Deduction framework for black swan events in the encryption market
Original title: "Deduction Framework of Black Swan Event in Encrypted Market"
Written by: Chain Hill Capital
This article is divided into three parts . The first part discusses the external factors that directly caused the black swan of the encryption market in March, that is, the entrenched US stock liquidity problem; the second part analyzes more market micro-factors behind this plunge to present a more complete story; finally Part of it proposes a "encryption market black swan event deduction framework" applicable to the current environment, and discusses the factors that have a significant impact on the possibility of similar market crashes happening again in the near future.
Part 1 Fragile US Stock Liquidity
Monetary Easing Policy and US Stocks’ Current Main Market Factors form a market incentive cycle, and when uncertain events occur, each link creates or exacerbates the vulnerability of market liquidity. The Federal Reserve chose to intervene in the financial period in 2008, and directly intervened in the market through monetary policy to solve liquidity pressure, thus starting a "bull market" for more than ten years. Until the new crown epidemic interrupted this carnival, the once powerful power turned against each other and turned into a violent backlash, and the market collapsed instantly. This time, the Federal Reserve still chose to extend a "helping hand" to rescue the market, and a new cycle began...
From the 2010 flash crash From the flash crash in February 2018 to the four circuit breakers in March 2020, the frequency of flash crashes in the US stock market seems to be increasing. However, these crises were accompanied by a decade-long melt-up in U.S. stocks from 2010 to 2020.
Fed policy is clearly the dominant factor in this phenomenon. Since the beginning of the financial crisis in 2008, the Federal Reserve has continuously introduced quantitative easing policies, which has led to an increase in investors' risk appetite. When the market is stressed, investors generally seek to deleverage and reduce risk, resulting in a rapid drying up of liquidity.
During the largest global credit crisis in modern history in 2008, in an effort to stabilize markets and economies, the Federal Reserve and central banks around the world began an era of experimental monetary easing . These monetary policies had two major effects: (1) incentivized investors to take greater risk by lowering short-term interest rates; and (2) increased confidence in investment risk taking through market stabilization programs.
This type of monetary policy transmission typically affects long-term real interest rates not through the expectations channel, but by shifting the demand curve of income-oriented investors outward, thereby Leading investors to take on more interest rate risk and reducing the term premium. The reason for this transmission is obvious when you consider that many investors (including pension funds, endowments, insurance companies, and individual investors) have fixed dollar liabilities. When U.S. Treasuries can no longer meet return targets, investors must take incremental risk in search of higher returns. In Figure 1, we can see the evolution of the portfolio that provides an expected return of 7.5% over time. An investor seeking a 7.5% return must now risk nearly six times as much (measured by standard deviation) as an investor in 1989.
Figure 1, data source: callan.com
Increased demand for riskier assets will in turn reduce risk premiums and raise asset prices. This can be seen from the valuation level of US stocks.
From 2010 to 2020, the return rate of the S&P 500 was 191.13%. ) continues to rise, and is currently 30.25, which is higher than the historical average of 17.1, which is already comparable to the historical extreme level before the Great Depression.
Figure 2, data source: gurufocus.com As of September 25, 2020
Another long-term stock market valuation indicator is "market capitalization/GDP", and Figure 3 shows the Wilshire 5000/GDP ratio. In recent years, the valuation level of US stocks has been much higher than the historical average level, and has exceeded the stock market bubble period in 2000 and 2007.
Figure 3, data source: fred.stlouisfed .org as of September 28, 2020
S&P 500 Shiller PE Indicator and Wilshire 5000/GDP Suggest Stock Market Valuation Rising to Historically High Levels .
At the same time, in the past ten years (before the outbreak), the growth rate of the US industrial production index and manufacturing output index was 18.9% and 16.1% respectively %. According to the research of Zhongtai Securities Research Institute, "The level of technology investment measured by the ratio of R&D expenditure to revenue, in addition to the growth of biotechnology (33%) R&D expenditure, including the Internet, semiconductors (R&D accounted for 15%) , software and consumer electronics (12%) did not increase significantly, or even declined slightly. This also shows that the bull market of the US stock market in the past decade was not driven by endogenous growth such as manufacturing or technology, but It’s based on a valuation push.”
Figure 4, data source: fred.stlouisfed .org Deadline August 1, 2020
Figure 5, data source: Zhongtai Securities Research Institute
The above evidence shows that the risk curve of investors has been greatly improved, and the important behind this The driving force is not only the guidance of monetary policy, but also the market's risk perception, especially the confidence in the Fed's willingness to act as the lender of last resort and support market liquidity. Figure 6 (announcement dates of Fed plans/actions during the 2008 financial crisis vs. the 2020 COVID-19 crisis) demonstrates that this confidence is not entirely unfounded: the tools the Fed spent over a year using in 2008 will not be as effective in 2020 Rapid adoption in less than a month.
