Stablecoin Premium Emerges as Market Sell-off Continues
Kaiko Research: June 21, 2021
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- Price Movements: A premium emerged on stablecoin markets as Bitcoin and altcoins trended downwards.
- Volume Dynamics: Korean cryptocurrency exchanges have undergone an exponential surge in volume despite major regulatory hurdles, with daily turnover at times greater than Korean equities markets.
- Order Book Liquidity: Spreads for BTC-USD markets have been volatile since January 2021.
- Macro Trends: The Fed’s balance sheet surpassed $8 trillion for the first time, having doubled since March 2020.
Price Movements
Bitcoin fails to hold above $40k following Fed meeting. All eyes were on the U.S. Federal Reserve last week during their highly-anticipated June meeting, which came against the backdrop of rising inflation and strong post-recovery economic data. The Fed suggested that interest rates will rise more quickly than expected and that inflation was “higher and more persistent” than anticipated, escalating monetary tightening expectations throughout global financial markets.
Bitcoin proved resilient immediately after the meeting but soon lost support at $40k, ultimately closing the week down 9% following news that China would step up its crackdown on Bitcoin mining. On Monday morning, Ethereum crashed below $2k for the first time since late May. Nasdaq, S&P, and the Dow Jones equities indices all took a sharp downturn as well, a sign that cryptocurrency and traditional financial markets are increasingly aligned with global news events.
Market downturn triggers premium for stablecoins. Nearly every top crypto asset ended the week down following a brief mid-week recovery. The price of Tether (USDT), the largest and most systemically important dollar-backed stablecoin, frequently fluctuates based on market volatility. This weekend’s market-wide sell-off caused Tether’s USD price soar to $1.002 as Bitcoin plummeted $4k in a mere 24 hours. USDC, an increasingly prominent stablecoin backed by Circle, also experienced a premium above $1.001.
Stablecoins are considered risk-off assets, and in times of volatility traders will offload their crypto into USDT and USDC markets, creating an imbalance in buying pressure which can result in a temporary premium. Recently, Tether has come under fire for releasing a breakdown of its reserves, which showed that the majority is composed by “cash equivalents” like commercial paper and bonds, rather than cash itself. This positions USDC as a more transparent rival.
Volume Dynamics
Korean crypto markets undergo unprecedented surge despite regulatory hurdles. South Korea has long been a fascinating and vibrant microcosm of the crypto industry, separate from global crypto markets due to a unique regulatory environment that restricts cross-border capital transfers for foreigners. Market isolation has resulted in phenomenons like the “Kimchi Premium”, which has led to Bitcoin trading as much as 20% higher against the Korean Won compared with the U.S. Dollar. Despite the isolation, Korean exchanges have thrived over the past year and undergone an exponential surge in volume.
The “Big 4” exchanges of Korea — Upbit, Bithumb, CoinOne, and Korbit — collectively processed more than $30 billion in daily volume at the market’s peak, around three times higher than daily average volume for the KRX100, the index that tracks the top 100 equities on the Korean Stock Exchange.
However, a recent regulatory clampdown on exchanges threatens the entire industry, according to the Financial Times. Strict regulation has already pushed Binance and Okex to shutter their Korean operations, and further measures threaten the livelihoods of the more than 200 exchanges that operate in the country today.
The biggest exchanges are working closely with regulators, but none are quite as dominant as Upbit, which over the past year has captured more than 81% of total market share. Upbit has become a force in the country, and recently announced intentions to expand globally. Korbit and CoinOne continue to lose market share, while Bithumb has struggled to compete.
Last week, we launched Sushiswap market data, the second decentralized exchange (DEX) added to our coverage.
A quick reminder for those new to the world of decentralized finance: DEXs enable direct, peer-to-peer transactions without the use of centralized order books, and have processed more than $100 billion in trades over the past year alone. Any user can create a trading pair without the listing process typified by centralized exchanges, which allows more recent and innovative projects to trade with fewer barriers to entry. Most DEXs operate on the Ethereum blockchain and enable the exchange of ERC-20 tokens, but several DEXs now operate on alternative blockchain networks like Binance Smart Chain (check out this great summary of DEXs here).
