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ETH and BTC Basis Trade Drives Up Short-Term Cash Rates Amid Bullish Market Sentiment

Lending Market Commentary 2405

In this report:

  1. Market Update: ETH and BTC Basis Trade

  2. Trend: Tokenized Government Debt Platforms Gain Momentum

  3. Trend: Onchain Savings Protocols Attract Rising TVL

Market Update

Bitcoin, Ethereum, and the broader crypto market had a sluggish start to May, with BTC opening below $57,000 and ETH below $2,950. Bitcoin regained the $60,000 level but traded sideways for the first half of the month, while Ethereum struggled to reclaim the $3,000 and consolidated for much of the period.

However, this lackluster sentiment shifted dramatically following a surprise announcement on May 20th by the SEC requesting 19b-4 updates for the spot Ethereum ETFs. This significantly increased the odds of a spot ETF being approved, which catalyzed a more than 20% single-day surge in ETH, pushing the asset above $3,700 for the first time since early April. The 19b-4 updates were eventually approved later in the month, paving the way for the approval of the S-1 filings and the eventual launch of a spot Ethereum ETF.

May 2024 BTC-ETH-Price

The crypto market interpreted the SEC's surprise request as a potential shift in regulatory sentiment. This perceived policy change reverberated across the broader digital asset landscape, reigniting bullish momentum. This renewed optimism was evidenced in the front month basis trade for both ETH and BTC, which, annualized, spiked above 25% and 19% respectively before consolidating at lower levels.

May 2024 ETH-CME
May 2024 BTC-CME

The increase of front-month basis, where the futures price positively diverges from the underlying spot price, indicates traders have disproportionately built long positions in the futures markets, in this case the CME. This dislocation presents a delta-neutral arbitrage opportunity. Traders can capitalize on this by buying the spot BTC or ETH while simultaneously shorting the futures contracts, capturing the spread as the prices converge towards the end of the contract period.

However, executing this trade requires significant capital - both to fund the spot purchase and to post as margin on the futures side. Moreover, the basis trade serves as a benchmark for short-term lending rates in the over the counter (OTC) crypto credit markets. It becomes challenging to justify lending cash at rates lower than the prevailing basis, leading to a general rise in short-term financing costs whenever the basis widens substantially. This interplay between spots, futures, and funding markets underscores the nuanced dynamics that traders must navigate.

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Key Trends We're Tracking...

Tokenized Government Debt Platforms Gain Momentum Amid Increased Demand for Treasury Exposure and Yield Opportunities.

The United States Treasury market, widely regarded as one of the world's largest and most crucial financial markets, has continued to grow significantly. The annual issuance of government debt surged to $23 Trillion in 2023, nearly tripling the amount issued in 2013. Over the same period, the Fed Funds rate has increased to 5.32%, up from less than 1% in 2013. This elevated issuance coupled with historically high Fed Funds rates, and other macros factors, has led to short-term Treasuries yielding in excess of 5%.

May 2024 US-Treasury
May 2024 Fed-Funds

The elevated yield levels have captured the attention of the broader crypto community. Market participants are actively seeking ways to gain exposure to Treasuries without taking their funds off-chain. This has led to the emergence of various product offerings from platforms such as Ondo Finance, OpenEden, Franklin Templeton's BENJI, and most recently, Blackrock's BUIDL. These solutions aim to bring Treasury exposure on-chain. The strong demand for these products is evident, as the total value locked (TVL) has grown to nearly $1.5 billion, with close to 2,000 unique holders of the tokens.

May 2024 Tokenized-Gov


These on-chain Treasury exposure products are widely regarded as offering safer and more sustainable yields compared to the returns typically associated with traditional defi yield strategies. The ability to gain exposure to the stability and liquidity of the US Treasury market, while maintaining the benefits of blockchain-based access and custody, has understandably piqued the interest of crypto investors seeking more conservative yield generation opportunities.

On-chain Treasury Table2

The demand for on-chain Treasury exposure products is driven not only by the attractive yield potential, but also by the expanding use cases within the decentralized finance (DeFi) ecosystem. For instance, an eligible trader looking to gain short-term Treasury exposure can do so through Ondo Finance's OUSG. By minting OUSG tokens using USDC, the holder can then benefit from the accruing yield, which is reflected in the increasing token value. Importantly, the liquid nature of the OUSG token allows it to be transferred and utilized across various DeFi protocols, including as collateral for stablecoin loans on platforms such as Flex Finance. While the liquidity on these platforms still has room for growth, the emerging use cases highlight the versatility and appeal of these products. As the crypto market continues to mature, we anticipate this trend of integrating traditional financial instruments like Treasuries into the decentralized finance landscape to further develop and gain traction.

Onchain Savings Protocols Attract Rising TVL Amid Favorable Market Conditions

Decentralized "stablecoin" protocols, including Maker, Ethena, and Frax Finance, share the common objective of creating a decentralized alternative to traditional fiat currencies. Beyond this core functionality, these protocols also offer crypto investors avenues to earn passive income through their respective savings or "staking" offerings. Holders of DAI, USDe, and FRAX stablecoins can earn variable yields by staking their holdings in the protocols' staking programs. This allows users to generate passive income on their stablecoin assets without needing to directly participate in the markets. These yields are highly variable and never guaranteed and are highly dependent on the current market dynamics and overall sentiment. For example, sUSDe was yielding upwards of 30% during the month of March and into the front half of April but had cooled off to end the month and into May, only to ignite again recently to end the month.

May 2024 DeFi-Stablecoin-APY

The yields offered by these stablecoin staking programs are highly dependent on market conditions. For example, sUSDe generates yield through ETH staking and ETH perpetual funding. We've seen the variable savings rates on sUSDe rise in tandem with elevated ETH perpetual funding rates, which occurs in bullish market environments. In this particular case, the spike in yields was driven by the announcement around the approval of the ETH spot ETF, which pushed the ETH price up over 20% and caused perpetual funding rates to climb above 30% on certain trading venues.

May 2024 ETH-Perpetual-Fund-Rate

The surge in market sentiment pushed the sUSDe yield to over 30% before settling above 20% - a significant increase from the ~14% rate during most of May. This higher yield attracted more capital, with sUSDe total value locked (TVL) jumping from ~$415 million on May 16th to ~$1.1 billion by May 30th. In contrast, the TVL for sDAI decreased from $1.5 billion to $1.2 billion over the same period. This was a result of Maker governance lowering the Dai Savings Rate from 10% to 8%. Overall, the total TVL across the three staking pools (sDAI, sUSDe, and sFRAX) increased from ~$1.7 billion at the start of the month to ~$2.4 billion by the end of May - a rise of $700 million.

May 2024 DeFi-Stablecoin-TVL

The growing demand for yield-generating stablecoin products is clear, as more protocols compete for total value locked (TVL). We anticipate that the protocols able to offer attractive, yet sustainable yields will capture the largest market share in this increasingly competitive landscape.

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