Is Bitcoin Bottoming Out?

Summary

Trading View (next 2-4 weeks): We like to be neutral bitcoin.

Investment View (next 1-3 years): We like to be long bitcoin.

Macro

• We expect 75bp hikes at the November and December FOMC meetings.
• We do not expect the Fed to pivot as inflation is still high and persistent.
• Recession probabilities remain near 80% on PCE data (+6.2% for September).
• The macro backdrop remains bearish.

On-Chain/Flow Signals

• Two metrics are bullish, two are bearish, and two are neutral.
• The on-chain signal is neutral.

Overall View

• With the macro backdrop still bearish, and our on-chain/flow signals neutral overall, our overall view is bearish-neutral (Chart 1).

Macro: Bitcoin Volatility Is at Yearly Lows

Bitcoin has been trading in a relatively tight range between $18,500 and $21,000 for several weeks now (Chart 1). The consolidation pattern may show bitcoin is bottoming out.

But that is not the only sign. We know bitcoin has a strong bias for negative correlation against the DXY, and the dollar has been under pressure recently. With the DXY retreating and its correlation against bitcoin (-35%) comfortably negative, are we poised for a leg up in the leading cryptocurrency?

This week, we look at how the volatility of bitcoin has fallen significantly and what data from options markets are telling us.

Bitcoin Is Less Volatile Than the NASDAQ

Bitcoin has spent most of the year in a regime defined largely by its correlation to risk assets like the NASDAQ. Aggressive rate hikes from the Federal Reserve (Fed) have weighed on crypto markets as broader risk sentiment has been driving the outlook.

Bitcoin’s relative price stability lately could signal the outlook is changing. Its correlation to the NASDAQ has fallen significantly from highs of close to 80% in April this year to around 40% (Chart 3). Consequently, we have seen divergence between their performances. Bitcoin has outperformed the NASDAQ in September and October. It closed September down 3% compared with 10% for the NASDAQ, and it closed October up 6% compared with 2% for the NASDAQ.

Bitcoin’s (realised) volatility estimated over a 30-day window has plunged from highs of over 60% in annualised terms in September to just 27%. For context, the NASDAQ’s 30-day volatility is currently 31% and has been increasing since September. As per our calculations, the last time bitcoin’s (30-day) volatility was lower than the NASDAQ’s was in 2020.

What Are Options Markets Showing?

A call option gives the holder the right, but not the obligation, to buy the underlying asset (in this case, bitcoin) at a predetermined price (the strike price) at a future date (expiry date). A put option gives the holder the right, but not the obligation, to sell the underlying at a predetermined future date. You could buy a call option if you were bullish on the underlying and a put option if you were bearish.

Options can be of American or European type. American options allow the holder to exercise the option (i.e., trigger the right to buy or sell the underlying) at any date on or before the expiry date. European options can only be exercised on the expiry date. We are using data from the Deribit options exchange, which facilitates European style options only.

A key quantity for options pricing is implied volatility. Implied volatility is the market’s expectation of the volatility of the underlying over the life of the option. So, it is a forward-looking indicator. The key thing to note is that larger implied volatility means higher option prices. We can compare the implied volatility of similar puts and calls (put implied volatility less call implied volatility) to get a measure of the skew between them. A positive skew can indicate a greater demand for puts (as puts are pricier than calls), which would be negative sentiment. A negative skew can indicate a greater demand for calls (as calls are pricier than puts), which would be positive sentiment. And a skew close to zero is a neutral signal.  

The skew of options expiring in one week, one month, three months, and six months have been trending down recently (Chart 2). The one-week skew has hit zero, which means sentiment has flipped from negative to neutral. The skew on the longer tenors remains positive (more demand for puts), but as noted above they are trending down. We can also look at the put/call ratio, which compares the open interest of put options to that of call options. This metric is also broadly in a downtrend (Chart 5), which shows the bias for puts is decreasing.

Data from the bitcoin options markets looks like it starting to show weakening in bearish sentiment.

Macro Backdrop: Inflation Is Still High and Persistent

Friday’s PCE data (+6.2%) for September confirmed inflation is still rampant. Core PCE, which strips out food and energy components, was up 5.1% in annual terms for September compared with 4.9% for August. Our view is that there will be no pivot announcement in November’s FOMC meeting as it would ease financial conditions when inflation is still high and persistent. Instead, the Fed will remain reactive to short-term data developments – chief of which is the latest inflation data. We therefore expect 75bp hikes in November and December. The macro backdrop is still bearish for crypto.

