High Volatility Is On the Horizon

Bitcoin futures and options markets are pricing in higher volatility in the near future. Meanwhile, on-chain activity remains firmly in bear market territory, but continues to recover meaningfully.

High Volatility Is On the Horizon

Bitcoin markets have seen another week of low volatility and price consolidation, trading up from $37,680 and towards the range high of $42,312 over the weekend. As prices trade within this narrow range, and volatility is squeezed out of the market, the odds of higher volatility in the near-term builds.

In this edition, we will focus on three core areas of the market, in an attempt to characterise the most likely mechanisms driving the next major move in the market:

  • Geographical dominance of buy and sell-side pressure using a suite of newly released metrics.
  • On-chain activity and supply maturation metrics which describe the recovery of the network user-base in bear markets.
  • Derivatives markets which price in current, and future volatility, as well as provide insight into behaviours associated with risk-neutral cash and carry positioning.

Executive Summary

  • Current buy side demand appears to be dominated by US and EU markets, with the majority of sell-side sources during Asian trading hours.
  • Bitcoin network utilisation and on-chain activity remains firmly within bear market territory, albeit is recovering. A sustained upwards impulse in network activity would likely be constructive, whilst deterioration likely favours the bears.
  • The amount of BTC supply absorbed during the current drawdown is similar in magnitude to the period after the March 2020 sell-off. However it remains modest at best, and is a key metric to keep an eye on in coming weeks.
  • Derivatives markets are currently pricing in historically low implied volatility, and futures premiums. Such market structure has historically preceded periods of very high volatility, and most often to the upside.


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Western Markets Bid, whilst Asia Dominates Sell-side

We released a suite of three new metrics last week, which track the cumulative 30-day price change in US, EU and Asian trading hours. These metrics provide insight into which geographic areas of the market are leading, or lagging in buy and sell-side pressure, particularly in reaction to fundamental changes in market structure.

Over the course of 2020 to 2022, US and EU markets have acted similarly with the following general structure:

  • General accumulation and bid support following the March 2020 sell-off. This is likely in response to the expansionary monetary policies, and fiat currency debasement enacted by western central banks at this time.
  • Heavy buy side during late 2020 to early 2021 bull market. US markets led this demand side through to January, with demand from European market bid support being heaviest in the Mar-May 2021 top.
  • Both regions capitulated throughout May-July, although the US notably led buy side recovery into September. There was notably less buy side from US and EU at the November top relative to August.
  • Europe is providing the largest bid support at present, although overall price changes are only moderately positive, and yet to signal the return of sustainable bull market style demand.
Live Workbench Chart

Asian markets tell a notably different story. In the chart below, we show US (blue) and EU (purple) ghost traces for ease of comparison. For Asian markets:

  • Primarily sell-side pressure after March 2020, potentially signalling a very different market expectation regarding the impact COVID would have on the global economy.
  • Notably lower participation and buy side demand throughout Q1-Q3 of 2021, however notably, demand in Asia peaked around the lows of bull market corrections.
  • Wide-scale sell-side at the lows in July 2021, with demand only peaking at the Oct-Nov All-time-highs. All three regions 'bought the top' at this time, but Asian demand eclipsed both US and EU.
  • Heavy sell-side dominance during the current draw-down, which has been sustained since December 2021, and is likely in response to heavier buy-side at the top.
Live Workbench Chart

New Glassnode Content

Part 3 of the Bear Market Survival Guide is live, focusing on late stage bears, and observations related to the final Capitulation Event.

The On-chain Recovery Grinds On

A useful tool-set for tracking Bitcoin demand is the analysis of on-chain activity, ranging from active addresses, new on-chain entities, transaction counts, and transfer volumes. Typically we see these style activity metrics collapse during early bear markets, and begin to signal recovery as smart-money demand increases at depressed prices.

Note that a new On-chain Entity is defined as a cluster of addresses that have no association with existing clusters. This metric therefore reflects new entrants to the network, or existing entities whom are not interacting with their existing addresses (e.g. HODLers with good privacy practices who avoid address re-use and combining UTXOs).

We can clearly see the accelerated growth rate in new on-chain entities a bull (blue), followed by a heavy collapse at the start of a bear (pink). Bear markets are characterised by a fairly persistent grind higher in new entities entering the Bitcoin network.

The current rate of 110k new on-chain entities per day is similar to the peak of the 2019 mini-bull, and is on a modest upwards trajectory.

Live Chart

A similar trend is observable in transaction counts, although the current rate of 215k Tx/day is lower that what was observed throughout 2019.

For metrics like active addresses, new on-chain entities, and transaction counts, an accelerated growth rate higher would be a constructive signal, and likely support a healthy recovery in prices. Conversely, a deterioration in network utilisation would be a more bearish observation, and one to watch out for as a sign of demand exhaustion.

Live Chart

One piece of data that is not captured by the analysis of active addresses/entities and transaction counts is the economic weight of these network users. Where the general characteristics of the above metrics are similar to the 2019-20 bear market recovery, transaction volumes and value settlement are notably different.

The 2017 bull market top was followed by a near complete 'destruction' of the new transaction volume that pushed prices to the cycle all-time-high of $20k. Throughout 2018 and 2019, daily settlement volume languished at around $1.5B/day, a level first established in July 2017. Large size transactions (>$1M in value) represented between 10% and 30% of all volume at this time.

In the 2021-22 bear market however, total daily value settlement has continued to trend higher, as measured at the lows of both 50%+ draw-downs. Large size transactions also now represent a sustained 65% to 70% dominance.

Note that transaction volumes are currently at the lows of this established range, and a severe decline may signal a reduction in network utilisation, and would likely favour a bearish case.

