Welcome back! This week’s special edition will be a review of 2023 in Macro and Crypto as well as a look ahead to what the market is pricing in for 2024.
Macro: 2023 Review
The financial year of 2023 was characterized by a blend of political turmoil, financial scandals, technological advancements, market fluctuations, and global economic shifts. This multifaceted landscape underscored the necessity for adaptability and vigilance within the market.
Political Turmoil and Financial Scandals
The year commenced with prolonged house speaker elections in the United States, intensifying debates over raising the debt ceiling and posing a genuine risk of a U.S. default. Hindenburg Research accused India’s richest man, Gautam Adani, of “brazen” stock manipulation and accounting fraud, leading to a significant drop in Adani’s company valuations leading to investigations by India’s Supreme Court and U.S. regulatory bodies. In February, Trafigura uncovered a “systematic fraud” involving nickel shipments highlighting the vulnerabilities in commodity trading.
The founder of FTX, Sam Bankman-Fried, faced legal issues stemming from the collapse of one the largest exchanges in Crypto. Testimony included leaked diaries and damning witness accounts from former employees who had agreed to testify against Bankman-Fried. After the high-profile trial concluded the jury handed down a guilty verdict to Bankman-Fried for defrauding FTX customers.
Former Binance CEO Changpeng Zhao admitted guilt and stepped down as CEO of Binance in a $4.3 billion settlement with the U.S. Department of Justice following a multiyear investigation into the cryptocurrency exchange. Appearing in a Seattle court, Zhao acknowledged the charges of violating financial regulations and economic sanctions, taking responsibility for his actions, and naming Richard Teng as Binance’s new CEO.
Crypto Advancements and AI Dominance
The dominance of AI emerged as a significant trend this year. The launch of ChatGPT prompted companies to swiftly adopt AI strategies, akin to the rapid adaptation seen with blockchain strategies from the previous year. Pivot to AI itself became a meme in crypto, with OpenAI becoming the most talked about company in recent memory.
Ethereum’s Shanghai upgrade, also known as the Shapella upgrade, was a hard fork that occurred in April. It was the first major upgrade since the transition to a proof-of-stake system in September 2022. The upgrade enabled validators to withdraw staked ETH that had been locked in the network, including ETH staked since December 2020, amounting to 16 million tokens worth over $26 billion USD. Despite concerns, the price of ETH rallied to $2,100 USD, its highest level in 11 months, after the upgrade, defying earlier worries about significant selling pressure and a price crash.
Solana launched Firedancer, a next-generation independent validator client for the Solana blockchain, developed by the team at Jump Crypto to introduce client diversity, increased performance, and scalability to the Solana ecosystem. It is written in C and C++, known for hardware performance and reliability, and will have some compatibility with Rust. Some of the benefits of using the Firedancer client include improved performance and scalability, enhanced reliability, more efficiency, an open-source codebase, and more failure points/options.
Bitcoin Ordinals are a method of generating non-fungible tokens (NFTs) on the Bitcoin blockchain through a process called inscribing. This method was introduced in January and is based on the Ordinals protocol, which aims to give each satoshi a unique identity by attaching data such as images, videos, and more to an individual satoshi on the base Bitcoin blockchain. Unlike traditional NFTs, the metadata for ordinal NFTs is held within the witness data of a transaction, and they don’t exist on a separate layer from Bitcoin. Instead, they use an arbitrary but logical ordering system called ordinal. This development was met with controversy in the bitcoin community but so far has generated interest among people looking to do more on the Bitcoin blockchain.
Market Dynamics and Monetary Policy
2023 was a year that began with consensus forecasting a recession by the second half of the year as a result of the U.S. Federal Reserve embarking on a monetary tightening cycle to combat inflation. This forecast extended to numerous OECD countries due to the unprecedented pace of rate hikes by global central banks. What unfolded next will fuel discussions among macroeconomists for years. Although certain economies, notably those more exposed to interest rate-sensitive cyclical industries such as manufacturing and housing (Canada, Australia, and Germany), did witness a slowdown in economic activity, the anticipated ‘crash to end all crashes’ did not materialize.
