Original author: David Duong, David Han, Coinbase
quick overview
As the fourth Bitcoin halving approaches, we believe that studies of previous cycles should be interpreted with caution, as small sample sizes make it difficult to generalize their patterns to the impending future.
The U.S. Spot Bitcoin ETF has also reshaped Bitcoin’s market dynamics by establishing a new anchor for BTC demand, making this cycle unique.
We believe that current price action is just the beginning of a long-term bull market and that rising prices will need to go further to drive supply and demand dynamics into balance.
We are just over a month away from Bitcoin’s fourth halving. Like all previous halvings, it will reduce miners’ Bitcoin issuance rewards in half, this time from 6.25 BTC to 3.125 BTC per block. Although studying past halving cycles can provide some reference for Bitcoins potential price trends, we believe that the sample size of three events is too small and may not provide enough data support to structure a clear pattern or predict the impact of halvings. Make clear predictions about the impact.
Furthermore, we believe that the market dynamics of Bitcoin have fundamentally changed with the emergence of the US spot BTC ETF. In just two months, its net inflows reached billions of dollars, irrevocably changing the landscape. Now that major institutional players have been able to invest through these instruments, Bitcoin’s reaction to this halving may not necessarily be reflected in its performance over the previous three cycles. We believe it is more important to understand the current supply and demand situation for the technology to help us better understand Bitcoin’s potential.
In fact, while the new Bitcoin supply limit is an important consideration, it is only one factor among many. Bitcoin available for trade (i.e. the difference between circulating and illiquid supply) has been declining since the start of 2020, which is a significant change from previous cycles. But recent data shows that the active BTC supply (bitcoins that have been transferred in the past 3 months) has increased significantly by 1.3 million since the beginning of Q4’23, while the number of newly mined bitcoins during this period Only about 150,000. While markets are more capable than in the past of absorbing this supply, we still believe it is prudent not to oversimplify the complex interplay between these market dynamics.
background
Bitcoin miner rewards are halved every time 210,000 blocks are mined, which happens approximately every four years (the exact date and time depends on the network hash rate, the calculations used to process transactions and mine new blocks capacity, but this halving is expected to occur between April 16 and 20 this year). This halving will reduce the total number of Bitcoins issued from approximately 900 Bitcoins per day (meaning an annual issuance rate of 1.8%) to approximately 450 Bitcoins per day, which means that the annual issuance rate will drop from 1.8% to 0.9% . After the halving, the monthly production of Bitcoin will be approximately 13,500 and the annual production will be approximately 164,250 (the exact number depends on the actual hash rate).The halving will continue according to the figured out mechanism until all 21 million Bitcoins have been mined, which is expected to occur around 2140. We believe the potential significance of the halving lies in its ability to increase media attention on what is unique about Bitcoin: a fixed, deflationary supply schedule that culminates in a supply hard cap.
This is often underestimated. For physical commodities, such as minerals, more resources can theoretically be put into mining and extracting more minerals, such as gold or copper, and even though the threshold may be high, it will help meet demand when prices rise. But due to preset block rewards and difficulty adjustment mechanisms, Bitcoin supply is inelastic (i.e. not price sensitive). Furthermore, Bitcoin is a growth story. The utility of the Bitcoin network scales with the number of users on the network, which directly affects the value of the token. In contrast, buying precious metals like gold comes without the expectation of such growth.
History doesnt repeat itself, but...
Analyzing the impact of halving cycles on Bitcoin performance is limited because our experience is limited to three halving events. Therefore, studies on the correlation between previous halving events and Bitcoin price should be interpreted with caution, as the small sample sizes make it difficult to model this from historical analysis alone. In fact, we believe that more halving cycles are needed to draw stronger conclusions about how Bitcoin “usually” reacts to halvings. Furthermore, correlation does not imply causation, and factors including market sentiment, adoption trends, and macroeconomic conditions can all contribute to price fluctuations.
In fact, we have previously argued that Bitcoin’s performance during previous halving events is likely to depend on context. This may explain why its price action varies so widely from cycle to cycle. As shown in Figure 1, Bitcoin prices were relatively flat in the 60 days leading up to the first halving in November 2012, and during the same period leading up to the second and third halvings in July 2016 and May 2020. , the price of Bitcoin increased by 45% and 73% respectively.
