Facing down the bear
Overview
Long-term Outlook - Sentiment: Bullish - The fundamentals of the Bitcoin Network remain strong. User growth continues along with investment into BTC mining, both critical to the health of the protocol. Long-term holders (LTH) of the Bitcoin protocol have recently changed behaviour from net accumulation to distribution. Historically, long-term holders have distributed into strong markets. MVRV Z-Score, a reliable metric for timing BTC market tops and bottoms is trending lower, a signal that BTC is becoming more undervalued in the market.
Mid-term Outlook - Sentiment: Bearish - The mid-term outlook remains bearish with fewer than 55% of the BTC Network holding profitable coins. NUPL shows near capitulation levels of profit and loss. More downside risk is possible with coins moving back on to exchanges.
Short-term Outlook - Sentiment: Bearish - $1B in open interest made its way back into derivatives exchanges following long liquidations that saw $2B in value disappear in the early weeks of May. The Estimated Leverage Ratio (ELR) metric spiked with the increase in futures contracts, setting the stage for more short term risk.
Long-term Outlook - Sentiment: Bullish
The BTC Network is here to stay
The current global market sentiment is overwhelmingly bearish. Recent black swan events in other cryptocurrency projects have crushed some stablecoins–along with many investor’s confidence in crypto. The short and mid-term time frames have merged due to the unusually negative macro environment that has extended into a multi-month bearish regime. This publication’s long-term, multi-year perspective still remains bullish on Bitcoin primarily due to steady and increased adoption rates by individuals and organizations; and the continued investment into BTC mining–all evidenced by on-chain data. User adoption continues to grow month-over-month and over 12 million of new investors have purchased BTC since the “COVID Crash” in March 2020. This data is captured in the Number of Addresses with a Non-Zero Balance illustrated below.
The Central African Republic accepts Bitcoin, mining grows
In April of this year, the Central African Republic moved to accept Bitcoin along with its national currency, joining El Salvador, the first country to accept BTC as legal tender in June of 2021. Additionally, BTC mining remains profitable and nearly every country in the world engages in mining BTC. It is clear that even though the price of BTC is relatively low, interest in mining and crypto continues to grow.
The metric above, Mean Hash Rate represents the growing number of miners adding processing power to the BTC network. Hash rates have been increasing steadily over the last two years–with the dip in the chart representing when China outlawed BTC mining last year. Since then, other countries have stepped in to rebuild mining operations investing billions in value to secure the Bitcoin Network. More miners do not mean more BTC mined or created, it only means more competition between miners for the same Bitcoins. Currently, approximately 1000 BTC are issued per day as a reward to miners–and this number will decrease (after the next BTC halving), irrespective of the number of miners. More accurately, high hash rates are bullish for BTC as more miners represent more investment into Bitcoin’s infrastructure and greater network security.
Long-Term Holders begin to distribute
In the past, this publication has explored the behaviours of long-term holders, specifically in regards to whether or not this group is buying or selling BTC. Glassnode (an on-chain data provider) defines LTH as entities holding BTC for greater than 155 days. In general, these investors can be considered more experienced and their decisions often correlate with other smart money players in the Bitcoin market. Long-term holders generally sell BTC into strength and accumulate with the expectation of higher future prices. Below we can see that this behaviour has generally held up throughout the last two years of market activity.
This year, long-term holders have been purchasing more BTC than they have been selling, with February being the exception as some older coins did make it to exchanges. These sales could be seen as more strategic due to the relatively small amounts of BTC that were sold, and the resumption of accumulation for most of April and May of this year. Currently, the coins being sold from long-term holders could be temporary or could be the start of a larger capitulation event that is necessary for market psychology to change back to bullish in the near term.
Testing the fair market value of BTC
On-chain data allows investors to examine the Bitcoin Network from a variety of perspectives that can be used to measure the true value of a Bitcoin. MVRV Z-Score can be defined as the ratio between the difference between BTC’s market and realized capitalisation, and the standard deviation of all historical market cap data, i.e. (market cap – realized cap) / std(market cap). In other words, MVRV Z-Score can be used to reliably mark the tops and bottoms of BTC market cycles. When the market value of BTC is significantly higher than realized value, MVRV Z-Score has indicated a market top (red area below). Conversely, during weak markets, the metric has marked market bottoms (green area below).
This May, MVRV Z-Score has made a significant downward move toward the green zone, signalling the bottom of the current market. The most recent bottom (observed on MVRV Z-Score) occurred in March 2020, during the “COVID Crash” that sent markets downward as investors from all markets rushed to move their assets into safe havens. Overall, MVRV Z-Score has been successful in recording the last four major bear market bottoms. It is expected that over the next weeks, MVRV Z-Score will dip down into the green area on this chart revealing the bottom of the cycle.
BTC: Undervalued periods can last for months
It should be noted that in past markets, MVRV Z-Score has shown BTC being undervalued for a period of 20 days up to nearly 300 days; an average of about 120 days. BTC market recoveries can take time to get momentum, but in March 2020 the market took less than a month to change direction and begin its’ relatively quick climb from $5,000 to over $60,000 later that year. Considering the macroeconomic sentiment is quite bearish across markets, the BTC Network could languish over the next months until market conditions change.
Mid-term Outlook - Sentiment: Bearish
55% of all entities are in profit
As markets move into Q2 2022, it is clear that investors will continue to face tough economic conditions stemming from significant geopolitical conflict, global inflation, supply chain issues, food shortages, and rising interest rates. The mid-term outlook has swung decidedly bearish, with more downside potential possible until some form of relief emerges in markets. Only about 55% of the entities in the market are holding BTC in profit, with the other 45% at a loss. The last time the BTC market was at this much of a loss was just prior to March 2020–and culminated in a large capitulation event that pushed the price of BTC down by 50% in a single day.
