Crypto markets have surged in recent weeks. Bitcoin (BTC) recently touched all-time highs at almost $67,000 – over 3% higher than the previous high in April (Chart 1). Sentiment towards bitcoin is very positive: a recent Macro Hive poll found most expect it to reach $100,000 in this current rally. Meanwhile, ethereum (ETH) has rallied 10% over the past week, and this raises the question: should I buy ethereum now? It is currently trading above the previous all-time daily close high of $4,140 (Chart 2). However, it is still below the intraday high of $4,380 from May. A return to the intraday high would imply a 5% gain from current levels.
Another way of understanding potential gains in ethereum is to compare its price with bitcoin. We can look at how much bitcoin one ether can buy. Currently, the cross is around 0.064, meaning one ether can buy 0.064 units of bitcoin. In earlier years, that cross traded closer to 0.03, so there has been a significant re-pricing of ethereum higher compared with bitcoin this year (Chart 3). In recent weeks, bitcoin has outperformed ethereum so the cross has been falling. But were we to see renewed interest in ethereum, the cross could return to the highs of 0.078 from early September. That happening would imply ethereum could breach $5,000 soon.
Of course, these are just potential scenarios. To validate these moves, we examine our ethereum flow metrics, first released two weeks ago. The punchline is that almost all of them are giving bullish ethereum signals. This suggests ethereum could breach the intraday high of $4,380 and even $5,000 in coming months. Here is a rundown of our metrics.
Institutional Demand: Neutral/Bearish Ethereum
Our preferred metric to track institutional demand is flows into ethereum ETFs. Flows have been positive but falling in size over the past month (Chart 4). This suggests institutions have been less willing to participate in the recent ethereum rally. This is a potentially bearish signal. Of course, this could reverse, so this will be a key flow to monitor.
We also track news around ethereum, where momentum has been positive. The approval of the first US-listed bitcoin ETF has brought focus onto the potential approval of an ethereum ETF. Grayscale CEO Michael Sonnenshein said the SEC will now be more inclined to approve an Ethereum ETF. Lastly, Interactive Brokers, one of the largest electronic trading platforms in the US, has launched ethereum and bitcoin trading for registered investment advisors (RIAs) in the US. So the news is more positive, while actual ETF flows more negative.
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). Increased flows onto exchanges can signal bearishness – it suggests investors want to hold Ethereum in a liquid form. Conversely, increased outflows can signal bullishness as investors are happy to hold onto their coins.
During the May selloff, flows onto exchanges spiked (Chart 5), implying bearishness. Since then, there has been a bias for outflows, with a net value of 270,158 coins flowing out of exchanges over the last seven days. This suggests investors are still bullish around the October price rally.
In tandem with continued outflows from exchanges, the overall exchange balance (the total number of ethereum coins held on exchange addresses) has maintained a downtrend from August 2020 onward (Chart 6). Currently, around 13% of the ethereum supply is held on exchange addresses. With the price of ethereum rallying, the decreasing supply suggests investors are willing to hold in anticipation of further price increases. This is broadly a bullish sign for the market. But, it’s worth noting that as more supply is drained, institutional investors/whales may face liquidity issues.
Futures Activity: Bullish 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. Throughout October, open interest has maintained an uptrend and is currently closing in on the all-time high of $11.7bn from the beginning of September (Chart 7). The picture on the CME exchange is also positive: open interest has been increasing since the release of the ethereum contract in February (Chart 8). Together, these suggest strong support for ethereum.
HODLers: Bullish 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). Short-term HODLers (3m-6m) have been decreasing as medium-term HODLers (6m-1y) have been increasing (Chart 9), suggesting short-term HODLers are converting to medium-term HODLers. Medium-term HODLers maintain the largest single share of all vintages, possessing 33% of ethereum in existence. We also note a gradual, slight increase in the proportion of long-term HODLers (5y-7y) (Chart 9). Together, these suggest bullishness for ethereum.
Investor Profit and Loss: Bullish Ethereum
An attractive feature of public blockchains and crypto markets is that we can track each transaction more easily. One measure of transactions is spent outputs – that is, some computing output is spent to enable a transaction. The spent output can tell us when a transaction has occurred, by whom and at what price. This allows us to track the profit and loss (P&L) of investors. We can then use this data to calculate three P&L-related measures: percent supply in profit (PSIP), net unrealised profit and loss (NPUL) and the spent output profit ratio (SOPR). (The Appendix details each.)
The share of the supply in profit (PSIP) is currently 97%, up approximately 13pp from the September lows (Chart 10). The size of the unrealised profits (NUPL) is currently 68% of market cap, up 10pp from the September lows (Chart 11). Realised profits are healthy with a SOPR value above one (Chart 12). Last week saw SOPR spike to 1.16 around a local top in the ETH price of approximately $3,800. SOPR has since reverted nearer to one, suggesting investors may be reluctant to continue realising profits with the belief that the price will continue to increase. To some extent, an ethereum rally would naturally lead to these ratios improving, but they nevertheless provide a bullish signal for 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). Conversely, we view a falling hash rate as bearish. The hash rate bottomed in late June following the China crackdown but has resumed an uptrend since (Chart 13). This is bullish Ethereum.
DeFi: Bullish Ethereum
A benefit of ethereum over bitcoin is its role in decentralised finance (DeFi). DeFi offers payments, lending and other financial products using coins such as ETH as the underlying protocol. The more DeFi products are created, the more ETH gets locked into the DeFi system and removed from the broader ETH market. This reduction in ETH supply should lead to higher ETH prices.
We can track the total value locked (TVL) in DeFi and what share comes from ETH. The TVL surpassed $225bn this week, registering new all-time highs. While the share of this coming from ETH has fallen as more protocols enter the space, it is still by far the most dominant player, maintaining a 70% market share (Chart 14).
We have introduced a framework for understanding the flow and microstructure dynamics of ethereum markets. The seven key metrics are:
- Institutional demand: subdued institutional flows. Neutral/bearish ETH.
- Liquidity demand: less flows onto exchanges and exchange supply decreasing. Bullish ETH.
- Futures activity: open interest increasing. Bullish ETH.
- HODLer behaviour: short-term HODLers converting to medium-term HODLers. Bullish ETH.
- P&L of investors: realised and unrealised profits increasing. Bullish ETH.
- Mining activity: hash rate increasing. Bullish ETH.
- DeFi activity: more ETH directed to DeFi. Bullish ETH.
On balance, the metrics are giving a bullish signal for ethereum.
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.