Bitcoin & Crypto | Monetary Policy & Inflation | US
Trading View (next 2-4 weeks): We like to be slightly bearish ethereum.
Investment View (next 1-3 years): We like to hold ethereum.
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Trading View (next 2-4 weeks): We like to be slightly bearish ethereum.
Investment View (next 1-3 years): We like to hold ethereum.
- Federal Reserve (Fed) speakers have generally been hawkish.
- Markets have added 50bp to the December 2023 FFR but continue to price a 25bp cut between July and December 2023.
- The probability of a recession rises to 90% again on deepening 2s10s yield curve inversion.
- We have one bullish signal, two bearish, and three neutral.
- With the macro backdrop still on the bearish side and our on-chain/flow metrics neutral, our overall signal is slightly bearish ethereum (Chart 1).
Macro: Crypto Regulation Is a Priority for the US
Crypto regulation is a priority for US regulatory bodies this year. Last month, the SEC charged Genesis and Gemini for the unregistered offer and sale of crypto asset securities through the Gemini Earn lending programme. Nexo agreed to pay $45mn in penalties for a similar charge. And the New York Department of Financial Services (NYDFS) ordered Paxos, a stablecoin issuer, to cease minting Paxos-issued BUSD due to ‘unresolved issues with oversight of its relationship with Binance’. Additionally, the SEC reportedly intends to sue Paxos for violating investor protection laws.
Most recently, the SEC acted against centralised exchange Kraken. Kraken will cease to operate its staking programme in the US and fork out a $30mn settlement with the SEC. The move has been controversial, with the SEC’s Hester Peirce publicly describing the enforcement as ‘paternalistic and lazy’. But how have markets reacted?
Crypto Is Unwelcome in the US
Crypto markets responded poorly to the SEC’s crackdown on Kraken with many tokens, including Ethereum, experiencing their worst daily performance of the year (Chart 2).
So far, the major SEC enforcement on staking has targeted staking/lending-as-a-service programs. But where does this leave proof-of-stake (PoS) tokens like Ethereum in terms of securities classification in the eyes of the SEC? According to Coinbase CEO Brian Armstrong, there are rumours that the SEC would like to ‘get rid of crypto staking in the US for retail customers’. Should that be true, Ethereum would essentially lose out on the participation of US retail investors in staking. That probably would not harm its ability to function as a PoS blockchain but would certainly hamper wider network adoption.
Currently, the messaging from the US feels like crypto is unwelcome, and that is being reflected in prices. In our latest Bitcoin flow metrics update, we introduced the regional MoM price change metric as a way to determine the relative bearishness or bullishness of the US, EU, and Asia. The metric shows us the 30-day change in the regional price set during US, EU, and Asia working hours. The US has seen the largest MoM price increases through 2023 so far, until the SEC enforcement on Kraken last week (Chart 3). The MoM price change for Ethereum in the US has fallen off a cliff in response to the news, compared with the more gradual drop across Asia and the EU.
Is the SEC Crackdown on Staking Good for Decentralisation?
Are there potential benefits to the SEC cracking down on large, centralised organisations like Kraken that offer a staking-as-a-service program? Kraken holds around 7% of the total Ethereum staked, and Coinbase holds 11% – for a total of 18%. Ignoring other centralised entities that offer staking-as-a-service programs, this is already a significant percentage.
Decentralised staking services like Lido (LDO), which currently dominates around 24% of the total Ethereum staked, may benefit from the SEC crackdowns. Lido is a DeFi protocol that enables users to pool their money to stake on Ethereum, lowering the barrier to participate (you need at least 32 ETH to become an independent validator on Ethereum). The LDO/ETH cross briefly spiked after the news and has been in a broader uptrend since the start of the year (Chart 3). Furthermore, Lido is up 9% WoW compared with -7% for Ethereum. Lastly, despite Ethereum prices falling on the SEC news, the number of new deposits (32 ETH) to the Ethereum staking contract continues to rise (Chart 4).
Macro Backdrop: Hawkish Fed Speakers
Over the past week, Federal Reserve (Fed) speakers were generally hawkish. Chair Powell indicated that the terminal federal funds rate (FFR) may have to rise if growth and inflation remain strong. Markets followed, adding 50bps to the December 2023 FFR, but continue to price a 25bp cut between July and December 2023.
