Last week was the largest short liquidation event in history for Bitcoin and Ethereum, with more than $1.6 billion in short positions closing between October 24 to 31 according to data from Cryptoquant. The liquidations came as markets found strength with BTC and ETH, over the same period gaining 8% and 19%, respectively, after a prolonged period of muted volatility. Let’s discuss what made the market move, including fundamentals, macro, and the derivatives market, and where we might be headed — could this be a bear market rally, or might we be out of the woods?
Source: Grayscale Research, Cryptoquant from 1/1/2019 to 10/31/2022
Market
One indicator that typically precedes an explosive move in either direction is high implied volatility. Implied volatility is a forward looking metric that shows investor expectations for price volatility over a period of time. In the crypto space, this measure is typically calculated by looking at the demand for various dated options.
Historically, when implied volatility hits a low point, prices tend to move violently in either direction, as evidenced by the following chart from Glassnode:
Source: Glassnode, data as of 3/2021 to 10/2022
Past performance is not indicative of future results.
ETH Fundamentals – Decreased Sell Pressure
From a fundamental perspective, ETH’s slowing supply growth post-merge has been a partial driver to outperformance relative to BTC. As we have covered in prior newsletters and market bytes, the ETH Merge resulted in decreased issuance of ~14,000 ETH per day, or ~5M fewer ETH issued per year,1 , since ETH miners no longer receive a base reward of 2 ETH per block mined. Due to the decrease in supply growth, as of 10/26/22, ETH’s inflation rate is currently at .007% a year, compared to 3.6% per year historically.2
Source: ultrasound.money, as of 10/26/22
In the past, ETH miners have had to sell ETH to cover operating expenses of their facilities, which meant daily sell pressure on the price of ETH. Without the constraint of miner sell pressure, ETH’s price is now potentially more exposed to larger positive movements.
BTC Fundamentals – Moving Off Exchanges
While BTC did not experience a dramatic change in supply flows like ETH, on-chain data reveals that:
- Exchange BTC balances continue to decrease (positive)
- Long-term holder supply of BTC is at an alltime high (positive)
- Miner cost of production is hovering near BTC price (negative)
Decreasing exchange balances and increasing long-term holders3 are both signs indicative that buyers are moving BTC into their own wallets, which suggests that buyers may expect an extended period of increased prices. Increases in long-term holders have historically marked an accumulation phase since holders are moving off venues (i.e. exchanges) that would allow them to sell.
Source: Glassnode, Grayscale Research. Past performance is not indicative of future results. Data as of 7/2010 to 10/2022
One caveat to the increase in long-term holder supply is the threat of miner stress and insolvency. Currently, BTC miners hold ~78K BTC, which is ~$1.5bn worth. Given that bitcoin’s cost of production is around its current price levels, many miners are on the brink of not being able to make required payments, putting them at risk of default. Any upward movement in BTC price could incentivize miners to sell, which partially mutes buy pressure.
Source: Glassnode, data from 1/2018 to 10/2022, shows the aggregate amount of BTC held by various BTC miner pools
Macro
As we stated in our recent newsletter, conversations about the implications of a strengthening dollar on foreign economies continue to dominate the macroeconomic narrative. While the consensus seems like the current environment remains rough, some speculate that the Federal Reserve (Fed) might reverse their stance on interest rate hikes because of decreasing US Treasury liquidity.
Source: Bloomberg
Based on recent US data that showed higher house prices and lower consumer confidence, along with some Fed officials beginning to voice concerns about the pace of the hikes, investors seemed to hold onto the hope that there could be a pivot with the S&P 500 index climbing 4.74% and the Nasdaq index rising 5.22% from 10/21/22 to 10/25/22, alongside a rise in crypto asset prices over the same period.
Looking forward
Is the bull market back? Despite the recent rise, the macro environment still may not point to a Fed pivot just yet. Compared to the previous bear cycle in 2018, volumes of crypto assets remain much higher than they once were. Despite low price volatility, BTC and ETH total futures volume hovered at ~$50bn on average per day in September and October, with estimates that the total daily activity of crypto is estimated to be ~$100bn, or one-fifth the figure of US equities. Given such a sustained amount of volume in the throes of a bear market, crypto seems to be here to stay.
