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People in the market game will always tirelessly analyze and dissect the market from various angles. As the popular saying goes, "History doesn't repeat itself, but it often rhymes", in order to keep up with the rhythm of the market, referring to various indicators is undoubtedly the most efficient way. Leading indicators can be used to predict the market, and synchronous and lagging indicators can be used to verify market changes.
Compared with lagging indicators and coincident indicators, people are more interested in leading indicators that predict market trends one step ahead of the market. Leading indicators often transcend economic cycles and are usually suitable for short-term and medium-term cycle analysis. In traditional markets, people often come into contact with two types of leading indicators: macroeconomic leading indicators for fundamental analysis and technical indicators for technical analysis. The previous liquor market is the best example. Under the leadership of Moutai, the liquor sector has become a well-deserved core asset in the A-share market.
Therefore, in order to avoid missing out on the next bull market, the market is looking for leading indicators of the liquor sector from a macro, meso and micro perspective. Fixed investment drive, money supply, catering income, and even Moutai prices and foreign holdings have become leading indicators of the liquor sector. The crypto world is no exception. In this 7x24 capital market, the surge and plunge of Bitcoin affects the emotions of investors, especially the plunge on March 12, 2020. Bitcoin fell almost without resistance in 24 hours, causing wailing in the market, and the 22 billion yuan liquidation made countless investors frustrated. This has also made more and more people start to think, when the Bitcoin market has fully presented commodity attributes, what are the leading indicators of this market?
Today, we found it.
For this emerging market, we will first transition from the already mature traditional financial market. Due to different countries and regions, different investment preferences, and different portfolio allocation positions, different investors attach different importance to different indicators. However, there are some common indicators that most investors will pay close attention to.
Stock index is widely regarded as a very effective leading indicator of macroeconomic trends, because market participants spend a lot of time and energy to judge the operating conditions of listed companies and then execute trading decisions. Usually when the stock market index is strong, it indicates that people are full of confidence in the future market. When the market is weak, it means that the market confidence is insufficient, and funds flow out of the stock market and into safe-haven assets. As the famous economic theorist Roger Babson said in his book "Economic Barometer for Accumulating Wealth": "In fact, if it is not manipulated, businessmen can almost completely use the stock market as a barometer of economic activity. If all companies are added together, the entire stock market can accurately predict the development of the overall economy."
The most typical example of stock indexes leading economic changes is the Panic of 1907. This catastrophe, also known as the US banking crisis or the Knickerbocker crisis, started with a stock market downturn and ended with a stock market recovery. However, there is a natural problem with stock indexes, that is, stock prices are often affected by speculative sentiment and it is difficult to directly reflect the actual operation of the company, which is why individual stock prices are usually overvalued or undervalued. The reflexivity of the market will unlimitedly amplify price fluctuations, and ultimately the flow of funds in the stock market will affect the trend of the real economy, which is why stock indexes can be regarded as leading indicators of economic trends.
Interest rate and Treasury yields Interest rate is a controversial indicator. It can be seen as both a leading indicator and a lagging indicator. The reason why it can be seen as a lagging indicator is that the central bank will use interest rates as a market intervention tool to regulate the economy according to economic conditions. It can be seen as a leading indicator because the market will respond immediately after interest rate changes.
Simply put, when the economy is sluggish, lowering interest rates is the most effective monetary stimulus policy. Lowering interest rates reduces borrowing costs, thereby stimulating production and consumption. Conversely, when the economy is overheated or in order to prevent excessive inflation, the central bank will raise interest rates, thereby increasing borrowing costs, absorbing deposits, and slowing down the pace of production and consumption. The yield on government bonds, especially the recent yield on government bonds, is closely related to the policy interest rate. Since government bonds are securities backed by national credit, their yield is called the risk-free rate of return, and is also regarded as one of the safe-haven assets.
When the economic trend is downward, investors lack confidence, and are uncertain and panic about the future, investors will choose to buy government bonds. But when the economy develops rapidly, because the return rate of other assets is higher than that of government bonds, funds will flow out of government bonds and into other markets. On the other hand, government bond returns are also closely related to inflation expectations and QE policies. Since the actual return of government bonds = nominal return - inflation expectations, when investors believe that the central bank will tighten monetary policy in the future and there is a possibility of raising interest rates, government bond returns will rise accordingly, which means that investors need to obtain higher returns to resist inflation, and funds will flow out of government bonds and into other markets.