More downside in the mid-term
Net Unrealized Profit/Loss (NUPL) is the difference between Relative Unrealized Profit and Relative Unrealized Loss. It differs from Percent Entities in Profit as it examines the unrealized P/L of the coins in the network rather than the entity holding the coins. This metric can be calculated by subtracting realised capitalisation from market capitalisation and dividing the result by market capitalisation. In layman's terms, NUPL answers the question, “if all coins in circulation were sold today, would they be sold at a profit or a loss?” The metric has changed dramatically in recent months and is currently down 50% from its ATH above 70% last spring.
The current market structure, expressed by NUPL above, resembles a similar period during the first part of 2020. At that time, the world was entering a period of uncertainty with the COVID pandemic starting to spread. Markets reacted with large sell-offs and BTC was not immune to the COVID Crash that followed. Profitability during that period was further hit with an additional 30% dip during the already soft period that emerged after a dead cat bounce recovery in February 2020. This pattern emerged again in 2022, albeit at vastly different price scales. The past four BTC bear markets have all been marked with large capitulation events that were evident on NUPL by an additional dip of at least 30% from the local lows. If the current trend continues and more LTH sell, the price of BTC could further weaken as it has in past bear cycles to the high teens or low $20,000s.
Supply moving back to exchanges: bearish
For most of 2022, a steady outflow from exchanges has been the overwhelming theme with some investors withdrawing up to nearly 100,000 BTC per day. This BTC is purchased and then stored in self-custody BTC wallets. This demand has been surprising, considering many investors view Bitcoin as one of the riskiest assets that can be used to store value in any environment. This behaviour, however, has reversed course in recent weeks as investors push coins back onto exchange balances looking for exit liquidity. The increased BTC exchange balances are likely to provide further downside pressure in the short- to mid-term.
Short-term Outlook - Sentiment: Bearish
While uncertainty feels like the primary driving factor in the current market, Bitcoin has remained resilient and has performed well during historically difficult challenges present today. The short-term BTC market sentiment is currently bearish–linked in lockstep with other financial markets. Bitcoin has always been sensitive to equities markets, and until a decoupling between them occurs, the expectation that the price of BTC will move with other markets still holds.
Investors go long after the dip
Using on-chain data, investors can look deeply into derivatives markets to see how frothy, or overheated the BTC market is becoming. When the Bitcoin market gets hot, prices can fluctuate up or down by 10% to 40% in the short term. Earlier this month the price of BTC dropped from $39,000 to $28,000 in just seven days–with nearly $2B lost in open interest over the same amount of time. This last week, investors returned with $1B of open interest flowing back to derivatives exchanges, following the crash that started on May 4th.
Using leverage to fund the recovery
Examining the quality of the funding for any particular asset is an important fundamental for any investment. Futures Estimated Leverage Ratio (ELR) is a metric that can be used to explore how much leverage is used by investors on average at a derivatives exchange. This information measures a trader's sentiment whether they are taking a high or low-risk position. ELR can be interpreted in two ways, by value or by trend.
An increasing trend means more investors are taking increasingly high leverage risk in the derivatives trade. If the value itself is high, then it could signal that the market is over-leveraged and investors should expect volatility.
A decreasing trend in values indicates more investors are taking off leverage risk in the derivatives trade. Low values signal low leverage in the market and less expected volatility
As the price of BTC drops significantly, as it did in the first week of May 2022, long positions can quickly unravel, pushing down prices further. Exchanges involuntarily liquidate positions opened with leverage to mitigate losses after stop losses are hit or margin calls go unanswered. In weak markets, liquidations cause prices to drop further as coins flood the markets at lower and lower prices. Earlier this month, over $2B in open interest was lost when long liquidations were triggered–dropping prices down into the $20,000s for the first time in two years. ELR is back on the rise, 10% higher than it was last year, as investors use leverage to secure their positions. This does present some short-term risk, as falling prices could force more coins onto the market via liquidations.
Conclusion
Fewer coins become illiquid as the bear market continues
The fundamentals of the Bitcoin Network continue to show strength throughout difficult global challenges that are affecting all markets. Long-term holders changed their accumulation behaviour and distributed some of their BTC last week. These sales were visible on the illiquid supply chart shown above–showing coins moving from cold to hot wallet storage.
Revived supply signals capitulation
Past markets have bottomed in pricing during capitulation events that emerged at the end of 2017 and 2019 when investors from all cohorts sold large amounts of their holdings at a loss. This created a flood of relatively inexpensive BTC that held prices down for more than a year. This market is no different.
Week 21 marked a strong sell-off that has long-term holders moving their Bitcoins to exchanges, evidenced by a surge in revived supply. This means some long-term holders are losing convictions in the protocol. Until recently, this sentiment has been balanced out with some LTH investors stepping up and absorbing the additional supply. Unfortunately, the demand has not been enough to support prices in the $30,000 range, if more coins appear on balances of exchanges–investors should expect further downside risk and pricing.
A negative macro-environment, inflation, and war
Fear of inflation and interest rate hikes were considered to have been priced in over the past months. This obviously was not the case as the weakened sentiment has changed from more neutral to clearly bearish.
The geopolitical landscape continues to create black swan events that are difficult to price into markets – creating unclear effects. What is clear is that Bitcoin remains tightly correlated with equities markets and until a decoupling occurs, BTC will be subject to the headwinds and tailwinds of the larger financial markets. With more Fed tightening expected this year, this bear market could extend into the fall months unless changes in monetary policy or unforeseen political actions are taken–considering it is an election year in the USA.
Disclaimer
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