Market makers from DeFi option vaults may be the unseen force assisting in the creation of a price boundary.
There is a ruckus in the bitcoin (BTC) market, similar to what we saw before the start of the late 2020 bull run.
According to data from Arcane Research, the leading cryptocurrency’s 30-day volatility, which measures the standard deviation of daily returns over four weeks, has dropped to 2.20 percent, the lowest since November 5, 2020.
The gauge peaked above 6% in June 2021 and has been declining ever since, with the exception of a brief spike to 4.5 percent around the March Federal Reserve (Fed) meeting.
The steady decline could be attributed to a number of factors, including the decision of dominant crypto exchanges Binance and FTX to reduce leverage, declining interest in crypto-margined futures, and, more recently, reduced speculative interest, as evidenced by the drop in trading volumes.
Kaiko Research data shows that weekly trading volumes for Bitcoin and Ether (ETH) have dropped to their lowest levels since the summer of 2021.
“Both bitcoin and ethereum trade volumes have declined significantly since December, as investors de-risked their portfolios amid growing macro uncertainty,” according to Kaiko Research’s weekly newsletter, which was released on Monday. “The trend accelerated in early April, with BTC and ETH weekly trade volume falling by more than 30% to $7 billion( R 105.3 bn) and $5 billion (R 75.2 bn), respectively, compared to the end of March.”
While bitcoin is down 10% year to date, ether is down about 15%, according to the charting platform TradingView.
There are also technical factors at work, which contribute to the bitcoin market’s tranquillity.
According to Two Prime, market makers who buy out-of-the-money calls and put options auctioned by decentralized option vaults (DOV) every Friday hedge their bullish/bearish exposure by taking opposite positions in the futures and perpetual futures markets, creating a price boundary within each expiration cycle.
Market makers are individuals or entities who have a contractual obligation to keep an exchange’s liquidity at a healthy level. They ensure that there is sufficient depth in the order book by offering to buy or sell an asset, futures contract, or call or put option at any time. These entities always take the opposite side of investors’ trades and keep a market-neutral book by buying and selling the underlying asset as the price fluctuates.
Since the second half of 2021, DOVs have grown exponentially and now add more than $100 million (R1.5bn) of notional exposure to the market each week. In other words, market makers’ books are becoming more sensitive to directional moves. As a result, their hedging activity may be assisting in containing wild price swings in the market.
“Having a larger open interest necessitates more hedging activity. This serves as a natural price floor or ceiling for spot prices at short strikes [levels where DOVs sold options] “Two Prime stated in an April 8 DOV explainer note. “By holding these options to expiration, as DOVs do, the gamma of the underlying option rises, necessitating more delta hedging from market-makers and exacerbating the price floor and ceiling dynamic.”
A prolonged period of low price volatility is often followed by violent price action on either side.
For example, the previous low volatility regime lasted nearly two months, from late September to early November, with cryptocurrency trading primarily in the $10,000 to $13,000 (R 150k – R196k) range. The breakout occurred on November 5, with prices rallying significantly above the June 2019 high of $13,800 (R 208k).
Nobody knows whether history will repeat itself. Having said that, there are indications that a major shift is on the way.
“The 7-day volatility has risen above the 30-day volatility, which could indicate that the market is waking up,” according to Arcane Research’s weekly newsletter, which was published on Tuesday.
According to CoinDesk data, Bitcoin was last seen trading near $41,500, (R 624k) representing a 2% gain in a 24-hour period.