The Pomp Podcast - #542 Will Clemente on The Science Behind A Price Drawdown

Episode Date: April 27, 2021

Will Clemente is a Finance Major at East Carolina University. He has quickly become one of my favorite writers on all things bitcoin, including deep dives on various on-chain analytics. In this conversation, we discuss leverage, bitcoin price, short liquidations, market cycles, and the science behind the recent bitcoin price drawdown.  ======================= Remote makes it easy for companies of all sizes to employ global full-time employees and contractors. We take care of international payroll, benefits, taxes and local compliance, so you can focus on growing your business. Learn more about Remote and their new Remote for Startups program at http://www.remote.com. ======================= BlockFi provides financial products for crypto investors. Products include high-yield interest accounts, USD loans, and no fee trading. To start earning today visit: http://www.blockfi.com/Pomp ======================= Choice is a new self-directed IRA product that I'm really excited about. If you are listening to this, you are likely part of the 7.1 million bitcoin owners who have retirement accounts with dollars in them, but not bitcoin. I was in that situation too. Now you can actually buy real Bitcoin in your retirement account. I'm talking about owning your private keys and using tax-advantaged dollars to do it too. Absolute game changer. https://www.retirewithchoice.com/pomp =======================

What's up, everyone? This is Anthony Pompliano. Most of you know me as Pomp. You're listening to the Pomp Podcast, simply the best podcast out there. Let's kick this thing off. Will Clemente is a finance major at East Carolina University. He has quickly become one of my favorite writers on all things Bitcoin, including deep dives on various on-chain analytics. In this conversation, we discuss leverage, Bitcoin price, short liquidations, market cycles, and the science behind the recent Bitcoin price drawdown. I really enjoyed this conversation with Will, and I think you will as well. Before we get into the episode though, I want to quickly talk about our sponsors. First up is Remote.com. In 2021, every business is a global business,

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All opinions expressed by Pomp or his guests on this podcast are solely their opinions and do not reflect the opinions of Morgan Creek Digital or Morgan Creek Capital Management. You should not treat any opinion expressed by Pomp as a specific inducement to make a particular investment or follow a particular strategy, but only as an expression of his opinion. This podcast is for informational purposes only. All right, guys. Bang, bang. I've got Will back here with me. Thanks for jumping on real quick. And let's just start off with the price of Bitcoin went down. Maybe not a lot, but it went down over the last couple of days and into the weekend before it came roaring back. What drove the sell off in price?

Yeah, sure. So there's been a lot of speculation on Twitter about what the catalyst was. But I think, you know, it really comes down to the fact that there was a lot of leverage. futures open interest was like off the charts and that basically means there's a lot of there's a lot of greed in the bitcoin markets everyone was super over leveraged every time price went up you know everybody hopped in on their 10x long 100x long on bitmex and wanted to you know ride this thing as they thought it was going to explode and so what happens is when there's that much leverage in the system it makes it makes it very fragile right and you can kind of analogize it to Like if you think about Jenga, where you're stacking the Jenga blocks higher and higher, it just the higher you go, the less of a push it takes to push the price back down.

And so there's been a lot of speculation. I know Willie Wu had talked about the hash rate had something to do with it, the power outage in China. And then speculators had kind of freaked out and tried to, you know, sell off to avoid a further sell off, which kind of became like a self-fulfilling thing. Right. So that could be true. Just by looking at the data, we did see a giant inflow of about 9000 bitcoins onto Binance. and Binance is primarily used in Asia, which would kind of line up with that theory that somebody had some kind of insider information about what was going on with the power outage and they were trying to avoid the sell off that they figured would come. But it really comes down to the fact, regardless of what the catalyst is, it comes down to the fact that there was a lot of

leverage. And so when you have the market that highly leveraged, it's very prone to these kind of events, right? And so throughout the last week, we've seen that leverage just get completely flushed out. When you look at the funding rates, which is how on these trading platforms in Bitcoin, we have something called the perpetual swap. So it's basically this contract, this futures contract that doesn't expire, that's pegged to the Bitcoin price. And the way it's pegged to the price is through funding rates, right? So when the majority of the market goes short, the funding rates go negative, right? And then it becomes profitable to take the other side of the trade to go long. Same the other way around, right? When everybody wants to go long,

