The market's rise will be a slow process, and the use of derivatives and leverage is difficult to drive the market in the short term.

Topic: Unveiling the Macro Analysis Methodology of Top Researchers in Crypto

Guests:

Zheng @ZnQ_626

• LUCIDA Founder

• Champion of the first season of the 2019 Bgain Digital Asset Trading League in the Mixed Strategy Group;

• April runner-up, May champion, and season third place in the 2020 TokenInsight Global Asset Quantitative Competition, Compound Strategy Group;

• Season third place in the 2021 TokenInsight x KuCoin Global Asset Quantitative Competition, Compound Strategy Group;

Vivienna @VV_watch

• BuilderRocket Accelerator Research Partner

• Entered the industry in 2017

• Former blockchain investment fund researcher under Foxconn

• Former Huobi Defi researcher

• Obsessed with macro research

HighFreedom @highfree2028

• Entered the industry in 2016

• Background in computer & finance

• Currently a research analyst at a securities firm

• Proficient in timing based on USD liquidity analysis and macro analysis

Albert @assassinaden

• Quantitative private equity fund manager

• Former forex market quantitative researcher, focusing on statistical arbitrage and relative value strategies

• Proficient in non-delta strategies and macro research

• Emphasizes the ability to deal with market cycles and bear markets

Unveiling the Macro Analysis Framework

Zheng@LUCIDA:

With the development of the crypto industry, the correlation between the market and the macro economy is increasing, and macro analysis is becoming more and more necessary for market analysis. Today, I want to talk to everyone about macro-related topics. Let's start with the first question, please share your framework and methodology for analyzing the macro economy, and what is the underlying logic.

HighFreedom:

Macro analysis for crypto consists of two parts: the first is off-chain (non-crypto native) macro, and the second is on-chain macro (crypto native, with BTC on-chain data analysis at its core).

For the first off-chain macro, my analysis framework is somewhat like an inverted triangle, divided into three levels.

The first level is various data, such as employment, GDP, inflation, PCE, etc.

The second level is summarizing the data. The data in the first level may seem chaotic, but in reality, we can ultimately categorize the data into two types: data related to economic conditions and data related to inflation levels. Because the ultimate goal of the Federal Reserve, which formulates monetary policy (raising or lowering interest rates, expanding or shrinking the balance sheet), and the Treasury Department, which formulates fiscal policy (how the government spends money), is to maximize employment and maintain price stability. In other words, the core goal of these two major institutions is to ensure a good economy and controllable inflation.

The third level is the specific composition of USD liquidity and its future expectations. The main components of USD liquidity include bank reserves, the Federal Reserve's balance sheet, the Treasury Department's balance, and overnight reverse repurchase agreement account balances. We need to pay attention to changes in these factors and the Treasury Department's quarterly re-financing announcements to assess the current and future USD liquidity situation.

Moreover, employment and price, these two core factors, are to some extent interrelated. For example, when the Federal Reserve decides whether to lower interest rates or stop shrinking the balance sheet, it will simultaneously consider employment and inflation data. Therefore, we need to comprehensively analyze this data to more accurately predict changes in USD liquidity. Through quarterly re-financing announcements and various economic data, we can better understand the operations of the Treasury Department and the Federal Reserve, and thus predict the future trend of USD liquidity.

These are the so-called off-chain factors, which mainly refer to non-crypto native content, such as the aforementioned macroeconomic indicators, policy changes, and market sentiment. Although these factors do not directly originate from the cryptocurrency market, their impact on the market is significant because they define the external environment of the market and investor expectations.

The second type is on-chain macro: on-chain macro refers to data and analysis directly derived from the cryptocurrency market, with BTC on-chain data at its core. This data includes changes in the holdings of long-term and short-term holders, profit levels, etc. Through the analysis of this on-chain data, we can gain a deeper understanding of the internal dynamics of the market, including investor behavior and market trends.

These two sets of analysis methods have their own focuses. Off-chain factors provide us with a macro perspective, while on-chain factors allow us to understand the cycles and rhythms of the cryptocurrency market. When analyzing the cryptocurrency market, it is very important to combine these two perspectives, as they together form a comprehensive macro analysis framework.

