Coinbase Weekly Report: Macro trends for the next quarter, the impact of tax season on the market, and whether altcoins can outperform the market

Summary: We believe that in the second quarter of 2024, the Crypto market will perform well under many favorable conditions. In addition, competition for on-chain derivatives is heating up.

Quick Facts

Crypto markets overall have held up well despite some disruptions to liquidity due to U.S. holidays and corporate month-end rebalancing.

Many of the headwinds we identified earlier this month are now a thing of the past, and looking ahead, we believe the overall market picture presented by the second quarter of 2024 appears to be more favorable for Crypto performance.

Meanwhile, the total locked value (TVL) of on-chain derivatives has reached an all-time high of $3.4 billion, although the TVL of the entire DeFi market is still about 50% lower than its peak in the previous cycle.

Market Highlights

Crypto markets have held up well despite liquidity disruptions from US holidays and corporate month-end (and quarter-end) rebalancing. USD demand typically picks up at this time of the month/year. Tax season remains a potential catalyst for profit taking in the near term. Additionally, we believe that speculators shorting MicroStrategy (MSTR) versus long Bitcoin may have contributed to the recent market volatility. On the other hand, many of the headwinds we identified earlier this month are now a thing of the past, and looking ahead, we believe the overall market picture presented by Q2 2024 appears to be more favorable for Crypto performance. That said, we believe these positive factors may only begin to become more clearly apparent in the second half of April.

For example, the upcoming Bitcoin halving (estimated to be sometime between April 16 and 20) remains a big event to watch on the supply side, which we have already covered in depth in the article "Coinbase: In-depth Analysis of Bitcoin's Trends after This Halving". But on the demand side, the 90-day review period adopted by many large securities firms when conducting due diligence on new financial products (such as spot Bitcoin ETFs) may end as early as April 10. That is, large broker-dealers generally conduct a rigorous 360-degree assessment before allowing wealth advisors to allocate client assets. Their assessment thoroughly examines (1) whether such products meet investment minimums and liquidity thresholds, and (2) whether the necessary daily trading, custody, and regulatory reporting activities pose any insurmountable operational challenges to their existing infrastructure.

That said, large securities firms like Morgan Stanley, Bank of America, UBS, and Goldman Sachs are not the only gatekeepers of wealth here. Outside of these large financial groups, there are also some mainstream wealth management platforms operating in the United States. While money managers like LPL Financial typically (and explicitly) have a three-month observation period, some platforms have shorter or longer observation windows. We believe this could unlock a large amount of capital in the medium-term timeline for spot Bitcoin ETF trading in the United States.

Meanwhile, according to the latest data from the U.S. Commodity Futures Trading Commission (CFTC), as of March 19, the level of leveraged short positions in CME Bitcoin futures has climbed to a record high of 19,917, which seems to indicate that institutional interest in this space remains high. In comparison, the total open interest in CME Bitcoin futures is 33,196 contracts with a total value of $100.5 billion (as of that date). We use the net short position of leveraged funds in CME Bitcoin futures as a proxy indicator of Bitcoin basis trading activity, similar to the proxy indicator of U.S. Treasury futures basis trading activity cited by the Bank for International Settlements (BIS). Many institutions that do not have direct access to cryptocurrency spot often use this spread to gain long Bitcoin exposure. Interestingly, the basis (30-day) between Bitcoin spot and CME futures averaged an annualized rate of about 16% in March, only slightly higher than 14% in February, which is profitable for many market participants despite the capital requirements of this trade.

On-chain: The dawn of derivatives

Additionally, the increased availability of high-throughput and low-cost blockspace (following a focus on infrastructure construction throughout the bear market) enables new forms of on-chain products. This has already been seen in the on-chain derivatives space, where total value locked (TVL) has reached an all-time high of $3.4 billion, although the TVL of the entire DeFi market is still about 50% lower than the high point of the previous cycle. It is particularly noteworthy that the collateral deposited into these protocols is generally limited to major L1 tokens and stablecoins.

The use of centralized limit order books (CLOBs) in many derivatives protocols is a direct result of cheaper block space, as it allows orders to be created and canceled quickly at minimal cost, which is critical for liquidity trading achieved through more traditional market making strategies. In fact, one of the original design considerations for early automated market makers (AMMs) was that providing liquidity through order books was not only too costly, but also generally unworkable given the long and discrete block intervals and uncertainty in transaction ordering.

