Analysis: Once the "arbitrage spread" between Bitcoin ETF and futures disappears, BTC may be at risk of a sharp drop

Original source: Uweb Chinese

Can ETFs, Fed rate cuts and election events help the crypto market usher in a bull market? Herman, former Executive Director of Goldman Sachs' Asia FICC business, analyzes the Web3 market and major events, with the following highlights:

1. The market needs to pay attention to macro factors, and the Fed has not given a clear commitment to cut interest rates

As early as one and a half to two months ago, the interest rate cut had been fully priced in. The market generally expects two rate cuts this year. Although there was no rate cut in July, the market's expectations for a rate cut in September exceeded 100%, which means that the rate cut may exceed 0.25 percentage points. Therefore, the impact of the Fed's rate cut on the market is very small.

After the speech of Federal Reserve Chairman Jerome Powell, we can think about macro regression, that is, re-emphasis on macro factors such as inflation and economic growth to re-evaluate the possibility of the Fed's rate cut in September. Because J.Pow's speech emphasized data tracking, requiring data set dependent, that is, a series of data performance is good before considering rate cuts. This time he gave equal weight to inflation and growth, which is a positive signal. In the past, inflation was prioritized and growth was secondary.

The Fed's shift to focus on economic growth requires a high threshold: non-farm employment must be less than 125,000 before the Fed may change its focus. This goal is difficult to achieve, so the Fed's focus is still on inflation. J.Pow mentioned that both are equally important in his speech, which means that inflation has been controlled to a certain extent, and confidence in the future is stronger than in the past, but no clear commitment to rate cuts has been given.

Compared with the European Central Bank's (ECB) attitude towards rate cuts in March, the Fed's attitude did not give the market 100% confidence, but the market pricing exceeded 100%. The entire interest rate market may be over-interpreting the Fed's actions. Although there is a possibility of a rate cut in July, the market will experience repeated confusion and conviction in the process, which is also part of the macro uncertainty cycle.

From the beginning of the year to now, the market has experienced a shift from focusing on inflation to focusing on micro-company performance, but now it needs to return to macro factors. The Fed's state is worse than expected, but US stocks, including US bonds and gold, are rising. The pricing reflected by the Bitcoin market is correct.

2. The rise of US stocks is affected by Gamma hedging and CTA; the rise in long-term interest rates hits BTC liquid assets, and the bull market is difficult to achieve this year

The logic of US stocks and Bitcoin is different: the rise of US stocks is mainly driven by Gamma hedging and CTA, and is not much affected by whether the Fed cuts interest rates or not. Once the uncertainty is resolved, US stocks tend to rise in a straight line. Interest rate cuts have a greater impact on Bitcoin liquid assets, but not limited to this. Interest rate cuts affect short-term interest rates, while long-term interest rates have a greater impact on risky assets. For example, a 0.25 percentage point interest rate hike, if the 10-year interest rate rises by 25 basis points, its influence is far greater than a single interest rate hike. The stocks of the seven major companies are not supported by liquidity, but by gravity. For example, Nvidia's PE has remained stable for a long time, mainly driven by the growth of earnings per share (EPS) and AI business.

The risk-bearing assets in the market are divided into demand assets and long-term risk assets. Demand funds are invested in bank deposits, short-term bonds, etc., and long-term funds are invested in Bitcoin, stocks, long-term government bonds, etc. When the yield on 10-year government bonds is higher than the yield on stocks, investors are more inclined to buy government bonds rather than stocks. If this happens, it means that the market is in the late stage and risky assets, especially Bitcoin, will be hit hard. Rising long-term interest rates have a greater impact on all risky assets, especially liquid risky assets such as Bitcoin.

The United States began issuing bonds on a large scale last year, but the economy remains strong, with interest rates at 5.25-5.5%. Normally, interest rate hikes lead to a recession, but the nature of the growth of the US economy has changed. Economic growth depends on the weighted average of private sector and government debt.

