The crypto party is over...

Jacob Pouncey
Cryptocurrency analyst, Saxo Bank

The total crypto market cap is down more than 70% from its 2018 high and overall, remains under pressure as sentiment is still muted. Hype among retail investors drove the 2017 bull market as newcomers were looking to make fast and large returns. The new speculators increased the price of the “common” coins (BTC, ETH), while earlier investors diversified their crypto wealth in the altcoin market, predominantly ICOs, driving up prices for these tokens and luring the new speculators to diversify their coin holdings. These dynamics concluded the cycle of adoption, returns, and diversification.

Are futures to blame?

The excitement around the bitcoin futures market reached a fever pitch around the launch of the CME and CBOE futures contracts in mid-December. However, after the futures launch, the price of Bitcoin collapsed dramatically with an intensity not seen in recent setbacks. The Federal Reserve Bank of San Francisco released an interesting report in May 2018 highlighting the behaviour of the Bitcoin market and stated that the market moves were similar to the behaviour of other assets around the launch of their futures product.

“…that the rapid rise of the price of Bitcoin and its decline following issuance of futures on the CME is consistent with pricing dynamics suggested elsewhere in financial theory and with previously observed trading behavior. Namely, optimists bid up the price before financial instruments are available to short the market (Fostel and Geanakoplos 2012). Once derivatives markets become sufficiently deep, short-selling pressure from pessimists leads to a sharp decline in value”. FRBSF Economic Letter: How Futures Trading Changed Bitcoin Prices.

crypto chart
Source: Federal Reserve Bank of San Francisco

The chart above shows a comparison of the three largest price declines Bitcoin in 2017, with the horizontal axis representing the number of days prior to and after the peak. The CME bitcoin futures started trading on December  17. 

The great wealth transfer

In the aftermath of the 2017 bubble, the blockchain forensics firm Chainalysis estimates that nearly $30bn worth of bitcoin changed hands from long-term investors to speculators from December 2017 to April 2018, with over half of that being exchanged in December 2017 alone. The main takeaways from the Chainalysis blog are that (1) the amount of Bitcoin held for transactions and speculation are now equal to coins held for investments, and (2) the new speculators could be depressing the price of bitcoin as the available supply for trading increased by 57% since December thereby dramatically increasing supply while demand and trading volume decreased over the same period.

The plot below shows the total supply of Bitcoins and the change in the proportion of coins used for various cases. Notice the increase in coins used for speculation and service transactions as a proportion of the total coins outstanding.

crypto chart
crypto chart
Source: Chainalysis


On the regulatory front, the fog is beginning to lift globally as the market slowdown gave regulators a chance to catch up. The Securities and Exchange Commission (SEC) and Commodity Futures Trading Commission (CFTC) are conducting a market manipulation investigation based on the market action around the launch of the futures contracts. 

The CFTC and the SEC appear to be pro-crypto currency and are not in favour of a heavy-handed ban. The SEC Chairman recently stated that Ethereum and Bitcoin were not securities, shedding light on the two biggest cryptocurrencies. This statement which still needs to become officially documented can open the space up for ETFs, enabling large institutions to get exposure to the crypto market through more easily accessible options. 

Additionally, the SEC has made a new rule making the process of bringing simple ETFs to market. This development can help aid the progress of proposed crypto ETFs. In the east, China is warming up to cryptocurrencies after an all-out ban on domestic trading. The state television aired a special on blockchain technology, and president Xi praised blockchain as a revolutionary technology.

Furthermore, Russia is moving forward with crypto legislation; we may see proposals enacted in July of this year, if not, certainly before the end of the year. The Moscow stock exchange is building infrastructure to support data feeds on ICOs. Two of Russia’s biggest banks are testing cryptocurrency-based investment options for retail investors. Meanwhile the island nation of Malta is positioning itself as one of most favourable jurisdictions in regards to crypto, with the passage of several key pieces of legislation providing a clear framework for crypto assets.

Critics will say that Malta is still suffering from corruption and money-laundering scandals, behaviour that is still also a problem in Russia and China, and that Malta is just positioning itself inside the global flow of money laundering.

The infrastructure supporting the technology itself is growing despite the price decline. Additionally, infrastructure that is supporting investments in the crypto industry, such as regulated trading desks, security products like the XBTprovider, and custodial services are on the rise. Right now the market is unsure of its direction in the short term. Long-term there might be more production ready solutions instead of only speculative potential. Many firms in the industry and untraditional financial markets are betting on cryptocurrencies becoming a new class of assets.

Bitcoin vs Ethereum

Positive price catalysts for both:

1. It is speculated that Ethereum will upgrade before the end of the year. The upgrade would reduce the supply and its inflation rate to about 2% a year versus Bitcoin’s inflation rate which will remain at 4% until mid-2020. The upgrade will also require users to lock their coins into smart contracts if they wish to take part in securing the network which will lead to a decrease in speculative/liquid supply.

2. Ethereum seems to be next in line for a regulated futures product. The CME Group launched an Ethereum reference rate and index this year paving the way for a futures product. Additionally, the SEC’s comments on Ethereum not being security also help the case for Ethereum futures.

Positive price catalysts for Bitcoin:

1. A Bitcoin ETF announcement could boost BTC price to new heights due to speculation.
2. Ethereum futures could already be priced into the market.
3. Global recession and a continued bear market in crypto makes investor run for Bitcoin, the de facto “safe haven” asset in crypto markets.

Investing in cryptocurrencies is highly risky and could result in the loss of your entire investment. 

Closing thoughts

This next half year we expect greater legislation to provide more certainty as regulators continue to educate themselves about this new technology. More research from well-known institutions will begin to colour their opinion on the topic. Both research and legislation will help to give entrepreneurs and investors a better framework to invest and innovate within the space. To help drive the next trend reversal, the new speculators need to convert to longer-term investors to limit liquidity of Bitcoins in the money supply. However, a major announcement by a large economy or a physically-backed ETF could trigger a reversal. Until then, the market seems locked into a downtrend even as more companies are getting involved in the sector.


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