When measuring trading volume relative to TVL, CLOBs generally have the advantage of being more capital efficient than AMMs. For example, according to DeFiLlama, the two leading derivatives protocols by TVL, GMX and dYdX, have similar aggregate TVL levels in their versions ($610 million and $520 million, respectively). However, on a similar capital base, dYdX has more than 20 times the trading volume of GMX (dydx ~5 billion per week, while GMX is ~200 million per week). In part, the difference in capital efficiency is because GMX utilizes the underlying AMM for liquidity, while dYdX runs on CLOB. This reduces price impact and slippage, and potentially lowers fees.

That said, volume can be easily distorted in the short term due to trading incentives such as points and airdrop farms, temporary fee waivers, and broader market volatility. Additionally, for many CLOB architectures, it is difficult to distinguish market making activity from organic trading. As such, we view TVL growth as a clearer indicator of sticky interest in the protocol at an early stage, although volume and revenue will ultimately determine the long-term success of the protocol.

From a TVL perspective, derivatives protocols are more diverse this cycle than the last. During the pre-TVL peak period in 2021 and early 2022, the top 4 protocols controlled over 85% of TVL in derivatives protocols. Now, the largest protocol, GMX, controls 17.7% of the market TVL across its V1 and V2, while dydx controls a total of 15.6% (see Figure 3). While certain protocols have an early lead and accumulated trust due to their longevity, we believe the clear winners in the space have yet to be determined.

Various scaling strategies will affect ease of onboarding, liquidity bridges, and long-term technical scalability. Different approaches, such as dydx's proprietary application chain based on Cosmos, GMX integrated into Arbitrum rollup, Aevo's proprietary application rollup, and Drift deployed on Solana, all require various trade-offs. At the same time, competition from centralized derivatives exchanges will continue to put performance pressure on these decentralized protocols.

Crypto and Traditional Data

(As of 4 p.m. ET March 28)

AssetPriceMkt Cap24 hour change7 day changeBTC correlationBTC$70,807$1.29T+3.40%+8.20%100%ETH$3,568$427B+2.24%+2.24%85%Gold (Spot)$2,220-+1.17%+1.80%49%S&P 5005,254.35-+0.11%+0.25%19%USDT$1.00$104B---USDC$1.00$32.1B---

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AssetMTD flow (US$B)YTD flow US$B)AUM (US$B)Bitcoin held (BTC M)Spot BTC ETFs (US)$4.4B$11.9B$57.1B0.83M

Source: Bloomberg

Coinbase Exchange and CES Insights

Crypto markets moved higher this past week on increased volume. Traders are once again adding to leveraged long positions as a short-term bottom may have been in place. Annualized funding rates for BTC and ETH perpetual contracts have climbed from 15% to 50% this past week. Open interest for major currencies also continues to climb and is at its highest level in over a year. With the overall trend up, traders are parsing altcoins for ways to outperform the rising market. However, there has not been a single narrative that has emerged as a winner, and as a result we are seeing capital circulating across sectors at a high rate.

Coinbase platform transaction volume (USD)

Coinbase platform transaction volume (asset ratio)

Funding Rate

3/28/2024TradFiCeFiDeFiOvernight5.35%5.00% - 10.75%9.12%USD - 1m5.50%5.25% - 11.00%USD - 6m5.75%5.50% - 11.50%BTC1.50% - 5.00%ETH3.00% - 8.00%1.33%

Notable Crypto News

mechanism

BlackRock's new tokenized fund brings traditional finance and crypto closer (Coindesk)

If Ethereum is qualified as a security, BlackRock will still move forward with the spot Ethereum ETF (The Defiant)

Regulation

KuCoin faces criminal charges in the US (The Defiant)

SEC faces lawsuit seeking to exempt airdrops from securities classification (Decrypt)

conventional

Fetch.ai, SingularityNET, and Ocean Protocol prices surge after proposed merger announcement (The Block)

Coinbase

How to Stay Safe This Tax Season (Coinbase)

Global Perspective

Europe

European Parliament approves ban on anonymous crypto transactions (CryptoBriefing)

EU markets regulator one step closer to finalizing MiCA rules (CoinDesk)

Patrick Hansen clarifies EU regulatory misinformation: self-hosted wallets are not prohibited (bitcoin.com)

Euronext CEO Stephane Boujnah said the exchange does not plan to introduce cryptocurrency trading without regulatory support (Reuters)

UK Treasury releases latest report on fund tokenization (The Block)

Asia

Singapore’s DigiFT Launches US T-Bill RWA Token (The Block)

Avalanche announces collaboration with Chainlink and Australia and New Zealand Banking Group to explore on-chain asset settlement (AVAX)

South Korean investors petition to further delay cryptocurrency taxation (The Block)