How Volatile Is Ethereum?

Summary

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

Investment View (next 1-3 years): We like to hold ethereum.

Macro Signals

• Inflation is at 40-year highs.
• The ethereum and equity correlation is now 90%.
• Risks remain around the Russia-Ukraine war.
• Recession probabilities are still elevated.
• The macro backdrop remains bearish.

On-Chain/Flow Signals

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

Overall View

• With the macro backdrop bearish and on-chain/flow metrics slightly bearish, our overall signal is slightly bearish ethereum (Chart 1).

Macro: Volatility at Lowest Levels Since Late 2020

Crypto markets are known for being volatile. Wild swings in price are common, but how does current volatility compare with that of the past? We examine trading volumes and volatility to assess how markets have been quieter than in recent history.

Ethereum’s trading volume as a percentage of market cap has been falling since around June 2021 (Chart 2). Its market cap currently sits at around $370bn – comparable to levels seen around May and September last year. But trading volumes were higher back then, too. One explanation could be that investors are trading less due to the bearish macro backdrop. Crypto seems to trade more like a risky asset, and the ethereum and NASDAQ correlation currently sits at 90%.

Ethereum’s 30-day annualised volatility is currently 47% (Chart 3). These are some of the lowest levels since the end of 2020. Notably, ethereum prices began to rally when volatility hit similar levels back in 2020 – this will be an important metric to monitor going forward. You may ask: should I invest in ethereum?  And we note that historically ethereum has been more volatile than bitcoin, perhaps since bitcoin is a more mature cryptocurrency. But volatility between the two is converging recently. (However, volatility could rise again around the upcoming Merge, which will represent a triple halving event for ethereum.)

On-Chain/Flow: ETF Outflows Return

We have one bullish signal this week:

• Significant bias for exchange outflows persists.Significant bias for exchange outflows.

There are three bearish signals:

• ETF outflows return.
• Futures open interest decreasing and a trend for negative funding rates.
• Realised losses on-chain.

Lastly, there are three neutral signals:

• Longer-term HODLers are quietly accumulating.
• Hash rate continues to rise, but miner revenues are down. 
• Ethereum TVL in DeFi remains well above competing protocols, but its week-on-week increase has been the smallest.

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

Institutional Demand: Bearish Ethereum

Our preferred metric to track institutional demand is flows into ethereum ETFs. The past two weeks saw ETF outflows return – this is bearish ethereum.

Demand for Liquidity and Exchange Activity: Bullish Ethereum

In the short term, a bias for outflows from exchanges exists. Net 177,000 and 238,000 coins left exchanges over the last seven and 14 days, respectively (Chart 5). This has been a noticeable bias for outflows that has persisted since around March onward. This is bullish ethereum.

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 is in deeply negative territory (Chart 6). Lastly, just 17% of the total coin supply currently sits on exchanges. This is bullish ethereum.

Overall, the continual drainage of coin supply from exchanges is bullish ethereum.

Futures Activity: Bearish Ethereum

Futures open interest is currently $8.2bn, down 12% over the past 14 days (Chart 7). Around $6.6bn (80%) of this comes from perpetual futures contracts.

Perpetual funding rates reveal the directional bias of investors. On average, they have been in a downtrend since 12 April – though this seems to be changing more recently (Chart 8).

Overall, futures open interest mostly sits in perpetuals, which have had a bias for negative funding recently. This is bearish ethereum.

HODLers: Neutral Ethereum

The 30-day moving average of the coin days destroyed (CDD) metric still shows little movement of older coins (Chart 9). Splitting HODLers into those who have held for under one year and those for one year or more reveals older hands are quietly accumulating (Chart 10). Over the past 14 days, the 1y+ vintage moved from 57% to 58%, which suggests around 1% of the coins in the <1y vintage matured into the 1y+ vintage.

On balance, we view these HODLer metrics as neutral ethereum.

Investor Profit and Loss: Bearish Ethereum

The percentage of circulating supply in profit (PSIP) is 79% (Chart 11) – down 8pp over the past 14 days. Net unrealised profit/loss (NUPL) is 0.47 (47% of market cap) (Chart 12) – down 5pp over the past week. SOPR has been in a broader downtrend since the beginning of April (Chart 13), suggesting a bias for realised losses on chain.

Mining Activity: Neutral Ethereum

The hash rate continues its uptrend and sets new all-time highs (Chart 14). It is currently up 3% over the past 14 days and 14% year to date. However, miner revenues have been falling sharply on average – they down 42% over the past 14 days (Chart 15). Together, these metrics are neutral ethereum.

DeFi: Neutral Ethereum

DeFi markets have been leading gains recently. Our latest Crypto Index Tracker revealed our DeFi Index is up the most (8%). The total value locked (TVL) in DeFi across all protocols is currently around $215bn – this is up 3% over the past seven days. We have seen an increase in TVL across all the top five chains (Charts 16 and 17) except Binance. However, ethereum’s TVL has only increased 1%. But it is still the dominant player in the space with $117bn TVL, eclipsing the next highest, Terra, with $30bn TVL. On balance, we view this as a neutral signal for ethereum.

Bottom Line

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

1. Institutional demand: returned ETF outflows. Bearish ethereum.
2. Liquidity demand: a large bias for outflows from exchanges. Bullish ethereum.
3. Futures activity: decreasing futures open interest and negative perpetual funding rates. Bearish ethereum.
4. HODLer behaviour: longer-term HODLers quietly accumulating. Neutral ethereum.
5. P&L of investors: decreased profitability of the coin supply and a bias for realised losses on-chain. Bearish ethereum.
6. Mining activity: the hash rate registers new all-time highs, but miner revenues are down significantly. Neutral ethereum.
7. DeFi activity: TVL increasing across all top-five chains except Binance, but ethereum’s TVL only increasing 1% week on week. Neutral ethereum.

Appendix

Institutional Demand

Perhaps the largest institutional vehicle for ethereum is the Grayscale ETHE Trust, with over $27bn in assets. It invests solely in ETH, and so many investors, notably institutional, who cannot hold ETH directly can get exposure through investing in Grayscale. Consequently, if the trust trades at a premium to ETH 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 ETH, whether through ETFs or directly holding ETH. 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 ETH directly. We put more weight on ETF 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 ethereum 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 ethereum 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 ETH. We define long-term or staunch HODLers as those who bought ETH 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 ETH supply in profit. That is the percentage of circulating ETH 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 ETH 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 ETH (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.

DeFi

We track the total value locked (TVL) in decentralized finance (DeFi) – the sum of all assets deposited in DeFi protocols, many of which use ethereum as the underlying protocol. The more DeFi products are created, the more ethereum gets locked into the DeFi system and removed from the broader market. This reduction in supply should lead to higher ethereum prices.

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.