Figure 6, data source: Federal Reserve, J.P. Morgan
The Fed's policies could drastically distort markets and introduce new risk factors. Specifically, investors' increased risk appetite may lead to non-linear responses related to market volatility that are generally procyclical under market stress, that is, as market volatility increases and liquidity decreases (2 The latter are essentially two sides of the same coin), as investors seek to reduce risk, putting further pressure on market prices and liquidity. This led to the flash crash of US stocks mentioned at the beginning of the article. The common feature is a rapid decrease in the depth of liquidity in a short period of time (the depth of the order book is greatly reduced, and the bid-ask spread is significantly expanded), that is, a liquidity crisis.
Using the industry term "Risk on/risk off" that is popular on Wall Street can be simply explained. When the market risk is on, investors generally have no fear of risks and pour into risk assets such as stocks, commodities, and financial derivatives; when the market risk is off, investors sell a large number of risk assets and buy US dollars in order to avoid risks and safe assets such as treasury bonds. In a market dominated by "risk on/risk off", the volatility of risky assets is highly correlated, and the market is full of uncertainties.
In addition to loose monetary policy, there are two other contributing factors to the phenomenon of increasingly frequent liquidity crises.
(1) The growth of passive investment and index investment has caused certain distortions to the market
The first effect is to create price momentum. First, active managers are increasingly using indices as performance benchmarks. This led investors to "divest money from underperforming fund managers, causing them to sell underperforming stocks". Instead, "outperforming managers receive funds and accumulate assets that perform well". Second, marginal buying and selling as investors switch from active to passive investing also contributes to price momentum. By observing the average holdings of value (Value), momentum (Momentum), size (size), and quality (quality) ETFs, it can be found that active funds basically reduce their holdings of the stocks with the largest market capitalization in the S&P 500 index. Therefore, when the market shifts toward passive investing, there will be marginal selling pressure on smaller cap stocks and marginal buying pressure on large cap stocks. Sustained over time, this pressure can cause large-cap stocks to consistently outperform small-cap stocks. These two reasons create price momentum.
This price momentum could pose a risk to market stability. Market participants focusing on convergent (such as value or mean reversion) strategies have a stabilizing effect on prices, as winners are sold and losers are bought. And strategies that focus on divergent (such as momentum or trend) can destabilize prices as winners are bought and losers are sold. Passive and indexing strategies (including so-called "smart beta" ETFs) are divergent strategies, as recent winners will be more heavily weighted and recent losers will be less weighted. As a result, as more money moves from convergent strategies to divergent strategies (momentum or index strategies), positions will become more crowded, with destabilizing effects on the pricing of individual stocks and cross-sector assets.
The second impact is the potential impact on the market microstructure. The job of active fund managers is to identify those stocks they believe are undervalued and buy them. Whereas with passive funds, the trade is not to discover the correct value of the stock, but to track the index while minimizing the impact of that trade on the market and executing the trade as efficiently as possible (keeping the ETF price pegged to its NAV). This could also have a destabilizing effect on the market. Because “market makers cannot distinguish price movements caused by factors related to the asset from other factors not related to the asset”, they cannot synchronize their prices in time, which may lead to further price distortions. In fact, stocks with a higher proportion of passive fund shareholders exhibit significantly higher volatility, higher transaction costs, higher "return synchronicity," and lower "future earnings returns" and lower analyst coverage , and there is even evidence that ETFs may even introduce a new source of noise to the market. In a healthy market environment, other players step in and reprice. However, in a troubled market environment, there may not be enough liquidity (or willingness) to step in and correct this behavior. The problem could be further exacerbated if the market is dominated by index traders who cannot distinguish between asset prices and their value.
(2) Leverage exacerbates structural imbalances in liquidity
Driven features of modern market structures Including electronic liquidity providers and high frequency traders. High frequency trading firms typically trade with high leverage. In the current increasingly complex market environment, fast trading may lead to the risk of a pro-cyclical spiral, especially as the market becomes more and more concentrated in a few large trading firms. Because high-frequency traders rely on leverage to provide liquidity, they often have to reduce capital investment due to risk budget constraints in volatile markets, resulting in a pro-cyclical decline in available margin.
