Crypto Investors Flee Centralised Exchanges

Summary

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

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

Macro

• We believe market consensus underestimates inflation and the terminal federal funds rate (FFR).
• The probability of a recession within the next 12 months is near 90%.
• The macro backdrop remains bearish.

On-Chain/Flow Signals

• Five metrics are bearish, and one is neutral.
• The on-chain signal is very bearish.

Overall View

• With the macro backdrop still bearish, and our on-chain/flow signals very bearish overall, our overall view is more bearish (Chart 1).

Macro: Bitcoin Is Flooding Out of Exchanges

The liquidity crisis that sealed the fate for Sam Bankman-Fried’s (centralised) cryptocurrency exchange, FTX, sent crypto markets into turmoil earlier this month. The contagion from its collapse continues to spread, with several crypto lenders pausing withdrawals and citing the FTX debacle as the reason.

Before the FTX collapse, bitcoin’s (annualised) volatility was trending below that of the NASDAQ Composite. This trend has been sharply reversed as bitcoin’s volatility has since surged (Chart 2). Its correlation to the NASDAQ has even flipped negative (-41%) since the collapse.

With bitcoin volatility near yearly highs again from the FTX fallout, what were the implications for other centralised exchanges? This week, we look at how the amount of bitcoin held on major exchanges has changed after the FTX collapse.

Are Investors Losing Confidence in Centralised Exchanges?

Normally, we associate exchange outflows as a bullish signal as it suggests investors are comfortable holding their cryptocurrencies in an illiquid capacity where it is harder to sell. That rationale changes in the context of the FTX fallout. Indeed, it was a bank run that eventually caused FTX to collapse.

The FTX collapse has likely decimated investor confidence in centralised exchanges. It is no coincidence that bitcoin has been pouring out of exchanges ever since as investors look for other (safer?) places to store their cryptocurrencies (Chart 3). The bitcoin balance held on several large, centralised exchanges is down double-digit percentages over the past 30 days. If an exchange as big as FTX can crumble so quickly, who is next?

Gemini and Huobi See Large Outflows

Outside FTX, Gemini and Huobi have seen the most outflows over the past month (Charts 4 and 5). The (bitcoin) exchange balances of Gemini and Huobi have tanked 75% and 52% over the past 30 days, respectively.

For Gemini specifically, the outflows have also corresponded with Genesis Global Capital (Genesis), the lending partner of Gemini’s yield-generating product (Gemini Earn), pausing withdrawals. The move left $700mn of Gemini Earn customer funds in limbo.  Again, this is an implication of the FTX fallout.

While the risk associated with holding crypto assets on centralised exchanges (CEX) enters the fray, evidence suggests users are turning to DeFi solutions. Decentralised exchange (DEX) trading volumes spiked throughout the month. DEXs have their own inherent risks too. Yet crucially, they require users to keep custody of their assets, which should (in theory) provide protection from a single point of failure (like the one that collapsed FTX).

Macro Backdrop: Still Bearish

Markets have been digesting a dovish twist from the November FOMC meeting minutes. The minutes revealed that ‘a substantial majority of participants judged that a slowing in the pace of increase would likely soon be appropriate’. However, St. Louis Fed President James Bullard said ‘we’ve got a ways to go to get restrictive’ in an interview with MarketWatch yesterday. Also, when responding to a question about how long he expects the federal funds rate (FFR) to remain in the 5-7% range, he said ‘I think we’ll have to stay there all during 2023 and into 2024’.

We believe market consensus underestimates inflation and the terminal federal funds rate (FFR). Even if the pace of hikes is slowed in December, we continue to expect a terminal rate near 8%. Meanwhile, our recession model is producing a probability of a recession within the next 12 months of near 90%.

The week ahead sees the US data calendar pick up again with personal spending, income, and PCE inflation on Thursday and NFP data expected on Friday. Outside that, Fed Chair Jerome Powell is giving a speech on Wednesday on the economic outlook of the labour market – we expect it to be hawkish.

The macro backdrop is still bearish for crypto.

