Searching for the bottom in Crypto: AltFi’s Market Outlook

“Are we nearly there yet Dad?” was my all too frequent question from the back seat on long car journeys as a child. Today it’s our investors and prospective investors who are asking us, “are we nearly there yet?” in reference to the bottom in Crypto prices.

To answer this, we’ll explore the top-down approach we utilize at AltFi Capital, with considerations to:

• Macro factors
• Technical analysis
• Market dynamics
• On-chain analytics

Many investors are lured by the quest of timing the bottom. Since it marks the lowest price in a given cycle, any price action that follows the bottom can be highly lucrative. Timing the bottom to the top of the last two major Bitcoin cycles would have led to gains of 6,500 % and 2,000 % respectively, but trying to time the bottom is usually a fool’s errand. The bottom is usually only obvious in hindsight. Just like the top.

Bitcoin and other digital assets have been hurt by the macroeconomic situation of soaring inflation that has forced the U.S. Federal Reserve and other central banks to hike interest rates, impairing all risk assets and pushing crypto’s price correlation with U.S. equities to an all-time high. BTC is currently down 70% from its all-time high from last November, in line with many other previously high-flying technology stocks ($NFLX down 73%, $META down 57%, $SNAP down 84%, and $PYPL down 76% as of July 16, 2022). So, the question now becomes, at what point does this price action create a buying opportunity?

Well, this answer requires a lot of nuance. To really grapple with the investment landscape, we think the application of AltFi Capital’s hybrid macro, fundamental and technical investment framework is a helpful place to start. At AltFi Capital, our macro approach determines our big picture outlook, our fundamental approach determines our asset selection, and our technical approach supports the timing for our entries and exits.

MACRO FACTORS

“I think we now understand better how little we understand about inflation.”– Jerome Powell, Federal Reserve Chairman — June 29, 2022

With this week’s CPI print of 9.1% — the highest level since November 1981 — the markets are pricing the likelihood of a July rate hike of 75bps with 100% probability and a 100bps hike with 70% probability. Coupled with storm clouds of a potential recession looming, the market remains heavily risk off.

On one hand, both consumer spending and the job market continue to grow, but geopolitical tensions, high inflation, rising interest rates and quantitative tightening have all led to waning consumer confidence, which will undoubtedly continue to weigh heavily on the global economy.

After the Fed’s infamous and disastrous “transitory” call, their credibility is now on the line, and we believe the Fed will continuously raise rates until they see a noticeable reduction in inflation or a real impact on jobs. It’s easy for the Fed to raise rates on the back of continued monthly 300,000 jobs gains, but let’s see what they do when we start to see monthly 100,000+ job losses instead.

The silver lining is that the bond market no longer seems to believe the Fed will continue its hiking, as Fed Fund Futures are beginning to price in fewer rate hikes (or at least much faster rate cuts), and a sharp decline in inflation expectations.

TECHNICAL ANALYSIS

The team at AltFi is comprised of both crypto native and traditional finance professionals. As long-term investors, we use fundamental analysis to identify and select investments coupled with a technical approach to risk management. Our deep experience with technical analysis helps us interpret market cycles, current trends, and manage risk.

Market bottoms are always formed following a declining market phase. Bottoms typically take time to form because the volume of buyers and sellers eventually has to come to an equilibrium until demand overtakes supply. In technical terms, those extended periods are referred to as “accumulation.” The bottom isn’t a trampoline. Once the market hits bottom, it doesn’t immediately jump. It may take a while for a new uptrend to begin.

The chart below shows BTC has been trading in a tight range for the last month. Does this represent an accumulation phase or another distribution phase before the next leg lower? That is of course the million-dollar question that we attempt to provide further insight on.

At AltFi, one of our favourite tools for looking for signs of accumulation is to use Volume Profile charts as shown below. Volume Profile shows volume at price, as opposed to volume at time as per the typical chart-based volume analysis. Markets are heavily dominated by large players who trade in such large sizes they leave volume footprints. These volume footprints or spikes tell us where the large players are getting in and accumulating at, or prior areas they got into and will want to defend. These are incredibly important price levels to be aware of.

