Blockware Intelligence Newsletter: Week 25

Bitcoin on-chain analysis, mining analysis, equity-analysis; overview of 2/04/22-2/11/22

Summary:

• It’s been a strong week for tech stocks, but there are a few red flags stemming from the CPI numbers announced on Thursday.

• Large influx of stablecoins onto centralized exchanges

• Bitcoin’s correlated to Nasdaq cooling off from historical levels

• Prolonged regime of spot premium to perps, as well as Coinbase and Bitfinex premium over Bybit

• BTC wrapped on ETH reached 1.38% of supply

• Valkyrie’s Bitcoin Mining ETF began trading this week.

• Valuing public Bitcoin miners ($RIOT and $MARA) on their hash rate.

On-Chain and Derivatives Update

It’s been another week of volatility for Bitcoin with several news events from 7.5% CPI print raising monetary tightening expectations to Russia considering crypto currency and Blackrock seeking to offer Bitcoin trading to their clients. Let’s look at the data to break down what’s going on beneath the surface.

Looking at price structure, fairly straightforward for BTC. When zooming out BTC has essentially been in a massive range between 30-60k for the last year. Key levels I’m watching are the 28-30k area, 40k, 46-47k, and 58k. IMO a retest of the 40k area (highlighted below) would be very healthy to build structure and set a higher low. If 40k if broken, think BTC would retest it’s local low at a minimum. 47k is a strong area of confluence: being the yearly open, point of breakdown of market structure in May (break below lower low), 180EHMA, and short term holder cost basis from an on-chain perspective.

Here is that short term holder cost basis (or realized price) which current sits at $47,100:

Now to move on to derivatives. For a long time, I’ve talked about funding rates and their importance. I still do think they are important, but recently I’ve come to a new understanding. When watching funding I am essentially trying to gauge the difference in behavior between perpetual swaps and the spot market. With each funding rate being calculated slightly differently by exchange, why watch the derivative (funding) of premium/discount when you can just look at the aggregated premium/discount itself.

The indicator below takes the difference between the weighted average of BTC all perpetual swap prices and weighted average of all BTC spot prices. When in gray, perps are trading at a premium; when in green, spot is trading at a premium.

What you’ll notice is that BTC is currently trading in a strong regime of spot premium, continuing to climb higher over the last few weeks.

We can also look at this on a bit more granular level and look at intra-exchange premiums/discounts. One of my favorites to look at is the delta between Coinbase spot and Bybit perps. Adding a smoothing factor, 7D or 14D moving average helps to paint a clearer picture. Bitcoin currently in a regime of Coinbase spot premium over Bybit perps.

Open interest dominance is declining, while the actual USD value of open interest isn’t budging. This means open interest dominance is declining because of BTC market cap rising because it compares the size of Bitcoin’s market cap to the number of contracts open. To me, this is another indication of spot leading in current market conditions.

Something else to keep an eye on is Bitcoin’s correlation to the Nasdaq has fallen over the last week after reaching extremely high levels of correlation, as much as 0.96. As a derivative of this, here’s some food for thought that I don’t have the answer to: How many macro hedge funds have offloaded their inventory over the last few months? How much supply is still in hands of entities that will change their Bitcoin thesis becuase of the potential of short-term monetary tightening? Who have been the buyers in the low 30Ks? I don’t know the answers, but something to think about.

From an on-chain perspective, continuing to see illiquid supply relentlessly climb. This means that supply is moving to entities that have a low tendency to sell. Think this illustrates a “gentrification” of BTC supply, transferred to entities who understand the longer-term global adoption story that is Bitcoin.

Of course, this only speaks to the supply side of the equation, which is one-half. The way to think of this is that the fuel is laid out, but when will the spark (demand/catalyst) come?

Over the last few weeks have seen a massive influx of stablecoins to exchanges. If open interest relative to market cap was high, would interpret this potentially as collateral being moved onto exchanges. My leading theory here is simply that there is an influx of dry powder on standby waiting to be deployed.

An interesting broader trend to note is the number of Bitcoin wrapped on Ethereum. Over the last 2 years, the number of Bitcoin wrapped on Ethereum has increased by 375x or over 37,500% Roughly 1.38% of Bitcoin's supply is currently wrapped.

Love or hate ETH, there is clearly an appetite from BTC holders to put their digital assets to work and get yield on DeFi.

And lastly for this week, we look at lightning network capacity. This illustrates how aggressive lightning network relative growth has been over the last few years. Although still just over 3,000 BTC, private capacity is unknown. We expect to see exponential growth over the next 5-10 years as the LN is used for global payments and remittances specifically. This is critical is Bitcoin becoming not only a store of value but a medium of exchange as well.

