Bitcoin Underperforms Around Tax Day

Summary

Trading View (next 2-4 weeks): We like to be bearish bitcoin.

Investment View (next 1-3 years): We like to be long bitcoin.

Macro Signals

• Inflation is at 40-year highs.
• Investors digest hawkish Fed minutes.
• Risks remain around the Russia-Ukraine war and a potential recession.
• The bitcoin and equity correlation is over 80%.
• The macro backdrop moves from neutral to bearish.  

On-Chain/Flow Signals

• A mixed bag with one bullish signal, three bearish, and two neutral.

Overall View

• With the macro signal moving to bearish and on-chain/flow metrics also bearish on balance, our overall signal is bearish bitcoin (Chart 1).

Macro: Tax Day on the Horizon

This year, Tax Day – the day individual income tax returns are due to be submitted to the federal government in the US – falls on 18 April. Does this have any implications for bitcoin, and could it (partly) explain the recent sell-off? We examine bitcoin performance around Tax Day in 2020 and 2021.

In 2020, Tax Day was on 15 July, and in 2021 it was on 17 May. Around this period, specifically two days before and two days after, bitcoin underperformed significantly (Charts 2 and 3).

April has been a choppy month so far for bitcoin and crypto in general – could we be seeing the same ‘Tax Day effect’ play out? Tax Day is on 18 April this year, and prices have been selling off throughout April so far. This could be driven by sell-side pressure from traders liquidating positions to pay their tax bills. This is by no means a standalone cause, but it is likely contributing to the downward moves, and we will be watching closely.

On-Chain/Flow: ETF Outflows Return

One metric is giving a bullish signal this week:

• Exchange flows have a bias for outflows.

There are three bearish signals:

• ETF outflows.
• Futures open interest declining and perpetual funding rates back in negative territory.
• Reduced profitability of the coin supply and realised losses on chain.

Lastly, there are two neutral signals:

• HODLers are still accumulating.
• Hash rate rises but miner revenues fall.

On balance, on-chain/flow metrics are giving a bearish signal. Here are the details of each metric (with explanations in the Appendix).

Institutional Demand: Bearish Bitcoin

Our preferred metric to track institutional demand is flows into bitcoin ETFs. We are seeing the largest outflows year to date (Chart 4). This is bearish bitcoin.

Demand for Liquidity and Exchange Activity: Bullish Bitcoin

In the short term, a bias for outflows from exchanges exists. Net 12,000 and 37,000 coins left exchanges over the past seven and 14 days, respectively (Chart 5). There have been net outflows for 10 out of the last 14 days. Additionally, only 13% of the entire bitcoin supply currently sits on exchange addresses. This is bullish bitcoin.

Longer term, the 30-day change in the exchange balance reveals fluctuations in the supply held on exchanges month on month. Relative to the last 30 days, this metric continues to show a significant decrease in the exchange balance. This is bullish bitcoin.

A bias for exchange outflows in the short term and the longer term is bullish bitcoin.

Futures Activity: Bearish Bitcoin

Futures open interest is trending down – it is currently $15.6bn, down 5% and 9% over the past seven and 14 days, respectively (Chart 7). Around $10.1bn (65%) of this comes from perpetual futures contracts.

Perpetual funding rates reveal the directional bias of investors. They have spent most of the past two weeks above 0% (Chart 8). However, they have returned to negative territory, which suggests leveraged traders are paying a premium to keep open short positions.

Overall, futures open interest is falling, and perpetual funding rates are negative. This is bearish for bitcoin.  

HODLers: Neutral Bitcoin

The 30-day moving average of the coin days destroyed (CDD) metric is trending down (Chart 9). Looking at the 1y+ revived supply metric confirms this – it is also trending down over the same period (Chart 10). Finally, splitting HODLers into those who have held for under one year and those for one year or more confirms most (64%) of the coin supply is still in an accumulation phase (Chart 11).

We experienced some older hands distributing their coins into market strength as prices were rising. More recently, as prices declined, we are seeing increased HODLer dormancy. On balance, we view these HODLer metrics as neutral for bitcoin.

Investor Profit and Loss: Bearish Bitcoin

The percentage of circulating supply in profit (PSIP) has plummeted to 67% (Chart 12). That is down 13pp over the past 14 days. Net unrealised profit/loss (NUPL) is 0.4 (Chart 13). That is down 10pp over the past 14 days – we still want to see a sustained break above 0.5 for this metric for a bullish conviction. Lastly, SOPR is displaying a bias for realised losses on chain with values below one recently (Chart 14).

Overall, the reduced profitability of the coin supply and realised losses on chain are bearish for bitcoin.

