1. At the macroeconomic level, there is a relationship between the dollar index performance declining, and Powell’s re-election hearing on the relatively moderate statement. However, the US 10Year TIPS is still rising, reflecting that the market’s expectations for US inflation remain high. Inflation expectations remaining high will strengthen the market’s fear of Fed tightening, and short-term risk assets are still being suppressed by this factor.
2. During the last round of interest rate hikes and tapering process, the S&P 500 and Bitcoin were not affected by the Fed tightening, and continued to record highs. It was not until the end of 2018 when the market experienced a liquidity crisis that it had a large impact on the S&P 500. And Bitcoin’s decline in 2018 had more to do with the bursting of its own hype bubble.
3. In terms of BTC fundamentals, the unilateral downward trend of Bitcoin balances on exchanges has tended to ease recently, showing a trend of low volatility. Market trading is still sluggish, and the leverage ratio of exchange contracts is still high. In the short term, we need to be alert to the impact of contract liquidation on the market.
4. Behind the market trading, the two forces are clearly differentiated. Among the current holdings of short-term holders, the number of profitable Bitcoins is approaching zero, and the yield of short-term holders’ selling Bitcoins continues to be negative. Among the Bitcoins traded on the chain, only 40% are in a profitable state. Considering that the SOPR of long-term holders is still positive — and this group is still increasing their holdings — the current on-chain trading volume is in 40% of profitable Bitcoins are contributed by long-term holders. In other words, short-term holders are selling out of the market. Historically, when this state was in, it was usually a big bottom area.
5. Looking at the market outlook, because smart funds are still entering the market, the fundamentals have not deteriorated due to the external macro environment. The current market continues to suffer more from external macro events. Therefore, this report believes that this position should not be pessimistic, and still maintains an optimistic view on the market outlook.
I. Macroeconomic Analysis
The recent decline in the U.S. dollar index is more obvious, and it has continued to decline since hitting a high of 96 at the end of November 2021. The recent acceleration of the downward trend has a clear relationship with Fed Chairman Powell’s re-election hearing last week. Powell’s remarks at the hearing that “inflation will peak and fall as originally expected in mid-2022” and Powell ignoring hawkish comments from other Fed FOMC votes, emphasizing that no quantitative tightening decision has been made lifted the market risk appetite and exacerbated the dollar’s weakness.
The U.S. dollar index is closely related to the tightness of the Fed’s monetary policy. Although the current market expects that the Fed will start raising interest rates as early as March and start shrinking its balance sheet in the middle of the year, Powell’s remarks have caused the market to re-examine whether the tightening is priced too early.
Chart 1: The market has overpriced hawkish expectations, the dollar index’s break-down may suggest that the correction trend of risk assets is coming to an end.
Judging from the fluctuation trend of the US dollar index, the current index has fallen below the upward trend formed since May 2021, and the 93–94 range below may form support. If the Fed’s follow-up related statements still have no further hawkish rhetoric — or the hawkishness is in line with market expectations — the US dollar index may weaken further. Weakness in the U.S. dollar index would be positive for risk assets, including cryptocurrency markets. On the whole, in the large-scale decline and decline of the US dollar index, the price fluctuation trend of Bitcoin is usually in an inverse relationship.
Chart 2: The US dollar index has a certain degree of inverse volatility relationship with Bitcoin.
Another thing to note is that the market’s expectations for inflation still haven’t dropped significantly. Powell also said that since the problem of supply chain bottlenecks has not yet been solved, the U.S. supply chain crisis caused by the epidemic is one of the core reasons for higher inflation. This trend can also be observed in the trend of the US 10 Year TIPS. The real interest rate is equal to the nominal interest rate minus the inflation rate. The increase in the real interest rate also reflects that the current high inflation rate cannot offset the increase in the nominal interest rate. Therefore, it is necessary to pay close attention to the monthly inflation data such as CPI. If the inflation data exceeds market expectations, not only will the 10Y TIPS rise, but the US dollar index will also rebound. The market will be more hawkish on the strength and speed of Fed rate hikes and balance sheet reductions, which will also be detrimental to the cryptocurrency market.
Judging from the recently announced annual rate of consumer price index (CPI) in December 2021, the annual rate of CPI is 7%, which is in line with market expectations. Therefore, on the night after the data was released, the yield of US 10 Year TIPS and the U.S. dollar index both fell, and risk assets stopped falling and rebounded. The annual rate of the core PCE price index will be announced on January 28, and the market is expected to be 4.8%. At the same time, the FOMC interest rate resolution meeting will be held on the 27th. If the data and statements are lower than expected and the relative dovishness or hawkishness is weaker than expected, it will continue to benefit crypto assets.
