Cryptocurrency market rising: This chart shows why it may continue
Has crypto winter been cancelled? At least one metric says the bottom may be in.
The second fastest way of losing money in cryptocurrency is to make short-term predictions with 100% certainty. The fastest way is margin trading on those predictions.
That said, cryptocurrency markets have been bounding upwards in the last few days, and there's at least one metric which says this rise may have some legs.
Very nice. What is it?
These are numbers from Grayscale's Q4 2018 report. Grayscale is one of the world's larger cryptocurrency investment funds, with US$825 million in assets under management (AUM). Investments in Grayscale are indicative of where the allegedly "smart money" is going in cryptocurrency.
This chart shows new investment as a percentage of Grayscale's total AUM, relative to cryptocurrency price changes, from 2013 to 31 December 2018.
- Dark blue line – Grayscale AUM growth. This is essentially a cross between crypto prices and Grayscale's investment inflow. The line itself is basically tracing crypto prices, except it's been accentuated on the upswings and softened on the downturns.
- Grey zone – drawdowns. The grey-shaded area shows Grayscale's trailing 12-month peak-to-trough price drops. It's a measure of how far crypto prices have fallen compared to their recent highs. Grey spikes show sharp price drops; wide grey areas show extended crashes.
- Green zone – inflows as a percent of AUM. The light green-shaded areas show how much is being invested in Grayscale as a percentage of its AUM. It's kind of like a mashup of investment activity and crypto price action.
By looking at all these numbers relative to Grayscale AUM, rather than relative to something like total cryptocurrency market cap, you get a chart that can show subtleties and patterns which would otherwise be drowned out by the sheer magnitude of cryptocurrency's movements over the years. It's also primarily weighted towards bitcoin movements.
There are a couple of things you can make of this information.
1. Big money called the bottom
At the end of 2018, Grayscale saw the highest level of crypto investment relative to crypto prices since late 2015. And in both cases, it saw these big investments after an extensive period of falling prices. A lot of the money going into Grayscale correctly predicted the bottom of the market back in 2015. Then, a proportionately similar amount of money did the same at the tail end of 2018.
Of course, Grayscale customers prefer to buy low, falling crypto prices make for a bigger green bar and markets have to hit bottom at some point. So in that respect, the creation of this pattern is a self-fulfilling prophecy and probably shouldn't be construed as a sign of smart money deliberately scoping out the bottom of the market.
However, it's still a pattern of market forces at work. Past performance is no guarantee of future returns, but this pattern has, in hindsight, signalled the bottom of the market and now here it is again.
As Grayscale says, "large increases in dollar inflows relative to asset prices during late-stage drawdowns have historically preceded bull markets. Though the number of observations is limited and the effects may not be immediate, it will be interesting to see how the next cycle plays out to gauge the strength and validity of this signal."
2. As a proxy for wider markets, it shows cryptocurrency's attractiveness as an asset class at its current prices
If you think of Grayscale as a proxy for cryptocurrency markets as a whole, rises and falls in the green stuff can be broadly seen as representative of shifting cryptocurrency supply and demand.
A growing green zone shows demand increasing more quickly relative to the total market size (pushing prices up), while a shrinking green zone shows demand dropping relative to the total market size (pushing prices down).
The obvious problem with this idea is that the green zone mostly runs exactly opposite to crypto prices. The green zone grows when prices go down, and shrinks when prices go up. So that analogous growing/shrinking demand and supply obviously isn't directly making prices rise/fall.
As Grayscale suggested, a more refined take might be to view it as a measure of cryptocurrency's attractiveness as an asset class, to sophisticated investors, at its current prices.
"This metric may serve as a proxy for broad-based investment activity occurring across the digital asset ecosystem, which could have important implications for future price action," Grayscale explains. "In fact, many investors view large capital inflows relative to asset prices as a fundamental sign of perceived value and potential future price momentum."
So instead of directly indicating supply and demand, as a measure of crypto's attractiveness, it could precede shifts in supply and demand. The green blob grew in the end of 2018, and now a couple of months later, crypto prices are rising.
3. Growing attractiveness as crypto markets drop suggests a natural price floor
If there's one thing the chart highlights, it's that cryptocurrencies genuinely get more attractive to many buyers as prices fall, and that there are many people with big bank accounts who believe cryptocurrencies can be fundamentally undervalued at certain price points.
Major cryptocurrencies are still finding more buyers as prices fall.
The bottom line
Of course, Grayscale's $825 million in crypto-assets under management isn't exactly making or breaking the markets, and of course there isn't any one indicator you can take to the bank.
But it's still an interesting way of highlighting the recurrences in crypto markets as well as emphasising that the attractiveness of cryptocurrency as an asset class tends to run directly counter to its prices.
"Institutional investors are building core strategic positions in digital assets over time and have largely viewed the 2018 drawdown as an attractive entry point," Grayscale says.
It may not be conducive to becoming a quick millionaire, but there are plenty of people hoping for blood on the streets.
Disclosure: The author does not hold any cryptocurrencies at the time of writing.