Q9 Markets | Great Expectations

22 July 2022

Q9 Capital: www.q9capital.com

Great Expectations

• Strong market rally led by Ethereum, Merge expected in Sept
• Growth equities rise, beat earnings forecasts
• 3AC, Celsius bankruptcy filings provide needed transparency on exposures and risks

A rally in crypto markets over the past couple weeks has suddenly built into something substantial, with the total market cap of crypto reclaiming $1tn, up from around $800mn in June.

The rally was very much Ethereum led, jumping to $1,576(+32%) following a developer proposing Sept 19th as the date for The Merge. ETH is now up 73% since the June 18th bottom. Bitcoin reached $24k mid-week before closing the week at $23,164 (+12%).

Other tokens also followed with Polygon (+28.2%), Avalanche (+26.9%), Solana (+16.4%) and Cardano (+13.4%) all posting significant weekly gains. Outside of the majors, ApeCoin’s APE surged +37.2% as buying momentum from last week’s metaverse game demo continued.

ETH/USD, BTC/USD, Nasdaq (NDX), % Change 7 Days

Source: TradingView

The recent gains can be attributed to a combination of factors: speculation that the Fed won’t be as aggressive in tightening monetary conditions as feared; better than expected earnings from major US firms; Ethereum nearing The Merge; and transparency on exposures and counterparty risks in the market following the bankruptcy filings from Three Arrows Capital and Celsius.

The crypto Fear and Greed Index, a factor model on market sentiment, has climbed out of the “extreme fear” zone for the first time in 72 days (its longest ever period ever in the red).

Positive Earnings

Earnings season is back in full swing with companies unleashing a deluge of quarterly numbers. This week was a monster for earnings: huge names in airlines, banking, casinos, homebuilding, payments, telecoms and trucking providing visibility into the economy.

Positive results offered respite to investors worried about higher inflation and a tightening Fed denting the corporate bottomline. Growth equities led value equities as the US stock market ground upwards, bucking a reasonably consistent trend of value leadership in 2022.

Netflix lost less subscribers than feared, Goldman Sachs blew away forecasts, IBM beat estimates, and Tesla sales came in above expectations. Amazon, Apple, Coca-Cola and other important consumer names are releasing their earnings next week.

These results are important for crypto markets in the near term — they show how the broader economy is functioning, how consumers are spending, and what the risk appetite is amongst investors.

Source: Bloomberg

Tesla’s earnings report also revealed that they sold 75% of their Bitcoin holdings worth $936mn, leading the cryptoassets price to retreat slightly from $24k.

Gold dropped to a 15-month low as the European Central Bank hiked interest rates for the first time in 11-years. Bullion is struggling to maintain its traditional status as a haven asset.

Surge on the Verge of the Merge

Ethereum is up 32.3% over the week, outpacing almost any other assets you can bet on. Traders are turning bullish as the protocol nears the end of a multi-year, hyper-complicated upgrade.

The rally began last week after Ethereum developer Tim Beiko proposed Sept 19th, during an open developer’s call for the network to finally switch from proof-of-work, an energy intensive way to secure blockchains, to the environmentally friendlier proof-of-stake protocol.

The final testnet deployment for the next iteration of Ethereum is set to go live on the Goerli test-network in three weeks. Ethereum’s devs then hope the code for The Merge will undergo minimal changes between launching on Goerli and hitting the mainnet in Sept.

The move will kick miners off the network in favor of Proof of Stake validation, ushering in a 90% drop in new ETH issuance and a more than 99% reduction in the network’s electricity consumption. The upgrade is tipped to render Ether deflationary, meaning that more supply will be destroyed through Ethereum’s burn mechanism than is created through rewards to validators.

So, what exactly is being Merged? The upgrade will combine the current Proof-of-Work blockchain with a Proof-of-Stake blockchain called the Beacon Chain, which has been running since 2020. Once complete, the Beacon Chain will take over the process of validating new transactions. Hundreds of thousands of validators have already staked more than 13mn ETH on the Beacon Chain.

Despite gains from other Layer-1’s, Ethereum remains the top revenue generating blockchain by far and The Merge is incredibly important for the crypto ecosystem as a whole.

Affidavit and Goliath

With the disclosure of liquidator documents, it is now known who lent the money to Three Arrows. The company owes $3.5bn to 27 different companies, however since most of the loans are secured, the total loss should be in the range of $1–1.5bn. These filings provide the market with much needed transparency and information to price counterparty risk accordingly and understand the extent of the exposure.

The largest creditor is Genesis Trading who are owed $2.3bn. Fortunately the Genesis loans were partially collateralised, so their losses are estimated at around $1.1bn.

The filings also accuse Zhu and Davies of using company funds to pay for a new $50mn yacht and other properties.

Crypto lender Celsius Network revealed a $1.2bn hole in its balance sheet in its court filings. It showed assets of $4.3bn and liabilities of $5.5bn, of which $4.7bn is owed to its users, who number 1.7mn as of this month.

In other crypto contagion news:

• BlockFi is offering its employees buyout options as a way to stealthily reduce its workforce. This comes a month after the crypto lender cut employee numbers by 20%. Blockchain.com is cutting 25% of its workforce. Gemini exchange is also trimming its headcount.
• Seven crypto exchanges in South Korea have been raided by prosecutors in connection with a criminal probe into failed decentralized stablecoin producer Terraform Labs
• Coinbase temporarily shutting down its US affiliate marketing program due to “market conditions” has spiked a round of rumours on Coinbase’s financial health.

The Power of Narrative

Virtually all that’s left now before The Merge takes place is a dress rehearsal.

The Merge would be the most sophisticated upgrade in the crypto industry’s 14-year history. It would move ETH to a less environmentally taxing system and improve the functionality of the most-used blockchain.

This major event is catalyzing a return to optimism in crypto markets after a months-long slog of depressed prices and is providing an important narrative for the market to gather around.

Narratives are important in markets: they are central to sensemaking and the attribution of meaning to events, they lubricate the exchange of information, inspire change, guide action, and are a central form of knowledge transfer and storage in communities.

Following the disastrous first half to the year, The Merge could help change the narrative and put crypto in the news under a positive light. There’s a growing acknowledgement that The Merge could drive the market.

Analysts are also suggesting that the worst of this year’s price crash might now be over, with many leading indicators turning more bullish. Demand among retail investors is improving, and the intense phase of deleveraging appears to be over. A compelling narrative will be a key ingredient to drive the market to previous heights and beyond.

“Suffering has been stronger than all other teaching and has taught me to understand… I have been bent and broken, but — I hope — into a better shape” — Charles Dickens, Great Expectations

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