Sound Money

We experienced a major 40% rally in bitcoin in October, driven by valuation, but triggered by SEC ETF approval. Valuation is less attractive than a month ago, but still very constructive heading into November so large price increases are the base case. However an increasing number of leveraged speculative implies the market will likely get more volatile and skittish heading into year-end.

Last month when bitcoin was at $44K I concluded:

• Major on-chain support remains below the $41K region (i.e. lots of previous buyers at these levels) so there is a good chance that price bounces strongly, once technical traders are confident that the levels has held.
• Our fundamental network valuation metrics remain very constructive, valuing bitcoin close to 50% below fundamental value. Importantly, network health has not been impacted by the price decline from $53K to $41K. Bitcoin is trading at some of the most undervalued levels on record. Subsequent bitcoin returns are particularly strong when price declines relative to fundamental value, which is the current condition in which we find ourselves.

ETF approval triggered rather than drove the rally

The perspective proved prescient as the bitcoin price jumped 25% on the month. Commentators may point towards the approval of the first bitcoin ETF in the US as the reason for the strong price action. We prefer to see the news as the trigger, arguing that fundamentals set up the conditions for the rally.

• In case you missed it, ProShares launched on launched on Tuesday 19 October, recording the second highest first day turnover in ETF history of almost $1 billion. After ETF approval in Canada and Sweden, we suggested in our 2021 outlook that the SEC would follow suit this year.
• ETF approval catches the eyes and the record first day flows confirm the importance of the event, but this is just another step in the institutionalization of bitcoin rather than a completely watershed moment. More bitcoin ETFs are in the pipeline but most of them will likely be futures-based, rather than settling in underlying bitcoin.
• Another important step in this process of institutionalization is approval of a bitcoin-settled ETF and perhaps the conversation of the Grayscale bitcoin trust into an ETF. It preferable if bitcoin financial products are based on top of bitcoin itself, rather than synthetic products, because bitcoin is a sounder foundation on which to build our financial future.

Lower probability of a >25% correction from these valuations

After the strong rally, bitcoin undervaluation as narrowed from close to 50% undervalued to 25%. We are still in extremely undervalued territory but obviously today is different prospect to where we were a month ago. Our medium term indicators are also still supportive of the price outlook over the coming quarter. The conclusion being that there is a lower probability of a >25% correction under these conditions.

On the less optimistic front, leverage has filtered back into the market as speculators try to take advantage of bullish market conditions. Leverage creates a fragility and exposes the market to a higher probability of a 10-20% type corrections. This is exactly the type of fragility the market was working through at the end of October. It will be interesting to see where it resolves itself but we see major on-chain support in the $58K region and think there is a lower probability that price will spend much time below those levels. Sudden flash-crash type events are more possible as leveraged speculators may get unwound by elevated funding rates.

The other big development of the past month was the strong performance of bitcoin vs. the rest of the crypto markets. Last month I commented

I expect we could experience a little more sideways price action in the ETHBTC cross over the next month because bitcoin fundamentals are looking incredibly optimistic at this stage and ethereum fundamentals do not quite match up.

We are starting to see ETH activity pick-up relative to BTC so, going forward, we could be in store for a larger ETH rally relative to BTC.

All the best out there.