Bitcoin & Crypto | Monetary Policy & Inflation
Fed Hawkishness = Buy Bitcoin!
- By Bilal Hafeez and Dalvir Mandara
- 12 min read
Summary
Trading View (next 2-4 weeks): We like to buy bitcoin.
Investment View (next 1-3 years): We like to be long bitcoin.
Macro Signals
- The Fed’s first hike and a clearer path for future hikes suggest the Fed is no longer behind the curve.
- This greater certainty is positive for bitcoin.
- Risks remain around the Russia-Ukraine war and recessions, but overall, the macro backdrop moves from bearish to neutral.
On-Chain/Flow Signals
- We have a mix of positive and neutral signals, and on balance they are bullish.
Overall View
- With the macro backdrop now neutral and on-chain/flow metrics positive, our overall signal is bullish bitcoin.
Macro: Will Fed Hikes Be Positive for Bitcoin?
On Wednesday, the Fed initiated its first hiking cycle since 2015. They also announced more aggressive hiking for the rest of this year – six hikes. And for 2023, they announced 3-4 hikes. This would bring the Fed policy rates to 2.75%, which would be higher than the previous cycle’s high of 2.5%. That said, in inflation-adjusted terms, policy rates would still be negative, which would be stimulative for risk markets such as bitcoin.
The reaction to the hawkish Fed was notable: risk markets including bitcoin rallied. This suggests markets believe the clarity around future hikes and the vote of confidence in the economy expressed in the FOMC statement are positive for risk.
Fed Hawkishness Could Help Bitcoin
Another way of looking at this is to determine whether the market believes the Fed is ahead or behind the curve. If it is behind the curve, there is more potential for an inflation spiral and consequently more aggressive rate hikes. But if the Fed is ahead of the curve, inflation should be tamed, and there would be less need for abrupt hikes. We constructed the Macro Hive Fed score to capture this dynamic.
A negative number means the Fed is behind the curve. This was the case from October 2021 onwards, which later led a sharp correction lower in bitcoin (Chart 2). But more recently, our score has turned positive, suggesting the Fed is ahead of the curve – this should be positive for bitcoin.
Some Risks Remain
But risks still exist. The Russia-Ukraine conflict remains a wildcard. Will skyrocketing commodity prices persist? And will disruptions to the supply chain disrupt the global economy? We also note that a combination of a flattening yield curve, commodity price shocks and Fed tightening have contributed to an increased risk of recession within the next year – our latest recession model probabilities are approaching 50%.
Overall, though, in the near term, we now think the macro picture is no longer bearish but neutral for bitcoin.
On-Chain/Flow: ETF Inflows Return
We have a mixture of neutral and bullish signals this week. The bullish signals are:
- ETF inflows return, and exchange outflows dominate.
- Futures open interest is rising, and there is a bias for positive funding rates.
- Hash rates and miner revenues are rising again.
The neutral signals are:
- HODLer vintages are not materially changing.
- Profitability of the coin supply increases, but there are realised losses on chain.
On balance, on-chain/flow metrics are giving a bullish signal for bitcoin (Chart 1). 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 a return to inflows for most of the past two weeks – only three days saw net outflows (Chart 3). This is bullish bitcoin
Demand for Liquidity and Exchange Activity: Bullish Bitcoin
In the short term, a bias for outflows from exchanges exists. Net 38,749 and 30,761 coins left exchanges over the past 14 and seven days, respectively (Chart 4). We view this as bullish. We saw a large outflow spike of 37,000 BTC on 11 March alone. It turns out that around 31,000 ($1.2bn) of this left the Coinbase exchange. Outflows of this magnitude are likely from institutional investors focused on longer-term investment horizons.
Longer term, the 30-day change in the exchange balance reveals fluctuations in the supply held on exchanges month on month. Relative to the last 30 days, the exchange balance has been decreasing since 7 March (Chart 5). This is bullish bitcoin.
In the short term and the long term, there is a bias for outflows. Overall, this is bullish bitcoin.
Futures Activity: Bullish Bitcoin
Futures open interest is trending up again – it is currently $14.5bn, up 8% WoW (Chart 6). Around $9.6bn (66%) of this comes from perpetual futures contracts, so a large majority of leverage sits in perpetuals.
Perpetual funding rates reveal the directional bias of investors. They have been volatile but have spent most of the past two weeks above 0% (Chart 7). Indeed, eight out of the last 14 days have seen positive average funding rates. Extending this to the last 30 days, 19 days have seen positive funding against 11 negatives.
Overall, futures open interest mostly sits in perpetuals, which have had a bias for positive funding. This is bullish bitcoin.
HODLers: Neutral Bitcoin
The 30-day moving average of the coin days destroyed (CDD) metric is trending up, though remains relatively low (Chart 8). Splitting HODLers into those who have held for under one year and those for one year or more confirms most (62%) of the coin supply is in an accumulation phase (Chart 9).
The 1y+ revived supply metric is also trending up slightly (Chart 10). Longer hands tend to distribute into market strength, so we look for any meaningful increase in this metric to signal a potential upside.
On balance, we view these HODLer metrics as neutral bitcoin.
Investor Profit and Loss: Neutral Bitcoin
The overall profitability of the bitcoin supply has been volatile. The percentage of circulating supply in profit (PSIP) is 69% (Chart 11). That is up 3pp over the past seven days.
Net unrealised profit/loss (NUPL) is 0.40 (Chart 12). We still wait for any significant break above 0.5 for this metric to signify potential upside.
SOPR has been volatile over the past week (Chart 13). The seven-day moving average of SOPR has been below one since 7 March, indicating a bias for realised losses on chain. Given longer-term HODLers (1y+) have not materially liquidated their holdings, these losses most likely come from more recent buyers.
Mining Activity: Bullish Bitcoin
The hash rate had recently set a new all-time high on 15 February but has since been declining on average (Chart 14). However, it has resumed an uptrend recently and remains historically elevated. Miner revenues have followed a similar pattern (Chart 15).
The hash rate and miner revenues resuming an uptrend is bullish bitcoin.
Bottom Line
We have introduced a framework for understanding the flow and microstructure dynamics of bitcoin markets. The six key metrics are:
- Institutional demand: ETF inflows. Bullish bitcoin.
- Liquidity demand: long-term and short-term bias for exchange outflows. Bullish bitcoin.
- Futures activity: positive funding rates and increasing open interest. Bullish bitcoin.
- HODLer behaviour: HODLers remain in accumulation phase. Neutral bitcoin.
- P&L of investors: PSIP and NUPL are up, but there are still realised losses on-chain. Neutral bitcoin.
- Mining activity: hash rate and miner revenue resume an uptrend. Bullish bitcoin.
Appendix
Institutional Demand
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.
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 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.
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 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.
Mining Activity
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.