Bitcoin & Crypto | Monetary Policy & Inflation | US
Did Ethereum Beat the S&P 500 in 2022?
- By Dalvir Mandara
- 10 min read
Summary
Trading View (next 2-4 weeks): We like to be bearish ethereum.
Investment View (next 1-3 years): We like to hold ethereum.
Macro Signals
- The Federal Reserve (Fed) is almost certain to hike 50bps at the December FOMC meeting on Wednesday.
- Even with hikes decelerating, we still believe market consensus underestimates the terminal Federal funds rate (FFR) and has unrealistic expectations of rate cuts in 2023.
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Summary
Trading View (next 2-4 weeks): We like to be bearish ethereum.
Investment View (next 1-3 years): We like to hold ethereum.
Macro Signals
- The Federal Reserve (Fed) is almost certain to hike 50bps at the December FOMC meeting on Wednesday.
- Even with hikes decelerating, we still believe market consensus underestimates the terminal Federal funds rate (FFR) and has unrealistic expectations of rate cuts in 2023.
- The probability of a recession shoots over 90%.
- The macro backdrop is bearish for ethereum.
On-Chain/Flow Signals
- We have three bearish and three neutral signals this week.
Overall View
- With the macro backdrop bearish and our on-chain/flow metrics bearish, our overall signal is bearish ethereum (Chart 1).
Macro: Did Ethereum Beat the S&P 500 in 2022?
It has been a chaotic year for cryptocurrencies. Correlations to tech stocks hit an all-time high. Terra (LUNA) collapsed, and a crypto credit crunch ensued that saw some of the biggest lenders in the space fall. Then came a slew of hacks, unprecedented rate hikes from the Federal Reserve (Fed), and the recent FTX implosion whose contagion is still permeating the cryptocurrency industry.
With an eventful 2022 ending, we look at how ethereum performed compared with other macro markets and cryptocurrencies.
Broader risk sentiment drove cryptocurrencies through much of 2022. That ethereum’s monthly correlation to the S&P 500 and Nasdaq Composite rose to new all-time highs above 80% confirms this.
Recently, however, crypto and traditional equity indices decoupled – something no one (in the crypto industry) wanted to see. Indeed, the ethereum (and bitcoin) correlation to both the S&P 500 and Nasdaq Composite flipped to negative on 10 November due to the FTX implosion. Year to date, ethereum’s correlation to the S&P 500 and Nasdaq Composite are 46% and 43%, respectively (Chart 2). If we ignore data from November onward, they are both over 50%.
Risk assets have had a tough year, with rate hikes from the Fed weighing on sentiment. Yet despite ethereum’s (relatively) heightened correlations to tech, year to date returns reveal ethereum (-67%) has underperformed the S&P 500 (-16%), Nasdaq Composite (‑30%), and even prominent cryptocurrencies.
Another significant feature of H2 2022 has been historically low volatility (excluding the FTX implosion) in ethereum (and bitcoin) prices. At times, some cryptocurrencies have been less volatile than the Nasdaq Composite, for example. Therefore, comparing the risk-adjusted performance of ethereum with competing cryptocurrencies and traditional markets is more useful.
Against crypto, ethereum outperformed bitcoin and cardano (Chart 3). But it underperformed some other noteworthy cryptocurrencies (polygon, litecoin, binance coin, ripple, and solana). On a Sharpe ratio basis, it also underperformed the S&P 500 and some single names like Apple, Microsoft, and Nvidea. It also underperformed gold and oil. However, it beat the Nasdaq, Alphabet, Tesla, and AMD.
All this suggests discrimination between coins will be important in 2023.
The Macro Backdrop: Markets Are Underestimating the Terminal FFR
Inflation pressures persist. November’s PPI (up 0.3% for the month) showed an increase in wholesale prices, and we expect November CPI data today – ethereum usually underperforms around this data release. Despite markets pricing a 50bp hike of the federal funds rate (FFR) this week, we maintain that they are underestimating the terminal FFR and have unrealistic expectations of rate cuts in 2023. Dominique expects a 2023 dot of 5.25-5.5%. Moreover, the probability of recession within the next 12 months recently soared to over 90%.
