Bitcoin Forecast – 24/01/2022

  • Long-term sentiment: Bullish - The long-term outlook for Bitcoin remains strong, with leading on-chain indicators signalling growth. A supply shock is forming, with illiquid supply at all-time highs (ATH), driving price appreciation over the long term. LTH (long-term holders) and miners have started to accumulate BTC, a marked change from the net distribution behaviour seen in the late fall of 2021. The smart money tends to accumulate Bitcoin with the expectation of higher prices later in the cycle. The Bitcoin Network continues to thrive as thousands of new addresses are being added daily and miner hash rates are at ATH.
  • Mid-term sentiment: Neutral - Despite the relatively strong on-chain fundamentals, the negative macro environment started to impact the short- and mid-term outlooks. BTC stubbornly continues to trade sideways - with a bearish bias - while on-chain indicators like Spent Profit Output Ratio are muted and provide little in regards to a clear signal. STH (short-term holders) have traded at a loss now for weeks, which usually led to a bounce in price in the past. Also the dormancy flow metric indicates that BTC is potentially close to bottoming out. Considering the negative macro backdrop, it remains to be seen however if the indicators are right and BTC is about to bounce.
  • Short-term sentiment: Neutral - Derivatives markets continue to loom over the Bitcoin Network as leverage in open interest remains relatively high. Liquidations are possible in both long and short positions as the market waits for the next factor that will drive short-term pricing. Another significant looming risk in the interim remains the macro backdrop as BTC continues to show a high correlation to traditional equities, which continue to trade near ATH. In addition, expectations of a more aggressive timeline on policy tightening by the Federal Reserve has negatively impacted risk assets in general, with the tech-heavy Nasdaq 100 down nearly 13% YTD.

Long-term Outlook - Sentiment: Bullish

2022 is shaping up to be an exciting year as greater BTC adoption feels inevitable and on-chain data confirms these assumptions. On-chain data allows us to reach a conclusive answer to where we stand in a market cycle and what kind of price movement is expected in the coming 12 months. On-chain analysis provides us with hundreds of key performance indicators to observe the economic activity of Bitcoin users, providing a unique view into the supply and demand dynamics.

Over 8 million new addresses in 2021 - A growing demand for Bitcoin

Last year we saw 8 million new addresses created in the BTC network, at a rate of about 22,000 new addresses per day. This year has matched that pace with over 200,000 new addresses created in the first 10 days of 2022. We can infer that as the number of addresses grows, the number of users grows with it. As users and investors require more BTC to store wealth or to use it as a currency, that demand is likely to translate into higher prices later in the cycle. Combining this growing demand for Bitcoin with a forming supply shock and illiquid supply at ATH, the expectation is to see growing prices over the long-term.

Long-term holder behaviour provides valuable insights into price expectations

We define the smart money BTC holders as individual and institutional investors who have the most experience trading BTC in a variety of social and economic climates. The data we use from Glassnode defines a long-term holder (LTH) as an entity that has held BTC for more than 155 days. Bitcoin older than 155 days have statistically proven to be much less likely to be sold than BTC that is “younger” than 155 days. In other words, if you’ve held your BTC for more than 155 days, you’re more likely to hold it than to sell it on any given day after that. We can also infer that if you do eventually sell, you did so because you either: 1. Need to sell it (to buy something) or 2. You’ve lost faith in the Bitcoin Network and you believe the price will drop in the future. As a matter of course, there are many other possible reasons, but, from a macro perspective, if large numbers of LTH sell their Bitcoin – in combination with other information - this provides a very clear signal on whether the price of BTC is expected to go up or down in a certain time period. Are LTH selling strategically to take profits or are they capitulating and dumping their positions as they lost faith in the Bitcoin Network? This key question can be answered by analysing the sentiment and behaviour of LTHs.

The smart money - long-term holders & miners - expect rising prices

The volatility that is present in cryptocurrency markets can be wide-ranging and gut-wrenching for new investors, which is why we must clearly differentiate short-term holders from long-term holders. Their behaviour in different market environments can be closely observed in on-chain data and linked to changes in pricing throughout a cycle.

In the above chart, we can see for the second half of 2021, LTH accumulated BTC at a high rate relative to the distribution that occurred in November and December. As we start this year, LTH changed back into net accumulation of BTC - something that is notable considering that the expectation is that we are in the mid-cycle of a long-term bull run. Once the price of BTC rebounds, the expectation is that LTH will change back into a distribution cycle as demand returns to the market and STH positions recover.

Another influential class of entities in the BTC network are the miners. While there are far fewer miners than general BTC holders and investors, their behaviour is generally considered to be in line with the smart money. The key difference is that BTC miners are doing more than just investing in the Bitcoin Network. The miners represent the infrastructure that the entire network resides upon. When miners are accumulating coins above and beyond what they are earning from block rewards and transaction fees, it is entirely because they expect higher pricing in the future. Therefore, with miners doubling their accumulation effects as they have in the past two weeks, we can assume that they are extremely bullish on higher prices later in this cycle.

A supply shock keeps on forming - Illiquid supply is at ATH

In previous Bitcoin Forecasts, we have focused on BTC supply shock and the reasons why a shock to supply is highly likely in the future. A key component to supply shock is Illiquid Supply. There is an unseen cost that those who are bullish on the BTC protocol often do not talk about. Creating your own currency and being your own decentralised bank sounds great in theory, but what happens when you make mistakes? It should be noted that a large number of BTC becomes illiquid due to the fact that someone sends it to the wrong wallet, or even because something as small as a typo can lead a multi-million dollar transaction to be lost forever.

