Bitcoin Flows Improving, But Still Following Tech Stocks

Tech stocks had staged an impressive rally over the past week until Wednesday’s poor Facebook/Meta’s earnings caused the rally to end. Bitcoin followed tech stocks – it hit $39,000 earlier in the week but has now fallen below $37,000 (Chart 1). This is still comfortably above the January lows of $32,970, so the current peak-to-trough drawdown is 46% (Chart 2). Overall, the correlation to tech stocks is 0.7 (Chart 3).

Crypto-specific dynamics reveal good news. We see ETF inflows return, a bias for outflows from exchanges (suggesting investors are less worried about needing bitcoin liquidity), and increased profitability of the coin supply. Also, the hash rate has held onto most of its gains despite disruptions from political unrest in Kazakhstan, which has the second-largest bitcoin hash rate globally. This is particularly constructive as it shows the network is more secure than ever despite the selloff. Lastly, valuations are attractive, with the MVRV z-score at 1.08.

In bad news, activity in derivative markets weighs on sentiment. Around 70% of futures open interest currently comes from perpetual contracts whose funding rates have been trending in negative territory. This indicates a directional bias for the downside. Also, the put-call ratio for open interest in options markets has been increasing – currently 0.57 (Chart 4). The recent prolonged rise in demand for puts contrasts the May-July 2021 selloff, when the put-call ratio was falling. This suggests continued nervousness among investors.  

On balance, our metrics are somewhat positive. We have four bullish signals, one bearish and one neutral. But we wait for a sustained rise in tech stocks to declare the worst of the bitcoin selloff over. Until then, we remain neutral.

We run through our bitcoin metrics below, with the Appendix explaining each.

Institutional Demand: Bullish Bitcoin

Our preferred metric to track institutional demand is flows into ETFs. Outflows dominated the first half of January, and inflows – albeit small – have resumed from 17 January onward (Chart 5). Recently, they appear on a knife-edge between inflows and outflows, without a clear directional bias for either.

That flows switched from persistent outflows to inflows is constructive for bitcoin. We need to see larger inflows to reconfirm a more constructive outlook, but this is the start of a bullish sign, nonetheless.  

Demand for Liquidity and Exchange Activity: Bullish Bitcoin

Exchange flows have been reasonably mixed throughout 2022, with pockets of inflow and outflow spikes (Chart 6). Despite the selloff, January had a bias for outflows, with net 3,155 coins exiting exchanges. The past week saw a similar pattern as prices picked up – a net 8,863 coins have left exchanges.

The 30-day change in exchange balance reveals how the net supply held on exchanges is changing month on month. Since 19 January, it has been decreasing (Chart 7). This contrasts the dynamics of the May-July 2021 selloff, which had comparatively huge inflows to exchanges. It suggests investors may be less bearish about the current selloff than that in the May-July 2021 one as their preference is still to keep moving coins into cold storage.

On both a short-term (weekly) and longer-term (monthly) basis the exchange balance has shown a bias for outflows. This is bullish bitcoin.

Futures Activity: Bearish Bitcoin

Futures open interest has started to tick up. Total open interest sits at around $13.8bn – up 1% on the week. Notably, around $9.4bn (70% of total futures open interest) is in perpetual futures contracts, suggesting a large majority of leverage is within perpetual futures.  

Perpetual funding rates reveal the directional bias of investors. We can interpret funding rates as the cost of holding bitcoin via perpetual futures. Positive funding rates imply longs pay shorts (traders are paying a premium to keep open long positions) and vice versa. They are currently negative, suggesting investors are paying a premium to keep open short positions (Chart 9). The funding rate is set at various intervals throughout the day; on an hourly level, there has been a significant bias for negative rates over the past week.

Overall, open interest largely sits with perpetual futures contracts, which currently have a directional bias for the downside as funding rates are negative. This is bearish bitcoin.  

HODLers: Neutral Bitcoin

The 30-day moving average of the coin days destroyed (CDD) metric has jumped recently, suggesting a spike in older coin spending (Chart 10). To validate this, we also look at the 1y+ revived supply – how many coins have re-entered circulation after being dormant for at least one year. This has also spiked (Chart 11). Finally, splitting HODLers into those who have held for under one year and those for one year or more reveals the latter proportion has dropped slightly (Chart 12).

Our HODLer metrics tell us that some older hands have stepped in to distribute their coins. This could indicate they want to cut their losses and realise their remaining profits if they anticipate further downside, which would be bearish bitcoin. But the 1y+ revived supply has generally tended to move with price action more from 2020 onward, which could indicate a significant uptrend might be underway. On balance, we view these HODLer metrics as neutral bitcoin in the short term.

Investor Profit and Loss: Bullish Bitcoin

On profitability, the percentage of circulating supply in profit (PSIP) is now 70% (Chart 13) – up 5pp week on week.

Net unrealised profit/loss (NUPL) has jumped to 39% of market cap (Chart 14) – up 3pp week on week. Retesting 50% of market cap would be a level to watch closely to signify further upside.

SOPR has been below one since 16 January, signifying realised losses on chain. However, it has recently spiked to 1.01 (Chart 15). This is expected given older hands have been selling, so realised profits will be larger for these investors. Overall, increasing profitability for the coin supply and an exit from realised losses is bullish bitcoin.

Mining Activity: Bullish Bitcoin

The hash rate has continued to grow aggressively throughout the selloff, indicating more computing power being contributed to bitcoin than ever (Chart 16). This comes amid disruptions to the hash rate such as anti-government protests in Kazakhstan (which has the second-largest BTC hash rate globally), resulting in the government shutting down the internet. Lastly, miner revenues are also picking up again as prices increase (Chart 17). Overall, this is bullish bitcoin.  

Bottom Line

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

1. Institutional demand: inflows to ETFs. Bullish bitcoin.
2. Liquidity demand: net outflows from exchanges. Bullish bitcoin.
3. Futures activity: negative perpetual funding rates. Bearish bitcoin.
4. HODLer behaviour: older hands starting to spend coins. Neutral bitcoin.
5. P&L of investors: increased profitability of supply and realised profits on chain. Bullish bitcoin.
6. Mining activity: hash rate holding onto gains despite disruptions. Bullish bitcoin.

Appendix

Institutional Demand

Perhaps the largest institutional vehicle for bitcoin is the Grayscale Bitcoin Trust, with over $27bn in assets. It invests solely in bitcoin, and so many investors, notably institutional, who cannot hold bitcoin directly can get exposure through investing in Grayscale. Consequently, if the trust trades at a premium to bitcoin prices, it may imply ‘excess’ demand from institutions, but ‘excess’ supply if it trades at a discount. Alternatively, investors may be using other vehicles to get exposure such as ETFs or holding bitcoin 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, possibly implying more bearishness.

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 long 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. We can break this down further into those who have held bitcoin from the very early days (7-10 years ago and 10+ years ago).

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 very 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 BTC 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 coin) 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.