Anticipating Bitcoin: Looking for leading indicators in the crypto world

People are always in the market game took pains from different angles to analysis and analyze the market, as widely circulated that "History doesn 't repeat itself, but it, rhymes", in order to keep up with the rhythm of the market, is undoubtedly the most efficient way of reference indexes, draw lessons from leading indicators to predict the market, synchronization, lagging indicator to verify this market changes.

People are more interested in leading indicators that predict the direction of the market ahead of the market than lagging and synchronizing indicators. Leading indicators tend to outpace the economic cycle and are usually appropriate for short - and medium-term cyclical analysis. In traditional markets, people are often exposed to two types of leading indicators: macroeconomic leading indicators for Fundamental Analysis and Technical leading indicators for Technical Analysis.

A prime example is the baijiu market, which under Moutai's leadership has become A well-deserved core asset in the A-share market. So, in order to let oneself no longer miss the next round of bull market, the market from the macro, medium, micro point of view to look for the leading indicators of liquor plate. Fixed investment drive, money supply, food and beverage revenue, and even Moutai price and foreign ownership have become leading indicators of the liquor sector.

The crypto world is no exception. In the capital market of 7x24, the rise and fall of Bitcoin affect the sentiment of investors. In particular, on March 12, 2020, the sharp fall of Bitcoin almost without resistance made the market cry all over in 24 hours, and the explosion of 22 billion RMB made countless investors frustrated.

This also makes more and more people start to think about what are the leading indicators of the Bitcoin market when it has fully taken on the commodity nature?

Today, we found it.

Macroeconomic leading indicators

For this emerging market, we have to transition from traditional financial markets that have already matured.

Because different people are in different countries and regions, have different investment preferences, and have different portfolio allocation positions, different investors have different degrees of emphasis on different indicators. Yet there are some general indicators that most investors watch closely.

The index

Stock index is widely regarded as a very effective leading indicator to judge the macroeconomic trend, because market participants will spend a lot of time and energy to judge the operating conditions of listed companies, so as to make trading decisions. Usually when the market index is strong, it is a sign of confidence in the future market. When the market weakens, it indicates a lack of confidence in the market, and money flows out of the stock market and into safe-haven assets.

As famous economic theorists Roger. Mr Gbagbo sen in his book the accumulation of wealth in economic barometer, puts it: "in fact, if not artificially, the merchants can almost completely using the stock market as a barometer of economic activity. If you add together, all companies can accurately predict the whole stock market the development of the overall economy."

The classic example of stock indexes leading economic changes was the Panic of 1907. Also known as the U.S. banking crisis or Knickerbock crisis, the carnage started with the stock market falling and ended with the stock market rallying.

However, the stock index has a natural problem, that is, the stock price is mostly disturbed by speculation, and it is difficult to directly reflect the real operation situation of the company, which is why the price of individual stocks is usually overvalued or undervalued. The reflexivity of the market will not limit the amplification of price fluctuations, and the final capital flow in the stock market will affect the trend of the real economy, which is why the stock index can be regarded as the leading indicator of the economic trend.

Interest rates and Treasury bond yields

Interest rate is a controversial indicator, which can be regarded as a leading indicator or a lagging indicator. The reason why it can be regarded as a lagging indicator is that the central bank will use the interest rate as a market intervention tool to regulate the economy according to the economic situation, and it can be regarded as a leading indicator because the market will give feedback immediately after the interest rate changes.

In short, when the economy is weak, cutting interest rates is the most effective monetary stimulus. Lower interest rates encourage production and consumption by making borrowing cheaper. Conversely, when the economy overheats or to prevent inflation from running too high, the central bank raises interest rates to slow production and consumption by increasing borrowing costs and absorbing deposits. And Treasury yields, especially recent ones, are closely related to policy rates. Since national debt is the securities backed by national credit, its yield rate is called the risk-free yield rate, and it is also regarded as one of the safe assets. When the economy is trending down, investors are not confident and they are uncertain and panicked about the future, investors will choose to buy government bonds. But when the economy is growing fast, money flows out of Treasury bonds and into other markets because other assets offer higher returns.