So what happened?
The single most underappreciated variable that everyone missed this year was interest income payments from the U.S. Treasury. Orthodox economic theory typically does not frame the macro economy through the lens of macro accounting, and by macro accounting we mean maintaining accounting identities even when discussing government spending and debt. For example: every deficit has a surplus, therefore the government’s deficit is the private sector’s income. Once the Fed raised rates, they made the Treasury of the United States a net payer of interest on government securities. At current debt/GDP levels, first the rate hikes work to dampen private sector deficit spending (2022 market decline), but eventually as they increase rates public sector spending offsets the decline through interest income payments, helping to sustain real growth. Longer term, the increased interest income from public spending then works to support private deficit spending.
This is why Q3 GDP came in above 5% and every economic data print beat expectations forecasted by consensus. This misunderstanding will continue to confound the mainstream and provide a unique perspective on 2024 outcomes for those who understand it (See: The Fed Does Not Exist).
The December FOMC meeting was the most dovish we’ve had since the beginning of the current rate hiking cycle. Inflation cooled this year even with the expansion in deficit spending leading to robust growth and low unemployment. This also confounded mainstream economic commentators as the rate hikes were supposed to create the opposite scenario which would then lead to lower inflation as a function of falling demand. As a result the Fed has signaled that they are now considering cutting rates in 2024. Markets have responded in kind pricing in 78% probability of rate cuts at the March 2024 FOMC meeting.
Crypto Market Overview
Ethereum realized volatility has outperformed BTC all year, and now option markets are beginning to rotate exposure to Ethereum to try and take advantage. This is a trade that has been tried numerous times this year, but often ended in catastrophe for ETH option holders.
BTC remains the protagonist between the two from a sentiment perspective as most fundamental catalysts that traders point to are BTC related. The upcoming having and pending ETF approval have been seen as the driver of crypto price action all year, but with the recent run Solana has been on institutional and retail attention are returning to crypto at a much higher rate.
Implied and Realized Volatility
- Options markets are pricing in significant event volatility for January 2024. This has long been rumored to be the month that the U.S. Securities and Exchange Commission (SEC) will finally decide on a spot Bitcoin ETF with consensus forecasting a positive outcome for Blackrock and other asset managers who have filed for approval.
- The same event vol is noticeable in ETH as well as many view crypto assets as compliments with few relative substitutes. If BTC outperforms as a result of ETF approval then traders expect the same from ETH and have positioned themselves accordingly.
Term Structure & Skew
- BTC and ETH term structure is in contango with January volatility trading at the same level as later dated expiries creating a flattening of the curve on the backend.
- This is unusual as longer dated options typically have more volatility as their time expiry is greater. The more time you have until expiry, the more price can move so market makers price in higher volatility for longer dated options.
- January volatility trading at this level means that market participants are anticipating a market moving event to occur in January and by process of elimination that can only be the ETF decision.
Options Flows and Gamma Positioning
- Options flows remain biased towards bullish positioning and long BTC and ETH exposure.
- Some notable trades that came in last week were 30,000 contracts of ETH March 2024 $2,000-$3000 USD call spreads. This is indicative of the hated ETH rotation we spoke about earlier as bitcoin and altcoins pullback.
- In Deribit’s recent market report Tony Stewart noted it is “uncommon to see an ITM-OTM call spread bought, furthermore on ETH.” This is further proof of how much BTC has dominated in options markets this year.
- Current BTC market maker positions are short gamma above the $45,000 USD strike, creating potential for dealers to chase price higher as we get closer to expiry. While ETH exhibited a more balanced gamma position last week, recent activity has left market makers short gamma at the $2,400 and $2,500 USD strikes.
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Disclaimer: This article is not intended to provide investment, legal, accounting, tax or any other advice and should not be relied on in that or any other regard. The information contained herein is for information purposes only and is not to be construed as an offer or solicitation for the sale or purchase of cryptocurrencies or otherwise.
