Uncovering the Crypto Macro Analysis Methodology of Top Researchers

Author: LUCIDA & FALCON Source: X, @lucidafund

Guest: Zheng @ZnQ_626

• LUCIDA Founder

• 2019 Bgain Digital Asset Trading League Season 1 Mixed Strategy Group Champion;

• 2020 TokenInsight Global Asset Quantitative Competition, Compound Strategy Group April Runner-up, May Champion, Season Third Place;

• 2021 TokenInsightxKuCoin Global Asset Quantitative Competition, Compound Strategy Group Season Third Place;

Vivienna @VV_watch

• BuilderRocket Accelerator Research Partner

• Entered the industry in 2017

• exFoxconn's blockchain investment fund doing investment research

• exHuobi Defi researcher

• Obsessed with macro research

HiahFreedom @highfree2028

• Entered the industry in 2016

• Compound background in computer & finance

• Currently a researcher at a securities firm

• Good at cycle timing based on USD liquidity analysis and macro analysis

Albert @assassinaden

• Quantitative private equity fund manager

• Former quantitative researcher in the foreign exchange market, doing statistical arbitrage and relative value strategies

• Good at non-delta strategies and macro research

• Attach importance to the ability to cope with cycles and cross bull and bear markets

I.Unveiling the Macro Analysis Framework

Zheng@LUCIDA:

With the development of the Crypto industry, the correlation between the market and the macro economy is getting higher and higher, and the macro economy is becoming more and more necessary for analyzing the market. Today, I will talk to you about topics related to the macro economy. We will start with the first question, that is, please share your framework and methodology for analyzing the macro economy, and what the underlying logic is.

HighFreedom:

The macro analysis for crypto consists of two parts: the first category is the over-the-counter (non-crypto native) macro, and the second category is the on-site macro (crypto native, the core is the BTC chain data analysis)

For the first category of over-the-counter macro, my analysis framework is a bit like an inverted triangle, divided into three levels.

The first layer is a variety of data, such as employment, GDP, inflation, PCE, etc.

The second layer is to summarize the data. The data in the first layer may seem messy, but in fact we can divide all kinds of data into two categories: economic data and inflation data. Because the ultimate goal of the Federal Reserve, which formulates monetary policy (raising and lowering interest rates, shrinking and expanding the balance sheet, etc.), and the Treasury, which formulates fiscal policy (how the government spends money, etc.), is to maximize employment and price stability. In other words, the core goal of these two institutions is to ensure that the economy is good enough and inflation is controllable.

The third layer is the specific composition of US dollar liquidity and its future expectations. The main components of US dollar liquidity include bank reserves, the balance sheet of the Federal Reserve, the balance of the Treasury, and the balance of overnight reverse repurchase accounts. We need to pay attention to the changes in these factors, as well as the refinancing announcements issued by the Ministry of Finance every quarter, to judge the current and future US dollar liquidity.

Moreover, the two core factors of employment and prices affect each other to some extent. For example, when the Federal Reserve decides whether to cut interest rates or stop shrinking the balance sheet, it will consider both employment and inflation data. Therefore, we need to conduct a comprehensive analysis of these data to more accurately predict changes in US dollar liquidity. Through quarterly refinancing announcements and various economic data, we can better understand the operations of the Treasury and the Federal Reserve, and thus predict the future trend of US dollar liquidity.

The above are the so-called off-market factors, which mainly refer to those that are not native to cryptocurrencies, such as the above-mentioned macroeconomic indicators, policy changes, market sentiment, etc. 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 investors' expectations.

The second category is on-market macro: On-market macro refers to data and analysis directly derived from the cryptocurrency market, with the core being Bitcoin's on-chain data. These data include changes in the amount of coins held by long-term and short-term holders, profit levels, etc. By analyzing these on-chain data, we can have a deeper understanding of the dynamics within the market, including investor behavior and market trends.

These two sets of analysis methods have their own focus. Off-market factors provide us with a macro perspective, while on-market factors allow us to gain insight into the cycles and rhythms of the internal operation of the crypto market. It is very important to combine these two perspectives when analyzing the cryptocurrency market, as they together form a comprehensive macro-analysis framework.

