Weekly market insights brought to you by OptiFi
Who we are
OptiFi is the first derivatives DEX with portfolio margining and delta-hedging AMM vaults on Solana. The protocol won Fourth Place in the Solana Riptide DeFi track in April 2022.
OptiFi aims to build the most capital-efficient derivative DeFi platform by utilizing high-performance techniques, systematic margining approaches, and favorable market-making conditions to ensure low fee structure, competitive spreads, and sufficient liquidity on OptiFi.
In the long term, we look forward to expanding into more product lines and to being part of contributors to push the multi-billion dollar derivatives market from TradFi (traditional finance) to DeFi (decentralized finance).
TL;DR
Macro: Risks Beyond Monetary Policy
- The UK’s £45bn mini budget caused huge volatilities in global bonds and the forex market.
- The tax cuts are especially concerning, since they are unfunded and more inflationary.
- Global risk aversion and tightening financial conditions might lead to a difficult situation for the UK in international funding.
- To prevent pension funds from bankruptcy, BoE decided to start QE to stabilize the UK bond market, which contradicts its tightening policy against high inflation, and OptiFi believes these moves will increase the hard landing risk for the UK.
- In similar logic, the increasing default risk for Credit Suisse raises the hard landing risk for the United States.
Special Events: Token2049 in Singapore
- Token2049 brings Web3.0 projects, investors, and believers together from all over the world to Singapore, and OptiFi is no exception.
- Just like last week, OptiFi put together some interesting insights from what we heard in Token2049 for OptiFiers.
Crypto Market Movements
- After factoring the hawkish Fed into the price, major tokens consolidated alongside U.S. stocks, with slowly falling volatility.
- Both implied and realized volatility for major token options continued to decline.
- Options traders currently do not seem to have a need for hedging on particular expiry dates.
Macro: Risks Beyond Monetary Policy
The UK’s mini budget caused huge volatilities in global bonds and the forex market. According to BCA Research, the main pillars of the £45bn fiscal stimulus are as follows:
- A £16bn increase per year in the National Insurance contribution would be canceled permanently.
- The previously tabulated increase in the corporate tax rate from 19% to 25% would be revoked, curtailing the Treasury’s revenue by £19bn per year indefinitely.
- The top marginal income tax rate has been cut to 40% from 45%, adding £2bn to the deficit permanently.
- Stamp duty would be cut by £1.4bn, also permanently.
- The payroll working rules would be changed, which would curtail government revenues by an additional £2bn, indefinitely as well.
Deepest Tax Cuts Since 1972
The net reduction in taxes introduced in the mini-Budget might be the largest one in the UK tax revenues since 1972. Recalling economics 101 in school, cutting taxes and increasing public spending create an inflationary combination. In such a global inflation background, the tax cuts are especially concerning, since they are unfunded (i.e., more UK government bond supply and higher yields) and more inflationary.
What’s worse, the UK already runs a large current account deficit of GDP, which means the UK is a net borrower in the international financial system. If foreign investors are still willing to lend their money to the UK government, the mini-budget would not be such a serious problem for the UK bond market or GBP. However, in a context where global risk aversion is elevated and where the major central banks’ hawkishness tightens global financial conditions, it becomes difficult to fund new budget initiatives in the international market.
The 10 Downing Street did not explain how to fill the fiscal gap created by the £45bn tax cut. In the face of market anxiety and turmoil, British Prime Minister Truss and Chancellor Kwasi Kwarteng did not take the initiative to respond, but tried to let the market digest policy changes on their own.
The investors’ confidence collapsed and the pound fell to a record low against the dollar, implying greater import inflationary pressures and a more difficult monetary environment.
Bidding in the UK bond market disappeared early last week. Many pension funds have leveraged their purchases of “risk-free” British bonds. The slump in the bond market forced them to cover their positions, but the drying up of liquidity has left the entire British bond market in a state of cliff decline. In the end, the Bank of England had to intervene, restart the bond purchase program, and announced that it would spend 65 billion pounds to maintain the order in the long-term government bond market.
