7 min readTowards the end of last year, we published The Dynamic Supply Cyclicality Thesis, which attempts to explain the behavioural patterns of investors through various phases of Bitcoin’s discovery and adoption.
The thesis claims that after each reduction in Bitcoin’s issuance rate, price increases attract new investor demand and lay the foundation of a new bull period. The price increases cause Bitcoin to garner further attention, leading to more investment as the population becomes increasingly informed of Bitcoin’s properties and potential.
The cyclical repetition of bitcoin price movement is therefore theorised to indicate successive new classes of investors being initiated to bitcoin. Then, once they’ve been through a full cycle top and enter a bear market, these investors typically resist the urge to sell their coins below acquisition cost during at least one full cycle down period. They thereby restrict supply and create downside support by holding coins during the price downturn, until finally finding profits in the next upswing where many start selling.
Their success then emboldens a new generation of long-term holders, who are often brought into bitcoin by a powerful narrative such as the supply halving. These new investors then undergo the same rough sequence of events and the cycle repeats.
The 2017 Class of Bitcoin Investors are Holding the Line, Like the 2013 Class Before Them — The HODL Army Grows
An increasing number of coins bought in 2016 and 2017 are now idling in illiquid or inactive addresses. This suggests that many investors from this time period are more keen to hold rather than spend their bitcoin, despite seeing the bitcoin price rise to heights well above their acquisition cost. From an immediate supply/demand perspective this is clearly price-supporting behaviour likely to help the market find a new strong bottom.
Interestingly, we have found similar conviction among a set of investors that accumulated bitcoin following the first halving event in 2012, albeit at reduced overall proportions (in terms of usd). As mentioned above, we generally interpret the trend of bitcoin investors refraining from spending their holdings, while having the opportunity to realise profits, as evidence of adoption of bitcoin as a long-term store of value and the amount of coins held idle for more than 5 years is not only growing on a nominal basis, it is also growing on a proportional basis, suggesting a more wholesale behavioural shift is taking place.
Many coins exchanged at lofty bitcoin prices in the beginning and closing months of 2013 remained unspent five years later, despite investors witnessing record high price levels in 2017. The restriction of supply by these long-term investors, along with the halving event reducing bitcoin emissions in 2016, ultimately laid the foundation for the rapid price appreciation in 2017, where new investor demand dramatically overpowered available supply.
We now see the same pattern having taken its course for coins exchanged at lofty bitcoin prices in 2017, where a new era of investors have chosen to resist the urge to sell their coins despite having the opportunity to realise profits at any time in 2021. This provides some explanatory power to the increase in bitcoin price following the 2020 halving, when available bitcoin supply was again constrained, while also suggesting the 2017 class of bitcoin investors carry a similar conviction to those initiated in 2013.
Transaction fees were also relatively low throughout this phase of potential profit-taking, making it cheap for bitcoin holders to submit transactions for reasons unassociated with selling, such as Lightning channel openings, CoinJoins, or UTXO consolidation. We believe this actually provides stronger assurances that coins deemed ‘inactive’ (that is, those that have not moved in over five years) remain unspent as a store of value, given holders were provided a highly favourable environment to make general bitcoin transactions.
Proportional Shifts in Coin Usage Suggests Longer Term Behavioural Shifts Among bitcoin Users
From a higher-level view however, the increasing proportion of bitcoin idling in inactive addresses, combined with the corresponding reduction in bitcoin taking part in the most liquid supply pools, suggests the existence of a longer term trend. We believe what we’re observing is users increasingly using bitcoin as a long-term savings tool, and less as a shorter term object of speculation.
Immediately, this suggests a reduction in the overall velocity of bitcoin which is price-supportive. But even more interestingly, it also suggests increased perceptions of system maturation and reduced perceptions of systemic risks among users who are seemingly increasingly comfortable with using bitcoin as a longer term store of value.