On the other hand, when the central bank stops its monetary easing policy, bond buying will shrink significantly and yields will soar. The most classic example is the "taper tantrum" in the United States in 2013. When then-Fed Chairman Ben Bernanke first mentioned the possibility of reducing bond purchases at the JEC hearing, the US 10-year Treasury yield soared. Global markets, especially emerging markets, fell into widespread panic and turmoil: capital outflows, currency depreciation, bond market sell-offs, and commodity crashes. Technical leading indicators can be roughly divided into trend indicators, momentum indicators, volatility indicators and volume indicators. The most common indicators include the relative strength index (RSI) used to determine whether the market is overbought or oversold, the stochastic oscillator used to determine the direction of market movement, and the on-balance volume (OBV) indicator that determines the relative price by the rise and fall of trading volume. Technical indicators are more suitable for short-term or ultra-short-term transactions, and investors will combine various technical indicators to make trading decisions.
Leading indicators in the crypto marketIn a sense, the cryptocurrency market is similar to the traditional financial market. In the crypto market, investors can not only judge the impact of economic trends of various countries on crypto assets through the monetary and fiscal policies of various countries, but also judge the flow of funds by observing macroeconomic indicators, and can also judge price trends through technical indicators of on-site transactions.
In addition, data shows that the lending rate of stablecoins and the basis and funding rate of derivatives in the crypto market are very effective leading indicators. Stablecoin lending rate As the most common medium of value exchange in crypto assets and the intersection of real assets and crypto assets, stablecoins can be regarded as the M0 of the crypto world. Since the stablecoins circulating in the crypto market are basically anchored to the US dollar, this article uses the US dollar stablecoin as a discussion sample.
The interest rate of the US dollar stablecoin is composed of two parts. The first part is the policy-based lending rate of traditional US dollars, and the second part is the risk premium, issuance cost and cognitive cost brought by the US dollar chain.
First, there are various risks of being attacked when putting assets on the chain, including contract risks and public chain risks, so there is a certain premium on the lending rate of on-chain assets. Secondly, since USDT and USDC are assets issued by centralized institutions, the asset issuers (Tether and Circle) are at risk of bankruptcy and default. At the same time, non-compliant stablecoins such as USDT may have insufficient collateral and may eventually face the risk of a run. From the perspective of issuance costs, centralized issuers need to bear the custody fees for the collateral assets required to issue stablecoins, technical issuance and maintenance costs, and so on. From the perspective of cognitive costs, since people still have doubts about on-chain assets and have cognitive biases about blockchain technology, this has also greatly increased the cost of using on-chain assets. From the data we can see:
Image source: TradingEconomics
The above chart shows the LIBOR (London Interbank Offered Rate) data based on the US dollar in 2020. We can see that at the beginning of the year, the highest interest rate was only around 1.8% annualized, and then fell below 0.5%.
Image source: DeFi Pulse
On the other hand, the annualized lending rate of USDT on decentralized lending platforms such as Compound and Aave peaked at nearly 50% at the beginning of the year and fluctuated violently. Although we can see from this that the cost of using on-chain assets is far higher than that of off-chain assets, decentralized lending platforms cannot see the full picture of stablecoin lending rates due to unstable liquidity and other factors.
A more representative interest rate indicator should be the inter-institutional lending rate. The inter-institutional lending rate refers to the short-term lending rate between institutions. It is also the most representative core interest rate in the entire market. It can timely, flexibly and accurately reflect the short-term supply and demand relationship of funds in the entire market. When the inter-institutional lending rate continues to rise, it reflects the continued rise in demand for funds in a short period of time, indicating that liquidity in the market may decline, and it can also indirectly reflect the increase in leverage in the market.
In the crypto world, the inter-institutional lending rate refers to the short-term lending rate between centralized lending institutions (Genesis Capital, PayPal Finance), centralized exchanges that provide lending services (Binance, Huobi, OKEx), and other institutions that provide lending services. According to PayPal Finance data, in early 2020, the inter-institutional lending rate for cryptocurrencies was similar to the interest rates of LIBOR and decentralized lending platforms, peaking between February and March, and then falling to the bottom in April. During the crazy February, users couldn't even borrow USDT from exchanges to do so, and the interest rate of some exchanges reached an annualized 36%. As the market recovers, interest rates have returned to normal levels.
