Macro Hive Metrics Still (Mostly) Bullish Bitcoin

Bitcoin, ethereum, and other large cap coins have continued to register new all-time highs over the past week. Bitcoin rallied to almost $69,000 (Chart 1) and its market cap reached $1.3tn; new all-time highs for both. This put the total crypto market cap at around $2.97tn with bitcoin at a 43.5% dominance. The push to new all-time highs came after CPI data for October revealed inflation is at a 30-year high. Bitcoin has since pulled back but is currently consolidating around the $65,000 mark below the previous all-time high.

Looking at the correlation between bitcoin and other asset classes, we find bitcoin is generally positively correlated with the S&P500, oil and US bond yields and negatively correlated to the dollar (Chart 3). This suggests a reflation environment of rising yields and equities and a weak dollar is most positive for bitcoin. Currently, the picture is more mixed (equities sideways, bond yields up, dollar up), which suggests the macro backdrop is less bullish bitcoin than before.

However, most of our bitcoin-specific metrics are giving bullish signals, notably bitcoin holders are keeping their holdings off exchanges (and so are less likely to sell), mining activity is healthy, investor P&L is robust and long-term HODLers are not entering the market to sell at current highs. Overall, we would maintain a bullish view. Here are the full details:

Institutional Demand: Bearish Bitcoin

Our preferred metric to track institutional demand is flows into bitcoin ETFs (Appendix). Recently, flows reached new all-time highs after the release of the first SEC-approved bitcoin futures ETF in October (Chart 4). However, inflows declined sharply after the debut of the ProShares ETF, and have been muted ever since, despite bitcoin registering new highs. This is bearish bitcoin.

We also track news around bitcoin, where momentum has also been slower. The approval of the first US-regulated bitcoin futures ETF brought focus onto the potential approval of a spot ETF as Grayscale revealed their intentions to convert their flagship bitcoin trust into a spot ETF. In particular, the SEC has until 14 November to approve the VanEck Bitcoin spot ETF. However, optimism remains mixed as SEC Chair Garry Gensler indicated reluctance to expand crypto offerings in unregulated spaces. That said, the success of the futures ETF has prompted more interest in a spot ETF, with BlockFi the latest firm to officially apply for a physically backed bitcoin ETF. Lastly, Twitter is setting up a dedicated crypto team to explore digital assets and decentralised apps. Overall, muted ETF flows and slower momentum in the news are bearish bitcoin.

Demand for Liquidity and Exchange Activity: Bullish Bitcoin

A measure of bitcoin bullishness is whether investors prefer to hold it in illiquid form (e.g., in a private wallet) or liquid form (e.g., on an exchange) (Appendix).

November has seen a noticeable bias for outflows from exchanges, with only two days showing net inflows. There has been a net outflow of 31,232 coins from exchanges month to date, 54% larger than the net outflow of 20,331 coins for all of October (Chart 5). The outflows have pushed the total exchange balance to levels last seen in early 2018 (Charts 6 and 7). Indeed, the percentage of supply held on exchange addresses is currently 12.9%, down 2.3% since the start of October.  

Bitcoin rallying to new all-time highs coupled with continued drainage of liquid supply from the markets are bullish bitcoin.

Futures Activity: Neutral Bitcoin

We track bitcoin futures open interest – the sum of long and short contracts, which provides a good measure of investor interest. Throughout October, open interest maintained an uptrend, surpassing previous all-time highs. But the late October correction saw open interest fall. November has seen open interest resume an uptrend, recovering to maximum value of around $26bn – up 1.4% from October highs (Chart 8). The picture on the CME exchange follows a similar trend, decreasing during the October correction but resuming an uptrend in November. However, it is still down 15% versus October highs (Chart 9).

Yesterday also saw open interest drop amid higher perpetual funding rates and traders opening new (late) longs during the rally to new all-time highs. This caused leveraged long traders to be liquidated as prices corrected from all-time highs, flushing out excess leverage.

Together, these are neutral bitcoin. That open interest remains high is constructive, but it remains low relative to October highs on one of the biggest exchanges (CME). 