Bitcoin Exchange Liquidity is Reducing with Ongoing Investor Withdrawals
It’s not necessarily a surprise that certain bitcoin investors decided to continue saving their coins throughout the full wind up and wind down of a bitcoin market cycle, and we mentioned this in our previous thesis report. However, the 2017 class of investors seem to be hoarding their coins even more aggressively than we’ve seen in past cycles.
As a refresher, the amount of coins flowing to and from bitcoin exchanges can be estimated by observing transaction data recorded directly to the Bitcoin blockchain. While typically we have found that experienced investors accumulating coins through market downturns later move coins to exchanges and realise profits during the upswing, bitcoin holders have lately behaved differently.
In both the 2013 and 2017 bull periods, large positive net inflows have coincided with decreasing bitcoin price levels (and decreasing average coin age), suggesting that many long time bitcoin owners took profits during the cyclical upturn. Recently however, we see that while some investors indeed decided to move coins to exchanges and realise gains at the 2021 market peaks, the outflows from exchanges have far outweighed the inflows. As mentioned in previous sections, this suggests a longer-term trend is in place.
The lack of inflows to exchanges since 2020 indicates that perhaps the 2017 class of bitcoin investors are the most steadfast savers of any group initiated by the market-broadening halving events. With 24% of circulating supply (or, 4.6 mm btc) now inactive, along with the trending decrease in exchange liquidity, investors may be encouraged that any event catalysing significant new investor demand would likely accelerate the bitcoin price.
Over a Million bitcoin is Custodied by Funds, Companies, and Ancillary Networks, Muddling the Inactivity Analysis
We caution however that the financial infrastructure surrounding the Bitcoin ecosystem has grown substantially in recent years, providing investors with many more opportunities to gain bitcoin exposure outside of holding coins themselves. With more market structure, bitcoin has to some extent become financialised, meaning that liquid alternatives to trading native bitcoin are available to investors, and market activity across these products impact bitcoin price discovery.
This is certainly the case for physically-backed exchange traded products which, due to their structure, do not impact the overall supply of products with exposures similar or near-equivalent to bitcoin. But it is more importantly the case for cash-settled futures products which are completely disconnected from the Bitcoin ecosystem and absorb demand by ‘synthetically inflating’ the bitcoin supply .
Here we offer a snapshot view into the coins custodied by various funds, companies, and ancillary networks (such as Lightning and Liquid), which oftentimes remain idle, somewhat muddling the narrative behind inactive bitcoin supply and may at worst mislead investors that rely solely on strict analysis of data from the Bitcoin blockchain.
We were able to identify 4.13 million bitcoin (or 22% of circulating supply) held across various centralised entities, ancillary networks, and bitcoin addresses widely considered abandoned. These coins will belong to a variety of UTXO bands, not merely the ‘Inactive’ band.
Bitcoin Supply and Demand Dynamics Heavily Influence Both Short- and Long-Term Valuation
The supply dynamics of bitcoin are and will continue to remain an important factor for investors to monitor from a valuation perspective. Similarly, it will remain critical to follow maturation events that impact long-term demand. With this, we find the tendency of bitcoin supply to constrain with each new era of investors discovering the properties and potential of Bitcoin both to be an encouraging sign for short-term price support, and for long-term adoption.
Prudent investors should however monitor changes to market structure that dilute the effects of any bitcoin supply restrictions, such as increasing evidence of rehypothecation or the market’s exposure to synthetic bitcoin products. As a counterweight to this trend, we both welcome and encourage industry standards that pressure custodians to prove bitcoin reserves and increasing levels of investor preference towards physically-backed bitcoin products.
The further one looks out into the future, the harder it is to predict the structure of bitcoin markets and the behaviours expressed by users. However, in the shorter term there appears to be a good amount of evidence that cyclicality-driving behaviour by users continue, and moreover, that there is an ongoing trend among users to increasingly use bitcoin as a long-term store of value rather than a shorter term object of speculation.
