With price down over 50% from May 2021 All-time-highs some analysts are now declaring Bitcoin is either in, or is approaching, a Bear Market - characterised by falling prices and pessimism. But what factors define a Bear Market, how long will it last and when might light appear at the end of this bearish tunnel?
One of the most fundamental things to learn about cryptocurrency markets is that they are largely driven by sentiment. They are new technologies looking to disrupt existing networks, one of which happens to be the government.
They are also new types of business proposition, with untested business models and - in many cases - no current revenue streams. This makes it hard to address their potential using familiar means such as fundamental analysis.
So the market is largely measuring the likely path to adoption based on perception rather than hard data.
When negative perception dominates, a Bear Market develops - read this article on the origin of the terms Bear and Bull Market. There is no specific definable point when this happens, it is a cumulative process which simply gathers momentum, and becomes self-fulfilling as negative interpretation feeds back on itself, becomes overwhelming.
In the current context, negative sentiment might be traced back to Elon Musk’s tweet reversing Tesla’s position on accepting bitcoin as a payment method, due to concerns about the environmental impact of Bitcoin mining.
That was quickly followed by a slew of bad news from China regarding the closing of mining operations and the enforcement of long standing policies banning cryptocurrency.
Though there was positive news from El Salvador, the impact of Nayib Bukele's decision to adopt Bitcoin as legal tender, was far less clear by comparison.
It is possible to do sentiment analysis by scrapping Bitcoin references on Twitter or Reddit and classifying the adjectives used. There is even a simple Fear & Greed Index that tries to boil down sentiment in the market to a simple emotional expression, which as of June 28th, reflects the extreme fear in the market, but are there more objective measures that another crypto winter is coming?
The most obvious indication of negative sentiment is selling, so logically any measure of an intention to sell is also a powerful leading indicator of pessimism around price. Measuring the flows of bitcoin to exchanges - which facilitate selling - should therefore act as a useful proxy.
This data is relatively reliable because the addresses of exchanges are known, the data is publicly available via the Blockchain and the logic is sound - money flows in to exchanges when investors want to offload, and out when they want to hoard.
There was a much reported quote from legendary investor, Stanley Druckenmiller, taken from a call he had from fellow billionaire, Paul Tudor Jones:
Do you know that when Bitcoin went from $17,000 to $3000, 86% of the people that owned it at $17,000 never sold it?
Druckenmiller compared bitcoin holders to religious zealots, and was clearly impressed by the strength of their faith. That faith, however, has its limits, and measuring it gives a good indication of sentiment. The best way is to analyse what are known as dormant addresses.
The term is pretty much self-explanatory. A dormant address is one where the balance has remained unspent for a significant length of time. When there is a noticeable shift in the number of dormant addresses and/or the average length of time that addresses remain dormant, this can signal a change in sentiment.
There are many other measures of the zeal of Bitcoin’s hardcore hodlers, each of which would provide indicators of whether the Bears or the Bulls are in the ascendency. Here are few popular ones but look at Glassnode or Willy Woo if this interests you:
Illiquid Supply Change - Also known as the 'Rick Astley effect' because it tries to measure whether Bitcoin is moving to those who, based on address age/behaviour, are 'never gonna give Bitcoin up'. Recent indicators are positive in that regard.
Market Value to Realised Value Ratio (MVRV) - This is a good measure of Bitcoin’s hodler mass. It divides the current market capitalisation of Bitcoin (Total supply*price) by the value of coins the last time that they moved (Realised Value). A number above 3.7 suggests the markets is overvalued and something approaching 1, undervalued. The current MRVR ratio is hovering around 1.6.
Long Term Holder Net Positions - This measures the profit or loss of addresses that have held Bitcoin long term. This has been turning positive as weak hands are flushed out.
Spent Output Profit Ratio (SOPR) - This may sound complex, but is just measuring the value of coins that have been moved and the ratio of the price when the UTXO was created against when it moves. I value above 1 is Bullish as coins are being sold for a profit, a value below 1 is Bearish, and that is where the SOPR ratio has been sitting as of mid-June.
As an extension to the observation of increasing flows to exchanges, monitoring the movement of bitcoin from the Miners that support the entire network to exchanges, is also indicative of negative sentiment.
Like farmers anticipating a harsh winter, Miners will anticipate a decline in price by selling bitcoin reserves they hold. While bitcoin’s price is variable, Miners have fixed costs priced in fiat - plant, machinery, energy. They will try and get ahead of any downward trend by selling in advance.
The same logic applies to all businesses that hold bitcoin or crypto treasuries - in other words bitcoin reserves. This has been highlighted as a lesson learned from the last bear market when ICOs burst on the scene, and saw their tokens rise dramatically in price, but for a very short time.
When the tide goes out you find out who's been swimming naked,. In crypto the signs of a turning tide mean that those people who don't want to be exposed take matters into their own hands.
Many didn’t capitalise quickly enough to build a war chest that could see them through the Bear cycle that followed - a lot simply folded. Those lessons will have been learned, so monitoring the selling behaviour of crypto projects will give a good insight into their own sentiment about where the market is going.
