Ethereum — spotlight for hidden drivers

delta.theta
Published in
6 min readJan 28, 2023

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Since the beginning of the year, the cryptocurrency sector has been steadily outperforming the orthodox markets. The top dogs, Bitcoin and Ether, have risen by more than 36%, while US equity indices have added between 5% and 9% with gold gaining 6.33%. Global markets are under pressure from the expected US recession and the selling policy of rate hikes by leading central banks. Against this backdrop, crypto assets were able to find their own internal growth driver, which was reflected in the overall capitalisation of the crypto market.

Options market

After a rough and challenging year, cryptocurrencies lost a lot of liquidity and the overall sentiment within the industry has been in decline. This was reflected in the options market as well — it didn’t have a clear trend at the beginning. In the first week, there were many large trades in different directions, with different strikes and expiry dates.

However, from the second week of the new year, call and calendar call spread options trading became the dominant trend. In addition, the trading volume of short-term options (a week or two before their expiry date) increased sharply. Such changes indicated the start of a local trend formation.

Indeed, from last week’s results, we can conclude that at the moment, call spread trading on options is a well-established “mainstream” in the market, which has entered the stage of short-term growth. To finance transactions for the purchase of call options, short-term put options with strike levels of 1,300 and 1,350 are also used. Such levels reflect market participants’ expectations of lower boundaries for near-term price movements.

In the short term, the nearest expiry is on February 3rd, which will take place after the Fed meeting. Here, it’s all relatively balanced. There’s only a 30% increase in call options, with most trading interest concentrated around the strings 1,400 and 1,500 for put options and 1,650, 1,700 and 1,750 for call options. However, the total volume of Open Interest is relatively low, at 170,000 ETH.

The bigger picture of the options market is much more interesting:

Among the current expiry dates, the highest open interest was formed on the quarterly expiry date (31st March) at 1,500,000 ETH. The ratio of Call/Put options indicates a more than threefold preponderance of Call options, which in turn indicates a strong bullish sentiment in the market and the absence of significant option hedging.

The situation looks even more contrasting with the ratio of call and put options if we take a closer look at the March expiry. The sixfold prevalence of call options suggests a massive expectation of an imminent “bull run” and nothing less. The bulk of trading at the moment is around the 2,200 and 2,600 strings, with open interest at the highs in the 3,000–4,500 range. Such a large skew in the basket of options sold could lead market makers to a “gamma squeeze” — a situation where, in case of an appreciation, they would need to increase their hedge position and buy more ETH.

The market landscape

There could be several reasons for this increased excitement in the market. Of course, apart from fundamental factors, the spot market movements were not the only ones.

According to the analyst platform Santiment, there were two large transfers related to the likely purchase of large amounts of BTC on 5th January. The two transactions, totalling 30,900 BTC (more than 450 million US dollars in equivalent), likely did not have an immediate impact on the price. However, they served as an excellent reason to pay more attention to crypto assets, which were heavily oversold in late 2022 on the back of the collapse of the major crypto exchange, FTX.

Logically, Bitcoin took form as the locomotive and other tokens followed. However, without a strong news backdrop, such momentum could be short-lived and exhausted in a matter of days. In this case, it was Ethereum and the upcoming protocol update called “Shanghai” that took on the role of support.

Why is this particular update so important?

After Ethereum switched to the new PoS algorithm for confirming transactions in mid-September of 2022, liquidity validators were blocked at the special Beacon Chain protocol level. It was only possible to access the funds through special companies known as liquidity staking providers. The largest of these were LIDO DAO, Rocket Pool, and Coinbase, using the original ETH deposit as collateral. The motivation to participate in transaction validation is to receive a fee (currently between 5% and 9% per annum depending on the validator chosen.

After the Shanghai update, it will be possible to move funds freely, which significantly changes the logic of ETH staking. On the one hand, the level of locked funds is significantly lower than in other blockchains. Potentially, there are prerequisites for increasing the number of tokens in staking and decreasing the free supply in the market, which will positively affect the upside potential of the ETH price. On the other hand, many current participants in the staking programme are at much lower price levels and may want to lock in profits. However, the process of exiting, staking and withdrawing the validator is quite complex in terms of technology and code. In order to reduce the risk of blockchain failure, the exit mechanism ought to be gradual, taking a significant amount of time.

Conclusions

Since the beginning of the year, the crypto market has significantly outperformed traditional equity markets.

The growth is based on internal drivers — large spot purchases of Bitcoin and optimistic expectations for an Ethereum update.

The crypto options market is significantly dominated by call options, which could lead to a gamma squeeze for market makers, similar to the events of August 2022, should the rate continue to rise.

If the analogy with the late summer 2022 market in the run-up to ‘The Merge’ is correct, it is very likely that this will continue to rise until the update is triggered.

Liquid staking is changing the Ethereum investment landscape significantly and is becoming a major theme for this year.

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delta.theta
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