Analyzing Bitcoin's Halving Cycle - Part II

Yesterday I shared an analysis of the supply/demand and price action during the first two halving cycles and we covered the basics of how Bitcoin’s halving cycle works. Click here to take a look at that article if you haven't already. 

The goal of this article is to give you some on-chain metrics and market signals to help us get an idea of market activity currently playing out on the blockchain. We can follow these metrics to paint a picture of where we are in the current halving cycle, relative to past cycles. The transparency of Bitcoin's blockchain is what makes this analysis possible.

It’s important to understand that the Bitcoin halving is part of Bitcoin’s adoption strategy. It may be the most important strategic design of the Bitcoin protocol. Satoshi Nakomoto, Bitcoin’s anonymous creator (who may or may not be alive today), prophesied that by by reducing the supply of new Bitcoins coming to market every 4 years on a programmed schedule, it would likely lead to increasing demand pushing up against contracting supply, and a run up in price. As with just about anything, price is everything with Bitcoin. 

Price captures people's attention. It drives emotion. It creates a viral loop. It builds FOMO. It brings in new market participants, and it drives innovation within the Bitcoin ecosystem. Once someone is in the market, their intellectual curiosity typically leads to them learning more and more about Bitcoin as their mind follows their money.  

They end up coming for the capital gains. 

And staying for the revolutionary innovation of a lifetime. 

Let’s go. 

First I want to start with a quick note regarding the recent sell off (10% drop over the last 24 hours). There has been a lot of chatter and fear in the air so hopefully looking at these data points can give you a little more conviction on the health of the market from a high level.

While we did see a fairly severe sell off last night, it appears the market has stabilized. Below we can see that there was a large transfer of Bitcoin to exchanges right before the sell off. When we see Bitcoin sent to exchanges in large quantities like this, we typically expect those coins to be sold and the price to drop. When we see coins leave exchanges, we expect the price to rise as it means long term holders are buying and moving the coins off exchanges to personal custody. The price dropped sharply after the coins were moved onto exchanges (pink circle), and we are now seeing coins leaving exchanges (green circle) with the price stabilizing.

Now let's get into the macro indicators of market activity so far in this cycle.

In the chart below, we can get a quick visual of Bitcoin's inflation rate and how the halving cycle has impacted price. The vertical gray lines indicate the halving dates. We can see on the orange line (inflation rate), that on each halving date, the issuance of new coins (inflation) decreases. You'll notice that the left side of the chart is more chaotic - this was prior to the first halving cycle and in Bitcoins early days of existence. As such, there weren't nearly as many miners on the network as there are today. We can see that as time progressed, and when we got into the first halving, the issuance of new Bitcoin has become extremely predictable per the protocol.

 Bitcoin is disinflationary which is why the orange line is dropping over time (opposite of our current system). And we can also see that the price typically shoots up after each halving date.

Basic economic principles of supply and demand tell us that these halving schedules are likely inducing the bull runs which ultimately are manifesting into exponential adoption cycles as Bitcoin’s price captures the attention of the market. One of the most unique traits of Bitcoin (of which there are many) is that its supply is completely inelastic in terms of it’s response to price. Bitcoin is the first ever commodity (as recognized by the CFTC) or financial asset that does not care how much demand there is. The supply stays locked. Contrast this with other commodities like Gold, Silver, or Oil - when demand increases, producers go out and ensure that more product is brought to market, and price rebalances. This is also true of just about any consumer product out there. It’s even true of stocks in many cases - companies raise more capital with stock issuance and dilute their current stockholders when the opportunity presents itself. This cannot happen with Bitcoin. 

And so the release valve when demand pushes up against supply is, you guessed it, the price. This is the reason some refer to Bitcoin as “number go up technology.”

Next up, we have Reserve Risk. Reserve Risk allows us to visualize the confidence amongst long term holders relative to the price of Bitcoin at any given moment in time. On-chain evidence suggests that, on average, long term holders of Bitcoin have greater knowledge about Bitcoin’s market cycles and are better at identifying good times to buy and sell Bitcoin. Not surprising, given that they are more experienced in the space vs newer market participants. How do we know how long an entity has been holding Bitcoin? The blockchain is fully transparent - so we can see when coins were purchased and moved to personal custody via wallet addresses. And we can see how long they have not moved. 