Albert:

I would like to add that in addition to the impact of the policies of the Federal Reserve and the Treasury Department, we should also pay attention to microeconomic factors such as bank deposits. For example, when faced with high interest rates, ordinary investors may choose to deposit funds in banks to earn interest, but this may also affect market liquidity. Historically, after the banking crises of the 1980s and 1990s, the growth rate of deposits slowed significantly. After the SVB event in 2023, we saw a similar situation where the scale of bank deposits decreased, while the stock market and other asset markets began to recover. In addition, international liquidity, such as the Japanese bank's yen-dollar arbitrage trading, also brings additional liquidity resources to the market.

In high-interest rate cycles, people tend to deposit funds in banks to earn interest. However, when banks face operational risks, investors may shift funds to the stock market or other assets, such as short-term government bonds. Currently, the yield on U.S. short-term government bonds is close to 5%, which has attracted many investors. At the same time, investors may also choose to invest in stocks, derivatives, or ETFs to seek higher returns.

Of course, when facing a banking crisis, investors may reevaluate the safety of depositing funds in banks. They may choose to invest in the stock market or other assets to seek relatively safe returns. This situation occurred in the 1990s and in 2019. In addition, the performance of money market funds can also serve as an indicator of liquidity. Starting in 2023, the growth rate of money market funds reached a new high in over 20 years, reflecting the market's demand for liquidity.

Ideally, we should consider all factors that may affect the market, including the liquidity conditions in other countries. However, in practice, due to the difficulty, we may not be able to analyze all factors. For example, the impact of carry trades in Japan and Europe on the market is difficult to quantify. We usually focus on the United States as the main focus and consider the influence of other countries as secondary factors. Nevertheless, we cannot ignore the impact of the offshore USD market overseas.

Vivienna

On Twitter, I published an article discussing the impact of U.S. liquidity on cryptocurrency prices. I mainly focus on domestic factors rather than the overseas USD market, as the data for the latter is difficult to quantify. When analyzing Bitcoin prices, I categorize its influencing factors into three types:

The first is observable indices: including the federal funds rate, government bond yields, the U.S. dollar index, and gold prices, etc. These indices form the basis of market expectations, but their relationship with the prices of risk assets is not directly linear. For example, raising interest rates usually leads to a tightening of market liquidity, which is not conducive to the rise of risk assets, while the opposite is true for lowering interest rates. However, this impact is subject to the complex superposition of monetary policy transmission mechanisms, economic, financial, and sentiment cycles, and does not directly affect market liquidity at the moment when monetary policy is implemented.

The second is liquidity indicators: such as the Federal Reserve's balance sheet, reverse repurchase operations, and the Treasury Department's account, etc. These indicators directly affect USD liquidity, thereby influencing the prices of growth-oriented risk assets such as Bitcoin. For example, the expansion of the Federal Reserve's balance sheet, a reduction in reverse repurchase agreements, or the depletion of the Treasury General Account (TGA) are all favorable for market liquidity.

The third is sentiment impact indicators: including dot plots, speeches by Federal Reserve officials, labor market data, and inflation data, etc. These data have short-term effects on market expectations and sentiment, affecting short-term trading. However, it is worth noting that traders should focus on changes in expectations rather than the data itself.

How Macro Factors Affect the Crypto Market

Zheng@LUCIDA:

I have completed the translation of the provided markdown text. Here is the English translation:

So how do you apply your macro analysis framework to the crypto market? Or in other words, how do these frameworks guide your trading and help you make money?

HighFreedom:

I think there are three ways to make money:

The first is to make money in the big direction: this means buying and holding spot positions when the market trend is clear, without frequent trading, and being patient.

The second is to make money from volatility: this usually involves quantitative trading, taking advantage of market volatility for buying and selling, without focusing on the specific direction of the market.

The third is to make money from liquidity: during a bull market, funds are invested in the market, and high interest is earned by lending to traders in need.

In my opinion, macro factors mainly affect the crypto market through two aspects: liquidity and penetration rate. Liquidity determines the amount of funds in the market, while the penetration rate is the proportion of funds allocated to cryptocurrencies such as Bitcoin.