Basis and Funding Rates in Derivative Markets As lending rates increase, funds will flow into the spot and derivative markets. Since the trading volume of the derivatives market far exceeds that of the spot market, the futures basis and funding rates in the derivatives market can better reflect market sentiment. Basis in the Futures Market Basis refers to the difference between the spot price of an asset at a specific time and its futures price. It is calculated by subtracting the futures price of an asset from its spot price. If the spot price is lower than the futures price, the basis is negative, and when the spot price is higher than the futures price, the spread is positive.
In traditional markets, the basis is often negative, and futures prices are higher than spot prices. This is because under normal circumstances, futures prices include costs such as storage, holding, loss, and interest. However, in the crypto market, there are no costs such as storage and loss for crypto assets, but most of the time people are bullish on Bitcoin, which leads to a negative basis. The absolute value of the basis is related to the scale of the market. The larger the absolute value of the basis, the larger the market, or in other words, the larger the market, the larger the basis.
Funding rateThe key role of funding rate is to narrow the price gap between the perpetual contract market and the corresponding spot market (price reversion). Unlike traditional contracts, perpetual contract traders can hold positions forever, there is no expiration date, and there is no need to track different delivery months. Therefore, crypto asset trading platforms have created a mechanism to ensure that the contract price is consistent with the index price. This mechanism is called funding rate. When the market trend is bullish, the funding rate is positive, and the longs will pay the funding rate to the shorts. On the contrary, when the market is bearish, the funding rate is negative, and the short traders pay the longs. When the inter-institutional lending rate rises, it proves that the market demand for funds has increased. This part of the funds is not only used for unilateral transactions such as buying spot and long derivatives, but more for arbitrage transactions. Common arbitrage modelsThe so-called arbitrage transaction refers to the use of spot and derivatives to conduct two transactions with related market conditions, opposite directions, equal quantities, and offsetting profits and losses, thereby hedging the impact of price changes.
The most common arbitrage in the market is spot-futures arbitrage and funding rate arbitrage. Spot-futures arbitrage is arbitrage through the price difference between futures and spot, which is a low-risk arbitrage. Once the basis (the difference between spot and futures prices) deviates greatly from the holding cost, there is an opportunity for spot-futures arbitrage. Among them, the futures price must be higher than the spot price and exceed the various costs used for contract delivery. For example, the spot price of BTC is 30,000USDT and the futures price is 35,000USDT. Then we hold a spot position of 1BTC and a futures short position of 1BTC, for a total of 2BTC positions. Usually, when the delivery date is approaching, the futures price and the spot price will tend to converge. If the market goes up and the BTC price is 38,000 USDT on the delivery date, then the 1BTC spot position purchased with US$30,000 will make a profit of 8,000 USDT, and the 1BTC position of the futures contract will lose 3,000 USDT. Ignoring the handling fee, the profit is 8,000 USDT-3,000 USDT=5,000 USDT. If leverage is used for hedging transactions, the risk of liquidation needs to be considered.
Funding rate arbitrage is to earn funding rates by holding equal but opposite positions in spot futures. As mentioned above, when the market trend is bullish, the funding rate is positive, so by holding a short position, you can get the funding fee paid by the longs. If the market is dominated by shorts, you can hold a long position to earn the funding fee paid by the shorts. Similarly, there is a risk of liquidation when using leverage. Market overheating, leverage is too high When market sentiment is high and people are driven by FOMO, many investors will ignore the control of leverage risk. Ordinary spot traders began to borrow money to buy leverage, contract traders began to increase leverage multiples to magnify their returns, and arbitrage traders began to use leverage for arbitrage, which caused a shortage of funds in the market, rising interest rates, widening basis, and soaring funding rates. At this time, the market is not far from a crash.
