Vol Commentary – Week 46, 2022

Cumberland is commenting on the recent volatility and potential opportunities to take advantage of it.

For further information about Cumberland, please visit Cumberland website here.

November 16

What we are seeing in the markets

FTX insolvency sent everyone scrambling for cover as fear permeated every corner of the market. BTC and ETH 1M vols jumped from 50/75 to highs of 100/140 on Wednesday evening, before selling off as the markets believed the big crypto headlines to be temporarily over and an undershoot in CPI numbers gave risk assets a reason to rally. 7D realized vol for BTC & ETH exploded from 45% & 68% to 112% & 155%. Solana, closely associated with SBF/FTX, is down ~55% since Monday last week, with 1M implied vols reaching a high of 288% before settling back at 184%.

Potential trades

Buy ETH Vol & Sell BTC Vol

30D implied BTC / ETH vol ratio is now up to 77%, pushing into the higher end of the historical range. Given potential for more disruption as fallout from FTX is uncovered, ETH vol, as the higher beta asset, could outperform BTC vol.

November 14

Market Color

After a historic week and weekend, the crypto landscape has once again changed. I don’t want to spend any time on a play-by-play of any of the events of the past week, as there’s enough of that out there, and instead want to highlight a few reflections. The industry right now is not where it wants to be, and most of these reflections are about closing the gap between where it is now and where it should be. (Warning: this is going to be a long one).

• Most of the work in bringing institutions into crypto thus far has been about making sure there was a reason for them to come into the space and building infrastructure rails for them to use. Post-FTX, a new challenge emerges: it is much more difficult to tell who the adults in the space are. Ignoring all the stories that are coming out now, FTX had been successful at painting itself as a responsible agent in the space. Going forward, even for companies that are enthusiastic about coming into crypto, it’s going to be harder for them to have the confidence about finding the right partners.

• Retail has a choice on how to trade: through centralized exchanges or decentralized ones. Overwhelmingly, they end up choosing centralized exchanges, for several reasons. CEXes are more convenient. You can trade across chains, which remains extremely difficult in DeFi. DEX UI is still below the quality of most CEXes. These are all pretty valid reasons. However, the one reason that I am hoping goes away is that many retail users use exchanges as a custodian. There are some good reasons for retail to trade on CEXes, but “that’s where my coins are” is not a good one.

• Institutions have a choice not available to retail: they can trade with OTC desks. OTC desks like Cumberland’s do not custody assets for counterparties and do not require prefunding to trade, so it is a way to significantly limit credit risk. In 2022, we have already begun to see institutions build their trading desks with absolutely no exposure to exchanges, and we expect the FTX collapse (as well as rumblings of issues at other centralized exchanges) to push already-established crypto trading desks off of exchanges and towards OTC.

• There is a healthy movement in crypto demanding to see proof of reserves from crypto exchanges. This is a good start, and Nansen has been pushing some great work here over just a short period. (Link). However, proof of assets is only half the question: this has to be reconciled against customer balances. It’s non-trivial for this to be supplied onchain without revealing individual account balances, but it should be cryptographically possible, and this should be the standard we’re shooting for as an industry. Attestations are simply not enough anymore.

• Traders are responsible for managing risk, but they should not be the only ones who are responsible for doing so. Risk teams are healthy checks on trading teams, and this year, a strong risk team that is able to push back on trading teams is probably the most important alpha possible. Every trader will, at some point, be wrong about the direction of the market. Risk teams are the ones responsible for making sure that risks taken are not existential. This includes exchange risk, lending risk, and directional risk. 2022 has made it extremely obvious that some desks are not giving enough authority to their risk teams, and other desks seem not to have them at all.

As for the market: crypto is sitting close to its YTD lows, and there is reason to be cautious here. There is significant risk of further contagion. There are several exchanges which have not sufficiently shown healthy reserves, sparking real fear of further dominoes on the exchange side. One prominent lender has closed withdrawals, and frankly the lending sector as a whole is at risk of completely shutting down. Finally, there is a risk of funds closing up shop this year; most are down massively on the year, and adding to that significant operational losses to FTX, some will have no reason to go on. The industry is facing severe risk of contraction across the board.

In the interest of not being a total downer, there are some positive notes here, though none seem likely to turn things around in the short-term. CPI came in lower last week, and it seems like inflation, which has been the biggest headwind for macro markets, has peaked. Equities rallied sharply at the end of last week, a rally that crypto would surely have joined in on if not for FTX. Fintech adoption has been picking up in recent weeks, with companies like Meta and Google moving towards crypto, with further similar headlines likely. And while it’s not for the best of reasons, ETH has become deflationary, with 5700 ETH burnt since the Merge.