Ethereum to Hit All-Time Highs Before Year-End?

Ethereum has shown strong price action lately. It has more than recouped last Friday’s losses when the Omicron scare first shocked markets, currently trading just 6% below its all-time high of $4,878 (Charts 1 and 2). We think new highs before the end of the year are possible. Reasons for this include:

• We are seeing growing dominance of ethereum. It now makes up 20% of the total crypto market cap – its highest-ever share. The cross between ethereum and bitcoin has surpassed 0.08 (Chart 3), which is its highest level since mid-2018.  
• The MVRV z-score remains constructive. The score is the difference between the current and realised market caps, expressed in standard deviation units (akin to the price-to-book ratio in equity markets). This metric can help ascertain whether ethereum is overbought or oversold. Higher z-scores imply market valuation is higher than when the circulating supply was last moved, and vice versa. Historically, this value has signalled local tops at above 5.5 (Chart 4), which we saw during the May bull run earlier this year. Currently, the z-score is 2.8, indicating plenty of room for further upside.
• All our ethereum metrics are giving bullish signals. Notably, ETF inflows increased, exchange supply continues to decrease, futures open interest resumes an uptrend, and the share of long-term HODLers increased (more details of each metric are below).
• Transitions to ETH 2.0 This switch should increase ethereum adoption. It already dominates the decentralised finance (DeFi) space, but other use cases should increase.

Institutional Demand: Bullish Ethereum

Our preferred metric to track institutional demand is flows into ethereum ETFs. Inflows registered highs around the ethereum all-time high and decreased throughout the correction (Chart 5). However, they renewed an uptrend at the end of November, suggesting increased institutional demand. This is bullish ethereum.

News around ethereum has been positive. CME Group, the world’s largest derivatives exchange, is set to release micro ether futures on 6 December. Ether futures continue to expand, with Kelly Investment Group filing for an ether futures ETF. FTX.US has added ethereum NFTs to its marketplace. Huobi announced it will launch Huobi Lending – a cryptocurrency lending service for institutions and high-net-worth individuals. Lastly, the latest CoinShares weekly report indicated digital asset investments saw inflows total $306mn last week. ETF flows increasing and positive news momentum are bullish 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 14 days experienced a bias for outflows, with a net value of 187,721 coins leaving exchanges. Only three of the last 14 days saw net inflows (Chart 6).

The story around the total exchange balance decreasing remains. Currently, only 14.15mn coins are held on exchange addresses (Chart 7), down 3.4% since the start of November and 25% year to date. Currently, only 12% of the circulating supply is held on exchange addresses (Chart 8).

During the correction, changes in exchange dynamics were relatively muted except for small inflow spikes. As prices recover, supply continues to exit exchanges. This further increases the risk of a supply shock, especially given the increasing supply also being locked in DeFi. Overall, these exchange dynamics suggest investors have a bias towards keeping their ethereum off exchanges, which we consider bullish.

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. Open interest resumed an uptrend towards the end of November as prices began to recover. Total open interest is currently $12.7bn – up 18% from the November lows (Chart 9). On Binance, the story is similar: open interest is currently $2.9bn – up 22% from last month’s lows (Chart 10).

We view the increasing open interest as a proxy for more investor interest, so this is bullish 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).

Higher coin days destroyed (CDD) suggests older coins are being spent. Between July and September there was a period of accumulation where CDD was relatively muted (Chart 11). After the September selloff, the average CDD value gradually increased until it spiked during the November correction. The average CDD value remains elevated. However, it has flattened out and looks to have begun a downtrend, suggesting movement of older coins has eased. To confirm this, we split all HODLers into two cohorts: those who have held for under a year and those for a year or more. After a recent drop, the percentage of 1y+ HODLers, has started rising again (Chart 12).  

Breaking down the longer-term HODLer vintage reveals more about which cohorts maintain the strongest conviction in the ethereum price recovery. A large proportion of the 2-3y vintage has seemingly converted to the 3-5y vintage (Chart 13). Indeed, the 3-5y vintage now dominates all 2y+ HODLers with 16% of the circulating supply.

After a brief period of increased old coin spending throughout the correction, long-term HODLers appear to have slowed their coin spending. We view this as bullish ethereum.  

Investor Profit and Loss: Bullish 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) (Appendix details each). The share of the supply in profit (PSIP) is currently 96.8%, up approximately 10pp from November lows (Chart 14). The size of the unrealised profits (NUPL) is currently 65.8% of market cap, up 4.4pp from November lows (Chart 15). The NUPL metric still has some recovery to make compared with November highs, indicating many investors likely bought at the late highs. Realised profits (SOPR) is around 1.07 (Chart 16). Together, these metrics show a return to profitability for much of the ethereum supply as prices approach all-time highs, which we view as bullish.

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 is currently 893TH/s (terahashes per second) (Chart 16). It started a downtrend during the correction but is now rising again as prices recover – it is down 5.5% since November highs, but up 184% year-to-date (Chart 17). Miner revenue is similar. It decreased during price capitulation and has started to increase again recently (Chart 18). Overall, the recovering hash rate and miner revenue are bullish ethereum.

DeFi: Bullish Ethereum

We track the total value locked (TVL) in 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.

The TVL across all chains/protocols has surpassed $280bn. Ethereum remains the most dominant player, with over $180bn of the $280bn TVL attributed to the ethereum chain alone. The next biggest chain, Binance, has around $19.7bn TVL (Chart 19). This is bullish ethereum.

Bottom Line

We have introduced a framework for understanding the flow and microstructure dynamics of ethereum markets. The seven key metrics are:

1. Institutional demand: increased ETF inflows and positive news momentum. Bullish ethereum.
2. Liquidity demand: continued outflows from exchanges and total exchange balance still decreasing. Bullish ethereum.
3. Futures activity: open interest increasing as prices recover. Bullish ethereum.
4. HODLer behaviour: long-term HODLers slow spending. Bullish ethereum.
5. P&L of investors: return to profitability for most of the ethereum supply. Bullish ethereum.
6. Mining activity: hash rate and miner revenue resume uptrend. Bullish ethereum.
7. DeFi activity: ethereum remains most dominant force in the DeFi space. Bullish ethereum.

Overall, all our indicators are giving bullish signals for ethereum.

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, possibly implying more bearishness.

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 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.

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 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.

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.

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.