Above we show the volume profile charts for BTC (above left) and ETH (above right) for the last 90 days. On BTC we can see once the prior strong support level of $28,000–$32,000 broke, it was a swift move down to the next major support level of $19,000–$21,000, which also is the major support level stemming from the 2017 cycle high. We are currently seeing strong institutional buying pressure at these current levels, supporting the case for a current accumulation phase.

Even more telling, however, is the volume profile chart for Ethereum showing massive institutional buying at and around the $1,000 level, suggesting a strong case for an accumulation phase. At AltFi Capital we have a very strong fundamental case for Ethereum, a protocol that is producing over $8Bn in annualized protocol revenue with a P/E ratio lower than most major technology stocks, and thus we have been adding to these volume footprints with our opening positions in ETH for our newly established Opportunities Fund.

How can moving averages inform our technical analysis?

Moving averages are probably the most common technical analysis tool used by market participants. Moving averages are used to smooth out fluctuations and highlight trends in price. Moving averages work well because they are widely followed, and very often become self-fulfilling.

Not all moving averages, however, are created equal and we discuss here how we at AltFi Capital use them in helping to form our technical view of the market.

Probably the most powerful and well known moving average for helping determine the long-term trend is the 200-day moving average. The chart below shows the BTC 200-day simple moving average on a daily timeframe.

From legendary trader Paul Tudor Jones:

“My metric for everything I look at is the 200-day moving average of closing prices. … the whole trick in investing is: “how do I keep from losing everything?” If you use the 200-day moving average rule, then you get out. You play defense, and you get out.“

At AltFi Capital, after considering the 200-day moving average for the longer term timeframe, we like to turn our attention to the 21-day moving average for the intermediate outlook, as a break-and-hold above or below this level can often be a first signal of a change in the intermediate trend.

The chart above shows the 21-day exponential moving average for BTC on a daily timeframe since October 2021 and clearly shows that breaks below this moving average are times that warrant a consideration of reducing risk, which is exactly the view the AltFi Capital team started to form last November.

Momentum indicators

Ask 10 traders their favourite momentum indicator, and you’ll probably get 10 different answers. Indicators are mathematically derived formulas presented visually, used by market participants to gain insight and help to identify or predict trends or reversals. All indicators by their very nature are lagging, based on past price information and should only be used in conjunction with other tools to help solidify a view of thesis.

That being said, at AltFi Capital, one such momentums indicator we do utilize is the Directional Movement Index (DMI), created by J. Welles Wilder who also created the much more widely known Relative Strength Index (RSI) indicator. The DMI oscillator helps determine the current direction as well as strength of a trend, and we find often gives signals earlier than many other comparable indicators.

When the oscillator turns red it signals negative trends and goes green for positive trends, with the height of the oscillator indicating the strength of the trend. The above chart is the same daily BTC price chart as above and we can again see how it gave an initial indication in mid-November of a potential trend reversal away from the all-time highs.

In the next chart we combine the 21-day exponential moving average and the DMI chart together.

And we see here that price below the 21-day moving average and negative DMI oscillator paint a highly correlated picture.

How to identify a strong uptrend — “Stacked Moving Averages”

At AltFi Capital we believe the clearest way of identifying strong trends is using a combination of several different moving averages on one chart.

In the chart above, which is the daily chart of BTC in the first three months of 2021, we show 5 exponential moving averages of different lengths (8, 21, 34, 55, 89). In this chart we have the 8 > 21 > 34 > 55 > 89, thus forming a perfect pattern of “Positively Stacked Moving Averages.” These are the market structures at AltFi where we will likely be positioned 100% long and/or buy the dips.

Compare this chart to the current daily BTC chart below:

Here we have the exact opposite market structure with perfectly negatively stacked moving averages signifying a sustained downtrend.

One of the most challenging aspects of asset management is determining the end of a trend and the transition to the next market phase. To help in this determination, we turn your attention to additional non-technical factors and analysis tools described below.

MARKET DYNAMICS — END OF DELEVERAGING ?

One of the key features of every boom and bust cycle in crypto has been the amount of leverage in the system and the contagion that it causes.