Albert:

I would like to add that in addition to the policy influences of the Federal Reserve and the Treasury, we should also pay attention to microeconomic factors such as bank deposits. For example, ordinary investors may choose to deposit their funds in banks to earn interest when faced with high interest rates, but this may also have an impact on market liquidity. Historically, the growth rate of deposits slowed significantly after the banking crisis in the 1980s and 1990s. After the SVB incident in 2023, we saw a similar situation, with bank deposits declining while the stock market and other asset markets began to resume growth. In addition, international liquidity, such as the Bank of Japan's Japan-US carry trade, also brings additional liquidity resources to the market.

In a high interest rate cycle, people tend to deposit their funds in banks to earn interest. However, when banks face operating risks, investors may turn their funds to the stock market or other assets, such as short-term government bonds. Currently, the yield on short-term U.S. Treasury 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, etc., in order to seek higher returns.

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

Ideally, we should consider all factors that may affect the market, including the liquidity conditions of other countries. However, in actual operations, due to the difficulty, we may not be able to include all factors in the analysis. For example, carry trade in Japan and Europe has an impact on the market, but it is difficult to quantify. We usually focus on the United States and regard the impact of other countries as a secondary factor. Nevertheless, we cannot ignore the impact of the overseas offshore US dollar market.

Vivienna:

On Twitter, I published an article exploring the impact of US liquidity on cryptocurrency prices. I focused mainly on domestic factors rather than overseas US dollar markets, as the latter's data is difficult to quantify. When analyzing Bitcoin prices, I divide its influencing factors into three categories:

The first is observable indices: including the federal funds rate, Treasury yields, the US dollar index, and gold prices. These indices are the basis of market expectations, but their relationship with risk asset prices is not directly linear. For example, interest rate hikes usually lead to tighter market liquidity, which is not conducive to the rise of risk assets, while interest rate cuts are the opposite. However, this impact is subject to the complex superposition of monetary policy transmission mechanisms, economic, financial, and sentiment cycles, and will not have a direct impact on market liquidity at the moment monetary policy is implemented.

The second is liquidity indicators: such as the balance of the Federal Reserve's balance sheet, reverse repurchase operations, and Treasury accounts. These indicators directly affect US dollar liquidity, thereby affecting the prices of growth-type risk assets such as Bitcoin. For example, the Fed's expansion of its balance sheet, the reduction of reverse repurchases, or the Ministry of Finance's consumption of TGA accounts will increase market liquidity and benefit risky assets.

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

2.How do macro factors affect the crypto market

Zheng@LUCIDA:

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

HighFreedom:

I think there are three ways to understand how to make money:

The first is to make money in the general direction: this means buying and holding spot when the market trend is clear, not trading frequently, and being patient.

The second is to make money from volatility: this usually involves quantitative trading, using the volatility of the market to buy and sell, without paying attention to the specific direction of the market.

The third is to make money from liquidity: during the bull market, put funds into the market and earn high interest by lending to traders in need.

I personally believe that macro factors affect the cryptocurrency market in two main ways: liquidity and penetration. Liquidity determines the amount of funds in the market, while penetration is the proportion of funds allocated to cryptocurrencies such as Bitcoin.

At the operational level, I tend to be fully invested in spot during the bull market, especially mainstream currencies such as Bitcoin. This is the first type I just talked about: making money in the general direction.

At the same time, I will appropriately use part of the funds to go long in the currency standard, but avoid frequent long and short operations in the bull market. I think the key is to identify the highs and lows of the market, which requires comprehensive consideration of multiple sources of information, such as miners' costs, market heat, lending rates, funding rates, etc.

Market performance in the second half of 2021 shows that the highs of Bitcoin prices are in chronological order with the highs of the Nasdaq index and US dollar liquidity. This suggests that when liquidity reaches its peak, risky assets may need to prepare to exit. Therefore, I will pay close attention to liquidity indicators to determine whether the market is close to the top or bottom.

At the same time, I believe that information orthogonality, that is, forming a comprehensive market judgment by widely collecting information from different angles, can help us grasp the highs and lows of the market more accurately, so as to make more reasonable trading decisions and minimize the possibility of operational errors. I will also adjust my risk control strategy according to market conditions to ensure that I can protect my investment when the market fluctuates.

Vivienna:

I recommended a book on Twitter, "Principles of Professional Speculation", in which the author, Sperandi, proposed two basic principles for market analysis and forecasting: one is that market trends are the result of the operation of basic economic forces, which are affected by political systems and policy activities; the other is that the psychological state of market participants determines the way and time 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 technological innovation and development paths. Secondly, the prediction of the psychological state of market participants is more instructive for trading. Macro analysis is often questioned because many people pay too much attention to economic and financial data and ignore expected changes. Successful trading requires not only analyzing the current situation behind the data, but also paying attention to how expectations change and how market games are conducted.

