Bitcoin's Muddy Floor

Whether you consider the notion of mainstream adoption of Bitcoin as a global monetary standard to be delusional or inevitable, it is hard to argue against the idea that, in principle, Bitcoin proposes one of the most revolutionary changes to financial systems and human behaviour in modern history. The first engineered, autonomously operated money, free of political pressures and capable of disrupting the concept of central banking and even national borders themselves. The debate as to whether Bitcoin has the fundamental design, momentum, and power to achieve such a feat is where a healthy debate should rightfully rage, but its intention should be clear to maximalists and deniers alike.

For something that promises such aspirational outcomes, it is then perhaps strange to hear me suggest that Bitcoin has been combatting a surprisingly familiar product strategy problem, that may also be the key to understanding what’s next for Bitcoin adoption. Since its inception, Bitcoin has had a highly inaccessible value proposition.

Geoffrey A. Moore wrote of the concept of “crossing the chasm” in his book by the same name, first published in 1991 and since becoming a mainstay in the theory of adoption-focused, entrepreneurial marketing. Crossing the chasm relates to the adoption curve for any new innovation, characterised by the bridging of knowledge gaps between the first adopters of a product who rationalise value early, and the increasingly pragmatic masses, primarily driven in their purchase decisions by simple, immediate value propositions. In plain terms, if the market needs to commit time and energy to understand your product before value becomes apparent, you’ve got a problem...

From understanding the basics of how to purchase and store Bitcoin to the refined simplicity of the demand-agnostic supply schedule, the incorruptible nature of a decentralised proof-of-work mining system, the historical trends of hard and soft money, or the societal implications of sound, self-sovereign money capable of lossless transfer across time and space, the Bitcoin chasm is wide. So how does this influence how we consider Bitcoin price action, and why is this an important consideration at this particular moment??

It is firstly important to clarify that Bitcoin does not purport to be a similar asset to any that we typically use (consciously or subconsciously) as a comparative point. It is not an equity, or a commodity, and shares little in common with anything else falling under the broad categorisation of “crypto”. Bitcoin does not derive its value from the ongoing operations and potential financial performance of a business as an equity does, nor the supply-demand driven value of an input into variable industrial utilization trends as does a commodity. As a foundational alternative to the existing monetary system, value is driven by the aggregate allocated resource of nodes across a broader network, electing to adopt Bitcoin as both a store of value due to its ability to fulfil the commonly accepted principles of sound money, and as a trustless, peer-to-peer payment system that circumnavigates the inherent flaws in centrally controlled currency. Bitcoin is a call option on a future where the world accepts that the combination of technology and transparent, principled design can solve legacy shortcomings in our monetary systems and pave the way for the mass digitization of title to real-world assets.

As such, we can assume that the two key drivers of price action are this intrinsic value, and speculative trading on the likelihood of greater adoption. Arguably, these two drivers are most clearly represented by Bitcoin’s realised price and the variation of price from this measure.

Simply put, realised price is the average cost basis for all market participants, and as can be seen in the chart above seems to present as a long-term, consistent upward trend coinciding with the network halving cycles. Market price on the other hand, has driven the better-known history of meteoric rises and devastating crashes that have spent the last decade dancing around the slow, steady ascent of realised price. As opportunity lures more participants across the knowledge chasm, galvanising fresh Bitcoin die-hards by the day, so too has capitulation cleared the decks of any speculators who buy because price-go-up and sell because price-go-down.

Captured another way, consider how these historic drawdowns have impacted Bitcoin’s march towards increasing adoption…

Establishing an idea of what Bitcoin truly represents and the characterisation of market price is necessary because it leads us to an important understanding about the nature of market participants. Specifically, those who’ve chosen to cross the chasm, those who haven’t, and our behavioural expectations of each. Strong conviction for an equity or commodity is subject to the conditions that support a thesis remaining. Strong conviction for Bitcoin driven by the human desire to effectively capture and value the allocation of time and energy, without leaking value to an inefficient vehicle or the perverse manipulation of that vehicle. The thesis for Bitcoin withstands any change to external conditions as long as that desire holds.

So, let’s take a look at how the portion of the market who’ve so far crossed the chasm - who understand this to be the driver that skews probability towards inevitable and away from delusional - are influencing the current market.

Firstly, the number of wallet addresses holding greater than 1 Bitcoin (~$20,000 US at the time of writing)…

Historically, a measure that follows price up and down as participants chase fast profits and exit the market, which has, counter-intuitively, surged during the most recent Bitcoin price crash. What conditions might exist to cause more participants than ever to accumulate Bitcoin amid a 75% price correction? Assuming such a price drop doesn’t fit the speculator’s model of increased likelihood of future adoption, are we left to assume we’re watching a march across the chasm, undeterred by ugly price action because of an understanding of something more fundamental? What could be driving such a shift?