Live Chart

The current drawdown has now been in play for 132-days since the Nov ATH, and the tail of our 155-day threshold used to define Long-Term Holder status is approaching the October price high. As such, we can make a broad assertion that Long-Term Holders own coins before the market high, and Short-Term Holders own coins purchased during or after the market top.

With this in mind, we can see that Long-Term Holder (LTH) supply holdings have stagnated since the October peak. This suggests that the volume of coins maturing into LTH status, is being met by equal spending pressure by this cohort.

Live Chart

To assess whether Short-Term holders are likely to become LTHs, we can look to the 3m-6m old HODL wave band. This age band is selected due to these coins being accumulated and HODLed through the worst phase of this drawdown. This likely increases the odds that the owners are more price insensitive (else they would have spent and redistributed already, as many have, described in Week 9).

The volume of coins that have now entered this age band is currently at 480k BTC, which is large on paper, but remains well below what we have seen preceding significant bullish impulses in 2019 and 2021. It is however similar to the March 2020 accumulation of 510k BTC, which is noteworthy given the scale of that economic shock is comparable to current conflict, commodity inflation, and supply chain disruptions.

Continuation of an uptrend in both of these supply held metrics would be constructive, however declines in both would suggest a lack of incoming accumulation alongside increasing spending by LTHs (Bitcoins stronger holders).

Live Chart

Derivatives Price in Volatility Ahead

In our newsletter published in mid-Feb (Week 7) we described how derivative markets were pricing in uncertainty and risk, largely associated with impacts of the Federal Reserve rate hike in March. With the Fed having announced an expected 0.25% to 0.5% rate hike this week, both futures and options markets are beginning to price in higher implied volatility in the short-term.

The futures market term structure remains either flat, or in backwardation for all exchanges through to April, with only a 4.46% annualised premium priced out to years-end.

Live Chart

Implied volatility priced into at-the-money options markets is also climbing in recent weeks. This is despite prices trading in a sideways range which usually lead a compression in implied volatility.

Options implied volatility is coming off relatively low levels between 60% and 80%, which have historically been followed by periods of extremely high volatility. Such high volatility events in 2021 include the May sell-off, the short-squeeze in July, and the October rally to ATHs.

Live Chart

If we look to the degree of leverage in Futures markets, we can see that open interest is on a steady ascent, reaching 1.94% of the Bitcoin market cap. Through 2021, leverage ratios of more than 2.0% of market cap have historically been high risk periods, often followed by a violent de-leveraging event (either a short or a long squeeze).

Live Workbench Chart

Note that given the relatively poor price performance of markets of late (both Bitcoin and TradFi) in recent months, there are two likely mechanisms driving this basis compression:

  • Risk neutral cash and carry trades, as investors seek any available positive rates of nominal return.
  • Short sellers and risk hedging via futures in preference to the sale of spot to reduce net exposure (explored in the Week 7 newsletter).

As a result of increased demand to capture futures premium during this drawdown, we can see that the 3-month rolling basis has compressed to an annualised return of just 3.5%. Basis compression to this extent has only been seen in Sept 2020, and at market the lows in June-July 2021, both of which preceded very violent upside rallies.

Live Chart

Of particular note is the open interest leverage in perpetual futures markets. Here we can see that the total value of open interest in perpetual swaps is now 1.28% of the Bitcoin market cap, which is a historically high risk zone. It also demonstrates that the market is currently preferentially deploying capital into perpetual swaps, rather than expiring futures.

Live Workbench Chart

If we calculate the annualised rolling basis from perpetual funding rates (pink), we can compare to the rate of return available from the rolling premium priced into 3-month expiring futures (blue). From this study, we can draw the following conclusions:

  • Perpetual futures basis are significantly more volatile than that of expiring futures. This is likely a result of demand for leverage in an instrument that closely tracks spot markets via price indexes, and the subsequent incentive that funding rates creates for traders to take the other side of the trade.
  • Periods where perpetual basis trades lower than 3M basis have historically reflected periods of near-term undervaluation (marked in green), either at the lows of bull market corrections, or during more prolonged bearish trends.
  • Conversely, periods where the perpetual basis is significantly higher than 3M basis have signalled short-term market tops when the demand for leverage in perpetual markets creates an oversupply as traders arbitrage down high funding rates.

The perpetual futures basis has now traded below 3M basis since mid-November, and is in the process of breaking above it. In combination with the above observation that 3M rolling basis is historically low, this suggests that a regime change in market structure, and higher volatility likely lies ahead.

It also suggests that a maximum number of traders are in risk neutral positions (cash and carry), and perhaps waiting for confirmation to deploy capital into a trend.

Live Workbench Chart

Summary and Conclusions

The Bitcoin market has now been in a drawdown from the November ATH for 132-days, and prices have consolidated inside the present trading range for over 2-months. This has lead to a compression of yields available from cash-and-carry trades in futures markets, and lower implied volatility in options markets.

At the moment, we have implied volatility climbing, and leverage ratios in futures markets approaching overheated levels, particularly across perpetual futures. Market structure such as this has preceded periods of very high volatility, as was seen in May 2021, and Aug 2021, and thus suggests a regime of higher volatility may be around the corner.

On-chain activity and supply dynamics remain firmly in bear market territory in magnitude and trend, but are somewhat directionless in their forward bias. Should evidence of strength appear in the form of accelerating on-chain activity, and increased supply migrating into long-term holder hands it would favour the bulls, especially given volatility expectations. Similarly, deterioration would favour the bears.

The market spring appears to be coiled, and a period of higher volatility just over the horizon seems increasingly likely.

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Disclaimer: This report does not provide any investment advice. All data is provided for information purposes only. No investment decision shall be based on the information provided here and you are solely responsible for your own investment decisions.