In a week in which we are yet again reminded how sharply sentiment can shift in crypto asset markets, it’s appropriate to look at the role volatility plays in our narratives, our portfolios and our psyches.
I also want to examine what volatility is not, as its specter takes on a disproportionate influence in times of turmoil.
This confusion is not unique to crypto markets – volatility is misunderstood across all asset groups. As with virtually all market metrics, however, it has particular nuances when applied to our industry.
Setting the table
First, let’s review what we mean by volatility. Technically, it is the degree to which an asset price can swing in either direction. Generally, by “volatility” we mean realized volatility, which is derived from historical prices. This can be measured in several ways – at CoinDesk we take the annualized rolling 30-day standard deviation of daily natural log returns.
Implied volatility represents market expectations of future volatility, as inferred from options prices. More on this later.
The volatility of an asset is an important part of its narrative, especially in crypto markets, which are associated with volatility in the minds of many investors. A survey of institutional investors, carried out earlier this year by Fidelity Digital Assets, singled out volatility as one of the main barriers to investment.
This is because many investors conflate volatility with risk. This is a fundamental investment error that says more about our psychological makeup than it does about our portfolio management insight.
We are, as a species, risk-averse, and have needed to be for survival. This extends to our vocabulary – higher risk also means the possibility of higher rewards, but you don’t hear anyone claim to be reward-averse. “Risk” will forever be associated with something bad, especially when it comes to investments. Investment advisors don’t warn about “upside risk.”
Our aversion to risk when it comes to finance is understandable. Risk implies irredeemable loss, which can mean total ruin for some. Yet the degree of our aversion is generally not compensated by the actual possible loss, especially in mature markets where downside can be managed. In other words, our fear of risk may be prudent but it is usually not rational.
Conflating volatility with risk makes the former also something to be avoided, in the minds of most investors. Yet volatility is not the same as risk. Volatility is a metric, a number, a measurement. Risk is an ambiguous concept.
A high volatility implies that the price can experience a handsome rise. It also means that it can come down sharply, and that possibility of doing us harm is what leads us to conflate it with risk and instinctively avoid it.
The fact that the CBOE Volatility Index (VIX), which measures the S&P 500 implied volatility, is also known as the “Fear Index” gives an idea of what a bad rap volatility has.
Conflating the two concepts leads us to another potentially dangerous disconnect: If we equate volatility with risk, then we are implying that we can measure risk. We can’t. Risk is based on the unknown. Bad things can happen from any direction, at any time, at any speed, in an infinite array of forms and configurations.
Volatility, on the other hand, is knowable. Implying that risk is knowable could lead us to underappreciate the potential damage.
Telling a story
Not only is volatility knowable; it can also tell us much about any given asset. Generally, the higher the volatility, the higher the return – but not always. When constructing a portfolio, the relative volatilities should be compared to the relative historical returns to evaluate whether the additional “risk” is worth it.
For instance, the 30-day volatilities of ether (ETH) and Litecoin (LTC) have been similar, while the returns over the same period have been notably different. (Note that historical performance does not guarantee future performance, and none of this is investment advice.)
Not only can we glean stories from recent (“realized”) volatility, we can also calculate investors’ expectations of volatility looking forward, through options prices. If this “implied” volatility is higher than realized volatility, that tells us that investors expect volatility to increase. The implied-realized differential has been positive in the past, but earlier this week it reached its widest point in over a year. That’s the market saying “buckle up.”
Crypto is different
Bitcoin (BTC) is the benchmark crypto asset, the oldest and the most liquid, and easily the one with the most developed derivatives market. Traditionally, the introduction of derivatives mitigates an asset’s volatility, as it adds liquidity and hedging opportunities. Not surprisingly, for this reason bitcoin’s volatility is among the lowest of the crypto assets.
What is surprising is that bitcoin’s volatility often moves in the same direction as the price. That is, when the price comes down, so usually does the volatility.
