Decreasing Bitcoin & Ether correlation may affect quantitative strategies, amid recent developments in Bitcoin infrastructure and global regulation.
The relationship between Bitcoin (BTC) and Ether (ETH) returns has experienced a notable drop since mid-to-late March, creating potential implications for quantitative investment strategies that rely on cross-hedging. The correlation between these two major cryptocurrencies has been mostly stable and high throughout 2022 and into 2023, except for the period following Ethereum’s Merge. Analysts anticipate that the current weakening of this relationship could persist throughout the first phase of ETH withdrawals.
Bitcoin Infrastructure Developments
Several recent developments in the Bitcoin infrastructure landscape have the potential to impact the wider cryptocurrency market. These include the introduction of Lightspark and the proposal of Civ Kit.
Lightspark: Enhancing the Lightning Network
Lightspark, a company specializing in Bitcoin infrastructure, is focusing its efforts on addressing the challenges associated with the adoption of Bitcoin’s Lightning Network. Supported by David Marcus, a former PayPal executive and co-creator of Facebook’s Diem project, Lightspark aims to offer enterprise clients streamlined access to Lightning channel liquidity. Additionally, the company seeks to provide APIs for seamless integration of Lightning payments into businesses and tools for improving the capital efficiency of their operations.
Civ Kit: Building Decentralized Marketplaces
Civ Kit is a concept proposed in a recent whitepaper, detailing a system designed for constructing peer-to-peer decentralized marketplaces. The proposed marketplace would operate on the decentralized communications protocol Nostr, in conjunction with the Lightning Network. This would enable users to post trade offers that other users can accept through hashed timelock contracts (HTLCs) via the Lightning Network. Furthermore, Civ Kit introduces a trustless reputation system that employs zero-knowledge proofs to minimize spam on the network.
Falling Correlation and Institutional Investment
#Bitcoin's surge past $30k only a start. It will take a lot more than that to fuel lasting crypto recovery. Eye-popping 83% rally in Bitcoin this yr has not been matched by newer coins. Ether, which greatly outperformed Bitcoin from 2020 and 2021, up 71%. https://t.co/ccagb6AL6S pic.twitter.com/bDjxewj4dS
— Holger Zschaepitz (@Schuldensuehner) April 15, 2023
The decline in the correlation between Bitcoin and Ether is of particular significance for institutional investors, as it could influence quantitative strategies that depend on cross-hedging between the two assets. However, from a fundamental standpoint, this trend bolsters diversification arguments in favor of holding both BTC and ETH. The current attenuation phase has persisted for approximately 30 days, and analysts project it could continue for another two weeks, considering that the first phase of ETH withdrawals is still in progress.
As of April 20, projections indicate that an additional 73k ETH could be unlocked through partial withdrawals, while 822k ETH could be unlocked through full withdrawals. This process may take around 15 days, with the remaining variable being the amount of fully unstaked ETH that may re-enter the deposit queue. The ratio of withdrawn principal and rewards to deposits has maintained a 2:1 ratio since the upgrade was activated.
Bitcoin (BTC) & Ether (ETH) Correlation. Source: Coinbase
Regulatory Uncertainty and Market Performance
The divergence of regulatory perspectives on Bitcoin as opposed to non-Bitcoin cryptocurrencies may have contributed to Bitcoin’s outperformance and the broader correlation gap. The regulatory status of Ethereum remains uncertain following SEC Chair Gary Gensler’s crypto testimony before the House Financial Services Committee on April 18. Gensler did not provide a direct response to questions about the classification of ETH as a security or commodity.
Crypto Market Overview
Following the successful Shapella fork, traders are closely monitoring net ETH withdrawals. Initially, deposits exceeded withdrawals, which traders perceived as a positive sign. However, the processing of full withdrawals began on April 20, leading to a sharp decline in the staking rate and likely exerting downward pressure on the ETH price. As the market moves forward, the ETH staking ratio will be scrutinized closely, with any upward movement potentially encouraging traders to increase their buying activity.
Crypto native hedge funds and traditional asset managers have become net sellers this week, while flows from traditional hedge funds have remained more balanced. Both BTC and ETH flows have been net for sale as traders aimed to secure profits and manage risk after recent significant gains. Altcoins have also experienced increased selling pressure. Concerns surrounding potential regulation and the looming threat of a recession have led traders to maintain an underweight position in the sector.
Financing Rates and Crypto News Highlights
Financing rates for traditional finance, centralized finance (CeFi), and decentralized finance (DeFi) have seen variations across the board. Overnight rates for traditional finance, CeFi, and DeFi stand at 4.75%, 4.25% to 7.50%, and 2.30%, respectively. Meanwhile, rates for 1-month and 6-month periods differ across these sectors. BTC and ETH financing rates also vary within the CeFi and DeFi sectors.
Current Finance Rates. Source: Coinbase
Developments Around the Globe
Forbes recently discussed the potential of ZkEVM to power the next industrial revolution, highlighting its transformative capabilities. In the regulatory landscape, The Block reported on SEC Chair Gary Gensler facing tough questioning from Republicans regarding the SEC’s approach to cryptocurrencies. Coindesk explored the differences between stablecoins and central bank digital currencies in a draft U.S. stablecoin bill, providing insight into the developing legislation.
In other news, The Block covered the New York regulator’s statement clarifying that Signature Bank’s failure was not due to crypto involvement. Meanwhile, a Hong Kong court set a precedent by recognizing crypto as property, following similar rulings in China, the US, and the UK.
The crypto market saw significant developments, as staked Ether deposits surpassed withdrawals for the first time since the Shapella upgrade. Blockworks provided an in-depth analysis of zero-knowledge rollups on Ethereum, tracking their growth and impact on the network.
In regional developments, a Hong Kong court ruled that crypto has property attributes and can be held in trust. This ruling echoes the stance taken by courts in China, the US, and a government-funded law commission in the UK.
Finally, the European Union’s Markets in Crypto Assets (MiCA) regulation received approval from the European Parliament. This legislation establishes a legal framework for the crypto industry that could take effect within 12 to 18 months. The approval paves the way for crypto exchanges and digital asset service providers to register under the supervision of the European Banking Authority and the European Securities and Markets Authority.
All these events can impact the market dynamics and valuation of cryptocurrencies, including Bitcoin and Ether.