In our view, the beneficial impact of the first halving did not really become apparent until January 2013, when the impact of the Feds quantitative easing program (QE 3) became intertwined with the US debt ceiling crisis. We therefore believe that increased media coverage of the halving may increase awareness of Bitcoin as an alternative store of value in response to widespread concerns about inflation. In contrast, in 2016, Brexit may have triggered financial concerns about the UK and Europe, which may have been a catalyst for Bitcoin buying behavior. This trend then continued with the ICO boom of 2017. In early 2020, central banks and governments around the world responded to the COVID-19 pandemic with unprecedented stimulus measures, which caused Bitcoin liquidity to rise sharply again.
It is also important to note that analysis of historical performance can vary significantly depending on the observation period relative to the halving event. The price return metric may change depending on whether the analysis looks at periods starting (and ending) 30, 60, 90 or 120 days from the halving date. Therefore, using different windows may affect the conclusions drawn from past price performance. For our purposes, we use a 60-day period because it both helps filter out short-term noise and is not so far away from the halving that other market factors may start to dominate price drivers in the longer term.
ETFs: The secret to success is getting started
The U.S. Spot Bitcoin ETF is reshaping Bitcoin’s market dynamics by establishing a new anchor for Bitcoin demand. In previous cycles, liquidity was a major impediment to upward price momentum as major market players, including but not limited to Bitcoin miners, would drive selloffs as they attempted to exit long positions.
Today, ETF inflows are expected to absorb most of the supply in a gradual, sustained manner. In fact, the current average daily BTC spot trading volume of ETFs is approximately US$4-5 billion, accounting for 15-20% of the total trading volume of global centralized exchanges, which makes the liquidity sufficient for institutions to trade in this field. This stable demand situation could have a positive impact on Bitcoin’s price in the long term, as it creates a more balanced market with less volatility from concentrated sell-offs.
The U.S. Spot Bitcoin ETF has attracted net inflows of US$9.6 billion in the first two months, with total assets under management reaching US$55 billion. This means that the cumulative net growth in BTC held by these ETFs (180,000) during this time period was nearly three times greater than the 55,000 new Bitcoin supply generated by miners (see Figure 3). According to Bloomberg, if we look at all spot Bitcoin ETFs globally, these regulated investment vehicles currently hold approximately 1.1 million Bitcoins, accounting for 5.8% of the total circulating supply.
In the medium term, we may see ETFs continuing to maintain or even increase current liquidity, as large brokerages have not yet started offering these products to clients. With more than $6 trillion currently held in U.S. money market funds, and with interest rate cuts on the horizon, we believe there will be plenty of spare capital to move into this asset class this year alone.
By the way, please note that potential centralization issues with Bitcoin held by ETFs do not pose a stability risk to the network, as simply owning Bitcoin does not give you any influence over the decentralized network or control over its nodes. Furthermore, financial institutions are not currently able to offer derivatives based on these ETFs (as the underlying assets), which could change the market structure for large players once these derivatives become available. However, regulatory approval is conservatively estimated to take several months.
Hypothetically, if we assume that the pace of new inflows into U.S.-based ETFs has slowed from $6 billion in February to a plateau of $1 billion in net monthly inflows, a simple psychological model suggests that relative to the monthly With around 13,500 BTC (after halving), the average price of Bitcoin should be close to around $74,000. Of course, an obvious problem with this model is that Bitcoin miners are not the only source of selling Bitcoin supply in the market. In fact, we believe the imbalance between newly mined Bitcoin and ETF inflows is only a small part of the equation behind the long-term cyclical supply trend.
Lies, damn lies and statistics
One way to measure the supply of Bitcoin available for transactions is to take the difference between: (1) the current circulating supply (19.65 million BTC); (2) the illiquid supply of Bitcoins due to lost wallets, Holding or otherwise locking in for the long term with essentially no trading. According to data from Glassnode, which classifies illiquid supply based on cumulative inflows and outflows over the lifetime of a given entity, available Bitcoin supply levels have been trending downward over the past four years, from a peak of 5.3 million BTC in early 2020 down to the current 4.6 million. This is a significant shift from the steady upward trend in available supply observed during the previous three halvings (see Figure 5).
At first glance, the decline in Bitcoin trading availability appears to be one of the main technical supports for Bitcoin’s performance as we have new institutional demand from ETFs. But in fact, given that fewer new Bitcoins are about to enter circulation, these supply and demand dynamics suggest that the likelihood of a market tightening in the short term may be high. That said, we believe this framework does not fully capture the complexity of Bitcoin market liquidity dynamics, especially since “illiquid supply” does not mean static supply.
