Trading View (next 2-4 weeks): We like to be bearish ethereum.
Investment View (next 1-3 years): We like to hold ethereum.
- Markets digest hawkish Fed minutes from the June meeting.
- The probability of a recession exceeds 60% on inversion of the US 2s10s.
- The macro backdrop is bearish for ethereum.
- We have two bullish signals, two bearish, and three neutral this week.
- With the macro backdrop bearish and on-chain/flow metrics neutral, our overall signal is bearish-neutral ethereum (Chart 1).
Hash Rates and Miner Revenues Are Falling
Ethereum continues to struggle to maintain any persistent rally above $1,000, and it has been underperforming bitcoin through most of the selloff. Alongside investors, miners are feeling the crunch. As prices drop, they are re-evaluating whether it is still profitable to operate their expensive mining rigs. And soaring energy prices exacerbate this effect as the margins for mining profitability tighten. Hash rates and miner revenues have come down significantly since the start of June, though they are relatively flat over the past week.
The Hash Rate Is Down 13% Since June 2022
When prices fall too low and profitability becomes harder to achieve, miners switch off their rigs. This results in a falling hash rate, which is a bearish sign for ethereum. Indeed, the 30-day moving average of the hash rate is down 13% since the start of June (Chart 2).
The hash rate and price usually move in tandem. However, the initial selloff saw the two diverge: hash rates continued to rise as prices sold off. This was a constructive sign as it showed there was still plenty of miner activity and interest in securing the network and generating miner revenues. The trend has been reset, however, and they are again moving in line with price action. This suggests miners are disconnecting.
Another factor is the upcoming ethereum merge. Delays are common in its schedule. But according to the ethereum website, it is now due in Q3/Q4 this year. The merge will see ethereum ditch proof-of-work for a less energy intensive alternative: proof-of-stake. This will remove the need for miners, so hash rates are falling partly due to that.
Miner Revenue Is Down 10% Since June Began
Miner revenues also provide colour to the narrative that miners are taking a big hit during the selloff.
Miner revenues have two parts:
- Newly minted coins: each time a miner solves for a new block on the ethereum blockchain, they get newly minted coins in reward.
- Fees: miners receive a fee for facilitating transactions on the ethereum blockchain.
Total miner revenue is the sum of the two. The 30-day moving average of that value is down 10% since the start of June (Chart 3).
Additionally, the proportion of the total revenue that comes from transaction fees is down to just 23%. This is a bearish sign for ethereum as it suggests less activity on the blockchain. A drop in the number of active addresses over the same period substantiates this. We explored the similar fate of bitcoin network activity last week.
It is becoming harder for miners to profit from their operations due to rising energy costs, reduced profitability, and lower fee revenue as a result of decreased network usage.
The macro backdrop for crypto remains bearish on rate hikes and inflation fears. Markets have been digesting the hawkish Fed minutes released last week from the June meeting. Several other macro factors related to the ongoing crypto credit crunch have been affecting crypto lately, including:
- Crypto exchange Blockchain.com faces a $270mn loss due to lending to the bankrupt crypto hedge fund Three Arrows Capital (3AC).
- Crypto brokerage Voyager Digital files for bankruptcy protection. This is also linked to loans to 3AC.
Ethereum and other cryptocurrencies remain highly correlated to tech stocks and are sensitive to news around rate hikes/inflation and broader risk sentiment. June CPI data comes out tomorrow, which will drive price action. Also, the Fed meets again at the end of this month – expect more rate hikes.
On-Chain/Flow Metrics: ETF Outflows
We have two bearish signals this week:
- ETF outflows.
- Reduced profitability of the coin supply.
We have two bullish signals this week:
- Bias for exchange outflows.
- Futures open interest and funding rates are trending up.
The remaining signals are neutral:
- HODLer vintages are not changing materially yet.
- Hash rates and miner revenues have been falling but are currently flat.
- TVL in DeFi for ethereum is flat.