Sushiswap vs. Uniswap
Sushiswap is a fork (duplicate) of the Uniswap protocol and launched to much notoriety in August of 2020 and quickly became one of the highest volume DEXs in the DeFi industry. The exchanges have since differentiated through their rewards structures and yield farming capabilities.
Below, we chart Sushiswap and Uniswap V2 volume, and can observe that both exchanges recently recorded their highest volume day ever. Throughout June, volumes have plummeted on both DEXs and CEXs following May’s extreme volatility. Uniswap’s recently-launched V3 protocol has also siphoned off volume from V2.
Stablecoins USDC and DAI are the leaders on Sushiswap, not Tether
DEXs have hastened the stablecoin race and have created a more competitive environment countering Tether’s dominance. The majority of all transactions on both Sushiswap and Uniswap are using USDC, issued by Circle. USDC has thus far failed to gain significant market share on centralized exchanges, but has found a niche on DEXs. DAI, a stablecoin issued by MakerDao, is also popular on DEXs.
While decentralized exchanges have undergone record volumes over the past year, Ethereum’s high transaction fees still pose a significant roadblock to widespread adoption. To use DEX’s like Uniswap and Sushiswap, users must pay Ethereum transaction fees, which at one point were higher than an average of $45/trade. These highly variable fees can significantly dissuade small volume traders from using DEXs, in favor of centralized exchanges with fixed fee structures.
Order Book Liquidity
A volatile year for crypto markets. From 2019 to 2020, order book liquidity improved drastically for BTC-USD markets (not pictured pre-2020). Following the March 2020 market collapse, liquidity improved throughout the summer and fall months, as measured by the bid-ask spread. Yet starting in early January, spreads began increasing sharply as market volatility rose to yearly highs.
Spreads have remained relatively volatile over the past few months. Coinbase and Itbit continue to have the narrowest spreads, on average less than 1 basis point, while Bitstamp has wider spreads ranging from 4–6 basis points. Since December, spreads on Gemini have widened more quickly than other exchanges.
Macro Trends
The Fed’s balance sheet crosses $8 trillion. Over the past year, abundant liquidity and low risk aversion by institutional investors contributed to a record-setting run-up in both equities and cryptocurrency markets. At the start of the pandemic, the Fed launched a quantitative easing program that has since doubled their balance sheet, which recently crossed $8 trillion for the first time, up from $4 trillion in March 2020. This accounts for more than 35% of the U.S. nominal GDP, a level not seen since World War II.
Risk-on tech heavy assets have benefited heavily from cheap liquidity, with the Nasdaq 100 gaining 49% over the past year. However, Bitcoin has been perhaps the biggest winner globally in this risk-on environment, with 308% annual returns as of early June. But what happens when the Fed puts a pause to QE? Will cryptocurrency markets continue to thrive?
Accommodative monetary policy provided key support for both traditional and cryptocurrency markets over the past year, but recent inflation concerns have dampened sentiment globally. The PCE price index, the primary inflation measure used by the Fed, rose by 3.6% y/y in April. The May consumer (CPI) and producer (PPI) price indexes also registered record high increases, confirming that inflationary pressures are indeed on the rise.
Growing fears around earlier than anticipated tapering of the Fed’s $120 billion monthly assets purchasing program has contributed to asset volatility and could spark a panic sell-off of bonds and a subsequent hike in U.S. Treasury yields (known as a ‘taper tantrum’). Rising U.S. Treasury yields could negatively impact investor’s appetite for risky assets such as crypto and cyclical growth stocks while raising the appeal of bonds.
It is clear that cryptocurrency markets are no longer isolated from global financial events and we can expect investors to pay closer attention to traditional economic data over the coming months.
Thanks for reading and see you next week!
Written by Clara Medalie, Strategic Initiatives and Research Lead
Contributions by Dessislava Aubert, Research Analyst