In terms of operations, I tend to be fully invested in spot positions during a bull market, especially in mainstream currencies like Bitcoin. This is what I mentioned earlier: making money in the big direction.

At the same time, I will use a portion of the funds for long positions in the coin, but avoid frequent long and short operations during a bull market. I believe the key is to identify market highs and lows, which requires considering various sources of information, such as mining costs, market sentiment, lending rates, funding rates, etc.

The market performance in the second half of 2021 shows that the peak of Bitcoin prices is related to the peak of the Nasdaq index and USD liquidity. This indicates that when liquidity reaches its peak, risk assets may need to prepare for an exit. Therefore, I closely monitor liquidity indicators to judge whether the market is approaching a peak or a bottom.

I also believe in information orthogonality, which means forming a comprehensive market judgment by collecting information from different perspectives. This method helps us more accurately identify market highs and lows, making more reasonable trading decisions and minimizing the possibility of operational errors. I also adjust my risk control strategy based on market conditions to protect my investments during market fluctuations.

Vivienna:

I recommended a book called "Professional Speculation Principles" on Twitter. The author, Sproul, proposed two basic principles for market analysis and prediction: one is that market trends are the result of the operation of basic economic forces, which are influenced by political institutions and policy activities; the other is that the psychological state of market participants determines the manner and timing of price trends.

Macro analysis should focus on these two points. First, we need to understand the basic principles of politics and economics, such as economic indicators, production and consumption cycles, investment and savings behavior, and the development path of technological innovation. Secondly, predicting the psychological state of market participants has a stronger guiding effect on trading. Macro analysis is often questioned because many people focus excessively on economic and financial data, neglecting changes in expectations. Successful trading not only requires analyzing the current situation behind the data but also paying attention to how expectations change and how market games are played.

Soros once pointed out that economic history is built on false lies, not truth. The way to make big money is to analyze incorrect trends, operate with the trend, and exit before being exposed. This reflects the above principles, as to distinguish incorrect trends, one must first know what is correct. For example, when the government adopts a high-interest rate policy during an economic recession, or attempts to stimulate the economy by adjusting interest rates through monetary policy, if one does not understand the transmission mechanism of these policies, it is impossible to judge their consequences or exit before most participants discover the problem.

Albert:

Regarding how the macro analysis framework affects the cryptocurrency market and our trading strategy, I will explain the following points:

First, starting from 2020, we have discussed a long-standing theory—the liquidity chain theory. According to risk analysis, we rank different assets such as commodities, foreign exchange, stocks, etc., in a chain. Cash is at the top of the chain, serving as the foundation for all assets, with extremely low risk, almost zero except for inflation. If even cash is at risk, it means that the global market may be facing a reset.

The second layer of the liquidity chain is bonds, especially government bonds, which are basic fixed-income assets and considered low-risk assets. The third layer is corporate bonds and stocks, as they offer relatively higher returns. The fourth layer is commodities, with higher volatility and risk. The last layer is cryptocurrencies, as they are at the end of the liquidity chain, with the highest volatility and risk.

This theory also explains the underlying reasons for the phenomenon mentioned by Highfreedom earlier, "the peak of Bitcoin prices is related to the peak of the Nasdaq index and USD liquidity."

When liquidity is released, it first affects the foreign exchange market, then the bond market, followed by the stock market, commodity market, and finally the cryptocurrency market. Conversely, when liquidity tightens, the process of withdrawal is in reverse. This sequence of liquidity flow has a significant impact on the market.

As traders, we use this framework to guide our trading. For example, when we see liquidity beginning to tighten or release, we can predict the market's response and adjust our trading strategy accordingly. We closely monitor interbank interest rates and bond futures, as these are the market's first reaction to policy changes. Then, we analyze the options market, as option prices reflect the market's expectations of future volatility.

Our trading strategy is mainly based on these macro expectations. For example, during a rate hike cycle, market sentiment tends to be bearish, and we allocate put options when volatility is low. At the same time, we adjust our options portfolio based on market sentiment and expectations to profit from the return of volatility.

