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The Delphi Chartbook – September 2021

Oct 1, 2021 · 10 min read

By Ashwath Balakrishnan, and Kevin Kelly, CFA

In this edition of the Delphi Chartbook, we cover crypto markets, DeFi, L1s & L2s, and important macro data points. Given the past month has been grueling for crypto investors – and mounting macro concerns threaten stability in global financial markets – this edition predominantly focuses on the state of crypto market structure and important updates from the macro world.

Crypto Markets

September was a forgettable month for crypto investors, with poor price action across the market. Bitcoin followed its usual September playbook, which gives some reassurance to those who’ve nervously watched BTC flirt with $40k support in recent weeks. While we remain structurally bullish on the entire crypto market, we highlighted the market’s tendency to disappoint this month in our market note titled “September Showers Bring Fall Gains”.

The rest of the crypto market also experienced a difficult September with some major names losing 15-20% over the month. ETHBTC appears positioned for a significant move after consolidating over the last several weeks; Q4 seasonality tends to favor the crypto market, which would imply ETH outperformance. Downside risk is still material at these levels but the fundamental outlook is as strong as ever.

ETHUSD is trying to find support at its 38 fib retracement level (~$2,775) amid its recent price weakness and stalling momentum.

BTC derivatives saw a sizeable open interest wipeout, with close to 25% of open interest at the start of September being erased by month end.

ETH saw a deeper deleveraging, with a near 40% contraction in derivatives open interest. While this is an obvious sign of poor sentiment, it also signals that a lot of leverage was purged from the system. This could serve as fuel for a near-term bounce.

The long term basis curve remains in contango, implying the market has an optimistic outlook for Q4. Exchanges like FTX, Binance, Huobi have the highest basis as these exchanges have a predominantly retail user base who want access to leveraged long exposure. CME, which is far more tempered, lags on the basis curve but is still in contango.

There was a large increase in perpetuals funding just before the breakdown in early September. Traders got ahead of themselves as crypto assets looked ready to rip higher. However, September’s consistently negative seasonal trend had other plans.

Option skews help us establish a rough base for forward looking market sentiment. The Oct. 2021 skew has a tail towards lower strikes (higher implied volatility) but not towards the higher strikes. Typically, this means the options market isn’t too positive in the near-term. However, Nov. and Dec. 2021 skews look positive with higher implied volatility for strike prices above current market price. Skews for expiries in 2022 are more balanced and signal a more neutral outlook given how far out these options are dated.

Short-term volatility rose heavily into the end of September as majors like BTC and ETH tried to find some footing. Rising volatility tends to be a sign of uncertainty as it becomes harder to establish a fair auction value for an asset.

A few days ago, an opportunity presented itself to near-term ETH bulls via the options market. Realized volatility, the actual volatility an asset experienced, was higher than implied volatility, which is the expected volatility that sellers price options with. Realized volatility is hardly ever higher than implied volatility, but when this happens, it’s a mispricing opportunity that favors option buyers. Simply put, ETH bulls could buy near-term calls at a volatility level that is lower than actual volatility.

A barrage of put purchases for options expiring Oct. 8 pushed the one week and one month put-call skews higher. The increase in the skew means people were buying more puts, making puts relatively more expensive than calls. Longer-term put-call skews, however, began to decrease even as the market looked shakier. If anything, this indicates that mid-to-long term sentiment remains optimistic.

Deribit’s DVOL index aims to estimate expected volatility over the next month. Towards the third week of September, historical volatility shot up but the DVOL index was in decline. As mentioned above, this gave way to some interesting opportunities for option buyers. As uncertainty creeps up again, it seems reasonable to expected the index, and implied volatility in general, to start moving up again.

Over the course of August, CME’s leverage funds doubled down and increase their short exposure to BTC. On the surface, it may seem like institutions remain bearish, but that’s likely far from reality. CME’s traders are more risk-averse and look for opportunities with minimal risk and decent yield – and that’s exactly what basis trades offer. These entities purchase BTC on the spot market and then short an equivalent amount of futures (which trade at a higher price) to lock in a yield. The bullishness of August gave way to higher basis yields, so this explanation for increased short exposure makes the most sense.

On a brighter note, Q4 is historically a decent quarter for crypto. While there have been instances of BTC getting battered in Q4, the average return in Q4 over the last seven years is net positive.

Despite experiencing a heavy sell-off over the last few days, long-term holders seem to be unfazed and continue to HODL. According to Glassnode’s on-chain data, this cohort continues to accumulate. The recent leg down was likely caused by speculators taking a risk-off stance in anticipation of macro and regulatory risk factors.

