Searching for the bottom
Overview
Long-term Outlook - Sentiment: Bullish - Investors with strong conviction in the Bitcoin Network continue to move more of their coins into the illiquid supply, adding to the probability of a future supply shock. The number of wallet addresses that hold BTC has increased despite tough economic conditions in the macro-environment, a sign that Bitcoin adoption is growing. Confidence amongst long-term holders (LTH) is still strong with more than 30% of the total supply of BTC being held for more than a year in LTH wallets according to the Realized Cap HODL Waves metric, HODLing is still favored amongst smart money players and LTHs.
Mid-term Outlook - Sentiment: Neutral - Month-to-month market structure feels bearish even with outflows from exchanges changing from net positive back to net negative; an encouraging signal that demand could be returning in the mid-term. Spent outputs indicate that long and short-term holders continue to experience losses at levels similar to previous bear markets, confirming the sentiment. MVRV Z-Score, a reliable indicator for timing market tops and bottoms is indicating that the market is near the bottom. The last time MVRV Z-Score was in this range was more than two years ago near the beginning of the COVID Pandemic.
Short-term Outlook - Sentiment: Bearish - News of increased inflation, interest rate hikes, and the geopolitical situation continues to hold down traditional and crypto markets. This is unfortunate considering that the market had seemingly priced in most of this risk months ago. While spot markets sagged, derivatives markets reacted by flushing out nearly $5B in open interest last week as leverage continues to grow along with risky crypto-margined positions. More short-term volatility is expected.
Long-term Outlook - Sentiment: Bullish
Long time horizons favour strength
This publication uses two approaches to form its short, mid, and long-term outlooks. The first approach is based solely on on-chain data; the Bitcoin Network is objectively evaluated using a number of indicators to explore the fundamentals of the network. Key Performance Indicators(KPIs) such as user retention and growth, supply and demand dynamics, miner hash rates, and exchange balances are just a few of the hundreds of data points that are explored and vetted using on-chain data. The second approach is formed through a philosophical belief that digital assets will continue to grow in value for the foreseeable future and that Bitcoin is the market leader in the realm of cryptocurrencies. Until there is a paradigmatic shift in the cryptocurrency market, BTC will continue to be the frontrunner in the world’s cryptocurrency markets and maintain a bullish long-term outlook.
BTC Supply Shock grows with more illiquid coins
In any market, price is derived from the interplay between supply and demand dynamics–expressed on various time horizons. This is particularly true for Bitcoin. On-chain analysis, therefore, places careful consideration on a concept coined “Supply Shock.” Supply shock is a phenomenon arising from increased demand in an asset countered by a dwindling or restricted supply. The question for Bitcoin is that if more and more coins purchased today are being held for future bull markets, should investors should expect price appreciation in the long run? Yes, if demand remains stable and more so if it increases.
Supply Shock = unavailable supply / available supply
The key to understanding the importance of a supply shock is that the available and unavailable supply carry intent. When data is combined and compared from all the illiquid and liquid sources, data can show which investors are selling, and which investors have little or no intention of selling. This is highly informative and can provide a leading indicator as to whether there may be a change in BTC supply with a possible long-term effect on price.
The chart above confirms our assumption that the illiquid supply of BTC is still growing. Despite the short change in behaviour last month, net accumulation is still positive amongst some investors and more Bitcoin is being put into “cold” storage. There is a visible surge in coins becoming more illiquid over the last week as investors move to scoop up the relatively cheap BTC. As altcoins and other crypto-related projects experience drawdowns of over 90%, investors may turn back to Bitcoin as a haven while the market searches for the bottom.
2022 BTC Bear Market: Addresses continue to grow through uncertainty
The current global market sentiment is overwhelmingly bearish. Recent black swan events in other cryptocurrency projects have crushed some stablecoins–along with many investors’ 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 new investors have purchased BTC since the “COVID Crash” in March 2020. This year has seen increased growth with more than two million new addresses created in the first five months of 2022. This bullish datapoint is visible below in the Number of Addresses with a Non-Zero Balance and marks considerable growth during a period of historic uncertainty and a challenging global environment.
The Long HODL: 30% of supply is 1-2 years old
Realized Cap HODL Waves is a metric that tracks the age of circulating supply of BTC by cohort. It provides a combined view of BTC’s circulating supply from the perspective of age and economic value. This provides insight into the relative economic weight stored by coins of various holding times, and changes arising from holding and spending behaviour.
