
Will Dollar Strength Ruin the Bitcoin Rally?
By Bilal Hafeez and Dalvir Mandara
(12 min read)
By Bilal Hafeez and Dalvir Mandara
(12 min read)
Trading View (next 2-4 weeks): We like to be bearish to neutral bitcoin.
Investment View (next 1-3 years): We like to be long bitcoin.
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Trading View (next 2-4 weeks): We like to be bearish to neutral bitcoin.
Investment View (next 1-3 years): We like to be long bitcoin.
Bitcoin has rebounded lately. It is currently up around 11% over the past seven days. A rally in tech stocks in Europe and Asia helped the rise – we know crypto is highly correlated to tech stocks these days (currently, bitcoin’s correlation to the NASDAQ is around 78%). However, if we zoom out slightly, we are quickly reminded that bitcoin is still amid a 67% cumulative drawdown from the November 2021 all-time highs.
One wildcard that could dampen the near-term bullish sentiment is dollar strength. The US Dollar Index (DXY) recently posted its highest levels since 2002 (Chart 2). As the Fed tries to tame inflation with rate hikes, the prospect of higher returns on investments such as US treasury bonds looks increasingly attractive to investors. This increased demand drives up the dollar value. But how does that relate to bitcoin?
One observation is that bitcoin and the dollar seem to move in opposite directions. Currently, the correlation between the two is negative, and it has a strong bias for negative correlation in general (Chart 2).
The macro backdrop is still bearish, and more rate hikes are expected. Should investor appetite for the dollar continue to rise, this could weigh on bitcoin sentiment. So, we will monitor the correlation between the two closely.
Two metrics give a bullish signal this week:
Two metrics give a bearish signal:
Lastly, the remaining two metrics give neutral signals:
On balance, on-chain/flow metrics are giving a neutral signal. Here are the details of each metric (with explanations in the Appendix).
Our preferred metric to track institutional demand is flows into bitcoin ETFs. We have seen inflows return over the past week, though small in magnitude (Chart 3). This is bullish bitcoin.
On exchange flows:
Together, we view this as neutral for bitcoin.
Futures open interest is trending up but remains historically low – it is currently $9.8bn (Chart 6). This is up 20% over the past two weeks. Around $7.4bn (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 7). This is bullish bitcoin.
The 30-day moving average of the coin days destroyed (CDD) metric has plunged (Chart 8). The 1y+ revived supply metric follows suit (Chart 9). The 1y+ vintage of the coin supply continues to dominate around 65% of the coin supply (Chart 10). This vintage has stopped increasing but remains close to 2022 highs of 66% set on 31 May.
We view these HODLer metrics as neutral for bitcoin.
On profitability of the coin supply:
Overall, 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.
The hash rate is still suffering – it is down 20% over the past seven days (Chart 14). Miner revenues have fared similarly and are down 19% (Chart 15). 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:
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.
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.
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