Trading View (next 2-4 weeks): We like to be marginally bearish bitcoin.
Investment View (next 1-3 years): We like to be long bitcoin.
- Central bank hawkishness is growing. A 75bp hike is expected at the September FOMC meeting, while the ECB is likely to hike by at least 50bp next week.
- The recent generic risk-off move has seen correlation rise again between bitcoin and US equities.
- The probability of recession within the next year is now at 75%.
- Overall, the macro backdrop remains bearish.
- Our metrics have slipped back towards neutral. Currently, only one measure is bullish, and one is neutral/bullish. Meanwhile, one is bearish, and the rest are neutral.
- With the macro backdrop still bearish and our on-chain/flow signals neutral to bullish, our overall view has pared back to slightly bearish bitcoin (Chart 1).
Correlations With Major Assets Are Changing
Bitcoin gapped below $20,000 again this week, 20% off its mid-August high, and just 12% off its mid-June lows. This correlates largely with the recent decline in other risk assets. The tech-heavy NASDAQ is down 4% over the past five days, with the S&P 500 close behind at -3.5%.
The generic risk-asset rout is largely central bank driven. Friday saw Chair Jerome Powell reaffirm the Fed’s hawkish stance at Jackson Hole, a move that came alongside a new bout of ECB hawkishness. Yet perhaps surprisingly for the traditionally volatile asset, BTC held the line around $20,000 and even gained slightly into Wednesday – prompting some to call a bottom to the beleaguered coin.
Our view remains that the Fed will need to hike considerably beyond market expectations (175bp by year-end). We also see a strong upside risk for ECB hikes. These two aspects together should sustain the risk-off momentum in the near term. For bitcoin, meanwhile, if the price drops further below current levels, we could see it reaching $16,000, or even $8,250.
On-Chain/Flow: Metrics Improving
We have introduced a framework for understanding the flow and microstructure dynamics of bitcoin markets. The six key metrics are:
- Institutional demand: ETF flows flat. Neutral bitcoin.
- Liquidity demand: short- and long-term bias for outflows. Bullish bitcoin.
- Futures activity: futures open interesting flat and low while funding rates remain positive. Neutral/Bullish bitcoin.
- HODLer behaviour: the 1y+ vintage remains close to its highs of 66%. Neutral bitcoin.
- P&L of investors: profitability of the coin has slipped back and realised losses on chain are slightly greater than profits. Bearish bitcoin.
- Mining activity: the hash rate has recovered while miner revenues have slid back. Neutral bitcoin.
On balance, on-chain/flow metrics are giving a neutral to bullish 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. We have seen flat flows over the past week (Chart 2). This is neutral bitcoin.
Demand for Liquidity and Exchange Activity: Bullish Bitcoin
On exchange flows:
- Short term, a bias exists for outflows from exchanges (Chart 3). 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 remains in negative territory (Chart 4). This is bullish bitcoin.
Futures Activity: Neutral/Bullish Bitcoin
Futures open interest has been roughly flat recently and remains historically low – it is currently $10bn (Chart 5). Moreover, the trend is slowing – it is up 3.4% through August. Around $8.3bn (76%) of this comes from perpetual futures contracts. This is neutral/bullish bitcoin.
Perpetual funding rates reveal the directional bias of investors. Funding rates remain positive, albeit low (Chart 6). This is neutral/bullish bitcoin.
HODLers: Neutral Bitcoin
The 30-day moving average of the coin days destroyed (CDD) metric is continuing its plunge (Chart 7). Meanwhile, the 1y+ vintage of the coin supply continues to dominate around 66% of the coin supply (Chart 8). This is close to the 2022 highs set on 31 May.
We view these HODLer metrics as neutral for bitcoin.
Investor Profit and Loss: Bearish Bitcoin
On profitability of the coin supply:
- The percentage of circulating supply in profit (PSIP) has collapsed to 50% (Chart 9). This is flat on the lows of July.
- Net unrealised profit/loss (NUPL) is now -0.08 after a short-lived period of positivity (Chart 10).
- The spent output profit ratio (SOPR) remains below one, albeit only just (Chart 11). That means there has been less realised losses on-chain than recently, and far fewer than the dearth in July.
Overall, profitability of the coin supply remains historically low, and has deteriorated following recent gains. This is bearish for bitcoin.
Mining Activity: Neutral Bitcoin
The hash rate has recovered recently after previously moving sideways (Chart 12). Meanwhile, miner revenues have slid back (Chart 13). Together we class this as neutral for bitcoin.
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.
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 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.
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.
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.
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.