The Bitcoin cycle: is the Crypto Spring imminent?

• Crypto spring on the horizon
• Is Bitcoin's volatility a signal for bull run?
• Read the analysis now

The cryptocurrency market is experiencing one of the worst liquidity crises of the last few years. Trading volumes and market depth have collapsed since the first quarter of this year.*

The foremost is down by nearly 43% on centralized exchanges, according to Coingecko. Bitcoin liquidity suffered a 53.5% decrease from its peak in October, according to CCData.

The sector has lived through a harsh Crypto Winter, marked by an unprecedented series of catastrophic events: The collapse of the FTX exchange in November 2022, the failure of crypto-friendly banks SVB and Signature, brokers like Genesis filing for Chapter 11, and finally the recent SEC regulatory crackdown on Binance and Coinbase. These events shook the centralized arm of the cryptocurrency sector. Hedge funds, market-makers, brokers, and financial institutions have all been affected. Many firms believed that the stakes were simply too high and chose to abandon the sector altogether.

The aftermath of FTX's collapse demonstrated the domino effect a bankruptcy can trigger, drawing parallels between the cryptocurrency sector and the financial sector's collapse with Lehman Brothers in 2008. Much like the competition that prevailed in the Lehman era, the intensity in the sector pushed many to distance themselves from FTX. It could have been an attempt by these competitors to insulate their operations from a potential toxic impact. Regardless, this decision had the unintended effect of unmasking their own financial, accounting, and ethical deficiencies, thereby further fracturing the already dwindling confidence. This move ultimately fueled the SEC's ongoing campaign.

But after the unprecedented storm comes a period of unprecedented peace. Here we are. Bitcoin volatility dropped to the lowest levels ever recorded in its recent history.

• The Bitcoin Volatility Index published by The Block estimates the 30-day implied volatility from the derivative options market. This index dropped to 43.8 at the end of June, which is still more than three times higher than the volatility of the S&P500 index, as indicated by the VIX index level. The BVIV Index (produced by Volmex) dropped to 38.45.
• The 30-day historical volatility dropped this month below 10, which is its lowest level on record, comparable to the volatility of major fiat currency pairs.

There are several reasons why the current market regime could trigger a rally by the end of the year, or the first half of 2024:**

1. low volatility could be perceived as the short-term precursor of a market rally.
2. Bitcoin has a cycle that resonates with the halving events that take place every four years. The next halving event is near.
3. a resilient US economy with a falling interest rate and a low unemployment rate.
4. a renewed interest in Bitcoin from centralized financial institutions.
5. regulatory clarity.

There are also reasons why the current market regime could persist or even worsen:

1. low volatility and liquidity could simply mark the transition of Bitcoin from a speculative asset into a long-term investment or a safe haven, the so-called 'Digital Gold’.
2. restrictive regulatory efforts pick upstream.
3. unforeseen consequences of the liquidity crisis. More generally: ‘black swan’ events.

We suggest in this article a short analysis and review of the most relevant arguments.

The low volatility

For an equity index like the S&P500, it is common knowledge that volatility drops when the market rallies, and soars when the market drops. The fundamental reason for this negative “equity-to-volatility correlation” is explained by the rising demand for protection (insurance) during market downturns. A rising demand for protection translates into higher option premiums and higher implied volatility.

The volatility and price dynamics of Bitcoin are different from those of the S&P 500. The dynamics of these assets are growing significantly apart. Looking at spot prices alone, Coindesk pointed out this month that the correlation of Bitcoin with traditional assets is “dwindling“ as pictured in the graph below.

For Bitcoin, the demand for protection has a tendency to increase with severe variations of the market price.

Indeed, during market rallies, market participants would be looking for:

1. protection against rising Bitcoin prices. The demand comes from borrowers looking to cover their short-term Bitcoin exposure.
2. or additional leveraged exposure to profit further from a market rally. The demand comes from bullish speculators.

In other words, the Bitcoin price and volatility are positively correlated during extreme variations. But there is no fundamental argument that would support the power of low volatility to predict a market rally.

If we look at the distribution ofet options open interest by strike above the December 2023 expiration, there is a concentration of open positions above the $40,000 strike. The options market is expecting the Bitcoin price to exceed $40,000 by the end of December, with a higher probability.

The Bitcoin halving event

Bitcoin halving events are among the most important events for the network.

They mark the halving of the reward fee paid to the Bitcoin block miners, therefore reducing their incentive to mine. Most importantly, decreased mining activity translates into lower Bitcoin supply growth and lower supply pressure on exchanges.

In the worst-case scenario, unprofitable miners would put their activity on hold.

Naturally, the miner’s activity and profitability in USD would recover if the price of BTC/USD doubles and so would the Bitcoin supply pressure.

According to Natixis, a market rally followed a few months after each of the three last halving events. If we believe that the cycles will endure, then the next bull run could happen in summer of 2024.

