Below is a chart that is both slightly jarring and fairly intuitive at the same time. The jarring aspect is obviously the rapid ascent of the expected terminal fed funds rate over the past six months. The intuitive part is that bitcoin does not like tightening monetary conditions and has steadily declined in direct opposition to the expected terminal rate.
Note that we are using the futures market pricing for the March FOMC meeting as a proxy for where the Fed is expected to pause its rate hikes. We had steadied for a bit around 4.25-4.50%, but recent weeks have seen this figure jump to north of 5.00%.
In conjunction with the slight pause in increasing rates observed in late September and early October (white box above), we saw crypto start to break its correlations with equities and outperform. Due to this behavior, we have recently speculated that even though crypto has behaved as a beta to tech stocks over the past couple of years, perhaps company earnings don’t necessarily affect crypto all that much. If this is true, then there are significant implications for how to manage risk around these assets.
The sample size is small, but trading sessions this week provided a few solid examples demonstrating the validity of this premise.
On Monday, Bank of America kicked off this first big week of earnings season by beating analyst expectations and portraying an economy that is stronger than many anticipated. This both (1) gave equities a boost due to a perceived decrease in recession risk and (2) increased rates as the bond market perhaps interpreted this as a sign that rates will need to remain higher for longer.
The net result was a day in which rates increased marginally (using the 2Y as a proxy for rates), equities broadly ticked higher, and crypto finished the day slightly lower.
We thought this was a very interesting example that lent some credence to our theory.
The following day was a trading session that had mixed earnings but was driven by the bond market from the start. Rates spiked during the first couple of hours of trading, which sent both equities and crypto lower.
This was an excellent example of a liquidity-driven market having a direct effect on both crypto and equities.
To round things out, we can factor in a trading session that featured elements of both (1) equities outperforming due to positive earnings, as well as (2) declining risk assets due to bond market activity.
The chart below features price action from Thursday. The day started out optimistically, on the back of upside earnings surprises on both Wednesday afternoon and Thursday morning. Interestingly, the Nasdaq outperformed crypto, consistent with our view on the dynamic presented. However, upon the release of solid labor data and hawkish language from Fed officials, rates spiked and started to lead the market, sending both crypto and equities lower.
So, what are the major takeaways here?
- Near-term risk management – from a relative value perspective, save for a market crash in which everything correlates to 1, a stair-step down in equities due to revised earnings could lead to continued relative outperformance from crypto. Obviously, the downside is that a bull market for earnings, absent any change in global liquidity, will likely have muted upside for crypto.
- Long-term considerations – one must also consider what this means from a long-term portfolio allocation perspective. We are not necessarily saying that we are about to enter a period of stagflation, but that is certainly an option on the table. Should this happen, we will be subject to a world where liquidity is nominally plentiful, but growth is stagnant. With a declining dollar and a persistent bear market for earnings, we could see a scenario in which crypto decouples from equities and does comparatively well alongside commodities, relinquishing crypto from its current role as a beta to risk.
It Smells Like Something is Burning
The Ethereum network has been deflationary over the past few weeks as network activity has ticked up substantially. A good portion of the action has been spearheaded by a project called XEN, which has accounted for over 5k ETH burned over the past 30 days. The next busiest contracts on Ethereum have been the usual suspects, Uniswap v3 and OpenSea, which consumed approximately 4k and 6k ETH over the same period, respectively.
Despite the excitement over the bout of deflation, the details of this XEN project are few and far between, and thus we would like to extend caution to anyone attempting to interact with this contract. However, this highlights the dramatic effect that Ethereum’s revised inflation rate will have on the network in the future, especially when paired with periods of increased network activity.
Below we map out how this increased burn, which, when combined with the new post-merge issuance rate, results in a supply dynamic that should be incredibly constructive for ETH price moving forward. We can see a significant drop in net issuance on the days immediately following the Merge, as gross issuance dropped by 80%.
With the first bout of significant activity on the network since the Merge, we have seen persistently negative net issuance (deflation) in recent weeks. Again, the point here is not necessarily to highlight or paint a generally bullish view on the activity currently taking place on Ethereum but rather to use this to focus on the effect that this new deflationary supply dynamic will have on ETH price whenever the next bull market arrives, and the activity atop Ethereum will presumably be both organic and sustainable.
Again, it is a small sample size during a challenging period for markets, but even this small instance of negative net issuance has coincided with ETH outperforming all other alts (in aggregate) by 5%.
Solana, one of our core holdings since Q2, has broken through the previously impenetrable $30 level and has seemingly gone without a bid over the past week. While we are still constructive on this asset, it has underperformed several major alts the past couple of weeks. After reviewing recent on-chain activity, it is clear that its recent struggles can be attributed to a decline in NFT activity.
Earlier this week, we discussed an ongoing dispute in the Solana NFT ecosystem. Last weekend, leading Solana NFT marketplace Magic Eden announced that they would make creator royalty fees optional for buyers on their platform. This was a controversial move, as one of the core value propositions of digital art is the ability to compensate creators for their work directly. The shift in strategy was likely catalyzed by the leading NFT project on Solana, DeGods, announcing that they would be moving to 0% royalty fees on resales going forward.
Following the announcement, NFT volumes started moving off Magic Eden to other competing platforms offering 0% royalty trading. MagicEden astutely pointed out that there should likely be a token standard that allows NFT creators to mint NFTs with royalties embedded, removing the responsibility from an exchange like OpenSea or MagicEden. The debate over royalty fee implementation will continue until such a token standard is developed.
For now, MagicEden is approaching the issue by offering $1 million in hackathon prize money for developers that can create solutions that bring thoughtful monetization to NFT creators. In an apparent attempt to regain market share, they also waved transaction fees on their marketplace. This move by MagicEden led to a brief uptick in NFT volumes. Still, the overall trend in NFT activity on Solana continued to trend downwards, likely due to the evident decline in market sentiment.
Further, we can see that overall transactions (including non-NFT transactions) have been trending lower over the past couple of weeks.
As a result, SOL has underperformed other altcoins since early October. While this is undoubtedly disconcerting from an NFT industry perspective, there are still ample reasons to remain bullish on SOL through year-end.
The most encouraging interpretation of recent price action is that SOL price has been dictated by fundamentals rather than speculation, a sign of the platform maturing and finding some semblance of product-market fit.
The name in our list of recommended holdings that have performed that best over the past week is undoubtedly Lido (LDO).
LDO has recently broken away from the pack due to its ongoing integration with Layer 2 networks on Ethereum. After launching wrapped tokens on Optimism and Arbitrum, Lido announced an incentive program in which those who move their staked ETH ($stETH) to Optimism or Arbitrum will be rewarded with LDO governance tokens.
The rationale for incentivizing the liquidity migration is that Lido DAO ultimately wants to enable native staking on L2. They are beginning by supporting wrapped stETH ($wstETH) bridging and staking on Layer 2 networks. However, they plan to allow users to stake ETH directly on L2 networks without bridging their assets back to Ethereum Mainnet. This incentive program is merely the first step in that process.
As demonstrated below, smart money (as labeled by Nansen.io) has followed Lido’s directive and engaged in this liquidity migration.
The obvious question becomes – why would the price of a token that is increasing in supply increase in price? Although there should, theoretically, be a dilutive effect from this type of incentive program, in the short term, these events often stimulate demand for the token across exchanges. Additionally, in this circumstance, this incentive program reflects a significant step in expanding what many views as a critical piece of Ethereum infrastructure. Thus, there is an inherent increase in demand for the LDO token now that it has broadened its use case in the industry.