The gyrations in global risk markets, such as equities, clearly impact crypto markets like bitcoin. But crypto markets have their own fundamentals too, whether flow dynamics, regulatory actions or new technology advances. The flow dynamics in particular can significantly impact bitcoin. We therefore like to track a range of flow metrics. Here are four important measures and what they are telling us.
(1) Institutional Demand
Bitcoin entered the mainstream in 2020, with traditional institutional investors finally allocating to it. The year also saw new funds and ETFs emerge as vehicles for these investors to get exposure.
Perhaps the largest 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. At the start of the year, it traded at a large premium, suggesting significant institutional interest. But since March, it has flipped to a discount that has continued to today (Chart 1). This suggests less support for bitcoin.
Another way to gauge institutional interest is examining flows into bitcoin ETFs like the German Xetra-traded BTCetc Physical Bitcoin fund or the Canada-traded Purpose Bitcoin fund. Aggregating the flows into these funds, we saw very large inflows at the start of the year, then large outflows in May and more moderate inflows recently (Chart 2). This suggests some moderate interest from institutions.
Together, the two measures clearly show the wave of institutional interest in bitcoin has receded significantly, so the bitcoin support from this channel is muted.
(2) Exchange Activity
One measure of bullishness in bitcoin is whether investors are willing to hold it in illiquid form, whether with a custodian or a private wallet. Bullish crypto investors would be comfortable holding it in illiquid form. However, if they turn bearish, they would prefer to hold it in liquid form, which most likely would mean holding it on an exchange. This would allow them to sell more easily.
We track net flows of coins to the major exchanges. We find that in May, around the large bitcoin sell-off, there were large flows onto exchanges. This suggests investors wanted to switch from holding bitcoin in an illiquid form to a liquid one. Since then, the flows have been more balanced, with a bias for outflows (Chart 3). Some of this may be due to regulatory crackdowns on exchanges. But generally, it suggests more comfort and so bullishness from crypto investors.
(3) Futures Activity
Bitcoin futures are becoming a larger part of the crypto market. Therefore, tracking futures activity can help gauge sentiment. Tracking open interest – the sum of long and short contracts – across the major bitcoin exchanges reveals that open interest has been falling over the past month (Chart 4). This suggests waning sentiment in bitcoin. Bitcoin futures activity on the CME reveals peak open interest in 2020, weakening ever since (Chart 5). Together, these suggest less support for bitcoin.
Derived from a misspelling of ‘hold’, HODLing refers to buy-and-hold strategies in the context of bitcoin and other cryptocurrencies. Investors who HODL, or HODLers, are the die-hard bitcoin adherents who will hold no matter what.
We can break down HODLers into the length they have held bitcoin. The hardcore HODLers bought bitcoin 10 years ago and still hold it. The more recent HODLers bought it 6-12 months ago and have held it ever since. This recent vintage has become the largest share of HODlers, followed by the hardcore HODLers. The share of vintages in between is declining. So recent converts and the hardcore originals are the dominant players now.
We can monitor their flows by tracking their spent output. This is a measure of selling. Currently, it shows the recent converts (6-12 months) have been steady but not aggressive sellers. Meanwhile, the original converts (10-years plus) have been selling more aggressively. This is a bearish signal as their conviction should be the strongest, so them selling is a negative sign. Admittedly, the other long-term HODLers (7-10 years) have not been selling, so we add a caveat to that view.
Summarising the results, we find the following:
- Mixed to weak institutional demand – negative for bitcoin.
- Improving demand for illiquid bitcoin – positive for bitcoin
- Declining derivatives open interest – negative for bitcoin.
- Oldest HODLers selling – negative for bitcoin.
On balance, the flow dynamics of bitcoin appear negative, warranting caution towards the cryptocurrency.
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.
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.