Summary
Trading View (next 2-4 weeks): We like to be slightly bullish ethereum.
Investment View (next 1-3 years): We like to hold ethereum.
Macro Signals
- Inflation is at 40-year highs.
- The Fed raises rates by 50bps, the biggest hike since 2000.
- The ethereum and equity correlation is still over 85%.
- Risks remain around the Russia-Ukraine war.
- Recession probabilities are still elevated.
- The macro backdrop is slightly bearish.
On-Chain/Flow Signals
- A mixed bag this week with four bullish signals, one bearish, and two neutral.
Overall View
- With the macro backdrop slightly bearish and on-chain/flow metrics bullish, our overall signal is slightly bullish ethereum (Chart 1).
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Summary
Trading View (next 2-4 weeks): We like to be slightly bullish ethereum.
Investment View (next 1-3 years): We like to hold ethereum.
Macro Signals
- Inflation is at 40-year highs.
- The Fed raises rates by 50bps, the biggest hike since 2000.
- The ethereum and equity correlation is still over 85%.
- Risks remain around the Russia-Ukraine war.
- Recession probabilities are still elevated.
- The macro backdrop is slightly bearish.
On-Chain/Flow Signals
- A mixed bag this week with four bullish signals, one bearish, and two neutral.
Overall View
- With the macro backdrop slightly bearish and on-chain/flow metrics bullish, our overall signal is slightly bullish ethereum (Chart 1).
Macro: Rate Hikes and Crypto Executive Orders
Crypto has traded like a risky asset all year. Hawkish Fed actions have been one reason for the decline in prices in 2022 as broader risk sentiment – rather than just crypto-specific dynamics – increasingly drive crypto markets.
Yet Wednesday’s Fed policy rate hike of 50bps, the largest jump since 2000, saw equities rally. And given the 85% correlation between equities and crypto, ethereum jumped 4% (Charts 2 and 3). Why, then, did risk markets rally on a seemingly hawkish action (a 50bps hike)?
It comes down to what the Fed signalled it would not do. There was speculation that it could hike 75bps either at this week’s meeting or those later in the year. But Fed Chair Jerome Powell stamped down on that speculation by saying ‘a 75bps hike is not something the committee is actively considering’.
The market deemed these comments dovish, setting the path for the Fed to do 25bp and 50bp hikes for the rest of 2022. This provides more certainty around the Fed’s hiking path, which is bullish for crypto (and equities). We saw a similar effect play out after the March meeting when the Fed initiated its first hiking cycle since 2015.
Lastly, California Governor Gavin Newsom signed a blockchain executive order yesterday aiming to protect investors and encourage responsible innovation. This builds on the crypto executive order President Joe Biden signed in March this year, which echoed the same sentiment. The increasing regulatory clarity provided by such moves is bullish for crypto.
On-Chain/Flow Metrics: ETF Inflows Return
We have four bullish signals this week:
- ETF inflows return.
- Significant bias for exchange outflows persists.
- Hash rate and miner revenues increasing.
- Ethereum’s TVL in DeFi increasing.
There is one bearish signal:
- Reduced profitability of the coin supply.
Lastly, there are two neutral signals:
- Little movement of long-term HODLers.
- Futures open interest is trending down, but perpetual funding rates are positive.
On balance, on-chain/flow metrics are giving a bullish signal for ethereum. Here are the details of each metric (with explanations in the Appendix).
Institutional Demand: Bullish Ethereum
Our preferred metric to track institutional demand is flows into ethereum ETFs. Recently, there has been a bias for inflows, except for a spike in outflows on 29 April. This is bullish ethereum.
Demand for Liquidity and Exchange Activity: Bullish Ethereum
In the short term, there is a huge bias for outflows from exchanges. Net 347,000 and 645,000 coins left exchanges over the last seven and 14 days, respectively (Chart 5). 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. Relative to the last 30 days, this metric is still in negative territory (Chart 6). Lastly, just 17% of the total coin supply remains on exchanges. This is bullish ethereum.
Overall, the continual drainage of coin supply from exchanges is bullish ethereum.
Futures Activity: Neutral Ethereum
Futures open interest is currently $7.6bn, down 8% over the past 14 days (Chart 7). Around $6.1bn (80%) of this comes from perpetual futures contracts.
Perpetual funding rates reveal the directional bias of investors. On average, they have been trending up and are in positive territory (Chart 8).
Overall, futures open interest is in a downtrend, but perpetual funding rates are ticking up. This is neutral ethereum.
HODLers: Neutral Ethereum
The 30-day moving average of the coin days destroyed (CDD) metric shows muted movement of older coins (Chart 9). Splitting HODLers into those who have held for under one year and those for one year or more reveals some older hands have sold as there is a drop in the 1y+ vintage (Chart 10). However, 57% of the coin supply has still not moved in at least one year. On balance, we view these HODLer metrics as neutral ethereum
Investor Profit and Loss: Bearish Ethereum
The percentage of circulating supply in profit (PSIP) is 68% (Chart 11) – down 10pp over the past 14 days. Net unrealised profit/loss (NUPL) is 0.41 (41% of market cap) (Chart 12) – down 7pp over the past week.
SOPR has been in a downtrend since the beginning of April (Chart 13). But there have been some spikes in realised profits recently due to some older coin selling.
Overall, we view these realised and unrealised profit and loss metrics as bearish for ethereum.
Mining Activity: Bullish Ethereum
The hash rate continues its uptrend and sets new all-time highs (Chart 14). It is currently up 5% over the past seven days and 17% year to date. Miner revenues are also trending up – rising 4% over the past seven days (Chart 15). Together, these metrics are bullish ethereum.
DeFi: Bullish Ethereum
DeFi markets have suffered recently. Our latest Crypto Index Tracker revealed our DeFi Index is down 17%. However, the total value locked (TVL) in DeFi across all protocols is currently around $200bn – up 2% over the past seven days.
Of the top five chains in DeFi (by TVL), only ethereum registered an increase in TVL over the past seven days (Charts 16 and 17). Ethereum’s TVL is up 5% on the week.
On balance, we view this as bullish for ethereum.
Bottom Line
We have introduced a framework for understanding the flow and microstructure dynamics of ethereum markets. The seven key metrics are:
- Institutional demand: returned ETF outflows. Bearish ethereum.
- Liquidity demand: a large bias for outflows from exchanges. Bullish ethereum.
- Futures activity: decreasing futures open interest and negative perpetual funding rates. Bearish ethereum.
- HODLer behaviour: longer-term HODLers quietly accumulating. Neutral ethereum.
- P&L of investors: decreased profitability of the coin supply and a bias for realised losses on-chain. Bearish ethereum.
- Mining activity: the hash rate registers new all-time highs, but miner revenues are down significantly. Neutral ethereum.
- DeFi activity: TVL increasing across all top-five chains except Binance, but ethereum’s TVL only increasing 1% week on week. Neutral ethereum.
Appendix
Institutional Demand
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.
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 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.
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 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.
Mining Activity
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.
DeFi
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.