Event Risk Volatility

Several event risks are appearing on the horizon that indicate significant uncertainty for crypto-asset prices, including a follow-up ETF application deadline, the halving of Bitcoin's block reward, and two chances for the first cut in interest rates after the sharpest hiking cycle in decades.

Crypto

Derivatives

Macro

Event-driven price volatility

Crypto asset spot prices, particularly those of majors BTC and ETH, have recently been driven by event risks. We saw that most recently in the ETF narrative, which dominated the news cycle from early October.

The impact that the ETF deadline had on volatility markets was quite clear – the date of the known event risk travelled along the term structure of at-the-money implied volatility as the event drew closer, marked by a significant upward kink in volatility pricing (shown in the chart below normalised by the level of realised volatility over the last 30-days).

Figure 1. Ratio of at-the-money (ATM) implied volatility to realised volatility (90d lookback) at several constant tenors on the term structure. Vertical lines show when the ETF event risk (on the 11th Jan) was the stated number of days away. *Source: Block Scholes*

In early December, clarity around the final deadline for a response from the SEC on the outstanding ETF applications came into focus. We saw implied volatility at tenors later than the 12th Jan rise significantly above both the level of recently delivered volatility and the levels implied by options at shorter tenors.

As the deadline passed the 30-day mark, we saw the volatility implied by options near to a 30-day tenor rise. Vols departed the level of shorter tenor options (which remained well anchored to the level of volatility recently delivered) and moved higher to match the increased volatility expected after the deadline date.

The collapse in volatility in the days after the announcement was dramatic. Spot prices failed to deliver either the sustained rally or sharp selloff for which long-volatility traders had been bracing, but realised volatility (the denominator in each of the series plotted in the figure above) actually rose into the ETF event. This was likely due to the bundled announcement by the SEC. Forward-looking volatility expectations (which had risen high above realised in the days before) corrected strongly back below.

Figure 2a. Hourly BTC ATM implied volatility at a 3-month tenor (light orange) and 90d realised volatility (dark orange) since Jan 23. *Source: Block Scholes*

Figure 2b. Hourly ETH ATM implied volatility at a 3-month tenor (light purple) and 90d realised volatility (dark purple) since Jan 23. *Source: Block Scholes*

Which narrative is driving prices now?

There are a few candidates. Most prominent is the factor driving all risky assets (but maybe not in the way that we have come to expect from history) – macroeconomics.

The median Federal Open Market Committee member (when polled in December’s SEP) expected to cut rates three times in 2024. When that program of cuts will begin has been far less certain than at the end of previous hiking cycles. We can see that in the behaviour of long-term bond yields since the last hike in July 2023, shown in the chart below.

Figure 3. Yield implied by a 10-year US Treasury note in the months before and after the final interest rate hike by the FOMC, compared to the yield observed on the day of the last hike for the last 5 cycles. The current cycle (assuming that Jul 2023 was the last hike date) is shown in white. *Source: MarketWatch, Block Scholes*

The end of the five previous hiking cycles has uniformly resulted in long-dated T-note yields falling as markets recognised that the Fed was approaching the end of the hiking cycle. This time around, yields continued to rise before peaking 85 days later – on the 19th of October.

Now, yields trade at almost the same levels as they did on the date of the Fed’s last hike, having hit this level at the end of December when expectations of a March cut (following the very dovish messaging in the FOMC meeting earlier that month) were at their highest. With a March cut now almost entirely off the cards (market pricing on FFR futures implies just a 7.5% chance after the strong CPI print on Tuesday), the next opportunity for a Fed-induced event risk date is the FOMC meeting on the 1st of May. There, the market prices for only ~40% chance of the Fed moving by that date.

Changes in monetary policy are important for all risky assets, including crypto-assets. Bitcoin’s spot price has been reactive to changes in the outlook for monetary policy throughout the inflation cycle – it has been particularly attentive to CPI data and FOMC meetings since 2022. We would expect uncertainty about the timing and nature (a recession or a soft landing?) of a cut in interest rates by the Federal Reserve to have a more recognisable impact on forward-looking volatility expectations.

Crypto-Factors

Beyond macro factors are the crypto-specific events that are coming across the horizon – and there are a few. The initial expectations of a follow-on ETF-fuelled ETH rally have been put on hold until the tentative deadline of May 23rd. Before that, the Ethereum foundation is expected to implement an upgrade to the network (currently scheduled for March 13th) and the Bitcoin mining reward is set to halve from 6.25 to 3.125 BTC per block (now expected on the 17th of April).

Previous Ethereum upgrades have passed largely without large volatility spikes. In fact, both the Merge (September 2022) and the unlocking of staked ETH on the Beacon Chain (April 2023) saw volatility fall once the event risk had passed.

However, popular consensus holds that Bitcoin halving events precipitate incredible rallies in spot price. It’s not hard to see why. The chart below shows BTC’s and ETH’s performance following a halving of the block reward. Note that we only have reliable exchange traded price data for ETH after 2017 and BTC after 2014. The halving event in 2012 saw a similar pattern to the charts below.

Figure 4. BTC (orange and yellow) and ETH (purple) as a multiple of the price at the date of the halving in block reward. Note that we only have reliable exchange traded price data for ETH after 2017 and BTC after 2014. *Source: Block Scholes, Yahoo Finance*

Historical performance would imply that the peak of the ”next” cycle will be around 525-550 days after the halving date on the 17th of April (expected, due to the variance around the average block time of 10 minutes). That’s between September and October 2025. However, the emergence of a post-halving rally has (historically) been clear long before that.

Interestingly, ETH followed a similar trajectory to BTC during the last halving cycle, reporting peaks and troughs (in the chart above) at largely the same times. If there is a repeat of the historic cycle, then it will be interesting to see how the bullish impact of a potential ETH ETF has on the timing of capital rotation between major tokens.

Event risks on the horizon

We saw the ETF event dominate the volatility term structure chart in the months before. Are any of the upcoming event risks showing up on the chart now?

Strangely not. This is surprising for the FOMC meetings. While a March cut appears to be all but ruled out, the May meeting is now the first realistic candidate for the end of the sharpest hiking cycle in decades. As Tuesday’s CPI print hinted at, the path to a soft landing is far from clear, and with equities remaining near all-time high valuations, any case except the best one could result in more spot action like Tuesday’s.

Figure 5. The term structure of BTC (orange) and ETH (purple) ATM implied volatility at 2024-02-13 16:00 UTC snapshot. Key event risks are highlighted with white lines. *Source: Block Scholes*

The lack of impact of the remaining events is not so surprising. The deadline for the SEC’s response to BTC ETF applications did not cause a significant kink in the term structure until around 50 days before. While historically it has been an important milestone in the cycle, the halving event itself does not usually herald much immediate spot price volatility and, as we noted above, Ethereum’s upgrades have usually resulted in a similar “non-event”. However, each upgrade has marked a change in the regime of ETH’s volatility compared to BTC’s.