The macro backdrop is still bearish for crypto.
On-Chain/Flow Metrics: Long-Term HODLers Dominate
We have three bearish signals this week:
- Institutional demand: ETF flows are relatively muted, but they have a bias for outflows.
- Liquidity demand: bias for outflows from exchanges – normally bullish, but given the FTX implosion, it is bearish as it shows less investor confidence in centralised cryptocurrency exchanges.
- P&L: profitability of the coin supply is less than 50%, the supply is in a state of unrealised loss again (NUPL < 0), and realised losses on chain (SOPR < 1) dominate.
The remaining three signals are neutral:
- Futures activity: open interest is low, but funding rates have turned positive again.
- HODLer behaviour: there is some older coin spending but long-term HODLer vintage (1y+, 60%) stays close to its all-time high.
- DeFi: total value locked in DeFi is relatively flat recently.
On balance, on-chain/flow metrics are giving a bearish signal for ethereum. 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. Flows have been muted in magnitude since the merge on 15 September but have shown a bias for outflows recently (Chart 4). For now, this is bearish ethereum.
Demand for Liquidity and Exchange Activity: Bearish Ethereum
On exchange flows:
- Short term, a bias exists for outflows to exchanges. Net 315,000 coins exited exchanges over the past seven days (Chart 5).
- 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 and is at multi-year lows (Chart 6).
Usually, we would interpret exchange outflows as a bullish signal for ethereum as it suggests investors prefer to keep their holdings in cold storage where it is more illiquid and so harder to sell. However, the FTX implosion provides a more negative backdrop. Indeed, there have been huge outflows from exchanges recently as investors lose confidence in centralised cryptocurrency exchanges. See our previous bitcoin update for more details.
Futures Activity: Neutral Ethereum
Futures open interest is currently around $4.4bn – down 4% month on month (Chart 7). Around $3.9bn (89%) of this comes from perpetual futures contracts.
Perpetual funding rates reveal the directional bias of investors. They became sharply negative in the run-up to the merge and after the FTX debacle. They have been increasing since. On average (across all the exchanges we track), they are positive again (Chart 8). This means traders are paying a premium to keep open long positions. This is bullish ethereum.
Together, this is neutral ethereum.
HODLers: Neutral Ethereum
The 30-day moving average of the coin days destroyed (CDD) metric is up a staggering 162% MoM (Chart 9), suggesting a substantial increase in the movement of older coins recently.
But if we split the entire coin supply into those who have held for under one year and those for one year or more, the 1y+ vintage stays close to its all-time high set last month. It currently dominates 60% of the coin supply (Chart 10) compared to just 43% at the start of the year. It has been a bearish year for crypto in general, but HODLers are still HODLing.
We view these HODLer metrics as neutral for ethereum because a significant portion of the supply continues to hold despite a recent spike in some older coins being spent.
Investor Profit and Loss: Bearish Ethereum
On profitability of the coin supply:
- The percentage of circulating supply in profit (PSIP) is 49%, up 2pp MoM (Chart 11). Less than half the circulating coin supply is at a profit.
- Net unrealised profit/loss (NUPL) is -0.1 (10% of market cap) (Chart 12). This means that the overall ethereum supply is in a state of unrealised loss as realised cap exceeds market cap.
- Spent output profit ratio (SOPR, price sold/price paid) maintains a bias for values below one (net losses, Chart 13). SOPR has exceeded one on only nine days since the start of November. Zooming out, around 69% of the year has seen SOPR values below one.
DeFi: Neutral Ethereum
The total value locked (TVL) in DeFi across all protocols has been relatively flat at around $42bn recently. Arbitrum replaces Avalanche in the top five protocols by TVL. Of the top five, Polygon (-3% WoW) and Ethereum (-2% WoW) are down the most in terms of their TVL (Charts 14 and 15). We view this as neutral for ethereum as its TVL has been relatively flat recently.
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 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 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.