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February 27, 2023

Futures Markets Optimistic as Crypto Prices Rattled by High Inflation Figures

February 27, 2023

After recording a new all-time high for 2023, bitcoin abruptly turned last week as investors eyed worrying inflation data. 

Higher-than-expected PCE figures revealed that inflation may not be falling as quickly as economists first thought. With employment remaining strong, investors are now becoming concerned that the Federal Reserve may increase interest rates quicker at the next FOMC meeting. 

Elsewhere, new entrants were launched into Ethereum’s layer-2 race, and bitcoin futures flag a bullish sign that institutional money is returning.

  • Bitcoin falls alongside stocks as high PCE data spooks investors
  • Ethereum’s layer-2 race heats up
  • Bitcoin futures trade at the widest premium since November 2021

Bitcoin falls alongside stocks as high PCE data spooks investors

Macroeconomic data weighed heavy on investors’ minds last week forcing the price of risk-on assets lower.

Although bitcoin fell during the first half of the week, bearish momentum accelerated on Friday as the US released January’s personal consumption expenditures (PCE) index.

Inflation worries came back to the forefront of investors’ minds as the PCE recorded a higher-than-expected increase of 0.6%. Economists had been expecting a figure of 0.4%.

US Core PCE Price Index year-on-year

US Core PCE Price Index year-on-year

Like the consumer price index (CPI), the PCE measures the price of a basket of goods and services. However, unlike CPI, it sources price data from suppliers rather than consumers, covers all US households rather than just urban households, and includes other expenditures that are not paid directly, like medical bills. 

For these reasons, it has become the favored metric used by the Federal Reserve to guide monetary policy. 

With investors’ eyes now fixated on the 22nd March FOMC meeting, many had been expecting the Fed to implement a mild 0.25% interest rate hike – in line with cooling CPI figures.

However, the higher-than-expected PCE data released on Friday caused concern that the Fed may shock the markets and implement a quick 0.5% interest rate hike instead.

According to the CME Fedwatch Tool, 73% of traders are now expecting a 0.25% hike, while 37% are now expecting a 0.5% hike. Some weeks ago, the ratio had been 99% to 1% in favor of a 0.25%.

The change in investor sentiment was enough to cause bitcoin to fall by over 4.5% for the week and record a weekly low of $22,700. Stocks shared the same fate. The S&P 500 fell over 2.02% and the Dow Jones fell 3.03%.

In addition to the negative macroeconomic data, bitcoin’s retracement also coincides with a pivotal technical zone of resistance between $24,000 and $25,000. Bitcoin will need to sustain price above this technical level before pushing higher.

Target rate probabilities for the next FOMC interest rate decision.

Target rate probabilities for the next FOMC interest rate decision.

Ethereum’s layer-2 race heats up

Layer-2s (L2s) are becoming an increasingly important narrative in 2023 as Ethereum continues to anchor its position as the dominant smart contract blockchain. The total value locked within the L2 ecosystem has increased by 51% since the start of January to $6.2 billion.

Total value locked within Ethereum’s layer-2s

Total value locked within Ethereum’s layer-2s

Layer-2 scaling solutions help to increase the capacity and efficiency of Ethereum, which helps to improve transactional speeds and lower costs. This helps to improve the usability of the network.

The majority of L2s remove transactions from Ethereum, validate them off-chain, and then roll them together as a single transaction that is recorded on the Ethereum network. 

However, the sector is becoming hotly contested with multiple L2s fighting for a dominant position. 

Most recently, Polygon and Coinbase have announced new entries in the space.

Polygon, an L2 ecosystem, that offers developers a range of scaling solutions confirmed last week that it would be releasing its brand new mainnet in late March. The mainnet will be known as zkEVM.

Importantly, Polygon’s new zkEVM mainnet is Ethereum Virtual Machine compatible which is rare for most L2s. It means that applications can be easily transferred from Ethereum without the need to change any underlying code. 

Meanwhile, Coinbase confirmed last week that it would also be launching a brand new layer-2 protocol called Base. 

The new Base L2 is set to be created using a sister L2 ecosystem called Optimism and it is aimed at scaling the crypto economy. 

In February 2023, according to L2beats, Arbitrum and Optimism currently holds the greatest market share amongst other L2s, sitting at 50% and 30% respectively. However, according to data from Token Terminal, Polygon outpaces both Abritrum and Optimism for daily active users.  

Daily active users across both decentralized applications and blockchains.

Daily active users across both decentralized applications and blockchains.

Bitcoin futures trade at widest premium since November 2021

Bitcoin futures on the Chicago Mercantile Exchange (CME) are now trading at a 14-month high and have outpaced those offered by other futures exchanges, such as Binance.

Future contracts offer investors the option to buy or sell bitcoin at a predefined date in the future and are often sold for a premium due to the time element involved. 

On the CME, bitcoin futures were trading 8.7% above spot market value last week, which is the highest positive basis level since November 2021. At that time, bitcoin was trading at $69,000, which is almost three times the current price of $23,200. 

Importantly, futures trading at a high premium is a sign that leverage in the market is skewed towards bullish sentiment, which occurs when the underlying asset is increasing in value. When the underlying asset falls, the opposite can occur.

Bitcoin has increased over 40% since the start of 2023, outpacing traditional assets including stocks and gold.

In addition to the high premium, market analysts from Arcane Research noted that the premium for CME futures was also higher than those offered by the offshore exchanges. Often the reverse is true as offshore exchanges can offer more leverage.  

However, while CME bitcoin futures traded at an 8.7% premium, Binance futures only traded at a 6.3% premium: a fact that analysts believe results from the CME’s continued dominant hold on the BTC futures market and the inability of offshore exchanges to offer high leverage during the crypto winter.

As three-month bitcoin futures are often considered a proxy for institutional investors, analysts believe the positive premium could be a bullish sign for the market.

Bitcoin spot market vs bitcoin futures CME market

Bitcoin spot market vs bitcoin futures CME market

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