The US government supports the economy by continuously issuing bonds, but this has also led to an intensification of the contradiction between market supply and demand. The DV01 of the US bond market in 2023 was about US$700 million, and it is expected to increase to US$1 billion this year. The Treasury Department is forced to issue long-term bonds, and the buyers of long-term bonds in the market are mainly hedge funds such as Goldman Sachs, which earn interest rate spreads by purchasing long-term high-interest bonds with short-term low-interest rate funds. However, the current inversion of long-term and short-term interest rates and the lack of buyers have led to insufficient demand for long-term bonds. It is expected that the 10-year long-term interest rate will be close to 5%, which is a huge blow to non-yielding liquid assets such as Bitcoin and gold. Bitcoin currently relies on arbitrage to maintain, but in the case of reduced liquidity, altcoins may return to zero. Overall, it is difficult for liquid assets to enter a bull market. Only when long-term interest rates fall can the market usher in a turnaround, but it is difficult to see such a change this year.

3. Republican policies tend to inflation, which is a major negative for liquid asset Bitcoin

The Republican Party’s rule is extremely unfavorable to liquid assets. For example, after Trump takes office, Bitcoin will face a major negative. Trump's policies have led to rising inflation. One of the main measures is to impose a 60% tariff on China and a 10% tariff on other countries, which has led to a 1.1 percentage point increase in CPI and PCE, directly triggering an increase in inflation. When inflation rises, interest rates will not only not be cut, but may be raised.

In addition, Trump's policy on immigration control has also affected inflation and the job market. There are two sources of employment data in the United States: Nonfarm Payroll (reflecting the real employment situation) and Household Survey (including illegal immigrants). There is an imbalance between nonfarm employment and unemployment, but the economy is still strong because of the demand brought by about 2.5 million immigrants each year and the reduction of basic wage costs. Trump's policies will reduce the entry of at least about 500,000 immigrants, which will lead to an increase in inflation. Trump's policies tend to maintain a higher level of inflation in the hope that manufacturing will return to the United States, which is unlikely to happen. High inflation is extremely lethal to liquid assets, such as Bitcoin, which means that a bull market in liquid assets is impossible after Trump takes office.

4. The continuous issuance of long-term bonds will lead to an increase in long-term interest rates, and the market will react and punish; the current position of the US dollar is solid, and if it is affected, it will lead to asset collapse

The United States will be forced to issue a large amount of long-term bonds, rather than selectively. The United States has strict guidelines and cannot rely entirely on short-term bonds, because this is equivalent to printing money. The short-term debt ratio allowed by the guidelines is only about 25%, although it can be slightly exceeded, but it is impossible to exceed it significantly. The Bank of Japan holds 58% of its own bonds and maintains a huge debt without affecting the financial system, but the United States must increase its bonds by 10% each year to maintain economic growth. If the increase in bonds is reduced, the economy will immediately have a hard landing. The continuous increase in US bonds will inevitably lead to an increase in long-term interest rates, and the market will punish it. Trump's policy attempts to keep the US dollar weak and promote inflation, but the market will respond by raising long-term interest rates. If long-term interest rates rise to 7%, 8%, or even 9%, all assets will be hit. Unlike China, the United States cannot control long-term interest rates, which are determined by the market. The rise of Bitcoin in early 2023 was because short-term bonds were mainly issued at that time, not long-term bonds, which did not exceed the guidelines, but now the Ministry of Finance cannot support it and must issue long-term bonds.

If the status of the US dollar is affected, global assets will face drastic deleveraging and all assets will be worthless: the US dollar is the global settlement currency, and any economic crisis will eventually lead to a surge in the US dollar, and all assets, whether gold, Bitcoin or stocks, will be destroyed.

5. It is difficult for Bitcoin to be used as a reserve asset; if Trump is in power, the Bitcoin market may face a big market, and investment should be cautious

Crypto as a reserve asset needs to be approved by Congress, and this process is extremely complicated. Gold has a historical role as a currency, and oil is a strategic resource, but Bitcoin does not have a similar clear purpose. Using taxpayers' money to buy volatile Bitcoin requires a good reason, which is extremely difficult to pass in Congress, and the proposal of Bitcoin as a national reserve asset is almost impossible to achieve. Bitcoin should be regarded as a macro asset, not a reserve asset. Trump's policy is inflationary, which is not good for Bitcoin. There are emotional factors in market transactions. In the short term, it may be driven by good news, but in the long term, after Trump takes office, the Bitcoin market may face a big market. Investors should not rely too much on short-term positives.