Chart 3: The real interest rate on US 10 Year TIPS reflects that market expectations for inflation remain high, which is also one reason for the continuous adjustment of risk assets in the near future.
The strength and speed of the Fed’s balance sheet reduction will be adjusted along with economic data, especially in the context of the COVID 19 epidemic. After the epidemic eases in the future, the economy will be accompanied by gradual easing of supply chain problems, a decline in the inflation rate and an increase in the labor force participation rate. At this time, the frequency and intensity of interest rate hikes, as well as the intensity of the reduction of the table will be faster. Only then will it really have an impact on market liquidity. The current impact is more of anticipation — that is, psychological panic. Therefore, in addition to paying attention to the Fed’s statement, we must also pay attention to the dynamics of the epidemic in the United States, especially the progress of vaccines.
In the process of the Fed’s balance sheet reduction in 2017, the volatility of risk assets was not directly related to the Fed’s balance sheet reduction. In April 2017, the Fed’s FOMC meeting minutes released a signal for the first time to shrink its balance sheet (the blue star in the figure below), and it was officially launched in October 2017 (the green star in the figure below). It failed to stop the S&P 500 and Bitcoin from continuing to rise. Even the shrinking of the balance sheet was officially launched in October 2017, and the S&P 500 and Bitcoin continued to rise sharply in the following two months. U.S. stocks performed strongly at the beginning of the balance sheet reduction in 2017, mainly because the fundamentals of the U.S. economy continued to rise under the impetus of Trump’s tax reform passed at the end of 2017, resisting the pressure of monetary tightening and rising interest rates. And Bitcoin is in the midst of its second halving bull run. At the beginning of 2018, the drop in the Bitcoin price was more related to the bubble bursting after the market was over-hyped. The S&P 500’s correction in the second half of 2018 was related to the Fed’s shrinking of its balance sheet. At that time, the shrinking of the Fed’s balance sheet led to a shortage of money in the market, that is to say, only when the market really had a liquidity crisis would it trigger systemic risks and their chain reactions.
Chart 4: Fed tapering process in 2017 (blue asterisks represent the first release of tapering signals, green asterisks represent the official launch of tapering), U.S. stocks continued to perform strongly at the beginning of tapering until a liquidity crisis in the system triggered a massive correction.
Chart 5: 2017 Fed tapering process (blue asterisks represent the first release of tapering signals, green asterisks represent the official launch of tapering) and Bitcoin volatility trends, Bitcoin continued to rise wildly by $15,000 after the official launch of tapering. The core driver of Bitcoin’s rise came from the imbalance between supply and demand brought about by the second halving, and the end of the bull market also had more to do with its own hype bubble.
The two graphs below depict Bitcoin’s 20-day rolling correlation with gold and the S&P 500. Although there is a certain positive or negative correlation in the short term (within 1–2 months), and sometimes the correlation coefficient is very high (plus or minus 0.8), this positive and negative correlation cannot be maintained for a long time.
If an asset has an obvious correlation law with another asset, it should maintain a stable positive or negative correlation in a long-term time period. Bitcoin and traditional risk assets (US stocks, gold, etc.) have a certain stage at a certain stage. The correlation between Bitcoin and traditional assets, the correlation coefficient is high and sometimes low, but the time axis is elongated, and the correlation coefficient between Bitcoin and traditional assets has a law that cannot be captured.
This report believes that although the Fed’s interest rate hike or balance sheet reduction will affect market liquidity and capital prices to a certain extent, if the time axis is extended (more than 2 quarters), this impact will gradually weaken. Only when there is a real liquidity crisis in the market will a chain reaction be triggered. At present, the liquidity in the market is still very abundant, and the panic in the market is more psychological. Finally, the fluctuation force that determines the Bitcoin price comes from the Bitcoin market itself. The supply and demand relationship dominates the Bitcoin price trend. We should pay more attention to Bitcoin itself.
Chart 6: The 20-day rolling correlation coefficient of Bitcoin and gold, the correlation coefficient fluctuates greatly, and there is no obvious positive or negative correlation.
Chart 7: Bitcoin’s correlation with the S&P 500. The correlation coefficient has a positive correlation in a certain stage, but there is no obvious positive and negative correlation in the long run.
