Markets

Is the crypto bear market coming to an end? 3 key indicators to pay attention to

Cryptocurrency market valuations have fallen significantly from their all-time highs, with the total market capitalization shedding around $2.2 trillion – a drop of around 73%.

Many altcoins, including some large-cap ones, have lost over 90% of their value from their all-time highs, and industry participants are scrambling to gauge the bottom.

In light of the above, crypto analytics resource Nansen has published a report that identifies systematic patterns in crypto derivatives markets and traditional spot markets, analyzing what they mean for the current market environment. In short, they are trying to answer the question of whether the crypto bear market is coming to an end.

Nansen highlights three key points.

U.S. dollar

At the time of writing, the USD has started to lose strength against other major currencies such as the JPI and CNI.

Nansen argues that one driver for this could be the pricing of the Fed’s highest interest rates in futures bond markets.

Bond futures currently see the Fed rate peaking at ~4.84% in May 2023 and tapering by 40bps+ in the second half of 2023. Admittedly, the US CPI release surprised to the downside for the second consecutive month , which may explain some of the prices due to rate increases. – He reads the report.

However, a rate cut could occur if there is serious weakness on behalf of the US at the macro level, with its real growth slowing significantly. The chairman of the Federal Reserve – Jerome Powell – has repeatedly pointed out that “the risks of under-tightening are greater than the risks of over-tightening” and that the labor market is too high and needs rebalancing.

Using complex indicators to assess relative growth between the US and other considerations, Nansen concluded that:

“…it is probably too early to call for a move to easier global financial conditions, and, therefore, the base case for bottoming out in crypto assets is probably not there yet.”

With this, analysts are shifting their focus to derivatives markets.

Calls vs. Puts for BTC and ETH

The question Nansen aims to answer here is whether option investors in BTC and ETH have capitulated yet, and to address that question, they look at the implied volatility of call vs. put option (CPIV) weighted by open interest.

The data they examine covers the period from January 2021 to November 2022, assuming that the derivatives market will develop in future cycles.

The conclusions they reached can be summarized as follows:

  • The CPIV indicator managed to generate more frequent risk on and off signals compared to the stable currency indicator.
  • Both marked BTC’s multi-month decline that began in November of last year.
  • The stable currency indicator returned to the risk level in May 2022, while the CPIV indicator was off since November 20, 2022.

*Note: The stablecoin indicator mentioned above is the Nansen Smart Money Stablecoin Risk Appetite Indicator.

Crypto Risk Premium

In the final part of the report, analysts conceptualize and calculate the risk premium for cryptocurrencies, called the Crypto Risk Premium or CRP. It is related to the fundamental value of crypto assets held by investors.

The methodology that analysts adopt was developed by Ian Martin in a paper published in April 2015 entitled What is the expected return on the market? Nansen also uses Deribit historical options data taking into account intraday bid and ask prices for calls and puts on BTC, ETH and SOL.

However, when determining the cryptocurrency and equity markets, analysts point out that the crypto derivatives markets are young and not as well-studied as the equity markets, meaning that it is necessary to keep an open mind when analyzing CRP valuations.

In addition, the conclusion (before speculation) is that:

“…in the event of a US recession and US equity sell-off (our main scenario for 2023 given the Fed’s determination to maintain tight funding conditions for longer), the ERP is likely to be much higher, and conversely the CRP or crypto risk premium will probably jump as well. Therefore, it is possible that cryptocurrency prices will experience a further (and “final”?) step in this cycle before financing conditions become more favorable for both equity and crypto assets.”

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