The last couple weeks have been a bit of a whirlwind. Massive deleveraging sparked a sharp and violent sell-off that the crypto market still hasn’t recovered from. Some would argue this was a necessary wash out as excessive optimism and bullish sentiment prompted tons of speculative buying. But even with most crypto assets sitting well off their prior highs, it’s hard not to step back and reevaluate if things have gotten a little bit frothy as of late. Adding insult to injury is the shifting macro backdrop that’s characterization served as a material tailwind for all risk assets, including crypto, over the last 12-18 months. As global liquidity growth slows and policymakers shift their rhetoric from “do whatever it takes” to “normalizing policy”, there’s several factors that could weigh on valuations going forward.

We’re adding this preface because, while our long-term conviction hasn’t swayed, it’s important to recognize when the tides may be shifting as their direction will impact how others act in the face of emerging headwinds, however short-lived we think they might be. Where we go next is uncertain, but right now it still looks a bit dire. Having said that, there’s clearly a lot on the horizon to be excited about, so stick to your principles and stay nimble; if and when the next bear market comes, you’ll want to be ready.

Market Structure and Mass Deleveraging

BTC open interest is down 50% from its peak a month ago, as a barrage of over-leveraged longs got wiped out. Deleveraging events are significant in crypto given market participants’ propensity for leverage and the volatility of the asset class. Typically, a deep deleveraging has given way to further upside in crypto, and while a short-term rebound is far from guaranteed, it’s quite possible this time will follow a similar playbook as prior occasions.

More interestingly is the pace at which OI has been wiped out; the 30-day % decline in OI for BTC has reached levels that previously signaled a bottom was forming (or wasn’t too far out).

ETH open interest is down 30% in a month, which is surprising given the drawdown in BTC open interest. However, as we’ve noted several times, ETH has held up remarkably well in the past month compared to most large cap crypto assets.

For those of you wondering what exactly went down last Friday and Saturday, when prices crashed about 20%, we covered this in Monday’s Delphi Daily, “A Post Mortem of Last Week’s Flash Crash“. But just to briefly recap, a momentary lapse in liquidity and aggressive selling — likely prompted by news regarding Evergrande’s default and Chinese monetary tightening — forced the market much lower than it should have gone. Sellers ate through buy walls on spot markets, and market makers took some time to recoup and repopulate the orderbook.

As a result, implied volatility (IV) for BTC jumped, albeit for a very short period of time, before reverting back to similar levels we saw ahead of the short-term liquidity crisis. As uncertainty continues to loom over BTC and the wider crypto market, it looks like IV is inching up again, implying a period of elevated volatility lies ahead.

Funding rates were forced lower as a big chunk of large open interest was wiped out and bearish sentiment