Behind The Bitcoin Blockchain

Hey everyone,

Last week, BlackRock made an audacious move:

Unsurprisingly, the market reaction was immediate and significant. The original crypto coin jumped 20% to two-month highs above $30k over just 11 days.

A ripple of anticipation washed over the market as the world's largest asset manager revealed its hopes for the long-awaited Bitcoin ETF in the US.

We covered the news event extensively last week, so today, we're switching gears to ask an important question:

Here's the thing about crypto - it's not just about the flashy headlines and skyrocketing (or plummeting) price points.

Beneath these surface-level phenomena is a bustling hive of activity. This is the realm of on-chain analytics - a treasure trove of data that can offer us a different perspective on the state of the Bitcoin market.

This week, we're delving deep into this hidden realm to understand if Bitcoin's on-chain activity supports the market's reaction to the ETF news. We’ll aim to provide a comprehensive understanding of the market's movements - not just from the investor's perspective but from the vantage point of Bitcoin's internal workings.

So, read on as we peel back the layers of the market, one block at a time. There's much more to this story, and together, we'll get to the heart of it.

Behind The Bitcoin Blockchain

As a primer for readers who are unfamiliar with on-chain analytics, picture your local supermarket. The shelves are stacked with produce, from exotic fruits to household staples. This is like the Bitcoin blockchain, teeming with transactions.

Now, imagine if you had a meticulous friend who tracked every single item's journey from shelf to checkout, noting down each shopper's behaviour.

They’re the supermarket CCTV of the Bitcoin world. Analysts watch every transaction on the Bitcoin blockchain, from the smallest microtransaction to whale-sized purchases. This game is all about digging into the nitty-gritty: the timestamps, the volume of transactions, and the addresses involved. It’s a comprehensive study of all active 'shoppers' in the Bitcoin supermarket.

So, with that understanding, we need to figure out whether the on-chain data corroborates the market reaction to the Bitcoin ETF announcement.

Just like our friend at the supermarket, we've brought in the experts to help with the deep dive – Glassnode. They're like the Sherlock Holmes of the crypto world, bringing clarity to the opaque.

Glassnode has laid out a pretty intriguing roadmap for us in their “Week Onchain” deep dive. Their approach is to explore how many bitcoins are available for sale.

They're essentially asking, "How much stock is there on the supermarket shelves?" With a wave of institutional demand on the horizon from the likes of BlackRock, Fidelity, and others, the answer to this question becomes critical.

If demand from these financial behemoths, amplified by ETF offerings, outstrips the 'supply' of bitcoins up for sale, then we’d expect Bitcoin's price to skyrocket.

After all, it's the classic law of supply and demand – scarcity drives prices up. As we dive in, we'll consider whether the stock of bitcoins on the supermarket shelf can meet the huge wave of institutional appetite.

Dissecting Regional Demand

First, let’s look at some “big picture” regional metrics around the demand for BTC.

Despite the SEC’s iron-clad grasp on the crypto industry in the US, we can see from the chart below that the Bitcoin rally was led by US traders, with traders in the EU and Asia following suit in their respective trading hours.

For the most part, this is unsurprising.

Remember that Bitcoin wasn’t implicated at all in the SEC’s most recent lawsuits against the crypto industry. So no wonder US traders are flocking to the one crypto asset that’s dodged regulatory scrutiny and the one with institutions lining up at the door to buy its dip.

To dig deeper into these regional shifts, Glassnode analyses BTC flows through fiat on-ramping entities (exchanges) within the next chart. The analysis is focussed on the top three exchanges from the US and Asia regions as ranked by CoinGecko:

• For the US (on-shore), we've got Coinbase, Kraken, and Gemini.

• And for Asia (off-shore), it's Binance, OKX, and Houbi.

By studying the weekly average BTC net flows, we can see that in the wake of events such as the LUNA meltdown and FTX fallout, there was a marked shift towards self-custody, with most exchanges experiencing daily net outflows of 5-10k BTC.

However, Binance, the largest exchange in the world, bucked the trend. During market sell-offs and downtrends, Binance saw large inflows.

Could this be investors shifting holdings away from perceived riskier exchanges like FTX and towards the crypto exchange titan? That's one theory.

However, as of today, Binance and Coinbase have been hammered with outflows of more than 5k BTC as a result of their legal battle with the SEC.

Glassnode then categorises exchanges based on their headquarters, breaking them down into on- vs off-shore entities. By aggregating the total net flows for each subcategory, we can paint a more nuanced picture of regional demand.

The next chart illustrates the monthly cumulative netflow for each region.

