Golden Cross and On-Chain Metrics Signal Opportunity

Key Takeaways

• Ratios for BTC and ETH demonstrate a return to normal leverage levels.
  
• The current valuation of the Bitcoin network as a multiple of miner revenue is rebounding and is set for further expansion.
  
• Bitcoin supply continues to be constrained by long-term holders accumulating, while the Lightning Network further drives supply crunch. Ethereum supply trending higher again on the back of decreased NFT activity.
  
• Soft economic data will prolong the Fed’s dovish policies long enough for a risk-on rally to take place into the fall, benefitting risk-on assets such as Bitcoin and Ethereum in the short term.
  
• Bitcoin price reestablishes itself above the 200-day SMA and underwent a “Golden Cross” on Tuesday as the 50-day SMA moved above the 200-day SMA.
  
• The Bottom Line: The combination of fundamental metrics presented on-chain, bullish technical indicators, and soft macro picture allows us to reiterate our view of a bullish run through the remainder of the year. We are buyers of BTC and ETH into any near-term selling.
  

Leverage Revisited

Last week, the market encountered volatility for the first time in several weeks, as $1 billion of Bitcoin longs and $855 million of Ethereum longs were liquidated. This was part of an overall leverage washout totaling $3.7 billion across all cryptoassets. We highlighted the fact that much of the stress on the market was the result of rapidly increasing leverage over Labor Day weekend, particularly in the altcoin market. Below, we assess the aftermath and look at how much leverage remains in the market a full week after the forced liquidations.

First, let’s look at the Bitcoin Leverage Ratio, which is the total amount of open interest across all derivatives platforms divided by the total Bitcoin supply held on centralized exchanges. This gives us a sense of leverage relative to “tradeable” BTC located on centralized exchanges. We can see last week’s rapid uptick in leverage from .13 to .15 followed by a wipeout back down to .12. Leverage has returned, but we currently hover around .13, which is the YTD average and well below the YTD high of .175.

Examining Ethereum leverage in the same manner, we can see that the leverage increase was much steeper and consequently the deleveraging was more drastic, as the leverage ratio increased to .195 into Labor Day weekend, followed by a ride down to 0.15. This behavior is consistent with our thesis that the altcoins were more overheated than BTC. We can see that leverage has returned slightly but sits around the YTD average of .16.​

A good barometer of how much leverage is in the system is the futures perpetual funding rate, the rate set by exchanges that one party pays another party to take the other side of a perpetual futures contract. When the rates are positive, longs are paying shorts (and vice versa). When these rates increase rapidly, we consider this a sign of overheating. As demonstrated in the chart below, ETH funding rates started to rise last Thursday morning at a rate inconsistent with the preceding month, followed by a clear reset. As demonstrated by the smaller green bars, rates have returned to positive territory but remain relatively tame compared to last week.

We can see below that the perp rates for BTC present the same general pattern.

Taking A Different Shape

It has been a while since we have looked at where Bitcoin stands from a fundamental valuation perspective. If you recall from prior analyses, we can assess the Bitcoin network’s value compared to the amount of cumulative USD revenue received by miners as a proxy for the total cost to secure the network. In other words, we can determine the price-to-book multiple of Bitcoin.

Based on the chart below, we can observe:

1. The network currently trades at a P/B multiple of 26x.
   
2. Bitcoin’s current bull cycle is notably different from the previous two, but more closely resembles the “double top” experienced in the 2013 bull run. Times are much different, but it is worth noting that there is precedent from a multiple pattern perspective.
   
3. The P/B multiple high for this current bull market was 46x, considerably lower than the 62x achieved in 2017, and the low from the most recent pullback was approximately 19x, still above the all-time average.

We believe that based on recent consolidation and increased realized cap, the current multiple may be viewed as a “raised floor” for this bull run and should expand considerably should we benefit from macro tailwinds into the fall.

