Bitcoin Forecast – 25/11/2021

  • Long-term sentiment: Bullish - The long-term outlook for bitcoin is excellent, with leading on-chain indicators signaling growth ahead. A supply shock is forming, driving price appreciation over the coming months. While selling of bitcoin from certain 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.
  • Mid-term sentiment: Bullish - On-chain data places us firmly in the middle of a bull market with an expectation of bullish price action over the coming weeks into the new year. Slowing network growth, renewed fear about Mt. Gox payouts scheduled for early 2022 and the potential for selling pressure arising from year-end tax events warrant caution, however.
  • Short-term sentiment: Neutral - 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 stability. We expect a consolidation with sideways price action followed by an ascend towards all-time highs (ATH).

Long-term Outlook - Sentiment: Bullish

The long-term price development of bitcoin is nearly exclusively driven by supply and demand dynamics. The 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 as to where we stand in a market cycle and what kind of price movement is expected in the coming three, six and 12 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 above metric clearly illustrates, a strong supply shock is forming. The available liquid supply of bitcoin for new buyers has reduced by over 700’000 bitcoins over the last 18 months and reached a four-year low in November 2021. In other words, 77% of the total circulating supply of 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 three to six months.

Experienced investors start selling BTC - A mid-bull market behaviour

In this context, tracking the buying and selling behaviours of 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 bitcoin 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 behaviour 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 Outlook - Sentiment: Bullish with Caution

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

The Spent Output Profit Ratio (SOPR) metric is useful to understand the overall market sentiment regarding profits and losses of Bitcoin holders 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 when 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 Unrealised Profit/Loss (NUPL) is the difference between Relative Unrealised Profit and Relative Unrealised 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 unrealised profit. Comparing this value to previous market cycles, it becomes evident that 0.6 is a mid-bull market reading, which is usually followed by 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 Outlook, Sentiment: Neutral with Caution

Weak hands continued to be flushed out of the market

The short-term price volatility of Bitcoin is not 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 reach a new ATH shortly thereafter. 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 its price 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, already a small 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.

The Futures Open Interest metric remains elevated – Higher volatility possible

High open interest (outstanding derivative contracts) with leverage continue to remain a short-term risk. Open Interest remains near an ATH at $22.5bn despite sideways price action from BTC. Compared to the last peak of high open interest in May this year, the percentage of leverage in the system has however reduced. In other words, there is strong interest in BTC but with less leverage and thus less risk in the market than a few months ago.

Whereas our on-chain mid- and long-term indicators paint a 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 for sideways consolidation before starting its ascend to new ATH over the course of the coming weeks and months.

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 three to six months.

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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