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Monthly Market Review - September 2022

For September, we will look at how The Merge impacted the market, a brief overview of the Wintermute hack and where we believe we are in the market cycle.


As we discussed last month, the big digital asset event of September was The Merge, where Ethereum upgraded to proof of stake. The Merge contained significant technical risk (and a lot of hype); it has also driven Ethereum to outperform Bitcoin for the last few months. However, the Merge was a 'buy the rumour, sell the news' event as the market sold off sharply after a successful Merge. Some participants had purchased ETH to benefit from the fork (ETHW), which traders quickly sold off once it was tradable on exchanges. It was uncertain what the price was for the ETHW and when traders could access it. On some brokerages, it is still inaccessible.



Some participants were hedging their long ETH positions with futures to collect the funding rate; this led to the ETH funding rates becoming sharply negative just into the Merge, touching -0.4% daily. After the event, these participants sold their ETH positions and closed their shorts, which snapped the funding rate back into alignment with Bitcoin. Ethereum is now trading back in line with Bitcoin.


On September 20, Wintermute, a specialist DeFi market maker, was hacked for $160m. The hacker exploited a recently disclosed security flaw in how Wintermute used to generate its wallet keys. Wintermute uses a software tool called Profanity to produce wallet addresses with many leading zeros (0x00000...). These addresses require less space to store, so they need less trading fees per transaction. The hacker reverse engineered the tool to discover Wintermute's private key (the security flaw they used had been publicly disclosed) and transferred the funds to another wallet. Most stolen funds were stablecoins (USDC, USDT and DAI). To prevent these funds from being stolen, the attacker used Curve (specifically the 3-pool), a Defi protocol that allows users to swap between different Stablecoins. Because the funds were in the 3-pool pools, entities can't easily blocklist the address as this will blocklist all Curve funds. This hack was particularly sophisticated and is a reminder of the caution needed (and return premium required) when trading in DeFi.


Overall, watching the news of this hack spread (or how little it did) serves as an anecdotal barometer of where we are in the market cycle. As prices have fallen (and activity in the rest of the market has driven price action), there has been less news coverage and less interest more broadly in digital assets. In past cycles, this period is the beginning of the sideways consolidation of the space, where there has been less activity, low trading volumes, choppy price action and fewer speculators. Historically, this has roughly been a 12-month period of sideways price action. Typically, there will be a catalyst to get the bull market underway again, and then interest will start to pick up. For digital assets, the prior two market cycles have been four years long, with the consolidation period lasting 12-18 months (we believe we are roughly six months through, with May and the LUNA event being the major capitulation). However, there are two large caveats: firstly, two cycles are hard to draw trends from, but the bigger caveat is that digital assets have always existed in a wider low-rate environment. Now, digital assets are in sync with the broader market, so it's very uncertain if the digital asset recovery will front-run or follow the global asset price recovery (when it comes). As a high-risk asset, investors may prefer to invest in lower-risk assets first, which means digital assets could be one of the last places to recover. Lagging global asset prices may lengthen the consolidation period for crypto.