Introducing Our New Flow Framework for Ethereum: Still Bullish
- By Bilal Hafeez and Dalvir Mandara
- 7 min read
Last week, we introduced a framework to understand the flow and microstructure dynamics of Bitcoin markets. This week we introduce a framework for Ethereum (ETH). We identify seven key metrics ranging from institutional demand to HODLer behaviour to DeFi activity. We find that all are giving a bullish signal for ETH – more so than our metrics for Bitcoin. We therefore continue to favour ETH over Bitcoin. Here are the metrics in more detail.
Institutional Demand
Ethereum (ETH) is the second-largest cryptocurrency by market cap after Bitcoin, so it is no surprise institutional investors want to gain exposure to it. Perhaps the most straightforward vehicle for this is trusts – the largest being the Grayscale Ethereum Trust. This solely invests in ETH and currently has over $10bn in assets.
One gauge of institutional demand is whether the Grayscale Ethereum Trust is trading at a premium or discount to ETH prices. A premium suggests institutional investors are willing to get ETH exposure at a price higher than ETH prices, while a discount suggests the opposite.
At the start of the year, the trust was trading at a premium, implying significant excess demand. However, it has since traded at a discount, implying less interest. 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: it has reduced since the mid-August low of -13% (Chart 1). This may suggest increasing demand from institutional investors.
Another source confirms this. The CryptoCompares Digital Asset Management Review for September found institutional investors withdrawing from Bitcoin into Ethereum, with the Grayscale Ethereum Trust the most-traded digital asset product in September. It had average daily volumes higher than their flagship Bitcoin Trust for the first time.
Demand for Liquidity and Exchange Activity
Another measure of cryptocurrency bullishness is whether investors are willing to hold it in illiquid form (e.g., a private wallet) or prefer to hold it in 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. During the large ETH selloff in May, flows onto exchanges spiked (Chart 2). This indicated more bearishness. However, since then, with some inflow spikes in late August and September, there has been a noticeable bias for outflows from exchanges. This suggests investors have become more bullish.
Futures Activity
We can track the growing market of ETH futures. In particular, open interest – the sum of long and short contracts – provides a good measure of investor interest. At the beginning of September, the total open interest in ETH on crypto exchanges reached an all-time high of $11.7bn (Chart 3). Open interest then fell on news of China crackdowns on crypto activity. However, October has seen open interest resume an uptrend (Chart 3). The picture on the CME has been even more positive, with open interest rising since the launch of the ETH contract in February. It registered all-time highs toward the end of September (Chart 4). Together, these suggest strong support for Ethereum.
HODLers
In our Bitcoin flow framework, we explained ‘HODLer’ or ‘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 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. Medium-term HODLers have become the largest single share of all HODLers with 30% of Ethereum in existence (Chart 5). Meanwhile, short-term HODLers’ share is declining, and long-term HODLers’ share has moved sideways. We interpret the fact that as recent converts moved to medium-term HODLers, they are more likely to hold as bullish for ETH.
Profit and Loss Landscape
An attractive feature of public blockchains and crypto markets is that we can track each transaction more easily. One measure of transactions is spent outputs – that is, some computing output is spent to enable a transaction. The spent output can tell us when a transaction has occurred, by whom and at what price. This allows us to track the profit and loss (P&L) of investors. We can then use this data to calculate three P&L-related measures:
- The percent supply in profit (PSIP). This tracks the share of circulating ETH supply in profit. That is the percentage of circulating ETH coins whose current price is higher than when it was last transacted (movement). This measure reached a low of 83% in late September, but the recent ETH rally has seen it rebound to 97% of the current supply now being in profit (Chart 6). This is bullish ETH.
- 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 very large.
More recently, the NUPL has followed the PSIP by rebounding from September to October. The NUPL went from 0.58 to approximately 0.66 (Chart 7). This means unrealised profits are equal to 66% of the current market cap. That is bullish ETH.
- 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.
As we would expect given the broad uptrend in ETH, SOPR has spent most of the time above one. It fell below one in late September but has now rebounded to 1.04 as ETH has rallied (Chart 8). This means investors who are selling are realizing profits again. Typically, buying ETH as SOPR moves around one has proven to be a profitable strategy. So the current SOPR is giving a bullish signal.
Together, these ratios paint a picture of profitability for ETH, providing a bullish backdrop for ETH.
Mining Activity
Computing power is central to the crypto market. Miners use advanced computing hardware to solve complex problems that confirm ETH (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.
Tracking the hash rate for ETH, we find that it bottomed in late July following the China crackdown and has risen ever since (Chart 9). This means more computing power is available to maintain the network, deliver more security (resistance to attacks), and facilitate more transactions. On balance, this suggests more confidence in ETH and more willingness by miners to invest in computing power to run the network. This is bullish ETH.
DeFi
A benefit of ETH over Bitcoin is its role in decentralised finance (DeFi). DeFi offers payments, lending and other financial products using coins such as ETH as the underlying protocol. The more DeFi products are created, the more ETH gets locked into the DeFi system and removed from the broader ETH market. This reduction in ETH supply should lead to higher ETH prices.
We can track the total value locked (TVL) in DeFi and what share comes from ETH. he TVL surpassed $200bn for the first time ever this month. While the share of this coming from ETH has fallen as more protocols enter the space, it is still by far the most dominant player, with 70% market share (Chart 10).
Bottom Line
We have introduced a framework for understanding the flow and microstructure dynamics of ETH markets. The seven key metrics are:
- Institutional demand: growing evidence of institutional flows. Bullish ETH.
- Liquidity demand: less flows onto exchanges. Bullish ETH.
- Futures activity: open interest increasing. Bullish ETH.
- HODLer behaviour: recent converts transition to HODLers. Bullish ETH.
- P&L of investors: realised and unrealised profits increasing. Bullish ETH.
- Mining activity: hash rate increasing. Bullish ETH.
- DeFi activity: more ETH directed to DeFi. Bullish ETH.
All metrics indicate a bullish picture for ETH. Moreover, we find they are more positive than the metrics we track for Bitcoin. So we continue to believe ETH will outperform.
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.