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Newsletter: March 2024 - BTC Shortage v2


In the evolving landscape of digital assets, Bitcoin (BTC) has undergone a significant transformation from its original intent as a "digital cash" system to what many now regard as "digital gold." This shift underscores its role as a non-sovereign store of value (SoV) that has grown into a ~$1 trillion asset. The appeal of Bitcoin as a digital gold stems from its unique attributes: it is non-sovereign, permissionless, decentralized, and possesses hard money qualities such as a high stock-to-flow ratio and a capped supply, distinguishing it from traditional fiat currencies. Bitcoin remains the only asset in the world with an immutable, predictable supply schedule. But how is this possible? 


Halvings and Issuance

Bitcoin's unparalleled feature is its immutable, predictable supply schedule, a direct outcome of the halving process and issuance mechanism embedded in its code. This process, where the reward for mining a new block is halved approximately every four years, ensures a diminishing rate of new Bitcoin creation, leading to a maximum supply of 21 million BTC. This halving mechanism is a stark contrast to the inflationary and often arbitrarily manipulated monetary policies of fiat currencies, drawing inspiration from Austrian economics. This school of thought advocates for a monetary system characterized by a fixed supply, minimal time preference, absence of central planning, and a market-driven determination of price and money flow.

The algorithmic and hard-capped nature of Bitcoin's monetary policy not only differentiates it from other commodities, where increased prices typically lead to ramped-up production but also safeguards it against manipulation and debasement. Despite the potential for short-term volatility, this inelastic supply model ensures long-term protection and stability for Bitcoin's value. 

Current Circulating Supply

Currently, with a creation rate of approximately 6.25 BTC every ten minutes, Bitcoin exhibits a roughly 1.8% inflation rate, positioning it as one of the scarcest assets on the planet, on par with gold production. With over 91% of the total supply already mined since its inception in 2009, the circulating supply of Bitcoin stands at around 19.4 million, edging closer to its 21 million cap and reinforcing its status as a disinflationary currency.

As of now, the Bitcoin network has approximately 19.4 million BTC in active circulation, with expectations of a halving event occurring in 2024. Research suggests that an estimated 3 to 4 million BTC may be permanently inaccessible due to reasons such as accidental losses, destruction, or the passing of individuals who were the sole possessors of their Bitcoin keys. Unchained Capital and Chainalysis have done independent research, and both came to similar conclusions: approximately 3-3.8 million BTC have been “lost” over the years. Lost, in this context, means there is no chance of recovery, and those coins are forever inaccessible. In fact, data analysis firm CoinMetrics even uses a filtered metric to account for lost coins in their “Realized Cap” metric, asserting that it is a more accurate measure of Bitcoin’s supply.

Beyond these losses, a significant amount of Bitcoin has not been transacted for periods ranging between three to five years (discussed more in next section). This trend is largely attributed to the perception of Bitcoin as "digital gold" and the adoption of a "HODL" (hold on for dear life) strategy by investors, indicating a preference to treat Bitcoin as a long-term investment rather than a currency for regular transactions.

Liquid vs. Illiquid Supply

Due to the blockchain’s transparent on-chain ledger, anyone can analyze the activity on-chain to determine certain user behavior or general heuristics. One such concept are "HODL waves," also known as Bitcoin age distribution bands. These play a critical role in assessing the movement and availability of Bitcoin's supply. By categorizing the Bitcoin supply according to how long it has been since it was last transacted, these waves offer a broad view of how Bitcoin's supply changes over time. For instance, the lowest red band in the diagram below illustrates that daily, approximately 1-2% of Bitcoin's total supply is active on the blockchain. In contrast, the darkest purple band at the top reveals that around 9% of all mined Bitcoin has remained untouched since its creation, a significant portion of which is speculated to have been mined by Bitcoin's enigmatic founder, Satoshi Nakamoto, during the cryptocurrency's infancy.

As of Q1 2024, ~79% of all circulating bitcoin has not been traded or exchanged in the last six months. This trend highlights the deep-rooted HODL mindset of many bitcoiners despite the BTC price appreciating ~85% over the same time period. This dynamic underscores a significant shift in the Bitcoin ecosystem, with supply becoming increasingly scarce as demand from large-scale investors continues to grow.

