Bullish Ethereum, but Headwinds to Risk Sentiment Are Growing
- By Bilal Hafeez and Dalvir Mandara
- 9 min read
Summary
Trading View (next 2-4 weeks): We are bullish ethereum.
Investment View (next 1-3 years): We like to be long ethereum.
Macro
- We expect the Fed to hike more than the market is currently pricing.
- The probability of recession within the next year has risen to above 75% – its highest level since before the dot-com crash.
- The near-term risk bounce is facing into a more hawkish Fed alongside elevated macro-political risks from US/China tensions.
On-Chain/Flow Signals
- Our metrics remained mixed this week: two bullish signals, two bearish, and two neutral.
Overall View
- The macro backdrop remains bearish, while our on-chain/flow signals bullish, our overall view is bullish ethereum (Chart 1).
Will the Risk-On Rally Last?
Ethereum has rallied alongside more traditional risk assets since the middle of June (it has correlated well with the S&P and NASDAQ since at least mid-2021. At $1,726 it is now close to 90% up from its lows. However, the macro headwinds are growing, as are fears that the risk-rally is little more than a dead-cat bounce.
In macro terms, positive US economic data (including NFPs) and the likelihood that inflation is continuing to accelerate, suggest that the Fed will need to tighten policy significantly more than the market is currently pricing. That will present a headwind to risk assets in general. The scale of the recession that the Fed will need to instigate to get inflation back to target does not seem to be being priced in right now. There is further room for weakness ahead in equities when companies begin to revise down future earnings. When that hits, crypto currencies in general may feel the pain too.
On-Chain/Flow: ETF Inflows Return
Five metrics give a bullish signal this week:
- Futures open interest is rising again, and perpetual funding rates are positive.
- Signals from HODLer data is bullish.
- Investor P&L is bullish.
- Exchange data is bullish.
- Hash rate is up and miner revenues are stable-to-positive.
One metric gives a mixed signal:
- Defi – three of the chains in the top five protocols saw declines in TVL this week, although Ethereum TVL still rose.
One metric gives a bearish signal:
- ETF inflows flipped to outflows.
On balance, on-chain/flow metrics are giving a bullish signal. Here are the details of each metric (with explanations in the Appendix).
Institutional Demand: Bearish Ethereum
Our preferred metric to track institutional demand is flows into ethereum ETFs. Inflows switched to outflows at the end of last week (Chart 3). This is bearish ethereum.
Demand for Liquidity and Exchange Activity: Bullish Ethereum
On exchange flows:
- Short term, a bias exists for outflows to exchanges. This is bullish ethereum.
- Longer term, the 30-day change in the exchange balance reveals fluctuations in the supply held on exchanges month on month. This metric remains mostly negative following consistent outflows over the past week (Chart 5). This is bullish ethereum.
Together, we view this as bullish ethereum.
Futures Activity: Bullish Ethereum
Futures open interest is trending up but remains historically low – it is currently $6.8bn (Chart 6). This is up almost 70% from recent lows.
HODLers: Bullish Ethereum
The 30-day moving average of the coin days destroyed (CDD) metric has plunged recently, suggesting less distribution of older coins (Chart 6). Meanwhile, the 1y+ supply metric dipped slightly following a recent rise (Chart 7). The different vintages of coin supply are now roughly equal.
We view these HODLer metrics as bullish for ethereum.
Investor Profit and Loss: Bullish Ethereum
On profitability of the coin supply:
- The percentage of circulating supply in profit (PSIP) is 61% (Chart 8). This is on our last report, and remains historically low.
- Net unrealised profit/loss (NUPL) is now c.+0.1 (Chart 9). This means the overall ethereum supply has moved back into an unrealised profit.
- The spent output profit ratio (SOPR, price sold / price paid) dipped back below 1 for much of the week (Chart 10).
Overall, the profitability of the coin supply remains historically low, but the continued rise in profitability metrics is bullish.
Mining Activity: Bullish Ethereum
The hash rate has been in a broad downtrend since May 2022, but is continuing to see a building recovery (Chart 11). Miner revenues have also benefitted from the ethereum rally (Chart 12).
Defi: Neutral Ethereum
Chains in the top five by TVL saw mixed results last week, with Solana, Avalanche and Tron all seeing TVL drop, while Binance and Ethereum TVLs were up (Chart 14). Ethereum beat most of the rest, up 2% WoW.
Bottom Line
We have introduced a framework for understanding the flow and microstructure dynamics of ethereum markets. The seven key metrics are:
- Institutional demand: ETF flows became outflows. Bearish ethereum.
- Liquidity demand: bias for outflows. Bullish ethereum.
- Futures activity: futures open interest trending. Bullish ethereum.
- HODLer behaviour: the CDD falling. Bullish ethereum.
- P&L of investors: increased profitability of the coin supply and reqalised profits-on-chain. Bullish ethereum.
- Mining activity: hash rate and miner revenues trending up gradually. Bullish ethereum.
- DeFi activity: TVL of ethereum up more than most others. Neutral 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 ethereum 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.