Additionally, the growth of complex derivatives markets and their associated leverage has led to an explosion in demand for liquidity in tail events, further exacerbating market pressures. Markets can also experience structural imbalances when there is systematic (often convex) hedging pressure in markets such as options markets, leveraged ETPs, and inverse ETPs. Because, hedging (especially with derivatives) is generally a convex function, and in many cases, its liquidity requirements increase as markets fall. Contrast this with the supply curve for liquidity, which is concave relative to market pressure. Thus, during periods of market stress, where liquidity scarcity meets high liquidity demand, a catastrophic mismatch can occur in the market, causing liquidity to dry up.
To sum up, the loose monetary policy, the rise of passive investment, and the imbalance of liquidity structure exacerbated by leverage have a common potential risk factor: liquidity . When combined, they create a market incentive cycle: when there is disruption in the market, there is a chain reaction that leads to the collapse of the entire market structure.
Figure 7 summarizes how the market incentive cycle formed between the three works. It should be noted that the market incentive cycle has no absolute starting point or end point. When uncertain events occur, each link creates or exacerbates the fragility of market liquidity. The Federal Reserve chose to intervene in the financial period in 2008, directly intervening in the market through monetary policy to solve liquidity pressure, thus starting a "bull market" for more than ten years. Until the new crown epidemic interrupted this carnival, the once powerful power turned against each other and turned into a violent backlash, and the market collapsed instantly. This time, the Federal Reserve still chose to extend a "helping hand" to rescue the market, and a new cycle began.
Figure 7
The second part is the history of the black swan event in the encrypted market and its ecological and structural BTC price correlation
The birth of Bitcoin In the past few years, its audience has only a small part of the population, including cypherpunks, technology developers, illegal traders, and liberals. These audiences are usually not those making money in traditional markets.
As the price continues to break through, Bitcoin has begun to attract the attention of some traditional investors. For example, California-based investment firm Social Capital invested in Bitcoin in 2013 and has held it ever since.
But such cases were extremely rare at the time. Until this point, there was still a firewall between investors in traditional markets and Bitcoin investors. Therefore, the correlation between Bitcoin and mainstream financial assets has been extremely low for a long time. Figure 8 shows the correlation of various encrypted assets including Bitcoin with gold, various national currencies, bonds, commodities, and stock markets from 2013 to 2019. Overall, the largest correlation between crypto assets and other asset classes is 0.31, the smallest correlation is -0.22, and the average correlation is 0.07. Taken individually, the largest correlation between Bitcoin and other asset classes is 0.18, the smallest correlation is -0.16, and the average correlation is 0.01.
Figure 8, data source: Grayscale Investments< /blockquote>
Since 2017, the isolation between traditional markets and Bitcoin has changed, and the world's first regulated Bitcoin fund has officially launched, opening the door for institutional clients; The Winklevoss brothers try to launch a Bitcoin ETF; the Wall Street Journal first presents Bitcoin as a legal investment asset, not just a dark thing confined to the fringes of society; CBOE and CME Bitcoin futures are launched, institutional investors and traditional investors Join the Bitcoin Army...
As of the first quarter of 2020, there are 150 Bitcoin hedge funds in the world (Figure 9), of which 63% It was established after 2018. Among the client composition of these hedge funds (Figure 10), about 90% are family offices (48%) or high-net-worth individuals (42%), and endowments, VCs, and funds of funds account for a smaller proportion.
Figure 9, data source: pwc
Figure 10, data source: pwc
Among the clients of Grayscale Investment, the world's largest encrypted asset trust fund (with a management scale of more than US$5 billion), more than 80% are institutional investors (Figure 10).
Figure 10, data source: Grayscale Investments< /blockquote>
According to a survey released by Fidelity Investments in June 2020, 36% of large institutional investors own digital assets such as Bitcoin; Outlook In the next five years, 91% of respondents believe that at least 0.5% of the investment exposure in the portfolio should be allocated to digital assets.
As more and more high net worth individuals and institutional investors flock to Bitcoin to allocate exposure, the firewall between traditional markets and Bitcoin investors be broken. This means that many people who trade in the crypto asset market are also trading in other markets at the same time. Will this development lead to a stronger correlation between Bitcoin and other assets?
Indeed, since 2019, we seem to have increasingly felt the correlation between Bitcoin and traditional assets.
The correlation between Bitcoin and gold appears to be increasing due to US-China trade tensions, escalating tensions between Iran and market concerns over COVID-19 (Figure 11 ). The current correlation between Bitcoin and gold is at an all-time high, suggesting that Bitcoin may be serving more of a safe-haven function than ever.
Figure 11, data source: Coin Metrics< /blockquote>
After the outbreak of the global new crown epidemic in 2020, the correlation between Bitcoin and the US stock market soared to a historical high of 0.597, the previous high was 0.32. And the correlation between the two has remained at a relatively high level since March. This seems to indicate that the crypto market has strengthened its connection with traditional markets and reacted similarly to external events.