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
Our preferred metric to track institutional demand is flows into ethereum ETFs. Outflows are still dominating (Chart 4), which we view as bearish for ethereum.
Demand for Liquidity and Exchange Activity: Bullish Ethereum
Coins are exiting exchanges again. Net 524,000 and 252,000 coins exited exchanges over the past seven and 14 days, respectively (Chart 5). One of the main reasons for this is a large spike in net flows on 7 July, which saw net 556,000 coins leave exchanges on that day alone. 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 is positive, indicating the exchange balance is still currently higher relative to the last 30 days (Chart 6). However, it is falling due to the recent outflows.
Together, we view these metrics as bullish for ethereum.
Futures Activity: Bullish Ethereum
Futures open interest is trending up – it is currently around $4.6bn, up 8% over the past seven days (Chart 7). Around $3.7bn (80%) of this comes from perpetual futures contracts.
Perpetual funding rates reveal the directional bias of investors. On average, they have been increasing since 1 July and are back in positive territory (Chart 8).
Overall, futures open interest is still historically low, but it is increasing, and funding rates are positive: this is bullish ethereum.
HODLers: Neutral Ethereum
The 30-day moving average of the coin days destroyed (CDD) is trending up (Chart 9). This suggests more distribution of older coins. Splitting HODLers into those who have held for under one year and those for one year or more confirms this as the 1y+ vintage is decreasing (Chart 10).
On balance, we view these HODLer metrics as neutral ethereum.
Investor Profit and Loss: Bearish Ethereum
On profitability of the coin supply:
- The percentage of circulating supply in profit (PSIP) is 50% (Chart 11). This means only half the circulating supply of coins have a current price that is more than the price at which they last moved.
- Net unrealised profit/loss (NUPL) is -0.27 (27% of market cap) (Chart 12). This means that the overall ethereum supply remains at an unrealised loss as realised cap exceeds market cap.
- Realised losses dominate on chain. Spent output profit ratio (SOPR) (price sold divided by price paid) remains mostly below one (net losses) (Chart 13). However, it briefly exceeded one on 7 June. Looking at the past 30 days, 28 have seen net losses. Further back, all but three of the last 60 days have seen net losses too.
Overall, these realised and unrealised profit and loss metrics are bearish for ethereum.
Mining Activity: Neutral Ethereum
The hash rate has been declining sharply but is currently flat over the past seven days (Chart 14). Miner revenues have also plummeted since June, though they are up 10% over the past seven days (Chart 15). Overall, hash rate and miner revenues are still historically low, despite flatter moves over the past week. For now, we view these metrics as neutral for ethereum.
DeFi: Neutral Ethereum
Our latest Crypto Index Tracker revealed our DeFi Index was leading gains as crypto markets rallied last week. The total value locked (TVL) in DeFi across all protocols is currently around $75bn – up 2% over the past seven days. All chains in the top five by TVL are up in terms of their TVL on the week (Charts 16 and 17). However, ethereum TVL is up just 1%, whereas Tron is up 17%.
That ethereum TVL has increased is a good sign, but concerns around the crypto credit crunch persist as lenders such as Celsius still prevent withdrawals. Overall, we view this as neutral for ethereum.
We have introduced a framework for understanding the flow and microstructure dynamics of ethereum markets. The seven key metrics are:
- Institutional demand: ETF outflows dominate. Bearish ethereum.
- Liquidity demand: bias for exchange outflows. Bullish ethereum.
- Futures activity: futures open interest and perpetual funding rates are rising. Bullish ethereum.
- HODLer behaviour: longer-term HODLer vintage decreases slightly. Neutral ethereum.
- P&L of investors: decreased profitability of the coin supply, a state of net unrealised losses, and a bias for realised losses on-chain. Bearish ethereum.
- Mining activity: hash rate and miner revenues are flat. Neutral ethereum.
- DeFi activity: TVL of ethereum is up 1% on the week, but concerns around the DeFi sector remain. Neutral ethereum.
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 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.