The resilient US economy

The US Federal Reserve (FED) is succeeding in its objective of taming inflation. The US annual Consumer Price Index (CPI) decreased for 12 consecutive months. It is now standing at 3% and getting closer to the 2% FED target. The rate hikes are likely coming to an end, and economists are starting to consider the scenario rate cut instead, more likely in 2024.

The higher rates regime has certainly persuaded investors to return to money-market and fixed-income products in general. It also reduced investment in the cryptocurrency sector, where staking rates are now comparable to T-bill yields (circa 5%).

Based on the economist’s expectations, the timing of a potential interest rate cut would precede the Bitcoin halving event. It certainly consolidates a bullish view for 2024.

A renewed institutional interest

Bitcoin has many advantages.

1. As previously noted, Bitcoin's correlation with conventional assets is rapidly diminishing. The unique dynamics of Bitcoin's price movement present valuable opportunities for diversifying a traditional portfolio.
2. Despite facing a liquidity crisis, Bitcoin retains its position as the most liquid cryptocurrency.
3. Bitcoin is categorized as a commodity, thus falling under the regulatory purview of the CFTC. From a regulatory standpoint, this makes Bitcoin arguably the safest investment in the cryptocurrency realm.

Blackrock has recently joined the race to get the first US Bitcoin ETF approved by the SEC. According to Reuters, the latter started reviewing six ETF applications this month, including Blackrock’s. There is still a low probability of approval despite Blackrock’s success rate, and its weight on the sector ($9.43 trillion of Assets Under Management). An approval would still be perceived as a positive surprise for the market, and spark a new rally. It would let traditional US investors finally invest in a transparent and liquid Bitcoin tracker, with a claim to actual Bitcoin that is held by a custodian (e.g., Coinbase).

Meanwhile, the latest CoinShares report indicates inflows in Bitcoin funds totalling $735 million in the past 5 weeks. On the contrary, there have been fewer inflows into Altcoins. Ether registered a low but promising $6.3 million inflows this month.

With the potential SEC approval of the first US Bitcoin ETF, the first cryptocurrency would likely become the focus of interest for a largely untapped institutional market.

Regulatory clarity

The judgement of the SEC versus Ripple Labs case finally came out this month, bringing some regulatory clarity to the crypto sector. But maybe not enough. The judge ruled that XRP, on its own, is not a security. But at the same time, it is a security if we consider the communication done by Ripple Labs’ around the benefits of owning or investing in XRP. Such communication prevailed in Ripple Labs discussions with large corporate investors, but not with retail ‘speculative’ investors. According to the judge, the circumstances around the sale of XRP do matter. They only pass the Howey Test in the circumstances surrounding the institutional XRP sale.

Regarding the judgement, both parties can still appeal. And a different judge might reasonably rule that XRP can either pass the Howey test, or not, but certainly not both.

Meanwhile, the Financial Innovation and Technology for the 21st Century Act has been approved by the US House Financial Services Committee last Wednesday. It gives the SEC and the CFTC a mission to design the cryptocurrency markets rules.

Overall, we are moving slowly in the right direction, and the crypto market certainly appreciates the progress made. There is still uncertainty, but a significant part of it has been removed this month, bringing confidence back in the sector.

Conclusion

In conclusion, the cryptocurrency landscape, primarily dominated by Bitcoin, appears to be in a transition phase. Following the turbulence of a crypto winter, marked by significant liquidity crises and regulatory challenges, there's a hint of a crypto spring on the horizon. The market demonstrates lower volatility, and the imminent Bitcoin halving event may stimulate a potential bull run. A resilient US economy, growing institutional interest in Bitcoin as a diversification tool, and regulatory clarity are all contributing to an optimistic outlook. However, the path ahead isn't without hurdles.

The sector could face low volatility and liquidity continuing to be challenging, regulatory hurdles could intensify, and unforeseen 'black swan' events could disrupt the market. Nonetheless, the progression towards a more regulated and mature market brings a renewed sense of confidence in the cryptocurrency realm.

*The prices of Cryptoassets fluctuate, sometimes dramatically. The price of a Cryptoasset may move up or down, and may become valueless. It is as likely that losses will be incurred rather than profit made as a result of buying and selling Cryptoassets.

** The value of cryptoassets may fluctuate significantly over a short period of time. The volatile and unprecedented fluctuations in price may result in significant losses over a short period of time. Any Cryptoassets may decrease in value or lose all its value due to various factors including discovery of wrongful conduct, market manipulation, change to the nature or properties of the Cryptoasset, governmental or regulatory activity, legislative changes, suspension or cessation of support for a Cryptoasset s or other exchanges or service providers, public opinion, or other factors outside of our control. Technical advancements, as well as broader economic and political factors, may cause the value of Cryptoasset s to change significantly over a short period of time.