Crypto market performance: Volatility is back
The beginning of 2022 has seen volatility return across the market with the price of BTC and ETH down -11.95% and -19.17% respectively in the first week of the year. Other large caps such as BNB and SOL similarly experienced double digit losses and were down -19.50% on average.
Out of the top 20 tokens by market cap, only Chainlink (LINK), the decentralized oracle network, saw a positive performance (+20%). The biggest losers in the big cap segment were AVAX -26.2%, LUNA -24.58%, and CRO -21.77%.
Macro recap : Rates, Rates, Rates, and Rates
The Fed’s December minutes were released on Thursday January 6th, 2022, signaling a more hawkish stance than expected. This caught the market off guard. Bond yields rose, signaling a risk-off market move with equities contracting by -3.3%. The crypto market also saw a strong sell-off as BTC and ETH reached 1-month lows on the back of the Fed’s minutes release. The BTC options market saw implied volatility (IV) decrease in the beginning of the year, despite the latest price action, as IV reached 50% versus its peak at 70% in December 2021.
Market Structure: Bottom is here!
On the bright side, there was a notable divergence in BTC Open Interest vs Market Cap ratio, similar to Aug 2021 when this divergence reached its highest level in over a year, coinciding with BTC’s price bottom at the time. A higher ratio implies a spot-driven bull run and a lower ratio implies a bear market divergence. (Open interest is the total number of futures contracts held by market participants at the end of the trading day. It is used as an indicator to determine market sentiment and the strength behind price trends).
The current crypto market structure is showing a glimmer of positive signs as we see funding rates in the major crypto derivatives exchanges start to turn overly negative (0.03%), reaching similar levels to July 2021(0.04%) and September 2021 (0.03%), both of which were followed by bull outbreaks. (Positive funding rates suggest speculators are bullish; long traders pay funding to short traders. Negative funding rates suggest speculators are bearish; short traders pay funding to long traders). Some signs of backwardation are also being spotted across different exchanges (when the spot price of an underlying asset is higher than prices trading in the futures market). If market backwardation remains, this could signal a strong support level for BTC spot markets.
On-chain data suggests market support as wallets from major centralized and decentralized exchanges show an outflow increase of 25,780 BTC and 537,093 of ETH in the last 7 days. (Inflows may indicate intention to sell, outflows may indicate intention to hold.) being a positive sign for bulls, at least in the short-term window.
Lastly, as the market continues to see high volatility, a good indicator of a market bottom is the Hodler Net Position Change by Glassnode, which shows the rolling 30-day change in coin maturation. As units of BTC age and mature in investor wallets, they accrue Coin Days, which are ‘destroyed’ upon spending and help to produce various lifespan metrics. Positive (green) values mean coins are ageing and maturing at a higher rate than spending. This is typically in bearish market conditions absent retail interest as long-term accumulation takes place by high conviction buyers.
Negative (red) values occur when elevated rates of spending, particularly by older coins, outpace the present accumulation behavior. This is frequently observed in the height of bull markets and moments of total capitulation, when older hands are more likely to relinquish their holdings. The market had a strong sell-off during Q2 and Q3 2021, before rebounding and peaking in November 2021. The chart below shows that we are once again starting to see stronger coin maturation going into 2022 with HODLers sticking around to provide market support. The bottom is here.
Theme of the month: Modular blockchains
2021 was a unique year for crypto, as it saw not only an increase in market cap by 1.5 trillion to reach the 2.5 trillion mark by the end of the year, but also the flourishing of new spaces such as the metaverse, the creation and growth of layer 1 blockchains (L1) as well as developments in DeFi 2.0. This new year will not be absent of growth as we see more and more developers transitioning from web 2.0 to web 3.0 DApps in the crypto ecosystem.
No longer “one chain to rule them all”
Last year, the market experienced an increased number of L1 chains providing the ability to create smart contracts. Many, such as Solana, BSC and AVAX, outperformed the returns of BTC and ETH. Further, we believe that as ETH continues its deployment of ETH 2.0 and completes its release in the first two quarters of 2022, it will continue to experience cross-chain and scalability difficulties. The idea of “one chain to rule them all” has shifted towards the “interchain” thesis. We expect to see continued growth of modular solutions this year.
What’s a modular blockchain?
A modular blockchain design entails the separation of the blockchain architecture in different layers focused on the execution of specific tasks: execution, data availability and consensus, and settlement. This is in contrast to blockchains like SOL, BSC or ETH ( all monolithic chains), which execute all the aforementioned tasks by themselves.
Ethereum has already started its transition to becoming a more modular blockchain. It will be utilizing Ethereum as the settlement and data availability layer and scaling solutions such as zkRollups (Zero-Knowledge Rollups) and optimistic roll ups, which will be fully implemented by the end of 2022. Optimistic roll up are a type of layer 2 construction that does not run on Ethereum’s base layer but rather on top of it. This enables running smart contracts at scale while still being secured by Ethereum.
Different types of modular blockchains
One of the most interesting players in the modular blockchain spectrum is Celestia. This blockchain solution is focused mostly on data availability and ordering transactions. They are building a blockchain dedicated to being the most efficient and decentralized data-availability layer and will be able to connect to other execution and settlement layers to complete the full modular stack (see Ansem’s Newsletter 2022 General Market Outlook for more detail). Another data availability and storage solution is Arweave, a decentralized protocol for storing data permanently. Based on a technology named Blockweave, it focuses on sustainability and easy usage of the system and accessing data.
Finally, Cosmos is the first to develop a modular network of blockchains. This model keeps the protocol open source and independent of the Cosmos “Hub” and its token, ATOM. This concept is known as the Inter-Blockchain Communication protocol (IBC), a technology that allows different blockchains to communicate to each other via a common hub. Most cross-chain bridges are built by independent third parties and vary drastically on maturity and security depending on which protocols they interact with, thus potentially compromising their security and providing an inconsistent experience. With IBC, the difference is that the data is sent via a dedicated channel by a trustless relayer and then authenticated once reaching the destination chain (see https://bisontrails.co/ibc-protocol/ for more detail).
If you’re interested in learning more, check out the other interesting infrastructure players in this space: Graph & Covalent (indexer and data query), StarkWare (scalability solutions), ZKSync (on- chain data availability for scaling low cost payments on ETH), and LIDO (multi-chain liquid stacking solution).