Opening bell | #8 | 25th March
Report highlights:
Scale and adoption
Transaction volume doubles, costs turn to fractions, all blockchains uplifted.
The debate over the optimal configuration of blockchain-based financial markets frequently centers on the level of decentralization.
The dominant theory, often described as the blockchain trilemma, asserts that it’s presently impossible to simultaneously achieve security, scalability, and decentralization without compromising at least one of these aspects.
Despite these theoretical challenges, there’s a clear trend among cryptocurrency enthusiasts for favoring blockchains known for their low transaction fees and quick confirmation times.
Comparative analyses often pit various blockchains against each other, with Base and Solana being recently spotlighted for their rapid transactions and minimal fees. Both are fulfilling the demand for an efficient and economical user experience, which is essential for their broader acceptance.
Amid the focus on Base and Solana, Ethereum has rolled out an upgrade called Dencun, marking the commencement of “The Surge” in its development trajectory, emphasizing Layer-2 transactions per second enhancements through rollups. This development may alter the competitive dynamic, though debates about the foundational nature of these solutions as Layer-1 or Layer-2 are less crucial than their effect on user experience and adoption rates. Uniswap costs have plummeted to cents from dollars in the case of Optimism.
However, the industry faces challenges, including a somewhat steep learning curve for bridging assets, securing private keys, and comprehending failed transactions – the last problem being a particularly notable with Solana.
But let’s not dampen the fun; with transaction numbers increasing and fees decreasing at the same time, we are moving in the right direction fulfilling promises made decades ago. Onwards and upwards.
Layer-2 swap price on uniswap | $
Layer-2 successful transactions | mn
Bitcoin ETF AUM & flows
Factually correct media headlines leave investors scratching their heads, probably.
“Bitcoin’s Drop from Peak Levels as Grayscale ETF Records $12 Billion in Outflows,” reported the Financial Times. Bloomberg added to the conversation with “US Spot-Bitcoin ETFs Experience Largest Three-Day Withdrawal Since Debut,” followed by “Bitcoin Nears Its Worst Week Since August Due to Declining ETF Interest.”
These reports are factually accurate. The trading data from the eleventh week shows a net outflow of $887 million, which is twice as much as the only other week when Bitcoin experienced withdrawals. So far, these are the only two instances recorded.
Despite this, Bitcoin remains profitable for March, potentially marking its seventh month of consecutive gains if it closes above $61,000 by Easter Sunday. However, the significant price fluctuations could be a cause for concern among investors.
The critical question remains: Which investors are most affected? Given that the current surge in cryptocurrency interest largely stems from ETF investors, it’s essential to examine the impact these fluctuations have on them specifically.
Assuming investors began adding Bitcoin to their portfolios at the start of trading in January, the impact of drawdowns and returns might not appear as dramatic as headlines suggest. For investors who diversified their portfolios by allocating 5% to Bitcoin, the drawdown would have been only 1.3%, with current returns nearing 7% (see chart). This scenario contrasts starkly with the perception created by headlines.
Even for investors who invested in Bitcoin at its peak, the resulting drawdown would mirror that experienced by gold investors (see chart).
As of last Friday’s close, a balanced portfolio including Bitcoin would have recovered to its original value, with a slight gain in portfolios including gold.
These outcomes challenge the narrative suggested by headlines focusing on the volatility following Bitcoin reaching new all-time highs, indicating that the real impact on diversified portfolios may be less severe than anticipated.
Net US-based Bitcoin ETF weekly inflows | $mn
Balanced portfolio* with 5% Bitcoin since start of ETF launch
Balanced portfolio* with 5% Bitcoin since all-time-high
Volumes and derivatives
Futures traders unrattled by volatility as open interest remains near record levels.
Deribit Bitcoin open interest | $bn
Deribit Ethereum open interest | $bn
Forward-dated futures | as of 25 March 2024
20% Average premium on forward-dated futures across cryptocurrency exchanges.
Weekly volumes | $bn
Recommended by LinkedIn
Weekly trading volumes drop 6% versus week before for perpetual futures on cryptocurrency exchanges. March volumes up 50% vs February.
Commodities & correlations
Higher (rates) inflation for longer as Federal Reserve takes dovish stance.
Global financial investors carefully tuned in to last week’s meeting of the Federal Reserve, the world’s most influential central bank. It indicated that rate cuts in 2024 are now under consideration. This dovish stance undoubtedly led to a rally in the markets, with commodities experiencing a significant uplift. Despite demand being markedly soft in the past eight months, gold reached new highs (as detailed in Report OB#7). The markets are now effectively pricing in the possibility of long-inflation, like that experienced during the COVID pandemic, or a shift towards safe-haven assets reminiscent of the Great Financial Crisis.
% Change from 2024 low
In recent times, the weekly correlation between Bitcoin and other commodities has shown a downtrend.
However, the rolling 90-day correlation has surged to its highest level since the start of last year’s market rally that lifted all boats.
The cyclical nature of these correlations can persist for some time before reversing direction, influenced by various factors such as industrial cycles, policy changes, or delayed responses in supply and demand.
Notably, Bitcoin has shown the highest correlations with gold, silver, and copper, respectively.
90-day Bitcoin correlation with commodities
Correlations (90-day)
Bitcoin and oil: Can high correlations between the two indicate reversals?
DeFi reality check in high interest rate times
Liquity stablecoin & lending protocol set to retool with user-set interest rates.
DeFi protocol Liquity developed a method for issuing stablecoins backed by Ethereum collateral. It operates on low fixed fees without imposing any recurring interest, ensuring each stablecoin is always supported by at least 110% Ethereum.
Initially, the protocol enjoyed significant uptake, with the volume of Ether-backed stablecoins peaking at $1.5 billion.