On-Chain/Flow: Hash Rate and Miner Revenue Plummet

Five metrics give a bearish signal this week:

• Liquidity demand: Bias for outflows from exchanges, usually we would view this as bullish but in the context of the FTX fallout, this is bearish.

• Futures activity: Futures open interest and perpetual funding rates plummet.

• HODLer behaviour: There is a huge spike in older coin spending.

• P&L of investors: Realised losses and reduced profitability of the coin supply dominate.

• Mining activity: The hash rate and miner revenues take a substantial hit.

The remaining metric gives a neutral signal:

• Institutional demand: ETF flows are muted.

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

Institutional Demand: Neutral Bitcoin

Our preferred metric to track institutional demand is flows into bitcoin ETFs. Flows have been muted since September with no clear and sustained directional bias (Chart 6). We view the subdued ETF flows as neutral for bitcoin.

Demand for Liquidity and Exchange Activity: Bearish Bitcoin

On exchange flows:

• Short term, a bias exists for outflows to exchanges. Net c. 60,883 coins left exchanges over the past 14 days (Chart 7).

• Longer term, the 30-day change in the exchange balance reveals fluctuations in the supply held on exchanges month on month. This metric hit a new all-time low of c. -178,000 on Thursday last week (Chart 8). For context, its previous all-time low set on 26 June earlier this year was c. -146,000.

Usually, we would interpret exchange outflows as bullish for bitcoin as it suggests investors prefer to keep their holdings in cold storage where it is more illiquid and thus harder to sell. However, the bearish backdrop of the FTX debacle paints a different picture. Indeed, there has been billions of dollars’ worth of outflows since FTX collapsed as investors lose trust in centralised exchanges. Therefore, we view the exchange outflows as bearish.

Futures Activity: Bearish Bitcoin

Futures open interest ($7.1 bn) has plummeted in response to the FTX fallout – it is currently down 34% MoM (Chart 9). Around $5.9bn (83%) of this comes from perpetual futures contracts.

Perpetual funding rates reveal the directional bias of investors. They plummeted in response to the FTX fallout, as you would expect (Chart 10). On average, funding rates hit lows of c. -0.05% on 9 November but have corrected sharply since – though they remain in negative territory.

The sharp drop in open interest and the fact that funding rates are still negative on average since the FTX collapse are bearish for bitcoin.

HODLers: Bearish Bitcoin

The 30-day moving average of the coin days destroyed (CDD) metric rocketed to its highest level this year (c. 18mn) on 23 November (Chart 11). It is currently up a staggering 120% MoM. The 30-day moving average of the 1y+ revived supply metric followed suit (Chart 12), indicating that most of the coins that came back into circulation were at least a year old. A lot of older hands sold amid the FTX fallout. That said, the 1y+ continues to dominate around 66% of the coin supply now (Chart 13).

Overall, there has been a significant increase in the movement of older coins recently, which we view as bearish in the context of the FTX fallout.

Investor Profit and Loss: Bearish Bitcoin

On profitability of the coin supply:

• The percentage of circulating supply in profit (PSIP) is 47% (Chart 14). This is down 11pp over the past 30 days.

• Net unrealised profit/loss (NUPL) is now -0.20 (20% of market cap) (Chart 15). This is down 20pp over the past 30 days and means that the supply is in a net loss position (NUPL < 0), with realised cap still exceeding market cap.

• The spent output profit ratio (SOPR) has a bias for realised losses on chain. It briefly exceeded 1 (realised profits) on just 3 days throughout November (Chart 16).

The profitability of the coin supply has plummeted post FTX fallout. It is back in a net loss position (NUPL < 0) accompanied by a bias for realised losses on chain (SOPR < 1). This is bearish for bitcoin.

Mining Activity: Bearish Bitcoin

The hash rate has not been spared from the FTX fallout either, it has plummeted 20% MoM (Chart 17). Naturally, miner revenues have taken a hit as a result of the bitcoin price drop and lower hash rate, they are down 31% MoM (Chart 18).

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.

(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)