"Where is the Crypto Market Heading?"

Aaro Capital

Where is the Crypto Market Heading?

Following the all-time highs in November 2021, the crypto market plunged in May and June 2022, hitting the mainstream media for all the wrong reasons. Started by the LUNA stablecoin collapse, the market selloff resulted in huge losses by some major crypto market players, the biggest being Three Arrows Capital. Its default and bankruptcy had a negative knock-on effect for the majority of centralised crypto lending businesses, some crypto exchanges and hundreds of crypto projects and funds. These events has forced the crypto market into a liquidity crunch, caused a large unwinding of leverage and a major withdrawal of credit from the ecosystem. However, this is far from being the first bloodbath that the crypto market has experienced.

The main fundamental issues which caused the market turmoil are hardly new: currency peg breaks, high leverage, volumes driven lending with insufficient risk management, or duration mismatches between deposits and loans. These market issues have been observed hundreds, if not thousands of times in traditional financial markets. 

Crypto market cycles

The crypto market has historically followed a 4-year market cycle relatively closely, with exuberant and parabolic market peaks followed by severe and painful bear markets. These market cycles have roughly followed Bitcoin's so-called halving events, which half the rate of new bitcoin supply. We are currently coming to the end of the third crypto market cycle with reliable trading prices, with the next bitcoin halving projected for April/May 2024. Historically crypto bull markets have started more than a year before the bitcoin halving event, possibly driven by the anticipation of the lower future supply and the completing of the washout of the previous market cycle.

A key aspect in determining where we are in the crypto market cycle is comparing prices relative to previous bitcoin bear markets and observing market corrections. While the particulars of each market cycle are different, the dynamics of each cycle are similar.

The maximum drawdown of the current market cycle has so far been less severe than previously. The crypto market tops and bottoms appear to be becoming less extreme over time as the market matures. Taking this into account, we could see the maximum drawdown of the current market to be less severe than in previous cycles which in turn might suggest we could be near the market bottom.

Where we are in the current crypto market cycle

One of the data sources that might shed some light on where we are in the current market cycle is blockchain data. It provides the ability to recognise patterns and behaviours of the users of the blockchain via their transactional data, known as on-chain data. This data generally points towards the market being in a late-stage bear market. The bitcoin mining industry also appears to be under financial stress, which has historically happened in the final stage of bear markets.

A more traditional way of accessing market health is technical analysis, which attempts to understand at which prices the market is willing to buy and sell. These again point towards a late-stage bear market, with many indicators recently being at record lows and the most oversold conditions ever.

Where the market is heading

Overall, the analysis of cryptoassets market data, in particular the bitcoin ecosystem data, clearly points towards the market currently experiencing a late-stage bear market. Whether we have already seen the market bottom or if it is still to come, is never clear until the next bull market has firmly taken hold. Identifying market tops and bottoms “in the moment” is more of an art than a science.

Nevertheless, the next few months are likely to be volatile with a high degree of uncertainty. The fallout from recent market events, from the LUNA stablecoin collapse to the bankruptcy of Three Arrows Capital to the contagion to many of the centralised crypto lenders, has not yet fully worked its way through the system. There may still be unknown events in the shadows waiting to rock the market. If these risks are realised, this could push the market below its June 18th lows.

Beyond these short-term risks, we expect the crypto market to follow previous crypto market cycles, relatively independently from wider macro conditions, unless there is a widespread liquidity crunch which causes all asset to sell off. A “U shaped” bottom is the most likely formation with a gradual recovery possibly taking hold by the end of 2022. If traditional markets continue to deteriorate, this will lead to a decupling of crypto markets from traditional markets, with correlations having traded downwards since May 2022. We expect 2023 to be another bright year for crypto, where the next crypto bull market will start to gain momentum.
 

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