Crypto markets capitulated over the past week after recently registering new all-time highs across the board. Ethereum (ETH) is currently down 12% over the past seven days and trading around $4,180, below the recently posted all-time high of $4,878 (Charts 1 and 2). The total crypto market cap is now around $2.58tn, with a 19.2% dominance from ethereum. While the overall crypto infrastructure is largely unchanged, the correction coincided with a press conference from the Chinese National Development and Reform Commission that reaffirmed China’s intention to crack down on crypto mining. Should I buy ethereum afterwards? No one can provide a definitive answer to this question as it ultimately depends on your individual financial situation and risk tolerance. Before investing in any cryptocurrency, we recommend that you do your own research and carefully consider all the risks associated with it.
Examining other asset classes, ethereum is most correlated to equities (positively) and the dollar (negatively, Chart 3). Therefore, recent dollar strength and the equity rally losing momentum has likely contributed to ethereum weakness.
As for our ethereum metrics, three are now giving bearish signals. ETF inflows have declined, futures open interest is falling, and longer-term HODLers have been taking profit. These are potentially worrying signs for ethereum. However, our other metrics like hash rates and DeFi activity are still bullish. Together, our metrics are giving a neutral signal.
Overall, we maintain our structural bullish view but are cautious in the short term. Watch HODLer behaviour, hash rates and DeFi activity trends to get a clearer signal for calling the end of the correction.
Here is the full rundown of our metrics:
Institutional Demand: Bearish Ethereum
Our preferred metric to track institutional demand is flows into ethereum ETFs. Inflows registered highs around the ethereum all-time high and have been decreasing since (Chart 4). That said, we have seen no outflows month-to-date. No outflows are positive, however, the decreasing trend in inflows with the price correction suggests less institutional demand. This is bearish ethereum.
We also track news around crypto, where momentum has been positive. A recent SEC filing confirmed institutional investors increased their ethereum exposure by 20% in Q3 through the Grayscale Ethereum Trust. Some of the biggest holders include Ark Invest, Tocqueville Asset Management, and Main Management ETF Advisors. A non-profit organisation, The Ethereum Foundation, has set aside $1mn in grants intended for Ethereum and blockchain education. On a less serious note, Burger King has teamed up with Robinhood to give away more than 2mn crypto tokens, including 200 ETH! In general, the news momentum has been positive, but slow. Coupled with the downtrend in ETF inflows, this is bearish ethereum.
Demand for Liquidity and Exchange Activity: Bullish Ethereum
A measure of ethereum bullishness is whether investors prefer to hold it in illiquid form (e.g., in a private wallet) or liquid form (e.g., on an exchange, see Appendix). The past week saw a mixture of inflows and outflows, though the magnitude of each has been relatively small. We view this as a neutral to bullish signal for ethereum.
The overall exchange balance (total ETH coins held on exchange addresses) continues its downtrend since August 2020 (Chart 6). Currently, 12.2% of the ethereum supply (14.34mn coins) is held on exchange addresses (Chart 7) – down 2% month-to-date.
Price capitulation absent sharp inflows to exchanges suggests investors are exercising caution around the current correction. Overall coin supply continues to drain from the exchanges, which is broadly bullish. Generally, changes in the exchange dynamics have been relatively muted despite a large price correction, and we view this as bullish ethereum.
Futures Activity: Bearish Ethereum
We track the growing market of ethereum futures. Open interest – the sum of long and short contracts – provides a good measure of investor interest. Open interest is trending down after recently registering all-time highs, though is still elevated historically. It is currently around $11.6bn (Chart 8) – down 3% month-to-date and 8% since October highs. The picture on Binance is starker: open interest is down 7% month-to-date and 15% since the October highs (Chart 9).
We view the decreasing open interest as a proxy for less investor interest, so this is bearish ethereum.
HODLers: Bearish Ethereum
HODLing refers to buy-and-hold strategies in the context of cryptocurrencies. We categorise HODLers by the length of time they have held ethereum (Appendix).
The coin days destroyed (CDD) metric is the number of coins in a transaction times 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. July to September saw accumulation, with CDD relatively muted (Chart 10). After the September selloff, the average CDD value has been increasing and, more recently, spiked considerably. This suggests older coins are being distributed. This could mark a key turning point in HODLer dynamics as long-term holders move to realise profits. Notably, a bull market can historically withstand extended periods of increased old coin expenditure, so this is not necessarily bearish when taken in isolation.
