Institutional top of mind | #5

Keep up with the top industry updates as we present bi-weekly market insights that are important to traders in the institutional space.

This week, Kelvin Lam, CFA, Head of Institutional Research for OKX, looks at one top-of-mind issue in this installment: how these three key market drivers present a compelling opportunity for crypto assets in Q4.

Top of mind: unveiling the three key drivers shaping the crypto market in Q4 2023

TL;DR

As we enter the last quarter of the year, our focus shifts towards providing key market drivers that are top of minds for institutional traders. The macroeconomic landscape stands at an intriguing juncture, while historical patterns and fundamental drivers offer valuable insights into the dynamics of the digital asset space during this critical period. In this edition of our newsletter, we delve into the three key drivers expected to shape the crypto market as we approach the year's culmination.

The challenging macro environment

• As pointed out in the previous edition published on September 6, we reiterate the strong correlation between Bitcoin and M2 money supply. Recent data from FRED* indicates a decrease in M2 supply in August, reaffirming the continuation of this relationship. Moreover, recent inflation and employment data** paint a picture of a robust economy, devoid of any clear signals prompting central banks to pause quantitative tightening (QT) or initiate a policy pivot. Consequently, global bond markets have experienced a significant sell-off, propelling treasury yields to levels unseen in the past 16 years (refer to the chart below). It's worth noting that the last time treasury yields reached these levels, Bitcoin had not yet come into existence. In fact, the current market environment is undergoing an adjustment to a new regime, leading to heightened uncertainty and increased volatility as market participants adapt to these evolving dynamics. Shifting our attention to the fiscal front, concerns had arisen regarding a potential US government shutdown, which has now been extended by an additional 45 days until November 17. Unless a bipartisan solution is reached, this issue will once again take center stage as the new deadline approaches. The persistence of these uncertainties further contributes to the prevailing market volatility throughout the remainder of the year.

* Board of Governors of the Federal Reserve System (US), M2 [M2SL], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/M2SL, October 5, 2023.

**US Bureau of Labor Statistics, US Inflation Rate (Aug), September 13, 2023; US Nonfarm Payrolls (Sep), October 6, 2023.

Source: TradingView

Bitcoin's seasonal strength

• Amid a challenging macro environment, there's a distinguished positive seasonal pattern for Bitcoin over the last 10 years. Analyzing historical monthly return for BTC, both October and November stand out as the best-performing months for Bitcoin, with an average return of 20.5% and 50.6% over the past decade. October recorded a hit rate of 80%, and it was up in all the last four years (see table below). Expanding our view to Q4, although the hit rate diminishes to 60%, the average return remains exceptional at 83.6%. History doesn't repeat itself, but it does often rhyme. While there are various fundamental and technical factors that explain the seasonality pattern at different points in time, it can be seen as a phenomenon of self-fulfilling prophecy, wherein traders tend to adopt a more optimistic stance due to the observed seasonality pattern. This behavior can be further reinforced and consolidated due to lowered trading volume and market participation in recent months. In short, the market appears to be in anticipation of a potential catalyst that could trigger a Bitcoin rally as we head into Q4. Any positive news has the potential to propel an upside breakout, aligning with the observed seasonality patterns.

Source: OKX

Resurgence of stablecoins activity

• A notable trend in the cryptocurrency market that's shown signs of reversing in recent weeks is the total market capitalization of stablecoins. After experiencing a decline, the total stablecoins market cap has started to stabilize and has even rebounded since mid-August this year (see chart below). Stablecoins play a crucial role in providing liquidity within the cryptocurrency market. The stabilization and potential increase in stablecoins supply indicate a resurgence of available capital that can be deployed in the cryptocurrency market. In addition to the established and dominant stablecoins, there have been new market entrants in the past two months, and their supply continues to experience healthy growth, as shown in the chart below. One notable example is PYUSD (PayPal USD), which is backed by one of the world's largest payment companies. Although currently limited to eligible customers in the US, the involvement and adoption of stablecoins by more institutions can potentially reduce friction in fiat-crypto conversions. There's also a flurry of activity happening behind the scenes in the stablecoins space. Paxos, for instance, has publicly mentioned working on white-label stablecoin opportunities with major technology and financial services companies. Additionally, several jurisdictions like Hong Kong, Japan, and Singapore have launched pilot projects focusing on stablecoins or central bank digital currencies (CBDCs). These developments further underscore the growing interest and experimentation with stablecoins in various parts of the world.

Source: DeFiLlama

In conclusion, while the macroeconomic environment introduces elements of uncertainty that may affect crypto assets, there are positive market developments that point to a potentially brighter Q4 for the crypto market. These factors also suggest that major crypto assets offer a compelling opportunity to outperform broader risk assets from an asset allocation standpoint. It's important for traders to closely monitor evolving market dynamics, seasonality patterns, and stablecoins adoptions, as these factors will shape the trajectory of the crypto market in the final quarter of the year.