Both the US and Asia experienced net outflows (indicating investor accumulation) during the bottom discovery phase between November 2022 and January 2023.

However, post-LUNA and throughout most of 2023, off-shore exchanges have seen net inflows, while on-shore exchanges have experienced net outflows. US-based investors appear to be accumulating or maintaining a neutral stance over time.

This data can help us keep tabs on regional market sentiment shifts in response to external factors. For instance, following the announcement of the SEC lawsuit against Binance and Coinbase, both regions reacted with notable exchange outflows.

As of today, Asian exchanges are showing net outflows of -37.7k BTC/month, while buying pressure in US exchanges has dropped outflows to -3.2k BTC/month.

From our analysis above, we can see clear regional variations when it comes to the demand for BTC and exchange behaviour.

US traders lead the pack in the face of regulatory hurdles, and interestingly, the shift towards self-custody highlighted by the recent exchange outflows showcases a sentiment shift despite the SEC’s regulatory onslaught.

Gauging Demand via Hot Supply

This is where we’re going to conjure up the available volume of BTC for sale on the market and look at metrics tracking any expansions (or contractions) in demand.

Glassnode’s recent research has highlighted how Bitcoin wealth is steadily transferring from high time preference investors to dedicated HODLers.

This growing illiquidity, reminiscent of past Bitcoin bull runs, sure gives us a supply shock. But for it to sustainably impact prices, an influx of new demand is needed.

So, in their analysis, Glassnode builds out a robust on-chain framework to track changes in demand using the momentum of highly active supply as a proxy.

The idea is to gauge capital flows through shifts in the active region of Bitcoin’s circulating supply. When new demand enters the scene, existing investors usually transact, distributing their coins at elevated prices to realise a profit. This prompts older coins to be spent, which increases the younger supply of coins.

Glassnode defines 'young supply' as coins moved within the last 155 days, categorised as Short-Term Holder Supply. The key fact is that there's a high likelihood of these coins being spent soon.

Coins older than 155 days are categorised as Long-Term Holder Supply as they’re unlikely to be spent on a statistical basis.

And so again, the first chart we show here sets the scene from a big picture; it separates Bitcoin’s circulating supply of coins into these zones — with the Short-Term Holder Supply in red forming the “liquid layer” of Bitcoin’s circulating supply.

Glassnode then digs deeper from here to isolate only the most liquid and highly active subset of the young supply region, which we will define as ‘Hot Supply.’

Now, the velocity of coins refers to the speed at which tokens change hands from one participant to another. It's a measure of how frequently bitcoins are spent within a given period, providing insight into the level of activity on the Bitcoin network.

Let’s illustrate the concept with a quick example:

Assume the total transaction volume of Bitcoin in a single day is 200k BTC. If the total supply of Bitcoin were hypothetically 1m BTC, then the velocity of Bitcoin for that day would be 0.2. This means that, on average, each bitcoin was moved 0.2 times that day.

And so, a velocity of more than one means, on average, each coin in that region moves more than once per day.

The chart below then shows the all-time-average velocity for the following markets:

• Perpetual Futures Market 🔵

• Spot Market (<1-week old coins) 🔴

• Spot Market (<1-month old coins) 🟠

The velocity of both the futures markets and the supply of coins less than one week old is more than one. Whereas looking at coins older than a week, velocity drops below one, highlighting the key takeaway that older coins have a much lower probability of being spent.

So going forward, Glassnode focusses on coins being traded in the futures market as well as coins less than a week old (the Hot Supply).

Now we want to get an idea of the scale of the Hot Supply relative to Bitcoin’s total circulating supply.

In the next chart, Glassnode pits this region against the Perpetual Open Interest and Total Supply. It’s fascinating to see that throughout the whole history of Bitcoin, price action has been driven by a fraction of the total circulating supply.

Hot Supply represents between ~3% and ~11% of the total supply, versus the volume of “probably lost coins” (those that haven’t transacted since Bitcoin’s first traded price in July 2010) at ~7%.

Perpetual Open Interest (472k BTC) and Hot Supply (511k BTC) are also similar when zooming in below, suggesting that around 983k BTC (~$29.5B) is currently ‘available’ for sale, with ~50% being spot BTC.

We can then take these volume metrics to show the interrelation between price action and changes in Hot Supply and Perpetual Open Interest.

The chart below looks at the 90-day Net Position Change in these regions, where we can identify the direction and magnitude of capital flow into (shown in red) and out of (in green) the market.

Throughout past bull markets and severe capitulation events, between 250-500k BTC in value is typically deployed into the market—this signifies older coins being flushed into the market, either to take profits or to gain liquidity in a crisis.