To get an overview of HODLer dynamics, we split HODLer vintages into those that have held for one year or more and those that have held for less (ignoring coins held for 24 hours). The former has dropped sharply, while the latter jumped up (Chart 11), suggesting longer-term HODLers have been distributing their coins into the new highs and subsequent correction. Splitting out the longer-term vintages evidences this: both 3-5-year and 5-7-year HODLers’ shares have decreased (Chart 12).
On balance, we view the increased distribution of older coins as a potential turning point for ethereum HODLer dynamics and consequently bearish ethereum given this dynamic is only just being formed.
Investor Profit and Loss: Neutral Ethereum
Public blockchains allow us to calculate three P&L-related measures: percent supply in profit (PSIP), net unrealised profit and loss (NUPL) and the spent output profit ratio (SOPR). (The Appendix details each.)
The share of the supply in profit (PSIP) is currently 89.9%, down approximately 9.3pp month-to-date (Chart 13). The size of the unrealised profits (NUPL) is currently 63.7% of the market cap, down 5.2pp month-to-date (Chart 14). Realised profits (SOPR) is around 1.02 (Chart 15).
Notably, SOPR spiked to 2.2 over the past week, indicating significantly larger-than-usual profit taking. The excessive profit taking looks to have preceded the large selloff and comes after prolonged muted profit taking. SOPR has subsequently reverted to one. Given the increased spending of older coins over the same period, the spike in SOPR is intuitive as realised profits would be higher for these cohorts. The last time SOPR spiked anywhere near 2.2 was when it reached around 1.33 at the end of the September selloff (also reverting to one subsequently), immediately after which ethereum went on its most recent bull run to new all-time highs (Chart 15).
Together, these metrics show unrealised profits have been decreasing, but significant realised profit taking has occurred. Given the dropping ethereum price would naturally lead to the ratios decreasing, we view this as neutral ethereum.
Mining Activity: Bullish Ethereum
We track the hash rate for ethereum. A higher rate means more computing power is available to maintain the network, deliver more security (resistance to attacks), and facilitate more transactions. We view this as a bullish sign (Appendix).
The hash rate has been consistently registering new all-time highs and is currently 793TH/s (terahashes per second) (Chart 16). It is up 3.5% month-to-date, 14.7% since the beginning of October, and 181% year-to-date. Lastly, despite bitcoin’s hash rate closing on new all-time highs, ethereum miner total revenue (fees plus newly minted coins) still outperforms (Chart 17). Together, these are bullish ethereum.
DeFi: Bullish Ethereum
We track the total value locked (TVL) in DeFi – the sum of all assets deposited in decentralised finance (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 supply reduction should raise higher ethereum prices.
The TVL across all chains/protocols remains above $250bn. Ethereum is still by far the most dominant player in the DeFi space, with over $171bn of the $250bn TVL attributed to the ethereum chain alone. To illustrate its dominance, the next biggest chain is Binance, with around $19.5bn TVL (Chart 18). This is bullish ethereum.
We have introduced a framework for understanding the flow and microstructure dynamics of ethereum markets. The seven key metrics are:
- Institutional demand: decreased ETF inflows and slow momentum in the news. Bearish ETH.
- Liquidity demand: a mixture of inflows and outflows from exchanges, though the overall exchange balance still decreasing. Bullish ETH.
- Futures activity: open interest is decreasing as prices pull back. Bearish ETH.
- HODLer behaviour: turning point for HODLer dynamics as longer-term HODLers begin to distribute into the all-time highs and subsequent correction. Bearish ETH.
- P&L of investors: unrealised profits decreasing as prices decrease and SOPR showing strong profit taking. Neutral ETH.
- Mining activity: hash rate consistently registering new all-time highs and miner revenue outperforming that of bitcoin. Bullish ETH.
- DeFi activity: ethereum remains the most dominant force in the DeFi space. Bullish ETH.
Three of our indicators – ETF flows, open interest and HODLer behaviour – are giving bearish signals. Meanwhile, three others – liquidity demand, mining activity and defi activity – are giving bullish signals. The decider, investor P&L, is neutral. Therefore, overall, our metrics hang in the balance, giving an overall neutral signal for ETH.
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.
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, possibly implying more bearishness.
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 long 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.
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 very 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 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.
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.