Monthly: Decoding the rally

This month, we look at some key on-chain indicators that may help investors put relative value into context. These include inflation, velocity, and transactions per capita, among others

February 2, 2023

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At a glance

The crypto rally in January shows that there is still some healthy appetite for digital assets despite the destabilizing developments of 4Q22.

Key takeaways

  • Post-FTX, on-chain data suggests users have withdrawn BTC and ETH from exchanges possibly to self-custody. This has created a supportive supply-demand dynamic in the short term.
  • We also discuss our views on the risks of ETH sell pressure ahead of the upcoming Shanghai Fork on Ethereum in March.

Written by

  • David Duong, CFA - Head of Institutional Research


Initially perceived as a bear market rally driven by short covering, cryptocurrencies seemed to have built some upward momentum towards the middle-to-end of January, driven by a mix of endogenous and exogenous factors. Technicals helped, for example, as on-chain data reveals that substantive bitcoin and ether outflows from exchanges in November and December may have taken many tokens out of circulation. Users pursuing self-custody solutions may be unlikely to bring these assets out of cold storage anytime soon, in our view, providing favorable supply-demand dynamics in the short term. 

One peculiarity about the rally in January was the outperformance of many altcoins over blue-chip names like BTC and ETH.  We think some of that strength was driven by idiosyncratic factors unique to the individual projects, but in some cases, the extent of the appreciation outstripped expectations.

With that in mind, we introduce some on-chain indicators in this report that may help shape investment views on relative value for the asset class. These include (1) velocity (a measure of how quickly tokens circulate in a given ecosystem based on the amount of transactions settled on a network), (2) accrued gas fees viewed in standard deviation terms to contextualize historical network activity, (3) the ratio of transactions to active wallets (i.e. the number of transactions per capita) alongside traditional metrics like inflation and total value locked, among others.

Performance recap

What ostensibly started as a bear market rally for cryptocurrencies in early January eventually gained some momentum towards the middle-to-end of the month. Both bitcoin and ether convincingly breached their 200d moving averages to the topside, which may have been a catalyst for some short covering – reflected in a decline in futures open interest. A weaker USD trend over the last two months helped, as long BTC and ETH positions tend to be an increasingly easy way to express a short USD view. We also believe market players may be pricing in the greater likelihood of a US economic soft landing scenario as well. Regardless of why, the outsized move in the asset class shows that there is still some healthy appetite for cryptocurrencies despite the destabilizing developments of 4Q22. 

Technical factors may have played a part here, in our view. A lot of assets are currently locked up in the custody of different government authorities, for example. But also, on-chain data indicates there have been significant bitcoin and ether outflows from centralized exchanges in recent months. Exchanges started registering net bitcoin outflows in late October 2022 but accelerated in November, totaling 165k BTC (US$3.0B) through January 2023. Net ether outflows, on the other hand, were concentrated only in November and December totaling 4.2M ETH ($5.4B).

We believe this partly reflects the movement towards self-custody that we had discussed in our 2023 Crypto Market Outlook. Indeed, anecdotal evidence has linked the rise in hardware wallet sales to the fallout from the FTX bankruptcy. This suggests many cryptoassets have been taken out of circulation for the time being. We think this may likely continue providing a supportive supply-demand dynamic for cryptocurrencies, at least for a few additional months.

1. Significant BTC exchange outflows leaves less supply in the system

BTC exchange flows
Screenshot 2023-02-01 at 2.34.49 PM

Meanwhile, securing funding - while still challenging - appears to be less onerous in this space, which may also have increased the scope for investment last month, at the margin. Maximum CeFi financing rates on BTC and ETH were both close to 12% in early December 2022, whereas these have moderated to 8.5% and 7.5% respectively as of end-January. Minimum CeFi financing rates for these assets are currently around 3.5%.

Looking ahead

The short term crypto outlook going forward will likely depend on the macro backdrop in our view with market players trying to parse the odds of no recession, a shallow recession, or a deep recession. Labor market data should drive expectations there alongside leading inflation indicators. With the US Federal Reserve quickly approaching the end of its tightening cycle, we think it’s more likely that market sentiment could be risk-on in the very near term – barring any major negative economic surprises.

Meanwhile, we anticipate a more realistic deadline to deal with the US debt ceiling to come in early June, after the $31.4T limit was breached in late January. Extraordinary measures have been taken to meet the country’s fiscal obligations for the time being, but that also means the US Treasury can’t issue any new debt until a revised debt ceiling is set. That limits the debt supply on secondary markets relative to presumably flat demand. That should keep rates anchored, theoretically supporting risk assets in the short term, in our view. But we expect market volatility to pick up towards the end of 2Q23, particularly if the US experiences any economic slowdown.

Something surprising about this crypto rally is that while BTC and ETH outperformed peers in the early stages of the recovery, many altcoins have rapidly caught up and overtaken these blue-chip names. Some of the appreciation has been driven by idiosyncratic factors unique to the individual projects, and certainly, it would be hard to see such price moves if it wasn’t for the benign market environment. 