How leverage can infinitely magnify a reasonable correction into a crash tragedy: Usually, a correction after a rise is a very normal phenomenon. This may be due to the departure of profitable funds, the market shock caused by some bad news (policy negative), etc. Under normal circumstances, a small correction will not have a big impact on the overall market, but in a market with high leverage, this may trigger a vicious cycle of crash tragedy. Due to excessive leverage, the impact of the decline is multiplied, and high-leverage positions will be the first to sell assets to protect the collateral from being liquidated. The selling of highly leveraged investors causes asset prices to fall again, which in turn affects investors with lower leverage, and ultimately leads to market panic and a death spiral. Replay 312
The 312 crash undoubtedly left many people with painful memories. If we put the trends of Bitcoin prices, lending rates, and perpetual contract funding rates throughout 2020 into one chart, we can clearly see: Source: PayPal Finance (call rate), CoinMarketCap (bitcoin price), Binance (perpetual contract funding rate)
Before the 312 crash, the high interest rates, abnormal funding rates and spot basis had already given people a warning. According to a person familiar with PayPal Finance, the highest daily loan amount in February was 15 million USDT, and it exceeded 50 million USDT in a single week. In February, the annualized premium of the quarterly contract reached more than 50%. So even if you lend at an annualized interest rate of 36% and make arbitrage, you can still get an arbitrage income of 14%. In addition, the dominance of Bitcoin continued to decline in February, which means that Bitcoin reached the level of $10,500 in February due to the role of leverage in the market. In early March, the failure of OPEC negotiations led to a drop in crude oil. Although the global epidemic had not yet completely broken out and did not cause excessive panic, the plunge in crude oil led to the collapse of individual US stocks, pulling down the US stock index, and Bitcoin also gradually fell with the US stock market. On March 8, Bitcoin fell from $9,000 to $8,000 without causing panic and gained support. However, clues can be seen from the data of Bitfinex Exchange, with a 24-hour net selling volume of 40,000 bitcoins, far exceeding the daily trading volume data. The further decline after two days of shock is most likely due to the liquidation of other large institutions. The decline in spot prices triggered a series of stampedes in the high-leverage futures market, including liquidation and liquidation. At 6 pm on March 12, Bitcoin fell 5% in one minute. The first wave of stampedes pushed the price down to $6,500, and then quickly fell to $6,000. The subsequent rapid decline caused a lack of liquidity and eventually led to the failure of market pricing. Bitcoin reached $3,300 at its lowest.
As analyzed above, the inter-institutional lending rate reached its peak first and became the first leading indicator. About a week later, the derivatives market reacted and the perpetual contract funding rate reached its peak. On the other hand, during the entire 312, under the influence of the negative market sentiment caused by the epidemic, crude oil collapsed first, followed by continuous circuit breakers in the U.S. stock market, and the crypto market collapsed at any time. The sell-off caused by high leverage brought the price of Bitcoin from $8,000 to the bottom of $4,000. The recent bull market correction In 2021, when major institutions rushed into the crypto market, Bitcoin rose from $29,000 to $58,000 in just two months. However, on the second day after breaking the new high, Bitcoin started a large-scale correction for two consecutive days. The price once fell below $45,000, and the number of contract liquidations reached 490,000, with a total liquidation of $3.3 billion, a data of more than 312.
Although this bull market is not driven by derivatives, who can resist the opportunity to magnify profits in a market where prices are skyrocketing? According to PayPal Financial data, the annualized premium of quarterly contracts is around 39%, while the annualized rate of perpetual contracts is as high as 80%, even exceeding the level before March 12. The inter-institutional lending rate is also far higher than the same period last year, reaching an annualized 20%-30% at its peak.
Before this large-scale correction, the abnormalities of the delivery contract basis, perpetual contract funding rate, and inter-institutional lending rate also effectively provided advance information. At the same time, as the asset attributes of Bitcoin are accepted by more and more institutions and enterprises, and more and more professional investors and institutions allocate Bitcoin, the correlation between Bitcoin price trends and US stocks and US bonds is getting higher and higher. In particular, the stock prices of US listed companies that have allocated Bitcoin are largely affected by the price of Bitcoin. The price of Bitcoin will be affected by the US stock market, which is closely related to the returns of US stocks and US bonds, and the returns of US bonds are closely related to the US dollar index.
Therefore, it can be clearly felt recently that before the US stock market opens, the price of Bitcoin is highly correlated with US stock futures, and after the opening, it is correlated with the spot price of US stocks. The rise in US bond yields and the US dollar index has led to a decline in US stocks and Bitcoin. There must be more and more accurate leading indicators in the crypto world. As crypto assets are accepted by more people, the crypto market will become more efficient. As investors become more aware, they will be one step ahead of the market. |