Figure 12, data source: Coin Metrics< /blockquote>
More stories behind the black swan event in the crypto market
March 12, 2020 BTC's historic price drop coincided with the stock market's worst day since 1987, with Bitcoin's price down more than 50% in less than 24 hours.
In fact, not only US stocks, but the correlation between Bitcoin and other assets also soared at the same time (Figure 13). From Figure 14, we can see that the selling of various assets started almost simultaneously. All of this should not be surprising. Looking back at the first part of this article, the market incentive cycle formed by the combination of loose monetary policy, the rise of passive investment, and the widespread use of leverage has infinitely magnified the positive cycle of liquidity. When the new crown epidemic brought market panic, investors sold a large number of risky assets in order to avoid risks, and the market had a chain reaction, which led to the collapse of the global market.
To put it simply, investors were liquidating all assets to obtain US dollar cash, including hard assets represented by gold. Bitcoin, hailed as "digital gold," was not immune to a record sell-off in March as the firewall between bitcoin and traditional markets has been broken, with more and more investors trading in both markets at the same time . To make matters worse, because the encrypted market has fewer transaction restrictions and is easier to liquidate than any traditional asset, Bitcoin has the largest price drop during the same period.
Figure 13, data source: cointelegraph.com
Figure 14, data source: cointelegraph.com
It is important to note that correlation only shows how two markets move together or apart, but does not explain that movement. Therefore, we need to be careful with the data, as ultimately these two assets represent respective markets that differ in terms of macro and microeconomic factors. The sell-off caused by the above-mentioned liquidity crisis is not the complete story behind Black Thursday in the encryption market. Let us review the real situation of the market at that time.
The collapse of the market structure is fueling the flames
Actually, the sharp drop in the encryption market is divided into two parts rounds, about 13 hours apart. The first round (March 12th) was about 27% lower, and as stated earlier this round was caused by a liquidity crisis in the context of a global stock market sell-off; however the second round (March 13th) It caused Bitcoin to fall another 21% within minutes, its biggest one-day drop in seven years. For the second round of decline, the collapse of the market structure of encrypted assets has an inescapable responsibility.
Figure 14, data source: AIcoin
First of all, the second round of slump was dominated by the derivatives market. According to Tokeninsight data, the single-day trading volume of the encrypted asset derivatives market on March 13, 2020 was 62.5 billion US dollars, much higher than the average daily trading volume of 23.3 billion US dollars in the first quarter of 2020, and higher than the first plunge on March 12 of trading volume. At the same time, the trading volume peak of the derivatives market in March 2020 preceded that of the spot market (Figure 15); from Figure 15, it can be seen that this phenomenon also appeared at other times in the figure, which indicates that encrypted asset futures have market current indicators in this quarter Attributes.
Figure 15, data source: Tokeninsight
In addition, due to the anticipation and hype of the halving market, the bullish sentiment in the market is strong, and the funding rate was at a high level in the two months before March 12. This indicates that the bulls in the market have a higher level of leverage and therefore a higher level of overall risk in the market.
Figure 16, data source: Skew.com
However, due to the unique reverse contract mechanism of the encrypted asset derivatives market and other characteristics of the encrypted market, under such extreme market conditions as 312, the derivatives market Structural collapse thus triggering a second irrational decline.
Inverse contract, also known as coin-based contract, is a special derivative contract rule unique to the encryption market. Most digital currency-related derivatives All products adopt the design of reverse contracts, including: reverse futures, reverse perpetual swaps, reverse options, etc. Because the reverse contract uses USD to mark the price and BTC to settle the profit and loss. Therefore, compared with the forward contracts adopted in the traditional market, the trading risks of reverse contracts are higher and the volatility is greater.
Because the inverse contract uses BTC as collateral, all BTC inverse contract longs in the market are passively under-leveraged. This situation creates a risk for market makers because when the price of BTC falls, the market maker not only bears the loss of long contract transactions, but also bears the loss of BTC collateral. 312 During the first round of decline, the market price fluctuated by more than 30% within a day, and low-leverage contracts began to be liquidated. Collateral liquidations lead to further price declines, which in turn cause more long contracts to be liquidated and the downward spiral begins. At this time, many market makers were unwilling to provide liquidity, and the shrinkage of liquidity further accelerated the downward spiral. At one point, there were only about $20 million in bids on the order book of BitMEX, the world’s largest inverse contract exchange, while long positions awaiting liquidation exceeded $200 million.
