Price Movements: Crypto markets performed better than traditional assets in Q3 despite a post-Merge September sell off.
Market Liquidity: After Kucoin implemented a series of 5th anniversary contests, trade volume surged to all time highs. Exchanges are getting increasingly creative amid a widespread rout in trade volume.
Derivatives: Luna Classic open interest tripled in September and funding rates turned deeply negative after Interpol issued a red notice for Do Kwon.
Macro Trends: Bitcoin's correlation with gold hits its highest level in over a year.
Fiat currency markets are shaking. Last week, the British Pound crashed to near parity with the U.S. Dollar while the Euro dipped decisively below 1-1 for the first time since 2002. Early this morning, the UK prime minister scrapped plans for a tax cut that had triggered the strong devaluation, causing the Pound to recover slightly.
The fiat volatility has rippled throughout cryptocurrency markets, particularly affecting GBP-denominated trading pairs. On September 26th, trade volume for BTC-GBP pairs surged to all time highs, driven predominantly by activity on Bitfinex and Bitstamp of the 9 exchanges analyzed. On Bitfinex, total daily BTC-GBP volume on the 26th was 42k BTC (£747k), more than 4 times greater than the next highest volume day.
A handful of cryptocurrency exchanges offering fiat trading services also experienced a surge in volume on the 26th. GBP-USD volume aggregated across Kraken, Bitstamp, and FTX climbed to record highs and remained at elevated levels over the weekend.
Since the start of September, fiat volatility has created dislocations in the price of BTC. Using the first of the month as an anchor, we can observe how the price of BTC trading against different fiat currencies has diverged within a range at times approaching 10%.
BTC-GBP currently trades about 5% above BTC-USD relative to September 1st. GBP and EUR markets are generally a lot less liquid than USD-denominated crypto markets, presenting some strong arbitrage opportunities for traders.
Price Movements
Crypto markets trade flat as equities sink.
It was another week of heavy macro volatility, particularly in fiat currency markets as the U.S. Dollar continued its meteoric appreciation versus virtually every global currency. Bitcoin closed Sunday night up a modest 1.4% after experiencing record high volumes for British Pound-denominated pairs. By and large, cryptocurrency markets have remained flat over the past two weeks while equity markets continue to sink in reaction to a slew of dismal economic indicators. German inflation hit double digits for the first time since WWII, the BoE temporarily started buying long-term UK bonds to ease market volatility, and the flash Eurozone CPI hit 10% y/y, cementing expectations for a 75bps ECB rate hike.
In crypto industry news, Solana had another outage, FTX won a bid to buy bankrupt Voyager Digital’s assets, the GBTC discount hit an all time low of -36%, and the interbank messaging system SWIFT announced a partnership with Chainlink.
Crypto outperforms traditional assets in Q3.
Despite heavy volatility, most crypto sectors outperformed other traditional assets in Q3, recovering from double-digits losses in Q2. We constructed several equally-weighted baskets of assets to compute sector returns, and throughout the quarter our DeFi token basket gained 60%, bolstered by the LIDO token. Despite a sharp post-Merge pullback, ETH managed to close the quarter up more than 20%, outperforming our Layer 1 and Layer 2 baskets.
After rallying in August, BTC lost most of its gains in September and ended the quarter slightly down following a drop in global risk sentiment. Safe-haven demand and real yield differentials continued fueling the U.S. Dollar (DXY), which was the only asset to register positive returns in both Q2 and Q3.
The end of the staked ETH discount?
The staked ETH discount may soon be a thing of the past for LIDO staked ETH (stETH), which remains the largest liquid staking service. Over the past two weeks, stETH has nearly hit parity with ETH following the successful completion of the Merge. Interestingly, the gap between LIDO's stETH and staked ether tokens offered by centralized exchanges is widening. Coinbase’s cbETH continues to trade at the largest discount of around 2.7%, despite a significant improvement over the past few days. Binance’s bETH still trades at a 2% discount.
Sell volume for Coinbase's cbETH has been extremely high since the Merge, which is contributing to the persistent discount. On Binance, buy volume for bETH outpaces sell volume.
The trend suggests perceived regulatory and censorship risks remain high, especially after the U.S. Securities and Exchange Commission (SEC) hinted that the U.S. has jurisdiction over Ethereum. The Merge provided an initial boost to the liquid staking derivatives market, taking some risk off the table, with buying interest initially spiking for both cbETH and bETH. However, while bETH-ETH buy volume outpaces sell volume on Binance, Coinbase’s cbETH has been facing considerable selling pressures in the second half of September, which suggests cbETH remains relatively illiquid.
We are now deep in a crypto bear market and trade volumes are showing it. Year-on-year, nearly every exchange has experienced a sharp drop in volume over the same period measured in 2021. Only three exchanges experienced the opposite trend, with FTX's spot volumes up more than 60% compared with last year.
To counter falling volumes, exchanges have started getting creative. Fee removals – temporarily or permanently suspending fees for selected trading pairs – which appear to have an immediate impact on trade volume are increasingly popular, along with trading contests. Suspending fees is not a new practice and has arguably improved liquidity when done right. A number of these promotions are designed to benefit from expected or unexpected market events such as the Ethereum Merge or the recent GBP/USD meltdown, and could add volatility to the market.
