It is much harder to pinpoint a bottom than it is to identify where we are in a cycle. If you invest on a multi-year time horizon, you’ll weather multiple cycles. So you benefit most from focusing on entry points, accumulating when valuations are attractive, and listening to the data.
What’s the data saying?
[h/t to the the latest NessGraphics drop for the title and header photo]
On Chain Indicators
In the last month, MVRV, a ratio of current BTC market cap relative to cost basis, bottomed at 0.94 and currently rests just above 1. During the March 2020 drawdown MVRV fell to 0.85 and dipped as low as 0.7 in December 2018. A further 9% or 25% drawdown would send MVRV back to those levels.
Unlike MVRV, which measures the value of held coins relative to cost basis, SOPR measures the value of spent coins relative to cost.
Periods when long term holder MVRV and SOPR dip below 1 have been a reliable bottom signal in past bear cycles.
For a bear market to reach an ultimate floor, the share of coins held at a loss should transfer primarily to those who are the least sensitive to price, and with the highest conviction.
Overall, the fingerprint of a widespread capitulation, and extreme financial stress is certainly in place. However, there may still be a combination of both time pain (duration), and perhaps further downside risk to fully test investor resolve, and enable the market to establish a resilient bottom.
Exchanges also saw major outflows, which likely reflected a self custody response to fears of further 3AC contagion. But a corresponding increase in wallets with little to no spending history suggests these coins made their way to long term hodlers who tend to be “least sensitive to price and have the highest conviction”.
MACRO
Given the high but decreasing correlation between crypto market cap and the S&P, we need to continue carefully considering macro headwinds and the possibility of another 20-30%+ downside in equity markets which could “fully test investor resolve.”
On the macro front, we’ve already seen major multiple compression which aligns the forward P/E ratio with its historical average.
However, analysts tend to underestimate the impact of a recession on earnings so we could see prices dip further as earnings expectations dim. For example, JP Morgan recently lowered earnings estimates on 26 internet companies.
The bond market is also flashing warning signs. An inverted yield curve, which happens when the 10 year treasury yield dips below the 2 year, often precedes a recession. It inverted in April when some experts such as Ellen Zentner, Chief Economist at Morgan Stanley, argued:
when we look at factors in the economy that are typically signals of a recession, such as job growth, retail sales, real disposable income and industrial production, we don’t see an approaching recession.
But it just inverted again and while the US added 372k jobs in June (exceeding expectations) and U.S. industrial production grew in May albeit at a slower pace than April (0.2% vs 1.4%), retail sales and real disposable incomes are down since April’s inversion:
Retail sales rose 1% in June and fell less in May than initially believed. But real (inflation adjusted) retail sales have been flat for over a year.
Inflation-adjusted per capita disposable income fell to $45,490 in May, down 3.6% yoy and down 20% since March 2021 when stimulus checks buoyed incomes to record highs.
Meanwhile, inflation continues to climb. The June print came in at 9.1%, which is another 40 year high.
The 10 year breakeven inflation rate and the 5 year, 5 year forward inflation expectation rate are both in the vicinity of the Fed’s target (2%) suggesting many believe they will bring inflation under control.
Alliance Bernstein also makes a case for a return to 2% inflation, a case which rests on the belief, “while we lack visibility on the supply side of the global economy, developments on the demand side are coming into clearer view.”
Lyn Alden isn’t convinced. She first explains why this cycle is different than the 1980’s:
When Paul Volcker famously raised rates to 19% in 1980 to slow down money supply growth, total debt (public and private combined) was 160% of US GDP. Today, total debt is 370% of GDP. So, a much lower interest rate would cause widespread insolvencies and economic contraction.
In 1980, the money supply growth was mainly coming from commercial bank lending, and price inflation was mostly a demographics-driven demand issue rather than a supply issue. Tightening monetary policy was effective at reducing bank lending, and thus effective at reducing money supply growth.
Today, the money supply growth mainly came from fiscal spending, and price inflation is more-so a supply-scarcity issue rather than due to particularly strong demand.
Messari analyst Tom Dunleavy, using FRED data, shows how supply and demand side factors are contributing to inflation, unlike the 1980’s when inflation was primarily caused by excess demand that could be tempered by Fed policy.
Lyn explains why she isn’t convinced tempering demand will be enough to tame inflation:
The two biggest countries [US and China] are actively contributing excess oil supply to the market and/or destroying oil demand, and yet oil is at $110/barrel. If inflation is reduced by reducing global energy usage over the next year (a.k.a. severe recession), while the supply-side problems remain mostly unaddressed, then inflation would be ready to return as soon as demand destruction ceases. […]
Destroying demand in the face of supply constraints is like running away and hiding from a monster in a closet, so the monster just sits outside and waits for you to come out again. Until the monster is actually dealt with, it’s still there, waiting.
