5th January 2022 > > L1 & L2 protocols, and an intro to leverage.

Market Snap

Market Wrap

Glassnode have reported that 76% of all BTC is now illiquid (BTC that has been moved to a wallet with no history of spending).

This on-chain metric is at odds with the price action since early December 2021, as BTC has struggled to regain $50k:

“… divergence between what appears to be constructive on-chain supply dynamics, compared to bearish-to-neutral price action.”

Curious Cryptos’ Definition of the Day – Layer 1 (L1) and Layer 2 (L2) protocols Part Two

The congestion on some L1 protocols, specifically the Bitcoin and Ethereum networks, started to become an existential threat to the crypto revolution. For Ethereum in particular, the rise of Non-Fungible Tokens (NFTs) and Decentralised Finance (DeFi) led to a situation where, on occasion, some transactions without a very large fee attached could take days to be incorporated into the blockchain.

The answer came in the development of L2 protocols, an example of which is the BTC Lightning Network. This allows for extremely fast and very cheap transactions (scalability) without compromising the L1 protocol, maintaining the decentralisation and security of the L1.

L2 protocols will all work in a different way, but they are based mostly on a common concept of off-chain scaling. In effect, they create mini chains of crypto transactions for a pre-determined period, before then providing a summary of those transactions to be incorporated back into the L1 blockchain.

BTC Lightning can provide confirmation of transactions in under a minute and sometimes in milliseconds compared to the ten-minute wait between each block in L1. BTC Lightning fees are of the order of cents, not tens of dollars.

Curious Cryptos’ Commentary – Open Interest in leveraged futures

My leading indicator for potential sharp moves up or down due to liquidation of leveraged positions is the Perpetual Futures Funding Rate, which has been firmly anchored to neutral for a while now.

I notice that total open interest in leveraged futures positions is back at all-time highs after that December shakeout:

Why does this matter in real life?

…

If perpetual futures rates move significantly higher than 0.01% this means that leveraged longs are dominating the futures markets.

If perpetual futures rates move significantly lower than 0.01% this means that leveraged shorts are dominating the futures markets.

Imbalances such as these are structurally unstable and cannot last long.

Imbalances such as these can precipitate violent and murderous carnage of the over-extended side of the trade with a short, sharp, and painful price move.

…

When funding rates are neutral at 0.01%, high open interest on its own won’t be a trigger for a price move. But once we have some market moving news, the liquidation of leveraged positions - long or short - will exacerbate the price move, deepening the sell-off or strengthening the rally.

And that is the situation we find ourselves in today. By tomorrow of course it could be completely different.

Going forward the CCC will report daily the open interest on Binance, the dominant player in the leveraged perpetual futures market for BTC globally. For future reference, today’s market snap of $3.8bn USDT is at the all-time highs.

Reserve Treasury Protocols (before they all go to zero)

Reminder – Olympus and Wonderland are, to the best of my knowledge, live viable projects. XEUS, FORT and JADE turned out to be scams, though they are still live scams. Scams are not uncommon in these Wild West fringes of Decentralised Finance (DeFi).

Open positions:

Closed positions: