Consensus Lab: Q1 2023 Secondary Market Research Analysis

Author: Consensus Lab

After experiencing a difficult and challenging winter in 2022, we welcomed a "spring rally" in the first two months of 2023, with risk assets rising to varying degrees. Recently, U.S. inflation has shown resilience again, and market expectations for a dovish Federal Reserve have begun to adjust, leading to a pullback in the cryptocurrency market. Although the process of U.S. inflation declining has had its ups and downs, the downward trend has been established, and the Federal Reserve is likely to stop raising interest rates by mid-year, so excessive pessimism is unwarranted. However, there remains significant uncertainty about whether the U.S. economy will enter a recession, and it is still difficult to find the driving force for a substantial rise in risk assets.

Looking ahead, we believe that after recent adjustments, the bullish and bearish sentiments have returned to balance. BTC will experience a period of consolidation followed by upward movement, and "buy low, sell high" will yield significant excess returns. It is worth noting that confidence among market participants is beginning to recover, and on-chain activity has significantly increased. We expect to see more Alpha opportunities this year.

U.S. Dollar Index Strongly Rebounds, Risk Assets Under Pressure

Since the February FOMC meeting, the U.S. dollar index has regained upward momentum, putting pressure on risk assets such as gold and the Nasdaq. Despite a month-on-month decline in CPI and non-farm payrolls and PCE data exceeding expectations, indicating that the decline in U.S. inflation is not straightforward, market optimism regarding a dovish shift from the Federal Reserve has begun to adjust.

Recently, the U.S. dollar index has rebounded strongly, while the Nasdaq and BTC have come under pressure.

As a late-cycle risk asset, BTC cannot escape the influence of global macroeconomic factors. The area around 25,300 was the high point of the rebound last August, and BTC attempted to break through this level multiple times last week, all of which ended in failure, currently returning to the consolidation range of late January. We believe this does not signify the end of the upward trend; although the process of inflation declining has had its ups and downs, the downward trend has been established, which is markedly different from last year. The Federal Reserve's rate hike pace has slowed to 25 basis points, indicating that the endpoint is not far off. Once inflation data continues to decline, the market will likely become optimistic again. We predict that the Federal Reserve will stop raising interest rates by mid-year and are optimistic about a subsequent upward trend, where "buy low, sell high" will yield significant excess returns.

BTC's attempt to break through 25,300 has failed, falling back to the consolidation range of late January.

The Ethereum Shanghai upgrade is just around the corner, but ETH's performance has not been strong, with the ETH/BTC exchange rate still around 0.07, indicating market concerns about the selling pressure from open withdrawals. According to estimates, under neutral conditions, there will be a daily selling pressure of 23,000 ETH, lasting over two months[1]. At the current price of $1,560, the total selling pressure amounts to $2.2 billion, enough for the market to prepare in advance. With a market cap of nearly $200 billion, we believe the impact of staking unlocks is more psychological. The Shanghai upgrade is beneficial for the long-term development of the Ethereum ecosystem, and we remain optimistic about ETH's long-term allocation value as a leading public chain.

ETH remains within the 1,500–1,700 consolidation range.

The ETH/BTC exchange rate remains at a relatively low level.

Bullish and Bearish Sentiments Return to Balance, Contract Basis Mildly Bullish

The trading mechanism of the on-chain futures trading platform GMX does not require strict parity between long and short positions, and it can offer higher leverage and lower slippage than centralized exchanges, making it popular among high-leverage traders. Currently, GMX's open interest exceeds $100 million, providing some reference for the overall bullish and bearish sentiment in the market.

According to GMX data, since January of this year, long positions have been continuously opened, with the proportion of long positions exceeding 90%, indicating a consistent bullish expectation. When prices are at the bottom and market participants gradually join the long camp, it often marks the beginning of an upward trend; conversely, when prices have risen for a while and nearly all market participants are long but cannot break through resistance levels, caution should be exercised regarding potential pullback risks. After multiple failed attempts to break through the 25,300 level, long positions have decreased from $160 million to $60 million, while short positions have increased from $40 million to $90 million, with short positions recently exceeding 50% for the first time. After the fervent bulls capitulate, the risk of a rapid decline from "long liquidation" has significantly decreased.

From the perspective of the BTC quarterly contract basis on OKX, the basis rate at the peak of the bull market in November 2021 exceeded 6%, while the current basis rate is 1.4%, only reaching the level of October 2020. Market participants have a relatively mild expectation for future price increases, and there is still significant room for the basis rate to rise.

High U.S. Treasury Yields, Comprehensive Bull Market Foundation Not Yet Established

While we have indicated that excessive pessimism is unwarranted, we should not harbor fantasies of a bull market at this point. Since March 2022, the total market capitalization of U.S. stablecoins has begun to decline, compounded by unexpected events such as Luna, 3AC, and FTX, leading to a continuous outflow of funds from the market.

After multiple interest rate hikes by the Federal Reserve, U.S. Treasury yields are generally above 4%, while the yields of major DeFi protocol stablecoins are generally below 3%. Large funds are clearly inclined to allocate to lower-risk, higher-yielding U.S. Treasuries, resulting in a continued outflow from the cryptocurrency market. In the absence of incremental funds, a comprehensive bull market is difficult to generate. We expect the Federal Reserve to begin cutting interest rates by the end of this year or early next year, and mainstream funds will gradually allocate to crypto assets, supporting a new round of bull markets.

On-Chain Activity Significantly Increases, Creating More Alpha Opportunities

As we have not yet seen signs of incremental funds entering the market, we believe that the foundation for a comprehensive bull market is currently lacking. However, from the activity level of on-chain funds, bullish sentiment is clearly better than in the second half of 2022. Since mid-January, ETH has entered a continuous deflationary state, and the USDC APY of the two major DeFi lending protocols, Compound and AAVE, has also rebounded to levels seen in March of last year, both indicating a significant increase in on-chain activity and capital utilization efficiency. Although we believe it will be difficult to see a massive Beta rally in the first half of this year, the active on-chain funds make it easier for quality projects to enter the "price discovery phase." As the saying goes, "Confidence is more important than gold," we expect to see more Alpha opportunities this year.

Conclusion: Short-Term Obstacles Do Not Change Long-Term Trends, Expecting Subsequent Upward Movement

Although macro factors still have uncertainties and the FTX-related events have not been completely resolved, the worst phase has passed, and it is not the time to be excessively pessimistic. As the ancients said, "Who has not experienced storms and rain, can see the moonlight after the clouds clear," we believe that deep pullbacks will bring good layout opportunities, expecting subsequent upward movement, and patiently waiting for the clouds to disperse and the moon to shine.

Reference: [1] Estimated Selling Pressure from Partial and Full Withdrawals, @korpi87

Consensus Lab was established in 2017 and is a leading investment research institution focused on exploring and investing in global blockchain technology. It emphasizes investments in cutting-edge infrastructure, trading platforms, technical protocols, and financial instruments. The main investment portfolio includes Polkadot, FTX, Filecoin, ZKSwap, AlchemyPay, Casperlabs, Coin98, and others. Consensus Lab includes the Consensus Investment Fund and the Consensus DeFi Innovation Fund, and is also a founding member of the Nova Club investment institution alliance.

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