Bitcoin Supply Crunch Continues, Ethereum Experiencing Supply Headwinds

Supply continues to be a major price catalyst for both BTC and ETH. To start, we’d like to provide an update around exchange supply – or the number of bitcoins held on centralized exchanges that are available to purchase. In line with the recent trend, coins continue to flow off exchanges at an increasing rate as highlighted by the chart below.

In previous weeks we’ve highlighted the accumulation of bitcoins by long-term whales contributing to decreasing supply and positive price action. Generally, prior to the beginning or continuation of a bull run whales accumulate more bitcoins while selling into the strength of speculative price runups. This week we’d like to introduce a new metric for gauging the behavior of long-term holders: Liveliness. Liveliness is defined as the ratio between Coin Days destroyed and the sum of total Coin Days ever created. For every day that a specific bitcoin is not spent a new Coin Day is created. Conversely, if a bitcoin has been held in a wallet for a year and then sold, 365 Coin Days are destroyed. Given this dynamic, we expect Liveliness to increase when long-term holders liquidate positions and decrease when they accumulate.

As you can see in the chart below, since the May sell-off Bitcoin Liveliness has trended lower – mirroring the same trend observed in the second half of 2020 before Bitcoin’s price increased from $10k to 60k.

The third observation we’d like to share regarding Bitcoin’s supply is the increasing relevance of the Lightning Network – a layer 2 scaling solution for Bitcoin that enables instant low-cost transactions. Lightning has become a critical component of El Salvador’s Bitcoin and payments infrastructure since the country made Bitcoin legal tender on September 7th. In fact, McDonald’s, Starbucks, and others have already implemented Lightning in their El Salvador-based stores to accept payment. Most noteworthy, the Lightning Network is not only for transferring bitcoins. App wallets such as Strike leverage Lightning and the Bitcoin network to transfer fiat currencies at a very low cost as well.

With these technical capabilities in mind, we expect Lightning to positively impact Bitcoin’s price. Since Lightning’s launch earlier this year, the number of bitcoins locked in the network has increased from about 1,100 to 2,500. Like coins removed from exchanges, bitcoins locked in Lightning decrease the supply available for purchase. While 2,500 coins won’t be drastically impacting Bitcoin’s price, we expect Lightning to continue to grow, as well as the bitcoins held in it.

When it comes to Ethereum’s supply in the post-EIP-1559 world we view NFTs as a key influencing factor given the high transaction fees necessary for minting and trading them. As a refresher, under EIP-1559 transaction fees paid in ETH are burned out of circulation – decreasing the asset’s total circulating supply. In times of high network activity, more transaction fees are paid thus more ETH is burned.

Last week, we highlighted that the recent NFT craze and corresponding high network activity resulted in Ethereum’s first deflationary day when total ETH burned exceeded total ETH created via mining rewards. Additionally, Ethereum had three more deflationary days last week following our note.

But since then, the pace of NFT sales has slowed – demonstrated by the chart below of volume on the biggest NFT platforms. OpenSea, the largest contributor of volume, can be thought of as the “eBay” of NFTs so its activity paints a clear picture of secondary market volume.

Taken together we can observe that as NFT volume picked up in late August, Ethereum’s token issuance decreased to the point of deflation. Additionally, as NFT volume has decreased to mid-August lows, Ethereum has returned to inflationary levels. If NFT volumes continue to decrease on Ethereum Mainnet we can expect a greater circulating supply of Ether which could act as a near-term headwind for price. While we are still bullish and generally view the Ethereum supply dynamics as incredibly favorable, we will continue to closely monitor Ethereum’s inflation rate and token supply.

Macro Update

U.S. Treasury yields fell across the board on Tuesday, as “cooling inflation” points toward the Federal Reserve taking a more relaxed approach heading into the end of the year. Data shows that consumer prices rose at their slowest pace in two quarters for the month ending August 31st, suggesting that inflation may have achieved a local peak. If this is the case, it might eliminate the Fed’s urgency in making their next rate increase. Most recently, Federal Reserve officials projected two rate hikes occurring in 2023 with fed fund rates reaching 2.5% in the long term.

