Bitcoin Forecast – 17/12/2021

  • Long-term sentiment: Bullish - The long-term outlook for bitcoin is strong, with leading on-chain indicators signalling growth. A supply shock is forming, driving price appreciation over the long term. The smart money continues to hold their bitcoin with the expectation of higher prices later in the cycle. With the Taproot upgrade complete, the bitcoin network has more potential for use and integration through Layer-2 solutions like the Lightning Network.
  • Mid-term sentiment: Bullish - On-chain data places us in the middle of a bull market with an expectation of bullish price action over the coming months. Short-term holders (STH) have been transacting at a loss for the past weeks, while long-term holders (LTH) continue to operate in profit. This suggests that the current selling in the market is being executed by recent speculators, who bought in near the ATH in November. In combination with the fact that distribution from LTH has been slow, this indicates that smart money expects higher prices in the future.
  • Short-term sentiment: Neutral - Derivatives markets lost ~$10bn in Futures Open Interest over the last few weeks, representing a 38% reduction since its peak in November. The drop in price triggered cascading liquidations, further accelerating downward price pressure. With considerable excessive leverage and the “weak” hands washed out of the market, a more sustainable basis for short-term price stability has been created. We expect a consolidation with sideways price action.

Long-term Outlook - Sentiment: Bullish

The long-term price development of bitcoin is nearly exclusively driven by supply-and-demand dynamics. Short-term news, events and sentiment play much less of a role. It is, therefore, 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 and twelve months.

A supply shock is forming in the Bitcoin market

A supply shock is an 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 highly liquid and liquid supply of bitcoin for new buyers has reduced by 700’000+ bitcoin over the last 18 months and nears a four-year low in December 2021. In other words, 77% of the total circulating supply of bitcoin is illiquid and this figure 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 three to six months.

Long-term holders (LTH) start selling BTC - A mid-bull market behaviour

Over the past weeks, we have observed LTH beginning to change their behaviour from net accumulation to net distribution. This change in activity usually happens in the middle of bull markets when price appreciation is expected.

LTHs are defined as wallet addresses that have been holding bitcoin for more than 155 days, or about five months. Glassnode data shows that bitcoin held longer than 155 days has a significantly lower probability of being spent than bitcoin held for less than 155 days. To put things into perspective, five months ago was mid-June and the price of Bitcoin was in the $35,000 range.

Accumulation of bitcoin by LTH started in April 2021 and has remained constant for seven months. Starting in mid-November, we can see that a fairly low number of coins are starting to leave LTH wallets and flow into short-term holder’s (STH) wallets. The above chart shows a clear change of behaviour with momentum shifting into distribution. The LTHs tend to sell into the rising prices of bitcoin, which they appear to expect throughout Q1 and possibly Q2 2022.

Coin Days Destroyed (CDD) metric confirms the mid-bull market signal

It provides perspective to realise that a little more than a year ago, the price of Bitcoin was trading in the $10,000 to $15,000 range. With entities classified as smart money, whales and LTHs, largely consisting of those who began to accumulate BTC more than a year ago, we can track their current behaviour by tracking the Coin Days Destroyed (CDD) metric.

Coin Days Destroyed (CDD) combines the variables of time and value. Time is measured as the number of days between when BTC is purchased by someone and when it is sold. The second variable is value, or the amount of BTC in the transaction. CDD is simply the number of days times the amount of bitcoin in the transaction.

  • Transaction #1: A UTXO (wallet or user) for two BTC stored for 100 days has accumulated 200 coin days.
  • Transaction #2: A UTXO for 0.5 BTC stored for 100 days has accumulated 50 coin days.
  • Transaction #3: A UTXO for 10 BTC stored for six hours (0.25-days) has accumulated 2.5 coin days.
  • Result: If all of these transactions get “spent”, the net result is 252.5 CDD for the 12.5 BTC on that day.

In the chart above, we use a variant of CDD to get a better picture of the macro behaviour of the smart money that is being recorded on-chain. We discard “in-house” transactions and use a 90-day rolling sum so that a clearer signal emerges. After doing so, we can clearly observe a trend of rising CDD into the peaks of bull markets, which falls in line with our current bullish long-term narrative.

As an example, last year we observed a large number of old coins being sold into strength with a direct correlation to price growth. This period extended until the second quarter of 2021. Today, we see a similar trend, however with considerably fewer CDDs. This provides further proof that LTH continue to hold the vast majority of their coins, while starting to distribute first bitcoins back into the market. The expectation is that this behaviour will continue and increase over the coming months as demand grows through Q1 2022.