The Fed balance sheet makes a pretty strong case as a core contributor to the phenomenon.

Here is Bitcoin’s supply schedule, just for context.

And secondly, having considered the rate at which the market is arriving at destination Bitcoin, we turn our attention to how these chasm-crossing participants could be expected to behave. Answer: they are not so easily parted with their Bitcoin. Whether you agree with them or not, it’s hard to rationalize why someone won over by Bitcoin’s sound money fundamentals would consider selling into the very asset they hope to escape!

The reserve risk oscillator gives us some insight into the sentiment of market participants. Specifically, how strongly the incentive to sell resonates among holders. Tracking the ratio of market price to the prevailing market trend to hold/sell, we can observe whether the current market price is providing incentive enough to separate participants from their Bitcoin. When confidence is low, the incentive to sell doesn’t need to be so appealing, but when confidence is high, you’ll need to offer some serious returns to pull people out of the market.

A decline in reserve risk indicates that the combination of market price and confidence is leading people to sell their Bitcoin. We’ve just experienced a major exit, as has happened through all Bitcoin’s major bear markets, and as we’d expect of a market draining itself of bull market speculators. If this really was the end of the road for Bitcoin, this metric hits zero and stays there until all the value has been sucked out of the network completely.

But let’s consider the possibility that this isn’t the end.

In that case, we find ourselves in the depths of the reserve risk cycle, the engine room for every price and adoption surge since the entry of organized crypto exchanges brought Bitcoin to the broader markets in 2013. The green band indicated on the above chart has typically been associated with the periods dominated by the highest conviction holders, those who buy into chaos because they know market price is a function of adoption teething rather than a reflection of intrinsic value. We’ve looked at this phenomenon in action already, as realised price. The only difference this time around is that wallets appear to be surging and broader market confidence is cratering. As the Bitcoin market becomes a more reluctant seller, it is also actively recruiting.

A quick recap;

1. Bitcoin’s price has been historically subject to understanding as a prerequisite to value,
2. Realised price has progressed steadily upwards since inception, suggesting that the market perception of Bitcoin value does not regress as understanding improves,
3. Bitcoin holders are growing at an increasing rate, and are doing so through conditions that have typically pushed adoption down,
4. Market price now sits at realised price, speculators have exhausted their reasons to sell, and principle-driven investors occupy as large a proportion of the market as ever,
5. Continuation of downward price trends requires convincing an increasingly hard-money-focused participant base that Bitcoin no longer fulfils the principles of their investment thesis, without any change to asset fundamentals,
6. And, as we continue to see monetary debasement, recessionary threats coupled with rampant inflation, and historic indebtedness, the conditions that incentivise the market to understand alternative stores of value will become more prominent by the day.

So what happens now…

I suspect that Bitcoin price has reached a “muddy-floor”, driven by the unwillingness of an increasingly principled market base to sell their hard-money asset for anything they consider fundamentally inferior, and especially as places to ride out the impending storm become harder to come by. This is not to say that Bitcoin’s price doesn’t have any further to fall. The practical liquidity demands that recessions can impose will take their toll on every market, but the question of how far Bitcoin will fall relative to everything else becomes key.

Should the last legs of the fragile global economy give out, what is the downside potential of equities…

…or commodities…

…how far can Bitcoin really fall from here?

And so, we find ourselves circled back around to where we started this article: crossing the chasm. Should Bitcoin hold the line as recession drives asset prices through the floor, the store of value narrative comes screaming to centre stage. No longer a product that needs to be understood before it becomes appealing, Bitcoin becomes the apparent store of value whether you understand why that’s the case or not. Of course, appearances aren’t everything, and this in itself is hardly enough to validate Bitcoin’s value proposition, but it is enough to lure more people down the Bitcoin rabbit hole. It may be enough to solve Bitcoin’s product strategy issue. From across the chasm, my message to you is - don’t wait by that rabbit hole, people don’t tend to return to the surface.

From a practical point of view, if the thesis stands, the impacts of this sequence should be observable in markets over the next 6-12 months, and in addition to all of the above, look set to be supercharged by an influx of unprecedented institutional demand. The long-awaited arrival of regulatory clarity, the final piece of the puzzle for institutional pipelines poised to bring the biggest balance sheets into play, will introduce a very large, sophisticated player to the scene, ready to relieve weak hands of more Bitcoin than they have to sell.

A flood of potential new bitcoiners, a finite supply paired with a rigid monetary schedule, and a highly stubborn existing holder base who won’t sell their hard asset for a softer asset, especially through market turmoil. The scene has been set for a major turning point in Bitcoin adoption based on a growing understanding of the asset’s unique benefits.

Whatever your take on what happens next, I can only recommend you remain vigilant to the moment when reward for being early, fast becomes punishment for being late.

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