General Market Update

Overall, it’s been a pretty strong week in the general market. The leading stocks are making new highs despite some underlying uncertainty among market participants. 

Fear, uncertainty and doubt are very necessary for the market to form a true bottom. Without them, everyone would buy immediately and the market would be over saturated with buyers very quickly.

The market indexes and some ETFs are starting to shape up quite nicely. One ETF that I’ve been keeping a close eye on is the Russell 2000 Growth ETF with the ticker IWM. 

IWM is currently in a make or break spot, with the potential to drag the market higher if it can show some strength. 

IWM 1D (Tradingview)

Price is currently right around this support zone from the previous base of February ‘21 until it failed in January of this year. It would be encouraging to see IWM clear through this area with strength. But this is a logical area for profit taking, as we saw on Thursday, with IWM forming a downside reversal candle from that level.

That $208 area was supported for almost a full calendar year, meaning that buyers stepped in whenever prices crossed into this zone. This means that there are likely many people and funds with buys around a $208 cost basis. Now that prices are back in this area, it would make sense for people to sell to break even after being down.

This explains Thursday’s downside reversal after hitting a high of $209.05 intraday.

There’s also been some funky price action in the main indexes this week. Specifically, on Thursday both the S&P and Nasdaq gapped down because of higher than expected CPI numbers (more on this later).

Nasdaq 1D (Tradingview)

Both indexes had buyers step in off the open and for a few hours it looked like the funds were buying the inflation fear. But with weak closes in both the Nasdaq Comp. and S&P, these intraday gains ultimately resulted in a downside reversal candle on high volume.

Thursday was a key day of price action due to the CPI news and it seems unlikely that the market will just ignore this day. How we close Friday should be a strong indication of if we can continue higher or if we need more time. 

The concept of overhead supply and declining moving averages are going to become very prevalent for investors once the markets have truly bottomed. 

Overhead supply is exactly like the $208 area I previously explained for IWM. For all stocks and assets, when prices decline significantly there are going to inevitably be folks who hold onto buys that are now underwater.

The concept is best explained by the very common saying among those who don’t use a stop loss. They say, “If I can just get back to breakeven, then I’ll sell.”. This is what overhead supply is. Those who are sitting on losing positions will sell them once they are back to even on the trade.

So for all these stocks and cryptos that are beaten down, there is going to be significant overhead supply that should provide continuation bases and places for traders to enter. This concept is pretty similar to the supply that enters the market at a declining moving average.

When price is below key moving averages that are in a downtrend, many funds will use these averages as a place to dump portions of their position. The fact that the moving averages are sloping downwards isn’t totally relevant, but when they are declining, it tells us that the stock is in a downtrend over the last X amount of days, weeks, etc. 

When a stock is still technically in a downtrend, it is likely that folks are going to take profits quicker. But when any stock/ETF/crypto comes into a key moving average from underneath, we can expect to see some sellers there. An asset ripping up through a key moving average from underneath is a sign of strength.

As I alluded to, the biggest news of the week came yesterday before the open. The US Bureau of Labor Statistics released their most recent Consumer Price Index (CPI) numbers. 

For those who may not know, CPI is a backward-looking way for us to measure inflation. It’s calculated by selecting a basket of goods and then measuring how much their prices increased over the last month, quarter, year, etc. 

They announced that the price of this basket of goods grew 7.5% since this time last year, which was apparently an unexpected increase. The effect this news had was immediate in the bond market, with yields jumping to price in inflation. 

US 10Y 5min (Tradingview)

Generally, bond yields and the performance of tech stocks have an inverse relationship, which is why it was surprising to see yields and growth equities both running higher yesterday morning. By day's end, it seems the stock market had come to its senses. 

Personally, I would like to see stocks form one more leg down for a last flush of weaker hands who have been late to trade this move. But of course, the market doesn’t care what I think. 

Crypto-Exposed Equity Update

The biggest news this week for cryptoassets in the tradfi world was the launch of Valkyrie’s Bitcoin Mining ETF with the ticker WGMI. This excites me because we have an even better way for us to gauge the relative strength of individual miners vs. just using BTC. 

We can compare the price action of a miner to that of the ETF to determine if it has been outperforming, or underperforming, the rest of the industry group. 

It will also be interesting to see how WGMI performs compared to spot Bitcoin prices. So far, WGMI is up 9% in the 3 sessions it has traded. But for ETF listings (or stock IPOs/direct listing) there’s always going to be weird price action for a while when they first begin trading. 

Therefore, I’ve yet to start using WGMI to spot relative strength. It is too new at this point to be very useful, but I am certainly keeping an eye on it. 