Understanding Realized Cap HODL Waves - From Glassnode Academy
“Realized Cap HODL Waves provide unique insight relative to the HODL waves in that it:
Combines coin age and economic weight into a single metric and accounts for changes in market valuation over time.
Minimizes the importance of very old or lost coins last moved at very cheap prices, thus providing a viewpoint that focuses on active, and economically meaningful supply.
Provides a more dynamic/responsive perspective for looking at coin distribution, whereas the original HODL Waves tend to present a slower/smoother chart.”
Despite the uncertainty in markets throughout 2022, it is clear that a large portion of the BTC Network is holding BTC for the long term. Based on the chart above, over 35% of the circulating supply is being held for more than a year and growing. This indicates conviction in the investor base–and an expectation for higher prices for the token in the future.
Mid-term Outlook - Sentiment: Neutral
For most of 2022, a steady outflow from exchanges has been the overwhelming theme with outflows reaching levels of nearly 100,000 BTC on some days. This BTC is purchased and then stored in self-custody BTC wallets. A net negative change in the number of BTC held by an exchange is generally a bullish indication of higher demand, while the opposite is true when coins find their way back to the exchanges for sale. Considering the high level of uncertainty and bearish sentiment in the markets, it is encouraging to see BTC once again flowing out of exchanges.
Outflows from exchanges resume
When coins flow from investor wallets back onto exchanges there can be a surge in selling pressure that can drive prices down. Fewer coins at exchanges can produce the opposite effect on the price, as long as there is healthy demand in the market. This last week, outflows resumed as the price of BTC moved lower and investors moved in to scoop up the lower-priced coins.
This reduction marks a change in the short trend that appeared last month triggered by the LUNA collapse that sent over 80,000 BTC to “protect” the UST stablecoin. Hopefully, this new demand will develop into a trend that will continue throughout the cycle and spark a more bullish sentiment for the protocol in the short and mid-term.
Long and Short-term holders are taking losses
The Spent Output Profit Ratio (SOPR) metric is useful to understand the overall market sentiment regarding profits and losses in the medium-term timeframe. These are the key points to consider when using this metric.
When SOPR is greater than one (>1), coins are transacting at a profit.
When SOPR is less than one (<1), coins are transacting at a loss.
“SOPR reset” (SOPR=1) can signal the start or end of a mid-term cycle.
aSOPR is a more advanced metric that filters transactions to remove any “in-house” activity. aSOPR is an effort to provide a better market signal compared to its raw-data counterpart.
aSOPR/SOPR can be further segmented by LTH/STH cohorts.
For all of 2022, aSOPR has been stuck in a neutral or sideways trading pattern since November of last year. This metric is especially useful for analysing market sentiment, as it is fairly easy to read. Currently, aSOPR is clearly struggling to remain below or above the value of one for any significant period of time. This choppiness can be attributed to lower interest and the overall intensity of trading in the market. Looking at past markets, the range of values in the current cycle is clearly compressed into a tighter range. This last week, aSOPR dipped to its lowest value since July 2021 – a clear indication of a bearish sentiment still present in markets.
Timing the Bitcoin market’s bottom
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).
Last week, MVRV Z-Score has made a significant downward move into 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. As expected, MVRV Z-Score has moved below the value of zero, the first time it has broken into the negative range in over two years.
MVRV Z-Score: In the green
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. The possibility that investors will take advantage of the relatively low prices remains tentative, as demand has been slow all year. However, should the macro sentiment change and demand returns–a relief rally or full-blown recovery could form in the short and mid-term.
Short-term Outlook - Sentiment: Bearish
Rising inflation, interest rates and fear
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.
Futures Open Interest loses $4B in value
Using on-chain data, investors can look into derivatives markets to see how frothy, or overheated the BTC market is becoming. When the Bitcoin market gets hot, prices can fluctuate wildly in the short term. Last month in early May, the price of BTC dropped from $39,000 to $28,000 in just seven days–with over $2B lost in open interest over the same amount of time. The drop in price was largely due to the LUNA/Terra fiasco that flooded the market with over 80,000 BTC deployed from the LUNA Guard Foundation–an non-profit group tasked with defending the now-defunct UST Stablecoin. That sell-off, combined with recent news of increasing rate hikes and higher inflation has triggered more fear in markets. The price of BTC reacted by dropping to below $22,000 on some exchanges as coins from long and short-term holders showed up for redemption throughout May.