The below chart is about a week old, but the Fear & Greed index is almost unchanged since. The market is still in a state of fear, struggling to figure out what comes next. Crypto is not isolated from exogenous risk factors and uncertainty from traditional markets can weigh heavily over the industry, especially during periods of elevated market volatility.

DeFi, L1s, and L2s

After extraordinary volumes in May, DEXes are starting to recover from July’s lows with consistent weekly volumes above $15B. Uniswap remains the market leader by a wide margin; Sushiswap, Curve, and 0x are slotted in close competition behind Uniswap.

dYdX is the first derivatives DEX to hit a billion dollars in daily volume. DYDX token rewards for the last epoch were distributed on Sept. 28. Towards the end of the last two epochs, we saw volume exploded as larger players trade more volume to earn a larger percent of DYDX emissions. During the last epoch, dYdX almost hit $10B in daily volume for two consecutive days.

L1 protocols were on a roll in August, and despite September’s poor market conditions, select L1 assets actually ended the month in the green. AVAX and ATOM were the leaders, followed by SOL and LUNA. KSM, ADA, ETH, and DOT ended the month with negative performance.

Capital flows in Avalanche, Terra, and Solana have been on a roll in Q3. Solana and Avalanche saw a sudden and quick increase in total value locked, while Terra has been steadily grinding up since Mar. 2021. The multi-chain narrative has finally come to life, and these three networks look posied to capture meaningful market share.

Arbitrum’s openness to deployments has given the network a substantial lead over Optimism. Both networks are optimistic rollups, largely possessing the same high-level merits and drawbacks. Several speculative farms gave Arbitrum a major boost, but there is real innovation on the network. GMX Finance, MCDEX, and Curve Finance already have live deployments on Arbitrum.

Macro Musings

Global markets have had a volatile month as several risks – some old, some new – took hold of investors’ minds. The drama surrounding Evergrande certainly made headlines alongside taper talks, the U.S. debt ceiling standoff, and our usual dose of inflation panic as market participants strained to read between the lines of the Fed’s latest word dance on future policy direction; the abrupt retirement of two Fed governors over their pandemic-fueled trading activity really was the cherry on top of a crazy month.

The MSCI All Country World Index, a benchmark for global equity markets, is on pace for its first quarterly loss in Q1 2020 when markets first reacted to the growing threat of a global pandemic. Chinese tech stocks took some of the biggest hits as the sector saw its worst quarter in six years; consumer discretionary peers didn’t fare much better, weighing on the major EM equity indices.

Speaking of, it’s interesting to note the tendency for BTC to ebb and flow with the peaks and troughs of Chinese tech stocks, as measured by the Invesco China Technology ETF (CQQQ). Whether there’s much to be said for their direct relationship with one another, the conditions that fueled the run up of both over the better part of the last decade do share some overlap. Interestingly, a large cohort of investors and traders in China are classified as retail, so there is some assumed overlap in ownership.

One of the reasons we haven’t seen a major fallout from excessive debt levels is because asset prices, like stocks and real estate, continue to rise. If and when the rise in asset prices runs its course, and begins to rollover, that is when we’ll see the “emperor has no clothes” moment because high debt levels require high asset prices, otherwise we fall into a spiral of collateral shortfalls, forced liquidations, and mass insolvency.

Luckily for the emperor, total U.S. household net worth — measured by the value of all assets minus liabilities — increased by $5.8 trillion to a record ~$142 trillion at the end of June, according to a report from the Federal Reserve released last week, in large part driven by the stellar performance of corporate equities and the red hot real estate market.

All the recent “taper talks” follow the trend of a decelerating pace of asset purchases across the world’s major central banks. We’ve noted historically these periods were not favorable for BTC and crypto assets more broadly, which is why we find it worth highlighting again as talks of tighter policy proliferate.

Bitcoin’s price peaked with inflation expectations (measured by 5-year breakeven rates), further supporting the notion that the market doesn’t believe the recent rise in well-known inflation readings signal a secular shift towards sustained higher prices.

In a somewhat similar vein, ETHBTC peak coincided with top in EM FX strength, which makes sense given the “reflation” narrative proved to be more hopeful than reality. This also signaled a shift in risk appetite, which crypto certainly benefits from; during risk-off periods, ETH would be expected to underperform.

WHAT TO WATCH: Economic Surprise indices show continued disappointment in the strength of the recovery (US, Europe, EM, etc.); if this continues, we believe it’s unlikely global policymakers (both monetary and fiscal) will be able to remove themselves from the equation as they seem to project. If markets react in dramatic fashion, they’ll be forced to step back in and provide support given the increased interdependence between financial markets and the real economy.