Bearish Ethereum Signals Across the Board

Summary

Trading View (next 2-4 weeks): We like to be bearish ethereum.

Investment View (next 1-3 years): We like to hold ethereum.

Macro Signals

• Inflation is at 40-year highs.
• Tighter liquidity conditions will continue to hurt risk markets.
• The ethereum and equity correlation remains high.
• The probability of recession within the next 12 months is still over 40%.
• The macro backdrop is bearish.

On-Chain/Flow Signals

• We have four bearish signals and three neutral signals this week.

Overall View

• With the macro backdrop bearish and on-chain/flow metrics bearish, our overall signal is bearish ethereum (Chart 1).

Macro: Broader Risk Sentiment Drives Crypto Weakness

In recent weeks, all the focus has been on the de-pegging of the TerraUSD (UST) stablecoin. The Luna coin, which acted as a ‘reserve’ for UST, has collapsed almost to zero. Meanwhile, the Luna Foundation Guard (LFG) has apparently been selling its holdings of bitcoin to prop up UST. This has amounted to around $2.4 billion worth of bitcoin sold. This could partly explain the weakness seen in bitcoin until recently.  

You would have expected Ethereum to have performed better amid this bitcoin selling. Yet ethereum suffered a similar 40% drawdown from late March to mid-May (Chart 2). Moreover, the correlation between ethereum and bitcoin remains at the highs (Chart 3). This suggests the broader macro backdrop is likely driving crypto weakness, rather than specific flows.  

Right now, equity markets have bounced, supporting ethereum and bitcoin. But we remain cautious on risk markets, so we would be careful not to get drawn into a flimsy rally.  

For key levels to watch in ethereum, we have analysed transaction volumes at different prices to determine pain points:  

1. Using on-chain transaction volumes, we find around 2,500 (range 2450-2700) is the level to watch on the upside, and around 1,800 (1700 to 1950) on the downside (Chart 4).
2. Using futures data, we find similar levels as on-chain transactions: 2,500 (range 2450-2700) on the upside and 1,800 (1700 to 1950) on the downside (Chart 5).
3. Using crypto exchange flows, we find 2,300 (range 2200-2450) is the zone where investors have moved onto exchanges to possibly sell (Chart 6).

Therefore, key levels to watch on the upside are around 2,300 and 2,500. Failure to reach these levels would be a bearish signal.  

On-Chain/Flow Metrics: Exchange Inflows

We have four bearish signals this week:

• A bias for exchange inflows.
• Futures open interest is declining.
• Reduced profitability of the coin supply and realised losses on chain.
• Ethereum’s TVL in DeFi decreasing.

And there are three neutral signals:

• ETF inflows return, but there are still large outflow spikes.
• Little movement of long-term HODLers.
• Hash rate is rising, but miner revenues plummet.

On balance, on-chain/flow metrics are giving a bearish signal for ethereum. Here are the details of each metric (with explanations in the Appendix).

Institutional Demand: Neutral Ethereum

Our preferred metric to track institutional demand is flows into ethereum ETFs. As prices have declined, ETF inflows have picked up with valuations becoming more attractive (Chart 7). However, a large spike in outflows met the inflows toward the end of last week. We need to see a sustained period of inflows or outflows to reconfirm a bullish or bearish signal. In the short term, this is neutral ethereum.

Demand for Liquidity and Exchange Activity: Bearish Ethereum

Recently, there has been a consistent bias for inflows to exchanges. Net 464,000 and 325,000 coins came onto exchanges over the last seven and 14 days, respectively (Chart 8). This is bearish ethereum.

Longer term, the 30-day change in the exchange balance reveals fluctuations in the supply held on exchanges month on month. Relative to the last 30 days, this metric is still in negative territory (Chart 9). But it has been increasing over the past few weeks.

Overall, there is a bias for exchange inflows in the short and longer term. This is bearish for ethereum.

Futures Activity: Bearish Ethereum

Futures open interest is currently $6.4bn, down 16% over the past 14 days (Chart 10). Around $4.9bn (76%) of this comes from perpetual futures contracts.