Signs of this might be attributed to what have been termed 'soft rugs'. A rug pull is crypto slang for a particular form of malicious exit strategy in Defi, where the value is sabotaged by the withdrawal of liquidity pools or buy support; essentially starving the project of oxygen. The soft version is where founders - feeling the Bearish pressure - just pull out their tokens, otherwise leaving the project untouched.
When we talk about the impact of sentiment on price, it is generally in the context of what is known as spot price - literally the price you can buy or sell bitcoin on the spot. But the market for bitcoin has expanded massively over the last five years with derivatives and futures - the latter are another valuable indicator on the Bear Barometer.
As their name describes, Futures enable investors to speculate on what the price of a share, commodity - or in this case - bitcoin, will be at a certain point in the future. Futures are sold as contracts with monthly expiry, generally available up to 6 months into the future. As such, they represent an expectation of where price will be rather than where it is.
So looking at both the price of Futures, whether people are long or short, and the level of open interest (which combines both) will tell you a lot about the state of the market and expectation.
In the same way that Futures enable exposure to price further down the road, there are mechanisms to allow traders to take speculate on cryptocurrency movement without actually holding the underlying asset. They are called Funding Rates, and work by charging a fee for a trader to either be long or short.
Now if the market expects the price of bitcoin to go up, the Funding Rate - what a trader will have to pay to borrow it and lock in the increase - will be positive and increase in line with sentiment. Funding Rates will go negative when the expectation flips because being long bitcoin is seen as a losing trade.
All of the indicators we have looked at so far are trying to establish a broader perspective of the market beyond what the screen is blinking right now. One the simplest mathematical ways to get a broad assessment of a data set is an average, and averages are a key tool of Technical Analysis - the use of volume and price charts to predict future price movement.
They are especially relevant over longer periods as they smooth out crypto’s volatility.
Moving averages simply calculate the ongoing average price for a fixed duration plotted as a moving line on a price chart. It is easier to understand by example:
7 Day Moving Average - The average price over the last seven days
Moving averages are available for any period but tend to be useful over specific benchmarks: 7, 25, 50, 100, 200.
Moreover, while moving averages can give you an assessment of price now, compared to a generalised view of the past, where they can be interesting indicators of Bear or Bull markets is where shorter and longer MAs interact.
If you think of a 50 day MA as being short term sentiment and 200 day MA as long term, the former dipping below the latter can be interpreted as a crucial indication of ebbing confidence. Within Technical Analysis this is known as the Death Cross, and hardly needs an explanation as to whether it's a positive or negative indicator.
Bitcoin formed a Death Cross on June 19th (2021) and though it fell significantly on June 22nd, dipping below $30k for the first time since January, the sky hasn't fallen it, illustrating that as with all these indicators, the Death Cross doesn't guarantee anything.
The converse is true when the short term average price measure - the 50 day MA - gathers steam and crosses above the longer term generalised benchmark, indicating that sentiment is turning positive. This is called the Golden Cross, and can herald a Bull Market.
If you’ve read this far, you may well have a churning sensation in the pit of your stomach at the thought of all this negativity. Based on all the indicators mentioned, Bitcoin - and by proxy all other cryptocurrencies - could be turning into a Bear Market.
If we look back at previous Bear Markets, that might mean years of negativity and declining prices, but there could some good news among all the doom and gloom.
Though the sentence ‘things are different this time’ is one of the most dangerous in any risk-based activity, it may actually be a valid assessment regarding bitcoin price cycles.
The Bitcoin ecosystem moves at lightning speed and so is barely recognisable compared to three years ago. Three of the most noticeable differences may suggest that history will not repeat itself, and that cycles could be mercifully shorter.
One of the most significant changes is the growth of institutional investment that is focused on the longer term, and not flipping for a short term profit. This likely broadens that base of diamond hand zealots that so impressed Druckenmiller.
The other key factor is the much greater utilisation of stablecoins. During the last Bear market investors cashed out of Bitcoin back to fiat, and waited for the winter to pass. This time traders are far more likely to simply sit on the sidelines with their portfolio in stablecoins, and able to instantly enter the market when they see fit.
Another of the key changes that may be a mixed blessing in terms of cycle duration is leverage - the ability to trade at huge multiples. Leverage exaggerates market moves on both the upside, as traders try and cash in on FOMO, and the downside as those same traders get caught and their liquidated positions create a cascade effect.
The impact of leverage can be brutal for the markets, but can act as a purge, which in previous cycles might have taken longer to run its course.
In the search for the signs of a Bear Market, and clues to its duration, the truth is that no one knows. We could easily see neither a big move up or down, but a sideways movement for a significant period - so called ranged price movement - as tradings and investors, confused by mixed narratives sit on the sidelines and try and figure where true sentiment lies.
If you are a fairly recent bitcoin holder, this may not provide much reassurance, but there is no avoiding the reality that bitcoin is a complex and volatile asset. You should prepare yourself for a rollercoaster ride because the market is still ruled by sentiment and in this cycle the mainstream media, regulators and even politicians are playing a bigger role.
With so many issues competing to set the future course of Bitcoin the only thing that we can know for sure is that, as sure as Bears shit in the woods, holding bitcoin will remain a bumpy ride for some time.