Our strategy relies on the return of volatility, especially near-term volatility. Far-term volatility may remain high for a period and not immediately return. Therefore, we are usually buyers in the far-term, obtaining value through cross-period allocation. Our portfolio strategy is to profit from the difference in value between near-term and far-term options.

Zheng@LUCIDA:

The next question will be relatively easier, and we have indirectly mentioned it in our previous conversation, which is the position of Bitcoin in traditional assets. I remember that in 2019, especially in the first half of the year, the market generally regarded Bitcoin as a safe-haven asset. At that time, due to some geopolitical crises, the price of gold soared, and Bitcoin also rose accordingly, and the market's acceptance of this view was increasing.

However, with the bull market cycles from 2020 to 2021, and the situation in 2022, the public gradually accepted that Bitcoin is a riskier asset than traditional risk assets. I want to know if you agree with this positioning, or if there are other descriptions of Bitcoin's position among major assets.

HighFreedom:

I think this description is quite accurate. I believe that in the medium to short term, Bitcoin is undoubtedly a riskier asset. However, in the long term, I am confident that Bitcoin can develop into a safe-haven asset. Currently, we are in the process of Bitcoin growing into a safe-haven asset. I believe that safe-haven assets need to have several basic elements, and we can discuss whether these are necessary conditions:

The first is that the market size needs to be large: the market size of the asset needs to be large enough for large funds to freely enter and exit.

The second is that volatility needs to decrease: although Bitcoin has historically had high volatility, it has now significantly decreased, approaching or sometimes even lower than the volatility of gold.

The third is the rationality and stability of market participants: as market participants gradually transition from insiders to more traditional and rational financial institutions, the market may become more stable.

When these conditions are met, Bitcoin may become a mature safe-haven asset with a large market size and low volatility, similar to gold. At that time, even major events will only have a slight impact on the price.

Vivienna:

I think the comparison of Bitcoin to digital gold is widely accepted, and its logic compared to gold is widely recognized. The total supply of Bitcoin is fixed, similar to the scarcity of gold, and it can serve as a store of value and a means of payment, which is highly consistent with the characteristics of gold.

However, the pricing of gold is a complex issue. In times of heightened risk aversion, such as during wars, the safe-haven characteristics of gold are particularly evident. If the basic market liquidity is not tight, but there are significant war factors, at this time, Bitcoin may follow the trend of gold, as the main factor affecting the price of gold is risk aversion sentiment. Correspondingly, the price of Bitcoin will also be affected by risk aversion sentiment.

However, if the basic market liquidity itself is insufficient, such as when the global or U.S. economy enters a recession or there is an expectation of a recession, even if risk aversion sentiment is high, it cannot drive trading volume. This explains why in some intense geopolitical conflicts, other markets did not have a significant reaction. In this case, it is the basic liquidity that determines the bottom line of the price, and Bitcoin is closer to a risk asset.

Therefore, the correlation between the prices of gold and Bitcoin mainly depends on the market's underlying liquidity at the time and the market's perception of the properties of Bitcoin. Most of the time, the price of Bitcoin is highly correlated with the U.S. stock market. During economic contraction, investment contraction, and deleveraging, Bitcoin will react first, and during economic recovery and re-leveraging, it will also react in advance, with a greater acceleration.

Gold holdings in global asset management companies are typically kept below 5% because the influencing factors of gold prices are very uncertain. Although gold has practical applications, it is more influenced by speculation and emotions, lacking fundamental analysis. This makes it difficult to explain to limited partners (LP) why they should invest in gold, and can only be based on predictions of future economic recessions or risks, which is very subjective and difficult to be convincing.

Bitcoin faces the same problem, as it is difficult to convince capital companies and LP to allocate funds to this asset. Although gold is considered a safe-haven asset, its ability to hedge against inflation is mainly reflected over the long term. Bitcoin may also be the same, and its position in the future may be very high, especially with the increasing difficulty of Bitcoin mining.

If more traditional financial asset management companies enter the Bitcoin investment field, the investment proportion of Bitcoin may converge towards that of gold.

Albert:

From a macro perspective, gold and Bitcoin have multiple attributes, as they can be both risk assets and safe-haven assets. This phenomenon may seem contradictory at first glance, but it actually has its inherent logic.