6. The current price of Bitcoin is mainly due to the arbitrage between spot ETFs and futures contracts. Once the price difference disappears, Bitcoin has the risk of plummeting in the short term

The current rise in the Bitcoin market is mainly driven by ETF expectations. During this round of rise, a total of about US$15-18 billion entered the market.

ETF buying sources include 6-8 billion US dollars of arbitrage funds, and Bitcoin holders with about US$5 billion transfer Bitcoin to ETFs. The long-term holding part is about 5-6 billion, and the remaining 3 billion is active buying. ETFs are concentrated in Coinbase and are specially managed, which is equivalent to taking Bitcoin out of the circulation market, resulting in a reduction in supply. ETF arbitrage takes advantage of the price difference between Bitcoin and futures. When the futures price is higher than the spot price, investors can buy Bitcoin in the spot market and short it in the futures market to make a profit.

Trading data from CME and Binance show that CME's open interest is high, reflecting that a large number of positions are not traded on a daily basis, but are used for arbitrage. High premiums trigger more arbitrage behavior, and arbitrageurs lock in risk-free returns by buying ETFs and shorting futures at the same time.

Arbitrage in the Bitcoin market drives prices up through the premiums of CEX and futures contracts. Arbitrageurs buy Bitcoin futures contracts, push up the futures premium, and then buy Bitcoin through arbitrage, forming a cycle. However, these arbitrageurs profit more when Bitcoin prices fall, because futures prices usually fall more than spot prices, and they can sell futures and spot at the same time to realize profits. Currently, the premium of Bitcoin ETF is still around 10%, which attracts more arbitrage funds into the market and maintains the price of Bitcoin. However, this also brings risks. Once the premium disappears, arbitrageurs may quickly withdraw from the market and sell ETFs and futures, causing the price to plummet.

7. Bitcoin ETFs in Hong Kong private banks are yet to be popularized, with great arbitrage potential. ETF buying and arbitrage funds support BTC price stability

Bitcoin ETFs have not yet been accepted by most private banks in Hong Kong, and only a few top brokers can conduct arbitrage transactions. If investors operate on their own, the arbitrage efficiency of Bitcoin ETFs is very low because it involves T+2 transaction settlement and requires frequent selling of ETFs to cover positions. Effective arbitrage operations require the Prime Broker of investment banks to operate. The approval process for new products is long, and when new products such as ETH are first launched, there are limited arbitrage opportunities. As the bank's review and access procedures are completed, there will be more arbitrage opportunities in the future, including Bitcoin ETFs. Once private banks such as HSBC, JPMorgan Chase and Goldman Sachs allow trading, Bitcoin ETFs will receive more buying support.

There is no bull market for BTC at present, and the price expectations of Bitcoin are divided into two situations. One is a bull market where the price of Bitcoin soars to $100,000 or $150,000, driving other cryptocurrencies to soar. The other is a bull market where the price of Bitcoin fluctuates between $50,000 and $70,000. The former is difficult to predict, but ETF buying and arbitrage funds can support Bitcoin to remain in the latter range.

8.BTC is highly correlated with the U.S. stock market, and insufficient liquidity and high interest rates suppress the bull market in the cottage market

BTC is highly correlated with the U.S. stock market, especially with U.S. bonds: its correlation cannot be judged by just looking at the price fluctuations of the day, but should be analyzed from the nature of the asset and trading behavior. BTC is highly correlated with risky assets, especially liquid risky assets, which are significantly affected by the Fed's policies and the liquidity of the U.S. dollar.

Since 2021, the cryptocurrency market has undergone tremendous changes. The introduction of USDT has made it easier for funds to flow between the cryptocurrency market and the external market. Previously, funds in the cryptocurrency market circulated internally, but now the popularity of US dollar stablecoins has changed this situation. The growth of mainstream currencies such as ETH has driven the rise of altcoins.

