Will the Dollar Crush New Year Crypto Hopes?

Summary

Trading View (next 2-4 weeks): We like to be slightly bearish bitcoin.

Investment View (next 1-3 years): We like to be long bitcoin.

Macro

• We believe market consensus underestimates inflation and the terminal federal funds rate (FFR).
• The probability of a recession within the next 12 months stays over 80%.
• The macro backdrop remains bearish.

On-Chain/Flow Signals

• Two metrics are bearish, two are bullish, and two are neutral.
• The on-chain signal is neutral.

Overall View

• With the macro backdrop still bearish, and our on-chain/flow signals neutral overall, our overall view is slightly bearish (Chart 1).

Macro: Will the US Dollar Dampen Crypto Sentiment in January?

The DXY rose for a good part of 2022 (Chart 2). However, the fourth quarter saw the index pull back as investors mulled the prospects of a Federal Reserve (Fed) pivot. Given the US dollar and bitcoin typically have a negative correlation, any positive momentum for the DXY in January could weigh on crypto sentiment.

This week, we look at January seasonality of the DXY and bitcoin to see if either have historic bullish or bearish biases.

DXY and Bitcoin January Seasonality

From 2000 onwards, the greenback delivered positive returns in January on 14 occasions – that is, 60% of the time (Chart 3). This is a bullish bias. Going further back, from 1980 onward, January saw positive returns 65% of the time. So, if history is anything to go by, January 2023 could be a strong month for the DXY. And if the DXY strengthens significantly, it could put downward pressure on the price of bitcoin.

Although positive DXY performance seems correlated with a drop in bitcoin prices, that does not imply causation. Crypto-specific events often flip the dynamic, such as the FTX implosion – it plunged bitcoin to multi-year lows and reversed its correlation to the DXY to positive. We must remember this when considering the DXY’s potential impact on bitcoin and other cryptocurrencies.

Finally, looking at bitcoin’s January performance in isolation from 2014 onward reveals a bias for negative returns (Chart 4). Again, if history is anything to go by, January could be a red month for bitcoin.

Macro Backdrop: Inflation and Recession Fears

2022 saw unprecedented interest rate hikes from the Federal Reserve (Fed) to try and tame rampant inflation. The final FOMC meeting of 2022 saw the Fed hike 50bp, as we expected. The presser was hawkish with Chair Jerome Powell ruling out an increase in inflation target anytime soon and leaving open the possibility of further increases in the terminal federal funds rate (FFR). Looking forward, we believe the market is under-pricing the terminal and end-2023 FFR.

Moreover, there are ongoing fears that the effects of high inflation and rising interest rates will plunge the world into a recession. Our recession probability indicator remains over 80%. Bitcoin is yet to experience a serious global recession, but we expect one would limit any potential upside in price action. This is because during times of economic uncertainty and weak growth, investors may be more inclined to sell risky assets like bitcoin and seek safer investments such as government bonds.

Therefore, the macro backdrop is still bearish for crypto.

On-Chain/Flow: ETF Outflows Resume

Two metrics give a bearish signal this week:

• Institutional demand: ETF outflows resume.

• P&L of investors: Realised losses and reduced profitability of the coin supply dominate.

Two metrics give a bullish signal this week:

• HODLer behaviour: Around 66% of the coin supply has not moved in at least a year as old coin spending falls significantly after the FTX fallout.

• Mining activity: The hash rate and miner revenues start to rise.

The remaining two metrics gives neutral signals:

• Futures activity: Futures open interest is yet to recover, but funding rates are at the highest levels since the start of 2022.

• Liquidity demand: Exchange outflows have slowed.

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: Bearish Bitcoin

Our preferred metric to track institutional demand is flows into bitcoin ETFs. After a brief spell of (muted) inflows in late 2022, outflows have returned (Chart 5). We have seen outflows from Bitcoin ETFs consistently since 14 December, and they have been growing in magnitude. This is bearish for bitcoin.

Demand for Liquidity and Exchange Activity: Neutral Bitcoin

On exchange flows:

• Short term, the first week of 2023 has seen a slight bias for inflows to exchanges. Net c. 7,616 coins entered exchanges over the past week (Chart 6).

• Longer term, the 30-day change in the exchange balance reveals fluctuations in the supply held on exchanges month on month. This metric is still in negative territory but has increased significantly from the all-time lows set after the FTX debacle (Chart 7).

Together, these metrics suggest exchange outflows have slowed. Outflows (inflows) are usually interpreted as bullish (bearish). However, in the context of the FTX implosion (which caused investors to flee centralised exchanges), a reduction in the magnitude of outflows would be good news for centralised exchanges.

For now, we view these metrics as neutral for bitcoin.

Futures Activity: Neutral Bitcoin

Futures open interest ($6.7bn) is yet to stage a recovery since the FTX fallout – it is currently down 10% MoM (Chart 8). Around $6bn (90%) of this comes from perpetual futures contracts.

Perpetual funding rates reveal the directional bias of investors. Unlike open interest, funding rates have more than recovered since the FTX fallout (Chart 9). On average, funding rates hit lows of c. -0.05% on 9 November but have corrected sharply since. They are currently at the highest levels since the start of 2022.

Open interest is yet to recover, but positive funding rates suggest traders are paying a premium to keep open long positions. Together, we view this as neutral for bitcoin.

HODLers: Bullish Bitcoin

On HODLer metrics:

• The 30-day moving average of the coin days destroyed (CDD) metric has plummeted from the highest level of 2022 (c. 18mn on 23 November 2022) to c. 7.9mn currently (Chart 10).

• The 30-day moving average of the 1y+ revived supply metric followed suit (Chart 11). It is down 36% MoM.

• The 1y+ vintage dominates around 66% of the coin supply now (Chart 12).

Overall, the recent movement of older coins has reduced significantly. During the fallout of the FTX implosion, some older hands clearly redistributed their coins as prices hit multi-year lows.

That activity has dropped significantly now, and a significant proportion (66%) of the coin supply has still not moved in at least a year – remarkable given the chaotic 12 months cryptocurrency investors just navigated.

Overall, we see the strong conviction to hold by most of the coin supply as a bullish signal for bitcoin.

Investor Profit and Loss: Bearish Bitcoin

On profitability of the coin supply:

• The percentage of circulating supply in profit (PSIP) is 52% (Chart 13). This is down 4pp over the past 30 days.

• Net unrealised profit/loss (NUPL) is now -0.15 (15% of market cap) (Chart 14). This has been relatively flat over the past 30 days but means the supply is still in a net loss position (NUPL < 0), with realised cap exceeding market cap.

• The spent output profit ratio (SOPR) has a strong bias for realised losses on chain. Around 80% of 2022 were days of realised losses on chain (SOPR < 1). More recently, it has exceeded 1 (realised profits) on just 3 days since November 2022 (Chart 15).

The profitability of the coin supply plummeted post FTX fallout. And while there has been some recovery with PSIP and NUPL rising, the coin supply is still in a net loss position (NUPL < 0) accompanied by a bias for realised losses on chain (SOPR < 1). This is bearish for bitcoin.

Mining Activity: Bullish Bitcoin

The hash rate has been increasing into the new year. It is currently up 30% WoW (Chart 16). Miner revenues have also started to tick up – they are up 30% WoW (Chart 17).

Appendix

Institutional Demand

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.

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 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.

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 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.

Mining Activity

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.

(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)