funding rates go up and the people that are long are actually paying people to go short to keep the price on the perpetual swap peg to the market spot price, right? And so for weeks now, we had incredibly high funding rates, meaning there was huge leverage and it was incentivizing more whales to come in and take the other side of the trade and go short. So it kind of was something where it wasn't definite when it was going to happen, but we were definitely prone to something like this. And it's not very surprising to see. Yeah. And so obviously a lot of the leverage, especially the levered longs, that's basically just people saying, Hey, I think the price is going to go up a lot. There's a lot of kind of excitement and bullish sentiment. And so people

end up adding that leverage in. How exactly does the leverage get washed out? Is that simply just the price begins to dump and then there's a bunch of liquidations on the way down and that then further accelerates the sell-off or is it something else? Yeah, exactly. So going back to the Jenga example, if you think about when the blocks at the top begin to fall, it causes the other ones under them and it becomes this huge cascade, right? And so it's the same kind of thing. We saw what happened with those 9,000 Bitcoins that got sent into Binance. It actually sent the price down to the market's liquidation price, the majority of the market's liquidation price, which is basically the point where traders that are taking a long position, when they hit that

liquidation price, they're forced to sell by the exchange to cover their losses, right? And so that selling pressure, which was presumed to be caused by those 9,000 Bitcoin sent on to Binance, was enough to push down the price to trigger a lot of liquidations, which causes you know, the traders to have to sell to cover their losses, which sends the price even further down, which triggers more liquidations, right? And it becomes this self-fulfilling thing on the way down. And so that's what really drove that initial huge crash. We saw like 15 or 20% in an hour or something crazy like that. It was just basically a cascade of those liquidations. We saw, I think, according to the data I'm looking at on Glassnode, we saw about $1.84 billion of

liquidations within like an hour or two. So I think that was the largest since, and it might actually be larger than March of last year during the 50% drawdown of March last year. And that's pretty crazy, right? When you think about there's either potentially more or actually more liquidations happened in a one hour period over the weekend than in a day in 2020 when the price dropped 50%, right? And that's just a function of there's way more leverage in the system right now than there was in March 2020, right? Yeah, absolutely. You know, we have a lot of really bullish sentiment in the market. And that obviously got wiped out in the last week. But, you know, for a while, we had everybody thinking we're going straight to 100,000.

And then it became profitable to take the other side of the trade once that the funding rates really spiked. So it was something that, you know, it was bound to happen eventually. But, you know, I think this is something where you can see some silver lining here in the sense that no one got bailed out right um in the traditional legacy system when when everybody has to capitulate everybody gets wiped out leverage um you see you know there's backstops the fed comes in and bails everybody out in this in this free and open market right completely decentralized everything settles instantly uh 24 7 right liquidity goes 24 7 so when everybody got wiped out, there was no backstop. There was nobody to bail anybody out. It's a true free

and open market, which is completely contrarian to what we have today. And you play stupid games and you win stupid prizes, right? When you saw the price dropping, it didn't seem to go below anywhere like $47,000, $48,000. And there was a couple of times where it kind of dropped to $51,000, came back to $52,000, $53,000, then it dropped to $50,000, came back to like 51, 52, dropped to 47, 48, 49, came back to 50. But it just felt like there was like almost like this floor kind of in that 47 to 50 range. Is that something structurally in the market? Is that something to do with kind of leverage or is that just people stepping in and buying at that price? Yeah, sure. So one of the main things I personally look at because I'm a

big proponent of the on-chain data, I look at the on-chain volume. So you see there's different support zones based on the amount of coins that were moved at different price levels so we saw one huge zone of coins that were moved was was at 53k and so that kind of served as a little bit of support for a few days there and then that broke and there wasn't much volume up until behind 47k which was the next like major support zone and in terms of on-chain volume and so that that served twice as a strong support zone. And then in addition, Charles Edwards hash ribbons is another thing to look at. You saw briefly it went flash to buy zone, which means that the miners capitulated and it became really attractive to buy. And off that note with

miners, you also saw during this event, miners continue to accumulate. So there's a glass node metric called miner net position. And you saw throughout the dip, miners actually ramped up their accumulation, which was really good to see because obviously miners have more skin in the game than anybody else. And they're more bullish on the asset than anybody else because they've invested their entire operational expenses into Bitcoin and Bitcoin went wrong. Everything that they have would be deemed basically like a paperweight. So it's good to see them. They were actually accumulating through this whole dip. And then as well, you saw the coins that were being sold were relatively young coins. So Glassnode has a metric called dormancy.