However, since July 2021, there has been a noticeable decrease, with the amount of outstanding stablecoins falling to less than $150 million today.
This decline has been attributed to a variety of factors, notably the diminished attractiveness of non-yielding assets like stablecoins in an environment of rising interest rates on bonds and a preference for assets with growth potential during bull markets.
The protocol’s foundational idea was considered ingenious, capitalizing on the concept that trapped capital could be leveraged.
This was achieved by locking Ether in a smart contract until the associated debt was repaid. The absence of interest charges on these transactions was particularly noteworthy, further highlighting the protocol’s approach to leveraging blockchain technology for financial applications.
The protocol’s reliance on a fixed-cost borrowing model became its Achilles’ heel when interest rates rose, however. Traders found little incentive to hold onto stablecoins with no yield, and at the same time losing returns by staking their Ethereum rather than just holding it in the protocol's vaults with no return. This led to a decline in Liquity’s ability to attract and retain users.
In response to these challenges, Liquity has announced plans to introduce a new concept: user-determined interest rates.
This new mechanism seeks to address the core issues faced by its predecessor, offering a dynamic solution that allows market participants to dictate interest rates.
This announcement marks a significant pivot from conventional DeFi protocols, which often rely on static fees, governance decisions, or algorithmic formulas for interest rate management. Liquity’s proposed user-centric model aims to enhance the efficiency and adaptability of interest rate mechanisms, offering a level of dynamism and market responsiveness previously unseen in DeFi, which has had a one-size-fits-all approach.
By planning to integrate user-set interest rates with its established redemption mechanism, Liquity aims to maintain its stablecoin’s peg more effectively once v2 is launched.
This system will allow users to tailor their interest rates according to their risk tolerance, offering a more nuanced and predictable borrowing landscape.
Moreover, the proposed Liquity v2 intends to employ the revenue accrued from interest payments to foster stablecoin demand and liquidity, creating a sustainable model that incentivizes protocol stability and participant profitability.
The announcement of Liquity v2, characterized by its market-responsive peg mechanism, underscores a deliberate move towards creating a more balanced and efficient DeFi ecosystem.
By aiming to democratize the process of setting interest rates, Liquity will at least try to establish a market environment where both borrowers and stablecoin holders can engage with greater returns on the differing levels of risk taken by each participant.
How this will play out is going to be another interesting test (pun intended). Current lending protocols are paying astronomical yields at face value. The more plausible explanation is that participants are paying a spread as they deposit assets and borrow against them with the hopes of upside negating the cost.
Liquity outstanding and issued stablecoins (LUSD) | $ bn
Economic calendar
Key events this week : US & UK GDP, Powell speaks.
Disclaimer.
THE INFORMATION CONTAINED WITHIN THIS COMMUNICATION IS FOR INSTITUTIONAL CLIENTS, PROFESSIONAL AND SOPHISTICATED MARKET PARTICIPANT ONLY THE VALUE OF DIGITAL ASSETS MAY GO DOWN AND YOUR CAPITAL AND ASSETS MAY BE AT RISK
Copper Markets (Switzerland) AG (“Copper”) provides various digital assets services (“Crypto Asset Service”) to professional and institutional clients in accordance with the Swiss Federal Act on Financial Services (FinSa) of 15 June 2018 as amended and restated from time to time.
This material has been prepared for informational purposes only without regard to any individual investment objectives, financial situation, or means, and Copper is not soliciting any action based upon it. This material is not to be construed as a recommendation; or an offer to buy or sell; or the solicitation of an offer to buy or sell any security, financial product, or instrument; or to participate in any particular trading strategy in any jurisdiction in which such an offer or solicitation, or trading strategy would be illegal. Certain transactions, including those in digital assets, give rise to substantial risk and are not suitable for all investors. Although this material is based upon information that Copper considers reliable, Copper does not represent that this material is accurate, current, or complete and it should not be relied upon as such. Copper expressly disclaims any implied warranty for the use or the results of the use of the services with respect to their correctness, quality, accuracy, completeness, reliability, performance, timeliness, or continued availability. The fact that Copper has made the data and services available to you constitutes neither a recommendation that you enter into a particular transaction nor a representation that any product described herein is suitable or appropriate for you. Many of the products described involve significant risks, and you should not enter into any transactions unless you have fully understood all such risks and have independently determined that such transactions are appropriate for you. Any discussion of the risks contained herein with respect to any product should not be considered to be a disclosure of all risks or complete discussion of the risks which are mentioned. You should neither construe any of the material contained herein as business, financial, investment, hedging, trading, legal, regulatory, tax, or accounting advice nor make this service the primary basis for any investment decisions made by or on behalf of you, your accountants, or your managed or fiduciary accounts, and you may want to consult your business advisor, attorney, and tax and accounting advisors concerning any contemplated transactions.
Digital assets are considered very high risk, speculative investments and the value of digital assets can be extremely volatile. A sophisticated, technical knowledge may be needed to fully understand the characteristics of, and the risk associated with, particular digital assets.
While Copper is a member of the Financial Services Standard Association (VQF), a self-regulatory organization for anti-money laundering purposes (SRO) pursuant to the Swiss Federal Act on Combating Money Laundering and Terrorist Financing (AMLA) of 10 October 1997 as amended and restated from time to time. Business conducted by us in connection with the Crypto Asset Service is not covered by the Swiss depositor protection scheme (Einlagensicherung) or the Financial Services Compensation Scheme and you will not be eligible to refer any complaint relating to the Crypto Asset Service to the Swiss Banking Ombudsman.
It is your responsibility to comply with any rules and regulations applicable to you in your country of residence, incorporation, or registered office and/or country from which you access the Crypto Asset Service, as applicable.