The cryptocurrency world is in somewhat of a strange state right now. While it’s becoming more and more of a retail-driven space, it is still highly immature and volatile. We therefore see a duality emerge. It’s almost as though there is a world “above ground” that believes one thing while the world “underground” believes another.
In the above ground world, we are seeing that new investors and traders are responding heavily to technical signals which continue to paint a bearish, risk-off scenario. In the above ground world, we are seeing that the media continues to sensationalize (and, at times, misrepresent) the headlines out of Asia. But in the underground world, a world where the technology and paradigms of tomorrow are being designed and built, we are seeing the opposite. In the underground world, we are seeing professional cryptocurrency investors cheering the price correction. In the underground world, we are seeing well funded teams make slow and steady progress as they roll out product updates. The problem is that the underground world is not as fast moving as the above ground world. It’s also harder to observe the underground world. Perhaps this is the perfect scenario for a professional investor (we hope so). In any case, because there is so much noise happening in the above ground world currently, we choose not to spend time on any particular theme or trend that popular media is busy talking up.
Instead, here are three very different thoughts on the state of the market in the past week:
1. It is STILL important to remember the drivers behind any price actionGoing down 10% every day is a tough process for any asset, even bitcoin isn’t immune to its grim reality. While inexperienced traders may panic, we think it is vitally important to understand the reasons behind this downward price action and act accordingly. The reasons we outlined a couple of weeks ago still stand and are compounded with a couple of others. First of all, certain price levels are bound to trigger stop-loss activation. We definitely saw this happening around the $8500 mark and even more so around the $8000 mark. The sell action which followed this was bound to drive the price further down. Moreover, the market is clearly reacting to the news surrounding the SEC and CFTC. Although we see their involvement in the market in a positive light, since they are bound to weed out at least some of the bad actors, many market players view this apprehensively. Tether was always sen as the break-the-glass and hit the pull the lever situation, if and regulatory scrutiny at all ever appears. Together with the reactive and panicky mentality of today’s retail-driven market, this creates a perfect storm. Nobody (not even us) can say where the bottom line will be. The silver lining is that this correction is, in fact, positive for the longevity of the market. The asset price needs to be at least somewhat grounded in fundamentals, so this fallback is expected and even welcome.
2. There is little doubt that the existence of bitcoin futures led to manipulation of bitcoin’s price. Large market participants bid up the price of bitcoin in the weeks prior to the CBOE launch, loading up on the underlying asset and then offsetting that exposure by shorting futures. The subsequent trade out happened last month by the same participants. They seemingly dumped the underlying, setting into motion panic selling and triggering stop losses, allowing for the closure of the trade on expiration with a positive basis. The speculation is that this can only be done by large participants because it is still very expensive for the average day trader to put on a short position in futures. Only a large participant with a decent bitcoin treasury and a much lower cost basis can sustain the margin requirements over a month. The reason why this trade exists is because there is little volume in futures (relative to other asset classes) and because the strike prices for expiration can be subject to manipulation. Does this make it illegal? Not really. It is a basis arbitrage trade. Anyone who has spent time on a trading desk knows this. It is frequently conducted in other markets but because those markets have way more liquidity and run way more efficiently, it is just harder to pull off. The cryptocurrency world is not efficient. Hence these trades exist (and will continue to exist for the medium term).
3. Correlations, or really the change in correlations over time, are changing. The daily return of bitcoin over the past 6 months exhibited an inverse correlation to that of other liquid altcoins. That same relationship existed over the past 3 months and over the past 30 days. This shouldn’t be news given that bitcoin is frequently a gateway ticker to other tickers. However what’s interesting is that in the past week, the relationship flipped to that of a positive correlation. Except against ETH, BTC has exhibited a positive correlation with that same sample set. Its a weak positive correlation but it is positive nonetheless. Why this matters and how much this matters is up for debate. This relationship could be a function of bitcoin futures expiration, punitive regulation in the biggest altcoin investor market in the world (South Korea) or tax optimization trading for 2018. Or it could be due to none of that.
Regardless, we believe this correlation change is secular in nature and that there will be a sustained dispersion of returns across different market cap assets for 2018 (which we posit is a good thing).