September 21, 2022|Commentary

Commentary from the Desk: September 21,2022


This week, we are closely following:

  • Post-Merge and the Macro
  • TradFi/Crypto Market Correlations

Recapping the “Uneventful” Merge Event

  • First and foremost, the Merge was a massive success;
  • On September 15, Ethereum underwent its most important upgrade to date, arguably the third most important event in crypto history, behind the creation of Bitcoin in 2009 and Ethereum in 2015;
  • From a technical perspective, the transition was impressively seamless and uneventful, particularly given the complexity of Ethereum and its entire ecosystem of dependencies built on top of it. Further, the execution was done in an entirely decentralized, global environment.
    • A major hat tip from us to the Ethereum Core developers.
  • In the long-term, the effects of the Merge will most certainly be significant; but in the near-term, the Merge was a “buy the rumor, sell the news” event;
    • While it’s not yet deflationary, the supply of Ethereum has increased by ~4000 ETH since the Merge, which equates to an annual net inflation of 0.2%, compared to ~4% pre-merge
    • If Ethereum was still operating under Proof-of-Work, the Ethereum supply would have increased by ~80k ETH since the date of the Merge;
    • Since the Merge occurred, Ethereum is down around ~17%
      • ETH fell as low $1,285 during the last week
    • It appears that miners sold ~17k ETH (~$220m) over the past week
    • ETH correlation to the SPX fell in the months leading up to the Merge, but is now currently at ~.9.
  • Side note: amongst all the revelry, the SEC also teased its interest for U.S. jurisdiction over the Ethereum Network.

    Continued Macro Focus

  • As with last week, all eyes continue to be on any and all developments from the central banks, particularly the Fed;
  • Last week’s CPI print caused significant negative reactions across the markets;
  • To recap
    • The consumer price index increased 0.1% in August. Excluding food and energy, the inflation gauge rose 0.6%, both higher than expected and double July’s pace;
    • This so-called core CPI increased to 6.3% in August from a year earlier, up markedly from the 5.9% rate in both June and July—a signal that broad price pressures strengthened.
    • Costs were driven by increases in food, shelter and medical care services, offsetting a sharp decline in gasoline prices;
    • Real average hourly earnings adjusted for inflation rose 0.2% for the month. However, they remained down 2.8% from a year ago.The consumer price index increased 0.1% in August. Excluding food and energy, the inflation gauge rose 0.6%, both higher than expected and double July’s pace;
  • The market’s reactions have been less than enthusiastic:
    • Stocks posted their worst one-day performance since June 2020 as investors digested the latest inflation data and raised concerns about the Fed’s path ahead around interest-rate increases
  • Generally a mom CPI miss of 0.2pp or more leads to a major market disruption but this was particularly important as the market had been looking for inflation to have peaked and also the drivers were more demand than supply led, which justifies Fed tightening.
    • Looking ahead: There is now increased expectations by investors that the central bank might ultimately push policy rates early in 2023 toward around 4.3%. However, this could also dampen economic activity in a way that forces re-easing policy before 2023 is out.
    • All eyes will be on the Fed on Wednesday afternoon
  • The CME Fed Watch is currently predicting an 84% of a 75bp increase and 16% chance of a 100bp increase;
  • Crypto risk premiums are also increasingly becoming reduced:
    • Stablecoin yields on top lending protocols such as Aave and Compound are anywhere from 0.5-2% APY currently;
    • The yield curve is still inverted, and the 2-year yield is currently sitting around 3.96% and the 10-year is 3.543%

TradFi/Crypto Market Correlations

  • The ETH/NASDAQ correlation is nearly back to the highs of the year, a feature which has currently overshadowed the idiosyncratic dynamics of the Merge;
  • In the price/action space, this macroeconomic correlation has provided hurdles for crypto-native participants to extract alpha from their edge, i.e. the deep understanding of on-chain dynamics;
  • We’ve noticed a trend among these participants to transact in dollars rather than xxxBTC or xxxETH pairs:
    • This is likely a throwback to when digital assets were wholly decorrelated from the broader world of low-vol post-GFC finance.
    • Disconnecting from this mentality is potentially an important key to crypto winter survival
  • Against that backdrop, it is critical to monitor the performance of ETHBTC post-Merge
  • The sudden disappearance of ~$100M/week of miner selling is a critical supply/demand dynamic that we believe will dominate once positioning/ miner selling has normalised.
    • At the moment: ETHBTC is trading on the local lows; perhaps the result of the “buy the news, sell the fact” crowd liquidating alongside the weak hands who held ETHUSD close to their stops into an ugly CPI number.
    • Over the longer term: it’s nearly impossible to fight the flows, and the economics of those flows has just shifted permanently.
    • Staking yields have risen to ~5.5% and while ETH staked has not yet risen materially we are seeing inflows
  • For a reference, look no further than the previous three BTC halvings, during which that chain experienced a similar (but smaller) shift in the dynamics of stock and flow;
    • In two cases the grind higher began immediately, but in 2016, there was a 10% selloff first.

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