Market Lull Shifts Focus to Fundamentals [Chartbook]

Market Follows Weak January Playbook

The new year picked up right where it left off at the end of 2021, with a vast majority of crypto assets struggling to maintain momentum as a wave of liquidations and bearish sentiment plagues the market. BTC and ETH have fallen ~8% and ~11% since New Year’s Eve, in line with the notion that January tends to be unkind to crypto investors; the two are both down roughly 30% over the last two months alone.

BTC and the public crypto market bucked seasonal trends in Q4, posting negative returns in both November and December. But a weak end to the year does not guarantee a strong rebound the following January; in fact, on average January has been one of the most disappointing months for BTC.

In our recent market report, “Why Bitcoin Is Behaving Like It Should”, we highlighted the changing macro landscape and some of the key headwinds for BTC, most notably a slowdown in global liquidity growth and tighter policy expectations. Given the overlapping tailwinds with traditional risk assets (like equities), it’s no surprise correlations between BTC and stocks have strengthened recently; interestingly, the correlation between BTC and gold has dropped over the same period.

Deleveraging, Funding Rates, & Liquidity

Since the Nov. 2021 highs, BTC open interest has contracted over 40%, in part driven by BTC’s considerable price drawdown the last two months. Negative sentiment and weakening momentum has helped push funding rates for perpetuals lower too, cleansing some of the excess leverage and exuberance that drove BTC to new heights late last year. However, we’ve emphasized how different the state of open interest and funding rates were in H1 2021, which tells us the market wasn’t necessarily unhinged with leverage in H2 2021. Regardless, clearly there was enough leverage in the market to trigger another volatile sell-off in Q4 ‘21, making OI and funding rates important variables to watch.

ETH followed a similar trajectory, albeit the open interest contraction was not nearly as drastic. Funding rates, however, turned negative much quicker despite ETH holding up better than BTC for the large portion of the recent downtrend. Once again, it’s quite easy to see leverage and funding rates were nowhere close to the extremes we saw in H1 2021.

BTC is still trying to find its footing, but last week’s drawdown didn’t help…

For the most part, the price contraction stemmed from liquidity issues in the perp/futures market, which triggered a series of liquidations that exacerbated BTC’s initial price weakness. The spread for a $5M order – relatively small compared to average daily trading volumes – saw consistent spikes on top exchanges Binance and FTX. When liquidity is poor, it’s not surprising to see wayward price movements.

Many are wondering when selling pressure will abate, allowing the market to stage a reversal. The reality is we never know definitively if a near term reversal is imminent; the best we can do is evaluate the evidence and try and position ourselves on the right side of