With this understanding, we can go one step deeper in understanding BTC’s true liquidity. Liquidity, in the context of Bitcoin, is measured by the frequency at which an entity engages in transactions involving the digital currency. One approach is to assess an investor who retains their Bitcoin holdings without selling a liquidity value of zero, indicating a complete lack of transactional activity. Conversely, an individual frequently buying and selling Bitcoin would be assigned a liquidity value of one, denoting high levels of market engagement.

This enables us to categorize Bitcoin's circulating supply into “buckets” of liquidity: highly liquid, liquid, and illiquid. This approach provides a nuanced understanding of market behavior and investor tendencies. Illiquid supply refers to the portion of Bitcoin that is held by entities retaining over 75% of their acquisitions, suggesting a long-term investment outlook or a strategy minimizing market impact. On the other end of the spectrum, the highly liquid supply comprises entities that retain less than 25% of their Bitcoin, highlighting a propensity for frequent trading. The liquid supply, lying between these two extremes, represents a balanced approach to Bitcoin transactions.

A pivotal observation from this analysis is the historical progression of illiquid versus circulating supply growth, particularly following Bitcoin's third halving event. Data indicates that, for the first time in the cryptocurrency's history, the growth of illiquid supply has surpassed that of the overall circulating supply post the third halving. This shift is characterized by an addition of approximately 1,694 bitcoins per day to the illiquid supply, in contrast to the 902 bitcoins per day increase in the circulating supply. This behavior indicates a strengthening investor confidence in Bitcoin's long-term value proposition, reinforcing its status as a digital store of value. 

Finally, the number of BTC available on exchanges is currently just 11.7% of the circulating supply — the lowest level since late 2017. This is another data point that supports the idea that people are buying BTC and storing it away (off exchanges) for the long term. 

Current Token Distribution and Whale Concentration

As of 2024, 100 million+ entities hold some amount of bitcoin, while the top 10 holders account for just ~6% of the supply.

Recent insights from Glassnode reveal a notable trend in the bitcoin landscape: a decrease in the concentration of wealth among large holders and a rise in the number of retail investors holding onto their bitcoin. According to the analysis, approximately 30% of the bitcoin supply is controlled by whales, which likely include institutional investors, large funds, corporations, and affluent individuals.

On the other end of the spectrum, small investors account for about 14% of the total bitcoin supply. However, when considering the bitcoin held on exchanges, which often represents retail traders, the portion of the supply attributed to smaller investors could realistically approach 30%. This redistribution of bitcoin ownership towards more modest investors became especially pronounced during the bear market period of 2018-19. The data suggests that the population of whale investors has remained relatively unchanged since 2015, indicating a steady shift towards greater democratization of bitcoin ownership among a broader base of participants.

Entities and Institutions Acting as New Buyers

A significant share of Bitcoin is held by a diverse array of institutional entities, encompassing exchanges, major corporations, and key governmental institutions, which collectively hold around 40% of all Bitcoin in circulation. This group includes a variety of stakeholders, from exchanges and government agencies to both publicly traded and private companies such as Tesla, Block Inc., MicroStrategy, Reddit, and others. Additionally, this segment encompasses miners who play a crucial role in maintaining the network's security, various publicly traded investment funds, including ETFs, Bitcoin assets available in wrapped formats, platforms catering to retail investors like Robinhood, and wallets that are currently not active. This broad ownership base highlights the widespread institutional involvement in the Bitcoin ecosystem, despite the potential for overlap in these categories.

ETFs Are the New Buyers

ETFs play a pivotal role in broadening the accessibility of Bitcoin to a wider audience, including investors, financial advisors, and those responsible for allocating capital in the markets. This expansion of access is expected to drive Bitcoin towards more widespread acceptance over time. The approval of US spot Bitcoin ETFs marked a significant milestone, with these products attracting around $1.5 billion in net investments within the first 15 trading days alone and holding over $44 billion in total across the ten products. According to recent data from River Financial, Bitcoin ETF providers and funds now hold ~4% of BTC's circulating supply, which eclipses the holdings of both publicly traded miners at 3.4% and businesses at 3.6%. 

