Blockforce Capital August Digital Asset Commentary

Key Highlights

• Gold was the best performing asset, returning 7.5% in August, while broader markets were slightly negative and bitcoin closed the month down 4.5%
• With the recent elevated volatility and macroeconomic news cycle, its often a forgotten point that the S&P 500 is up 18.3% YTD. Gold has experienced a nice run as of late, up 18.5% for the year, while bitcoin’s 162% return is head and shoulders above the broader market’s return
• Non-correlated assets are great diversifiers, but leave questions surrounding an asset's performance in an untested, broader risk-off scenario. Recently, bitcoin has a shown spurts of short-term, statistically significant correlation to the S&P Volatility Index
• After a three month run-up from April to June, bitcoin is down 26% from its peak on June 26th, and the price consolidation has dropped volatility to an eight-week low
• After four consecutive months of growth in sequential monthly volumes for Coinbase and Binance, monthly volumes dropped off considerably in August, declining 40% and 36% respectively
• While spot volumes had a considerable decline in August, CME futures contracts posted positive gains after dropping off a cliff in July. Volumes rose 90% month-over-month, while average open interest grew 18%
• Ethereum’s 2019 year-to-date volumes are considerably lighter compared to the first eight months of 2018. Bitcoin boasted a 123% gain in volume over the same timeframe while ethereum volumes are down 34%
• Further Ethereum weakness is apparent as it’s price has declined 48% since digital assets peaked on June 26th, while bitcoin has fared slightly better with a decline of -26% over the same period.
• Bitcoin’s hash rate continues to set new highs, while ethereum’s is 37% below its peak value set in August of 2018. Furthermore, bitcoin’s hash rate has grown 458% since its peak asset value was reached in December 2017 while ethereum’s hash rate is only 29% higher.
• Monthly transaction volume on the bitcoin network has seen considerable growth since early 2018 while ethereum’s transaction volume has not had the same clear trajectory. Bitcoin’s transaction volume is -9% from December 2017 while Ethereum’s network transactions are down 18% from their peak set in December 2017
• Binance Coin (BNB) is the only top ten asset to outperform bitcoin YTD. Only four assets (including bitcoin) are up more than 50. After a considerable rally from April 1st to June 26th that saw may altcoins appreciate over 100%, most have given back a fair amount since the year-to-date peak on June 26th. Bitcoin is the only top ten asset to give up less than 40% since the year-to-date peak.
• Bitcoin’s dominance of total cryptocurrency market cap continues to push higher as August’s month-end value grew to 73%, +7% month-over-month and +35% since December 2018
• Binance Coin (BNB) remains the only top coin to boast a Sharpe Ratio higher than bitcoin, with a year-to-date reading of 2.54. Both Ripple (XRP) and Stellar (XLM) have a negative Sharpe for the year and six of the top ten assets have a Sharpe less than one through the end of August, compared to only two at the end of June

Market Overview

Global assets were quite turbulent in August relative to recent history, with the Volatility Index (VIX) closing the month at 18.98 — the highest value since the index hit 36 in December 2018. The increased volatility in global assets has been spurred by the continued trade spat between the US and China, an inversion of the yield curve, and an increase in negative interest rates around the globe. Investors’ appetite for safe-haven assets was on full display as gold returned +7.5% for the month of August. The S&P 500 posted positive gains over the last week, finishing the month -1.1%, while bitcoin finished the month -4.5%.

Not all is bad though, as US consumer spending rose 4.7% in the second quarter, the most substantial gain posted in four years. The boost in consumer spending was unexpected, considering consumers have been continually whipsawed by the ongoing trade war with China (President Trump recently asked American companies to pull all manufacturing out of the country). With all the recent news headlines, it’s hard to remember that many global markets are positive on the year. Bitcoin’s recent price consolidation still leaves the asset +162% year-to-date, head and shoulders above its peers.

Bitcoin is Correlated to . . . the VIX?

One of the most exciting features of bitcoin is that it’s a long-dated macroeconomic experiment. We often tout bitcoin’s uncorrelated nature to traditional assets, with the caveat that it brings a significantly elevated risk-reward versus its global peers. Many proponents cite its use as a potential safe-haven asset like gold, which returned +7.5% in August and is +18.5% year-to-date. Others cite that bitcoin is an emerging technology and should be treated like any other emerging asset — as a speculative investment. Given the fact that we are calling bitcoin’s month-end volatility reading of 62% an “eight-week low,” it’s hard to argue against the speculative nature of the asset.

