21Shares Research Newsletter - Issue 60

Market Outlook

This Friday, June 26, around $1B-worth of Bitcoin and Ethereum options contracts on Deribit — the leading crypto options exchange — are due to expire. This is an important milestone in the options market, especially as this market has grown rapidly over the past year led by the developing trading needs of market participants. The sector is now of the size that it can begin to tangibly have an effect on the market microstructure for spot Bitcoin and Ethereum and there’s good reason to think that Friday could be a noticeably volatile day for the cryptoasset.

In total around 70,000 Bitcoin contracts are due to expire, 290,000 Ethereum contracts are set to expire on the same day. Market makers and traders that were either long or short positions in these options contracts were likely hedging exposure through the spot or futures markets. This means that as some of these contracts expire, the underlying spot markets of Bitcoin and Ether may be subject to some volatility as traders unwind their positions.

According to Deribit Insights, of the options that are due to expire on June 26, there are 20,000 out-of-the-money (OTM) puts and 50,000 OTM calls with strike prices between $5,000 and $15,000. Of these contracts, there is a 2:5 put-call ratio which has typically indicated a bullish sentiment among traders.

The cryptoasset market saw a late rally near the tail end of this week as it was announced that PayPal and Venmo were to roll out cryptoasset purchasing through their applications. This move will increase the amount of users who are able to easily buy and sell cryptoassets by effectively turning the services into wallets. Understandably so, the market spiked, especially for Bitcoin and Ether, upon the news breaking — BTC (2.58%), ETH (5.20%), XRP (-1.55%), BCH (2.11%), and BSV (1.97%).

News - Coronavirus (COVID-19): Market Fear as Implied by Options Prices | European Central Bank

What Happened?

Since the 2020 stock market crash occurred, as a result of the COVID-19 pandemic, the EURO STOXX 50 has been on a slow but steady rise. The Eurozone stock index has increased by around 40%, as the confidence of European investors also saw an uptick in the aftermath of the sell-off in the financial markets. While Europeans are known to be relatively skeptical, the recent measures by countries in the Eurozone to contain the coronavirus outbreak have helped boost investor’s overall confidence. The monetary policy actions of the European Central Banks such as the asset purchase program (APP) have also contributed. The tail risk aversion index helps quantify such claims.

Why Does It Matter?

Tail risk is a phenomenon when the possibility of an investment will move more than its normal return distribution due to unexpected events such as the current health crisis triggered by the Coronavirus outbreak. Although these events have at least a 99.73% probability of not occurring, when they take place, they have historically spread panic across markets as the value of portfolios tend to move more than 3 standard deviations from the asset's average historical return. Left tail events have a devastating impact on portfolio returns as they move more than negative 3 standard deviations from the mean. In other words, they initiate large losses.

In a nutshell, this tail-risk aversion indicator compares the left tails of two metrics to measure investors’ risk aversion.

• The risk-neutral density of an equity price. This metric estimates price expectations and risk attitudes of investors. In other words, it measures the future equity returns based on daily call and put options traded on the EURO STOXX 50, adjusted to the level of investors’ risk aversion.
• Physical density represents investors’ best judgment about the probabilities of future equity prices.

When the index is above 1, investors are more fearful and will tend to pay higher premiums on options contracts than historically recorded to insure against adverse outcomes. As such, risk-neutral density will overstate the potential physical density, in other words, investors’ best judgments about the probabilities of future equity prices being affected by negative tail events.

Conversely, an index between 0 and 1 likely shows a higher appetite for risk and better investors’ judgments. Currently, the EURO STOXX 50 tail risk aversion indicator stands at 0.2 indicating greater confidence for potential equity returns and more appetite for riskier assets such as Bitcoin.

While the EURO STOXX 50 index is -14.2% since its pre-COVID-19 level in early March 2020, Bitcoin has risen by 10.1% over the same time frame. This market rebound once again seals the narrative of Bitcoin as digital gold for European investors, especially in circumstances where social distancing is required. According to a survey conducted by Fidelity Investments, in Europe and the United States, 45% of respondents are invested in cryptoassets. In fact, there’s been an outflow of money from private banks going to Coinbase accounts and to more traditional investment vehicles such as the 21Shares Bitcoin ETP, ABTC.

Nonetheless, with a potential second wave on the horizon, drastic lockdown measures as the ones earlier this year could hurt European investors’ confidence. But only time will tell, at 21Shares, we will closely follow how the future pans out.

Learn more here.

Bitcoin is a new type of money - The Federal Reserve of New York

What Happened?

Last week, the editorial section of the Federal Reserve of New York, Liberty Street Economics, argued that Bitcoin is not a new type of money. Instead, the authors pointed out that Bitcoin’s innovation lies in a new type of exchange mechanism, unseen in history, chiefly an electronic exchange mechanism that does not rely on a trusted third party. Additionally, the authors speculated that, along the way, this new type of exchange mechanism could unleash new ways to facilitate the transfer for various assets in the future.

Why Does It Matter?

While such information is not new nor groundbreaking to those involved in the cryptoasset industry, a positive mention of Bitcoin is an important step towards more investor awareness and acknowledgement from the traditional financial world. Especially in a case such as this where Bitcoin is featured in a prestigious editorial section owned by the Federal Reserve of New York.

For the record, the Fed of New York holds the world's largest depository of gold, stored on behalf of numerous government institutions from around the world. As mentioned in this article, the innovation behind Bitcoin will undoubtedly pave the way for alternative means for the transfer of assets. Only history will tell if eventually, the Federal Reserve of New York and other central banks will consider storing Bitcoin, as the need for neutral custodians might become of importance in the cryptoasset industry.

Learn more here.