Last week KuCoin announced several campaigns to celebrate its fifth anniversary. Despite delays in implementing the promotions, the exchange saw its trade volumes surge to an ATH of $5bn after the announcement before it dropped nearly five-fold over the following days.
We observe a similar trend in volume on the largest exchange Binance, which suspended fees for ETH-BUSD pairs for a month starting Aug 26 in an attempt to benefit from increased interest in trading Ether ahead of The Merge.
The share of ETH-BUSD relative to ETH-USDT more than doubled immediately after the launch of zero fee trading from 34% to 73%, but it has lost most of its gains after fees resumed on Sept 26th. Overall, though, ETH-BUSD market share has risen and currently hovers at around 48%. This suggests that the move attracted new investors and possibly generated new revenues, such as benefits from cross-trading of alternative assets which have fees.
Both Binance global and its U.S. affiliate Binance.US permanently eliminated fees for BTC trading pairs, which has boosted their trade volumes. However, in the long run this model contains risks for exchanges as the revenue give-up could be hard to sustain. Other exchanges such as Coinbase have opted for a different strategy, revising its fee structure to target large investors and launching new services, such as Ethereum staking.
With Q3 in the books, let's take a look at how liquidity has evolved for the most liquid BTC-USD trading pairs. The Terra collapse in May and crypto credit crisis in June caused a wave of sharp sell-offs that hit liquidity hard in Q2, with spreads on nearly every exchange spiking and remaining volatility for weeks as market makers accounted for increased risk. Spreads largely settled down in Q3 with very little variation day-to-day, despite markets remaining volatile. Bitstamp saw the largest improvement in liquidity, with spreads halving from around 5bps to just 2.5 by October.
Derivatives
Traders place bets against Luna Classic.
Luna Classic (LUNC), the remnant token of the collapsed Terra ecosystem, has experienced strong volatility over the past month, more than doubling in value in early September, crashing, and then climbing around 60% last week. Open interest for LUNC perpetual futures has also surged in a surprise rally, although funding rates have turned deeply negative suggesting derivatives traders are bearish.
The volatile market activity is linked to several updates in the Terra saga: on Sept 26th, the largest crypto exchange Binance announced plans to reduce LUNC's supply while Bloomberg reported that Interpol had issued a red notice – i.e. a request to law enforcement worldwide to locate and detain a person – for Terra’s founder Do Kwon. Open interest for LUNC-USD perpetual futures nearly doubled from $30M to $55M in just one day and remained high throughout the week.
Bitcoin open interest increased 26% in Q3.
Despite displaying strong volatility, BTC's open interest expressed in native units (eliminating price effects) has risen by 6% in September and by over 26% in Q3 to around 380K BTC. Fresh capital has re-entered the largest cryptocurrency in the second half of September, despite declining spot prices. After declining in early September, funding rates, which give an idea of the direction of investors' positions, have improved. However, they remain neutral to slightly negative suggesting market uncertainty remains high.
Macro Trends
Bitcoin-Gold correlation hits highest level in over a year.
Bitcoin’s correlation with gold hit its highest level in more than a year last week. After benefiting heavily from the Russia-Ukraine conflict in the first quarter of the year, gold has lost all its gains and is currently down 10% YTD. Bitcoin has also declined double-digits this year dragged down by global monetary policy tightening. Despite core inflation remaining persistently high, gold has failed to act as a safe-haven asset i.e. an asset that is expected to retain or gain in value during periods of economic downturn. Over the past year bitcoin has been mostly uncorrelated with gold, with its correlation oscillating between negative 0.2 and positive 0.2. However, as the U.S. Dollar continues strengthening, negatively impacting both crypto and gold, the correlation between the two assets has shifted.
UK central bank re-starts quantitative easing after bond market rout.
Last week, the UK long-term bond market - known as the gilts market - saw its version of a tantrum after the government unfunded fiscal package shocked financial markets, triggering a sharp meltdown of the British Pound (GBP) and a surge in borrowing costs. As of Monday morning, the government has since canceled plans to cut taxes at the highest bracket. Yields on 30-year gilts – which move inversely to prices – exceeded 5%, their highest levels since 2002.
In a move designed to halt the heavy sell-off in UK assets, the Bank of England (BoE) announced a new round of bond buying, effectively re-starting quantitative easing (QE). The BoE is the second central bank after the Bank of Japan to intervene in currency markets in September. While the move appears to have calmed markets, fears of a global contagion and further de-risking are mounting. Both U.S. and German Treasury yields increased, though at a slower pace.
Kaiko's research newsletter is written by the Kaiko research team: Clara Medalie, Dessislava Aubert, Riyad Carey, and Conor Ryder, CFA. This content is the property of Kaiko, its affiliates and licensors. Any use, reproduction or distribution is permitted only if ownership and source are expressly attributed to Kaiko. This content is for informational purposes only, does not constitute investment advice, and is not intended as an offer or solicitation for the purchase or sale of any financial instrument. For any questions, please email research@kaiko.com.