For brevity, I won’t go into the details of how the metric is calculated, but if you’re interested in doing so, Look Into Bitcoin has a great explanation here.

From the chart, we can see that the confidence of long term holders indicates we are mid-cycle. In the past cycles, when Reserve Risk moves into the reddish shade on the chart, it has indicated we are close to a cycle top. The chart today indicates we are nowhere near that level currently, despite the price rising past $60k.

Here's some more evidence that long term holders are still confident. Below we can see that as the price of Bitcoin has consolidated in the $47-$57k range over the last few months, long term holder have been adding to their positions. The green bars indicate buying activity. We know these are long term holders because of the transparency of the blockchain - these wallet addresses have no history of selling or moving coins long term.

Next is MVRV Z-Score, otherwise known as Market Value to Realized Value, adjusted for extreme volatility. It is used to identify periods where Bitcoin is extremely over or undervalued relative to it’s “fair value.” Note that Realized Value = the value when the coins were last moved/purchased. 

The chart helps us identify prior price peaks which typically occur when the metric gets above 10. We are currently at a level of 4 despite the big run up in price. 

Next up we have the RHODL Ratio. This indicator gives us a ratio of the Realized Value HODL Waves. Realized Value HODL waves are different age bands of UTXO’s (coins) weighted by Realized Value of coins within each band. The Realized Value is the price of UTXO’s (coins) when they were last moved from one wallet to another. The metric looks at the ratio between RHODL band of 1 week vs RHODL band of 1-2 years. 

How to use it: when the 1 week value is significantly higher than the 1-2 year value it’s a signal the market is becoming overheated.

As with the previous metrics we’ve looked at, once again, it appears we are mid-cycle. During past cycles, when the RHODL Ratio gets into the reddish band, it is a sign that the cycle is peaking. It appears we are currently about half way there. 

Next is Bitcoin balances on all exchanges. 

A bullish signal for Bitcoin has typically been when we see coins being pulled off exchanges. It's a sign that the liquid supply available for purchase is reducing. This typically means that long term holders are making their purchases on exchanges and then moving to hardware wallets for long term storage. Interestingly, since January of this year, we can see supply is increasingly being pulled away (color bands dropping). This contrasts from the bull run in 2017 when we mostly saw balances on exchanges rising through the bull run. When we see this happen in this cycle, it will likely mean that newer participants have entered and are leaving their coins on the exchanges after purchasing. 

Additionally, each halving cycle so far has had 3 distinctive peaks in supply being held by short term holders. So far, in this cycle, we are just coming off of the first peak. 

Credit: Will Clemente

Up next is SOPR, or Spent Output Profit Ratio. SOPR measures price sold / price paid. It indicates whether people are selling at profit or loss, and is a good metric to visualize buying opportunities (SOPR below 1).

In the chart, we can see that SOPR is currently hovering around 1.01, meaning people are currently just barely selling into profit, on average. When SOPR gets up into the 1.1 range, we can see that it typically indicates we are nearing a cycle peak, so it appears we have a ways to go. 

Finally, I want to highlight the recent price consolidation over the last 2 months. Bitcoin has been building strength and consolidating in the $47-57k price band. This is very healthy. It means that despite the run up from $10k to $64k, new market participants have entered the market. Any bull run that perpetually goes straight up is bound to move violently in the opposite direction. Bitcoin is building strength at these levels. Historically this has been bullish. Below we can see that consolidation at $57k is the strongest we've seen since the price was $11k last fall.

This is just a small taste of the insights we can glean by analyzing activity on the blockchain with on-chain data. This is meant to give us a high level, macro view of where we currently stand in the market. We wouldn’t use this information to trade short term, but rather to get an idea of high level market activity to determine the best times to enter/exit the market.  

I hope you’ve found this helpful. I'll be sure to continually update you as we progress through this bull market.

The analysis presented is for educational and discussion purposes only and does not constitute investment advice. Please do your own research. 

Have an insight, question, comment, or bone to pick? Hit me in the comments.