Bitcoin fever is running high, again – Saxo Bank MENA Market Report

By Charu Chanana, Head of Forex Strategy, Saxo Bank

Bitcoin surged to a record peak yesterday, fueled by rising demand since the introduction of spot ETFs in January and anticipation surrounding the April halving event, which is expected to limit supply. Moreover, the boost in liquidity and the prospect of Federal Reserve rate cuts are propelling risk assets. However, prudent risk management is warranted, given the stretched positioning and significant volatility.

The price of bitcoin (XBTUSD) soared to all-time highs of over $69,000 on Tuesday before turning lower as some traders locked in profits. Gains have reached over 50% year-to-date, with much of the surge occurring recently as trading volume surged for US-listed Bitcoin funds.

Ethereum (XETUSD) outperformed Bitcoin even as the SEC recently pushed back against Ethereum ETFs proposed by BlackRock and Fidelity. Markets are awaiting the SEC’s decision on the VanEck Ethereum ETF, which has its final decision deadline on May 23rd. Any approval, however, will likely come with the rest of the ETF filings as well, just like the spot Bitcoin ETFs, to prevent a first-mover advantage.

What is driving the bitcoin rally?

Record inflows in the recently launched Bitcoin ETFs

The first spot Bitcoin ETFs were launched in January this year, and investors are rushing to invest in them. Bitcoin spot ETFs have attracted everyday investors who want to buy digital assets through their brokerage accounts without going to a crypto exchange or to funds that track Bitcoin’s price through futures contracts.

BlackRock’s iShares Bitcoin Trust eclipsed $10 billion in assets Thursday, the fastest a new ETF has ever reached that milestone. Fidelity’s fund, with more than $6 billion in assets, is already the asset manager’s third-largest ETF and has accounted for most of its net ETF inflows this year.

Anticipation ahead of the halving event

The halving, also known as the “halvening,” is a scheduled event in Bitcoin’s protocol that occurs approximately every four years. During this event, Bitcoin miners’ reward for validating transactions and securing the network is halved. This reduction in the reward decreases the rate at which new bitcoins are created, effectively reducing the available supply.

The halving aims to control inflation and ensure that the total supply of bitcoins remains capped at 21 million, as specified in Bitcoin’s code. This scarcity is one of the key factors driving Bitcoin’s value.

The next bitcoin halving is expected to occur in April 2024, when the number of blocks hits 740,000. It will see the block reward fall from 6.25 to 3.125 bitcoins. The general consensus is that Bitcoin halving events are positive for the price of Bitcoin, and historically, they have been.

Flush liquidity and general risk-on environment

The Fed’s overnight reverse repurchase agreement facility, or RRP—where eligible counterparties can park cash to earn a fixed rate—has been dwindling. This means that money market funds that parked excess cash at the RRP before have been withdrawing it, particularly to buy T-bills, adding to market liquidity. As hinted by Fed member Chris Waller, the Fed may be at a point to start discussing the tapering of QT.

Even as policy rates may remain higher for longer, the market is flush with liquidity. This could be partly fuelling the recent all-time highs across risk assets, including NASDAQ. Bitcoin remains sensitive to liquidity shifts, given it is a high-volatility tech proxy.

FOMO buying

For those undecided about entering the crypto sphere, few things induce more FOMO (fear of missing out) than witnessing Bitcoin’s ascent from the sidelines. Knowing others are making money while they’re not can push people to take big risks. Indeed, FOMO serves as a potent catalyst for impulsive buying decisions.

The fragmentation game

Bitcoin provides an alternative asset choice for those looking to diversify away from government-controlled assets. This has been a factor supporting gold, as many central banks have bought gold over the last few years to diversify their USD reserves. Bitcoin could face a similar demand if it is increasingly accepted as the ‘digital gold’ of the 21st century. However, there are inherent risks to consider. Presently, Bitcoin’s volatility makes it an unreliable store of value.

Exit from the crypto winter

The market seems to be healing from the aftermath of the crypto winter, marked by the collapse of firms like TerraLuna, Genesis, BlockFi, and FTX, which tarnished cryptocurrencies‘ reputation. A recent period of calm suggests stability, while some see it as a necessary cleanup of the crypto ecosystem.

Risk management is warranted

Bitcoin price action follows a high-beta cycle. When it rises, it rises fast, but when it falls, it also falls much quicker than other risk assets because of a high level of leveraged play in the crypto market. The recent run higher could have been a result of a short-squeeze, as strong ETF flows lead to higher prices and force some shorts to cover. Likewise, leveraged traders are forced to liquidate when the price declines, exacerbating the selloff. Thus, volatility is a key risk.

Also worth noting that speculative positioning is also long, which makes it potentially vulnerable to a reversal if ETF demand starts to moderate. Positioning in altcoins, such as Ether, is relatively more modest and long.