Bitcoin and Earnings Season

Summary

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

Investment View (next 1-3 years): We like to be long bitcoin.

Macro Signals

• Inflation is at 40-year highs.
• The Fed is tightening with an aggressive rate hike outlook.
• US recession probabilities are back at 50%.
• The bitcoin and equity correlation remains over 80%.
• Risk remains around the Russia-Ukraine war.
• The macro backdrop remains bearish.

On-Chain/Flow Signals

• Our metrics are split this week: three give bullish signals, three bearish.

Overall View

• With the macro signal remaining bearish and on-chain/flow metrics neutral on balance, our overall signal is slightly bearish bitcoin (Chart 1).

Macro: Earnings Season Kicks Off

Bitcoin has been highly correlated to the NASDAQ throughout the year (Chart 2). Indeed, correlation between the two is currently over 80%. Elon Musk’s $44bn buyout of Twitter certainly helped crypto at the start of the week, but now it is time for heavyweight US tech giants to potentially impact bitcoin.

Tech stocks fell sharply on Tuesday following weaker-than-expected earnings from Google parent, Alphabet. The NASDAQ hit its lowest levels since late 2020 on Tuesday and pulled bitcoin prices down in tandem (Chart 3). Amid a regime of high correlation to tech and rising interest rates, any surprises in corporate earnings from prime movers of the NASDAQ/tech will influence bitcoin.

On-Chain/Flow: ETF Outflows

Three metrics are giving a bullish signal this week:

• Exchange outflows deepen.
• Longer-term HODLer proportion continues to rise.
• Hash rate and miner revenues are increasing.

The remaining three metrics are giving bearish signals:

• ETF outflows.
• Futures open interest declining.
• Reduced profitability of the coin supply and realised losses on chain.

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

Institutional Demand: Bearish Bitcoin

Our preferred metric to track institutional demand is flows into bitcoin ETFs. ETF outflows have persisted since our last update (Chart 4). This is bearish bitcoin.

Demand for Liquidity and Exchange Activity: Bullish Bitcoin

In the short term, a bias for outflows from exchanges exists. Net 23,000 and 57,000 coins left exchanges over the past seven and 14 days, respectively (Chart 5). There have been net outflows for 11 of the last 14 days. In general, 2022 has had a noticeable bias for outflows: 62% of days have seen net outflows year to date.

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 continues to get into deeper negative territory. Except for a brief week at the beginning of March, this metric has been negative since 22 January. This is bullish bitcoin.

A bias for exchange outflows in the short term and the longer term is bullish bitcoin.

Futures Activity: Bearish Bitcoin

Futures open interest is trending down – it is currently $14.9bn, down 3% and 5% over the past seven and 14 days, respectively (Chart 7). Around $10.3bn (70%) of this comes from perpetual futures contracts. This is up 5pp from 65% dominance in our last report – perpetual futures are becoming more popular to trade.

Perpetual funding rates reveal the directional bias of investors. On average, they have provided little directional signal of late (Chart 8). However, they are in slightly negative territory so leveraged traders are paying a premium to keep open short positions.

Overall, futures open interest is falling, and perpetual funding rates are negative. This is bearish for bitcoin.

HODLers: Bullish Bitcoin

The 30-day moving average of the coin days destroyed (CDD) metric is still trending down (Chart 9). Looking at the 1y+ revived supply metric confirms this – it is also trending down over the same period (Chart 10). Finally, splitting HODLers into those who have held for under one year and those for one year or more confirms most (64%) of the coin supply is still in an accumulation phase (Chart 11). For perspective, the 1y+ vintage was at around 57% at the start of the year and has been growing ever since.

The year has been choppy for crypto so far with numerous headwinds including increased regulatory pressures, Fed tightening, and increased tendency to trade like a risky asset amid inflation shocks. Despite this, longer term HODLers (1y+) have maintained their conviction to hold. On balance, we view this as bullish for bitcoin.

Investor Profit and Loss: Bearish Bitcoin

The percentage of circulating supply in profit (PSIP) has plummeted to 60% (Chart 12). That is down 10pp over the past seven days. Net unrealised profit/loss (NUPL) is now 0.37 (Chart 13). That is down 5pp over the past seven days – we are yet to see a sustained break above 0.5 for this metric (historically a bullish signal). Lastly, SOPR is displaying a bias for realised losses on chain with a value less than one for five out of the last seven days (Chart 14).

Overall, the reduced profitability of the coin supply and realised losses on chain are bearish for bitcoin.

Mining Activity: Bullish Bitcoin

The hash rate is up 14% over the past seven days and remains very close to all-time highs (Chart 15). Miner revenues have also started to recover – they are up 9% over the past seven days (Chart 16). Together, these metrics are bullish for bitcoin.

Bottom Line

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

1. Institutional demand: ETF outflows. Bearish bitcoin.
2. Liquidity demand: long-term and short-term bias for exchange outflows. Bullish bitcoin.
3. Futures activity: futures open interest trending down. Bearish bitcoin.
4. HODLer behaviour: longer-term HODLers vintage increasing. Bullish bitcoin.
5. P&L of investors: decreased profitability of the coin supply and a bias for realised losses on chain. Bearish bitcoin.
6. Mining activity: hash rate and miner revenues on the rise. Bullish bitcoin.

Appendix

Institutional Demand

Perhaps the largest institutional vehicle for bitcoin is the Grayscale Trust, with over $27bn in assets. It invests solely in BTC, and so many investors, notably institutional, who cannot hold BTC directly can get exposure through investing in Grayscale. Consequently, if the trust trades at a premium to BTC 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 BTC, whether through ETFs or directly holding BTC. 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 BTC directly. We put more weight on BTC 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 bitcoin 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 bitcoin 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 BTC. We define long-term or staunch HODLers as those who bought BTC 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 BTC supply in profit. That is the percentage of circulating BTC 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 BTC 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 BTC (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.

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.