Bitcoin (BTC) has jumped 7% over the past week and is fast closing on the all-time high of $64,870. That global equities have started to recover certainly helps: the NASDAQ is up 0.5% over the past week, European stocks 2.5%, and the Hang Seng 3.5%. But bitcoin flow metrics also turned more positive. Notably, the US is now the biggest region for bitcoin mining, overtaking China after its clampdown. We are also seeing the largest flows into bitcoin ETFs since the start of 2021. Here are the details of all our recently introduced metrics:
(1) Institutional Demand: Bullish Bitcoin
We track institutional demand through several channels. One is to monitor whether the largest institutional vehicle for bitcoin, the Grayscale Bitcoin Trust ($27bn in assets), is trading at a premium or discount to the price of bitcoin (Appendix). Currently, the trust is still trading at a discount, suggesting less institutional demand (Chart 1).
However, investors could be preferring to invest in other vehicles like ETFs. Indeed, flows into bitcoin ETFs exhibit the biggest increase since February (Chart 2). This suggests institutional demand has risen noticeably. We put a larger weight on these flows than the Grayscale discount.
With many people asking, ‘should I buy bitcoin now?’, we also like to monitor BTC news and whether evidence exists of bitcoin entering the mainstream. On that front, the news has been positive. Bancorp launched a cryptocurrency custody service for institutional investors, Bank of America published their first research piece on digital assets, and optimism around a potential US-approved bitcoin ETF is growing.
(2) Bitcoin Liquidity Demand: Neutral Bitcoin
A measure of cryptocurrency bullishness is investors willing to hold bitcoin in an illiquid form (e.g., private wallet). Conversely, increased flows onto bitcoin exchanges is a sign of bearishness– it suggests investors want to hold bitcoin in a liquid form.
During the large bitcoin selloff in May, flows onto exchanges spiked (Chart 3), implying bearishness. August saw outflows from exchanges, implying bullishness. More recently, the flows have been balanced. This suggests investors are cautious around the current bitcoin rally, which we would classify as neutral on the market.
(3) Futures Activity: Bullish Bitcoin
We track the growing market of bitcoin futures. Open interest – the sum of long and short contracts – is a good measure of investor interest. Throughout September, the total open interest fell on news of the China crackdown on crypto activity. However, from October, open interest has resumed an uptrend (Chart 4). The picture on the CME exchange is also positive: open interest has shown a notable turnaround from earlier in the year (Chart 5). Together, these suggest strong support for Bitcoin.
(4) HODLer Dynamics: Bullish Bitcoin
‘HODLing’ refers to buy-and-hold strategies in the context of bitcoin and other cryptocurrencies (Appendix). We categorise HODLers by the length of time they have held bitcoin. Medium-term HODLers have seen a continued uptrend, currently possessing 20% of bitcoin in existence and making this vintage the largest single share of all HODLers (Chart 6). Meanwhile, short-term HODLers’ share is declining. We interpret this as recent converts moving to become medium-term HODLers, therefore being more likely to hold. We view this as bullish for bitcoin.
(5) Investor P&L: 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 use this data to track three measures of P&L: percent supply in profit (PSIP), net unrealised profit and loss (NPUL) and the spent output profit ratio (SOPR). The details of each are in the Appendix.
The upshot is that the share of supply in profit (PSIP) and the size of profits (NUPL) have increased. Realised profits are healthy, with the SOPR ratio above one (more profits than losses). To some extent, a rally in bitcoin would naturally lead to these ratios improving, but they nevertheless provide a bullish signal for bitcoin (Charts 7-9).
(6) 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). Conversely, we view a falling hash rate as bearish. The hash rate bottomed in late July following the China crackdown but has resumed an uptrend since (Chart 10). This is bullish bitcoin.
We can also track the geographical distribution of the total hash rate over time using the Cambridge Bitcoin Electricity Consumption Index (CBECI). The index is the result of an extensive effort by the Digital Assets Programme Team at the Cambridge Centre for Alternative Finance. According to the latest numbers, as of August, BTC miners in the US now dominate, with approximately 35.4% of the global hash rate distribution (Chart 11). This likely reflects significant mining activity from the East migrating to the West after the China crackdowns on crypto.
We have introduced a framework for understanding the flow and microstructure dynamics of BTC markets. The key metrics are:
- Institutional demand: growing evidence of institutional interest. Bullish bitcoin.
- Liquidity demand: small inflows and small outflows. Neutral bitcoin.
- Futures activity: open interest increasing. Bullish bitcoin.
- HODLer behaviour: recent converts transition to HODLers. Bullish bitcoin.
- P&L of investors: realised and unrealised profits increasing. Bullish bitcoin.
- Mining activity: hash rate increasing. Bullish bitcoin.
On balance, the metrics are giving a bullish signal for bitcoin.
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, 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. At the start of the year, it traded at a large premium, suggesting significant institutional interest. But since March, with the advent of various BTC ETFs, it has flipped to a discount that has deepened ever since.
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.
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.
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.
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.