Ecoinometrics - Market sentiment

July 21, 2021

Jul 21, 2021

With Bitcoin we have all this on-chain data that can be used to get an accurate picture of the state of the network. But the big problem is to know what to do with it.

How about using some simple metrics to gauge the market sentiment?

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Market sentiment

Alright, so you can do a lot of things with on-chain data.

You can do transaction forensics to try to uncover what individual entities do on the network. I guess that's interesting if you are the tax authorities… That's also interesting if you are trying to find coins that are going to make their way to the BTC/USD market with a potential impact on the price. I'm sure there is some alpha to be found there but technically this is no easy task.

You can analyze how different entities react to some key price levels. You probably need only aggregate data for that and it is definitely something valuable if you are doing short term trades.

But since we are new to this on-chain analysis, there is something that's probably even simpler: look at the coin accumulation trends to try to gauge the market conditions.

Without overthinking it you might guess that:

When addresses accumulate coins they feel bullish about the market.
When addresses offload coins they feel bearish about the market.

If we break down the addresses on the Bitcoin network by the amount of coins they control, we can use a scale that goes from small fish to whales:

- Addresses controlling less than 1 BTC (small fish).

- Addresses controlling 1 to 10 BTC.

- Addresses controlling 10 to 100 BTC.

- Addresses controlling 100 to 1k BTC.

- Addresses controlling 1k to 10k BTC (whales).

So as an example, if we see that the addresses controlling less than 1 BTC are accumulating coins in aggregate, we can interpret it by saying small fish are bullish on the market.

Now of course there are some caveats.

First, this approach does not tell us who controls what. We are working with addresses not entities.

Example, all else being equal, some whale might decide to move coins to a small address they control and we would see something that looks like an accumulation for the small fish. In fact it is just some reorganization that might need to be interpreted differently.

But for big enough moves we should be able to spot those kinds of transfers by observing some offloading on the whales side. As long as we are careful this can be sorted out.

Second, we also need to be mindful of the fact that not all buckets contain the same amount of coins in aggregate.

E.g. as of today whales control about 5m BTC while the small fish only control 1m BTC. That means we need to be careful when comparing percentage changes between different categories. A 1% accumulation in the whales category is 5 times larger in BTC terms than a 1% accumulation in the small fish category.

See the breakdown below.

But keeping those adjustments in mind, associating accumulation to bullishness and offloading to bearishness should make sense in most cases.

Ok, so can we apply this logic to gauge the current market sentiment?

Turns out we can for the simple reason that pretty much all the categories seem to share the same sentiment these days: bullish, or at least not bearish...

Check out the chart below. For the last three months we show the price action (bottom panel) and a heat map of the 30 days change in coins held by each address group. Colours on the blue side correspond to coins offloading. Colours on the red side correspond to coins accumulation. Neutral is at the border between yellow and orange.

Have a look.

Even though Bitcoin has been slowly sliding towards the $30k level over the past couple of weeks most address groups are still accumulating.

Sure, we are not talking about crazy levels of accumulation. Mostly 1% change over 30 days. But if it continues like that, those 1% will compound…

So while it doesn’t look like a bet on the imminent start of a parabolic move, it does look like most entities are happy to bet on higher prices. That counts as a bullish sentiment in my book.

Now the question is: does this kind of market sentiment necessarily lead to rising prices?

We’ll try to answer that question next week by looking at the history of those coin accumulation trends during the past bull and bear markets. So don’t forget to subscribe if you don’t want to miss that.

CME Bitcoin Derivatives

Given the price action, or maybe I should say the lack of price action, there is not much to expect from the futures.

The daily traded volume remains very low and while we did see the open interest climb back to 40k BTC, this is nothing earth shattering.

More puts have popped up at the $29k strike. This shows that traders are cautious about a breakdown below the $30k level. But except for that the options market is very quiet.

Looking at the data coming out of the Commitment of Traders report, it is clear that the retail crowd is giving up on the bull market. All hope is gone and some have even turned short. The result is a level of net positions which is almost as low as during the crash of March 2020.

For the smart money the story is different. The spread between spot BTC and the futures isn’t what it used to be so there is less demand for the shorts coming from the basis trade. Still we are at 3 times the amount of short contracts when compared to the start of 2020.

So who knows, it could be that some of the smart money is actually betting on lower prices. Or maybe Elon Musk put up some shorts while preparing some Bitcoin tweets…

Let’s see where it goes.