Will Inflation Concerns Doom the Bitcoin Rally?

Liquidity needs

Another measure of cryptocurrency bullishness is whether investors are willing to hold it in illiquid form (eg a private wallet) or prefer a liquid form (eg on an exchange). The former suggests that investors are bullish, as they are comfortable not being able to sell easily. Conversely, keeping it in liquid form would indicate that investors are bearish, as they prefer to be able to sell easily.

Therefore, large flows to crypto exchanges would suggest that investors want to convert their holdings into a more liquid form, which implies more bearishness.

Futures activity

We track the growing bitcoin futures market. Open interest – the sum of long and short contracts – is a good measure of investor interest.

Perpetual funding rates reveal the directional bias of investors. Exchanges set funding rates to prevent a lasting divergence in the price of the futures contract and the underlying since perpetual contracts have no expiration date, so never settle in the traditional sense. Accordingly, we can interpret funding rates as the cost of holding bitcoin via perpetual futures. Positive funding rates mean longs pay shorts and vice versa. We use it as a proxy for trader sentiment since a positive funding rate suggests that traders are paying a premium to hold open long positions.

HODLers

In our initial bitcoin flow framework, we explained “HODLers” and “HODLing”. HODLing refers to buy-and-hold strategies in the context of bitcoin and other cryptocurrencies. Those who HODL for longer periods are die-hard followers.

We can categorize HODLers by how long they have held BTC. We define long-term or faithful HODLers as those who bought BTC five or more years ago and have held it since, medium-term HODLers as those who bought 6-12 months ago, and short-term HODLers as those who bought 3-6 months ago.

Coin days destroyed (CDD) is defined as the number of coins in a transaction multiplied by the number of days since the coins were last used. So increasing CDD suggests that older coins are being used (more coin days are being destroyed) and vice versa.

Profit and loss

The percentage contribution in profit (PSIP). This tracks the proportion of circulating BTC supply in profits. It is the percentage of circulating BTC whose current price is higher than when it was last transacted (movement).

Net unrealized profit (NUPL). This is the ratio between unrealized profit and total market value. While PSIP only focuses on whether BTC coins are in profit or not, NUPL focuses on the size of profit. So we can have a situation where the PSIP is low – that is, a low proportion of the supply is in profit – but the NUPL can be high if the size of those profits is large.

Used Production Profit Percentage (SOPR). While PSIP and NUPL focus on unrealized profit or mark-to-market, this measure focuses on realized profit. SOPR is the realized value of a transaction divided by the value at initiation (or creation) – more simply, sold price divided by paid price. If the SOPR is above one, the investors have collectively realized profits, while below one means they have realized losses. In broad uptrends, SOPR spends a significant amount of time above one, while the opposite is true for broad downtrends.

As the SOPR rises, sellers increasingly realize profits. The opposite is true when it falls. A price rise with a flatter SOPR trend indicates that investors are yet to realize the gains from the rise. Investors’ reluctance to sell and realize a profit may be because they believe the price will rise further, which would be bullish. At the same time, more profit taking could precede a correction. Generally, it has proven to be a profitable strategy to buy while the SOPR is moving around one during bullish periods.

Mining

Data power is central to the crypto market. Miners use advanced computer hardware to solve complex problems that verify BTC transactions (and other coins) on the public ledger or blockchain. The miners are rewarded with new coins for their efforts. A measure of the complexity of the problems and therefore the computing performance required to solve them is the hash rate. The higher this speed, the more computing power is required to maintain the blockchain. The exchange rate may vary depending on the demand for crypto.

Dalvir Mandara is a quantitative researcher at Macro Hive. Dalvir has a BSc Mathematics and Computer Science and an MSc Mathematical Finance both from the University of Birmingham. His areas of interest are the use of machine learning, deep learning and alternative data for predictive modeling of financial markets.

Bilal Hafeez is the Managing Director and Editor of Macro Hive. He spent over twenty years doing research at major banks – JPMorgan, Deutsche Bank and Nomura, where he held various ‘Global Head’ roles doing currency, rate and market research.

Image credit: depositphotos.com

(The commentary in the article above does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)