Mid-term Outlook - Sentiment: Bullish

Mid-term expectations are similar to the long-term ones, as we continue to push through mid-cycle corrections and volatility that is expected in bull markets. Since the mid-term forecast period directly spans through the end of 2021 into 2022, there are additional notes that should be mentioned as we close out 2021.

BTC had an incredible 2021 - Happy New Year

Economic activity around a new year can be volatile, as private companies and investors prepare their books for a new fiscal year or liquidate holdings to lock in profits and pay taxes. While impossible to detail each factor or link with on-chain data, we did see a significant bump in demand and price over last new year. Between 11 December 2020 and 9 January 2021, the price of bitcoin gained over 100% in value going from $18,000 to $40,000 in that time span.

Analysing the profit and loss of bitcoin holders provides a bullish outlook

Zooming out past the next few weeks into the new year, on-chain data continues to provide insights into supply-and-demand dynamics. Dormant coins become revived, as the bull market runs and investors rush to capture short and long-term gains. We can see that there will always be days where corrections happen for a variety of reasons. However, the mid-term outlook looks bullish, with the expectation that heavy demand from more speculative STH will absorb the steadily increasing inflow of coins from LTH, whales and others.

As we track the transfer of coins from LTH to STH, we can visualise when both LTH and STH are entirely in profit. The above chart shows LTH/STH supply in profit and loss, illustrating exactly when and where it happens in regards to the price of BTC.

Last year, in November, we can see times (in the circled areas of the chart) when the entire supply of BTC was in profit. During these times we see LTH selling their supply to STH holders and can observe a corresponding price appreciation.

Over the next few months, the expectation is that the market will behave similarly to how it did at nearly the same point in time last year. We are now seeing LTH gradually distributing coins back into STH positions and on-chain data suggests this might continue into Q2 of next year.

The average bitcoin is sold at a profit - A healthy market signal

Using Adjusted Spent Output Profit Ratio (aSOPR) in the chart above gives a simple metric that we can use to infer the market’s sentiment. When aSOPR is > 1, investors are in profit when they spend or sell their BTC. Below 1, they are executing transactions at a loss. We add the 30-day Simple Moving Average to smooth the data and give us a better monthly signal and a broader focus.

Something to note when looking at last year’s cycle is that the aSOPR has been greater than 1 and in an uptrend during the last bull market, which started in late 2020. This year, we see similar on-chain activity and aSOPR is trending sideways above the value of 1, which denotes BTC transacting at a profit and that we are currently in a bull market. When we see aSOPR dip below 1, caution should be exercised, as this denotes a change in market sentiment. Currently, aSOPR is hovering above 1, investors are net-transacting in profit and prices are gradually recovering from the dip. Mid-term price expectation remains bullish as we start 2022.

Short-term Outlook, Sentiment: Neutral

From a short-term perspective, BTC’s price volatility is ever-present with corrections up to 40% in past bitcoin bull markets. The weekend of 4 December saw the price of BTC dip down below $40,000 on some exchanges. The price recovered early in the week, hovering in the high $40,000 and low $50,000 range.

Excessive leverage flushed out of the system

The main driving factor behind the dip on 4 December 2021 brings our attention to the derivatives markets and Futures Open Interest (outstanding derivative contracts). Over the course of a few hours, $5bn of leverage unraveled from long positions as stop-losses triggered cascading liquidations that sent prices tumbling. The total open interest was reduced by over $10bn, representing a 38% reduction since its peak in November.

Some (mainly retail) exchanges allow their investors to leverage their assets at a ratio of 1:125, with others allowing up to 200x. Investors with this much leverage are exposed to the risk of liquidation, as small price movements can trigger cascading liquidations through an exchange very quickly.

When the price of BTC falls, investors who have taken long positions with leverage are automatically liquidated to limit further losses. This triggers more downward price movement and further liquidations. The recent liquidations removed excessive leverage from the system, building a more sustainable basis with which to expect sideways price consolidation.

Conclusion

Short-Term: Neutral

Derivatives markets took a large hit in early December, flushing out 38% of the Future Open Interest that had built up over the past weeks, as the price of BTC soared to a new ATH in November. This opens the possibility of less risk in the short term at current prices.

Mid and Long: Bullish

The mid- and long-term outlook is bullish as a supply shock is forming and favorable advancements in financial markets, such as different ETF products, are emerging. Recent updates to the bitcoin protocol (Taproot upgrade) have made it easier for developers to integrate bitcoin payments into their applications. In addition, the hash rate of the BTC network has never been stronger, meaning there are more computers mining and hosting a bitcoin node than ever before.

Nothing in this article constitutes professional and/or financial advice. The content is provided exclusively for informational and/or educational purposes. Nothing is to be construed as an offer or a recommendation to buy or sell any type of asset. Seek independent professional advice in regards to financial, tax, legal and other matters.

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