And the way you can think of this is if a coin has been moved into a wallet and it's sitting there for one day, it has one day of coin day, right? And that's an on-chain metric term. And so let's say a coin is in a wallet for 10 days and then the coin is sold. Then there's 10 coin days destroyed. And so dormancy takes a ratio of the coin days destroyed through the market, right? And so you saw dormancy actually went down throughout the sell-off, meaning that the older coins, aka the long-term holders, were not selling during this dip. It was primarily driven by newcomers into the market that probably got spooked out that hadn't been through any of these huge corrections that we know are very well just part of the way Bitcoin operates.

So my read of the situation is that even though there was kind of this washout of the leverage, a lot of the data that you're looking at, a lot of the data points you're talking about suggest that the bull thesis is still very much intact or the bull market is still intact. Is that your read as well? Yeah, absolutely. When you look at some of the long-term indicators, you see that the bull market is still very well, very far from being overheated. and none of the major indicators, the macro indicators of the cycle are anywhere near

being overheated or showing any signs of a top. So, you know, this is just another short term correction that Bitcoin has on the way up in the last cycle on the way up in 2017. We saw multiple corrections over 30 percent. And this is just how the market works. Right. And you wash out the weak hands, the people that don't have conviction and then the people with conviction come in and scoop those coins up. Yeah. And they definitely scooped them up pretty hard. What we've seen over the last 24 hours is I think what makes people so excited about Bitcoin. We've seen about a 14, 15 percent upward move in price. And it was so violent that it just wrecked a bunch of shorts. I think at one point last night, you tweeted saying that there was over

$88 million worth of shorts in just a one or two hour span, right, that were all liquidated. So talk a little bit about kind of the shorts, are they using leverage and then liquidations as the price moves back up after a drawdown like this? Yeah, absolutely. So it's the same thing about what we talked about when we came down, right? Everybody goes long, everybody goes leverage long because the price goes high. Market psychology says, okay, we're going higher. So I'm going to go leverage long because we're going higher. And then on the way down, we're going down, you know, we have some pretty violent drawdowns. Everybody gets really bearish market. You know, the market psychology flips. Everybody says, oh, price is going down. So it's going to go

way further down. So I'm going to go leverage and take a leverage short position. And so the further down we go, the more the more shorts pile in. And that was evident when you see the funding rates, more people were taking the short side of the trade. And so it just takes similar to it just takes a little push to liquidate people on the way up. It just takes a little push to liquidate people on the way down. So last night, people have been in the Bitcoin space know that whenever we have these drawdowns, you can really tell there's a bottom because we see the huge violence just spike up in like an hour or two. Right. And that's evident because you see some buyers step in, some huge whale come in and say, OK, I'll take those cheap coins. They step in

with a huge buy and then it initiates a chain of short liquidations on the way back up when the market gets over leveraged in the short position. And so that's exactly what we saw last night. Like you said, in two hours, we saw over $88 million of short liquidations, which is pretty unprecedented. Yeah. And what I'm looking at right now is the Bitcoin price as of this recording is about $53,800. It's up about 8% in the last 24 hours. We're seeing a Bitcoin market cap of a trillion dollars. And what to me is fascinating is you still have over a million active addresses. The mining reward is still $48.8 million in a 24-hour period. GBTC is down 11% on that discount. and from the all time high, we're down about 17 and a half percent. And so people look at that

and they're like, wait a second, this looks pretty bullish, even though we're down that 17 and a half percent from the all time high. Is this something where we should expect based on a lot of these fundamentals for price just to rocket right back up to the all time high? Or how do you see this coming out of one of these bottomings and a lot of the shorts actually getting liquidated? yeah it's a great question um so one thing i'm seeing is i keep a close eye on stablecoin flows so basically you can track um the stablecoins that are flowing onto different exchanges and this morning we did see a huge batch of it was over 400 million dollars of tether which was moved on to exchanges which is you know an indication of someone uh moving stablecoins

onto an exchange to buy and we've seen price go up throughout the day and so we haven't seen that any short liquidations, which is kind of an indication that the rally throughout the last couple of hours has been driven by spot buying rather than just any kind of short liquidations, which is a good sign. And we're also seeing this, you know, you'd mentioned where we are right now in price. We're right above that one trillion dollar threshold. And that's really deemed a really strong point of support for Bitcoin. Obviously, we dipped down over the last week, But I think it's over 14 or 15% of Bitcoin supply has moved over that $1 trillion market cap threshold, which really shows a strong validation from the market of Bitcoin as a macro asset, right? For sure. As we move forward in the coming weeks, what are some of the data points that you're going to be looking at or things that you want to see from a milestone basis?

