Flow Metrics Turning Positive For Bitcoin

The good news for bitcoin is it has traded sideways recently even as equity markets fell. And the divergence is starker between bitcoin and US small caps (Chart 4). Bitcoin has also remained above $40,000, which could give investors’ confidence (Chart 1). That said, bitcoin is still amid a 37% drawdown from the November 2021 all-time highs (Chart 2). The maximum drawdown during the current decline is 39%. That makes it the eighth-worst drawdown in its history (Table 1).

Valuations can help us determine whether bitcoin is ending its drawdown. For example, when the MVRV z-score has previously reached between 0 and 1.1, bitcoin has typically bottomed. It was this level that marked the end of the spring/summer 2021 drawdown. Currently, the score is 1.4 and continues to fall (Chart 3). Valuations are starting to become attractive.

On our flow metrics, ETF inflows have started returning, and long-term HODLers maintain their conviction. Meanwhile, investor leverage rose but recently reduced. Investor bias now appears bullish with funding rates turning positive. This suggests investors are attempting to bottom-pick.

For now, we think positive signs are forming for bitcoin. But for a clear buy signal, we need equity markets to stabilise.

Our Flow Metrics in Detail

• Overall, our flow metrics continue giving a neutral signal for bitcoin.
• We have three neutral signals: small ETF inflows resume, small changes in the exchange supply, and bitcoin-denominated futures open interest signifying some potential volatility ahead amid funding rates recovering from negative territory.
• We have two bullish signals: long-term HODLers maintaining their conviction to hold and the hash rate continuing to soar.
• Lastly, we have one bearish signal: reduced profitability of the coin supply.

Below is the full rundown of our metrics.

Institutional Demand: Neutral Bitcoin

Our preferred metric to track institutional demand is flows into bitcoin ETFs (Appendix). After outflows from December 2021 continued into the new year, flows appear at a turning point as we start to see inflows again, albeit small (Chart 5). To reconfirm a bullish view from this metric, we need larger inflows. Therefore, we view this as neutral for bitcoin in the short term.

On news around bitcoin, Gemini acquired trading technology provider Omniex as they push services for institutional investors. Swiss bank Seba predicted bitcoin could reach $75,000 in 2022 as ‘institutional money will probably drive the price up’. Lastly, bitcoin mining company GRIID is set to be the first company to receive Intel’s new Bonanza Mine chips – described as an ‘ultra-low-voltage energy-efficient bitcoin mining ASIC’. This will likely factor into ESG concerns around bitcoin in institutional money.

Demand for Liquidity and Exchange Activity: Neutral Bitcoin

There are currently 2.5mn coins (13.5% of the total circulating supply) held on exchange wallets. The 30-day change in the exchange supply indicates how many coins are moving to and from exchanges. The past week saw a continued stream of increases in this metric, meaning the supply held on exchanges has been rising on average (Chart 6). However, the magnitude of these inflows remains small versus historical selloffs, suggesting caution around current price action. Therefore, we view this as neutral for bitcoin.

Futures Activity: Neutral Bitcoin

Considering dollar value, futures open interest has been declining since the December flash crash. However, when removing for the effects of price differences by denominating open interest in BTC, a different picture emerges. Open interest appeared to be increasing from the start of the new year and currently remains historically high. Indeed, current open interest sits at 369,179 BTC, which is above the 2021-to-date average of 346,755 BTC.

The 30-day changes in futures open interest denominated in BTC reveal periods of rising open interest often coincide with large price movements (Chart 7). We identify key instances of this with the red circles. Notably, periods of heightened open interest often precede deleveraging events. Given open interest is currently high relative to the last 30 days, this will be a key figure to watch. Open interest in perpetual markets when denominated in BTC is also historically high.

Perpetual funding rates reveal investors’ directional bias. 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. 

Since falling into negative territory on 11 January, funding rates have been increasing on average and currently sit at around 0.006% (Chart 8). This means investors are paying a premium to keep open long positions.  

High open interest hinting at more volatile price action and positive funding rates providing a constructive backdrop yield a neutral signal for bitcoin.

HODLers: Bullish Bitcoin

We split HODLers into those who have held for greater than or equal to one year and those for under one year (Appendix). The longer-term HODLer vintage (1y+) continues its steep rise (Chart 9). The shorter-term vintage (<1y) displays the opposite trend. Despite the new year’s tumultuous price action, the longer-term vintage is up 2pp year to date, claiming 59% of the total circulating supply.  

Both the coin days destroyed metric and the 1y+ revived supply metric validate this view. They have been falling on average (Charts 10 and 11). Overall, longer-term HODLers are maintaining their conviction to hold – this is bullish bitcoin in the longer term.

Investor Profit and Loss: Bearish Bitcoin

We also track profitability (Appendix). The percentage of circulating supply in profit (PSIP) is currently 70%, down 15pp since the start of December (Chart 12). This is similar to July 2021 values, whereafter prices rallied.

Net unrealised profit/loss (NUPL) is currently 43% of the market cap (Chart 13), also similar to July 2021 levels. In our last bitcoin update, when we noted NUPL had dropped below 50%, we reiterated the significance of this. We also argued that should NUPL fail to recover, this would be a signal for further downside. This has been the case. NUPL values right now are characteristic of a market hovering between optimism and anxiety. If it does not bounce back, this sentiment may convert into fear.

Spent output profit ratio (SOPR) has been bouncing in a range around one. It is currently below one, signifying realised losses on chain (Chart 14). The overall decrease in the profitability of the supply and realises losses on chain is bearish bitcoin.

Mining Activity: Bullish Bitcoin

We track the hash rate for bitcoin. 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 bullish (Appendix).

Bitcoin’s hash rate again registers new all-time highs on average (Chart 15). Recently, miner revenues have also started to pick up (Chart 16).

Overall, the hash rate is consistently hitting new all-time highs, and we view this as bullish for bitcoin.

Bottom Line

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

1. Institutional demand: ETFs resume small inflows. Neutral bitcoin.
2. Liquidity demand: small changes in supply held on exchange wallets. Neutral bitcoin.
3. Futures activity: bitcoin-denominated open interest high signifying some potential volatility ahead and funding rates increasing. Neutral bitcoin.
4. HODLer behaviour: longer-term HODLers maintain conviction to hold. Bullish bitcoin.
5. P&L of investors: reduced profitability in the coin supply. Bearish bitcoin.
6. Mining activity: hash rate registering new all-time highs. Bullish bitcoin.

On balance, the metrics are neutral bitcoin in the short term.

Appendix

Institutional Demand

Perhaps the largest institutional vehicle for bitcoin is the Grayscale Bitcoin Trust, with over $27bn in assets. It invests solely in bitcoin, and so many investors, notably institutional, who cannot hold bitcoin directly can get exposure through investing in Grayscale. Consequently, if the trust trades at a premium to bitcoin prices, it may imply ‘excess’ demand from institutions, but ‘excess’ supply if it trades at a discount. Alternatively, investors may be using other vehicles to get exposure such as ETFs or holding bitcoin 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 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. We can break this down further into those who have held bitcoin from the very early days (7-10 years ago and 10+ years ago).

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 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 BTC 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 coin) 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.