How Has Ethereum Performed Since the Shapella Upgrade?

Summary

Trading View (next 2-4 weeks): We like to be slightly bearish ethereum.

Investment View (next 1-3 years): We like to hold ethereum.

Macro Signals

• The Federal Reserve (Fed) hiked 25bps.
• US nonfarm payrolls was higher than expected and added to labour market overheating.
• April CPI showed no incremental progress on disinflation.

On-Chain/Flow Signals

• We have two bullish, two bearish, and two neutral signals.

Overall View

• With the macro backdrop still bearish and our on-chain/flow metrics very bullish, our overall signal is slightly bearish ethereum (Chart 1).

Post Shapella Analysis

In our last Ethereum update, we identified three possible scenarios that could play out after the much-awaited Shapella upgrade completed on 12 April:

• Ethereum sells off. If a significant proportion of validators were to claim their staking rewards and sell the staked ETH immediately after the upgrade, a sell-off could be triggered.
  
• Nothing happens. The ability to sell the staked ETH is already priced in (e.g., via liquid staking token providers such as LIDO).
  
• Ethereum rallies. The prospect of being able to withdraw staked ETH from the ethereum network may make more people willing to stake ETH. This would further reduce the liquid supply of ETH and would be bullish for ethereum overall.
  

Now a month on from the successful upgrade, we investigate how ethereum has performed since and any changes in the staking landscape.

Ethereum price little changed. Ethereum rallied +12% in the days after the upgrade, followed by a decline in tandem with the broader crypto market (Chart 2). Currently, it is down around 2% since the upgrade, so overall there has been little movement since Shapella. Notably, several significant macro events have impacted crypto markets over the period, too (CPI, NFP, and central bank rate hikes to name a few).

What sell-off? One scenario was a sell-off induced by validators claiming their staking rewards and offloading them onto exchanges. Around 119,000 ETH entered exchanges a day after Shapella, before settling at a lower daily rate (Chart 3). This is a relatively small spike in the exchange deposits and within range of typical exchange flow patterns.

How many validators exited the validator pool? There are two types of withdrawals: partial and full. Partial withdrawals allow validators to periodically withdraw their staking rewards over time. Full withdrawals occur when a validator withdraws their entire staked ETH and any accumulated rewards and stops participating in validation. We saw a spike in full withdrawals a day after Shapella, with around 14,249 validators exiting the validator pool (full withdrawal, Chart 4).

Staking deposits rise. One possible scenario was the Shapella upgrade making more people willing to stake ETH. This seems to have played out, with the number of new 32 ETH stake deposits made into the staking contract rising exponentially post Shapella (Chart 5).

Overall, the completion of the Shapella upgrade saw staking rewards withdrawn, but with little direct impact on ethereum prices. Our original estimate of a limited impact on prices in the short to medium term seems to have played out.

Macro Backdrop: Inflation Remains High and Stable

The Federal Reserve (Fed) hiked 25bps, in line with market consensus and our expectations. Fed Chair Jerome Powell did not rule out a June hike and sees financial instability impacting Fed policy through a credit crunch, if at all.

April CPI showed no incremental progress on disinflation, as a large increase in used car prices offset slower inflation in other categories. Additionally, the ongoing recovery in rental indices suggests the progress on shelter cost inflation (+42bps MoM vs +56bps MoM for March) could turn out to be transitory.

April nonfarm payrolls (NFP) at +253,000 exceeded expectations of +185,000. In line with labour market tightness, wage pressures are starting to show with average hourly earnings (AHE) accelerating +0.5% MoM against expectations of +0.3% MoM. This acceleration occurred alongside a decrease in overtime hours (which tends to weigh on average wages as overtime work is paid more), suggesting a strong underlying trend in wage growth.

Markets are under-pricing the risk of a 25bp hike at the June FOMC meeting. Despite ongoing banking turmoil, the Fed’s assessment of the economy was unchanged: the labour market remains very tight, inflation is well above target, and ‘the process of getting inflation back down to 2 percent has a long way to go.’ Should the current inflation and growth dynamics continue, and barring a debt ceiling crisis, we believe the Fed could hike 25bps in June, in contrast to a virtually 0% chance of a hike currently priced in by markets.

