Bitcoin
Bitcoin extended its rally last week, closing higher on Sunday by +7% at $30,326. The move was done on thinly traded volume. There were no signs of significant short liquidations on last week’s move - as evidenced by the low volume and the fact that short interest remains near its historic lows. What has been driving the recent leg up is not so short liquidations - but the fact that there is very little bitcoin for sale.
The above chart shows the aggregate bitcoin balances on the world’s top exchanges. As you can see from the above chart, bitcoin balances on exchanges are at their lowest levels in the last 12 months. In other words, demand may have dropped, but supply has dropped even further - which drives equilibrium prices higher. If demand persists, the supply imbalance could continue driving prices higher until more bitcoin comes on exchanges to be sold.
In terms of technical support and resistance levels, we continue tracking the 200-week moving average price at $25,857 as potential support. And in terms of resistance, we are monitoring the $30k level - which it is working through right now. Beyond that, the next key technical level would be $35k.
Digital Assets Markets:
1. 0DTE Options on Bitcoin are coming on May 22nd - and that’s a very big deal
Bitcoin Options contracts have been surging in popularity since 2020. On July 1st, 2020 the total open interest for bitcoin options (or open active option agreements) was a mere $1.25 Billion in notional. Today, there is more than $12.4 Billion worth of notional value in open interest. That’s almost 10X growth in less than 3 years.
This should not come as a surprise though, as a similar trend is happening in traditional finance. Since the end of 2019 until today, the daily average option volume traded in the S&P 500 has doubled.
Option pricing models are highly impacted by the implied volatility of the underlying asset. The more volatile the asset, the more expensive the “option” on that asset - all things being equal.
There have been 2 catalysts that have elevated the popularity of options in traditional finance, as well as in bitcoin.
The first one was the increased market volatility that started with the COVID drop in March 2020, and the subsequent recovery that lasted until 2022. The increased volatility attracted people to the options market as they can implicitly or explicitly trade “volatility” through options contracts.
The second one was the introduction of “daily expiration options” for the S&P 500 in May 2022. Originally, options contracts were issued on a weekly basis, expiring the Friday of every week. Over time, expiration dates were added on Mondays and Wednesdays. In May 2022, the CME introduced options that expired every day of the week.
These “daily options” or “0DTE Options” (zero days to expiration) became wildly popular after they were introduced. So much so, that the popularity of these products caused certain analysts to highlight that they could introduce systemic risk.
For context, approximately 45% of S&P 500 options volume on a typical day comes from single-day options, according to Bank of America. Given the popularity of these instruments, the CME is doubling down on the format and introducing it for Bitcoin and Ethereum futures starting May 2022.
This is also a business decision for the CME, as it wants to grow its market share of the bitcoin options market. Today, the CME only has a 13.5% market share of the Bitcoin options market, with Deribit dominating the market at 80% of total volume.
The introduction of these options for bitcoin could have 3 effects:
1. Reduce volatility in the long-term: Daily options on the CME will allow one more avenue for sophisticated investors to hedge their risks. The ability to buy “price insurance” for a specific period of time, should reduce the number of forced buyers or forced sellers during market cycles.2. Attract more institutions to the market: Being able to hedge risk more precisely, and through the Chicago Mercantile Exchange should attract more institutions to participate in the market. As many of them already trade on the CME and were waiting for “the right instruments” to get involved.
3. Accelerate development of new financial products for bitcoin: The increased depth of the Bitcoin options market, and the introduction of another reputable venue to trade these options, should accelerate the development of financial products that require derivatives in the back-end to exist.
Macro
2. The Yuan wants to “Float”
Many people debate the reason for the U.S. dollar dominance around the world. Some say it is “backed by the U.S. army”. Others say that it is backed by “a credible Central Bank”. If you ask an average person why they prefer the dollar, they will likely say something like “because it holds its value” and “because you can spend it anywhere”.
The first line “because it holds its value”, is referring to the USD relative to other currencies. Historically, most - if not all currencies, have lost value vs. the U.S. dollar since the Bretton Woods accord. Over time, this has reinforced the idea that the U.S. dollar is a “superior currency” to almost all others.
The second line, “because you can spend it anywhere” speaks to the potential uses that can be given to a U.S. dollar. Broadly speaking, it can be used to purchase any type of good - or to be invested in a USD denominated asset - or an asset that is based in, or offered from, the United States.
The above reasons highlight “The Impossible Trinity” that Central Banks face, and the strategic decisions made by the U.S. with regards to their currency.
The Impossible Trinity:
The impossible trinity (also known as the impossible trilemma or the Unholy Trinity) is a concept in international economics which states that it is impossible to have all three of the following at the same time:
1. a fixed (or stable) foreign exchange rate
2. free capital movement (absence of capital controls)
3. an independent monetary policy (setting an interest rate different from your peers)
The United States manages to maintain a stable currency (1) and allow for free capital movement without capital controls. As we’ve seen, their ability to maintain an interest rate that is different from their peers directly impacts their ability to keep the USD exchange rate “stable”.