During bear markets, a similar amount of BTC is accumulated and taken off-market long enough to exit the Hot Supply category.

For example, we can see that throughout 2022 we entered an accumulation phase, where coins in Hot Supply exited the category by being bought and held by Long-Term HODLers (moving from red to green spikes on the chart).

In other words, this particular chart is great at telling us what the “smart money” investors are doing with their capital at different points in the market cycle.

We can also show the impact on price action from expansions in Hot Supply in the chart below—Glassnode does this by zoning in on the Hot Supply (red spikes) from the previous chart.

The next chart becomes a proxy for new demand flowing to Bitcoin.

We can see that there were seven instances of capital inflow over the last five years, ranging from ~400-900k BTC per quarter.

We’re then able to analyse the potential market effects of major supply liquidations, such as the Mt. Gox funds to be distributed (~137k BTC shown by the black horizontal line) and bitcoins held by the US government (~204k BTC in green).

The key takeaway from this is that a single quarter’s worth of demand (whether in a bull run take-profit cycle or a bear market accumulation cycle) would vastly eclipse the supply of BTC held by Mt. Gox or the US government.

So to all the investors who worry that these supply liquidations are going to tank the market, rest assured—that’s extremely unlikely to happen.

At this point, it’s crucial that you keep these two figures from our analysis in mind:

• There are about ~1m BTC available for sale today, with ~50% being spot BTC.

• And the average demand that enters the market each cycle is around ~700k BTC.

These two figures answer the question we posed earlier around how much BTC is actually available to purchase on the market. Now, we can find out whether Bitcoin’s ETF pump to $30k has been justified.

The Institutions Are Coming…

…with a lot of resources.

As a reminder, these are the big dogs we’re dealing with when it comes to Bitcoin ETFs. Those Assets Under Management (AUM) figures are in the trillions, by the way.

Putting their collective $27 trillion in AUM aside, the vital question remains:

…and, therefore, was the market justified in its pump? Estimates vary, but it's clear the influx could be monumental.

A Fundstrat Global Advisors report posits that up to $300 billion could flood into Bitcoin within the first year of a spot ETF launch. However, looking at data from Q1 2022, crypto ETFs pulled in just ~$16 billion in assets.

Let's start our analysis by considering the lower-end estimate.

Even at a modest $16 billion influx, this represents around ~500k BTC at today's prices. Keep in mind that the average supply of BTC available for sale each cycle hovers around this exact figure.

So these ETFs would have to purchase every available BTC that comes onto the market each cycle—US traders would have something to say about that…

Now, ramp up to the Fundstrat projection of $300 billion, which equates to a jaw-dropping 10 million BTC. If demand ever rockets to this level, we’ll be looking at a supply squeeze of epic proportions.

However, there's absolutely no guarantee about the degree to which institutional demand will materialise. Yet, if anywhere from $20-300 billion of institutional capital decides to chase after Bitcoin, it's pretty clear that the supply-demand imbalance could launch its price into the stratosphere…

…in fact, Fundstrat’s own Head of Research, Tom Lee, believes that Bitcoin’s price+ could reach $200,000 in the next few years from the excess demand that’s coming.

It's a game of musical chairs, with far more players than seats. And when the music stops, we could witness a scramble to acquire bitcoins that’s never been seen before.

A Long-Term View

As tantalising as the bull case for Bitcoin might seem, there are several hurdles to clear before this becomes a reality.

While the appeal of a Bitcoin Spot ETF is clear to the market, the approval from the SEC is not. Historically, the SEC has resisted approving Bitcoin ETFs, citing investor protection concerns.

Even if one gains approval, it could be years before it's live and trading.

It's critical to remember that the wave of demand for BTC may or may not ever arrive. As investors, we must accept this risk and temper our excitement about potential price explosions.

But despite these uncertainties, we remain steadfast in our long-term bull case for the “battle-tested” digital assets—Bitcoin and Ethereum.

The investment journey in crypto is a marathon, not a sprint. Doubling down on one's thesis and conviction is crucial, especially when the path ahead is littered with uncertainties.

In this rapidly evolving landscape, sticking to the fundamentals and having the patience to weather the storm can always yield asymmetric opportunities.

Like front-running BlackRock.

…then they create a Bitcoin spot ETF trust.

The timeless quote underscores the value of holding onto long-term conviction.

It might seem like a lonely journey at the start, but with persistence, those who hold on (or HODL?) are often rewarded the most. Moral of the story:

Do not sell your coins to BlackRock.

Thanks for reading. Share this with a friend if you found it insightful.

— Luca