volatility, as measured by implied volatility (IV) of at the money (ATM) options, has also been on the downswing over the past year. We think the decline in IV is a reflection of both the bounded trading range bitcoin has exhibited that traders believe will continue and continual vol selling by those looking to generate “yield” while continuing to hold the underlying asset.
This is not always the case but occurs often enough to warrant a mention – bitcoin’s moves are often telegraphed by movements in altcoins. Altcoins are less liquid and further out on the risk spectrum and therefore can react further and faster than the battleship of the industry, bitcoin. Certain alts, particularly throughout the DeFi ecosystem, were noticeably weak on Wednesday heading into Thursday. Maker (MKR), Uniswap (UNI), Compound (COMP), and Aave (AAVE), to name a few, were off 5-9% on the Wednesday preceding the Thursday drop in bitcoin. There was no fundamental news associated with the move, only a rumor of a market maker exiting the market, but perhaps the weakness was a harbinger of the broader weakness to come.
This one took us by surprise, especially for the swiftness with which expectations were built up based on faulty analysis (we detailed last week), but on Tuesday morning, a contingent of the crypto Twitter community (CT colloquially, or is it CX now?) was expecting a ruling in the Grayscale vs SEC case. Given how favorably the market interpreted the March 7th oral arguments for Grayscale, the view was that at 11 AM ET, the U.S. Court of Appeals for the District of Columbia Circuit would rule in favor of Grayscale, paving the way for the Grayscale Bitcoin Trust (GBTC) to be converted into an ETF. Unfortunately, that didn’t happen, and erroneous expectations were disappointed.
Bitcoin had been weak throughout the day, but the sharpest part of the sell-off occurred at around 5:40 PM. There were numerous news items proximate to the sell-off, but none that directly line up with it. The closest was the WSJ article at 3:22 PM ET detailing the finances and operations of SpaceX, which had previously owned bitcoin. The second to last sentence of the article, as cryptic as it is, was that SpaceX “wrote down the value of bitcoin it owns by a total of $373 million last year and in 2021 and has sold the cryptocurrency.” It is not clear when SpaceX sold its bitcoin, but the article seems to indicate that was at some point in the past. It has been over a year since Tesla sold any of its bitcoins and still retains 25% of its original position purchased in 2021.
The other piece of news around the sell-off was at 4:43 PM ET when an embattled Chinese real estate company Evergrande filed for Chapter 15 bankruptcy protection in New York. The only cryptocurrency connection to Evergrande was the (denied) 2021 rumor that Tether owned its debt. That being said, ongoing financial issues within China, including the aftereffects of a property bubble of which the Evergrande bankruptcy could be a symptom, could have knock-on effects on digital asset markets. Digital assets have a historically high uptake in Asia, especially China where despite a ban on trading and mining going back two years now, reportedly still does $90B a month in transaction volume on Binance according to a recent WSJ article. Therefore, we wouldn’t be surprised if financial market stress in China spilled over to crypto markets. Would that happen precisely at 5:40 p.m. last Thursday? Probably not.
Bitcoin price began to trade off at around 5:41 PM ET on Thursday evening. Just minutes prior, bitcoin had been trading at around $27,500, but at its lowest point, the spot price on Coinbase dipped to $25,234. The carnage on Binance was even worse, and we observed significant discounts to bitcoin traded there compared to Coinbase, even when accounting for the difference in the USDT and USD quote currencies.
While spot prices on Binance traded at a discount to Coinbase during the sharpest part of the correction, based on liquidation data, it was other trading platforms, not Binance, that were likely the locus of market stress. The trading of unregulated bitcoin derivatives using leverage, whether they be futures with daily, weekly, monthly, or quarterly expiration dates, or the more popular perpetual swaps, which never expire, are highly popular and exceed trading volume of spot by 3-4x. Unfortunately, the liquidation of these derivatives positions which have exceeded their margin position, which is done automatically by the platforms, often in a hasty manner detrimental to prices, is often the cause of these discontinuous price movements.
Binance is by far the largest unregulated derivatives exchange as measured by futures and perp Open Interest (OI). By comparison, OI on the largest regulated exchange, the CME, is about $2.0B. Given that fact and the discount spot experienced on Binance, it is natural to think that traders on that exchange might be at fault.
But by looking at the dollar amount of long liquidations (the automated sell of long derivatives positions by the exchange), a different story emerges, one where traders on OKX, Deribit, and Huobi are more likely the culprit.
The argument for trading action on exchanges other than Binance being at fault become even more pronounced when we scale the liquidations by OI. While CoinEx jumps to the front of the pack in terms of its OI, liquidating $11M of longs is unlikely to have much of an impact on the market. Instead, liquidations on Huobi, Deribit, and BitMEX become more pronounced.
While not conclusive, our best guess as to the reason for last week’s sell-off had to do with poorly positioned trading positions into a tough setup for longs. The fundamental news around the sell-off most likely wasn’t the reason for the sell-off, but it probably added tinder to an already combustible situation.
Where does that put us now? Bitcoin now sits below the 200-week moving average (WMA) of $27,512, a range it has found itself in only 10.7% of the weeks since 2015, and most of those weeks have been in 2023. This may represent a unique buying opportunity for those who are positively inclined. Others may look at that 200 WMA of $27,512 as a ceiling in the short term, especially as other risk assets such as equities have struggled as of late. We would urge investors to keep their eye on the calendar for upcoming catalysts that may indicate the next direction for price. There are several milestones in the various ETF processes coming up (see below) as well as a decision in the Grayscale case (sometime) this fall, plus a resolution to the Mt Gox bankruptcy case supposedly coming on Halloween (Oct 31st). These are, of course, likely the short-term undulations in the market. For investors with sufficiently long hold periods, say 5 years, these factors will likely just be small bumps in the rearview mirror.
Bitcoin fell 6.6% on the week, as described in detail above. It has been a tough period for bitcoin, one that might have been predicted by the calendar alone. But it hasn’t just been bitcoin that has had a tough time. Equities, despite their positive performance on the week, have had a rough August. On the week, the S&P 500 bounced back 1.5% while the Nasdaq Composite rallied 1.1%. Commodities were mixed as gold rallied 1.8% as real yields fell while oil fell 1.7%. Bonds rallied with investment grade corporate bonds up 1.1%, high yield corporate bonds up 0.4%, and long-term US Treasuries up 1.6%.
Declaration of CEO in Prime Trust Bankruptcy Case - DE Bankruptcy Court (PDF)
Sept 1 - Expected SEC response date for BlackRock iShares ETF
Sept 13 - August CPI release
Sept 22 - FOMC rate decision
Sept 29 - CME expiry
Oct 3 - Valkyrie Bitcoin and Ether Strategy ETF Effective Date
Oct 31 - Mt Gox claims payment date
Fall 2023 - US Court of Appeals for the DC Circuit decision in Grayscale Case
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