HODLers: Bullish Bitcoin

HODLing refers to buy-and-hold strategies in the context of cryptocurrencies. We categorise HODLers by the length of time they have held bitcoin (Appendix). Short-term HODLers (3m-6m) continue to convert to medium-term HODLers (6m-1y) or sell to realise profits at the new highs (Chart 10). Medium-term HODLers still dominate 21% of all bitcoins in existence. We also note an uptick in the proportion of some longer-term HODLers: the 1y-2y vintage is up 10% since the start of October.

One measure of bullishness is the proportion of previously dormant coins re-entering the liquid supply (i.e., being spent). We examine coins that re-entered circulation that previously had been untouched for 1y+ and 5y+, finding the levels are far more subdued in the current bull run versus previous ones (Charts 11 and 12). Over the past week, leading up to the rally to new all-time highs, a daily average of around 6,000 coins at least 1y+ and 370 coins at least 5y+ old re-entered the liquid supply. These numbers are much lower than the number of these coins revived in the run-up to the May all-time highs – investors are holding more during the current rally.

Overall, we view these HODLer dynamics as bullish bitcoin.  

Investor Profit and Loss: Bullish Bitcoin

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: percent supply in profit (PSIP), net unrealised profit and loss (NUPL) and the spent output profit ratio (SOPR) (The Appendix details each).

The share of the supply in profit (PSIP) is currently 98.5%, up approximately 3.8pp month to date (Chart 13). The size of the unrealised profits (NUPL) is currently 64.5% of market cap, up 2.4pp from the start of the month to date (Chart 14). SOPR momentarily dipped below one during the October correction, but realised profits have mostly remained healthy, with an SOPR value above one (Chart 15). SOPR remains muted during the current runup to new all-time highs compared with previous cycles, suggesting investors are still optimistic about further price increases before realising profits. To some extent, a bitcoin rally would naturally lead to these ratios improving, but they nevertheless provide a bullish signal.

Mining Activity: Bullish Bitcoin

We track the hash rate for bitcoin. A higher rate means more computing power is available to maintain the network, deliver more security (resistance to attacks), and facilitate more transactions. We view this as a bullish sign (Appendix). The hash rate has maintained an uptrend throughout October and November and is currently up 24% from the start of October (Chart 16).

We also track miner revenue. Naturally, during a price rally, it is more profitable for miners to mine coins as they receive block rewards in the native coin. Miner revenue is currently up 60% from the start of October (Chart 17).

Together, increasing hash rate and more incentives for miners are bullish bitcoin.  

Bottom Line

We have introduced a framework for understanding the flow and microstructure dynamics of bitcoin markets. The key metrics are:

1. Institutional demand: muted institutional flows and slow momentum in the news. Bearish BTC.
2. Liquidity demand: outflows from exchanges/exchange supply decreasing. Bullish BTC.
3. Futures activity: open interest remains relatively high after the October correction. Neutral BTC.
4. HODLer behaviour: medium-term HODLers dominate and long-term HODLers increase. Bullish BTC.
5. P&L of investors: realised and unrealised profits increasing and SOPR remaining close to one during the rally, presenting a historically good buy opportunity. Bullish BTC.
6. Mining activity: hash rate and miner revenue increasing. Bullish Bitcoin.

On balance, the metrics are bullish bitcoin.  

Appendix

Institutional Demand

Perhaps the largest institutional vehicle for bitcoin is the Grayscale Bitcoin Trust, with over $27bn in assets. It invests solely in bitcoin, and so many investors, notably institutional, who cannot hold bitcoin directly can get exposure through investing in Grayscale. Consequently, if the trust trades at a premium to bitcoin prices, it may imply ‘excess’ demand from institutions, but ‘excess’ supply if it trades at a discount. Alternatively, investors may be using other vehicles to get exposure such as ETFs or holding bitcoin 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, possibly implying more bearishness.

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 long 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. We can break this down further into those who have held bitcoin from the very early days (7-10 years ago and 10+ years ago).

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 very 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 BTC 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 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.

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.