China, on the other hand, has been able to maintain a stable currency (1) but they maintain strict capital controls on all flows in and out of China. There are strict limits to how many U.S. dollars a Chinese national can buy with their hard earned Yuan. In other words, it’s not so hard to invest dollars into China, but it is very difficult to get them out.
Historically, countries who are net producers, have chosen to be paid in U.S. dollars, as they can invest those U.S. dollars into U.S. assets like treasury bills, U.S. government bonds, U.S. real estate, or U.S. equities. And these can be sold and converted back to their local currency on-demand.
However, net-producer countries realized the fragility of this model when Russia, a net-producer country that had accumulated some savings in U.S. dollar assets, had those assets impaired and access to the U.S. dollar banking system removed. The U.S. dollar was effectively weaponized against them.
The recent development has prompted a series of net-producer countries (or exporting countries) to re-think their use of the U.S. dollars for commerce and their sovereign reserves. Several countries, or groups of countries, have been fighting to become “the next global currency” - namely China, and the BRIC countries.
We’ve covered the BRIC currency concept in a previous issue. Today, we will focus on China’s efforts - and why they will likely be unsuccessful in the short term.
In a recent interview in Washington, the Governor of the People’s Bank of China stated that China has “largely ended regular foreign-exchange intervention”. While he mentioned that the bank “still retains the right to intervene” they are letting “the market” determine the exchange rate. This is a clear attempt to show that the Yuan is “a stable currency” and that it does not require the intervention from the Central Bank to remain stable.
What this doesn’t do is get rid of China’s strict capital controls, and general restrictions to move capital in and out of China.
In order for any currency to challenge the U.S. dollar, it must be equally convertible - with no restrictions. Under this scenario, you could see why a Chinese vendor would prefer to get paid in U.S. dollars and _not_ convert them. If they do convert them to Yuan, they may never be able to go back to USD. Or not do so in time, or at the right rate.
Moreover, exporting countries desire the U.S. dollar because the U.S.-based assets that can be purchased with those dollars are equally desirable and high quality. They can also be bought and sold with very little friction. Capital can flow in and out of the U.S. very freely.
China not only needs to solve its capital controls issues to challenge the dollar. It also has to ensure that capital can move in and out of China as easily as it does in the U.S.
The fear is that once China lifts its capital controls or movement restrictions, it will introduce extreme demand for U.S. dollars and that will cause the Yuan to destabilize. It is the same predicament that Latin American countries face - and a difficult problem to solve.
So long as capital controls exist in China, and capital flows are restricted, the Yuan will not be able to challenge the U.S. dollar.
The Week Ahead đź“°
The focus in the week ahead will be on U.S. corporate earnings reporting Q1 results. This week we will get some bitcoin-relevant companies like Tesla, and financial heavy hitters like Bank of New York Mellon - where Circle holds USDC’s cash reserves.
We will also get 8 Fed speeches throughout the week as Fed members talk to the media for the last time ahead of their next FOMC meeting on May 3rd. Given the Fed’s mandate to bring inflation under 2%, they cannot be liking the current rally in asset prices as much as investors are. The Fed could try to talk down markets ahead of the meeting and during the press release on May 3rd.
Thursday should also usher in another record-setting difficulty adjustment for Bitcoin!
As always, here’s a summary of the events and data that could move markets in the week ahead:
Notice for Canadian Residents: As of January 4, 2023, Canadian clients will no longer be able to take out new B2X loans.As of February 1, 2023, Canadian clients will no longer be able to open a new BTC or USDC Savings Account, deposit BTC or USDC to existing Savings Accounts or earn yield on any existing BTC or USDC Savings Account balances.
Notice for U.S. Residents: Effective March 1, 2023, U.S. clients will not earn interest on any BTC and/or USDC balance in their Savings Accounts and/or Legacy Savings Accounts.This article is intended for general information, educational and discussion purposes only, it is not an offer, inducement or solicitation of any kind, and is not to be relied upon as constituting legal, financial, investment, tax or other professional advice. This article is not directed to, and the information contained herein is not intended for distribution to, or use by, any person or entity in any jurisdiction or country where such distribution, publication, availability or use would be contrary to law or regulation or prohibited by any reason whatsoever or that would subject Ledn and/or its affiliates to any registration or licensing requirement. This article is expressly not for distribution or dissemination in, and no Ledn product or service is being marketed or offered to residents of, the European Union, the United Kingdom, the United States of America or any jurisdiction in Canada, and such product or service may only be marketed or offered in such jurisdictions pursuant to applicable laws or reliance on regulatory exemptions. A professional advisor should be consulted regarding your specific situation. Digital assets are highly volatile and risky, are not legal tender, and are not backed by the government. The information contained in this publication has been obtained from sources that we believe to be reliable, however we do not represent or warrant that such information is accurate or complete. Past performance and forecasts are not a reliable indicator of future performance. Any opinions or estimates expressed herein are subject to change without notice. This article may contain views or opinions of the author that do not necessarily reflect the opinions, standards or policies of Ledn. We expressly disclaim all liability and all warranties of accuracy, completeness, merchantability or fitness for a particular purpose with respect to this article/communication. Read our Disclaimers at https://ledn.io/legal/disclaimers