Mining Activity: Neutral Bitcoin

The hash rate is up 4% over the past 14 days and remains near all-time highs (Chart 15). The recent decline in prices has hit miner revenues – they are down 15% over the past 14 days (Chart 16). Together, these metrics are neutral for bitcoin.

Bottom Line

We have introduced a framework for understanding the flow and microstructure dynamics of bitcoin markets. The six key metrics are:

1. Institutional demand: resumed ETF outflows. Bearish bitcoin.
2. Liquidity demand: long-term and short-term bias for exchange outflows. Bullish bitcoin.
3. Futures activity: futures open interest trending down and negative perpetual funding rates. Bearish bitcoin.
4. HODLer behaviour: most of the coin supply is accumulating and less movement of older coins. Neutral bitcoin.
5. P&L of investors: decreased profitability of the coin supply and realised losses on chain. Bearish bitcoin.
6. Mining activity: hash rate increasing but miner revenues decreasing. Neutral bitcoin.

Appendix

Institutional Demand

Perhaps the largest institutional vehicle for bitcoin is the Grayscale Trust, with over $27bn in assets. It invests solely in BTC, and so many investors, notably institutional, who cannot hold BTC directly can get exposure through investing in Grayscale. Consequently, if the trust trades at a premium to BTC prices, it may imply ‘excess’ demand from institutions, but ‘excess’ supply if it trades at a discount. Alternatively, the discount may suggest investors have found other ways to get exposure to BTC, whether through ETFs or directly holding BTC. We therefore focus on how the discount has changed in recent months to gauge investor interest.  Alternatively, investors may be using other vehicles to get exposure such as ETFs or holding BTC directly. We put more weight on BTC flows than the Grayscale premium.

Liquidity Demand

Another measure of cryptocurrency bullishness is whether investors are willing to hold it in illiquid form (e.g., a private wallet) or prefer a liquid form (e.g., on an exchange). The former would suggest investors are bullish, as they are comfortable with being unable to sell easily. Conversely, holding it in liquid form would suggest investors are bearish, as they prefer being able to sell easily.

Therefore, large flows onto crypto exchanges would suggest investors want to convert their holdings to a more liquid form, implying more bearishness.

Futures Activity

We track the growing market of bitcoin futures. 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 expiry date so never settle in the traditional sense. Consequently, we can interpret funding rates as the cost of holding bitcoin via perpetual futures. Positive funding rates imply longs pay shorts and vice versa. We use it as a proxy for trader sentiment since a positive funding rate implies traders are paying a premium to keep open long positions.

HODLers

In our introductory 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 extended periods are die-hard adherents.

We can categorise HODLers by the length of time they have held BTC. We define long-term or staunch HODLers as those who bought BTC five or more years ago and have held it ever since, medium-term HODLers as those who bought 6-12 months ago, and short-term HODLers as those who bought 3-6 months ago.

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

Profit and Loss

• The percent supply in profit (PSIP). This tracks the share of circulating BTC supply in profit. That is the percentage of circulating BTC whose current price is higher than when it was last transacted (movement).
• Net unrealized profit and loss (NUPL). This is the ratio of unrealised profits over total market capitalisation. While PSIP just focuses on whether BTC coins are in profit or not, the NUPL focuses on the size of profits. So, we could have a situation where the PSIP is low – that is, a low share of supply is in profit – but the NUPL could be high if the size of those profits is large.
• Spent output profit ratio (SOPR). While PSIP and NUPL focus on unrealised profits or mark-to-market, this measure focuses on realised profits. SOPR is the realised value of a transaction divided by the value at initiation (or creation) – more simply, price sold divided by price paid. If SOPR is above one, investors in aggregate have realised profits, while below one means they have realised losses. In broad uptrends, SOPR spends a significant amount of time above one, whereas the opposite is true for broad downtrends.

When SOPR is rising, sellers are increasingly realising profits. The opposite is true when it is falling. A price rally with a flatter SOPR trend indicates investors are not yet realising their profits with the rally. The reluctance of investors to sell and realise a profit may be because they believe the price will increase further, which would be bullish. At the same time, more profit taking could precede a correction. Typically, buying as SOPR moves around one during bullish periods has proven to be a profitable strategy.

Mining Activity

Computing power is central to the crypto market. Miners use advanced computing hardware to solve complex problems that confirm BTC (and other coins) transactions 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 so the computing performance required to solve them is the hash rate. The higher this rate, the more computing performance is needed to maintain the blockchain. The rate can fluctuate depending on 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 in the applications of machine learning, deep learning and alternative data for predictive modelling of financial markets.