Data last week showed initial jobless claims rose to 196,000 (+7% WoW) – the first increase in 6 weeks. A rise in unemployment is considered positive for risk assets like crypto as it paths the way for potential dovishness from the Federal Reserve. But crypto correlations to the S&P 500 and the NASDAQ are low relative to recent history (see our latest crypto index tracker). For now, it seems like regulatory concerns are trumping macroeconomic developments.
US inflation data will be the focus today – the overall CPI rose 0.5% MoM in January, meeting expectations. YoY, the measure slowed slightly to 6.4%, from 6.5% in December, less than expectations of 6.2% and reflecting persistent price pressures. Outside that, there is another series of Fed speakers this week too.
On-Chain/Flow Metrics: ETF Outflows Resume
We have one bullish signal this week:
- P&L: the supply is in a state of unrealised profit (NUPL > 0) and realised profits on chain (SOPR > 1) dominate.
We have two bearish signals:
- Institutional demand: ETF outflows resume.
- DeFi: total value locked in DeFi is down for ethereum.
The remaining three signals are neutral:
- Liquidity demand: outflows briefly return, though small in magnitude.
- Futures activity: open interest is down but perpetual funding rates remain positive.
- HODLer behaviour: there is some increased movement in older coins in response to the sell off over the past week, but over 61% of the coin supply has not moved in at least a year.
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
ETF inflows resumed in January, but the trend was short lived as outflows have returned since the start of February (Chart 5). We use ETF flows as a measure of institutional demand, so this is a bearish signal for ethereum.
Demand for Liquidity and Exchange Activity: Neutral Ethereum
On exchange flows:
- Short term, a bias exists for inflows to exchanges. Net 573,253 coins exited exchanges over the past two weeks (Chart 6).
- Longer term, the 30-day change in the exchange balance reveals fluctuations in the supply held on exchanges month on month. This metric remains has flipped back to negative territory after spending the second half of January positive (Chart 7).
Outflows from exchanges is generally considered bullish, but we would like to see them sustained over a longer period to reconfirm a bullish signal from this metric. For now, it is neutral ethereum.
Futures Activity: Neutral Ethereum
On futures markets:
- Futures open interest, a good proxy for investor interest, is currently around $4.8bn – down 4% MoM (Chart 8).
- Perpetual funding rates remain positive, though they been positive (traders paying a premium to keep open long positions) on average (across all exchanges we track) throughout 2023 so far, though they have resumed a downtrend recently since December 2022 (Chart 9).
Together, this is neutral ethereum.
HODLers: Neutral Ethereum
On HODLer metrics:
- The 30-day moving average of the coin days destroyed (CDD) metric is up 32% MoM (Chart 10), suggesting a sharp rise in the movement of older coins recently.
- 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 shows no signs of abating yet. Indeed, 61% of the coin supply has not moved in at least a year (Chart 11).
The spike in movement of older coins recently has corresponded with the SECs staking crackdown on centralised crypto exchange Kraken, which has agreed to end its staking programme in the US and fork out a $30mn fine. Prices fell on the news, and some movement of older coins is to be expected around such events. On the other hand,
a significant portion of the supply continues to hold. Together, we view these HODLer metrics as neutral for ethereum.
Investor Profit and Loss: Bullish Ethereum
On profitability of the coin supply:
- The percentage of circulating supply in profit (PSIP) is 61% (-11bps MoM, Chart 12).
- Net unrealised profit/loss (NUPL) is now 0.08 (8% of market cap) (Chart 13). This means that the overall ethereum supply remains in a state of unrealised profit (NUPL > 0) as market cap exceeds realised cap. The ratio has come down slightly from our last report (11%).
- Spent output profit ratio (SOPR, price sold/price paid) maintains a bias for levels above one (realised profits, Chart 14). Year to date, 79% of days have seen realised profits.
The profitability of the coin supply is has dipped as a result of news of the SECs crackdown last week, but it remains in a state of unrealised profit (NUPL > 0) and realised profits (SOPR > 1) return. Overall, this is bullish ethereum.
DeFi: Bearish Ethereum
The total value locked (TVL) in DeFi across all protocols has been in an uptrend for most of this year, but it has started to decrease as broader crypto markets took a hit last week. Of the top five DeFi protocols by TVL, Ethereum and Binance Smart Chain are down the most (+4% each WoW, Charts 15 and 16). Arbitrum is the only one of the top five chains to have registered an increase in TVL over the past week (+8%).
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.
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.
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.
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.
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.
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.)
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