The VIX, on the other hand, tends to move inversely to the S&P 500. The average 60-day correlation between the two for the month of August was -0.84, an almost perfect negative association. Using bitcoin’s 30-day realized volatility as a proxy for a bitcoin VIX, we get an average 60-day correlation for August of 0.45. A very different scenario.
Another peculiarity of crypto volatility is that crypto markets trade 24/7. Traditional markets don’t. So, measures of traditional asset volatilities are working off fewer data points than crypto assets. Theoretically, were stocks to trade on Saturdays and Sundays, we could have a wild swing up on one day followed by a wild swing down on the other, with the Friday-Monday measurement showing no volatility at all. These movements are captured in crypto asset volatility calculations.
In reality, this doesn’t seem to matter too much for the bitcoin narrative – the 30-day average volatility for BTC when you take weekend trading out of the equation is not that different from the full data set result. For August, for instance, the monthly average using daily standard deviations was 51.2%, while the monthly average using only S&P 500 trading days was 51.6%.
So, volatility is higher in the crypto asset markets. It is also more measurable, in that there are a greater number of data points from which to glean information.
And finally, the relatively high volatility of crypto markets is a barrier for some but a magnet for others. Many professional traders have entered the crypto market because of the volatility. They bring with them liquidity which reduces spreads and further pushes market maturation forward. And as one asset’s volatility starts to settle down, another younger, more restive asset is but a couple of clicks away.
Volatility may not be for everyone, but it should be respected and harnessed, not avoided. Bitcoin has a lively derivatives market to help manage that volatility, and that of ether (the second largest cryptocurrency by market cap) is rapidly growing.
All portfolios aim to have a mix of volatilities, with the relative weightings determined by individual investor profiles and preferences. The high volatility of bitcoin should not be a reason to stay away. Just the opposite – it gives the asset group an even more compelling role in asset diversification. As investors of all types get more comfortable with the main fundamentals supporting the value case for bitcoin and other crypto assets, and as the volatilities become more manageable, we are likely to see this particular characteristic become less of a barrier and more as a quality to be embraced.
Anyone know what’s going on yet?
Just when there seems to be glimmers of vaccine-related hope, markets around the world lose their enthusiasm and head down. At time of writing on Friday afternoon, the board is a sea of red, with the Nasdaq leading the dip.
So far the moves are barely a blip on the charts, but the mood seems to have shifted. To highlight the shaky ground on which the tech stocks’ recent gains stand, the Cboe Nasdaq 100 Volatility index (VXN) reached its highest differential with the S&P 500’s VIX equivalent since 2004.
This correction could be temporary, but it feels like election fear is muscling its way to the front of the queue of big-things-to-worry-about, understandable given the escalating mutterings about the possibility of no conclusive result. I imagine that if there’s one thing markets don’t like, it’s not knowing who the leader of the Free World is going to be.
Bitcoin, as usual, showed investors that it wins at volatility, with weekly losses several times greater than the main stock market indices. While analysts scramble to make sense of the move, bitcoin yet again has thrown its narrative up in the air – not quite a safe haven, not quite a correlated asset – and who knows where it will land.
Tyler and Cameron Winklevoss, founders of crypto exchange Gemini and investment firm Gemini Capital, have laid out their macroeconomic thesis on bitcoin and why they believe it could go to $500,000 (spoiler, it’s to do with the value of gold). TAKEAWAY: One criticism often labelled at tech people touting a new form of finance is that they are trying to fix a problem they don’t understand. That doesn’t mean we shouldn’t check out the potential solutions, though, as long as we are aware that every solution does bring with it new problems. And sometimes a view from outside an industry can highlight big-picture issues that are hard to see from within. The whirlwind of ideas is the key to understanding both the problems and the potential, so, whether you or agree or disagree, essays like this are worth a read.