But we think it’s worth looking at some comparative market metrics to see what we might be missing on relative value. For our purposes, we look at the top ten layer-1 tokens by market capitalization and attempt to capture fundamentals like the growth in on-chain activity, value locked up in these projects, and respective adoption rates.

Table 1. On-chain indicators for top 10 networks by market cap (January 2023)

In table 1, we look at the following indicators:

  • Monthly return. This captures the total increase or decrease in spot prices on a month-on-month basis.
  • Inflation. This metric reflects the increase or decrease in the circulating supply of a given cryptoasset. After we calculate the monthly inflation rate, we multiply it by 12 to annualize it.
  • Total value locked (TVL). We track the amount of cryptoassets locked on these networks’ decentralized applications in USD terms, using data from DeFiLlama.
  • Change in TVL. We look at the expansion or contraction of TVL in month-on-month terms. Note: because the TVL is based in USD terms, this metric includes price appreciation.
  • Transaction fees. We contextualize the total transaction (gas) fees collected by network miners (validators) as a proxy for the relative growth in network activity compared to its own history. This is calculated using native token amounts and measured as the number of standard deviations between (1) the average of the daily fees earned over the last 30d versus (2) the average of the fees earned over the previous 365d.
  • Velocity. This is a measure of how quickly an asset is being circulated within an ecosystem. Based on Irving Fisher’s fundamental equation on monetary theory (MV=PT), we measure this as the 30d total of on-chain transaction volume (i.e. the total monthly amount settled on a network) in native token terms divided by the circulating supply of a token.
  • Transactions per capita. This ratio examines the number of transactions executed on a network relative to the number of active addresses. That is, we are attempting to assess network value not just through the number of active wallets but also by how much activity those wallets generate. This is calculated as the total transactions in a given month divided by the 30d average of active wallets.
  • Market cap vs wallets ratio. This is an estimate of the extent to which the value of a network is rising or falling with respect to the number of active participants over the last 30d. This is an equivalence measure to Metcalfe’s Law which defines value in proportion to the number of users in a network. Higher percentages may suggest that the value of the network may be outpacing the actual network usage.
  • Supply in circulation. For cryptocurrencies with a fixed (vs dynamic) supply, we want to know how many of those tokens are in circulation to evaluate the liquidity and market saturation of that particular asset.

Stray observations

Looking at this table, we notice a few stray observations:

  • Some month-on-month growth metrics may overstate their significance as those indicators tend to start from a low base. TVL is a good example of this, as the majority of value (59.4%) on DeFi and dapps is disproportionately locked up on Ethereum compared to other networks.
  • Supply growth (inflation) of a token is an important metric to consider, but it’s prudent to note that some of these assets are deflationary by design. This is the case with BNB, which will burn a portion of its supply every quarter until it reaches 100M tokens, which explains its high annualized deflation rate of 15.5%.
  • Bitcoin supply has seen a deceleration in terms of its velocity from an average of 3.2 in October and November 2022 to 1.2 as of January. In our view, this corroborates our theory that more BTC is being locked up in cold storage. That is, more bitcoin are being taken out of circulation rather than being used for transactions on the network.
  • Meanwhile, Litecoin (LTC) and Cardano (ADA) exhibited the highest turnover among these assets last month at 4.4 and 9.7 respectively. Cardano’s velocity in particular picked up from 8.9 in December.
  • There was evidence of activity deceleration on BNB Smart Chain (BNB) as transaction fees are 1.35 standard deviations below the 1y rolling average. The number of transactions executed per active active wallet also declined 24% from the previous month.
  • Meanwhile, Tron (TRX) saw an increase in the amount of fees collected, which was 1.17 standard deviations above the rolling 1y average. The number of transactions per active wallet increased by 13.5% last month.
  • The value of Polkadot (DOT) meanwhile had a 145% MoM increase in January with respect to the level of actual active addresses on the network compared to an average of 45% among the peers measured in this table.

ETH: Shanghai Fork cometh

Finally, the eagerly awaited Shanghai Fork is coming in March, which will enable withdrawals for ETH stakers. Some investors are concerned about the potential sell pressure that could result as previously illiquid staked ETH are unlocked by validators looking to capitalize on rewards. We think it’s more likely that ETH could strengthen or range trade into the event. That is, we believe that the ability to stake and unstake freely may actually encourage more users to become validators, as it removes a key obstacle for any users who were interested in staking but were concerned about the liquidity versus yield tradeoff. Moreover, there are several mitigating factors that investors should consider.

2. Liquid staking balances for ETH by provider

Liquid staking balances
Screenshot 2023-02-01 at 3.00.28 PM

First, many validators who want or wanted to exit their positions have (had) the ability to use liquid staked tokens to execute this. Second, liquid staked tokens represent 40% of the 16.3M ETH currently staked on the Ethereum network, and many of those receipt tokens are utilized in decentralized finance vehicles that cannot easily be unwound. Third, we believe that the group that is at greatest risk of withdrawing are independent validators who are not using a third-party platform (staking pools). However, this group represents less than 30% of all staked ETH. Plus, many of these users were willing to become validators despite little to no visibility on their ability to eventually exit their positions.

Thus, unless the macro environment presents additional complications, we would expect this event to be relatively benign for price action.


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