Multi-Party Analysis: Reasons for the drop in the crypto market and The Future of Terra Eco After Being Out of Control

Editor | Colin Wu

With the Fed raising interest rates by 50 basis points, the US stock market and crypto market have started to fall dramatically, Bitcoin has fallen to $30,000, Luna has plunged 50%, and UST started to decouple. Let’s look at the reasons behind what happened and what might happen in the future.

Griffin, macro and options trader at Blofin

There is no doubt that the crypto market seems to be out of control. The volatility of crypto assets, as represented by BTC, has risen to its highest level since the beginning of the year due to a combination of factors, including UST de-anchoring and selloff in US stocks. Net selling by crypto investors has also reached a new year high. According to the skewness data, short-term risk aversion across the market has reached a yearly high, and investors are buying a lot of puts to hedge against the risk of further declines.

Another red flag is that mainstream crypto forward futures premiums are already significantly below risk-free yields. In this case, crypto investors’ expected returns are lower than risk-free returns. More investors may turn further to risk-free assets, and the liquidity exodus from crypto assets will hardly improve in the near term.

However, we are also seeing some signs that the runaway market is starting to trend towards an end. The largest negative Gamma exposure on record in the crypto market has been tentatively contained, with the negative Gamma exposure in ETH having narrowed significantly. Still, the significant negative Gamma exposure looks set to remain in place until Friday’s derivatives settlement, signaling the continuation of high market volatility in the near term.

For now, the US CPI data for April, due out on Wednesday, will be the focal point for reversing the current market conditions. If the CPI data is under control as expected, the Fed’s possibility of taking more aggressive measures will be significantly reduced, and market confidence will be supported. However, if the CPI data is still out of control, for the crypto market, the Fed’s negative impact on the risk asset market will be further exacerbated in the future. In short, it isn’t easy to see the possibility of the crypto market returning to its highs in short to medium term.

Huobi Research Institute

From a historical perspective, the two 50BP rate hikes in 1994 and 2000 produced different policy effects: the former achieved a soft landing for the U.S. economy and kept the economy thriving, while the latter punctured the stock market bubble and plunged the U.S. economy into recession.

The 50BP rate hike in 1994 was successful for two main reasons: prudent front-loaded rate hikes and a stable external environment. While the 50BP rate hike in 2000 failed because, in addition to the fact that the US stock bubble was already high at that time, the 9/11 event in 2001 shattered the myth of US domestic security and shook the market confidence.

Compared to 1994 and 2000, the macroeconomic backdrop in 2022 is volatile, and uncertainty is extremely high. U.S. inflation has long been high, and interest rate hikes at this time are no longer the prudent hikes of 1994, compounded by the impact of the new crown virus, the Russia-Ukraine war, and a higher stock market bubble. As a result, the current interest rate hike has disastrous consequences similar to those of 2000.

BitMEX Founder’s Blog Post

BitMEX founder Arthur Hayes predicted in his latest article on April 11 that the price performances of BTC and ETH are highly correlated with the Nasdaq 100 index. With the Fed raising interest rates, the prices of BTC and ETH will test $30,000 and $2,500 by June this year, respectively (both have fallen below that number). He also said he had purchased puts for June 2022.

Further, he said support was at $28,500 for bitcoin and $1,700 for Ethereum. “The market will not bottom until these levels are retested. If the support levels hold, then great, that problem has been solved. If not, then I believe bitcoin and Ethereum will fall to $20,000 and $1,300 due to being liquidated.”

BitMEX Analyst @lasertheend

There are two things people are concerned about right now: the decoupling of UST and the other is whether LFG will drag the whole broader market down with it.

I am fond of comparing public chains/projects to countries where each country has its monetary policy and economic model, just like each public chain has its ecology and currency model. For Terra, the most significant difference is that Terra is a bit like Hong Kong with a “linked exchange rate system” instead of other direct USD settlements.

The advantage of this is that UST can gain some privilege of printing money like the “Federal Reserve” in terms of capital efficiency. The downside, of course, is that when public confidence in the UST is low, or when financial predators find it profitable to short it by over-issuing beyond the size of their economies, they are dealt a fatal decoupling blow. Like the Argentine peso at the time. The current UST is facing a severe challenge as well.

Fundamentally, we are seeing a reduction in demand growth for USTs due to lower Anchor rates and no second “killer app” to attract more UST inflow for the time being, which makes one wonder if USTs are being “over-issued”. In the short term, the decoupling of UST is mainly due to the flight of large investors on the anchor -> UST under pressure -> bad market conditions -> LUNA falling more. This chain reaction leads to a slow death cycle.

As for whether the UST decoupling will burst the market or not, because of the incomplete on-chain arbitrage mechanism of LFG, we need to know if LFG will continue to increase the BTC loans to market makers. Recent loan behavior can be interpreted as LFG giving market makers risk-free arbitrage opportunities. Market makers can buy bitcoin with UST by selling bitcoin -> exchanging for USD -> buying UST -> waiting for UST to resume peg. Even if the bitcoin is sold, you can still use the borrowed UST to repurchase the bitcoin. This somewhat illustrates the level of desperation of LFG.

The scariest thing is not that LFG sold $2 billion of bitcoin and collapsed but that the continued decoupling of UST will destroy confidence in the entire market. The loss of confidence will spread to the whole market and the traditional institutions that invest in cryptocurrencies.

Researcher Lucas Lu

There are still a lot of similarities between the current situation and 2018. From a macro perspective, the plunge of US stocks back then was a significant trigger for the crypto market to enter a severe winter at the end of 2018. Now the same thing happens again. The bubble of the whole financial market is bursting at an accelerated pace, and cryptocurrencies are not immune to it.

In addition, the current market selloff is overlaid with some factors of its own, such as the bursting of the Defi bubble. Defi was the engine of this bull market. Still, Defi is a bit like the various derivatives that previously triggered the 2008 financial crisis and is itself an amplifier that can amplify both returns and risks. Defi’s complex nested chains could start systemic risk if they collapse at a single point in a down market. In particular, projects that claim to be “risk-free arbitrage” and “free money” tend to attract huge capital, which is extremely risky.

Finally, for the UST events, after all, the current market generally believes that the collapse of the UST is the direct cause of the market crash, and the future fate of the UST will also affect the trend of the broader market. Personally, it’s hard to tell if UST will survive this time. On the bright side, the recent crash can be seen as a stress test for the UST.

If you compare the UST to the USDT back then, the USDT has had more than one crisis of confidence, similar to the extreme scenario of the UST where the exchange rate fell by 20–40%, the USDT experienced it back then, but later USDT was rescued. The current ordeal was a baptism that UST had to go through to become a god. Of course, on the downside, UST is still an algorithmic stablecoin, after all. Previous algorithmic stablecoins seem to have ended poorly, and UST will likely not be the only successful exception.

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Colin Wu, Chinese journalist, won 2013 China News Award

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Colin Wu, Chinese journalist, won 2013 China News Award

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