Market Commentary
Market Commentary: Riptides
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Tuesday, June 21, 2022

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Macro weakness paired with new concerns over the solvency of a few large crypto firms led to accelerated declines for bitcoin and digital assets; bitcoin touched ~$17,600 before quickly regaining the psychological $20,000 level.

Key Takeaways:

  • “When the tide goes out, you find out who is swimming naked.” Some overleveraged lending institutions and hedge funds now face solvency concerns after the fallout of Luna in early May, likely the reason for digital assets’ underperformance versus expectations last week
  • Bears, pundits, and news outlets quickly danced on bitcoin’s “grave” as the asset broke $20,000 support over the weekend, touching ~$17,600 before quickly rallying back above the psychological $20,000 level
  • This week, we offer reasoning for underperformance versus expectations, compare bitcoin’s drawdown versus its past, and illustrate a significant deviation from longer-term price trend

THE BIRD'S EYE VIEW

Digital assets faced further volatility last week and into the weekend as idiosyncratic concerns over the solvency of established crypto players led to a break of both $30,000 and $20,000 in the last two weeks.  

As Warren Buffett once said, “When the tide goes out, you find out who is swimming naked.” It appears that the decline in digital asset prices has overleveraged institutions and crypto-native hedge funds now facing issues related to solvency.

While broader macro weakness was one culprit for the decline last week, it was likely the margin calls, forced selling, and fear that led to bitcoin breaking the key level of $20,000 early Saturday morning. While ether also broke $1,000, the two quickly rallied back to $20,427 and $1,120 by Monday’s close. Still, the assets are now down 35.7% and 42.6% since the beginning of June and 55.4% and 66.1% quarter-to-date.

So, what’s happened?

Celsius, with $11.8bn as of May 17th, paused all withdrawals, transfers, and swaps earlier this month, sparking concerns over the “next domino to fall”  within digital assets. The firm is known for offering interest to depositors through sometimes risky, but attractive yields on DeFi.

The two main concerns with Celsius are a large borrow through DeFi protocol “MakerDao” in which the firm originally deposited around 17,758 wrapped bitcoin to borrow ~$278 million in Dai. With a 145% collateralization requirement, a liquidation price of $22,731 caused fear that collateral could be sold if price breached that level. Since, the borrower improved the health of their loan with now 23,963 wrapped bitcoin backing $225 million in Dai. This reduced liquidation price to $13,604, removing some near-term worries.

But the second concern with Celsius is their use of liquid staked ether, an asset built by DeFi platform Lido that allows users to deposit ether to participate in proof-of-stake and receive block rewards as yield. In doing so, investors receive a synthetic asset labelled ‘stETH’ (which is one-to-one to ETH) that is not locked up and can be utilized throughout the DeFi ecosystem.

with for proof-of-stake) does not allow withdrawals until after the Merge, and therefore, Celsius can only trade stETH for ETH, but not redeem. This in turn has led to a duration mismatch as the firm owns over $400 million in stETH, and likely a large reason for the pause in withdrawals.

StETH traded down to a 7% discount relative to ether as Three Arrows Capital (3AC, a crypto-native hedge fund based in Singapore), sold over 30,000 stETH in an attempt to meet margin calls from lenders such as BlockFi and Genesis. These stETH losses are on top of a $200 million loss in Luna and a rumored large position in GBTC, with the founders of the ~$10 billion hedge fund now “committed to working things out.”

THE “GOOD NEWS”

As bitcoin broke $20,000 early Saturday morning, many news outlets were quick to dance on bitcoin’s “grave”, highlighting the loss of the $20,000 level, bitcoin’s record losing streak (10 out of 11 weeks) and the break below 2017’s high of $19,041. While sensationalism is now the norm in today’s news, these articles are not unexpected – bears, pundits, and news outlets have called for the “end of bitcoin” many times in its 13-year history.

As we now know, each of these calls have been proven wrong. Last week, we offered our answers to many questions received from clients in these volatile times - we urge those that have not done so yet to read through the commentary.

One thing to note is today’s problems are not the future’s - ultimately, this year’s washout improves the infrastructure and stability of this asset class. While these overleveraged institutions and hedge funds now drive the price lower from forced selling, the fundamental theses has not changed for bitcoin: a global payments system and digital store of value taking market share from traditional monetary assets.

While rough waters can remain, those with long-term time horizons have an opportunity to buy at significant valuation discounts, which we discuss on page 2.

THE DRAWDOWN COMPARED

We illustrate bitcoin’s annual drawdowns and annual returns to offer perspective on this most recent decline.

With the highs of the year placed on March 28th of $47,968, the most recent drawdown to a low of $17,785 on June 18th was a 63% intra-year drawdown, slightly more than the 55% average and 53% median from 2011 to 2021.

Further, while bitcoin often draws down, it often rallies back.  The average rally from the intra-year low to the end of the year is 248%, while the median rally is 107%.

The average length from high to low is 125 days, with the median 87 days; this current drawdown has lasted 82 days.