The price difference between BitMEX and the spot exchange Coinbase also exceeded $500 at one point. However, at this time, the Bitcoin blockchain is extremely congested, and it may take tens of minutes or even hours to recharge Bitcoin to the exchange, so even if there are arbitrageurs, it is impossible to smooth out the price difference between exchanges in time. Many market views believe that if it is not for the BitMEX downtime, the BTC price may briefly fall to $0.
In addition to the inherent risk factors of reverse contracts and the limitations of blockchain technology, the imperfect infrastructure of the encrypted asset market has also exacerbated the problem. Including: there are a large number of exchanges distributed around the world and they are relatively fragmented; the market mechanisms of different exchanges are not unified; no prime broker can provide traders with cross-exchange cross-margin leveraged accounts, resulting in high capital costs for the entire market, etc.
Long-term investor confidence has not wavered
According to Coin Metrics data, March 12 The daily sell-off mainly came from relatively short-term traders (Figure 17). Among them, 281,000 BTCs were held for only 30 to 90 days, and only 4,131 BTCs were held for more than one year. A plausible explanation is that these short-term traders come from traditional markets and thus react similarly to external events.
Figure 17, data source: Coin Metrics< /blockquote>
Figure 18 shows the movement of bitcoins held over a year, which can be seen during the March market sell-off Bitcoins have not seen unusual movements. Therefore, we can assume that the confidence of long-term investors in Bitcoin has not been affected by this global market stress.
Figure 18, data source: Coin Metrics< /blockquote>
To sum up, it is undeniable that the connection between the encryption market and the traditional market is becoming closer and closer, and the encryption assets known for their low correlation have also been hit when the global market collapsed. Selling, but it's not fair to lose faith in this market because of it. We need to see the fuller reasons behind this market crash, and the fuller story.
The third part is the deduction framework of the black swan event in the encryption market and thinking about the future
In In the previous two parts, this article discussed the macro and micro factors that caused the black swan of the encryption market in March this year. The summary is as follows:
Monetary easing policy and the current market structure of US stocks have formed a market incentive cycle around epidemics, which has led to the vulnerability of US stock liquidity; more and more More and more traditional market investors are entering the encryption market, and the connection between the encryption market and the traditional market has become closer than ever before; when the uncertainty of the epidemic brought pressure on the market, investors sold a large number of risky assets in order to avoid risks , which also includes hard assets represented by gold. Since the encryption market has fewer trading restrictions and is easier to liquidate than any traditional asset, the short-term selling pressure of encrypted assets is greater than other traditional assets; and this sell-off is mainly from short-term traders, who often hold for speculative purposes Cryptoassets, therefore, are more susceptible to market sentiment; market structural factors of cryptoassets themselves, including inverse contracts, technical limitations, and immaturity of market infrastructure, further amplify price declines.
The sharp drop in March has left many investors in the crypto market with lingering fears. Due to the recent increase in the correlation between crypto assets and U.S. stocks, the crypto market has paid more attention to U.S. stocks than ever before. Coupled with the many uncertainties in the current macro environment, including whether the epidemic will break out again, the U.S. presidential election, geopolitical Political crisis, etc., it seems that any disturbance in the external environment will cause market concerns about the reappearance of 312.
It is true that multiple factors, including US stocks, led to the turmoil in the encryption market in March, but the exact same situation may not necessarily recur in the future. Because the interplay between macro and micro factors affecting the crypto market is complex and still evolving dynamically. However, it is meaningful to establish a thinking framework based on past experience, which helps us to recognize the current market environment and identify the possibility of black swan occurrence. Therefore, this article proposes a "encryption market black swan event deduction framework" suitable for the current environment (Figure 19).
Before 2020, the encryption market had experienced big and small crashes. However, past black swan incidents often only involved the ecology of encrypted assets, such as the theft of the early Mentougou exchange, 94 regulatory incidents, Bitcoin hard forks, and so on. As encrypted assets are gradually accepted by traditional investors, the connection between the encrypted market and traditional markets has become closer, and the structure of encrypted asset investors has become more diverse and complex. Therefore, risk events that affect traditional assets will inevitably have an increasing impact on encrypted assets. The "encryption market black swan event deduction framework" explores the conditions and factors that constitute a black swan event based on the current environment.
Figure 19
In this deduction framework, different types of risk events, encrypted investor structures and encrypted asset narratives, and different possibilities of the three factors of encrypted market infrastructure have formed different permutations Combination, when certain conditions are met, a certain combination may lead to a black swan event in the encryption market.
If this framework is used in the deduction of the 312 incident, its path is in the section of liquidity crisis: long-term loose monetary policy--> market Risk on--> Uncertain events occur (epidemic)--> Market risk off (short-term)--> Due to the liquidity crisis, risky assets, speculative products, and even hard assets such as gold will be sold, because Encrypted assets were also sold off, and the market plummeted --> problems with the structure and infrastructure of the encrypted market further amplified the black swan effect.