The core measure of U.S. consumer prices edged up 0.3% in August, according to the U.S. government, the smallest gain since February 2021. We note that these figures could see elevated volatility towards year-end as shortages of basic materials and bottlenecks have been plaguing supply chains since the start of the pandemic.

November seems to be a more feasible time for the Fed to announce a timetable for the tapering process. In the exhibit below, we can see that dealer positions were lower following the 2014 taper. Since the 2014 tapering, demand for Treasuries domestically and from abroad has remained strong. A modest rise in yields could transpire, assuming the US dollar remains relatively stable.

As interest rates remain low in some jurisdictions around the world, with some countries experiencing negative rates, Treasuries in the United States have become more attractive. According to the International Monetary Fund, an estimated $25T of global savings seek to be invested. A portion of the estimated savings goes into Treasuries. Despite a decline of ownership from investors abroad, foreign investors continue to drive demand for U.S. Treasuries.

On Tuesday, the U.S. dollar climbed to a two-week high against other major currencies, boosted by expectations that the Fed could reduce their asset purchase program by the end of the year. If the Fed buys fewer debt assets, this means there will be fewer dollars in circulation. Conversations about tapering have strengthened the dollar. As demonstrated in the exhibit below, long dollar positions are at their highest level since March 2020.

(Tapering tends to lift the U.S. dollar since it tightens monetary policy.)

So far in 2021, the consumer price index (“CPI”) and the personal consumption expenditures measure (“PCE”) have been running hot at 8.4% and 5.6%, respectively (on a 7-month percentage change). Both measures are well above their 12-month percentage changes (See exhibit below). Wholesale prices have experienced an increase to levels not seen since the 1970s. The near-term inflation outlook continues to move further from market expectations, creating a grim outlook for the long term. The Fed’s economic projections for the PCRE stand at 2.1% for 2022 and 2.2% for 2023. In the June 16th FOMC meeting, no member of the committee expected PCE inflation rate higher than 3.9% for the remainder of 2021 and until after 2023, despite it running at 5.6% so far in 2021. Needless to say, there may be a disconnect between the committee’s expectations and what data is showing.

Average hourly earnings (“AHE”) have increased at a pace of 4.9% to 5.1% in 2021, up from circa 3% before the COVID-19 pandemic. August jobs came in at 235,000 net hiring compared to the projected 750,000. Additionally, the increase in home prices makes it quite unlikely that inflation will drop as quickly as the Federal Reserve and consensus economists expect. In the last 12 months through June, home prices rose the most in history, at a staggering rate of 18.5%, based on the S&P Home Price Indexes, see exhibit below.

Inflation remains well above the Federal Reserve’s target, see exhibit below.

Given that inflation is well above the Fed’s expected levels, the market consensus generally expects that the Fed will ease the gas pedal off its dovish policy and initiate tapering of asset purchasing in November. This could create some turbulence for equity markets. Tapering timing is crucial as the Federal Reserve risks derailing the jobs market recovery if it increases interest rates before the country returns to full employment yet waiting too long could lead to an uptick in inflation.

Ultimately, it is our view that the recent soft economic data will prolong the Fed’s dovish policies long enough for a risk-on rally to take place into the fall, benefitting risk-on assets such as Bitcoin and Ethereum in the short term.

Technical Indicators

We would be remiss if we did not note the bullish trading patterns exhibited by Bitcoin following the leverage washout last week. We are once again watching BTC rally above the 200-day moving average, a key trading level that our own Tom Lee notes as an important bullish indicator.

What is new this week is that the 50-day moving average crossed the 200-day moving average on Tuesday, signaling a “Golden Cross” pattern. As a point of reference, following the last three golden cross events, subsequent price rallies were 600%, -2%, and 132%.

The Bottom Line

The combination of fundamental metrics presented on-chain, bullish technical indicators, and soft macro picture allows us to confirm our view of a bullish run through the remainder of the year. We are buyers of BTC and ETH into any near-term selling.