BTC Now: Week #25
The On-chain BTC Weekly Forecast: Week #25/2022
Long-term Outlook - Sentiment: Bullish - The probability that a BTC supply shock will occur in future market cycles grows as investors move to store more coins in cold storage and self-custody wallets. Addresses with newly-acquired Bitcoin (or a fraction of a BTC) continue its’ two-year trend as the Bitcoin Network grows to over 42 million wallets. On-chain data reveals that 35% of Bitcoin’s circulating supply has matured into the 1-2 year HODL waves, a significant indicator of conviction and the expectation of future price appreciation.
Mid-term Outlook - Sentiment: Neutral - Mid-term market structures remain unclear even as more coins move out of exchanges, a change in behaviour from last month after sharp sell-offs occurred, triggered by negative events in the cryptocurrency industry and the macroenvironment. Spent Outputs reflect a deeply bearish sentiment in the short term, with MVRV Z-Score signalling a potential bottom. MVRV Z-Score has been a reliable bottom indicator marking the last four bear markets.
Short-term Outlook - Sentiment: Neutral - Futures Open Interest has sunk to levels not seen since December 2020, dropping $5B in the last two weeks and over $17B since November 2021. Currently, BTC investors are increasing their use of leverage and crypto to bolster their positions. During bull markets, this behaviour can indicate high levels of conviction and confidence in the market.
Long-term Outlook - Sentiment: Bullish
Long time horizons favour strength
This publication uses two approaches to form its short-, mid-, and long-term outlook for the Bitcoin Protocol. The first approach is based solely on on-chain data; the Bitcoin market 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. 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 will remain the market leader for all cryptocurrencies. This analysis is ongoing and more subjective relying on a solid and pervasive understanding of technology adoption formed through decades of experience as technology investors. This perspective, combined with a macro-financial view of the market provides context and a narrative for the on-chain analysis. Based on these two approaches it is clear that 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.” A supply shock is a phenomenon arising from increased demand for 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 expect price appreciation in the long run? Yes, if demand remains stable and more so if it increases. Current markets validate this sentiment. There is a strong cohort of buyers that continues to buy regardless of market conditions.
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 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 a bottom.
The current cycle is more bullish than in 2018-2019
The above chart shows that the number of illiquid coins in the network is increasing, indicating that the current cycle is less bearish than the most recent major bear market that occurred in 2018-2019. During that time period, more than 500,000 BTC was removed from the illiquid supply with the trend changing back to growth in early 2019. Even as recently as last summer when China banned crypto, illiquid supply was reduced for a month before reversing back into the macro-trend of net positive growth. This is a great example of how the Bitcoin Network is maturing and showing fundamental strength amidst the negative macro backdrop.
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 in general. The short- and mid-term outlooks are similar due to the unusually negative macro environment that has extended into a multi-month bearish regime and the high correlation of BTC and traditional equity markets.
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 three million new addresses created in the first half of 2022, bringing the number of addresses to just below 42.5 million. This considerable growth is quite bullish even while the world struggles during a period of historic uncertainty and a challenging global environment.
The Long HODL: 35% of BTC being held long-term
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.
Glassnode - an on-chain data provider - defines Realised Cap HODL waves as follows: “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 negative sentiment 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 30% of the circulating supply is being held for more than a year and growing. Quite remarkably, any BTC purchased after December 16, 2020, is currently being held at a loss. Even more remarkable is that some of the coins being held today were purchased at the top of the market back in October 2021 at $69,000. This indicates strong conviction of 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 (the equivalent of USD XXX billion) 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.
Bitcoins flow out of exchanges: a hopeful sign
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 is positive, despite weak market conditions and consistently negative news on inflation, aggressive rate hikes, and continued contagion due to the Ukrainian situation.
Throughout 2022, the trend has been for investors to buy and hold BTC in self-custody wallets. The trend changed in May, triggered by the LUNA collapse that sent over 80,000 BTC to unsuccessfully “protect” the UST stablecoin. Billions in value were lost by thousands of investors when the stablecoin lost its’ peg with the US dollar and crashed below a cent. This event occurred on the back of news that the Fed planned on adding 50 basis points to interest rates on the fourth of May drove many crypto investors to exchanges looking for exit liquidity. 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.
Spent Outputs similar to the COVID Crash in March 2020
The Spent Output Profit Ratio (SOPR) metric is useful to understand the overall market sentiment regarding profits and losses of investors 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 has dipped past previous bearish markets. This last week, aSOPR dipped to its lowest value since global markets crashed at the start of the COVID pandemic. Notably, aSOPR in March 2020 was an additional 5% lower than it is now, a sign that the price could slide further in the coming days and weeks before reaching a bottom.
Market Cycles: Bear Market Bottoms
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 of 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 month, MVRV Z-Score has made a significant downward move into the green zone, signalling the potential 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 marking the last four major bear market bottoms. During the current market, 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: Is this the bottom?
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 about a year later 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 or sellers become hesitant to sell–a relief rally or full-blown recovery could form in the short- and mid-term.
Short-term Outlook - Sentiment: Neutral
Strong macro headwinds still present in the market
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 $17B in value over 6 months
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 $20,000 on some exchanges as coins from long- and short-term holders showed up for redemption throughout May.
Short squeeze potential grows in the current market
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.
Funding rates are already negative
Funding rates in April 2021 swung from massively positive to negative in a few days, contributing to a flush out of leverage and $9B in open interest. Liquidations peaked at that time and more than $5B in long BTC positions were forced to sell–pushing prices down more than 50% in just a few weeks. The funding rates across exchanges in the current market are already negative, a sign that investors are expecting more downside and betting their open interest on falling prices. This creates the conditions for a potential short squeeze similar to the one that occurred between July and November 2021.
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.
Bitcoin has weathered many challenges in the past 13 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.
Net positive outflows from exchanges are positive
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 later in the cycles. In the past weeks, more than 35% 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.
BTC: Undervalued in a bear market on average for 120 days
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.
Margin call: Crypto-backed positions add more risk
BTC Futures markets flushed out to more than $17B in open interest over the last six months pushing open interest down to levels not seen since December 2020. 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 would be 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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