Soros once pointed out that economic history is built on false lies, not truth. The way to make big money is to analyze the wrong trend, follow the trend, and get out before being exposed. This reflects the above principle, because to distinguish the wrong trend, you must first know what is right. For example, if the government adopts a high interest rate policy during a recession, or tries to stimulate the economy by adjusting interest rates through monetary policy, if you do not understand the transmission mechanism of these policies, you cannot judge the consequences and cannot get out before most participants find the problem.

Albert:

Regarding how the macro analysis framework affects the cryptocurrency market and our trading strategy, I will talk about it in the following points:

First, since 2020, we have discussed a long-standing theory-liquidity chain theory. According to risk analysis, we sort different assets such as commodities, foreign exchange, stocks, etc. according to a chain. At the top of the chain is cash. As the basis of all assets, cash has extremely low risk, almost zero except for inflation. If cash is at risk, it means that the global market may face a reset.

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

This theory also explains the underlying reason for the phenomenon mentioned by Highfreedom just now that "the high point of Bitcoin price is in a sequential relationship with the high point of Nasdaq index and US dollar liquidity".

When liquidity is released, the first thing affected is the foreign exchange market, then the bond market, followed by the stock market, commodity market, and finally the cryptocurrency market. On the contrary, when liquidity is tightened, the withdrawal process is reversed. This liquidity flow sequence has an important impact on the market.

As traders, we use this framework to guide our trading. For example, when we see liquidity start to tighten or release, we can predict the market's reaction and adjust our trading strategy accordingly. We keep a close eye on interbank interest rates and bond futures because these are the market's first reaction to policy changes. Then, we analyze the options market because option prices reflect the market's expectations of future volatility. Our trading strategy is mainly based on these macro expectations. For example, in a rate hike cycle, market sentiment tends to be bearish, and we will configure put options when volatility is low. At the same time, we will adjust our option portfolio based on market sentiment and expectations to earn returns from volatility regression. Our strategy relies on volatility regression, especially near-term volatility. Far-end volatility may remain high for a period of time and will not return immediately. Therefore, we are usually buyers at the far end and capture value through cross-period configuration. Our combination strategy is to earn the difference in value between near-term and far-term options by holding them.

3.Bitcoin's position in the major asset classes

Zheng@LUCIDA:

The next question is relatively easier, and we have already indirectly mentioned it in previous conversations, 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 rose, and Bitcoin also rose accordingly. At that time, the market's recognition of this view was increasing.

However, with the bull market cycle from 2020 to 2021, and the situation in 2022, the public gradually accepted that Bitcoin is an asset with higher risk than traditional risk assets. I would like to know whether everyone agrees with this positioning, or whether there are other descriptions of Bitcoin's position in the major assets.

HighFreedom:

I think this description is quite accurate. I think Bitcoin is undoubtedly a riskier asset in the short to medium term. But 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 think there are several basic elements that safe-haven assets need to have, and we can discuss whether these are necessary conditions:

The first is that the market size should be large: the market size of the asset needs to be large enough for large amounts of money to flow in and out freely.

The second is that volatility should be reduced: Although Bitcoin has historically been very volatile, it has now dropped significantly and is close to or sometimes even lower than the volatility of gold.

The third is the rationality and stability of market participants: as market participants gradually transform 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 logic of Bitcoin being called digital gold is widely recognized. The total amount of Bitcoin is fixed, similar to the scarcity of gold, and it can be used as a store of value and a means of payment, which is highly consistent with the characteristics of gold.

However, the pricing of gold prices is a complex issue. The safe-haven characteristics of gold are particularly evident when risk aversion is high, such as war. If the market's basic liquidity is not tight, but the war factor is significant, then Bitcoin may follow the trend of gold, because the main factor affecting the price of gold is risk aversion. Correspondingly, the price of Bitcoin will also be affected by risk aversion.