Sure. So I think one thing to look at is the funding rates. I know we touched on this a few times, but that can really be a good judge of the sentiment of different market participants. In addition, just keeping a close eye, one thing I'm looking at is the entity net growth. So that basically is measuring the amount of new users on the blockchain. This isn't taking into account new users on exchanges, but generally just Glassnode has different clustering algorithms that they put together addresses and identify them as different entities. So one entity can be a person, right? Like you or I who has their own hardware wallet, or it can be a corporate treasury, or it can

be an investment fund, right? And so we're seeing this kind of like, Willy Woo calls it a hockey stick curve of adoption. We're seeing this huge parabolic increase in entity growth on chain, which we've seen each cycle, we have this huge spike in that, which is really good for the growth of the network and the adoption of the network. And we're kind of in that phase. And so that's also indicative of retail coming on the network as well, which means we're probably somewhere midway through the cycle. We see retail coming in usually about midway. But yeah, I mean, just keeping a close eye on some of these, the broader indicators, it's really hard to predict these moves on the

way up because they have a lot to do with market psychology. But the moves on the way down, you can generally time the bottoms pretty quickly. I know like one indicator I use is SOPR, which we put in the newsletter last week on Friday, which I highly recommend everybody to check out when it comes out. And so SOPR measures the amount of profit taking in aggregate for the network. And so whenever you see SOPR dip below one, that means that the market is taking losses in aggregate. You know, if it's at one, it means the market is neutral. Above one means that people are in profit in aggregate. But when we go under that one threshold, that means that the market's in the loss. And so we did see, we saw SOPR go below one back in January, which was like one of the largest

corrections of this cycle so far. And then for the second time, we saw that happen like two days ago. And then we saw we saw a violent uptick in that, which to me indicated that whoever was going to capitulate on their holdings had already done so. And that was that was a huge bottom indicator. So, yeah, just just keeping an eye on some of these overheated metrics and especially in regarding the leverage, because that can, as we touched on, be a be a huge catalyst for for some of these huge drawdowns that we see. But as far as like the overheated in the short term, it's hard to predict because there is that huge aspect of psychology that comes into play. You know, the FOMO kicks in. A lot of the people that were betting on the price going down to 40K, you know, we see this huge spike up today and they're like, oh, maybe I'm wrong. The market's telling me I'm wrong. I better get in before we go up to 60K. And the sentiment can change on a dime. And so I think that's what we'll probably see over the next couple of days.

I'll be keeping a close eye on these short liquidations for sure. That is a fantastic view of the world. And I tend to think that you frame it best, right? It's like a lot of these data points can give you really interesting kind of guardrails or directional information, but probably are not things that folks want to kind of time the market or trade off of or anything like that. It more so just helps you understand what's happening and why it could be happening. So I think that's important. I wish that somebody could figure out the laser eye metric, which would just be like what percentage of Twitter users has laser eyes?

And is there any correlation to price there as well? Because it seems like you're going to get the last note on that one. Absolutely. All right, man. Listen, this is fantastic. I really appreciate you kind of jumping on real quick and helping to explain what happened. But for those that are listening, basically, the summary is very simple. folks got overly bullish, lots of leverage in the system. Somebody came in, dumped about 9,000 Bitcoin. Price starts to trickle down. As that happens, those long levered positions get liquidated, which accelerates a further and further downward spiral. And as that occurs, sentiment shifts, people become bearish. They start to then put on levered shorts.

Obviously, at some point, you kind of exhaust that drawdown and then it violently rips up and it basically liquidates the shorts. So lesson for each of you at home using leverage, probably not the best idea, especially if you are an inexperienced trader or somebody who simply just wants Bitcoin exposure, just Bitcoin and chill. You'll probably be much, much better off, much less of a stressful situation as well. So Will, listen, thank you so much for taking the time to do this. And people will be hearing much more from you over time, whether it's in the newsletter future podcast episodes um and where can we send them to follow you on twitter yeah sure so i'm on twitter at w clemente um i i i because i i'm the third in my family and then

as well i'm putting out you know a newsletter for you on uh every friday which is kind of an on-chain update um i highly suggest checking those out because you know the on-chain metrics are very um unique to bitcoin where we're able to track the the capital flows through the through the network completely transparently um you could basically think of it as you know if you were in the in the traditional financial system able to see every time someone was was trading cash with each other that that's the way it is you know we can see everything all the movements of coins on chain and so you can get a really like you said good outlook of kind of the macro um where we are in the broader cycle and you know the behavior of different kind of entities so um that that's what

that that's what that on-chain update is on every friday and that'll be posted on palm's twitter awesome man well listen thank you so much for doing this and we'll do it again in the future absolutely thanks for having me on