We believe investors should not overlook several key factors that may influence selling pressure:
Not all Bitcoin in illiquidity is “stuck.” Long-term holders (holding Bitcoin for more than 155 days, accounting for 83.5% of holdings) may be less economically sensitive to their holdings than short-term holders, but we expect this Some in a group may still realize profits when prices rise.
Some holders may have no intention of selling in the near future but can still provide liquidity by using their Bitcoin as collateral. This also affects the illiquidity attribute of these Bitcoins to a certain extent.
Miners may sell their Bitcoin reserves (currently 1.8 million BTC between public and private miners) to expand their operations or cover other costs.
A short-term holding of around 3 million BTC is not small, and as prices fluctuate, speculators may still make profits and exit.
Without considering these meaningful sources of supply, it is too simplistic to suggest that scarcity is inevitable due to reduced mining rewards and steady ETF demand. In our view, a more comprehensive assessment is needed to determine the true supply and demand dynamics behind the upcoming halving event.
Active supply and traffic
Even though Bitcoin has been included in the ETF, the active circulating supply (which we define as Bitcoin that has been transferred in the past 3 months) has grown much faster than cumulative ETF inflows (see Figure 6). Since Q4’23, the active BTC supply has increased by 1.3 million, while only about 150,000 newly mined Bitcoins have been mined.
Some of this active supply does come from the miners themselves, who may be selling reserves, both to take advantage of price movements and to build liquidity in the event of reduced revenue. We discussed this in more depth in our previous report, “Bitcoin Halving and Miner Economics,” published on January 30. This is similar to what miners did in previous cycles. However, Glassnode reports that between October 1, 2023, and March 11, 2024, net miner wallet balances decreased by only 20,471 Bitcoins, meaning that the newly active Bitcoin supply mainly comes from elsewhere .
In previous cycles, changes in the active supply have outpaced the growth of newly mined Bitcoin by more than five times. In the 2017 and 2021 cycles, active supply nearly doubled, from a trough to 6.1 million in 11 months (an increase of 3.2 million), and from 3.1 million to 5.4 million in 7 months, respectively. an increase of 2.3 million). By comparison, the number of Bitcoin mined during the same period was around 600,000 and 200,000.
At the same time, Bitcoin’s inactive supply (which we define as Bitcoin that has not moved for more than a year) has also been declining for three consecutive months during this cycle, which may represent long-term holders starting to sell ( See Figure 7). Under normal circumstances, this would be interpreted as a mid-cycle sign. In the 2017 and 2021 cycles mentioned above, there was a time frame of approximately 1 year from the peak of inactive supply to the highest price moment of the cycle, which is 12 and 13 months respectively. The number of inactive Bitcoins in the current cycle appears to have peaked in December 2023.
However, it is unclear what percentage of these Bitcoins have been moved to exchanges (sold), locked on cross-chain bridges, or otherwise used in financial transactions (such as over-the-counter transactions). According to data from Glassnode, although the volume of Bitcoin transfers to exchanges has doubled this year, Bitcoin balances on exchanges have dropped by a net 80,000. This suggests that there are other pools of funds beyond ETFs that are helping to offset the increase in transfers to exchanges from long-term and short-term holders.
In reality, supply and demand dynamics in spot markets capture only part of the story of capital inflows and outflows. Bitcoin exhibits a derivatives multiplier effect similar to that of commodities, where the nominal value of outstanding Bitcoin derivatives is significantly higher than the market capitalization of physical Bitcoin. Since Bitcoin’s derivatives market amplifies spot trading volume several times, analyzing spot public exchange data alone does not fully reflect the true liquidity and adoption in the Bitcoin economy.
Therefore, while increased activity in “dormant” Bitcoin coincides with previous bull market peaks, we believe the exact dynamics of how supply and demand interact in the current environment remain less certain.
in conclusion
This cycle may indeed look different. Sustained daily net inflows into the U.S. Spot Bitcoin ETF will continue to be a huge tailwind for the asset class. Since the supply of newly mined Bitcoin is about to be halved, this will lead to tighter market dynamics. However, this does not necessarily mean that we are about to enter a supply crunch situation where demand will outweigh selling pressure. But what is clear is that Bitcoin spot ETFs have officially become a new digital asset class that mainstream financial institutions can now incorporate into traditional investment portfolios, marking an important milestone in Bitcoin’s mainstream adoption. Therefore, we believe that current price action is just the beginning of a long-term bull market, and further price improvements are needed to push supply and demand dynamics into balance.
