Trading View (next 2-4 weeks): We like to be bearish bitcoin.
Investment View (next 1-3 years): We like to be long bitcoin.
- Rate hikes expected.
- June inflation to be released on 13 July.
- Bitcoin’s correlation to the NASDAQ remains close to 70%.
- The probability of recession within the next twelve months is inching closer to 60%.
- The macro backdrop remains bearish.
- Our metrics are mixed this week: one bullish signal, three bearish, and two neutral.
- With the macro backdrop still bearish, and our on-chain/flow signals bearish overall, our overall view remains bearish bitcoin (Chart 1).
Bitcoin Network Activity Continues to Suffer
Last week, we investigated how activity on the ethereum blockchain was dropping throughout the selloff and less capital is being deployed to the ethereum staking contract. This week, we make a similar observation for bitcoin network activity.
Active addresses are unique addresses that have participated in a successful transaction on any given day. We can measure activity on the bitcoin blockchain by looking at how the number of active addresses is changing over time. The 30-day moving average of this metric is down almost 10% year to date (Chart 2). This is a bearish sign as it means there is less usage of the blockchain.
One criticism of metrics that use active addresses is that a single person could own multiple addresses so there is no one-to-one mapping between users and bitcoin addresses. One way to address this, is to look at entity adjusted metrics. Entities are defined as a cluster of addresses that are controlled by the same entity and metrics related to entities can give a more precise measure of the number of users in the bitcoin network.
The number of new entities is a metric that describes the number of unique entities that appeared for the first time in a transaction of bitcoin on the bitcoin blockchain. Therefore, it can be used as a measure of new user adoption/growth. This metric, as well as the number of active addresses, has been declining throughout the drawdowns (Chart 3).
Together, a reduction of active addresses and new entities on the bitcoin network confirms that network activity has been dragged down as markets have tried to navigate the price drawdowns. Ultimately, this is a bearish sign as it means there is less usage of the bitcoin network.
There are several macro events to keep track of over the coming weeks that will influence crypto markets:
- Inflation data for June is due to be released on 13 July. Crypto markets remain sensitive to inflation and rate hikes as it trades more like a risk asset with correlation to the NASDAQ still around 70%.
- The 26-27 July FOMC meeting where interest rates are expected to rise again.
- An advance estimate of second quarter GDP growth for 2022 is set to be released on 28 July by the Bureau of Economic Analysis (BEA). With a 1.6% decline in real GDP in Q1 2022 (Chart 4), a further decline would indicate that we are in a recession (generally identified by a fall in GDP in two successive quarters). Our latest recession model update indicates recession odds are inching closer to 60%.
On-Chain/Flow: A Mixed Bag
One metric gives a bullish signal this week:
- Bias for exchange outflows.
Three metrics give bearish signals:
- ETF outflows.
- Perpetual funding rates are still negative on average.
- The market remains into a state of unrealised losses (NUPL < 0) and there has been a sustained period of realised losses on chain for several months now.
Lastly, the remaining two metrics give neutral signals:
- There is little movement among the HODLers.
- Hash rates have started to recover, but miner revenues remain low as they continue to track price action.
On balance, on-chain/flow metrics are giving a bearish 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. We saw a large spike in outflows recently that was met with some low magnitude inflows (Chart 5). Outflows have returned though also small in magnitude. This is bearish bitcoin.
Demand for Liquidity and Exchange Activity: Bullish Bitcoin
On exchange flows:
- In the short term, a bias for outflows from exchanges persists. Net 5,400 coins have exited exchanges over the past seven days (Chart 6). This is bullish bitcoin.
- Longer term, the 30-day change in the exchange balance reveals fluctuations in the supply held on exchanges month on month. This metric remains in deep negative territory (Chart 7). This is bullish bitcoin.
Futures Activity: Bearish Bitcoin
Futures open interest is flat on the week but remains historically low – it is currently $8.2bn (Chart 8). Around $6.2bn (75%) of this comes from perpetual futures contracts.
Perpetual funding rates reveal the directional bias of investors. Funding rates have been rising on average, but they remain negative (Chart 9). This is bearish bitcoin.
HODLers: Neutral Bitcoin
The 30-day moving average of the coin days destroyed (CDD) metric has started to move down slightly (Chart 10). The 1y+ revived supply metric follows suit (Chart 11). The 1y+ vintage of the coin supply continues to dominate 65% of the coin supply (Chart 12). This vintage had been increasing throughout 2022 but has recently started to decline.
There has not been a great deal of old coin spending recently. The most notable changes we are seeing is the turning point in the 1y+ vintage which was previously increasing sharply throughout Q1 2022. It is now potentially in a downtrend.
We view these HODLer metrics as neutral for bitcoin.
Investor Profit and Loss: Bearish Bitcoin
On profitability of the coin supply:
- The percentage of circulating supply in profit (PSIP) is 53%, down 2pp over the past seven days (Chart 13). This means just over half of the coin supply is currently in profit.
- Net unrealised profit/loss (NUPL) is now -0.13 (13% of market cap) (Chart 14). The market remains in a net loss position with realised cap currently greater than market cap (i.e., the aggregate value of each UTXO at the price when they last moved is greater than the current aggregate value of those UTXOs).
- The spent output profit ratio (SOPR) continues to trend down and below one (Chart 15). It has been below one for 56 out of the last 60 days, this means there has been realised losses on-chain almost every day for the past two months.
Overall, the reduced profitability of the coin supply and realised losses on chain are bearish for bitcoin.
Mining Activity: Neutral Bitcoin
The hash rate has started to recover, it is up 11% over the past seven days (Chart 16). Miner revenues have fared worse. They are yet to stage a sustained move upward as bitcoin prices continue to struggle to hold above $20,000 (Chart 17). Together, these are neutral for bitcoin.
We have introduced a framework for understanding the flow and microstructure dynamics of bitcoin markets. The six key metrics are:
- Institutional demand: ETF outflows. Bearish bitcoin.
- Liquidity demand: bias for outflows from exchanges. Bullish bitcoin.
- Futures activity: futures open interest flat and funding rates negative. Bearish bitcoin.
- HODLer behaviour: we could be at a turning point for the 1y+ vintage. Neutral bitcoin.
- P&L of investors: decreased profitability of the coin supply and sustained realised losses on chain. Bearish bitcoin.
- Mining activity: hash rate is up but miner revenues are flat. Neutral bitcoin.
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.
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.
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.
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.
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.
Bilal Hafeez is the CEO and Editor of Macro Hive. He spent over twenty years doing research at big banks – JPMorgan, Deutsche Bank, and Nomura, where he had various “Global Head” roles and did FX, rates and cross-markets research.