It is important to note that in the event of a liquidity crisis, it is meaningless to consider the structure of encrypted investors and the narrative of encrypted assets, because at least until So far, the safe-haven asset for the liquidity crisis is still the US dollar (the Japanese yen and the Swiss franc are acceptable, but not as effective as the US dollar). This was evident in March, when other safe-haven assets such as gold and U.S. Treasuries sold off. Perhaps, under the continued loose monetary policy, the credit of the US dollar will one day go bankrupt, and at that time, this framework will be rewritten.
But at the current stage, the monetary policy of the dollar is still the biggest risk variable in the black swan event caused by the liquidity crisis. The US dollar continues to maintain a loose policy, which is good for encrypted assets, because the attributes of high-growth technology stocks and digital gold are good tools to hedge against the depreciation of the US dollar; even for speculators, they also have good hype value. However, if the epidemic recurs or the Federal Reserve tightens monetary policy, causing a liquidity crisis to recur, market volatility similar to 312 will recur.
Whether other types of risk events will lead to black swan events in the encrypted market depends on the structure of encrypted investors and the narrative of encrypted assets. Specifically, only when encryption is dominated by value investors and its safe-haven value is widely recognized, can it avoid shocks in risk events such as economic crises or geopolitical events.
Therefore, to judge whether there will be another black swan event similar to 312, we need to focus on the following issues.
Will the Federal Reserve stop releasing water?
Now, the question we face is, when will the world be free from the new coronavirus? How will the global economy recover? Will there be prolonged disruptions to global supply chains? No one can answer these questions, but it is clear what the Fed will do.
Looking back at the last crisis, the Fed’s playbook is simple:
Phase 1: When a crisis occurs, a large amount of liquidity is quickly injected
The second stage: the initial large-scale release of water, and it stabilizes after a few months
The third stage: a full 7-year system QE program
From 2008 to 2018, the Fed's total assets grew from less than $1 trillion to $4.5 trillion (Figure 20). The immediate consequence of this is an increase in investor risk appetite, thereby enhancing the "monetary nature" of financial markets (i.e. the use of markets as savings vehicles). The ensuing effect is that markets and the real economy are increasingly linked, creating reflexivity between the two. So the Fed is becoming more and more important not only in keeping the market stable, but also in keeping the economy stable, so it is getting harder and harder for the Fed to disengage from the market in the short term. The Fed tried and failed to "normalize" monetary policy in 2018.
Figure 20, data source: BOARD OF GOVERNORS of the FEDERAL RESERVE SYSTEM
12 years after the crisis in 2008, we seem to see history repeating itself. Since the intervention began in 2020, the net worth added to the Fed's balance sheet has been absolutely staggering: $2.9 trillion in a few months (Chart 20), it took five years after 2008 to add that much. However, if you look at it from the perspective of growth rate, the game of releasing water has just begun...
Figure 21, data source: BOARD OF GOVERNORS of the FEDERAL RESERVE SYSTEM
So far, the Federal Reserve The balance sheet expanded by 67% (Chart 21), compared to 150% in the same period after 2008. The total Fed balance sheet ended up growing by almost 400% in the 7 years after 2008.
Now that the market is getting bigger and bigger, more liquidity needs to be injected to achieve the same goal. Therefore, it seems more meaningful to focus on the growth rate of the balance sheet than on the net worth. If the Fed continues with the same policies, the total balance sheet could grow to $15 trillion over the next decade.
The liquidity injected by the Federal Reserve, at best, can only push up investors' risk appetite and flood financial assets again. The S&P 500 recovered quickly after March, reaching pre-pandemic levels by mid-August before rising to new highs (Figure 22).
Figure 22, data source: fred.stlouisfed .org
The housing sector experienced a similar V-shaped rebound as record low mortgage rates and pent-up demand boosted property sales, the second Total US real estate market value increased by approximately $458 billion quarter-over-quarter.
However, it is important to note that 45% of Americans do not own stocks, while about 33% of Americans do not own homes. The V-shaped recovery is one for the wealthiest Americans, while those without significant assets or income continue to struggle. Employment of high-wage workers has largely returned to pre-COVID levels, but employment of low-wage workers remains difficult (Figure 23). So, it's a "K-shaped" recovery.
Figure 23, data source: CNBCThere are two possibilities for the future.
