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A hawkish tone for this week’s FOMC meeting

Digital Assets Insights Vol. 9

Jun 15, 2022

Macro Overview

Inflation reached another 40-year high as the U.S. Consumer Price Index (CPI) surged 8.6% for the 12 months ended May, setting a hawkish tone for this week’s FOMC meeting. As expected, the Fed announced a 75-bps rate hike, which was followed by a brief market rally on Wednesday. The announcement followed a week of turmoil in the market. DXY gapped up to 104 and stayed above 104; broad correlated equity markets sold off, led by high beta tech and rate-sensitive consumer discretionary names; the Nasdaq was down 3.55% and the S&P 500 down 2.91%. While the S&P 500 real earnings yield spell-bounded in negative territory, it continued its path to recovery, reflecting a high equity valuation (Exhibit 1). The U.S. Treasury curve continued bear-flattening with both front-end and long-end sell-offs during Friday’s session. U.S. 2-Year Treasury underperformed on the curve with a 25-bps selloff, the largest since August 1994, dropping to 3.06%. In addition, 5s/30s curve inversion of approximately 7 bps pointed to an impending recession, albeit it may still be too early to infer based on major U.S. economic barometers, as the employment rate and consumer balance sheet metrics remain solid. Both the CDX IG (92 bps) and HY (530 bps) experienced a post-pandemic widening and, as the credit market has not priced in quantitative tightening or liquidity premia, we can expect further widening. Looking beyond the recession debate, we continue to argue for an “all-weather” defensive portfolio, heavy in cash and cash equivalent allocations.

Exhibit 1: U.S. Treasury 5s vs 30s Basis and S&P 500 Real Earnings Yield with Recession

Source: Bloomberg as of June 10, 2022.

Source: Bloomberg as of June 10, 2022.

This week in Cryptoland

BTC dropped below 29,000 following last Friday’s CPI inflation report. The pain did not end there. Over the weekend, the potential insolvency of Celsius Network, one of the largest lenders in the nascent crypto space, weighed down on the market and, by Sunday night (Asia Monday trading session), Celsius paused all withdrawals for its customers. The market took a nosedive with double-digit losses for the day as the heavy volume sell-off continued through Monday, with BTC closing at 22,000 and ETH at 1,160. Celsius Network offers their retail customers earnings of up to 17% per annum on cryptocurrency deposits, in part by using Anchor Protocol, which offered a yield of 20% before the LUNA collapse. On May 11th, it managed to withdraw $0.54 billion (or 260k ETH) and move the assets to the Aave v2 lending protocol in the form of staked ETH (stETH), a “synthetic” ETH on the Lido platform that is programed to peg 1:1 with ETH on smart contract. However, Celsius customers had started to pull their assets from the platform en masse, spooked by the close call. To redeem stETH, Celsius can either wait until after the Ethereum network merger and the Beacon blockchain launch, or buy ETH with stETH on the secondary market, subject to supply/demand dynamics. stETH is now 78% of the Curve stETH/ETH pool value, and liquid ETH is only 22%. This considerable imbalance pushed stETH to trade at a discount of 0.93ETH to 1ETH on Monday (Exhibit 2). Since a significant amount of assets are locked up in various of DeFi protocols, Celsius gated customer redemption requests on Sunday night to avoid a “bank-run.” We expect stETH/ETH de-pegging to worsen as the Celsius illiquidity issue unfolds.

Exhibit 2: Lido Staked ETH vs ETH

Source: CoinMarketCap as of June 13, 2022.

The collapse of Anchor-UST-LUNA last month caused permanent damage to the DeFi ecosystem. We continue to caution investors against DeFi “yield farming” products, which are analogous to on-chain unrated leveraged structured products, but without institutional sponsorship.

Options

Options markets continue to reflect downside stress with both BTC and ETH risk reversals. Front-end BTC skew is at 35% and ETH at 50% due to significant demand for downside volatility. On Deribit, 80 million notional of 1,400 strike ETH puts for June is currently deep in-the-money. The next strike to watch is 1,000 (120 million notional).

Spotlight on...

USDD

On May 5th, Tron founder Justin Sun revealed that the blockchain will have its own native stablecoin. USDD is an algorithmic stablecoin like UST-LUNA. Rather than being backed by reserves, the stablecoin uses Tron's native coin, TRX, to help the USDD stablecoin stay pegged to the dollar, along with $10 billion of cryptocurrency as collateral. Tron DAO has also set its basic risk-free interest rate to 30% per annum.

Given its similarities to UST, let’s highlight a few irregularities:

Overall, at 80%, Tron still displays a significantly higher collateral ratio than Terra ever did (20%), making it conceptually a better project. However, current market turmoil cracked the USDD-USD peg (Exhibit 3) dropping it to 0.97 to one dollar. To defend its peg, Tron DAO has added $650 million USDC over the last several days to 2.5 billion, effectively converting USDD to “asset-backed” stablecoin in order to avoid a similar demise as UST-LUNA. Current funding rate to short TRX is a negative 500% p.a. on Binance. A potential collapse of USDD-TRX will further deepen “crypto winter.”

Exhibit 3: De-pegging of USDD to USD

Source: CoinMarket Cap as of June 13, 2022.

Market Update

Tracking the weekly movement of the major cryptocurrencies.

  • The market took a hit this week, with most cryptocurrencies seeing negative movement. The biggest movers in the top 20 market cap coins were AVAX (-36.15%) and NEAR (-35.45%).
  • Bitcoin and Ethereum decreased by 24.04% and 33.00%, respectively this week. While not included in the chart, USDC consistently tracks the US Dollar with 0% change.

Top 20 Cryptocurrencies – 7-Day Price Change

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