On-Chain/Flow: Hash Rate at New Highs

Two metrics give a bullish signal this week:

• Liquidity demand: Bias for outflows from exchanges.
• Futures activity: Futures open interest is rising, and perpetual funding rates are positive.

Two metrics are giving a bearish signal:

• P&L of investors: realised losses still dominate on chain.
• Mining activity: The hash rate and miner revenues take a hit.

The remaining two metrics give a neutral signal:

• Institutional demand: ETF flows are muted.
• HODLer behaviour: There is a spike in some older coin spending, but the 1y+ vintage remains elevated (66%).

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

Institutional Demand: Neutral Bitcoin

Our preferred metric to track institutional demand is flows into bitcoin ETFs. Most of September saw muted ETF flows, and this trend has continued throughout October as well (Chart 6). Recent inflows have been relatively very small. Overall, we view the subdued ETF flows as neutral for bitcoin.

Demand for Liquidity and Exchange Activity: Bullish Bitcoin

On exchange flows:

• Short term, a bias exists for outflows to exchanges. Net 48,465 coins left exchanges over the past 14 days (Chart 7). This is bullish bitcoin.

• Longer term, the 30-day change in the exchange balance reveals fluctuations in the supply held on exchanges month on month. This metric is currently in deep negative territory at around -111,000 (Chart 8). For context, its all-time low is around -146,000, which was set on 26 June earlier this year. This is bullish bitcoin.

Futures Activity: Bullish Bitcoin

Futures open interest has been picking up – it is currently up 17% MoM at around $10.7bn (Chart 9). Around $9bn (84%) of this comes from perpetual futures contracts.

Perpetual funding rates reveal the directional bias of investors. They are starting to decrease on average but have remained positive for most of October (Chart 10). This is bullish bitcoin.

HODLers: Neutral Bitcoin

The 30-day moving average of the coin days destroyed (CDD) metric has jumped recently (Chart 11). It is currently up 35% MoM. The 1y+ revived supply metric is up 58% over the same period (Chart 12). Together, this suggests a spike in movement of older coins.

That said, the 1y+ vintage continues to grind up slowly – it makes up around 66% of the coin supply now (Chart 13).

Overall, there has been some increased movement of older coins recently, which can be viewed as bearish given the negative macroeconomic backdrop. But a significant majority of the HODLers are still not moving their coins as the slow rise of 1y+ vintage shows no signs of abating yet. Together, we view this as neutral for bitcoin.

Investor Profit and Loss: Bearish Bitcoin

On profitability of the coin supply:

• The percentage of circulating supply in profit (PSIP) is 59% (Chart 14). This is up 5pp over the past 30 days.
• Net unrealised profit/loss (NUPL) is now -0.02 (2% of market cap) (Chart 15). This is up 7pp over the past 30 days. This means the supply sits just about in a net loss position (NUPL < 0), with realised cap still exceeding market cap.
• The spent output profit ratio (SOPR) still has a bias for realised losses on chain. It briefly exceeded 1 (realised profits) on just 4 days throughout October (Chart 16). Zooming out, 75% of this year so far has seen SOPR less than 1 (realised losses).

The profitability of the coin supply is rising, but it still sits in a net loss position (NUPL < 0) accompanied by a bias for realised losses on chain (SOPR < 1). On balance, this is bearish for bitcoin.

Mining Activity: Bearish Bitcoin

The hash rate has been moving mostly sideways with a slight bias for the downside recently (Chart 17). Its currently down 6% MoM (Chart 16). Miner revenues have taken a hit, they are down 15% MoM (Chart 18).

Appendix

Institutional Demand

Perhaps the largest institutional vehicle for bitcoin is the Grayscale Trust, with over $27bn in assets. It invests solely in BTC, and so many investors, notably institutional, who cannot hold BTC directly can get exposure through investing in Grayscale. Consequently, if the trust trades at a premium to BTC 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 BTC, whether through ETFs or directly holding BTC. 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 BTC directly. We put more weight on BTC 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 bitcoin 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 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.

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 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.

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 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 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 BTC (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.

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.)