We could soon find ourselves in a situation where the Fed, through a combination of rate increases and quantitative tightening, slows the economy and reduces demand-driven causes of inflation.
But given we are in the late phase of a debt cycle, the Fed will reach a point sooner than in prior cases of high inflation where it has to back off unless it’s willing to face widespread insolvencies and economic contraction.
Horizon Kinetics and others believe inflation is here to stay. The Fed won’t be able to raise rates enough to bring inflation under control given the magnitude of today’s debt levels, and the last time they tried reducing the money supply was during the Great Depression.
So it seems like there are at least three possible futures:
1/ modest rate hikes and QT will be enough to tame inflation
2/ the fed is too aggressive and the US is forced to spend over 25% of a shrinking economy servicing debt
3/ the fed will be aggressive but soon realize its inflation target is unattainable without cratering the economy (fed pivot)
A recent Bloomberg article highlights three sources who believe the third scenario is most likely.
Chris Weston, head of research at Pepperstone Group:
the 21 September FOMC meeting could see a major direction change from the Fed. One where it is hoped they will pivot to a more accommodative stance, and this could be the trigger for a bullish turn in risk into year-end
Mislav Matejka, head of global and European equity strategy at JP Morgan:
the risk-reward for equities will start to look more attractive in the second half of the year as the Fed policy becomes more balanced following July and September rate hikes
Christian Nolting, Deutsche Bank AG private bank global chief investment officer
the fed will do faster now and then slow down a little bit
What Does This Mean For Crypto?
If you liked BTC 6 months ago at $45k, you’ll love buying at $20k. And even if dollar cost averaging is your strategy to accumulate crypto exposure, you might consider accumulating at a faster rate now than you would when fewer indicators suggest we are in the trough of a cycle.
That said, there is likely to be more pain in the equity markets and other correlated assets. Crypto has been correlated with a beta >1 suggesting it would fall more than the average stock during a drawdown.
But based on its beta, “two-thirds of the recent decline in crypto prices can be attributed to macro factors, and one-third to a weakening of the outlook solely for cryptocurrencies.” This suggests “only changes in the outlook of the crypto industry relative to what is already expected will bring changes to prices.”
Warranted concerns about (and liquidations caused by) 3AC’s insolvency and the contagion left in its wake can at least partially explain the excess crypto drawdown relative to what can be explained by its beta.
The modest bull case for crypto from here is markets will continue to value it like a tech stock in which case valuations are attractive and likely to improve towards the end of the year.
The aggressive bull case accounts for healthy closure to the 3AC unwind, the ATH in stablecoin balance rotating back into active positions, a fed pivot by end of year, and other narratives strengthen that may not be fully reflected in the current price:
The MERGE
Ethereum becomes environmentally friendly*. ETH staking yields increase. and ETH becomes deflationary.
*ESG may be a scam, but as Lucas Campbell acknowledges, ESG mandates can act as a significant barrier for large-scale investors looking to allocate capital towards crypto.
The Metaverse Onboards Millions to Crypto Ecosystem
Phil Sanderson, managing director of Griffin Gaming:
in many ways I see the introduction of blockchain into gaming as transformative as free-to-play gaming was to mobile
- The global gaming market is projected to reach a staggering $256 billion of annual consumer spend in 2025. One-third of the world’s population, 3.1B players, play games almost an hour a day. Consumers spent an average of 5B+ hours and $1.7B+ per week on mobile games in the first half of 2021. [Sources in order: Newzoo, DFC Intelligence, App Annie]
[Coindesk, May 2022]: Over $3 billion committed by venture funds and gaming industry giants into Web3 gaming or metaverse projects since mid-April.
- Epic raises $2B to build kid friendly metaverse
- a16z debuts $600M games fund
- Framework ventures secures $400M blockchain gaming fund
- Whitestar capital raises $120M for metaverse investments
Crypto Adoption in the Developing World
IMF [July 2022]:
crypto adoption is greater in countries with higher digital penetration and remittances as well as weaker macroeconomic fundamentals—such as high inflation
WSJ [June 2022] Rising Inflation and Interest Rates Heap Pressure on Emerging Markets
Energy Industry Embraces Crypto Mining
crypto mining also offers energy companies intriguing opportunities to create new revenue streams, improve demand response and even accelerate the expansion of the long-term renewable resource base.
Exxon Weighs Taking Gas-to-Bitcoin Pilot to Four Countries:
Oil and gas producers are increasingly under pressure from regulators and investors to reduce their carbon footprint to help combat climate change. That includes reducing the amount of gas they flare. At the same time, there is a rush of miners trying to use cheap gas in oil producing fields to fuel their operations.
ConocoPhillips Is Supplying a Bitcoin Miner With Gas From Bakken:
The gas supplied to the pilot project, owned and managed by a third party, would otherwise be burned into the atmosphere in a process known as flaring