Although the initial surge in investments can be attributed to the novelty of these ETFs and the accumulation of demand, a consistent inflow of funds, coupled with the ongoing growth and development of the Bitcoin ecosystem, is expected to offset a meaningful portion of the “normal” underlying sell pressure. 

ETFs Within the Broader BTC Market

However, analyzing the impact of the net inflows into these products is not simply that straightforward and should be contextualized along with other BTC market dynamics. This adds some complexity when interpreting the several factors that are crucial to understanding the nuanced effects of these inflows on Bitcoin's performance.

Firstly, it's essential to contextualize the scale of these ETFs within the broader market. Despite their groundbreaking nature, U.S.-based Bitcoin ETFs account for only 10-15% of the total BTC spot trading volume on global centralized exchanges and represent a mere ~4% of the outstanding Bitcoin supply, approximately 650,000 BTC. This proportion underscores the ETFs' current role within the vast ecosystem of Bitcoin trading and ownership.

Furthermore, the landscape is complicated by various offsetting flows, not only within U.S.-based ETFs but also across global exchange-traded products and Bitcoin proxies. These include a reallocation of investments from less efficient Bitcoin holding mechanisms to more streamlined ones like ETFs, a shift from higher-fee products to those with lower fees in the U.S., and the liquidation of positions in existing vehicles, exemplified by FTX's sale of its 22.3 million shares in the Grayscale Bitcoin Trust (GBTC).

In addition to ETF-related factors, Bitcoin miners have exerted significant selling pressure on the market, selling ~4800 BTC per day since January 2024. The initiation and subsequent unwinding of basis trades (long Bitcoin spot, short CME futures) around the time of the ETF launches may have also impacted market liquidity and trading algorithms, though the open interest in CME Bitcoin futures has now aligned with December averages, indicating the closure of these positions.

Estimates on BTC Price

The momentum behind the inflows into Bitcoin ETFs, particularly those managed by industry giants such as Blackrock and Fidelity, has been (literally) market-altering, with inflows surging to an average of well over 10,000 bitcoins per day. This level of buying is staggering when juxtaposed to the current daily new bitcoin issuance of 900, dropping to ~450 BTC after the halving in April. To drive home the halving impact a bit more, the reduction in BTC issued daily post-halving equates to ~$7 billion less in issuance over a one-year period.

Should the current pace of ETF acquisitions persist, these funds are set to absorb over 11 times the daily bitcoin issuance leading up to the halving. Post-halving, assuming demand remains constant, this absorption rate could effectively double to over 22 times the daily issuance. However, sustaining such acquisition rates is implausible over the long term because, as we have discussed, the liquid supply of BTC is quite constrained.

The relentless demand from ETFs, while unsustainable in terms of physical bitcoin acquisition, underscores the profound impact of supply and demand dynamics on a finitely scarce asset like Bitcoin. With the price of Bitcoin currently exceeding $55,000, it's evident that these market dynamics are already influencing its valuation. And understanding that the managers of the ten spot bitcoin ETF firms have a combined AUM of ~$18.5 trillion, with just ~$44 billion (0.21%) of it currently in the spot bitcoin products. Assuming that percentage only trends up over time, combined with the reduced supply of the halving and liquid supply constraints discussed above, the only “release valve” in this equation is the BTC price.



In conclusion, the transformation of Bitcoin from a digital cash system to a widely recognized digital gold highlights its significance as a non-sovereign store of value in today's financial landscape. The combination of its halving mechanism, capped supply, and unique attributes such as decentralization and immutability has not only cemented Bitcoin's position as a critical asset in the digital age but also underscores its potential for long-term value retention. With over 91% of its total supply already mined and a significant portion of Bitcoin being held with a long-term investment outlook, the asset's scarcity continues to intensify. The growing adoption by institutional entities, the emergence of Bitcoin ETFs, and the shifting distribution of Bitcoin ownership towards a more democratized base further enhance its appeal and stability as a digital store of value. As we edge closer to the next halving event, the dynamics of supply and demand are poised to further propel Bitcoin's status and value, making it an unparalleled asset in the evolving landscape of digital currencies and assets.


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