How Will Ethereum React to This Week’s Inflation Data?

Summary

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

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

Macro Signals

• The Federal Reserve (Fed) hiked 75bps at the November FOMC meeting, and we expect the same at the December meeting.
• October jobs data suggest the labour market is still tight.
• The 2s10s curve inverts to four-decade lows, sending the probability of a recession back over 80%.
• The macro backdrop is bearish for ethereum.

On-Chain/Flow Signals

• We have five bullish and one neutral signal this week.

Overall View

• With the macro backdrop bearish and our on-chain/flow metrics neutral, our overall signal is slightly bullish ethereum. But we are cautious ahead of CPI data released on Thursday (Chart 1).

Macro: How Does Ethereum React to CPI Releases?

Nothing suggests the Federal Reserve (Fed) will pivot soon. We think the Fed will likely remain reactive to short-term data developments, chief of which is inflation. And with inflation still high and persistent, and October’s CPI data due Thursday, we look at how ethereum trades in the period immediately before, on, and after CPI release dates.

CPI Releases Prompt Intraday Losses

We can gauge how ethereum performs around CPI release dates with range-based data –specifically the intraday open, high, low, and close prices. Crypto markets can see extremely volatile price moves around key macroeconomic release dates (FOMC meetings are another example), and we can use intraday data to quantify this.

Looking from seven days prior to seven days after each CPI release from 2021 and 2022 onward, we calculate the average (open to close) intraday return across each period.

From 2021 onward, there is a roughly equal number of positive intraday returns (seven) and negative intraday returns (eight) surrounding the CPI release (Chart 2). Notably, the day of the CPI release (day zero) shows an average intraday loss of -1%.

If we ignore 2021 and consider 2022 onward only, the picture is bleaker. Only four of a possible 15 occurrences see positive intraday returns around CPI releases (Chart 3). Moreover, the day of CPI releases (day zero) shows an average intraday loss of -1.5%.

If recent history is anything to go by, we could be in for another drop in the short term should inflation persist.

The Macro Backdrop: More Rate Hikes to Come

The Federal Reserve (Fed) delivered a fourth straight 75bp hike at the November FOMC meeting last week, as we expected. In response, US treasury yields soared, and the inversion of the 2Y10Y part of the yield curve hit four-decade lows (-57bps), which pushed recession probabilities to four-decade highs (84%). Additionally, October jobs data suggests the labour market is still tight with nonfarm payrolls (NFP) for October coming in higher than expected on Friday last week. We expect another 75bp hike in December. The macro backdrop is still bearish for crypto.

On-Chain/Flow Metrics: Long-Term HODLers Dominate

We have five bullish signals this week:

• Liquidity demand: bias for outflows from exchanges.
• Futures activity: open interest is increasing, and funding rates have turned positive again.
• P&L: profitability of the coin supply is close to 60%, the supply is in a state of unrealised profit again (NUPL > 0) and realised profits on chain (SOPR > 1) have returned.
• HODLer behaviour: long-term HODLer vintage (1y+) is at a new all-time high (59%).
• DeFi: total value locked in DeFi is increasing for ethereum.

The remaining signal is neutral:

• Institutional demand: ETF flows are muted.

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

Institutional Demand: Neutral Ethereum

Our preferred metric to track institutional demand is flows into ethereum ETFs. Flows have been muted in magnitude since the merge on 15 September and have shown no significant bias to inflows or outflows (Chart 4).

We would look for more significant (in terms of magnitude) flows for a prolonged period in either direction to reconfirm a bearish or bullish signal from this metric. For now, this is neutral ethereum.

Demand for Liquidity and Exchange Activity: Bullish Ethereum

On exchange flows:

• Short term, a bias exists for outflows to exchanges. Net 305,400 and 468,000 coins exited exchanges over the past 14 and 30 days, respectively (Chart 5). This is bullish ethereum.

• Longer term, the 30-day change in the exchange balance reveals fluctuations in the supply held on exchanges month on month. This metric remains in negative territory (Chart 6). This is bullish ethereum.

Futures Activity: Bullish Ethereum

Futures open interest is up 6% month on month – it is currently around $6.8bn (Chart 7). Around $5.8bn (85%) of this comes from perpetual futures contracts.

Perpetual funding rates reveal the directional bias of investors. They became sharply negative in the run-up to the merge and have been increasing since. On average (across all the exchanges we track), they have now entered positive territory again (Chart 8). This means traders are paying a premium to keep open long positions. This is bullish ethereum.

HODLers: Bullish Ethereum

The 30-day moving average of the coin days destroyed (CDD) metric continues to fall. It is now down 60% MoM (Chart 9), suggesting a substantial slowdown in the movement of old coins. The reduction in this metric corresponds with the ETH merge date (15 September) – it is down 66% since its September highs.

Splitting HODLers into those who have held for under one year and those for one year or more shows the 1y+ vintage continues to grind up. It now dominates 59% of the coin supply (Chart 10). This metric is now at its all-time. Rate hikes have been weighing on crypto sentiment, but there is still a sizable investor base with a strong conviction to hold.

We view these HODLer metrics as bullish for ethereum because a significant portion of the supply continues to hold despite ongoing macroeconomic headwinds.

Investor Profit and Loss: Bullish Ethereum

On profitability of the coin supply:

• The percentage of circulating supply in profit (PSIP) is 58%, up 11pp MoM (Chart 11). More than half the circulating coin supply is at a profit again.

• Net unrealised profit/loss (NUPL) is 0.08 (8% of market cap) (Chart 12). This means that the overall ethereum supply has moved back into an unrealised profit as market cap exceeds realised cap.

• Spent output profit ratio (SOPR, price sold/price paid) has been returned to levels above one (net profits, Chart 13). SOPR has exceeded one since 25 October, indicating net profits on chain since.

DeFi: Bullish Ethereum

The total value locked (TVL) in DeFi across all protocols has been relatively flat recently. Polygon, Binance Smart Chain, and Ethereum are all up between 4% and 7% MoM in terms of their TVL (Charts 14 and 15). This is bullish 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, 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.

(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.)