On average, the total drawdown (high to recovery date) is 410 days, skewed by 2014’s Mt. Gox and 2018’s bull/bear polarization, while the median is 209 days.

Even with an average 55% intra-year drawdown, bitcoin has had a positive return in nine of the 11 years assessed.

Volatility is nothing new for bitcoin.

DEVIATION FROM TREND

This week we offer two separate metrics that illustrate bitcoin’s significant deviation from trend when compared to history.

  • Distance from Moving Average: Bitcoin is at a significant discount from its 200day moving average, with a disparity of -48.2% by Monday’s close. A difference of this magnitude has only occurred in three periods. Using the most recent date this has occurred in each, we find: 12/16/2018 (-48.8%, one-year forward return 114.7%), 1/20/2015 (-50.0%, one year forward return 92.8%), and 12/26/2011 (-48.9%, one-year forward return 235.1%).
  • Market Value to Realized Value: We write about this valuation metric often, which we view as the “amount one pays vs. the average store of value price.” With Glassnode data, Monday’s close of $20,642 compares to the on-chain cost basis of $22,605, indicating a market price that is below the average on-chain cost basis. We offer historical lows and extremes in last week’s weekly, but an MVRV of < 1 has happened very few times in bitcoin’s history, all of which were great buying opportunities for long-term investors.

We also point out this is an unusually long losing streak (11 out of 12 weeks), as well as the second worst quarter bitcoin has had in its history (QTD performance of -55.4% as of Monday’s close, worst was -68% in Q3 ’11).

While rough waters can remain, long-term investors with conviction in bitcoin have great opportunity to buy or dollar cost average on significant weakness vs. long term trend.

Click here for the full PDF. As always, please reach out with any questions or comments.

Stay tuned,

Joseph Orsini, CFA
Vice President of Research

DISCLOSURES
Investment advisory and management services are provided by Eaglebrook Advisors, Inc., a registered investment advisor. Information presented is for educational purposes only. Past performance is no indication of future results. Please see our Form ADV Disclosures and Privacy Policy in our website.
Price Volatility of Digital Assets – A principal risk in trading Digital Assets is the rapid fluctuation of market price. High price volatility undermines Digital Assets’ role as a medium of exchange as consumers or retailers are much less likely to accept them as a form of payment. The value of client portfolios relates in part to the value of the Digital Assets held in the client portfolio and fluctuations in the price of Digital Assets could adversely affect the value of a client’s portfolio. There is no guarantee that a client will be able to achieve a better than average market price for Digital Assets or will purchase Digital Assets at the most favorable price available. The price of Digital Assets achieved by a client may be affected generally by a wide variety of complex and difficult to predict factors such as Digital Asset supply and demand; rewards and transaction fees for the recording of transactions on the blockchain; availability and access to Digital Asset service providers (such as payment processors), exchanges, miners or other Digital Asset users and market participants; perceived or actual Digital Asset network or Digital Asset security vulnerability; inflation levels; fiscal policy; interest rates; and political, natural and economic events.
Digital Asset Service Providers – Several companies and financial institutions provide services related to the buying, selling, payment processing and storing of virtual currency (i.e., banks, accountants, exchanges, digital wallet providers, and payment processors). However, there is no assurance that the virtual currency market, or the service providers necessary to accommodate it, will continue to support Digital Assets, continue in existence or grow. Further, there is no assurance that the availability of and access to virtual currency service providers will not be negatively affected by government regulation or supply and demand of Digital Assets. Accordingly, companies or financial institutions that currently support virtual currency may not do so in the future.
Custody of Digital Assets – Under the Advisers Act, SEC registered investment advisers are required to hold securities with “qualified custodians,” among other requirements. Certain Digital Assets may be deemed to be securities. Currently, many of the companies providing Digital Assets custodial services fall outside of the SEC’s definition of “qualified custodian”, and many long-standing, prominent qualified custodians do not provide custodial services for Digital Assets or otherwise provide such services only with respect to a limited number of actively traded Digital Assets. Accordingly, clients may use non- qualified custodians to hold all or a portion of their Digital Assets.
Government Oversight of Digital Assets – The regulatory schemes—both foreign and domestic—possibly affecting Digital Assets or a Digital Asset network may not be fully developed and subject to change. It is possible that any jurisdiction may, in the near or distant future, adopt laws, regulations, policies or rules directly or indirectly affecting a Digital Asset network, generally, or restricting the right to acquire, own, hold, sell, convert, trade, or use Digital Assets, or to exchange Digital Assets for either fiat currency or other virtual currency. It is also possible that government authorities may take direct or indirect investigative or prosecutorial action related to, among other things, the use, ownership or transfer of Digital Assets, resulting in a change to its value or to the development of a Digital Asset.

About Eaglebrook Advisors
Eaglebrook is a tech-driven investment manager specializing in bitcoin and digital assets. The firm offers various Bitcoin and Digital Asset SMAs serving financial advisors, registered investment advisors (RIAs), family offices, and institutions. Eaglebrook is backed by wealth management executives and institutions.
For more information, please contact us at +1 (202) 798-1880 or send an email to contact@eaglebrookadvisors.com.