On-chain Weekly April 14th

  • Long-term Outlook - Sentiment: Bullish - Long-term holders continue to accumulate, which is a bullish long-term indicator. The Accumulation Trend Score confirms light distribution and accumulation behavior for a big part of the Bitcoin Network, suggesting muted action in short and mid-term markets.

  • Mid-term Outlook - Sentiment: Neutral - The Spent Output Profit Ratio (SOPR) metric has dipped back below one (1) following a “dead cat bounce” recovery this week. This pattern has been observed in the recent past and contributes to a bearish narrative that is emerging in the mid-term timeframe.

  • Short-term Outlook - Sentiment: Bearish - Bearish sentiment continues to dominate, exacerbated by rising inflation focused in the areas of energy and housing. This, combined with the increasingly difficult geopolitical landscape, has created a “risk-off” environment. Futures volumes remain low, with the quality of Open Interest in question with recent spikes in crypto-margined positions.

Long-term Outlook - Sentiment: Bullish

Measuring conviction in the BTC market

While long-term holders’ economic activity is important and observable on-chain, it is also very specific and can create blind spots in Bitcoin’s supply and demand dynamic. To broaden this perspective, the BTC market can be explored more generally looking at what Glassnode calls “a big part of the network”. To do this, Glassnode has created a new metric called the Accumulation Trend Score (ATS) to collectively track if a large part of the BTC network (or a collection of its largest entities) is accumulating or distributing Bitcoin.

ATS is a metric that attempts to express the relative size of entities that are actively buying and selling in regards to their current Bitcoin holdings. The scale of the ATS metric represents both BTC balance and the amount of change (monthly) to the balance of the entities that it classifies. The ATS metric is scored between the values of zero and one (0-1).

Accumulation Trend Score

An Accumulation Trend Score of closer to one (darker color) indicates that, on aggregate, larger entities (or a big part of the network) are accumulating, and a value closer to zero (lighter colors) indicates they are distributing or not accumulating. This provides insight into the balance size of market participants, and their accumulation behavior over the last month.

  • A score closer to 1 reflects that, over the last month, big participants (or a big part of the network) have been accumulating coins.
  • A score closer to 0 reflects that, over the last month, big participants (or a big part of the network) haven’t been accumulating coins or have been selling them.
  • Exchanges and Miners are not included in this metric.

For the past weeks, ATS has been trading sideways as the market continues to experience choppy price action. This data point corroborates data showing long-term holders (LTH) accumulating – although at low levels compared to past markets. Most of this year has been marked with a mix of light and dark colors, reflecting uncertainty and a lack of clear direction in the market.

This pattern of choppiness has been expressed in previous markets, usually following strong periods of accumulation and then distribution into strong bull markets. The last 90-days bear market has a strong resemblance to the market structure that was observed after the “Covid Crash” in March of 2020. During that time, the pandemic created a great deal of uncertainty for risk-on assets and BTC traded sideways for almost the entire year, before going on to reach new ATHs in the early spring of 2021. As demand flows back into a stronger market, we should see the accumulation taper off and change into distribution.

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Slow accumulation by Long-Term Holders

Glassnode defines LTH as entities holding BTC for greater than 155 days. In general, these investors can be considered more experienced and their decisions often correlate with other smart money players in the Bitcoin market. Long-term holders generally sell BTC into strength and accumulate with the expectation of higher future prices.

This year, long-term holders have been purchasing more BTC than they have been selling, with February being the exception as some older coins did make it to exchanges. These sales could be seen as more strategic due to the relatively small amounts of BTC that were sold, as is typical during slower more bearish markets when fewer coins are traded. However, LTH accumulation is a bullish long-term indicator and fundamentally positive for the health of the BTC network.

Mid-term Outlook - Sentiment: Neutral

Over the past two years, on-chain data shows that BTC is consistently flowing out of exchanges. While this fact does not immediately contribute to either a bullish or bearish sentiment, it can reveal important characteristics about the behavior and knowledge of the investors on the network.

The first question that comes to mind is, “where is the BTC going when it moves away from exchanges?” The simple answer is that the outflowing BTC is moving into self-custody wallets. Self-custody wallets are wallets that are not controlled or maintained by any centralized exchange. These types of wallets are wholly controlled by their owners and can be hardware wallets, browser-based wallet plugins, or app-based like the Numbrs Bitcoin wallet solution.

Many enthusiastic Bitcoin investors see out-flows from exchanges into self-custody as a bullish indicator, positing that BTC moving away from exchanges means they are being taken out of liquid circulation thus restricting supply. Whereas this usually is the case, it does not always hold true, as BTC can be moved back onto exchanges just as easily as it is taken off.

Self-custody and self-storage of an investor’s BTC imply a greater level of sophistication and experience with crypto, as there are risks to managing and safeguarding your wallet and private keys. Bitcoin moving off of exchanges into self-custody wallets is not directly bullish or bearish in regards to the market. However, self-custody is more in line with the value of decentralization that crypto offers and thus could be interpreted as an overall net positive for BTC and the crypto ecosystem.

