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bitcoin's on-chain market cycles

bitcoin's on-chain market cycles

Bitcoin is a free market for exponential, digital monetary technology. It has attracted interest from all manner of investors ranging from the individual, right through to global institutions. Number go up technology has driven both speculation and investor conviction, as the thesis of digital sound money is tested, challenged, and ultimately proven through price performance and adoption.

Within that context, Bitcoin has proven to be a cyclical asset, with extreme price run-ups and lengthy and significant draw-downs. At all stages in these cycles, there are pools of people buying, selling, holding, transacting and mining within the Bitcoin network. To fully understand the psychology and characteristics of these market cycles, there are few data-sets more suitable to study, than the Bitcoin ledger itself.

In this article, we will explore some select on-chain metrics that provide insight into the sentiment and macro spending patterns of hodlers, speculators and miners. The objective is to equip readers with the tools needed to appreciate the progress and data patterns as they relate to of the current bull market.

In bear markets, interest in Bitcoin the protocol typically wanes, and by the end of it, only Bitcoiners, smart money, and miners remain standing. These are the buyers of last resort, and they all have one goal: to accumulate as much bitcoin as possible before everyone else works it out.

For on-chain data, the patterns and fractals we observe during bear markets are largely driven by these low time preference accumulators. The chart below shows supply accumulation by long term holders and how it consistently peaks during the darkest times.

Bull markets on the other hand, are a very different beast. The dynamics between on-chain supply and demand are in constant flux as new speculators and old holders compete for block-space, profitability and test their resolve to hodl through epic price rises. Old hands typically begin to distribute in bulls, transferring their expensive coins into the hands of new speculators (who return the favour in bears, selling cheap coins at a loss to hodlers).

As investors enter and exit this market, they leave behind on-chain footprints that capture the aggregate hodling conviction and spending patterns. Through study of Bitcoin cycles, we can establish sets of assumptions and fractals to describe the balance between supply and demand. With an appreciation for market cycles, and how different parties typically behave, we can use these patterns to better gauge the progress of bull and bear markets alike.

Bitcoiners and the smart money tend to have a similar modus operandi. Their incentive is to accumulate Sats as cheaply as possible, and realise profits late in the bull cycle (if at all). As such, their total holdings grow during bear markets as sats and stacked and withdrawn to cold storage.

We can observe this in the HODL waves metric as older age bands (cool colors) increase in thickness, suggesting coins are maturing, and are held by strong hands. The thicker these cool bands become, the more supply is owned by long term holders.

Conversely, as old coins are spent, they are reclassified as young coins (warm colors) with a corresponding increase to young HODL wave thickness. Typically, smart money coins are spent only late in the bull market and when young age bands begin to swell in size, it may indicate a change in macro sentiment is underway. Note, coins older than 5-6 months are usually considered HODLed coins.

The Spent Output Age Bands provide a view on the age distribution for all coins spent that day. The chart below has been filtered to show only coins older than 1yr, indicative of hodlers. We can see that these old coins tend to be spent mostly during periods of high volatility, in particular:

The older a coin is, the more coin-days it will have accumulated, and when it is spent, these coin-days are 'destroyed'. Coin-days Destroyed (CDD) tracks the total sum of coin-days destroyed each day. We can use this metric to observe macro spending patterns and changes in behaviour for long term holders.

When Bitcoiners are accumulating, few old coins are spent, and CDD tends to be low. During late stage bull markets, old coins are increasingly spent to realise profits, leading to a spike CDD. Applying a long term moving average (e.g. 90DMA) can help to smooth out noise and identify these macro shifts and even approximate market tops and bottoms.

It is well known that Bitcoin volatility specialises in shaking out weak hands. The market often rewards long term holders who exercise patience, and punishes more inexperienced market participants and late bull cycle entrants. Long term holders recognise this and tend to wait for peak market hype before realising profits on expensive coins.

