After enduring a prolonged period of unfavorable developments, the crypto market received a much-needed boost last week with the emergence of spot bitcoin ETF filings by major players such as BlackRock, Invesco, and WisdomTree. This positive development was greeted with enthusiasm by crypto traders, resulting in a substantial surge of over 20% in the value of bitcoin (BTC) within the past eight days. However, caution is advised as certain indicators in the traditional market suggest a potential aversion to risk on the horizon.
Over the past few years, it has become evident that digital assets cannot remain detached from the realm of traditional finance (TradFi) for extended periods. Notably, significant downturns in stocks and other high-risk assets often impact sentiment in the crypto market. To gain insights into the current state of affairs, it is worthwhile to examine the Cboe Volatility Index (VIX), commonly referred to as Wall Street’s “fear gauge,” as well as the associated futures contracts. The divergence between the costliest VIX futures contract and the index itself has expanded to levels that historically coincide with major peaks in the S&P 500, the leading equity index benchmark. The behavior of the S&P 500 is regarded as a reliable indicator for risk assets worldwide, including cryptocurrencies. Tom McClellan, a technical analyst and editor of The McClellan Market Report, noted via a tweet that the current widespread is indicative of a potential market top.
With a reading exceeding 60%, attributable to the VIX falling significantly below the futures contracts, there appears to be an excess of optimism among stock traders, a phenomenon frequently observed at market peaks. A similar reading was observed in early January 2022, preceding a decline in stocks from their record highs. This particular indicator also captured the attention of James Choi, a trader, and analyst who has maintained a bullish stance on Bitcoin and technology stocks since January.
Choi points to the recent expansion of junk bond spreads, coupled with declines in oil prices and traditional inflation hedges such as gold and silver, as harbingers of an impending deflationary downturn—an event characterized by a broad retreat from risk. The term “junk bond spread” refers to the disparity in yields between high-risk, high-return bonds and safer U.S. Treasuries. The widening spread signifies that investors are demanding a greater premium to invest in riskier debt. Both Choi and Sven Henrich, founder, and chief market strategist at NorthmanTrader, assert that U.S. dollar liquidity is being drained from the system—a development that bodes unfavorably for bitcoin and other risk assets heavily influenced by changes in fiat liquidity.
Earlier this year, bitcoin rallied alongside stocks following the U.S. Treasury’s decision to utilize its cash balance after the government reached the debt limit. This move improved liquidity conditions, benefiting both the cryptocurrency and equities markets.