The Daily Dive #100 - Leverage Dynamics And Equity Correlation

Our 100th Daily Dive! Special thank you to all of our subscribers!

Bitcoin Derivatives Market Update

The last twenty-four hours have seen some bearish price action for bitcoin, and what's the cause? One of the main catalysts is the leverage in the derivatives market. 

When looking at the perpetual futures funding rate, we can see downturns in bitcoin price coupled with a reduction in funding rate from the highs. What this is showing is that the derivatives market bulls got ahead of the spot bitcoin market, and were speculating with leverage on a rise in price. If/when this rise in price does not come, these traders are caught offsides, and a leverage unwind occurs.

Source: Glassnode

Below we can see the current state of the perpetual swaps bitcoin market, which shows mostly neutral positioning following the dip below $60,000: a classic shakeout. 

Source: https://app.laevitas.ch/dashboard/btc/derivs 

One of the things that is so often misunderstood about the bitcoin market is that the price discovery and volatility that exists in the market is a way of shaking off any and all market participants that are overexposed/leveraged. Large buyers and sellers in the bitcoin spot market oftentimes closely follow the developments in the derivatives market, because they know that if the derivatives market finds itself offsides either to the upside or to the downside, a lot of money can be made by forcing these traders to unwind/exit their positions at a loss. 

This is what has unfolded recently. Nothing about the on-chain accumulation dynamics nor macroeconomic backdrop has materially changed, rather the bitcoin market is shaking off the speculators looking to capture outsized returns during the imminent next leg up.

Volatility is the price you pay for returns in the bitcoin market, and those who look to amplify these returns with excess leverage may just find themselves with far less or even no bitcoin if they aren’t an expert at managing risk. 

This is why spot bitcoin in personal self-custody is by far the best way to allocate to the bitcoin market. Short-term volatility is just noise if you understand what you are allocating towards. 

Rising Bitcoin Equities Correlation

The bullish long-term on-chain picture for bitcoin remains largely unchanged with the latest derivatives liquidations. With on-chain painting a bullish picture, we turn to trying to understand what will happen in the larger macro environment over the next few months and how it will affect bitcoin’s trajectory. Barring a major macroeconomic correction over the next couple of quarters, bitcoin is still primed for a major bull cycle move. 

Bitcoin’s rolling 90-day correlation with the S&P 500 Index is increasing back to the 5-year all-time highs. This correlation jumped to new highs during the start of the pandemic and is now rising back to those levels. 1-month realized correlations have also been rising, reaching a peak of 63.4% in September. Although bitcoin is growing as an independent asset class, the broader U.S. stock market is a $54 trillion market compared to bitcoin’s $1.1 trillion. A market risk-off narrative taking hold in U.S. equities will have impacts on bitcoin’s price. 

We highlighted the correlation between bitcoin and the S&P 500 during the recent market correction surrounding the Evergrande Group concerns in The Daily Dive #063 saying, 

“A larger macro correction in the S&P 500 and broader global markets has been the most significant risk to slowing bitcoin’s Q4 double-bull cycle. Almost every bitcoin correction in 2021 has correlated with an S&P 500 correction. Although little has changed in bitcoin’s bullish on-chain supply dynamics indicating a bigger move coming, short-term bitcoin price is at the whim of a much larger market move.”

Bitcoin may be on its way to being a consistent inflation hedge and long-term holder safe haven asset in the future, but right now it is still a risky, speculative investment for many investors in the market. There’s no doubt that bitcoin’s price appreciation over the last decade has benefited from “the everything bubble” we find ourselves in today. The question now is where does the S&P 500 speculation go next and how will bitcoin respond? 

Even amidst growing inflation concerns and talks of rising interest rates on the horizon, our broader macro view is that a rising U.S. stock market is a matter of national security. The U.S. government and Federal Reserve Board must continue to support market growth or risk a broader market credit collapse and recession. As a result of this support via increased fiscal policy and continued manipulation of the cost of capital, our thesis is that bitcoin will continue to see increased adoption and more capital flowing into the network as a response, further separating itself from risk-on correlations. 

Source: Bloomberg, Eric Balchunas

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