Perpetual funding rates reveal the directional bias of investors. On average, they have been trending down recently (Chart 11).

Overall, futures open interest and funding rates are both in downtrends, which is bearish ethereum.

HODLers: Neutral Ethereum

The 30-day moving average of the coin days destroyed (CDD) metric has jumped. This suggests an increased distribution of older coins (Chart 12). Splitting HODLers into those who have held for under one year and those for one year or more reveals some older hands have sold as the 1y+ vintage has dropped (Chart 13). However, 61% of the coin supply has still not moved in at least one year, and this vintage continues to increase. On balance, we view these HODLer metrics as neutral ethereum.

Investor Profit and Loss: Bearish Ethereum

The percentage of circulating supply in profit (PSIP) is 60% (Chart 14) – down 10pp over the past 14 days. Net unrealised profit/loss (NUPL) is 0.25 (25% of market cap) (Chart 15) – down 17pp over the past 14 days.

Realised losses on chain have spiked. SOPR (price sold divided by price paid) touched its lowest levels year to date (0.86) last week. It has since remained below one (net losses) (Chart 16).

Overall, these realised and unrealised profit and loss metrics are bearish for ethereum.

Mining Activity: Neutral Ethereum

Negative price action has failed to deter the hash rate of the ethereum network. It has remained decoupled from prices since the start of the year and continues to rise (Chart 17). It is currently up 2% over the past seven and 14 days.

Miner revenues have taken a massive hit as crypto prices plummeted. They are down a staggering 88% over the past 14 days (Chart 18).

That the hash rate continues to rise during negative price action is constructive for ethereum, but miner revenues have taken a serious hit. Together, we view these as neutral for ethereum.

DeFi: Bearish Ethereum

DeFi markets and smart contract platforms have been at the forefront of the selloff. Our latest Crypto Index Tracker revealed our DeFi Index is down 46%. The total value locked (TVL) in DeFi across all protocols is currently around $111bn – down 44% over the past 14 days.

Tron has replaced Terra in the top 5 chains by TVL after the TerraUSD stablecoin collapse. All are down considerably in terms of TVL on the week, with ethereum faring the second worst with a 29% drop in TVL (Charts 19 and 20). Avalanche TVL is down the most at 36%.

On balance, we view this as bearish for ethereum.

Bottom Line

We have introduced a framework for understanding the flow and microstructure dynamics of ethereum markets. The seven key metrics are:

1. Institutional demand: returned ETF inflows with occasional outflow spikes. Neutral ethereum.
2. Liquidity demand: a large bias for inflows to exchanges. Bearish ethereum.
3. Futures activity: futures open interest and perpetual funding rates both in downtrends. Bearish ethereum.
4. HODLer behaviour: some older coin spending, but the overall proportion of the coin supply holding for a year or more continues to rise. Neutral ethereum.
5. P&L of investors: decreased profitability of the coin supply and large losses on-chain. Bearish ethereum.
6. Mining activity: the hash rate continues to rise, but miner revenues plummet. Neutral ethereum.
7. DeFi activity: TVL of ethereum is down 29% on the week. Bearish ethereum.

Appendix

Institutional Demand

Perhaps the largest institutional vehicle for ethereum is the Grayscale ETHE Trust, with over $27bn in assets. It invests solely in ETH, and so many investors, notably institutional, who cannot hold ETH directly can get exposure through investing in Grayscale. Consequently, if the trust trades at a premium to ETH prices, it may imply ‘excess’ demand from institutions, but ‘excess’ supply if it trades at a discount. Alternatively, the discount may suggest investors have found other ways to get exposure to ETH, whether through ETFs or directly holding ETH. We therefore focus on how the discount has changed in recent months to gauge investor interest. Alternatively, investors may be using other vehicles to get exposure such as ETFs or holding ETH directly. We put more weight on ETF flows than the Grayscale premium.