The first possibility is that the dollar liquidity crisis breaks out again. Although the unprecedented monetary easing policy has rapidly stabilized the market, it is also continuously strengthening the market incentive cycle, making liquidity more and more fragile. Once there is a new stimulus, such as the resurgence of the winter epidemic, or changes in monetary and fiscal policies brought about by the general election, the dollar liquidity crisis may break out again. However, this article believes that the market shock brought about by the recurrence of the epidemic is indeed likely to cause a liquidity crisis, but this time the intensity will be much smaller than last time, because, first, the US dollar has expanded by 67% since March; The main theme of the signal is "Under the current situation, the budget deficit should not be a priority, and the risk of overdoing the proactive fiscal and monetary support policies is relatively small." The worries about future liquidity will not be as serious as in March. Considering liquidity factors alone, the market risk off sentiment will not occur on a large scale. In addition, these signals from the Federal Reserve have also reduced the impact of the US presidential election on monetary and fiscal policies. Therefore, considering the above factors comprehensively, the liquidity crisis in March may happen again, but the possibility of happening is small, or even if it happens, the intensity will be much smaller than last time.< /p>
The second is the failure of the Federal Reserve to release water and the outbreak of a broader economic and financial crisis. Liquidity crises often appear in the early stages of economic or financial crises. At present, the Federal Reserve Unlimited release of water is obviously limited in promoting the recovery of the real economy. In the long run, this will inevitably lead to a depreciation of the dollar and significant inflationary pressure. If the epidemic is not brought under control, economic recession will be inevitable. By then, more A wide range of economic and financial crises. Corresponding to the "Encryption Market Black Swan Event Deduction Framework", the "uncertain event" factors in the figure will be transformed into other crises.
Bitcoin Future Narrative
Bitcoin has many faces. For some, it is a censorship-resistant medium of exchange that is not controlled by foreign exchange when sending money. For others, it is a tool for speculation and investment. This article argues that the two most important narratives about Bitcoin are "digital gold" and "tech stocks."
Digital Gold
In essence, Bitcoin is a It is a revolutionary alternative currency system, which makes Bitcoin have the property of hedging assets. Moreover, this is the only monetary system that has implemented a deflationary policy so far, so it has better inflation hedging properties than gold. Bitcoin is "digital gold" and has always been the most respected narrative in the encryption market. Many people believe that Bitcoin was built to withstand the turmoil of the global economic crisis.
It is true that Bitcoin has historically been a relatively independent and uncorrelated asset. However, the plunge in March and the level of correlation between Bitcoin and U.S. stocks have made many people question Bitcoin's safe-haven asset attributes. Because, if Bitcoin is to be a true safe-haven asset, it must be resilient against volatility in other financial markets, especially in times of turmoil like this.
This view is not entirely accurate, because in the previous two parts, we have discussed that this market crisis is a US dollar liquidity crisis. Even gold has been affected. It is necessary to distinguish different hedging logics corresponding to different types of risk events. As a monetary system not controlled by any sovereign state, Bitcoin is an insurance against the collapse of the financial system, economy and political system. This should not be denied because of its performance in this liquidity crisis. And as previously analyzed, the market structure and infrastructure at that time also had an unshirkable responsibility for the collapse of the encryption market.
Of course, it is undeniable that, compared with gold, the public still has a long way to go in terms of awareness and acceptance of Bitcoin as a safe-haven asset to go. Thankfully, we've seen some encouraging changes. After the plunge in March, more mainstream institutions and groups saw the safe-haven value of Bitcoin.
Legendary Wall Street hedge fund manager Paul Tudor Jones (Paul Tudor Jones) announced in May that he would hold Bitcoin as a macro hedge. Paul wasn’t particularly keen on Bitcoin in the past, but after witnessing the Fed’s rampage, Paul said that “Bitcoin reminds me of gold when I first entered the business in 1976.” In a letter to investors, Paul argues: "We are witnessing enormous monetary inflation - unprecedented inflation of all forms of money, unprecedented in the developed world. The best profit maximizing strategy is to bet on the fastest horse, and if I had to make a prediction, it would be Bitcoin. "
As the manager and legendary trader of a nearly $40 billion hedge fund, Paul's opinion is more valuable than anyone else's. Believe Other hedge fund managers will also have to pay attention to the emerging thing of Bitcoin and encrypted assets.
In addition to investment institutions, forward-thinking companies have also taken important steps In August this year, MicroStrategy, a traditional industry giant, announced that it would adopt a new fiscal reserve policy and would continue to use Bitcoin as the main financial reserve asset. In the following month, MicroStrategy spent nearly $400 million to purchase about 38,250 bitcoins. This is the first listed company in the world to publicly announce that it will use bitcoin as an asset allocation. The reason why MicroStrategy invests in bitcoin is also very simple. They are worried about the macroeconomy and believe that bitcoin is a reliable asset superior to cash Store of value. The reason to buy bitcoin instead of gold is that bitcoin is "harder" than gold.