As hodlers distribute coins into new hands, the supply of young coins will swell in volume. The Realised Cap HODL waves are an ideal tool for tracking this wealth transfer via the expansion of young coin supply. We can see in the chart below during the late stages of the 2013 and 2017 bull markets, the height of young coin bands (warm colors) spiked in three distinct instances. These peaks generally corresponded with the major rallies and corrections.

In the current bull market, we have seen the first major spike in young coin supply. What is interesting is the warmest colors (Youngest coins) have not spiked as high this cycle. This likely reflects two phenomena:

Using this observation, we can construct the Realised HODL ratio metric (RHODL) which takes the ratio between the 1y-2y and 1w R.HODL waves, and creates cyclical oscillator that closely tracks the macro market.

Finally, we take a look at Proof-of-Work miners. Miners are some of the biggest bulls in the space, having sunk large amounts of capital into ASIC hardware, logistical setups and power consumption. Their compulsory selling of coins necessitates distribution to cover costs, which are typically denominated in fiat currencies.

As such, observing miner incomes and hodled balances is often useful to establish a gauge for their sentiment and conviction. The chart below shows the balance of miner coins since 2016 and we can see three typical phases:

Lastly we can analyse the income side of the miner equation, seeking periods of profitability or income stress. Miners generally operate with long time horizons. Given volatility in coin price, miners will assess income streams using long term averages to make economic decisions.

The Puell Multiple is a metric that builds off this observation, taking the ratio between current miner income and its 365-day average. This creates an oscillator based on aggregate miner profitability.

The supply and demand balance of the Bitcoin market is an extremely dynamic system, despite being cyclical in nature. Whilst the programmatic halving cycles may make it seem 'obvious', it remains difficult to pinpoint which stage of the bull market we are in. On-chain metrics provide tools and insights into macro changes in spending patterns and conviction of hodlers, speculators and miners.

Disclaimer: This report does not provide any investment advice. All data is provided for information purposes only. No investment decision shall be based on the information provided here and you are solely responsible for your own investment decisions.

the week on-chain (week 21, 2021)

the week on-chain (week 21, 2021)

The Bitcoin market has just experienced the largest deleveraging event since the March 2020 sell-off. The market traded down by over 47% from the weekly high of $59,463, to lows of $31,327. This weekly candle is now the single largest in total price range in history, a whopping $28,136 candle.

Price action was heavily driven by what can only be described as a FUD-bath, with topics pulled form every chapter in the Bitcoin critics textbook as @nlw summarises. This sell-off has been so severe that it has raised the question in many minds as to whether the 2021 Bull Market remains in play. This week we will review the scale of the correction and the response from various entities observable on-chain.

The chart below presents the USD value of losses realised by spent coins and shows that a new ATH of $4.53B in losses was hit on 19-May. This is higher than the previous spikes in Mar 2020 and Feb/Apr 2021 by over 300% and is the peak from a total weekly realised loss of $14.2B.

Accounting for profitable coins that were spent, this capitulation event is still the largest net realised loss by a significant margin. Over $2.56B in net losses were taken on-chain on 19-May, a sum that is 185% larger than the March 2020 COVID sell-off. The chart below shows that this capitulation follows a strong period of net profit taking (green spikes) so could be considered an equal an opposite reaction to the downside.

These net losses on-chain have resulted in a decline in the Realised Cap, as coins purchased higher are revalued to lower prices. The Realised Cap has declined by $7B (-1.8%) this week from its all time high of $377B.

Looking at the number of unique entities on-chain who are now in profit, we can see that the current FUD-bath has reduced profitable entities to 76%. This means that 24% of all on-chain entities are currently holding UTXOs that are underwater. In a bull market context, this compares to three periods in 2011, 2013 and 2016. This metric also highlights the proportion of the market who purchased coins higher and thus who may become panic sellers.

There is no question that a large portion of the recent spending activity was driven by short term holders, those owning coins purchased within the last 6-months. The spent output age bands shows that the 1m-3m and 3m-6m age brackets in particular spiked substantially higher than the typical baseline leading into, and during the sell-off.

