BTC Now: Week #48

The On-Chain BTC Forecast: Week 48

Overview

1. Long-term > 60 days, Sentiment: Bullish - The long-term outlook for Bitcoin is bullish, with leading on-chain indicators signaling strong growth ahead. A supply shock is forming, which should drive price appreciation over the coming months. While the distribution of Bitcoin from some long-term holders (LTH) has been observed, the volume was low. This suggests that experienced investors continue to hold their Bitcoin with the expectation of higher prices later in the cycle. 

2. Mid-term > 14 days < 60, Sentiment: Bullish - On-chain data places us firmly in the middle of this bull market with an expectation of bullish price action over the coming weeks into the new year. 

3. Short-term < 14 days, Sentiment: Bullish with Caution - High open interest (outstanding derivative contracts) with leverage continue to remain a short-term risk. The recent drop in price has however flushed some of the excessive leverage and the weak hands out of the market, building a more sustainable basis for short-term price appreciation. This dip in price was bought by retail investors, which is a healthy bull market behaviour. 

4. BTC Price Expectations:

1. Long - $100,000+

2. Mid - $70,000+

3. Short - $53,000-$70,000

Long-term > 60 days - Sentiment: Bullish $100,000+

The long-term price of Bitcoin is nearly exclusively driven by supply and demand dynamics. The short-term news, events, and sentiment play much less a role. It therefore is particularly important to analyse advanced on-chain data to reach a conclusive answer to where we stand in a market cycle and what kind of price movement is expected in the coming three, six or 12 months. 

A supply shock is forming in the Bitcoin market

A supply shock is an (unexpected) event that changes the supply of a product or commodity, resulting in an unforeseen change in price. Assuming aggregate demand is unchanged, a negative supply shock causes a product's price to spike upward. For our purposes, we define supply shock as the “Illiquid Supply Shock Ratio” (ISS)  with the following formula 

ISS = Illiquid Supply / (Liquid + Highly Liquid Supply)

As the aforementioned metric clearly illustrates, a strong supply shock is forming. The available liquid supply of Bitcoin for new buyers to purchase has reduced by 700,000 + Bitcoins over the last 18 months and reached a four year low in November 2021. In other words, 77% of the total circularating supply of 18.8m Bitcoins is illiquid, a figure that is rapidly growing. With the demand for Bitcoin staying at least unchanged, the continued reduction in supply is expected to lead to price appreciation over the coming two to six months.

Experienced investors start to sell BTC - A mid bull market behaviour 

In this context, tracking the buying and selling behaviors of the long-term holders (experienced investors or the “smart money”) can give us a clearer picture as to what we can expect in regards to pricing when we look past the new year into Q1 of 2022.

The below chart highlights that experienced investors have accumulated coins since the significant fall in price of Bitcoins in Q2 2021, a strong sign that the smart money expects price appreciation. Notably, these long-term holders have recently begun selling some of their holdings. This is a significant change in their behavior and provides insights into what may transpire over the coming months. The distribution by LTHs has almost always coincided with price appreciation of Bitcoin. The notable outlier was the unexpected Covid equity market crash in early 2020.

The typical behaviour is that experienced investors begin to sell into strength in the middle of bull markets, with an expectation that they can load off a part of their holdings into price appreciation. Even though the general supply dynamic appears to be changing, we should note that LTHs sold less than 1% of their positions in recent weeks. This suggests strategic profit-taking rather than liquidating whole positions and outlines the expectation of LTHs for continued price appreciation. That relatively small 1% was quickly bought up by retail investors, a healthy bull market behaviour. 

Mid-term > 14 < 60 days - Sentiment: Bullish $70,000+

The average Bitcoin is sold at a profit - A healthy sign

The Spent Output Profit Ratio (SOPR) metric is useful for understanding the overall market sentiment regarding profits and losses in the mid-term timeframe. There are three key ideas to understand when reading this model. 

1. When SOPR is greater than one (>1), coins are transacting at a profit.

2. When SOPR is less than (<1), coins are transacting at a loss.

3. “SOPR reset” (SOPR=1) can signal the start or end of a mid-term cycle.

SOPR is useful for looking at specific periods, in which it oscillates above and below the value of one. When SOPR hits one, it is referred to as a “SOPR reset”. During the last year, there have been seven key SOPR resets. In bull markets, each reset has corresponded with a bounce in prices and higher profitability. During bear markets, SOPR mainly stays below one with less profitability as coins are spent at a net loss. 

In late September 2020, SOPR reset and then went on a 150-day run that extended well past its next reset on 27 February 2021. Since then in 2021, SOPR resets have corresponded with upward and stable price action in the 30-60 day range. The only exception to this was during the mini bear market between May and August this year. During that time, SOPR was consistently below one, confirming an overall bearish sentiment in the market.

The recent SOPR reset indicates that we should see positive price action over the coming weeks into the new year.

Bitcoin has already seen significant growth in price, is a recession looming?

One way to answer this question is to look at the metric NUPL. Net Unrealized Profit/Loss (NUPL) is the difference between Relative Unrealized Profit and Relative Unrealized Loss. This metric can be calculated by subtracting realised capitalisation from the market capitalisation, and dividing the result by the market capitalisation. 

The metric answers the question, if all Bitcoins in circulation are sold today, what percentage of holders would be in profit. The NUPL is currently in the 0.6 range, which means 60% of the market is in unrealized profit. Comparing this value to previous market cycles, it becomes evident that 0.6 is a mid-bull market reading, which usually was followed by strong price growth that leads to a bull market peak within three to six months. The expectation is that prices will appreciate in the mid-term as they have in 2013, 2017, and last year. Once the NUPL goes above the 0.75 mark, you will need to pay attention as historically the price peaked soon after. 

Short-term < 14 days, Sentiment: Bullish with Caution $53,000-70,000

Weak hands continued to be flushed out of the market

The short-term price volatility of Bitcoin is not really driven by supply and demand dynamics but rather by short-term sentiment, speculation, news and the behaviour of other asset classes including equities. It is common to see 10%, 20%, 30% or even 40% drops in price during a bull market, only to shortly thereafter reach a new ATH. 

This volatility in Bitcoin markets triggers - and is partly driven by - liquidations at exchanges that allow investors to leverage their Bitcoin holdings. Just as the price of Bitcoin reached a new ATH, we saw Bitcoin go down from $69,000 to $62,800 in a matter of hours. 

In the chart above, we can see a pattern of “weak” hands getting flushed out with liquidations. As the price of Bitcoin soars, investors - particularly inexperienced retail investors - use leverage to increase their holdings. Once this happens, even a relatively small spike in price volatility might trigger cascading liquidations driving the price significantly lower within a short period of time. We have seen such liquidations over the course of the last two weeks. 

Whereas our on-chain mid and long-term indicators paint a clearly bullish picture, the short-term outlook is much more mixed and is dependent on other - non fundamental - factors. Having said that, we tend to believe that the recent liquidations have mostly flushed the weak hands out of the market, building a more sustainable basis to stabilize prices here and start its ascend over the course of the coming weeks. 

Conclusion

In recent weeks, Bitcoin has made history with new ATHs and continues to thrive as it becomes more widely accepted and used. From a short-term perspective, indicators paint a bullish outlook but caution is warranted as excessive leverage may create some downside risk. In the mid and long-term, the outlook remains strong and the expectation is for the bull run to continue over the coming two to six months.

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