Hawks Start to Circle

Key Takeaways

• The Fed announced an expedited tapering of monetary stimulus and anticipates three rate increases in 2022. We discuss the implications.
  
• Based on recent price action, BTC still behaves more like a high-beta tech stock than an asset designed to offset the effects of inflation.
  
• This week, SOPR broke through to profitable territory. Short-term SOPR is lagging, which signifies that the market may need to shake out a few more “paper hands” before marching onward.
  
• At the time of writing, the total illiquid supply of Bitcoin is at an all-time high. Notably, 76% of the total circulating supply of Bitcoin is now in the hands of illiquid entities (“diamond hands”).
  
• On Monday, Bitcoin reached a significant milestone as 90% of the total Bitcoin supply has now been mined.
  
• Bottom Line – While we continue to monitor Bitcoin’s price action to confirm a breakout to the upside, we maintain a constructive outlook on the leading cryptoasset. Additionally, we still see the potential for Ethereum outperformance and view our altcoin baskets as an opportunity for those venturing further out on the risk curve.

Investors Buy the FOMC News

Last week, we noted that despite recent liquidations, investors should maintain a constructive outlook on Bitcoin and the broader crypto market through year-end and into Q1. The recent sentiment reset combined with a shakeout of speculative investors was a painful but effective medicine to improve the overall market structure.

This afternoon, the Fed announced an expedited tapering of monetary stimulus, increasing its monthly reduction in asset purchases from $15 billion to $30 billion, which will bring stimulus to an end starting in March. While many feared a “taper tantrum” from BTC and other cryptoassets, it was apparent that the hawkish pivot from Fed Chairman Jerome Powell had already been priced in as Bitcoin increased from its daily low to nearly $50k on the release of the Fed’s report. As demonstrated by the chart below, we also saw impressive price action from Ethereum and other major smart contract platforms.

While much of this can be attributed to masterful delivery by Powell and the Fed, we also think this speaks to the idea that a “taper tantrum” is not the straw the breaks crypto’s back.

The Fed also released a revised dot plot demonstrating that the majority of FOMC participants anticipate three rate increases in 2022. We find this interesting since it will likely separate tapering from rate increases, which may allow for easier market digestion. But, this remains to be seen.

Bitcoin is Still a Risk-on Asset

While Bitcoin’s ultimate use case is a decentralized monetary asset that protects consumers’ purchasing power (“digital gold”), Bitcoin is still early in its adoption phase. It, therefore, is still subject to the same risk profile as an early-stage tech company.

While many have debated whether the leading cryptoasset is maturing to the point where it is used as an inflation hedge, it is clear that BTC still behaves more like a high-beta tech stock than gold or any asset designed to reciprocate the effects of inflation. (Obviously, tech stocks protect against inflation but merely because they outpace inflation. A true hedge would increase with CPI and decrease during deflationary periods).

The chart below demonstrates that Bitcoin (orange line) pumped alongside the Nasdaq 100 (green line), a tech-heavy index, following the Fed’s announcement.

Relative Valuation

We have stated that the underlying Bitcoin market structure remains constructive. Still, the question persists – is Wednesday’s price action a sign that we have achieved a local bottom like the one achieved in September?

Below we revisit entity adjusted SOPR (Spent Output Profit Ratio), which measures the profitability of all coins sold. We have been using this metric to understand on-chain profitability and the relative appetites of long-term and short-term holders to sell out of their positions during periods of volatility.

During periods of favorable price action, this metric tends to drift higher as holders maintain their positions with the objective of selling at an increased level of profitability. During times of consolidation or weakness, this metric will often either hit 1 (break-even) and return to negative levels or remain soundly in negative territory, an indication of capitulation among investors who choose to sell at a loss.

This week, we witnessed an encouraging sign as SOPR broke through 1 and currently sits in profitable territory. If the market is to recover, we should see this metric either (1) retest 1 and bounce higher or (2) continue higher and achieve support above 1.

As we discussed last week, we can further dissect SOPR to evaluate the behavior of short-term and long-term holders. Our interest during volatile periods is with short-term holders (STH) as they are the market participants known to trade in and out of positions quickly and often fuel the more speculative run-ups in price (such as last winter/spring).

When sentiment is high and the price is rising, we can observe that STH SOPR repeatedly tests 1 but generally remains above this level, as short-term holders remain active participants on the way up. However, as one would expect, this metric will dip below 1 and find resistance there when we experience weaker price action or diminished market sentiment.

Despite encouraging price action and total SOPR breaching profitable territory (chart above), short-term holders are still exiting positions once they reach break-even, which is a sign that holders who bought at higher prices are merely trying to exit their respective positions instead of holding in anticipation of selling at a more profitable level.

In the week ahead, we should look for this metric to move above 1 and hold that level, a sign that short-term holders are (1) profitable and (2) are anticipating higher prices.

Will the STH selling pressure subside soon? It might not, but the chart below gives us reason to think that most of the “paper hands” have already exited the market.

Unrealized loss reflects the total loss denominated in USD of all BTC in existence whose price at purchase time (cost basis) was higher than the current price. During times of price drawdowns, we can observe unrealized losses increase and are subsequently realized during periodic price bumps during a consolidation period. We can see that unrealized losses generally increase, and the realization of said losses decreases until we observe the marginal seller become exhausted (or no longer exists) and the price starts to march higher.

We could theoretically flip this metric and look towards realized losses to gain the same insight, but we feel that this paints a clearer picture. Given the muted realization of losses on the latest round of price dips, we have reason to believe that we will see limited selling pressure at current levels from the existing crop of BTC holders.

Diamond Hands

Last week we discussed how the recent increase in hash rate corresponds to a market drawdown more like the one we experienced in September instead of the sentiment-driven wipeout in May. Similarly, the composition of wallet addresses currently accumulating coins also reflects a temporary market pullback.

In May and June, we witnessed many coins held by otherwise illiquid entities be moved to other, presumably less long-term focused entities. This was the result of significant capitulation among all BTC holders. This shift in wealth from illiquid to liquid hands proved to be a substantial cause of the extended period of consolidation that we witnessed over the summer months.

Fast forward to today, and we can observe that the total supply of BTC held by illiquid entities has continued to increase. This metric has been on the uptrend since this summer and just reached an all-time high. At the time of writing, 76% of the total circulating supply of Bitcoin is now in the hands of illiquid entities. While this does not necessarily signal an imminent price run-up, it provides a healthier market construction and reduces the relative supply of liquid coins should short-term demand enter the picture.

Bitcoin Milestone

On the topic of Bitcoin’s supply, we would like to point out a significant Bitcoin milestone.

On Monday, Bitcoin surpassed 90% issuance, meaning that only 10% of the 21 million BTC that will ever exist remain to be mined.

While this does not provide much near-term investment guidance, we think that this is a fact worth remembering when allocating capital over the next decade. As Bitcoin presumably climbs its adoption curve, its scarcity will only increase.

Bottom Line

While we continue to monitor Bitcoin to confirm a breakout to the upside, we maintain a constructive outlook on the leading cryptoasset. We continue to expect a rally for the majors, leading layer 1 platforms, and our altcoin baskets through year-end and into Q1.