Ⅱ. BTC Fundamental Analysis:
Last week, the BTC balance of exchange continued to fluctuate, and the net inflow did not change much. From the beginning of December 2021 to the present, the exchange’s BTC balance has been in a downward trend, followed by a rebound and constant fluctuations. There is still buying power in the market withdraw Bitcoin. However, in the past month or so, affected by the clearing of mainland China and the expected U.S. monetary policy orientation, the panic level in the market has increased significantly, resulting in a large number of short-term speculators and a small number of long-term holders selling their chips. As a result, the Bitcoin balance of the exchange temporarily stopped the unilateral downward trend, and has been hovering at a low level. The current exchange BTC balance is 2.53 million, accounting for about 13.4% of the circulating supply.
Chart 8: Affected by various external events in the past month or so, the Bitcoin balance on the exchange has ended its unilateral downward trend and is hovering at a low level.
Chart 9: Although the unilateral downward trend of the exchange’s BTC balance has temporarily disappeared, there has been no significant inflow similar to the 519 (May 19) period, and the exchange’s BTC balance is about 2.53 million.
The current market sentiment is still sluggish, and this phenomenon can also be found from the proportion of miners’ fee income. The income of BTC miners includes block reward and fee income, of which the block reward is fixed, so the proportion of fee income can measure the congestion degree of the blockchain network. When the proportion of handling fees is high and continues to increase, it means that the number and frequency of on-chain transfers using the network are relatively active, and network users are willing to pay higher “satoshi” in order to package transactions as soon as possible. At present, the proportion of fee income remains below 2%, and this trend has continued since the “May 19” incident in 2021.
The congestion of the network usually has little to do with the amount of transfer amount, but has a high relationship with the number of transfers, the number of accounts, and the frequency. These parameters usually reflect the enthusiasm of retail investors for participation. Therefore, at least it can be explained that a large part of the current market downturn is due to the fact that the popularity of retail investors participating in BTC trading is still at a low level.
Chart 10: The proportion of miners’ fee income has remained below 3% for the past six months, and the network congestion is not obvious, indicating that the participation of retail investors is still not high.
If the market is active, the price volatility is usually large, and the positive and negative range of the capital rate is also large, indicating that the long or short position is extremely frenetic. However, the funding rate of BTC futures contracts remains at a low range of positive and negative values (-0.01% to 0.01%). The current funding rate still shows the market downturn, and it also shows that most retail investors are losing confidence in the market.
Chart 11: The funding rate fluctuates in the range of -0.01% to 0.01%, and the speculative atmosphere is poor, indicating that retail investors are losing confidence in the market.
What is alarming is that while the market is not currently trading at a high level of activity, positions in futures contracts are still not low. BTC futures contract positions on the major cryptocurrency exchanges continue to be above 250,000 units. Over the past 2 years, when positions are at high levels, they are usually followed shortly thereafter by strong deleveraging, and while it is impossible to predict whether to liquidate long or short positions, the high contract positions are warning investors of highly leveraged contracts.
Chart 12: BTC contract positions on major cryptocurrency exchanges remain high, requiring caution against liquidation risk in the near term.
Although the market is trading at a low level, the probability of a bottom forming is gradually increasing from an objective point of view. Percent of Transfer Volume in Profit is usually used to reflect what percentage of Bitcoins packaged and traded per block are in an on-chain profitable state (on-chain profitable state means that the current price of moving Bitcoin is higher than the price at the time the Bitcoin UTXO was created). If Percent of Transfer Volume in Profit is high, it means that there is, and a large number of people have, profitable chips in their hands, which is often at the end of an upward market phase. Conversely, if the Percent of Transfer Volume in Profit is low, it indicates that a large number of people are holding chips at a loss. When they are in a losing position and still moving chips, it means that this group of investors is “selling out”. When a large number of loss-making chips sell off, the market pressure will gradually weaken, and the probability of the market bottom formation is increasing.
The historical pattern shows that the last 2 years when Percent of Transfer Volume in Profit was below 40% (i.e. 60% of the chips in each block packaged for trading left the market at a loss) constituted a bottom area. The indicator has recently fallen briefly below 40% and is currently at 45%.
Chart 13: Percent of Transfer Volume in Profit is around 40% and the probability of bottom formation is gradually increasing.
Further dismantling of the structure shows that the profitability of holding by Short Term Holders has been almost zero. In the last 2 years, when Total Supply in Profit Held by Short Term Holder is close to the horizontal line position of 0 axis, it means that the profit margin of short-term holders has been lost at this time. The Short Term Holder Spent Out Profit Ratio (STH-SOPR) has also been in the negative range recently, indicating that the short-term holders have been losing money on their Bitcoin sales. However, the Long Term Holder Spent Out Profit Ratio (STH-SOPR) has been in the positive range, indicating that the long-term holders are holding their positions at a lower cost.