Ark Invest has produced, in collaboration with Coin Metrics, an excellent treatise on the role of Bitcoin as an economic institution. It points out why the current financial system falls short of basic economic assurances, how Bitcoin can satisfy them, and some excellent charts that make it easy to understand some of Bitcoin’s thornier issues such as governance.
The open interest in options on ether (ETH), the native token for the Ethereum blockchain and the second-largest crypto asset in terms of market cap, has reached a record high on leading crypto options exchange Deribit. TAKEAWAY: This signals a growing maturity in the ether derivatives space which in turn should support greater trader interest in both the derivatives and the underlying asset. ETH is generally more volatile than bitcoin (BTC) – a more robust derivatives market might tame some of that volatility, which would also make it more attractive to longer-term investors.
Crypto lending firm BlockFi now offers yield on PAX Gold (PAXG, a gold-backed token issued by Paxos) and stablecoin tether (for non-U.S. accounts). TAKEAWAY: According to the company, the initial APY on PAXG will be 4%. This is interesting because yield on gold has been an elusive concept for centuries. There are traditional platforms that offer interest on gold deposits, but the custody angle is cumbersome. Here, BlockFi is offering yield not on gold itself but on a token issued by Paxos, backed by physical bullion. This sounds more liquid and more flexible. It also allows clients to use PAXG as collateral for loans. PAXG volume has shot up over the past couple of months after a slow start, so it will be worth keeping an eye on whether this propels it even further.
And speaking of tether (USDT), derivatives exchange Opium has introduced credit default swaps for the world’s largest stablecoin and the fifth largest cryptocurrency overall. TAKEAWAY: This pays out in the event of default by Tether, the issuer of USDT. The token has become the de facto base currency for most crypto trades, and the very idea of it breaking would send tremors through the market. Last year there was turmoil when Tether was having banking issues and it turned out that not all of the issued tokens were 1:1 backed with U.S. dollars. Since then, the market has settled into a new kind of trust, and for many, the idea of Tether folding is laughable. For others, it’s terrifying.
Huobi Futures, the crypto derivatives unit of Huobi Group, now offers trading in weekly, bi-weekly and quarterly bitcoin options. TAKEAWAY: Deribit is such a giant in the crypto options market that challenging it will be tough, but greater diversity and liquidity in options will be good for the market as a whole. A lively options market not only supports hedging strategies, it also encourages new investment by mitigating volatility, and it gives rise to new revenue opportunities for options writers.
Zero Hash, the crypto asset clearing organization spun out from former crypto exchange Seed CX, has closed a $4.75 million funding round led by tastyworks, the owner of the app-based brokerage tasytrade, with other participants including app-based broker-dealer Dough, retail-focused futures market Small Exchange, Bain Capital, TradeStation and others. TAKEAWAY: It’s not a large raise, but it is indicative of the growing interest in crypto market infrastructure. The settlement layer is arguably one of the most immature for now, and its development will be key for more mainstream platforms to enter the industry.
Podcast episodes worth listening to:
Opimas estimates that over US$190 billion worth of Bitcoin is currently at risk due to subpar safekeeping
May 2021. Safekeeping of cryptocurrencies presents a challenge for institutions holding cryptocurrencies on their clients’ behalf. Cryptocurrency transactions are irreversible and anyone with full access to a wallet’s private key controls the cryptocurrencies that reside within it. Frighteningly, a number of institutional participants and even some large cryptocurrency exchanges rely on subpar custody approaches, leading Opimas to estimate that over US$190 billion worth of Bitcoin is currently at risk due to subpar safekeeping.
Luckily, a number of companies have emerged to address this problem. A new research report from Opimas—Crypto Custody: No More Excuses, authored by analysts Suzannah Balluffi and Anne-Laure Foubert—looks at the landscape of cryptocurrency custody-enabling technology providers and institutional-grade cryptocurrency custodians as well as the size of the market for cryptocurrency custody and brokerage services.