BTC is currently already a deflationary asset as more Bitcoins are lost then newly minted by miners a year. The total amount of BTC in circulation is more than 18 million Bitcoins. Glassnode estimates that up to 78% of all BTC is illiquid, which is nearly 15 million BTC. Some experts estimate that of that 15 million BTC that are illiquid, 20% (3 million) Bitcoin are potentially unrecoverable forever.

The Illiquid Supply metric in the chart above tracks the number of BTC that is effectively out of circulation because it is in a “cold storage (not connected to the internet)” wallet, or it is lost and has not been moved for years since its creation. The Illiquid Supply is currently at an all-time high, increasing the probability of a supply shock forming and rising prices later in the cycle.

Mid-term Outlook - Sentiment: Neutral

Looking at the relative supply in profit and loss - and separating that supply into STH and LTH holders - provides valuable insights. In the chart below we can see “clouds” of lighter reds and blues, which indicate supply that is being held at a loss by the respective holder. Darker red signifies the percentage of STH in profit, while darker blues signify percentage of LTH in profit.

Once STH supply is entirely being held at a loss, the STHs tend to capitulate and sell their BTC at a loss. Over the last two years, three such occasions materialised (see green boxes above). Usually this is a truly BTD (Buy The Dip) situation. Once the short-term holders' Bitcoins are entirely being held at a loss, the price of Bitcoin begins to appreciate in the short- and mid-term (green arrows). Considering the negative macro backdrop, it remains to be seen if the same pattern will materialise in 2022.

Dormancy Flow indicates BTC may be close to bottoming out

The Dormancy Flow metric is a way to track BTC market tops and bottoms by using Bitcoin transaction data. Specifically, dormancy flow is calculated by dividing current market capitalization by annualised dormancy value (USD), as follows:

Dormancy is the average number of days destroyed per coin transacted, and is defined as the ratio of coin days destroyed and total transfer volume. Coin days destroyed is measured as the number of coins in a transaction multiplied by the number of days held.

The metric has been very accurate in identifying when BTC markets are at historic lows. As you can see from the above chart, Dormancy Flow has successfully signalled strong buy signals in previous cycles. Low dormancy flow values indicate moments where market cap is undervalued relative to the yearly sum of realised dormancy, indicating moments where Bitcoin is possibly a good buy.

The difference to the “Mini-Bear” Market of 2021

Despite relatively bearish sentiment that seems to be propagated throughout the news. Current market conditions, that mark the beginning of this year, look quite a bit different than during the most recent bearish market we experienced from May through August 2021. During that time, the price of BTC dropped dramatically in May and drove down to below half of the ATH it attained earlier that spring. Today, even though the Bitcoin market sentiment seems bearish, on-chain data paints a different picture. The above SOPR metric shows the market operating just around 1, and can be interpreted as the network transacting in a general break-even environment. Huge profits and losses are not being taken on either side of the equation. The takeaway is that while the market may feel bearish, the on-chain data would suggest more neutral, muted conditions.

Short-term Outlook, Sentiment: Neutral

Since the price of BTC reached $69,000 back in November of 2021, derivatives markets have been purging long leveraged positions to the tune of billions of dollars in just a few weeks. The first week of December, last year, was especially tough, because over $10bn was lost in just a few hours as long positions unravelled when the price of BTC crashed and left leveraged accounts depleted.

Leverage has been flushed, but is it enough?

The effect of those liquidations, together with a negative macro environment, have set the tone of relative bearishness in the short term, and that sentiment has been pervasive even as we now start the new year. As we explore the current open interest it is notably much lower than before and while there is some open interest growing at some exchanges, the trend is clearly in an overall macro decline.

We can see from the Futures Open Interest chart above that while open interest is generally still relatively high, open interest decreased by nearly 50% since its peak in November 2021. In other words, there is less leverage represented in the system. Whether this translates to greater price stability is yet to be seen.

Impact of a negative macro environment

A significant looming risk in the interim remains to be the macro backdrop as BTC continues to show a high correlation to traditional equities, which continue to trade near ATH. In addition, expectations of a more aggressive timeline on policy tightening by the Federal Reserve has negatively impacted risk assets in general, with the tech-heavy Nasdaq 100 down nearly 13% YTD. There are various other potential negative macro factors such as a tense geopolitical environment with Russia, or uncertainty around the impact of Omicron on countries and economies. A significant drop in equity markets is 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 paint a bullish picture, 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. 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 stabilise prices here and potentially - absent an equity market crash - start an ascend over the course of the coming months.

Conclusion

On-chain data continues to provide valuable insights into the behaviour of smart money as they continue to accumulate throughout the start of 2022. The silver lining to the otherwise negative macro backdrop is that we know the price of BTC, in the long term, is based on supply dynamics and not on sentiment.

The long-term outlook for Bitcoin thus remains strong, with leading on-chain indicators signalling growth. A supply shock is forming, with illiquid supply at all-time highs (ATH), driving price appreciation over the long term. LTH (long-term holders) and miners have started to accumulate BTC, a marked change from the net distribution behaviour seen in the late fall of 2021. The smart money tends to accumulate Bitcoin with the expectation of higher prices later in the cycle. We also have observed in the past that when LTHs begin to sell, they sell strategically into strong markets and rising prices. The latter has not yet materialised in this market, so while downward price action and bearish sentiment can be uncomfortable in the short term, the winning strategy for BTC has always been on longer time horizons.

On the other side of the holders’ spectrum, when we observe that short-term holder supply is entirely being held at a loss, prices have tended to start to bounce upward, shortly thereafter, at various occasions throughout the last two years. This year, a negative macro environment has created headwinds in the short-term that seemingly limits price action. This combined with consistent losses in derivatives markets have stagnated demand leaving BTC trading sideways for the near term.

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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