On the other hand, government bond yields are closely related to inflation expectations and QE policies. Since the real yield of government bonds = nominal yield - inflation expectation, when investors think that the central bank will tighten monetary policy in the future and there is a possibility of interest rate increase, the yield of government bonds will go up accordingly, which means investors need to get higher yield to resist inflation, and capital will flow out of government bonds and into other markets. On the other hand, when the central bank stopped monetary easing, bond buying collapsed and yields soared.

The classic example is the "panic" in the United States in 2013, the federal reserve chairman Ben bernanke's then for the first time in JEC hearing about possible cuts to buy debt scale will cause the 10-year Treasury yield soared, particularly in emerging markets into the global market widespread panic and turmoil: capital outflows, currency devaluation, bond market sell-off, large slump.

Technical leading indicator

Technical leading indicators can be generally divided into trend indicators, momentum indicators, volatility indicators and trading volume indicators. The most common indicators include the relative strength index (RSI), which is used to determine whether a market is overbought or oversold, the Stochastic Oscillator, which is used to determine the direction of a market's movements, and the energy tide index (OBV), which looks at trading volume to determine relative prices. Technical indicators are more suitable for short-term or ultra-short-term trading, investors will combine all kinds of technical indicators to make trading judgments.

Leading indicators in the crypto market

In a sense, the cryptocurrency market is similar to traditional financial markets.

In the crypto market, investors can not only judge the impact of the economic trend on crypto assets through the currency and fiscal policies of various countries, but also judge the flow of funds through the observation of macroeconomic indicators, and judge the price trend through the technical indicators of exchange transactions. In addition, the data show that the stablecoin lending rate and the basis and capital rate of derivatives in the crypto market are very effective leading indicators.

Stablecoin lending rate

As the most common value exchange medium among crypto assets and the intersection between real assets and crypto assets, stablecoin can be regarded as the M0 of crypto world.

Since the current stablecoins flowing in the crypto market are basically anchored to the US dollar, this paper takes the US dollar stablecoin as the discussion sample.

The interest rate of US dollar stablecoin is composed of two parts. The first part is the borrowing rate of the policy base of traditional US dollar, and the second part is the risk premium, issuing cost and cognitive cost brought by US dollar linking.

First of all, there are various risks of being attacked in the on-chain of assets, including contract risk and public chain risk, so the lending rate of on-chain assets is at a certain premium. Secondly, since USDT and USDC are assets issued by centralized institutions, the issuers of the assets (Tether and Circle) are at risk of bankruptcy and default. At the same time, such non-compliant stables as USDT may have the problem of insufficient collateral, and there may be a run risk in the end.

From the perspective of issuing cost, the centralized issuer needs to bear the custody cost of the mortgage assets required for issuing stablecoin, and the technical issuance and maintenance cost, etc.

From the perspective of cognitive cost, due to people's skeptical attitude towards on-chain assets and the existence of cognitive bias towards blockchain technology, the use cost of on-chain assets has also been greatly increased. From the data, we can see:

Photo source: TradingEconomics

The chart above shows Libor (London Interbank Offered Rate) in dollar terms for 2020. We can see that rates peaked at around 1.8% a year at the beginning of the year and have since fallen below 0.5%.

Source: Defi Pulse

On the other hand, the annualized lending rate of USDT in decentralized lending platforms such as Compound and AVE peaked at nearly 50% at the beginning of the year and fluctuated wildly. Although we can see from this that the use cost of on-chain assets is much higher than off-chain assets, the decentralized lending platform cannot see the whole picture of stablecoin lending rate due to the influence of unstable liquidity and other factors. A more representative indicator of interest rates would be crypto inter-agency lending rates.

Encrypt inter-agency lending rates

Inter-agency lending rate refers to the short-term fund lending rate between institutions. It is also the most representative core interest rate in the whole market. It can reflect the short-term fund supply and demand relationship in the whole market in a timely, flexible and accurate manner. When the institutional lending rate continues to rise, it reflects the continued rise in the demand for funds in a short period of time, indicating that the liquidity in the market may decline, and it can also reflect the increase of leverage ratio in the market. IFIs in the crypto world refer to short-term lending rates similar to those of centralized lending institutions, centralized exchanges that provide lending services (Binance, Huobi, OKEx), and other institutions that provide lending services.

