Trading View (next 2-4 weeks): We like to be marginally bearish bitcoin.
Investment View (next 1-3 years): We like to be long bitcoin.
- A 75bp hike is expected at the September FOMC meeting.
- We expect US 2Y yields to trade much higher.
- Correlation between bitcoin and US equities has collapsed.
- The probability of recession within the next year is nearing 80% on a deepening inversion of the US 2s10s curve.
- The macro backdrop remains bearish.
- Our metrics are becoming more supportive for bitcoin: three are bullish, three are neutral.
- With the macro backdrop still bearish, and our on-chain/flow signals neutral to bullish overall, our overall view upgrades to marginally bearish bitcoin (Chart 1).
Correlations with Major Assets Are Changing
Bitcoin is trading just below $25,000, a 28.5% rise from the 30 June low. But what is helping the cryptocurrency recover? The risk-on mood deserves some credit. Since bitcoin’s bottom, the S&P500 is up 13.5%, and the NASDAQ 100 is up 18.8%.
This rally is partly due to a constructive, if not outright upbeat, Q2 earnings season alongside the undershoot in July inflation figures (CPI). Together they have created a more supportive environment for equities, at least in the near term.
However, US equities now matter less to bitcoin (Table 1). That is, while the S&P 500 has continued to rise, bitcoin has not; it prefers to move with global (MSCI EAFE: 89.1%) and EM (MSCI EM: 78.3%; CSI 300: -79.6%) equities. This suggests bitcoin strength may be fading.
Equities, however, are not the only factor driving bitcoin. The cryptocurrency could be trading closer to $30,000 was it not for the DXY rally. Moreover, recession odds are nearing 80% thanks to a strong US 2Y-10Y curve inversion. It is leaving investors cautious, us included.
Turning to the outlook, in our last update we said the macro backdrop could worsen for bitcoin. We are repeating the statement here for two key reasons. First, in the near term, bitcoin is likely to benefit less from any continuation of the bear market rally. Moreover, should the correlation return, we remain bearish on equities.
Second, we think the Fed will hike more than currently priced (Dom sees 75bp in September and 175bp by year-end), which our network largely agrees on. This would materially push US 2Y yields higher. Both would be detrimental to the price of bitcoin. Should it fall, we could see it reaching $16,000, or even $8,250.
On-Chain/Flow: Metrics Improving
We have introduced a framework for understanding the flow and microstructure dynamics of bitcoin markets. The six key metrics are:
- Institutional demand: ETF inflows continue. Bullish bitcoin.
- Liquidity demand: short- and long-term bias for outflows. Bullish bitcoin.
- Futures activity: futures open interesting is trending up, albeit now slowing, while funding rates remain positive. Bullish bitcoin.
- HODLer behaviour: the 1y+ vintage remains close to its highs of 66%. Neutral bitcoin.
- P&L of investors: profitability of the coin is increasing while realised losses on chain no longer dominate. Neutral bitcoin.
- Mining activity: the hash rate has suffered but is now moving sideways while miner revenues have crept higher. Neutral bitcoin.
On balance, on-chain/flow metrics are giving a neutral to bullish signal. Here are the details of each metric (with explanations in the Appendix).
Institutional Demand: Bullish Bitcoin
Our preferred metric to track institutional demand is flows into bitcoin ETFs. We have seen inflows return over the past week, though small in magnitude (Chart 2). This is bullish bitcoin.
Demand for Liquidity and Exchange Activity: Bullish Bitcoin
On exchange flows:
- Short term, a bias exists for outflows from exchanges. Net -7,560 coins exited exchanges over the past seven days (Chart 3). 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 negative territory (Chart 4). This is bullish bitcoin.
Futures Activity: Bullish Bitcoin
Futures open interest is trending up but remains historically low – it is currently $11.0bn (Chart 5). Moreover, the trend is slowing – it is up 3.4% through August. Around $8.3bn (76%) of this comes from perpetual futures contracts.
Perpetual funding rates reveal the directional bias of investors. Funding rates remain positive (Chart 6). This is bullish bitcoin.
HODLers: Neutral Bitcoin
The 30-day moving average of the coin days destroyed (CDD) metric is continuing its plunge (Chart 7). The 1y+ revived supply metric is following suit (Chart 8). The 1y+ vintage of the coin supply continues to dominate around 66% of the coin supply (Chart 9). This is just shy of the 2022 highs set on 31 May.
We view these HODLer metrics as neutral for bitcoin.
Investor Profit and Loss: Neutral Bitcoin
On profitability of the coin supply:
- The percentage of circulating supply in profit (PSIP) is 64% (Chart 10). This is up 2pp through August but remains historically low.
- Net unrealised profit/loss (NUPL) is now +0.12 (Chart 11). The market turns to be just in a net profit position.
- The spent output profit ratio (SOPR) remains below one (Chart 12). However, it is spending more time above one than we saw in the last report. It has been above one for five of the past 14 days, a substantial improvement of the 57 of the last 60 days from the last report. That means there has been less realised losses on-chain.
Overall, profitability of the coin supply remains historically low. However, the coin supply is still in a net profit position, while the number of realised losses is substantially falling. This is neutral for bitcoin.
Mining Activity: Neutral Bitcoin
The hash rate has suffered but is now moving sideways (Chart 13). Meanwhile, miner revenues have crept higher (Chart 14). We see this as an improvement and class this as neutral for 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.