Some key findings in the report include:
Many of even the largest holders of Bitcoin and other digital assets continue to rely on storage devices meant for individual investors. Although some of these self-custody devices and wallets are secure and reputable, the operational risk posed by this approach is significant for institutional investors. Furthermore, a chunk of institutionals’ cryptocurrency holdings sit in hot wallets on exchanges. In total, about 22% of institutional cryptocurrency holdings are safeguarded in these relatively risky manners (Figure 1).
Figure 1. CUSTODY METHODS UTILIZED BY INSTITUTIONAL INVESTORS
Source: Opimas analysis.
There are no more excuses for lackadaisical safekeeping – institutions can now choose from several reputable cryptocurrency custody-enabling technology providers and institutional-grade cryptocurrency custodians. Yet no custody solution is equal – there is still no best practice when it comes to security and governance relating to private keys. For example, some providers may rely on time-tested Hardware Security Modules (HSMs), while others use a newer technology known as Multi-Party Computation (MPC) – see Figure 2.
Figure 2. A COMPARISON OF HSM AND MPC TECHNOLOGY PROVIDERS
Source: Ledger, Fireblocks, Opimas analysis.
Some cryptocurrency custodians have followed in the footsteps of traditional capital markets by adding prime brokerage services to their offerings, including trading and settlement, lending, margin finance, staking, reporting, and capital introduction services. Opimas estimates that the current annual revenues generated by the institutional crypto brokerage and custody market are roughly US$2 billion and will grow to nearly US$8 billion by 2026 – a sizeable portion of this coming from brokerage services (Figure 3).
FIGURE 3. THE MARKET FOR CRYPTO CUSTODY & PRIME BROKERAGE SERVICES IS GROWING
Source: Opimas analysis.
- Regulations surrounding institutions’ ability to store cryptocurrency have become clearer (and in some cases more favorable) in numerous jurisdictions. Notably, the Office of the Comptroller of the Currency (OCC) ruling in the US has allowed banks to store cryptocurrencies for their customers. This regulatory clarity has led a number of financial institutions around the world to provide trading and custody for digital assets. With the advances in brokerage and custody solutions, Opimas expects institutional cryptocurrency holdings to grow from 20% of the cryptocurrency market cap to over 50% by 2026 (Figure 4).
FIGURE 4. INstitutional cryptocurrency holdings over time
Source: Opimas analysis.
Source: PlatoData Intelligence
Bitcoin (BTC) Price Prediction: BTC/USD Faces Rejection Thrice at the $60,000 Resistance Zone, Resumes Downward Correction
Bitcoin (BTC) Price Prediction – May 9, 2021
Bitcoin bulls have broken above the $58,000 resistance but the bullish momentum could not be sustained. Today, BTC/USD traded as price reached the high of $59,450. The king coin is likely to retrace to $57,000 low if the bulls fail to break the $60,000 psychological price level.
Resistance Levels: $65,000, $70,000, $75,000
Support Levels: $50,000, $45,000, $40,000
Bitcoin price was rejected thrice at the $60,000 resistance level. Buyers made frantic efforts to sustain the bullish momentum above the recent high but were repelled by overwhelming selling pressure. Consequently, Bitcoin has resumed a downward move as a result of a strong rejection at the resistance of $59,200. The current retracement will extend to the low of $57,000. Nevertheless, if price breaks below the $57,000 support, the market will continue the downward move. That is, the selling pressure will extend to the low of $53,000. On the upside, if price retraces and finds support above $58,000, the upside momentum will resume.
Bank of England Governor Warns on Crypto Investment
Andrew Bailey is the governor of the Bank of England who has warned crypto investors of the inherent dangers of cryptocurrency investment. The governor argued that cryptocurrencies lacked intrinsic value. According to him, “I would only emphasize what I’ve said quite a few times in recent years, [and] I’m afraid they have no intrinsic value. I’m sorry; I’m going to say this very bluntly again: Buy them only if you’re prepared to lose all your money.” Bailey’s comments are coming at a time when crypto markets are characterized by a huge spike in crypto prices. Major altcoins such as Polkadot, Chainlink, and XRP have also seen vertical price actions.