Spikes in profit have preceded declines in the price of BTC

The metric “Adjusted Spent Output Profit Ratio” (aSOPR) is useful for understanding the Bitcoin Market in regard to the general market sentiment. When aSOPR is greater than one, investors are in profit when they spend or sell their BTC. Otherwise, below one, they are executing transactions at a loss. Another way to interpret this metric is that when SOPR is above or below the value of one for a series of days or weeks, then the market sentiment is generally bullish or bearish, respectively.

The first quarter of 2022 has been a continuation of a difficult market that emerged at the end of last year. As visualized in the chart above, spikes in the aSOPR metric in recent months have preceded so-called “dead cat bounces” where the market begins to show a recovery in prices followed by a rapid return to lower prices. This occurred in early February this year, and again at the start of the month in April.

Short-term Outlook, Sentiment: Bearish

While uncertainty is definitely a factor in the current market, Bitcoin has remained resilient and has performed quite well during the conflict in Europe. Spot demand has been weak during the first quarter of 2022, with much of the price action in the BTC market being driven by futures markets.

Using on-chain data, investors can look deeply into the derivatives markets to see how frothy, or overheated the BTC market is becoming. When the Bitcoin market gets overheated, prices can fluctuate up or down by 10% to 40% in the short term. Currently, Futures Open Interest levels are relatively low at exchanges suggesting a relatively calm market with plenty of room to grow if and when investor demand increases in the short term.

Examining the quality of open interest with the metric ELR

Examining the quality of the funding for any particular asset is an important fundamental for any investment. Futures Estimated Leverage Ratio (ELR) is a metric that can be used to explore how much leverage is used by investors on average at a derivatives exchange. This information measures a trader’s sentiment whether they are taking a high or low-risk position. ELR can be interpreted in two ways, by value or by trend.

  • An increasing trend means more investors are taking high leverage risk in the derivatives trade. If the value itself is high, then it could signal that the market is over-leveraged and investors should expect volatility.
  • A decreasing trend in values indicates more investors are taking off leverage risk in the derivatives trade. Low values signal low leverage in the market and less expected volatility.

Current ELR levels are slightly high and have recently spiked into the lower end of the 0.2 range, meaning that the open interest at exchanges reached 20% of exchange balances. It should be noted that a high leverage ratio has not always corresponded with high risk and could also be interpreted as conviction forming in the market. However, the current market sentiment is firmly on the bearish side combined with other negative macro conditions that have created a great deal of choppiness in the price of BTC.

Along with knowing the amounts at stake in the futures markets, it is also important to inspect the funding quality provided to back those contracts. Futures contracts can be paid for with cash or other cryptocurrencies. However, futures contracts funded with crypto are riskier, since downward price movement affects the contracts and the underlying assets used to pay for those contracts.

Currently, we can observe that futures open interest financed with crypto assets is generally on the decline. There has been a recent spike in crypto-margined positions. While this can immediately appear to be a positive sign, there have been a number of instances where sharp increases in crypto-margined open interest have preceded drops in price. Last week, the metric spiked and should be considered a short-term risk, as recent spikes have produced weakening prices in this uncertain market.

Stablecoins are the fuel for the recovery

Another silver lining to the current market sentiment is that a relatively large amount of stablecoins are on exchange balances. Cryptocurrency coins that are pegged to the dollar - so-called “stablecoins” - have been growing exponentially over the last two years. Tokens like USDC, USDT, BUSD, and others are used as proxies for fiat currency that traders can use on crypto exchanges. Stablecoins offer low volatility for traders and are attractive “placeholders” for value before entering or when exiting trades. It should be noted that currently stablecoins are traded at volumes higher than any other type of cryptocurrency, denoting their popularity and usefulness.

Many traders use these tokens as a primary vehicle to open and exit Bitcoin positions on exchanges. Stablecoins play a critical role in the supply and demand dynamics of various global cryptocurrency markets, which in turn can directly influence the price of BTC. Stablecoins live natively on the blockchain, allowing on-chain analysts to observe the supply and demand dynamics between BTC and USD.

Investors use stablecoins to deploy capital into crypto markets and also use them as proxies for fiat currency. When we observe large levels of stablecoins in wallets, we can assume that those investors are planning on using those funds to quickly enter markets. Otherwise, we would see them converted on exchanges into fiat currencies. Overall, large amounts of stablecoins can be viewed as a bullish signal, since investors are keeping “dry-powder” ready to be deployed at short notice in the crypto ecosystem.

Conclusion

Bitcoin dipped below $40,000, mid week, as the market reacted to the news that inflation in the US had reached a forty-year high. This, combined with the announcement that the Fed will likely add 50 basis points to interest rates in May, has pushed markets bearish. Geopolitical conflict continues to create black swan events that are difficult to price into markets. What is clear is that Bitcoin remains tightly correlated with equities markets and until a decoupling occurs, BTC will be subject to the headwinds and tailwinds of the larger market.

Last week, a short rally pushed the price of BTC into the upper $40,000s, but sell-offs over the weekend and a steady stream of negative news continue to drive investors for cover. The Bitcoin Network has been trading sideways with low volumes since the beginning of December 2021.

Even while the short-term perspective is quite unclear, the long-term fundamentals of the BTC protocol remain strong with consistent demand evidenced by a two-year trend of BTC outflows from exchanges into self-custody wallets. In addition to the steady demand, it is becoming more obvious that users who store their Bitcoin in self-custody or cold storage are more experienced, more confident investors.

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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