Firstly, both gold and Bitcoin serve as safe havens for capital during times of crisis. During wars or other turbulent periods, asset transfers are restricted, and liquidity seeks safe havens. Investors tend to transfer funds to assets that are easy to cross borders, such as gold and Bitcoin. This causes these assets to experience significant price increases during times of crisis.

However, in stable market periods, the properties of gold and Bitcoin are different. Due to its high volatility, Bitcoin behaves more as a risk asset. Its price fluctuations are related to the stock market, partly because the Bitcoin market has many leverage tools and a large number of market participants, leading to significant price fluctuations.

In stable environments, investors tend to pursue stable investment portfolios and avoid significant price fluctuations in assets. Therefore, they may be more inclined to allocate some traditional assets, such as gold and other commodities. Gold, due to its long history and stable value, is usually kept within 5% of investment portfolios.

In addition, the prices of gold and Bitcoin are also influenced by market expectations. When liquidity is abundant, investors may seek higher-yielding assets, while in times of liquidity tightening, they may revert to traditional safe-haven assets.

Finally, the status of Bitcoin and gold as safe-haven assets also depends on the market environment and the stage of the macroeconomic cycle. In specific situations, they may exhibit safe-haven characteristics, while in other situations, they may more reflect risk assets.

What is the focus of macro analysis?

Zheng@LUCIDA:

Next, we discuss a question about the data sources you usually rely on for macroeconomic analysis. Do you collect data on your own, or do you have some non-traditional analysis tools? Are there any exclusive information sources you can share?

HighFreedom:

I wrote some code on tradingview to create a dashboard for continuous monitoring and analysis of macro liquidity. These tools are no different from the data provided by the U.S. Federal Reserve and the Treasury Department's official websites, but I have integrated them into a single interface for continuous monitoring. In addition, I also follow some analysts on Twitter, especially a blogger from Taiwan who aggregates interesting data, such as lending rates from different exchanges. This data can reflect the operational trends of large and retail investors, as well as their order of operations. I find this data very valuable, but I have not successfully applied his tools.

I have also been looking for data on U.S. bonds, especially the daily net issuance of short-term, medium-term, and long-term bonds (the net issuance value is the amount of newly issued bonds minus the amount of bonds maturing on the same day). This data is crucial for understanding and judging the current and upcoming market liquidity. Currently, I can only manually download data from the U.S. Treasury Department's website and process it myself. If anyone knows of better data sources, please recommend or contact me.

Albert:

I would like to add some macroeconomic data sources that we focus on. Because I mainly focus on risk commodities, the data services I use include Spotgamma Menthor Q, which provides comprehensive options data for the U.S. stock market, bond market, and other commodity options data.

In addition, for the U.S. stock market, there are services like GR, which provide real-time data at relatively low prices. For more in-depth data, such as gold or interbank market data, it may be necessary to rely on industry-specific resources.

For the cryptocurrency market, the recommended data source is Amber Data Derivative, which is very comprehensive in terms of options data and has clear advantages. Additionally, this service provides real-time data from exchanges such as CME.

We also need to pay attention to data from some exchanges, especially those with a large proportion of institutional trading volume, such as Deribit, where 80% of the trading volume comes from institutions and 20% from professional individual investors. This data can reflect the market's institutional-level expectations and have a significant impact on the market.

Furthermore, exchanges like Bitfinex can be considered the interbank market of the cryptocurrency market, and their short-term lending rates can reflect the risk-free rates of the market, which is crucial for calculating the risk premium of the cryptocurrency market.

Compliant exchanges, such as Coinbase and their large trader transaction data, are also important, especially dark pool trading data, which may have an impact on the market.

Overall, although we can obtain a large amount of market data, the ultimate trading decisions still rely on our own risk management capabilities. Our goal is to avoid losses or make small profits in most cases, and achieve large profits in a few cases.

Review and Outlook for the Current Cycle

Zheng@LUCIDA:

We turn to the last question, which is about the outlook for the future market.