With bitcoin’s long-term lack of correlation to anything other than cryptocurrencies, our quantitative team is continuously screening traditional global assets and alternatives to find a more established asset exhibiting a statistically significant relationship. This will allow us to run Monte Carlo simulations on historical global macroeconomic events, so we can theorize and assign probabilities of the assets’ return during major shocks to the financial ecosystem. After all, an improved risk-adjusted return and lack of correlation are valuable during an economic expansion but leaves questions about the asset’s performance during a recession.

An interesting development that has occurred in recent months is an elevated short-term correlation between bitcoin and the Volatility Index (VIX). Over the past few months, we have seen negative news about the US/China trade war, devaluation of the Chinese Yuan, yield curve inversions, and negative rates cause global assets to sell off while bitcoin’s price rose. While this may be apparent to close watchers of markets, it doesn’t show up in long-term correlations as there are many outside factors that influence the price of the S&P 500, the VIX Index, and bitcoin. Based on daily data, the year-to-date correlation between the VIX index and bitcoin sits at 0.17 (statistically insignificant), but when zooming into shorter timeframes using the rolling 5-day correlation of the two assets (with 5-minute data), it appears the assets have an elevated relationship particularly when the VIX Index is greater than 20. While it’s too early to call this statistically relevant over the long term, it’s something our team will continue to evaluate in the coming months.

Bitcoin Price Consolidation and Decreasing Volatility

It’s been a rough two months for bitcoin, as the asset’s price has fallen 30% from its June 26th high. This negatively trending environment has been met with a rangebound consolidation of price and a significant drop off in volatility, as bitcoin’s 30-day volatility closed the month at an eight-week low, almost half its peak year-to-date value seen on July 19th.

In addition to the drop off in recent volatility, bitcoin’s monthly range decreased for the second straight month to a 25% difference, the lowest since March 2019. March 2019 was also the month before bitcoin’s rally kicked off. The lackluster price performance, decreasing volatility, and diminishing monthly range suggest neither bulls nor bears are firmly in control.

Monthly volumes

After four consecutive months of growth in sequential monthly volumes for Coinbase and Binance, monthly volumes dropped off considerably in August, declining 40% and 36% respectively. Coinbase’s bitcoin volume is now 73% below its December 2017 peak, while Binance posted 125% growth over the same period, but is still down 41% since its record-setting $24 billion month in June 2019. However, the drastic fall in monthly volumes is to be expected given the range-bound, lower volatility environment seen in August. Looking ahead, Binance is expected to block its user interface from US IP addresses in mid-September, so it will be interesting to watch how this affects the volumes on the two exchanges, given the fact that Coinbase predominantly consists of US investors, while it’s estimated that only 15% of Binance’s volume is represented by investors in the United States.

Institutional Volume on Caspian

Caspian, an institutional asset management platform, decided in June to start publicly posting their aggregated order flow. While there are other competitors to Caspian, and their growth is dependent upon platform adoption, it still shines a positive light on the institutional spot trading flow. We are eagerly awaiting the release of August volumes. Caspian has seen accelerated month-over-month growth, with July volumes 519% above their January 2019 levels. This healthy growth from one of the most established institutional cryptocurrency platforms is a continued positive sign for institutional adoption.

Futures Volume

While spot volumes had a considerable decline in August, CME futures contracts posted positive gains after dropping off a cliff in July. Volumes rose 90% month-over-month, while average open interest grew 18%. The volume and open interest dollar value was still dwarfed by the record set in June, with trading volume down 89% and average open interest down 56% from June 2019. It’s clear that both of these metrics follow the cyclical nature of the quarterly futures expiration as volume grows into expiry, so it will be interesting to see what September has to bring given the recent lower volatility environment.

Futures Premium Receding

Last month, we noted the premium that CME futures contracts exhibited versus the spot rate of bitcoin. The contract price remained at a premium for the month of August as well, although it receded from a high of 3.7% on July 9th to close at the lowest value in two months at 0.80%. We believe the 3%+ premium seen at the beginning of July, the first month of the September contract, to be more an anomaly than the norm, but the futures contracts may still continue to differ due to liquidity issues of the futures versus the spot rate as well as an increased value in the contracts’ theta (time to expiration).

Ethereum’s Struggles Show in Blockchain Statistics

Like bitcoin, ethereum’s volume on Coinbase and Binance dropped considerably since July — down about 49% month-over-month. Ethereum’s 2019 year-to-date volumes are considerably lighter compared to the first eight months of 2018. Bitcoin boasted a 123% gain in volume over the same timeframe while ethereum volumes are down 34%.

Ethereum’s relative lack of interest is also apparent in its price appreciation, as bitcoin is +160% year-to-date, while Ethereum is trailing significantly, only +31%. Furthermore, ethereum is -48% since digital assets peaked on June 26th, while bitcoin has fared slightly better with a decline of -26% over the same period.