However, if the underlying liquidity of the market itself is insufficient, such as when the global or US economy enters a recession cycle or there is an expectation of a recession, even if risk aversion is high, it will not drive trading volume. This explains why other markets do not react significantly when certain geopolitical conflicts are intense. In this case, it is the underlying liquidity that determines the bottom line of the price, and Bitcoin is closer to risky assets

Therefore, the correlation between the price of gold and the price of Bitcoin depends mainly on the underlying liquidity of the market at that time and the market's view on the attributes of Bitcoin. Most of the time, the price of Bitcoin is highly correlated with US stocks. In the process of economic contraction, investment contraction, and deleveraging, Bitcoin will react first and will also react in advance when the economy recovers and investment returns to leverage, and its acceleration is also greater

Gold holdings are usually controlled within 5% in global asset management companies because the factors affecting gold prices are very uncertain. Although gold has practical applications, it is more affected by speculation and emotions and lacks fundamental analysis. This makes it difficult to explain to LPs (limited partners) why they should invest in gold. It can only be based on predictions of future economic recessions or risks, which is very subjective and difficult to convince.

Bitcoin faces the same problem, and it is difficult to convince capital companies and LPs to allocate funds to this asset. Although gold is regarded as a safe-haven asset, its ability to fight inflation is mainly reflected in the long term. The same may be true for Bitcoin, and its status may be very high in the future, especially as the difficulty of Bitcoin mining increases.

If more traditional financial asset management companies enter the field of Bitcoin investment, the investment proportion of Bitcoin may move closer to gold.

Albert:

From a macro perspective, gold and Bitcoin have multiple attributes. They can be both risky assets and safe-haven assets. This phenomenon seems contradictory at first glance, but in fact it has its own internal logic.

First of all, whether it is gold or Bitcoin, it is a safe haven for funds in times of crisis. During war or other turbulent times, asset transfers are restricted and liquidity seeks safe havens. Investors tend to move funds to assets that are easily cross-border, such as gold and Bitcoin. This leads to a sharp rise in the prices of these assets during times of crisis.

However, in times of market stability, the properties of gold and Bitcoin are different. Bitcoin, due to its high volatility, is more of a risky asset, and its price fluctuations are related to the stock market, partly because the Bitcoin market has more leverage instruments and many market participants, which leads to its sharp price fluctuations.

In a stable environment, investors tend to pursue a stable portfolio and avoid large fluctuations in asset prices. Therefore, they may prefer to allocate some traditional assets, such as gold and other commodities. Gold, due to its long history and stable value, is usually controlled within 5% of the portfolio.

In addition, the prices of gold and Bitcoin are also affected by market expectations. When liquidity is sufficient, investors may seek higher-yielding assets, and when liquidity is tight, they may return 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 certain cases, they may exhibit safe-haven characteristics, while in other cases, they may be more reflected as risky assets.

Fourth, What is the grip of macro analysis?

Zheng@LUCIDA:

Next, let's discuss a question, that is, when analyzing the macro economy, what data sources do you usually rely on, do you collect data on your own, or do you have some non-traditional analysis tools? Is there a more exclusive source of information to share?

HighFreedom:

I wrote a little code on tradingview and made a dashboard to continuously observe and analyze macro liquidity. These tools are no different from the data provided by the Fed and Treasury websites, but I have integrated them into a single interface for continuous observation. In addition, I also follow some analysts on Twitter, especially a Taiwanese blogger who aggregates some interesting data, such as lending rates on different exchanges. This data can reflect the operation trends of large and small investors, and the order between them. I think this data is very valuable, but I have not yet successfully applied his tools.

I have also been looking for data on US Treasuries, especially the daily net issuance of short-term and medium-term & long-term bonds (net issuance is the amount of new bonds issued on the same day minus the amount of bonds maturing on the same day). This data is very important for understanding and judging market liquidity now and in the next period of time. At present, I can only manually download the data from the US Treasury website and process it myself. If you know of a better data source, please recommend it and contact me.

Albert:

I would like to add some macroeconomic data sources that we are concerned about. Because I mainly focus on risky commodities, the data services I use include SpotgammaMenthorQ, which provides data on US stocks, bond markets, and other commodity options, and these data are quite comprehensive.

In addition, for the US stock market, there are services such as GR, which provide real-time data at a relatively cheap price. If you need more in-depth data, such as data on gold or interbank markets, you may need to rely on internal industry resources.

For the cryptocurrency market, the first recommended data source is Amber DataDerivative, which is very comprehensive in options data and has obvious advantages. In addition, this service provider provides real-time data from exchanges such as CME.