As a liquid asset, Bitcoin, due to the intervention of US dollar tokens, puts crypto assets such as Bitcoin on the same level as the US stock market. This year, the lack of money-making effect in the Bitcoin market is due to the lack of liquidity. The poor long-term interest rate of the US dollar has destroyed the previous capital circulation model. It is difficult for altcoins to form a bull market, mainly because insufficient liquidity and high interest rate environment have suppressed market activities. As a liquid asset, Bitcoin behaves similarly to lagging gold or unprofitable US stocks. Excluding the influence of the seven major technology giants, the performance of S&P 500 and S&P493 is similar to Bitcoin.

9. The US dollar interest rate remains high for a long period of time, suppressing the cryptocurrency market; a hard landing of the economy may cause the Fed to relax its policy, which is good for the cryptocurrency market

It is difficult for the cryptocurrency market to have a bull market in the short term. The US dollar interest rate will play a decisive role in the pricing of risky assets and market risk preferences. With such an increase in the scale of long-term bond issuance, interest rates will remain high for a long period of time. This will put pressure on liquid assets such as BTC.

Of course, if the US economy is at risk of a hard landing, this expectation may change quickly. Although a hard landing will impact US stocks and cryptocurrency assets in the short term, it will give the Fed more reasons to intervene, which is beneficial to cryptocurrency assets. The Fed currently has a large number of tools to deal with recessions: from QT reduction, interest rate cuts, special lending, QE, and so on.

10. Trump's policies or market expectations may trigger a major adjustment in the US stock market. The Fed may cut interest rates or start QE. Bitcoin and other assets may usher in a bull market

There are two main reasons why the US stock market may experience a major adjustment: First, the US economy will experience a hard landing. If Trump comes to power and implements inflation and deficit reduction policies, the issuance of treasury bonds will decrease. Once the issuance of treasury bonds, which economic growth depends on, decreases, it will inevitably lead to a hard landing and a decline in corporate profits. At present, the profits of AI companies depend on the four major cloud companies, and the revenue of these companies mainly comes from advertising. If the economy has a hard landing and advertising revenue decreases, the revenue of Meta and Google will drop sharply.

Second, market expectations are adjusted. Taking Nvidia as an example, the market has extremely high expectations for its performance. If the performance fails to exceed expectations, the stock price will plummet. Similarly, although Microsoft's performance met expectations, its revenue decreased slightly, causing a sharp drop in its stock price. This expectation adjustment may occur at the end of this year or the beginning of next year, triggering a substantial market adjustment.

Although the US stock market may experience a 20%-30% correction, it will usually rebound in the short term. If the US stock market plummets, the impact on Bitcoin will be devastating. After that, the Federal Reserve may cut interest rates or launch QE, which may drive assets such as Bitcoin, Ethereum, BNB and Solana to a bull market.

11. The key to the valuation of new projects is whether they can attract investors and whether the project is unlocked after listing; large funds usually flow to BTC, ETH, BNB and Solana

The valuation of new projects mainly depends on whether they can attract the next round of investors. Most of the data of Web 3 projects are not real, so when evaluating, pay attention to two key points: whether they can attract new investors and whether the project is unlocked after listing. There is little hope that Web 3 technology can change the market, and there are no projects that have come out at present. The core is whether it can be listed on Binance. As long as it can be listed on Binance, there will be trading opportunities.

Altcoins will mostly return to zero, or at least fall by 90%. This is mainly due to liquidity issues and the lack of activity in altcoins. A few altcoins such as Solana can continue the nesting game and complete the self-circulation.

The valuation model of the entire crypto market is similar to that of a casino. Mainstream currencies BTC, ETH, BNB and Solana are regarded as casino stocks. Belief is the key to supporting their value, and large funds usually flow to mainstream currencies. If you want to allocate assets, Solana is a good choice.

12. Bitcoin halving has less impact on the market, and prices are more affected by trading volume and macro factors

Bitcoin's four-year halving cycle has little impact on the market. Although halving will lead to a decrease in supply and increase deflation costs, miners, as price takers, have little bargaining power and have limited impact on Bitcoin prices. Market prices are more affected by trading volume, macro factors and other buyers and sellers. The impact of the halving cycle is gradually decreasing, and it is unrealistic to believe that the halving cycle will inevitably bring a bull market.

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