Further evidence of ethereum’s relative weakness can also be garnered from the underlying blockchain data. As an example, the below chart displays the growth in hash rates, which represents the processing power of the network. Bitcoin’s hash rate continues to set new highs, while ethereum’s is 37% below its peak value set in August of 2018. Furthermore, bitcoin’s hash rate has grown 458% since its peak asset value was reached in December 2017 while ethereum’s hash rate is only 29% higher.

Lastly, the average monthly transaction volume on the bitcoin network has seen considerable growth since early 2018 while ethereum’s transaction volume has not had the same clear trajectory. Bitcoin’s transaction volume is -9% from December 2017, but network transactions set a new high in May 2019, eclipsing the December 2017 mark by 3%. Ethereum’s network transactions are down 18% from their peak set in December 2017 and have not been within 10% of their high since.

Altcoins are Trailing Bitcoin

While bitcoin still promotes a healthy year-to-date return of +160% and Binance Coin (BNB) is the only coin in the top ten to outperform bitcoin over the same period. Only four assets (including bitcoin) are up more than 50%, while Stellar (XLM) has seen the worst year-to-date performance, -44%. After a considerable rally from April 1st to June 26th that saw may altcoins appreciate over 100%, most have given back a fair amount since the year-to-date peak on June 26th. Bitcoin is the only top ten asset to give up less than 40% since the year-to-date peak.

The continued lackluster performance of altcoins relative to bitcoin, as well as bitcoin’s dominance, continues to support the theory that new institutional entrants have been responsible for this year’s rally. It suggests institutions are starting with, and only interested in, gaining cryptocurrency exposure through bitcoin, the largest digital asset. Bitcoin’s dominance of total cryptocurrency market cap continues to push higher as August’s month-end value grew to 73%, +7% month-over-month and +35% since December 2018. As we noted in last month’s commentary, bitcoin’s dominance has not been this elevated since a majority of altcoins exploded on the scene during the summer of 2017 before Binance’s launch.

Risk Reward’s Negative Trend

Bitcoin’s year-to-date Sharpe Ratio peaked at the end of June with a reading of 3.41, falling to 2.28 at the end of August. Binance Coin (BNB) remains the only top coin to boast a Sharpe Ratio higher than bitcoin, with a year-to-date reading of 2.54. Both Ripple (XRP) and Stellar (XLM) have a negative Sharpe for the year and six of the top ten assets have a Sharpe less than one through the end of August, compared to only two at the end of June. In addition, bitcoin’s Sharpe Ratio is negative quarter-to-date after posting an astounding 4.92 during the second quarter. This elevated second quarter Sharpe was 4% greater than the Sharpe ratio posted during the fourth quarter of 2017.

Correlation

As we have previously noted, correlations tend to tick up during selloffs and wane during bull runs. The pattern continued for another month. The average correlation between the top ten altcoin assets and bitcoin increased 1.5% month-over-month and is 12% above the year-to-date low set in June. Ethereum often sports a correlation greater than 0.80 to bitcoin. After posting its lowest metric in June 2019 of 0.75, it has climbed back above its long-term average with a month-end reading of 0.83. Binance Coin (BNB) often shows less significant correlation to the other top digital assets but has been trending higher as of late with a 0.69 reading at the end of August, higher than five of the ten top assets.

Looking forward to the next month

Bitcoin continued its consolidation in August, posting its second straight month of negative return while volatility has crept down to an eight-week low. The ongoing underperformance of altcoins and bitcoin’s dominance continue to be of focus, especially with Binance slated to cut off US investors from its primary exchange. It will be an interesting month to watch where this flow ends up, as it’s estimated that 15% of Binance’s flow is from US investors. Ethereum’s struggles continue to be a focal point for our team, and we will continue to watch the relative trading action. Also, the long-awaited launch of Bakkt is coming to fruition, and the company has started to onboard customers as it prepares for its late September launch. Institutional volume continues to grow, so it will be intriguing to see how much volume is attracted by Bakkt’s new futures contracts.

Tracking all the developments and market moves in August only leave us more excited to see how September and the rest of 2019 play out. If you would like to receive our monthly market commentary again next month, please sign up here.

The opinions and data presented herein are not investment advice and are for informational purposes only and should not serve as the basis of any investment decision. Information is given in a summary form and does not purport to be complete. Information and data have been obtained or derived from sources believed by Blockforce Capital to be reliable, however, Blockforce Capital does not make any representation or warranty as to its accuracy or completeness. The sole purpose of this material is to inform, and in no way is intended to be an offer or solicitation to purchase or sell any security, other investment or services, or to attract any funds or deposits. Past performance does not guarantee future results.

DISCLOSURE: Blockforce Capital manages investment vehicles that invest in and hold digital assets, including the digital assets discussed in this article.