Leverage continues to pile up at exchanges
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
Over the past two months, ELR has continued to drive higher into new ATHs indicating that investors are over-leveraged. The last time ELR went above 0.22, in April of 2021, the price of BTC plummeted from $63,000 to $29,000 in just three months. A year later ELR is again on the rise, in a market that has already seen the price of BTC move from $47,000 in April of 2022, to $20,000 in mid-June. Considering that the macroenvironment has not seen any meaningful changes in sentiment, further price weakness is likely and expected.
More downside risk is possible as investors use crypto to fund investments
Along with knowing the amounts at stake in the futures markets, it is also important to inspect the funding quality provided to back those contracts. Futures contracts can be paid for with cash or other cryptocurrencies. However, futures contracts funded with crypto are riskier since downward price movement affects the contracts and the underlying assets used to pay for those contracts.
Before April 2022, futures open interest financed with crypto assets was generally on the decline. Since then, the structure within crypto-backed positions has changed and the trend has reversed. Looking more closely, there have been a number of instances where sharp increases in crypto-margined open interest have coincided with negative price action. This assumption has held in recent weeks, as the price of BTC has dropped precipitously from over $40,000 to around $20,000 as crypto-margined positions rose from 35% to just below 50% during the same period. If the trend continues, investors should expect more downside risk in the short term as the market continues to develop and more investors use crypto to bolster their positions during this bearish cycle.
Conclusion
Bitcoin has weathered many challenges in the past ten years of its’ relatively short life. The protocol that began as an unregulated shadow cryptocurrency has emerged as a case study for concepts such as decentralization and blockchain technology. This movement is being driven by a cohort of investors in the global market that is determined to create their own currency and financial system that is not affiliated with any single government or policy.
Slow but steady demand
Demand for Bitcoin has slowed in 2022, and despite the large sell-offs that the network has experienced over the past months, coins continue to flow out of exchanges into illiquid supply. As more and more BTC is moved into cold storage, the potential for a supply shock remains highly probable. In the past weeks, more than 30% of Bitcoin’s circulating supply has matured into the 1-2 year HODL wave bands, signifying strong conviction amongst the long-term holder class of investors.
Searching for the bottom
MVRV Z-Score, a market cycle top/bottom indicator has dropped into negative values–an indication that BTC is undervalued and that the market is nearing the bottom of the current cycle. Some investors may see this as a buying signal, as MVRV Z-Score has only found these levels four times in the history of the Bitcoin Protocol. Each time, prices have rebounded following these indications, taking anywhere from 20 days to 300 days before the market responded with a meaningful recovery.
Crypto-margined positions on the rise
BTC Futures markets took a hit last week when the price of BTC dropped to around $20,000 and flushed out up to $5B in futures open interest. Investors continue to use crypto to fund their futures contracts. On-chain data shows that close to 50% of all open interest is being backed with crypto. This adds additional risk as price volatility can quickly unravel positions and move exchanges to liquidate investors involuntarily. When investors over-leverage and use crypto to back their positions, short-term volatility should be expected.
The continued impact of a negative macro environment
Over the past few months, the correlation between equities and Bitcoin has been strong, with the major events that plagued risk on growth equities spilling over into Bitcoin and other digital assets. A significant looming risk in the interim thus remains to be the negative macro backdrop. The expectations of a more aggressive timeline on policy tightening and rate hikes by the Federal Reserve continue to negatively impact risk assets in general, with the tech-heavy Nasdaq 100 down nearly 30% YTD. Bitcoin and other crypto projects are facing other challenges that are unique to crypto. Recent hacks, the LUNA collapse, stablecoin issues, and impending regulation have created a great deal of uncertainty in the cryptocurrency market.
There are various other potential negative macro factors such as a tense geopolitical environment with Russia, or uncertainty around the impact of COVID-19 on countries and economies. A significant drop in equity markets is expected to pull BTC down with it in the process - despite relatively strong on-chain fundamentals. Whereas we would expect BTC to recover relatively quickly in such a scenario, it still could lead to heavy losses in the short term.
Whereas our on-chain long-term indicators indicate a more bullish outlook, the mid-term and short-term perspective is much more mixed and is dependent on other, non-fundamental, factors - in particular the negative macro environment.
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