One thing about WGMI that is interesting but potentially hazardous is its holdings. I honestly have no idea how they chose the weighting of each holding, but the top 5 holdings by size are BITF, CLSK, ARBK and SDIG. 

A traditional ETF would rank their holdings by market cap, meaning a mining ETF would have MARA and RIOT as its top 2 holdings. Maybe Valkyrie is most bullish on BITF and CLSK but to me this seems a little odd. 

But this week has been a solid one for spotting relative strength for crypto-exposed names. By comparing the price of stocks to some of their key moving averages, and also looking at the strength of their candlesticks this week, we can fairly easily determine which names are being accumulated the most. 

 At the moment, I believe some of the strongest miners are EBON, CLSK, CAN, IREN and HUT.

Here is my comparative excel sheet for the week, sorted by how much they have gained since bottoming relative to how far they corrected. This week I have added a few new names to the list: MIGI, SDIG and CIFR. 

COIN is still leading the pack in terms of bounce vs. dip. CLSK has had a very strong week which boosted its bounce vs. dip value, it is now ranked 3rd behind COIN and HUT. HUT and CLSK are the two leaders when solely looking at how much they have returned off the lows.

Mining

Public Bitcoin Miners vs. Buying and Hosting Rigs

Valuing public Bitcoin miners is hard, and there are many different approaches investors can take. A simple approach is doing a Market Cap / Hash Rate comparison, but let’s dive deeper into this idea.

Billions of dollars are currently flooding into public Bitcoin mining companies. They are able to raise a significant amount of capital for two key reasons. 

First, these are high-growth technology companies that actually spin-off a positive cash flow. Second, many traditional firms may not be able to buy Bitcoin directly, so they invest in related equities to get proper exposure.

This shouldn’t come as a surprise that Vanguard and Blackrock are the top two institutional holders of $RIOT and $MARA.

Let’s break down just how much you’re paying per ASIC if you decide to invest in these large publicly traded Bitcoin mining companies.

As noted in the table, both $RIOT and $MARA have market capitalizations above $2 billion, and they trade at steep valuations compared to the market value of the ASICs they currently have deployed.

As of February 9th, the data above was compiled from RIOT and MARA corporate websites and a few other sources noted below. Their cash was extracted from their most recent balance sheet. The current value of their Bitcoin treasury was obtained from BitcoinTreasuries.net. For infrastructure, RIOT’s Whinstone US facility was obtained from the acquisition amount on Bloomberg, and MARA has an asset-lite investment strategy where they invest only in miners rather than infrastructure as noted in their most recent Investor Presentation on slide 11. It’s also important to note that RIOT and MARA don’t only own S19 pros, but it is a relevant new generation machine that can be used for this non-perfect comparison.

At current market valuations, removing their cash, BTC treasury, and infrastructure capex (if applicable), and assuming their fleet of ASICs contains mostly new generation S19 pros, you’re buying their deployed RIOT S19 pros at $46,000 and MARA’s S19 pros at $84,000.

That is more than 5x what you would pay from a broker like Blockware Solutions. However, that’s not a completely fair comparison since many more miners will be deployed throughout this year.

Zooming out and using their hash rate projections to value their future fleet at today’s market capitalization, you’re buying RIOT S19 Pros at $11,300 and MARA’s S19 Pros at $11,500.

This is much more competitive, but still, a majority of these are yet to be deployed.

2021 Public Miner Perforamnce vs S19 Pro

Let’s compare the 2021 performance of $MARA, $RIOT, Bitcoin, and running an S19 Pro @ $0.07 per kWh.

• $RIOT +31%

• spot #Bitcoin +49%

• S19 Pro +169%

• $MARA +215%

$MARA did outperform, but its high volatility should be noted. 

Owning and running S19s is more like holding private equity. There’s not a clear market price, and the new generation machines spit off consistent free cash flow regardless of #Bitcoin’s extreme swings.

So should you buy public miners or buy and host your own rigs if you want exposure to #Bitcoin mining?

I think it depends on what your goals are, if you want more control, and if you prefer less volatility and more consistent cash flow.

Mining in practice is not easy, and it’s one reason why so many prefer to simply invest in large public miners like MARA and RIOT. It is difficult to procure ASICs, build large mining facilities, and source cheap scalable electricity all on your own.

As an institution, hedge fund, or HNWI, it makes sense to purchase and host ASICs with a trusted partner like Blockware Solutions.

You can buy ASICs, not have to manage physical mining infrastructure, and have full control over what you do with the Bitcoin you mine.

If you are looking to deploy capital to the Bitcoin mining space, Request a Quote from Blockware Solutions.

Also read the full version of this Blockware Intelligence report: Valuing Public Bitcoin Miners on Their Hash Rate