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

In addition, exchanges like Bitfinex can be regarded as the interbank market of the cryptocurrency market. Their short-term lending rates can reflect the risk-free rate of the market, which is very important for calculating the risk premium of the crypto market.

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

In general, although we can obtain a lot of market data, the final trading decision still depends on our own risk management capabilities. Our goal is to maintain no loss or small profit in most cases, and to achieve big profits in a few cases.

V.Review and Outlook of This Cycle

Zheng@LUCIDA:

Let's turn to the last question, the view on the future market.

Let me share my views first: the general market expectation is that the Fed's interest rate cut in the second half of this year or next year will bring huge liquidity, coupled with favorable factors such as Bitcoin halving, many people expect to replicate the bull market in 2021. However, I am very pessimistic about this generally optimistic expectation, because historically, highly consistent market expectations are often accompanied by huge potential risks.

Especially for institutional investors such as public funds in the United States, although they are institutional types that hold positions for a long time, they also make adjustments to investment decisions based on market conditions and will not blindly "chase high".

HighFreedom:

My views are very similar. This year's main market upswing started in November last year, especially after the spot ETF trading in January, the market has fluctuated significantly. The liquidity and penetration of the first-degree are both rising, but it is mainly retail investors who participate, and real institutional investors have not yet entered the market on a large scale. For example, 80% to 85% of the inflows into spot ETFs come from retail investors. Liquidity declined in the second quarter and penetration stagnated. My outlook for the third and fourth quarters is that I hope liquidity will remain stable and penetration will increase due to further participation from institutional investors.

I believe that rate hikes or rate cuts do not immediately change liquidity, but rather change the market's expectations of future liquidity. My question is whether there will still be a loose fiscal and monetary policy environment like in 2021, which seems unlikely at the moment. Therefore, I am cautious about the future performance of the market and hope that there will not be overly optimistic expectations.

The market may not change much in the short term, and liquidity expectations may have 4 to 5 rate cuts in the next 15 months, which provides the market with a robust expectation. But the real liquidity release will be slow, and large-scale rapid changes are unlikely. Unless there is a severe economic recession or crisis, it is unlikely that a loose fiscal and monetary policy environment will appear again.

So if there is no serious economic recession, it is likely that this rate cut may be the so-called "asymmetric rate cut". The previous rate hikes and cuts were symmetrical. For example, it took one year for the federal benchmark interest rate to rise from a low level to a high level, and it took almost one year to fall from a high level to a low level. This violent rate hike started from 0-0.25 in March 2022 to 55.25 in May 2023, which took almost a year, but this rate cut may take an asymmetric route, and the rate cut process will be continuous and slow.

Vivienna:

My conclusion is relatively simple and similar to everyone's views. From July and August this year to the end of the year, the market may face a less optimistic liquidity situation. Even if there is a rate cut, it may only be once. Although this provides positive expectations for the market, it will not fundamentally change the status quo.

The economy is not in recession and the stock market may continue to rise. People's lives do not seem to be affected much. Deposits and dividends can still fill household savings and promote consumption. However, if inflation continues to rise, it may trigger trading expectations for a stagflation cycle. If interest rates continue to be high next year, and even in some cases further interest rate hikes are needed, and the Ministry of Finance 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 of institutional investors to enter the market on a large scale, I think it is more of an expectation than a reality. In the current situation of poor basic liquidity, insufficient understanding of cryptocurrencies in the market, and high volatility, institutional investors are unlikely to hold or build positions on a large scale. This expectation may be too idealistic and the actual situation may not be as we wish.

Albert:

Current short-term market expectations are bearish, especially for Bitcoin. Although market volatility may increase in July due to factors such as option expiration, in the long run, the asset allocation cycle may drive prices up. However, for the market to rise, it may need to rely on two factors: one is the large allocation of institutional investors, and the other is the further improvement of investor sentiment. But this sentiment-driven rise may not be healthy, because high capital costs and high volatility are difficult to maintain for a long time.

My view is that the market rise will be a slow process because the booking of market participants is a gradual process. The use of derivatives and leverage is difficult to drive the market in the short term. In this case, the operation of market makers may become an important factor affecting the direction of market prices. The macro factors of the market may only be a factor that drives the hedging behavior of market makers, rather than directly acting on prices. This may cause the market to look more irregular, increasing the difficulty of executing strategies such as CTA.

In general, the market may not have a large-scale crash or rapid rise in the short term, but a slow and long process. Liquidity will not rise and fall 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.