Trading View (next 2-4 weeks): We are neutral-to-bearish bitcoin.
Investment View (next 1-3 years): We like to be long bitcoin.
- We expect the Fed to hike more than the market is currently pricing.
- Bitcoin remains positively correlated to equities and negatively correlated to the US2Y.
- The probability of recession within the next year remained at 70% on a deepening inversion of the 2s10s curve.
- The macro backdrop remains bearish.
- Our metrics remained mixed this week: two bullish signals, two bearish, and two neutral.
- With the macro backdrop still bearish, and our on-chain/flow signals neutral, our overall view is neutral-to-bearish bitcoin (Chart 1).
Are We Due Another Leg Lower in Bitcoin?
Bitcoin peaked at $67,500 in November 2021. It spent the rest of the year falling towards $40,000, found support around there, then briefly rallied towards $50,000 before selling off again. From there, support levels were broken at $40,000 and $30,000 before it found a base around $20,000. For HODLers, it has been a grim ride.
Risk assets more broadly have underperformed over the same period. Since the November peak, the S&P 500 and NASDAQ 100 have fallen 12.4% and 20.8%, respectively. Meanwhile, EM equities have fared worse – they are down 21.6%. As a result, BTC’s correlations with equities have remained high (Table 1).
So, are we due another leg lower in Bitcoin, or is this really a bottom? Like the fall from November, strong price action has followed the leg lower in June. Bitcoin is up 22.6% from this local bottom, 18.0pp of which came in July. However, this bump is 7.6pp smaller than the November leg. Meanwhile, equities have been likewise strong. The S&P500 returned 9.1% through July (the third-strongest July on record for the index) while the NASDAQ 100 climbed a more impressive 12.6% through the month.
However, we think the macro backdrop could get even worse for bitcoin. First, we are bearish on equities. Second, we think the Fed will hike more than currently priced: Dominique sees the Fed hiking by another 175bps this year. Ultimately, she sees the Fed Funds rate reaching 8%. This would push US 2Y yields much higher. Both would be highly detrimental for bitcoin. Should it fall, we could see it reaching $16,000, or even $8,250.
On-Chain/Flow: ETF Inflows Return
Two metrics give a bullish signal this week:
- ETF inflows continued.
- Futures open interest is rising again, and perpetual funding rates are positive.
Two metrics give a bearish signal:
- The coin supply is in a state of increasingly small profits (NUPL~0), while realised losses on chain (SOPR < 1) have dominated the past two months.
- The hash rate and miner revenues are down.
Lastly, the remaining two metrics give neutral signals:
- There is little movement among the HODLers.
- There is a mix of short-term inflow bias to exchanges and longer-term outflow bias.
On balance, on-chain/flow metrics are giving a neutral signal. Here are the details of each metric (with explanations in the Appendix).
Institutional Demand: Bullish Bitcoin
Our preferred metric to track institutional demand is flows into bitcoin ETFs. We have seen inflows continue over the past week (Chart 2). This is bullish bitcoin.
Demand for Liquidity and Exchange Activity: Neutral Bitcoin
On exchange flows:
- Short term, a bias exists for outflows to exchanges. Net 9,000 coins exited exchanges over the past seven days (Chart 3). This is bearish 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.
Together, we view this as neutral for bitcoin.
Futures Activity: Bullish Bitcoin
Futures open interest is trending up but remains historically low – it is currently $10.6bn (Chart 5). This is up 35.2% over July. Around 76% of this comes from perpetual futures contracts.
Perpetual funding rates reveal the directional bias of investors. Funding rates have been rising on average (Chart 6). This is bullish bitcoin.
HODLers: Neutral Bitcoin
The 30-day moving average of the coin days destroyed (CDD) metric has plunged (Chart 7). The 1y+ revived supply metric followed suit (Chart 8). The 1y+ vintage of the coin supply continues to dominate around 66% of the coin supply (Chart 9). This vintage has moved closer to 2022 highs of 66% 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) is 61% (Chart 10). This is up 4pp from our last report but still historically low.
- Net unrealised profit/loss (NUPL) is now +0.09 (Chart 11). The market has switched to marginally in a net profit position.
- The spent output profit ratio (SOPR) remains below one (Chart 12). It has been below one for seven of the last 60 days. This means there have been realised losses on-chain almost every day for the past two months.
Overall, the profitability of the coin supply remains historically low, the coin supply is still in a net loss position, and realised losses on chain continue to dominate. This is bearish for bitcoin.
Mining Activity: Bearish Bitcoin
The hash rate is still suffering – it is down 21.5% from its peak (Chart 13). Meanwhile, miner revenues continue to sit near year lows (Chart 14). Together, these are bearish for bitcoin.
We have introduced a framework for understanding the flow and microstructure dynamics of bitcoin markets. The six key metrics are:
- Institutional demand: ETF inflows continued. Bullish bitcoin.
- Liquidity demand: short-term bias for inflows but longer-term bias for outflows. Neutral bitcoin.
- Futures activity: futures open interest trending up and funding rates positive. Bullish bitcoin.
- HODLer behaviour: the 1y+ vintage remains close to its highs of 65%. Neutral bitcoin.
- P&L of investors: profitability of the coin supply remains low; realised losses on chain dominate. Bearish bitcoin.
- Mining activity: hash rate and miner revenues are low. Bearish 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.