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  • Crypto's reaction to Omicron

  • Key Takeaways:

    • The macroeconomic backdrop has created uncertainty for risk assets like equities and cryptocurrencies, causing investors to pause and evaluate risk positioning across their portfolios.
    • After a volatile 72 hours, with sharp corrections and tight liquidity, FalconX has seen a continued positive sentiment in crypto, as investors largely swung to the buy side after the pull-back.
    • Omicron will dominate the news over the next couple weeks and could potentially keep traders on edge. From a structural point of view, the crypto market might be entering (or moving towards) the next phase of the cycle where BTC rotates into ETH and then into Alts and these transitional phases are usually accompanied by periods of heightened volatility.
    • Institutions are reacting to fundamental developments in the macroeconomic environment and responding in the crypto markets using a traditional finance investment framework – pointing to further validity that the digital economy is cementing itself in the mainstream.

    It’s Been a Wild One

    Over the course of the last week, the prevailing macroeconomic narrative has created additional uncertainty around risk assets broadly. We can point to two economic indicators – a less accommodative Federal Reserve, that is using a constrained monetary policy toolkit, and a new variant of Covid-19, Omicron. This backdrop has created uncertainty for risk assets like equities and cryptocurrencies, causing investors to pause and evaluate risk positioning across their portfolios.

    Within the last 72 hours, traders and investors witnessed sharp corrections across market segments, broadly led by macroeconomic concerns like the onset of the Omicron variant and concerns of a rate hike amidst a high inflation environment. This led to a major risk off in equities and cryptocurrencies alike, with the former represented by a 2% move down on the SP500 and similar reflections across global assets. The drawdown started on Friday morning on the back of a mixed jobs report. On one hand, we learned that hiring is slowing across industries (added +210K jobs in November vs. +550K expected), especially automakers and retail outlets. This news was paired with the unemployment rate hitting a pandemic-era low of 4.2%. As the unemployment rate falls, we would expect wage growth and inflation to rise which would push Chairman Powell to take a more hawkish stance on monetary policy. The sell-off accelerated through Friday night as the UK announced stricter travel guidelines for international travelers. Poor liquidity on centralized exchanges heading into the weekend caused volatility to be amplified.

    Bitcoin traded as low as $42.0K on Friday night in a market move that represented a 27% drawdown from $57.3K price levels seen mid-last week. The majority of the pullback occurred in a matter of minutes and was exacerbated by over $1.8 billion of BTC longs being liquidated on centralized exchanges within a span of an hour, leading to an eventual 25% drop in OI on perpetual futures, and large discounts on short dated futures and swaps, with opportunities aplenty for those that had liquidity on hand. The sharp move in BTC sent ripples across the cryptocurrency trading ecosystem, with 24-hour cross-crypto liquidations passing $2.5 billion. Prices have stabilized since Friday night with BTC trading within a 4% range over the last 24 hours and currently sits just under $49K. Across the board in crypto, altcoins are down in the high double digit range, with sparse winners amongst the carnage. LUNA held some value and even rallied to all time highs, while retail favorites like SHIB and DOGE crashed over 30%.

    The activity we have seen across personas this week point to a continued positive sentiment in crypto, as investors largely swung to the buy side after the pull-back. FalconX experienced a spike in trading volume around the market volatility and crossed three times our usual daily trading volume. BTC led trading volumes and crossed hands two times more than ETH on our platform. Trading in both names were skewed to the buy side as institutional investors perceived the pull-back as an opportunity to expand existing positions (BTC buy-to-sell ratio: 1.3:1, ETH buy-to-sell ratio: 1.4:1). Hedge funds were our most active persona on platform as they used the market volatility to capitalize on cross-exchange arbitrage opportunities as well as deploy dry powder to existing long positions. Funds were also active further down the market cap spectrum in ATOM (buy-to-sell: 12.5:1) and SOL (buy-to-sell: 2.1:1). Retail aggregators were our next most active as retail traders took to markets to trade the momentum.

    ​​Whenever In Doubt, Zoom Out

    The bigger picture has several moving parts which need to be closely monitored in the next two weeks. Macro uncertainty is growing. The sell-off began around the time International Monetary Fund’s managing director Kristalina Georgieva made a statement about global growth downgrades. About a month back, Fed tapering became the biggest risk for the markets until several new threats created ripples across risk-on assets, the largest being the new Covid-19 variant Omicron, which we are still a couple of weeks away from understanding its true repercussions. Rising inflation across the globe and supply chain woes are too real to ignore as well.

    It’s also been a record risk-taking year. 2021 has been extraordinary for the amount of capital deployed in "risk-on" assets. Stock funds took in more cash ($1.1 trillion) in 2021 than the previous two decades combined. ETFs and long-only funds have absorbed almost $900 billion (bond funds at just $496bn and money market funds at $260bn). For context, the crypto market cap is up over $1.5 trillion since the beginning of the year. As crypto's correlation with "risk-on" assets strengthens, the liquidity boost brings with it the added risk of froth in valuations. If the macro environment under-delivers, expect a healthy correction across risk-on assets.

    The swings we saw this past weekend could happen again. We don't have to go far back in time to see how thin liquidity coupled with leveraged liquidations can result in sharp price movements. Case in point, the week starting May 10, 2021. Weekend weakness in prices extended with liquidations, ensuring a massive ~50% correction. And, the 24/7 nature of crypto trading amplifies such drastic price movements, and will continue to do so. For Investors, the long term narrative of crypto assets powering the digital economy remains intact. Increasing adoption, legitimacy as an asset class and clarity in regulation are primary drivers for investor interest, searching for returns in a low interest environment. With VC's flush with cash to deploy, they have bet big on crypto start-ups in 2021, investing more than $27 billion globally as of late November and another $3 billion over the last 30 days - all of which is more than the previous 10 years combined, according to PitchBook. Besides taking equity positions via private sales, long-term investors are exploring direct token exposure via spot purchases. This period should be approached with cautious optimism to build long term positions. Omicron related-news will dominate in the coming two weeks and could potentially keep traders on edge, deciding on their approach and deployment of "dry powder" and searching for directional moves. From a structural point of view, the crypto market might be entering (or moving towards) the next phase of the cycle where BTC rotates into ETH and then into Alts and these transitional phases are usually accompanied by periods of heightened volatility. Market volatility can be managed via hedging strategies and with crypto-specific tokenomics in play (unlocks, airdrops, burning, etc) with traders exploring various structures for risk management.

    What Does All of This Mean for Institutional Investors?

    Institutions are reacting to fundamental developments in the macroeconomic environment and responding to these developments using a traditional finance investment framework with crypto as the investment vehicle – pointing to further validity that the digital economy is cementing itself in the mainstream. FalconX plays an essential role during these periods of market stress. When we look at this latest spike in volumes, FalconX allowed for 99% trading uptime as a result of our access to deep liquidity sourcing and our flexible routing of orders. The last 72 hours illuminates the need for a partner that reduces the fragmentation experienced in the prevailing crypto trading infrastructure, especially in an asset class that trades 24/7/365.