According to the data, crypto interagency lending rates followed similar trends in Libor and decentralized lending platforms in early 2020, peaked between February and March, and then dropped to a bottom in April. During the frenzies of February, users could not even borrow USDT on exchanges to do so, with some exchange rates hitting an annualized 36%. Interest rates have returned to normal as markets have recovered.

Basis and capital rates in the derivatives market

As borrowing rates rise, money flows into the cash and derivatives markets. Since the volume of transactions in the derivatives market is much larger than the cash market, the futures basis and capital charges in the derivatives market are a better indicator of market sentiment.

The basis of a futures market

The basis is the difference between the spot price of an asset and its future price at a given time. It is calculated by the spot price of an asset minus its future price. When the spot price is lower than the futures price, the basis is negative, and when the spot price is higher than the futures price, the spread is positive.

In traditional markets, the basis is often negative, and the futures price is higher than the spot price, because under normal circumstances, the futures price includes the costs of storage, holding, depletion and interest. However, in the crypto market, crypto assets do not have the cost of preservation, depletion, etc., but most of the time people are bullish on Bitcoin, so the basis is negative.

The absolute value of the basis difference is related to the market size. The greater the absolute value of the basis difference, the greater the market is, or it can be said that the greater the market is, the greater the basis difference is.

Funds rate

The key function of the capital rate is to narrow the gap between the perpetual market and the corresponding spot market (price regression). Unlike traditional contracts, a trader with a perpetual contract can hold a position indefinitely, has no expiration date and does not have to track different delivery months. As a result, crypto asset trading platforms have created a mechanism to ensure that the price of the contract matches the price of the index, known as the capital rate.

When the market trend is bullish, the fund fee is positive and the bulls will pay the short. In contrast, when the market is bearish, the capital rate is negative, and the short trader pays a fee to the long.

When the interagency rate goes up, the demand for funds goes up. This part of the fund is not only used to buy spot, derivatives long unilateral trade, more is used for arbitrage trade.

Common arbitrage patterns

The so-called carry trade refers to the use of spot and derivative to make two trades related to the market, opposite, equal, break-even, so as to hedge the impact of price changes. The most common in the market is the current arbitrage and fund rate arbitrage.

Spot and forward arbitrage is an arbitrage through the price difference between futures and spot, which belongs to low risk arbitrage. Once the basis (the difference between spot and futures prices) deviates significantly from the carrying cost, an opportunity for spot arbitrage opens up. The futures price is higher than the spot price and exceeds the costs of delivering the contract.

For example, if the spot price of BTC is 30,000USDT and the futures price is 35,000USDT, then we hold a spot position of 1BTC and a futures short position of 1BTC, a total of 2BTC positions. Usually in delivery day approaches, the futures price and spot price will approach of convergence, if the market higher delivery day BTC for 38000 usdt, 1 in $30000 into enough BTC spot positions 8000 profit usdt, 1 BTC futures contract positions 3000 loss usdt, ignore the handling fee, income is 8000 usdt usdt - 3000 = 5000 usdt, if use leverage trading hedge risk need to consider the detonation storehouse.

Rate arbitrage is earned by holding the same amount of cash and futures positions in the opposite direction. As mentioned above, when the market trend is bullish and the capital rate is positive, the long position can be held to earn the capital fee paid by the long position, or if the market is dominated by bears, the long position can be held to earn the capital fee paid by the short. Similarly, there is a risk of an implosion in the use of leverage.

The market was overheated and overleveraged

When market sentiment is high and people are driven by FOMO sentiment, there are many investors who will ignore the control of leverage risk. Ordinary stock traders began to borrow money to buy leverage, contract traders began to increase the leverage multiple to magnify returns, arbitrage traders began to use leverage to arbitrage, which caused the shortage of funds in the market, the rise of interest rates, the widening of the basis, the soaring of the capital rate, and then the market crash was not far away.

How leverage endlessly magnifies a reasonable correction into a crash tragedy:

Usually, a pullback after a rally is a very normal phenomenon, which may be due to the departure of profitable funds, the market due to a bad news shock (policy bearish), etc. Under normal circumstances, a small pullback would not have a big impact on the overall market, but in a highly leveraged market it could trigger a vicious circle of declines. The impact of a fall is magnified by excess leverage, with highly leveraged positions selling assets first to protect collateral from liquidation. Selling by highly leveraged investors causes asset prices to fall again, which in turn affects less leveraged investors, leading to market panic and a death spiral.

