Multi-party analysis: What is the reason for the Terra ecosystem to lose control after the crypto market plummeted? What is the future trend?

As the Federal Reserve raised interest rates by 50 basis points, the U.S. stock market and the crypto market began to fall sharply. Bitcoin fell to $30,000, Luna plummeted by 50%, and UST has begun to decouple. What is the reason? What is the future trend?

Blofin Macro and Options Trader Griffin

There is no doubt that the current crypto market seems to be out of control. Under the combined effect of multiple factors such as UST de-anchoring, the sharp drop in US stocks, and the net selling of crypto asset investors reaching a new high this year, the volatility of crypto assets represented by BTC has risen to the highest level since the beginning of the year. Judging from the skewness data, the short-term risk aversion sentiment of the entire market has also reached a high point this year, and investors are buying a large number of put options to hedge against the risk of further declines.

Another more dangerous signal is that the premium of mainstream crypto asset forward futures is significantly lower than the risk-free rate. In this case, the expected return of crypto asset investors is already lower than the risk-free rate, and more investors may further turn to risk-free assets. The liquidity outflow of crypto assets will be difficult to improve in the short term.

However, we have also seen some signs that the market out of control is beginning to end. The largest negative Gamma exposure in the history of the crypto market has been initially controlled, and ETH's negative Gamma exposure has narrowed significantly. The change in Gamma exposure means that market makers and investors are beginning to be able to "correct" the current market invalidation trend, but before the delivery of derivatives on Friday, the strong negative Gamma exposure looks like it will continue to exist, which means that the high volatility of the market will continue in the short term.

At present, the US April CPI data to be released on Wednesday will become the focus of reversing the current market situation. If the CPI data is under control as expected, the possibility of the Fed taking more aggressive measures will be significantly reduced, and market confidence will also be supported; but if the CPI data is still out of control, for the crypto market, this means that the Fed's negative impact on the risk asset market will be further exacerbated in the future. In short, in the short and medium term, it is difficult to see the possibility of the crypto market returning to its highs.

Huobi Research Institute

From a historical perspective, the two 50BP interest rate hikes in 1994 and 2000 produced different policy effects: the former achieved a soft landing of the US economy and maintained healthy economic growth; the latter burst the stock market bubble and plunged the US economy into recession.

The 50BP rate hike in 1994 was successful due to two main reasons: one was the preventive, pre-emptive rate hike; the other was the stable external environment. The 50BP rate hike in 2000 failed mainly because, in addition to the fact that the U.S. stock bubble was already very high at the time, the 9/11 incident in 2001 broke the myth of U.S. domestic security and shook market confidence.

Compared with 1994 and 2000, the macroeconomic background in 2022 is turbulent and highly uncertain. Inflation in the United States has long been high, and the interest rate hike at this time is no longer a precautionary rate hike like in 1994. Coupled with the impact of the new coronavirus and the Russia-Ukraine war, the stock market bubble is high. Therefore, this rate hike currently has disastrous consequences similar to those in 2000.

BitMEX founder blog post

In his latest article on April 11, BitMEX founder Arthur Hayes predicted that Bitcoin and Ethereum are highly correlated with the Nasdaq 100 Index. With the Fed raising interest rates, Bitcoin and Ethereum will test $30,000 and $2,500 by June this year (both have fallen below this figure). He said he has purchased a put option for June 2022.

Earlier, he said that the support level is $28,500 for Bitcoin and $1,700 for Ethereum. "Until these levels are retested, the market will not bottom. If the support level holds, then it's great and the problem is solved. If not, then I believe Bitcoin and Ethereum will fall to $20,000 and $1,300 due to liquidations."

BitMEX Analyst @lasertheend

Now everyone is concerned about two things. One is the decoupling of UST, and the other is whether LFG will drag down the entire market.

I like to compare public chains/projects to countries. Each country has its own monetary policy and economic model, just like each public chain has its own ecosystem and monetary model. For Terra, the biggest difference is that compared with other direct settlements in US dollars, Terra adopts a "linked exchange rate system" a bit like Hong Kong. The advantage is that UST can obtain some privileges of printing money like the "Federal Reserve" in terms of capital efficiency. The disadvantage is of course obvious, that is, when the public lacks confidence in UST, or when financial giants find that it is over-issued beyond its own economic size and can be shorted profitably, it will be hit by a fatal decoupling. Just like the Argentine peso at the beginning. The current UST is also facing severe challenges.

From a fundamental perspective, we see that the growth in demand for UST has decreased due to the interest rate reduction of Anchor. At the same time, there is no second "killer app" to attract more UST inflow. This makes people begin to wonder whether UST is "over-issued". In the short term, the decoupling of UST is mainly due to the large investors on Anchor fleeing -> UST is under pressure -> the market is not good -> LUNA falls more. This butterfly effect of accumulating small amounts leads to a slow death cycle.

As for whether the decoupling of UST will cause a market crash, since LFG's on-chain arbitrage mechanism has not yet been completed, we need to pay attention to whether LFG will continue to increase BTC loans to market makers. The recent loan behavior can be understood as LFG giving market makers risk-free arbitrage opportunities. Market makers can sell Bitcoin -> exchange for USD -> buy UST -> wait for UST to recover the peg and then use UST to buy Bitcoin. Because even if Bitcoin is sold at a loss, it can still be bought back with borrowed UST. This shows the degree of desperation of LFG to a certain extent.

The most terrifying thing is not that LFG sold $2 billion worth of Bitcoin and exploded, but that the continued decoupling of UST will destroy the confidence of the entire market. Terra’s loss of confidence will spread to the entire market and traditional institutions that invest in cryptocurrencies.

Researcher Winter Soldier

There are still many similarities between the recent situation and that in 2018. From a macro perspective, when the nest is overturned, all the eggs will be broken. The sharp drop in U.S. stocks that year was an important reason for the crypto market to enter a severe winter at the end of 2018. Now the same structure has appeared again. The bubble of the entire financial market is bursting at an accelerated pace, and cryptocurrencies are no exception.

In addition, the current market crash is also superimposed with some of its own factors, such as the bursting of the DeFi bubble. DeFi is the engine of this round of bull market, but DeFi is a bit like the various derivatives that triggered the 2008 financial crisis. It is an amplifier that can amplify both returns and risks. When the market is down, the various complex nested chains of DeFi may cause systemic risks as long as they collapse at a single point. In particular, some projects that claim to be "risk-free arbitrage" and "free prostitution" often attract huge amounts of funds, but the risks are actually very high.

Finally, let me briefly talk about my views on the UST incident. After all, the market generally believes that the collapse of UST is the direct cause of the market crash, and the future fate of UST will also affect the trend of the market. It is difficult for me to judge whether UST can survive this time. On the bright side, the current plunge can be regarded as a stress test for UST. If UST is compared with USDT in those years, USDT has actually experienced more than one trust crisis. USDT has experienced extreme situations like UST where the exchange rate fell by 20-40%, but it was rescued without any danger. It is precisely because of those stress tests that the market today generally accepts and trusts USDT. The current ordeal is the baptism that UST must go through on its way to becoming a god. Of course, on the bad side, UST is still an algorithmic stablecoin after all. The previous algorithmic stablecoins seem to have had a bad ending, and UST is likely not to be the only successful exception.