The collapses in this cycle have been exacerbated by the combination of leverage plus cross-collateralization across centralized lending platforms. This has recently resulted in the collapse of algorithmic stablecoin TERRA/LUNA; Chapter 11 bankruptcy filing of Celsius, the retail lending platform that promised retail investors high yields for depositing their crypto; the blow up of the highly leveraged crypto hedge fund Three Arrows Capital (3AC), which had an extensive list of counterparties that it connected to and had borrowed money from, which in turn led to Voyager Digital filing for Chapter 11 bankruptcy after 3AC defaulted on roughly $670 million from the company. BlockFi, another retail lending platform, is about to be rescued and bought by FTX in a fire sale.

Time will tell if the deleveraging process is complete or not, but capitulations, deleveraging and bankruptcies are a common phenomena at or near the bottom of all market bottoms.

At AltFi Capital, we use zero leverage in our fund and do not invest in lending platforms, focusing instead on digital assets with fundamental values.

ON CHAIN ANALYSIS

A healthy crypto network is one with actual activity, which makes on-chain analysis one of the most fundamental concepts in crypto. The idea is to identify relative strength, or weakness in the character of a network given the open-source, real-time information made available on public blockchains.

For AltFi Capital, several prominent on-chain metrics we track to help deduce the value of crypto economies include: transaction volume, transaction value, active wallet addresses, gas costs, and total circulating supply.

The volume and size of transactions are a strong indicator of the quality of network usage, active addresses offer a rough proxy for the number of network users, gas costs help depict the demand for network compute, and a token’s circulating supply supports the assessment of market capitalization alongside future supply-side inflationary or deflationary pressures.

A notable trend in the latest crypto route revolves around the surprising resiliency of the decentralized finance (DeFi) ecosystem. Many of the leading DeFi lending and borrowing protocols, which unlike their centralized counterparts, have held up quite well, owing to their over-collateralization, transparency, and programmatic execution. Investors can actually monitor the loan books of protocols like Compound and Aave. Although impossible to rule out further downside risk attributable to deleveraging, as FTX founder Sam Bankman-Friedman points out, it looks as if the worst has past.

DeFi remains among the most promising growth areas for blockchain adoption and continues to enjoy growth by meaningful measures. Per Greyscale; “monthly decentralized exchange (DEX) volume has remained stable amidst volatile market conditions. A year ago in June 2021, DeFi was nearly non-existent, with DEXs handling a few billion dollars in volume. As of June 2022, DEXs on Ethereum, like Uniswap, did approximately $75 billion in trading volume. July 2022 DEX volume also remained on par with February 2022 volume when the price of Ethereum was ~2.5x higher at approximately ~$2800 vs. ~$1100 respectively.”

Another positive factor is that the number of wallet addresses holding less than 1 BTC continues to increase, reaching new all-time highs. This marks an interesting change in market sentiment as, historically, smaller investors have exited the market in times of uncertainty — notably in 2018 after the price of Bitcoin fell from ~$20k.

CONCLUSION

The near-term macro outlook remains fragile and given tight risk asset correlation to macro conditions, our big picture outlook remains cautious.

On-chain analysis suggests a redistribution of wealth from low to high conviction holders. From a technical perspective we are seeing signs of an accumulation phase, a view that is further supported by signs of recent deleveraging and capitulations, which are also common phenomena at market bottoms.

As such we have cautiously started to add some initial long positions in our newly established fund in assets with the strongest fundamentals, but remain with significant cash on hand ready to deploy when macro conditions turn and when we see clearer signs of trend change.

Contact

Tim Calveley — tim@altfi.capital — +1 (441) 300–0204

Cooper Jefferson — cooper@altfi.capital — +1 (705) 790–2959

About AltFi

AltFi Capital Management Ltd. offers an alternative investment management service with a specialization in digital assets. AltFi offers investors hedge fund, venture capital and strategic investments in the digital asset sector, via a single open ended non-leveraged fund vehicle.

*This article is not an offer to sell shares of any investment fund or a solicitation of offers to buy any such securities, nor should it be misconstrued as investment advice.