I'll share my view first: the market generally expects that the Fed's rate cuts in the second half of this year or next year will bring huge liquidity, coupled with bullish factors such as Bitcoin halving, and many people expect to replicate the bull market trend of 2021. However, I hold a very pessimistic view on this generally optimistic expectation, as historically, highly consistent market expectations often come with significant potential risks.

Especially for U.S. public funds and other institutional investors, although they belong to long-term holding institutions, they also make investment decisions based on market conditions and will not blindly "chase highs."

HighFreedom:

My view is very similar. The main uptrend in the market started in November last year, especially after the spot ETF trading in January, the market experienced significant volatility. Liquidity and penetration in the first quarter were on the rise, but it was mainly retail participation, and true institutional investors have not entered on a large scale. For example, 80% to 85% of the funds inflow into spot ETFs came from retail investors. Liquidity has decreased in the second quarter, and penetration has stagnated. My outlook for the third and fourth quarters is that I hope liquidity can remain stable, and penetration can increase due to further participation of institutional investors.

I believe that interest rate hikes or cuts do not immediately change liquidity, but rather change the market's expectations for future liquidity. My question is whether we can still see an environment of loose fiscal and monetary policies like in 2021, and currently, this possibility seems unlikely. Therefore, I am cautious about the market's future performance and hope that overly optimistic expectations do not arise.

There may not be much change in the market in the short term, and the liquidity expectation may see 4 to 5 rate cuts in the next 15 months, providing a stable expectation for the market. However, the real release of liquidity will be slow and unlikely to see large-scale rapid changes. Unless there is a severe economic recession or crisis, it is unlikely to see another environment of loose fiscal and monetary policies.

So if there is no severe economic recession, then most likely this rate cut may be a so-called "asymmetric rate cut." Previous rate hikes and cuts have been symmetric, for example, if the federal funds rate went from a low level to a high level over a year, then the reverse from a high level back to a low level would also take about a year. The recent aggressive rate hike from 0-0.25 in March 2022 to 5-5.25 in May 2023 took about a little over a year, but this rate cut may take an asymmetric route, with the rate cut process being slow and gradual.

Vivienna:

My conclusion is relatively simple and similar to everyone else's views. From July/August to the end of the year, the market may face less optimistic liquidity conditions. Even if there is a rate cut, it may only happen once, which, although providing positive expectations for the market, will not fundamentally change the current situation.

The current economy has not fallen into a recession, and the stock market may continue to rise. People's lives seem to be relatively unaffected, and deposits and dividends can still fill household savings and promote consumption. However, if inflation continues to rise, it may trigger trading expectations for a stagflationary cycle. If high interest rates continue next year, and in some cases even require further rate hikes, while the Treasury does not relax its policies, this may lead to tighter liquidity next year. This is definitely not good news for markets that rely on liquidity, such as Bitcoin.

As for the desire for large-scale entry of institutional investors, I believe this is more of an expectation than a reality. In the current situation of poor underlying liquidity, insufficient understanding of cryptocurrencies in the market, and high volatility, institutional investors are unlikely to heavily invest or build positions on a large scale. This expectation may be overly idealistic, and the actual situation may not turn out as we hope.

Albert:

Currently, the short-term market expectations tend to be bearish, especially for Bitcoin. Although market volatility may increase in July due to factors such as options expiration, the asset allocation cycle may drive prices higher in the long term. However, for the market to achieve an increase, it may need to rely on two factors: one is the substantial allocation of institutional investors, and the other is a further improvement in investor sentiment. However, this sentiment-driven increase may not be healthy, as high funding costs and high volatility are difficult to sustain in the long term.

In my opinion, the market's rise will be a slow process, as the entry of market participants is a gradual process. The use of derivatives and leverage is unlikely to drive the market in the short term. In this situation, the operations of market makers may become an important factor influencing market prices. Macro factors in the market may only be a factor driving market maker hedging behavior, rather than directly affecting prices. This may make the market appear more irregular and increase the difficulty of executing strategies such as CTA.

Overall, there may not be a large-scale collapse or rapid rise in the market in the short term, but rather a slow and prolonged process. Liquidity will also not experience significant fluctuations unless there is a severe economic recession. Investors should remain cautious and pay attention to the allocation trends of institutional investors and changes in market sentiment.

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