It can be concluded that when Percent of Transfer Volume in Profit is at 40%, the percentage is almost contributed by Long Term Holders, and Short Term Holders have a loss of up to 60% of their holdings.
Chart 14: Short-term holders have almost no more profitable chips in their hands.
Chart 15: Short-term holders sell their Bitcoins with negative returns, indicating that they are leaving the market at a loss.
Chart 16: Long-term holders have a low cost line for their positions and still have a positive return on selling Bitcoin.
Since Holder has been increasing its position (Holder Net Position Change), we can conclude that the above sell-offs are almost from “short-term holders”.
At this point, the market pullback is strong enough to achieve the effect of the washout. In the last 2 years, when the ratios reached the above values, the bottom of the major levels.
Chart 17: Long-term holders continue to hold more chips and sell less Bitcoin overall.
Another bottom indicator also shows that a major bottom is being established. Entity-Adjusted Dormancy Flow reflects the ratio of Bitcoin market capitalization to annualized dormancy value. The annualized dormancy value is the fiat value of the average dormancy time of each transferred BTC, and its formula is as follows:
Destruction is the value of Coin Day Destruction (CDD), Volume is the number of Bitcoins transferred per block, and Dormancy reflects the average dormancy value of each Bitcoin transferred per block. The average dormancy value for the day is multiplied by the price to get the fiat value of the dormancy time for the day. Multiply the dormancy value’s fiat value by 365 to get the annualized dormancy value’s fiat value. Divide the Bitcoin market cap by the annualized dormancy value of the fiat value, i.e. Dormancy Flow.
If Dormancy Flow is low, the denominator is high, i.e. Dormancy is high. Since Dormancy = the average dormancy value per Bitcoin, either the Coin Day Destruction value is high or the Volume is low. Since the current Coin Day Destruction value is not high (i.e. CDD is not high), the Dormancy is high because the Volume is low, i.e. the market has a low volume of on-chain transactions.
From this, we can conclude that the Dormancy Flow is low because the CDD is not high, that is, the current sellers are selling less Bitcoin, the sellers are holding Bitcoin for a shorter period of time, plus the Volume is not high.
This usually happens at the bottom, when the market is trading low because the giant whales are not selling and the long term holders are not selling. At this point it is almost exclusively small retail investors who are selling Bitcoin, and the volume of selling is not high, which is usually a big bottom performance. We have seen this by looking at the performance of Dormancy Flow, which has historically entered the green range only 6 times, with the previous 5 times being big bottoms.
Chart 18: CDD is low, indicating that the giant whales are not selling Bitcoin and neither are the long-term holders, but mainly the short-term holders and small retail investors are selling Bitcoin.
Chart 19: Dormancy Flow is in the green zone and has only occurred five times in history, all times with large bottoms.
While the market is on the verge of a desperate downturn, the miner community is frantically increasing its Bitcoin holdings. From April 2021 to date, the miner community has increased its holdings by 24,212 Bitcoins, including a significantly faster rate of 5,577 Bitcoins in January alone.
Chart 20: The miner community has recently increased its bitcoin holdings significantly.
Although the price correction is strong, the computing power of the entire network has not been greatly affected, and miners are still actively investing in computing power. The average computing power of the entire network exceeds 183EH/s, setting a record high.
Chart 21: The average computing power of the entire BTC network is around 183EH/s, a record high.
Ⅲ. Afternoon Outlook
The short-term market is still affected by the external macro environment, especially the intensified expectations of the Fed to raise interest rates and shrink its balance sheet, which has led to a large number of liquidity-sensitive positions leaving the market, which has brought a certain amount of selling pressure. At present, the market is still in a weak bottoming state, and the open interest of futures contracts is relatively high, which is a big risk point in the current market.
Despite the subdued market sentiment, we observed a clear divergence in the forces behind the market. Since long-term holders are still accumulating Bitcoin and they are still making some profits. The current market forces that cause heavy selling pressure come from short-term holders, and a large number of short-term holders are in a loss state.
Historically, when the number of short-term holders in a profitable state is close to zero, and the Dormancy Flow is at a lower position, it is usually a big bottom area. Therefore, we need to wait patiently for the market to complete the correction and bottom. Since smart funds continue to enter the market, it just shows that the fundamentals have not deteriorated due to the external macro environment, so we should not be pessimistic in this position. On the market outlook, still maintain an optimistic view.