Ok… What does it mean?
Let’s site the most important part of BoE’s announcement for OptiFiers:
“To achieve this, the Bank will carry out temporary purchases of long-dated UK government bonds from 28 September. The purpose of these purchases will be to restore orderly market conditions. The purchases will be carried out on whatever scale is necessary to effect this outcome. The operation will be fully indemnified by HM Treasury.”
The quote means that the QE (quantitative easing) is back. This is particularly ironic for the Bank of England which raised rates by 50 bps in September and intends to start selling £8.7 bn bonds in Q4 to start QT (quantitative tightening).
BoE was originally more active in shrinking the balance sheet (it was the first G7 central bank to consider actively shrinking the balance sheet), but once there is a systemic risk in the market, it still has to come to the rescue. It is the first central bank in this cycle, but it should not be the last central bank.
The more fundamental problem is that the central bank is out of sync with government policy, or even in reverse. The day after BoE launched an extremely tightening monetary policy (50bps hike + active bond selling), the Truss government launched an extremely expansionary fiscal policy. This is fairly rare, and OptiFi believes these moves will increase the risk of UK policy mistakes leading to a hard landing in the UK.
In addition, OptiFi found that another risk that could occur in the United States is the bankruptcy of Credit Suisse.
Some investors argue that, with the experience of 2008, the Fed will prevent systemic risks through some credit facilities or other temporary monetary policy tools. But don’t forget that the Fed is using extreme measures to tighten monetary conditions to combat global inflation. Tighter financial conditions are not a good thing for leveraged financial institutions. OptiFi believes the Fed will have a tough time dealing with this issue, with a high chance of policy mistakes.
Special Event: Token2049 in Singapore
Token2049 brings Web3.0 projects, investors, and believers together from all over the world to Singapore, and OptiFi is no exception. Most of the activities we participated in were DeFi-related events, because we hope to build strong connections with more parties and investors, receive their feedback on OptiFi, and share our views on the crypto market.
Just like last week, OptiFi put together some interesting insights from what we heard in Token2049 for OptiFiers. Note that most of the views are from crypto VCs and hedge funds, and some views are from DeFi projects.
- Liquidity integration: People are talking about multi-chain ecosystems, but VCs and projects think “liquidity integration” is the key in the multi-chain world.
- Worries beyond the monetary policy: Some crypto hedge funds are starting to talk about credit risks (e.g. Credit Suisse, OCC cash management) and further slowdown for the global economy.
- Waiting for the positive spiral: Many projects and investors believe that crypto industry needs an institutional-retail spiral, but due to the negative macro backdrop and the tightening of cryptocurrency regulations in many countries, only a few institutional funds have entered the crypto market.
- DeFi and CeFi cooperation: Some CeFi (centralized finance) companies are exploring the possibility of DeFi-CeFi cooperation. CeFi companies have a broader user base, and DeFi projects have its composability advantage, but how to deal with regulation issues might be hard for CeFi companies.
Next, xHack in Chicago:
Crypto Market Movements
After factoring the hawkish Fed into the price, major tokens consolidated alongside U.S. stocks, with volatility slowly falling. Concerns about the UK’s fiscal stability and risk reactions to the possibility of a hard landing due to policy mistakes have been modest for the time being in the cryptocurrency market.
OptiFi believes that if the policy mistakes of central banks and governments lead to a hard landing, global risk assets, including the crypto market, will experience greater volatility, and it’s hard to predict ups and downs now as it is difficult to guess how traders will respond to the QE or default risks.
Both implied and realized volatility for major token options continued to decline slowly. Options traders haven’t had much demand for hedging through options after The Merge.
The September options for major tokens have all expired. The BTC and ETH options curves have roughly returned to their generally positive slopes, indicating that option traders currently do not seem to have a need for hedging on a particular expiry date. In the future, if there is a need for hedging against special events in cryptocurrency, OptiFi will let OptiFiers know as soon as possible.
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