Perhaps, more and more companies will join the ranks of configuring Bitcoin. On October 8, square, the payments company founded by Twitter CEO Jack Dorsey, announced that it had purchased $50 million in bitcoin. The company's chief financial officer said, "We believe that Bitcoin may become a more common currency in the future"
From code in the hands of geeks, to hedging assets in the eyes of top investment institutions, to The asset reserves on the financial statements of mainstream companies, perhaps, Bitcoin has gone from 0 to 1 on the road to becoming "digital gold".
Tech stocks and risk assets
From the price history of Bitcoin alone, it is in the The price action of Bitcoin in the growth phase is like that of tech stocks - both are driven by the growth of the network (number of users, number of nodes, transaction volume). Furthermore, as a revolutionary technology, Bitcoin’s risk profile is very similar to that of tech stocks: if Bitcoin reaches its potential, its value could be enormous, but at the same time, it can fail completely and be worthless .
This view makes sense, given the fact that Bitcoin is both a cryptocurrency and a technology. The underlying technology of Bitcoin is as new as the Internet. It may become a new global payment method that is popularized, it may also become a value storage tool that replaces gold, and it may become a next-generation financial system. Thus, cryptoassets such as Bitcoin may be experiencing the dotcom stock market phase of the 90s that the Internet experienced, where Internet technology exhibited a very volatile asset class, which also included various speculative stocks.
Like any other technology that changes the world, early-stage bitcoin and crypto assets remain a high-growth, high-risk asset. This is why the price of Bitcoin has so far been characterized by such high volatility and high returns. Research by Chainalysis shows that Wall Street institutional investors are increasingly entering the Bitcoin and crypto markets. Some well-known stock market day traders have also taken an interest in Bitcoin - and they are scouting for exciting alternatives to stocks. When investors and traders view Bitcoin as a technology stock, they will adopt stock market thinking to react to the crypto market, and their actions will also be reflected in the price of Bitcoin.
So, what exactly is Bitcoin? For a single participant, it is one or more of payment methods, safe-haven assets, technology stocks, alternative investments, and the next-generation financial system; for the entire market, Bitcoin is all of the above. Of course, at some stage, one or more narratives are bound to dominate the market. This/these dominant narratives guide investor behavior, which in turn determines how the market reacts to the outside world.
Tech stocks and digital gold are the two narratives currently dominating the Bitcoin and crypto markets. From the perspective of development stage, at this stage, 2/3 of Bitcoin may be technology stocks (including speculative attributes), and 1/3 is digital gold. These two specific ratios are just very subjective feelings. As more and more mainstream investment institutions, companies, and individuals use Bitcoin as a hedge against fiat currency depreciation and economic and political systemic risks, its narrative focus will increasingly be biased towards digital gold. But there is still a way to go "from 1 to 100".
Of course, the narrative and cognition about Bitcoin is constantly evolving, and there will be more possibilities in the future.
How the future narrative of Bitcoin develops is extremely important, because it determines whether it is a risk or an opportunity for the encryption market when external risk events occur. Only when the consensus and acceptance of Bitcoin as a safe-haven asset reaches a certain level, can it deal with more types of external risks and truly play a safe-haven role. Until then, it may behave more as a risk asset. The figure below sorts out the performance of gold in different types of crises in history, as a reference for Bitcoin's future hedging performance.
Data source: GF Securities
Summary
Based on the research on the external and internal reasons of the recent crypto market black swan, this paper proposes A "encryption market black swan event deduction framework" applicable to the current environment is used to help investors identify the risks faced by the current encryption market and the possibility of black swan occurrence. Finally, the article discusses two major influencing factors in the deduction framework, including the future direction of the Fed's policy and the development of Bitcoin narrative.
Regarding the possibility of a similar black swan event happening again in the near future, this article’s view is that the liquidity crisis in March may happen again, but the possibility The sex is less, or even if it happens, its intensity will be much smaller than last time. However, the current dominant narrative of encrypted assets may still be high-growth and high-risk assets, which means that risky investment and speculation are dominating market pricing. In addition, the market structure or infrastructure problems exposed in the 312 incident will take longer to improve. Therefore, if there is another US dollar liquidity crisis, the crypto market is likely to be affected again.
But we need to consider more about the possibility of crises other than liquidity and the future development direction of Bitcoin narrative. Fortunately, we have seen the shift in perception and actions of the mainstream crowd towards Bitcoin from cases such as Paul Tudor Jones, MicroStrategy, and square, and we believe that as the consensus on Bitcoin as a safe-haven asset continues to grow, it can Respond to and benefit from more types of external risks.
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