On-Chain/Flow Metrics: Exchange Outflows Dominate

We have two bullish signals this week:

• Liquidity demand: bias for exchange outflows.
• HODLer behaviour: 59% of the coin supply has not moved in at least a year and uptrend in the proportion shows no signs of abating yet.

We have two bearish signals:

• Institutional demand: ETF outflows resume.
• DeFi: total value locked in DeFi for ethereum falls.

The remaining two signals are neutral:

• Futures activity: futures open interest is flat MoM while funding rates remain positive (though trending down).
• P&L: the profitability of the coin supply has ticked down recently but realised profits still dominate on chain (SOPR > 1).

On balance, on-chain/flow metrics are giving a neutral signal for ethereum. Here are the details of each metric (with explanations in the Appendix).

Institutional Demand: Bearish Ethereum

Our preferred metric to track institutional demand is flows into ethereum ETFs. The year so far has had a bias for outflows, though flows have been small in magnitude compared to recent history (Chart 6). More recently, there have been around $6mn of outflows from the ethereum ETFs we track over the past five days. This is bearish.

Demand for Liquidity and Exchange Activity: Bullish Ethereum

On exchange flows:

• Short term, a slight bias exists for exchange outflows exists with net 405,000 coins exiting exchanges over the past week (Chart 7).

• Longer term, the 30-day change in the exchange briefly entered positive territory at the start of May but has flipped back to negative territory recently (Chart 8).

On balance, the bias for exchange outflows is bullish for ethereum.

Futures Activity: Neutral Ethereum

On futures markets:

• Futures open interest, a good proxy for investor interest, is currently around $5.1bn – up just +1% MoM (Chart 9).

• Perpetual funding rates have been trending down though they remain positive on average, meaning traders are paying a premium to keep open long positions (Chart 10).

Futures open interest has not moved meaningfully on a MoM basis and despite funding rates remaining positive on average, their magnitude has been decreasing. Overall, this is neutral for ethereum.

HODLers: Bullish Ethereum

On HODLer metrics:

• The 30-day moving average of the coin days destroyed (CDD) metric is flat MoM (Chart 11), suggesting muted movement of older coins over the past month.
  
• Splitting the entire coin supply into those who have held for under one year and those for one year or more reveals the latter vintage continues to set new all-time highs with 59% (+246bps MoM) of the coin supply having not moved in at least a year (Chart 12).

A significant proportion of the ethereum supply remains dormant which points to a strong investor base that continues to hold despite ongoing macroeconomic and regulatory headwinds. This is bullish for ethereum.

Investor Profit and Loss: Neutral Ethereum

On profitability of the coin supply:

• The percentage of circulating supply in profit (PSIP) is 70% (-6bps MoM, Chart 13).

• Net unrealised profit/loss (NUPL) is now 0.22 (22% of market cap, -3bps MoM, Chart 14). This means that the overall ethereum supply remains in a state of unrealised profit (NUPL > 0) as market cap exceeds realised cap.

• The spent output profit ratio (SOPR, price sold/price paid) has been falling on average this month, but it still maintains a bias for levels above one (realised profits, (Chart 15). Year to date, 81% of days have seen realised profits. Furthermore, over the past 30 days, 80% of days have had a SOPR value above one.

The profitability of the coin supply has taken a small hit recently but realised profits on-chain (SOPR > 1) still dominate. Overall, this is neutral ethereum.

DeFi: Bearish Ethereum

Of the top five DeFi protocols by total value locked (TVL), ethereum’s TVL is up the second highest at +5% WoW, after Tron’s TVL which is up +6% WoW (+1% WoW, Charts 16 and 17). All other chains in the top 5 by TVL are also up in terms of their TVL between 2% and 4% each. The increase in ethereum’s TVL is bullish.

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, implying more bearishness.

Futures Activity

We track the growing market of ethereum 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 ethereum 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 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 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.

DeFi

We track the total value locked (TVL) in decentralized finance (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.

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 Head of Research at 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.

(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)