Liquidity Demand

Another measure of cryptocurrency bullishness is whether investors are willing to hold it in illiquid form (e.g., a private wallet) or prefer a liquid form (e.g., on an exchange). The former would suggest investors are bullish, as they are comfortable with being unable to sell easily. Conversely, holding it in liquid form would suggest investors are bearish, as they prefer being able to sell easily.

Therefore, large flows onto crypto exchanges would suggest investors want to convert their holdings to a more liquid form, implying more bearishness.

Futures Activity

We track the growing market of ethereum futures. Open interest – the sum of long and short contracts – is a good measure of investor interest.

Perpetual funding rates reveal the directional bias of investors. Exchanges set funding rates to prevent a lasting divergence in the price of the futures contract and the underlying since perpetual contracts have no expiry date so never settle in the traditional sense. Consequently, we can interpret funding rates as the cost of holding ethereum via perpetual futures. Positive funding rates imply longs pay shorts and vice versa. We use it as a proxy for trader sentiment since a positive funding rate implies traders are paying a premium to keep open long positions.

HODLers

In our introductory bitcoin flow framework, we explained ‘HODLers’ and ‘HODLing’. HODLing refers to buy-and-hold strategies in the context of bitcoin and other cryptocurrencies. Those who HODL for extended periods are die-hard adherents.

We can categorise HODLers by the length of time they have held ETH. We define long-term or staunch HODLers as those who bought ETH five or more years ago and have held it ever since, medium-term HODLers as those who bought 6-12 months ago, and short-term HODLers as those who bought 3-6 months ago.

The coin days destroyed (CDD) metric is defined as the number of coins in a transaction multiplied by the number of days since the coins were last spent. So, increasing CDD suggests older coins are being spent (more coin days are destroyed) and vice-versa.

Profit and Loss

• The percent supply in profit (PSIP). This tracks the share of circulating ETH supply in profit. That is the percentage of circulating ETH whose current price is higher than when it was last transacted (movement).

• Net unrealized profit and loss (NUPL). This is the ratio of unrealised profits over total market capitalisation. While PSIP just focuses on whether ETH coins are in profit or not, the NUPL focuses on the size of profits. So, we could have a situation where the PSIP is low – that is, a low share of supply is in profit – but the NUPL could be high if the size of those profits is large.

• Spent output profit ratio (SOPR). While PSIP and NUPL focus on unrealised profits or mark-to-market, this measure focuses on realised profits. SOPR is the realised value of a transaction divided by the value at initiation (or creation) – more simply, price sold divided by price paid. If SOPR is above one, investors in aggregate have realised profits, while below one means they have realised losses. In broad uptrends, SOPR spends a significant amount of time above one, whereas the opposite is true for broad downtrends.

When SOPR is rising, sellers are increasingly realising profits. The opposite is true when it is falling. A price rally with a flatter SOPR trend indicates investors are not yet realising their profits with the rally. The reluctance of investors to sell and realise a profit may be because they believe the price will increase further, which would be bullish. At the same time, more profit taking could precede a correction. Typically, buying as SOPR moves around one during bullish periods has proven to be a profitable strategy.

Mining Activity

Computing power is central to the crypto market. Miners use advanced computing hardware to solve complex problems that confirm ETH (and other coins) transactions on the public ledger or blockchain. The miners are rewarded with new coins for their efforts. A measure of the complexity of the problems and so the computing performance required to solve them is the hash rate. The higher this rate, the more computing performance is needed to maintain the blockchain. The rate can fluctuate depending on demand for crypto.

DeFi

We track the total value locked (TVL) in decentralized finance (DeFi) – the sum of all assets deposited in DeFi protocols, many of which use ethereum as the underlying protocol. The more DeFi products are created, the more ethereum gets locked into the DeFi system and removed from the broader market. This reduction in supply should lead to higher ethereum prices.

Dalvir Mandara is a Quantitative Researcher at Macro Hive. Dalvir has a BSc Mathematics and Computer Science and an MSc Mathematical Finance both from the University of Birmingham. His areas of interest are in the applications of machine learning, deep learning and alternative data for predictive modelling of financial markets.