Cryptocurrency bull market on the rise?Focus on these 2 important indicators

Why did the market rebound?

We believe that there are two main reasons for the emergence of this round of bull market since the beginning of 2023:

External reasons: Liquidity in the global financial market is picking up; US inflation is slowing down, and the market predicts that the Fed will slow down interest rate hikes; Internal reasons: After the cryptocurrency market exploded in 2022, the market has completed deleveraging. There are no new black swan events, and the funds in the market gradually start to build positions from high-quality assets.

Liquidity picks up in traditional financial markets

Although the performance of digital assets may be decoupled from the performance of traditional investment products in the future, the cryptocurrency market is still closely related to the performance of traditional financial markets at this stage. In the past year, both stocks and bonds in traditional financial markets have fallen, which is the worst performance in decades. The main reason is that the Fed raised interest rates sharply and quickly in order to curb US inflation, which led to a rapid tightening of global financial liquidity.

Since the second half of 2022, US inflation has begun to slow down. In December, US inflation rose by 6.5% year-on-year, the lowest value since December 2021. The market generally expects the Fed’s interest rate hike will slow down. Stress in financial markets eased and liquidity restored. The figure below is an index measuring the overall financial market pressure, covering the credit market, stock market, financial institution financing market, safe-haven assets and volatility. The financial market pressure is currently the most moderate since the beginning of 2022.

Crypto Market Completes Deleveraging

After the bloody baptism of the cryptocurrency market in 2022, the leverage within the market has been greatly reduced.

There are two main sources of leverage in the cryptocurrency market, one is leveraged transactions on exchanges, and the other is DeFi mortgages on the chain. Whether it is leveraged transactions on exchanges or mortgage lending in DeFi, they are currently at a low level for several years, and the overall leverage level in the market has dropped significantly.

Contract open interest (Open Interest) refers to the total amount of open interest contracts of derivatives held by investors, representing the value of active positions. The change in open interest can help us understand the situation of leveraged trading on the exchange. At present, the open interest on the exchange has fallen by 30% compared to last November before the collapse of FTX, and has fallen by more than 60% compared to the bull market in 2021.

In on-chain mortgage lending, $ETH is the most important collateral in DeFi. We can observe the leverage on the chain through the potential liquidation amount in lending with $ETH as collateral. According to DeFi Llama, if the price of $ETH drops to $1,000, only $220 million worth of $ETH will be liquidated. This shows that the leverage ratio of on-chain lending is very low, and mortgage borrowers control the loan amount within a very safe level. With such a low leverage ratio, the probability of large-scale liquidation is almost negligible.

Financial liquidity has picked up, and the cryptocurrency market has completed internal deleveraging. We judge that the market has bottomed out by the end of 2022. However, in this strong rebound, funds are still in a wait-and-see state for non-mainstream currencies, worrying about whether there will be a new thunderstorm, so bottom-hunting Bitcoin has become the first choice for funds to return to the market.

This led to an obvious feature of this market rally, led by $BTC. The market share of Bitcoin has risen to a high in nearly 6 months (the rapid jump in the market share of $BTC between May and June 2022 is due to market risk aversion and the outflow of funds from small and medium market capitalization tokens).

Activities on the chain are picking up, but there are hidden worries

The rise in prices is only one aspect. The goal of the industry is to build an economy based on the blockchain, and the active economic activities on the chain are the fundamentals of digital asset prices. In the real world, we use GDP to measure the development of the economy, but the world on the chain does not yet have an indicator to measure overall economic activity. The gas cost of Ethereum can be used as a short-term reference indicator, and active economic activities on the chain will lead to higher gas costs. (We want to emphasize that the gas cost is only suitable for short-term observation. With the technical development of Ethereum and the popularity of Layer 2, the gas cost trend is getting lower and lower. In the long run, the gas cost cannot be used as an indicator to measure economic activities on the chain)

Excluding the soaring gas fee caused by the FTX panic in November, the current gas fee of Ethereum is 26 gwei, which is at a half-year high. On-chain activity is clearly picking up, and Ethereum is returning to deflation.

Prices are up, on-chain activity is up, but we still don’t think the market has fully recovered. At present, the biggest hidden worry in the market is that stablecoins in the whole market are still flowing out.

Stablecoins are the source of liquidity in the cryptocurrency market. When funds outside the market enter the market, they will first be converted into US dollar stablecoins. The net inflow of USD stablecoins represents the entry of external funds, while the net outflow represents the departure of funds in the cryptocurrency market.

There have been two notable outflows of stablecoins in the past year. The first wave of outflows occurred from May to July 2022, caused by the bankruptcy of Terra and 3AC, and the second wave began in October, before the collapse of FTX and continues to this day. In August and September, the period of calm between the two severe market panics, the outflow of stablecoins was significantly reduced, and there was even a certain inflow.

We expect that with this round of market recovery, stablecoin outflows will gradually ease, turning from net outflows to net inflows.

The question everyone is most concerned about is whether it can continue to rise?

Whether it can continue to rise and return to the bull market, investors only care about this issue.

What does a real bull market look like? To use a saying in the traditional investment field: large-cap stocks set up the stage, and small-cap stocks perform. In a bull market, the tokens of various small and medium-sized projects are driven by funds and will rise several times, dozens of times, while Bitcoin has very limited room for growth due to its huge market value. When small and medium tokens rise several times or dozens of times, Bitcoin can only double or less than double, so the ratio of Bitcoin’s market value to the overall cryptocurrency market value drops. At the same time, the hot market and various opportunities to make money attract a steady stream of off-market funds to flow into the market, further pushing the market forward.

Therefore, we need to observe two indicators:

Stablecoins gradually changed from net outflows to net inflows; Bitcoin’s market share began to decline slowly.

The most ideal scenario is that after the strong rebound from the beginning of the year to the present, the market will stabilize and gradually attract new funds to enter the market. The new funds will further promote the general rise of various projects in the market and gradually form a new round of bull market. We are still in phase one.

Although I think the market is advancing according to the most ideal scenario, we have not yet reached the stage where we only need to follow the wave to make money in a big bull market. What we need at this stage is to observe indicators and remain flexible. If the market does not follow expectations If the situation in the middle is not deduced, then leave the field decisively.