If we compare this to the equivalent spending by longer term investors, particularly those with coins 1y-3y old (last cycles buyers) we see the opposite picture. Holders of coins aged 1y-3y were actually spending their coins much earlier, likely rotating capital to capture the price out-performance of ETH at that time.

During this capitulation sell-off however, the spending of 1y-3y old coins was actually significantly less and declining as a proportion of total activity. This suggests that old hands did not panic sell nor rush for the exits.

A major question that remains is what is the magnitude of unrealised losses, or in other words, how many underwater coins could still panic sell out? We inspect the Relative Unrealised Losses metric which presents the ratio between total underwater value and the current market cap.

Using this metric, we can see that around 9.0% to 9.5% of the current market cap ($700B) exists as unrealised losses, equal to around $65B in underwater value. Despite this being a historical capitulation event, relative to the market size, the value of underwater positions on-chain is actually relatively small. We can compare this to relative unrealised losses of 44% in March 2020 and over 114% in Nov 2018.

Note that prior to a major sell-off, coins that were purchased higher have essentially 'stored value' at a higher market cap. After the sell-off, the new market cap is lower and thus it is possible to achieve > 100% relative unrealised losses.

Across the aggregate market, the Net Unrealised Profit and Loss metric has pulled back to just below 0.5 indicating that the market currently holds an aggregate of 50% of the Bitcoin market cap in profitable coins. This level has acted as a support in all three of the prior bull cycles and this is actually the first touch in the 2021 market.

If we filter out for short term holders however, we can see that a major capitulation has occurred. Short term holders currently hold an aggregate unrealised loss of -33.8% of the Market Cap on their coins. This compares only to the most extreme draw-downs in Bitcoin history including:

4, Were miners selling Bitcoin? Some already panic sold, others had no choice. Not everyone have access to western hosting sites. There are also added level of uncertainty on current RMB OTC trading channels. Need fiat to cover operational costs at end of the day.

Observing the spending of miner coins demonstrates that whilst there is an uptick in miner-to-exchange flows, up from 100 BTC/day to 300BTC/day, this still represents a relatively small portion of the ~900BTC/day issuance.

The Miner Net Position Change metric confirms this is the case. We can see a slight decline in aggregate accumulation this week, however the rate of 'mined and held' coins remains a larger share relative to those that are 'mined and sold'. It remains to be seen if miners begin spending more of their coins as these changes roll out.

There was a distinct increase in net deposits to exchanges, both in the weeks leading into, and during the sell-off. Peak net inflows spiked above +30k BTC/day on 17-May. At the same time, the magnitude of outflows has been increasing steadily the lower price falls, suggesting that there remain buyers of last resort even as the wider market capitulates.

An interesting observation is that a bifurcation of the exchange market is underway in terms of which exchanges are increasing their BTC balances. The majority of exchanges have actually seen relatively flat to declining balances over the past weeks. Aside from a small increase during this weeks sell-off, these exchanges have effectively maintained an uninterrupted balance downtrend since March 2020.

There are however three exchanges that have received almost all of the net inflows observed: Binance, Bittrex and Bitfinex. The balance on these three exchanges has been increasing throughout 2021, although Binance leads with the lions share of inflows. During this sell-off however, all three exchanges saw significant increases to their held BTC balance.

Given all three of these exchanges service clients outside the US, this may suggest a difference in response between markets in different jurisdictions. Another explanation is that Binance in particular hosts a large catalogue of trading markets, derivatives, and is the gateway to Binance Smart Chain, a preferred venue for recent retail speculation.

Finally, on derivatives markets, open interest on Bitcoin futures has seen a tremendous decline from the ATH set in April. Open Interest across all futures markets has declined by over $16.4B (down 60%) from the peak and now returned to levels last seen in February 2021.

We have released a new content series focused on insights and analysis pertaining to the rapidly expanding DeFi sector. Our latest piece analyses and explores a series of strategies and DeFi products available to earn a yield using stablecoin collateral.

Disclaimer: This report does not provide any investment advice. All data is provided for information purposes only. No investment decision shall be based on the information provided here and you are solely responsible for your own investment decisions.

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