December 2021 Market Commentary and Performance

Crypto markets experienced extreme volatility over the weekend with Bitcoin down 14% from $57,000 where it started the month to its current level of around $49,000.

At one point on Saturday it was down 25% to an intra-day low of $42,588 before bouncing 15%!  All other major DeFi crypto assets and smart contract protocols were also down between 20%-30%.  Although markets have recovered substantially off their lows, they are still quite jittery and volumes remain muted.

Catalysts for the Correction

As the Proverb goes: “If an unfortunate event has already occurred twice, a third unfortunate event is likely to occur” or bad news tends to come in three’s.

The main catalysts for the selloff were firstly the emergence of the new Omicron Covid-19 variant in November which seems to have initially caused a general state of panic with further travel restrictions imposed globally. This is a non-event as the new variant is now recognised as having mild conditions. The markets and indeed global populations also expect new variants at regular intervals, so going forward these will not be a big surprise.

Secondly, Federal Reserve Chairman Jerome Powell changed his sentiment and outlook for inflation and guided the markets that the Fed will begin tapering stimulus soon and then look to raise interest rates next year. This is a major shift in both the inflationary outlook and timing as to reduced stimulus and increasing rates. The expectation is that this will cause a shift out of risk assets such as small cap equities, VC and cryptocurrency and back into credit markets. We are not convinced this will be the case, but respected investors such as Charlie Munger have flagged that market ratings, particularly in technology stocks, are higher than they were ahead of the DotCom bubble, so future growth expectations are likely to disappoint. Sticky inflation and increasing rates do not bode well for risk assets.

Thirdly, the US Employment came in much better than expected on Friday and as the Fed focuses intensely on that metric it gives them further ammunition to begin reducing stimulus and raise interest rates.

Was Leverage to Blame?

Going into December, open interest leverage in futures and options was quite elevated as investors expected a rebound after a poor November in which BTC lost 9%. As per the chart below, we can see that the open interest on the popular futures exchange Bybit is at a three-month low trading back at Augusts levels after the crash, which is a good sign in terms of sentiment in that there has been a lot of deleveraging across the system. As per market commentary by Galaxy: “The sudden move caused more than $2.6bn of futures liquidations in the 24 hours between 7am EST Friday and 7am EST Saturday, with $1.35bn of that occurring just in the midnight to 1am EST hour, according to Coinglass. Bitcoin saw more than $1bn in futures liquidations over the last 24h, ETH almost $630m. Bitcoin and Ethereum futures open interest had been elevated, nearly at all-time highs.”

As an aside, it should be noted that excess liquidity and the cheap availability of capital is fuelling a boom in VC and Private Equity investment in the cryptocurrency space. This is allowing new entrants to the cryptocurrency world to operate for extended periods of time without reaching profitability and it is also pulling labour and skills out of the traditional financial industry incumbents. The question becomes that if capital no longer remains cheap, can new crypto ventures and ecosystems be sustained? This is the big question for 2022.

We believe that the crypto industry is a lot more resilient at the end of 2021 that it was a year ago as crypto has solidified its place as an asset class with the first ETF having being approved by the SEC and a whole host of new applications such as DeFi and NFT’s have been enabled by Ethereum. There are many new and exciting developments expected as well as many new funds and small intuitions poised to enter the space in 2022, and we believe this will be the main driver of wave 2 in the digital asset space – a massive amount of new products and a large injection of new liquidity in the form of investors.