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L1s Take Off, Can ETH Catch Up?

Aug 23, 2021 · 4 min read

By Ashwath Balakrishnan, and Jeremy Ong

Market Update

The market bounced hard into the Asia session, only to chop around a short-term top during the European session and pull back a few hours later. AVAX, ADA, BNB, and RUNE were a few of the biggest winners amongst the top 100 crypto assets today. Visa’s CryptoPunk purchase is sending the price floor soaring.

Fresh Narrative

  • Over the last couple of weeks, crypto has enjoyed a relentless uptrend and layer one protocol tokens performed the best. SOL, LUNA, and AR led the way with stellar performances in early August. AVAX has recently caught up on the back of it’s 9 figure liquidity mining program.
  • Each outperforming L1 has its own narrative driving price. For Solana, it’s NFTs — though NFTs on Solana don’t have anything close to the same volume as their counterparts on Ethereum. LUNA price catapulted as Lido and Anchor partnered to bring liquid staked ETH to Terra.
  • What stands out, however, is ETH’s underperformance relative to other L1 assets. Ethereum’s market cap is 10x higher than the second-largest network on this list (DOT), which makes it much more difficult to move price. But remember: the less liquidity and the steeper an asset’s price swings up, the more likely it is to fall with an equivalent ferocity. ETH’s liquidity and size partially shields it from this, though it still does have violent drawdowns from time to time.

ETH Apes Stepping Back In

  • We’re seeing the market position itself for exposure to ETH. But, as noted above, it’s just not easy to move an asset’s price when it has over $20 bn of daily trading volume (per CoinGecko).
  • Funding for ETH perpetuals on BitMEX has been out of whack compared to the rest of the market. But in the last 2 days, we’ve seen traders on other exchanges catch up, with funding starting to move into positive territory after chopping around near 0%.
  • While this indicates demand for ETH, it also means leverage on the long side is amping up. A pullback is certainly in the cards — it always is — as the funding uptick could see a bunch of longs get trapped as the market momentarily moves lower. However, given the strength of this rally, it’s entirely possible that ETH just keeps ripping.

Bidding Up Futures

  • Apart from perpetuals, there’s also sizeable demand for ETH futures. On Aug. 22, ETH had a minor pullback, and futures basis fell almost 6%. But the dip was eaten up near-instantaneously, sending basis back up over 12% in less than a day.
  • From the chart below, it’s also obvious that CME is lagging big time — and this is very much expected. CME traders don’t care as much about price exposure as they do about earning a solid yield for basis trading (buy spot, sell marked-up futures). Crypto-native exchanges always lead rallies, and current demand for these assets is, for the most part, contained to crypto-native investors — be that institutions or retail.

Liquidity Improves Across the Board

  • Unrelated to the layer one narrative, we came across an interesting chart that seemed worthy of a highlight. Over the last month, the bid-ask spread on BTC perps, particularly Deribit, has improved dramatically. The spread on Deribit went from 60 basis points to under 30 basis points. While this may not seem like much, this data is for a $5 million order. The spread reducing from 0.6% to 0.3% would save a trader close to $15,000 ([0.6%-0.3%]*$5 mn).
  • Given the blow-off top on options open interest in May. 2021 and the subsequent revival over the last month, the most logical explanation for a decrease in the bid-ask spread is the recent activity surge in the options market. As more money moved into Deribit to buy options, more liquidity leaked into the perps and futures market as dealers hedged all the options they sold.

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