Bitcoin risks another downward correction as the king coin faces stiff rejection at the $59,450 resistance. The Fibonacci tool has already indicated a marginal upward move of Bitcoin and a possible reversal. On May 1 uptrend; a retraced candle body tested the 78.6% Fibonacci retracement level. The retracement indicates that Bitcoin will rise to level 1. 272 Fibonacci extension or the high of $59,819.90. From the price action, BTC price has reached a high of $59,450 and has commenced a downward move.
Dogecoin dumps following mention from Elon Musk on Saturday Night Live
Meme cryptocurrency Dogecoin finally got its long-awaited shoutout on Saturday Night Live — but despite hodler hopes, the immediate result has been a violent dump.
First teased by entrepreneur and DOGE cheerleader Elon Musk in late April, the Tesla CEO finally mentioned the digital asset on live television tonight in his opening monologue of the sketch comedy show. The reference was a throwaway line from Musk’s mother, who joined him onstage and asked if her Mother’s Day gift would be Dogecoin; Musk replied that it would be.
In the minutes afterwards, $DOGE dumped upwards of 25%, falling as low as $.50 from $.66 highs at the start of the show. It has since partially recovered, trading at $.52 at the time of publication.
SNL May 8
— Elon Musk (@elonmusk) April 28, 2021
An hour before the episode began, the price of DOGE sat at $.66, down from an all-time high of $.72. A pair of bearish headwinds may have shared responsibility for the pullback: Musk himself seemed to try and get ahead of the hype, urging followers in a Tweet to “invest with caution,” and a host of new data indicates that many investors may be rolling their DOGE profits into other, largecap digital assets.
Cryptocurrency is promising, but please invest with caution! https://t.co/A4kplcP8Vq
— Elon Musk (@elonmusk) May 7, 2021
Additionally, Barry Silbert — the founder and CEO of Digital Currency Group, the parent company of crypto investment vehicle company Grayscale — announced a public short on DOGE via the FTX exchange. In a series of follow-up Tweets, he revealed that the position was $1 million in size, and that any proceeds or remaining funds after closing the short would be donated to charity.
Okay $DOGE peeps, it’s been fun. Welcome to crypto!
But the time has come for you to convert your DOGE to BTC
[disclosure: we’ve gone short DOGE via https://t.co/s8Qde2Ub4Z]
— Barry Silbert (@BarrySilbert) May 8, 2021
(It’s unclear if Silbert was is using “we” in reference to Digital Currency Group, one of its portfolio companies, or is simply and bizarrely using a plural pronoun in reference to himself).
Many DOGE investors were nonetheless holding out hope for a high-profile shoutout on what looked to be a major pop culture event. NBC, the studio behind SNL, chose for the first time ever to live-stream the episode on Youtube, per the Wall Street Journal.
Even a mention could have significant impact on the price of DOGE as well: the meme currency has proven to be susceptible to price movements based on positive social media volume, and multiple studies have shown that Tweets from Musk often lead to price appreciation. A mention on an even bigger platform was thought to potentially lead to even greater gains.
Leading into the premier of the episode, Alameda Research trader Sam Trabucco (who said in a previous Tweet that he was “studying the typical SNL episode structure to try and understand when a DOGE mention would be the most natural”) speculated that if a joke or mention didn’t come in Musk’s opening monologue, it would be “all over.”
My instinct is if it’s not in his monologue it’s all over.
— Sam Trabucco (@AlamedaTrabucco) May 8, 2021
Despite arriving during the monologue, traders nonetheless responded negatively. It remains to be seen if a DOGE-centric skit later in the show can perhaps turn the speculative asset’s fortunes around.
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