Back in 312

The crash has certainly left many people with bitter memories. If you put bitcoin prices, lending rates, and perpetuity rates for the entire year of 2020 into a single chart, you can see clearly:

Sources: PayPal Finance (interbank lending rate), CoinMarketCap (Bitcoin price), Binance (perpetual contract funding rate)

Exorbitant interest rates and abnormal capital rates and liquidity spreads had already given rise to alarm before the December 12 crash. According to people familiar with the matter, the maximum amount lent in a single day in February was USD15 million and exceeded USD50 million in a single week. Quarterly contract premiums rose at an annualised rate of more than 50% in February. So even if you were to borrow and arbitrage at an annualized interest rate of 36%, you would still get a 14% arbitrage return. In addition, the Dominance of bitcoin is declining in February, which means that the $10,500 level in February is being driven by market leverage. At the beginning of March, the failure of OPEC negotiations caused the decline of crude oil. Although the global epidemic had not completely broken out and caused no excessive panic at that time, the collapse of crude oil along with the collapse of individual stocks in the US stock market dragged down the US stock index, while Bitcoin gradually followed the decline of the US stock market.

Bitcoin's fall from $9,000 to $8,000 on March 8th caused no panic and found support. But there is already evidence from the Bitfinex exchange, where net sales of 40,000 Bitcoins in 24 hours far exceed the daily trading volume. A further drop after two days of volatility is likely as other large institutions begin to liquidate positions, and the fall in spot prices triggered a series of stampedes in the highly leveraged futures market, where positions are cut and closed. At 6 PM on March December, Bitcoin dropped by 5% in one minute. The first stampede pushed the price down to $6,500, and then it quickly dropped to $6,000. The subsequent rapid decline caused the lack of liquidity and finally led to the failure of market pricing, and the lowest price of Bitcoin reached $3,300.

As discussed above, the first leading indicator was the peak of inter-agency lending rates, and about a week later the derivatives markets reacted by pegging the perpetual funding rates. In the whole 312, under the influence of the negative market sentiment caused by the epidemic, crude oil took the lead in the collapse, followed by the continuous circuit break of US stocks, the cryptographic market was on the brink of collapse, and the selling caused by high leverage brought the price of Bitcoin from $8,000 to $4,000.

A recent bull market correction

In 2021, as institutions scramble to enter the crypto market, bitcoin has soared from $29,000 to as high as $58,000 in just two months. However, on the second day after breaking the new high, Bitcoin started a massive pullback for two consecutive days. The price fell below $45,000 at one time. The number of people in the contract was as high as 490,000, with a total of $3.3 billion. This bull market has not been derivatives-driven, but who can resist the chance to amplify gains in a market where prices are soaring?

According to statistics, the annualized premium of quarterly contract is about 39%, while the annualized rate of perpetuity contract is as high as 80%, even exceeding the level of the eve of 312. The inter-agency lending rate is also far higher than the level of the same period last year, and the peak reached an annualized rate of 20-30%. The anomalies in deliverable basis spreads, perpetual funding rates, and inter-agency lending rates were also effective early signals ahead of the big correction.

At the same time, as the asset attribute of Bitcoin is accepted by more and more institutions and enterprises, and more and more professional investors and institutions allocate Bitcoin, the price trend of Bitcoin is more and more correlated with US stocks and US bonds. In particular, the share prices of U.S. listed companies that are allocated to bitcoin are heavily influenced by the price of the currency. Bitcoin prices, in turn, are influenced by U.S. stocks, which are closely linked to U.S. bond yields, which in turn are closely linked to the U.S. dollar index. Therefore, it can be clearly felt recently that before the US stock market opened, the price of Bitcoin was highly correlated with the US stock futures, and after the opening, it was correlated with the spot price of US stock. The rise of US bond yield and US dollar index led to the decline of US stock and Bitcoin.

There must be other, more accurate leading indicators in the crypto world. As crypto assets become more widely accepted, the crypto market will become more efficient. As investors become more aware, they will be more ahead of the market.

Welcome to join the official BlockBeats community:

Telegram Subscription Group: https://t.me/theblockbeats

Telegram Discussion Group: https://t.me/BlockBeats_App

Official Twitter Account: https://twitter.com/BlockBeatsAsia