Cycling On-Chain is a series of articles that use on-chain and price-related data to estimate where we are in the Bitcoin market cycle. In the first installment of this article Cycling On-Chain will review the first phase of the bull market and market enthusiasm from 2020 to 2021, they later brought about a downward correction, which brought panic to the market. The second part will attempt to build a case by establishing the reasons why we may not have seen the top of the current market cycle yet, and the fragile side of those reasons.
Just like the previous two halving cuts, the 2020 Bitcoin halving caused a reduction in supply, triggering an exponential rise in Bitcoin prices. However, this cycle heated up much faster compared to the 2016 halving cycle (Figure 1).
Figure 1: Bitcoin Price Temperature Bands for Each Halving Cycle (Bitcoin Price Temperature Bands)
As would be expected during such a rapid price rise, market participants began to take profits when the Bitcoin price broke above all-time highs in December 2020 and beyond (Figure 2). Since the formation of a local market top in January 2021, profit-taking has decreased – although the price has continued to rise further during this period.
Figure 2: 7-Day Moving Average of Entity-Adjusted Spent Output Profit Ratio (SOPR)
What typically happens during a rise in the Bitcoin price index (Figure 3) is that long-time Bitcoin holders (green) begin to gradually sell, while new market participants (purple) begin to build positions – until the market cycle peaks and the two sides swap roles.
Figure 3: Bitcoin Price (black) and Total (blue), Bitcoin Held by Long-Term Holders (green) and Bitcoin Held by Short-Term Holders (pink)
If we zoom in on the change in the net position of long-term Bitcoin holders (Figure 4), we see that long-term holders mostly sold off at the local high in January 2021, then slowed their selling and became net accumulators during the subsequent price decline.
Figure 4: Bitcoin Price (black) and Change in Long-Term Holders’ Holdings (green and red)
A similar trend can be seen in the change in net position of miners (Figure 5), another category of market participants with explicit long-term market experience and exposure.
Figure 5: Bitcoin price (black) and change in net position of miners (green and red)
In March 2020, a massive macroeconomic-driven price crash cleared all leverage from the Bitcoin market and created more organic market conditions that set the stage for a bull market in 2020-2021. Since then, we have witnessed a clear trend of decreasing bitcoin reserves on centralized exchanges, suggesting a large bitcoin supply shortage is developing. This trend accelerated on pure spot exchanges that do not offer derivatives trading after the bitcoin price broke out to new all-time highs in 2017 (Figure 6).
Figure 6: Bitcoin Reserves on Spot Exchanges
However, the opposite is true when looking at exchanges that offer derivatives trading (Figure 7). Bitcoin reserves on these derivatives exchanges increased, especially after the price started to consolidate and correct.
Figure 7: Bitcoin Balances on Derivatives Exchanges
Bitcoin reserves on derivatives exchanges (at least partially) serve as collateral for (highly) leveraged trades. Open interest in bitcoin futures more than doubled in the months following the January 2021 partial high (Figure 8), suggesting that market participants are increasingly willing to take risk – a possible sign of market euphoria.
Figure 8: Positions in Bitcoin futures on all exchanges
As can be seen in Figure 9, the majority of open positions represent long positions. When the market is heavily (over)leveraged in one direction, there is a clear incentive for large market participants to drive the price in the opposite direction. When the price of bitcoin falls below the closeout price of a long position, exchanges can force the position to be sold, creating more downward pressure and potentially creating a ripple effect of long closings while prices fall sharply, which is exactly what we saw on May 19, 2021.
Figure 9: Funding Rates for Perpetual Bitcoin Futures on All Exchanges
Several other metrics in Q1 2021 witnessed a shift in the environment. For example, bitcoin holdings of the grayscale Bitcoin Trust, which is based on institutional demand, stopped increasing in February 2021 (Figure 10), while the premium of its stock GBTC actually turned negative.
Figure 10: Bitcoin price (black) and grayscale holdings (green) and premium relative to spot market price (purple)
In the first quarter of 2021, the anticipation of a direct Coinbase IPO (sometimes referred to as an initial public offering or IPO) was another major event on the radar of many market participants. In the months leading up to this event, both the Bitcoin price (orange) and COIN price (black and white) climbed and hit record highs around the direct listing date of April 14, 2021 (Figure 11). The direct listing was accompanied by significant selling pressure from Coinbase executives, who sold some of their positions, causing their stock price to fall sharply.
Figure 11: Coinbase (COIN, black and white) and Bitcoin (BTC, orange) prices
Another notable trend change that occurred after the January 2021 local high is that we have seen a rapid decline in bitcoin dominance since then (Figure 12). The decline in bitcoin dominance implies that rising cryptocurrency prices are outperforming bitcoin, which could be attributed to a large influx of retail investors.
Figure 12: Bitcoin dominance (black and white) and price (orange)
Young whales break into the party
Since the January 2021 local top, a clear downward trend can be seen in the degree of influence older coins have on on-chain trading volume (Figure 13). This means that recent price movements are increasingly attributed to relatively young market participants.
Figure 13: 7-Day Moving Average Entity Adjusted Dormancy Time
When looking closely at the on-chain movements of the largest players (“whales”) in the Bitcoin market, it is also clear that most of the on-chain movements are done by younger whales. An example is shown in Figure 14, where the green circles highlight the addresses (number) of whales that traded on-chain during the May 19, 2021 crash. These on-chain movements were likely made by these young whales who (1) triggered the price crash themselves, (2) sold out of anxiety, (3) had their long positions liquidated, and (4) bought back tax benefits at lower prices (“tax harvest”).
Figure 14: Outflow of the whale purse on May 19, 2021
Mountains without peaks
The big question that remains – is the current cycle over now ……?
Predicting the future based on historical data is impossible because the environment of the data is constantly changing and future events can simply take a different course. Nonetheless, comparing current and historical on-chain data structures may help gauge the extent to which (cyclical) investor behavior rhymes in terms of market psychology.
Figure 15 illustrates an example. Unlike previous market cycles where tops were marked by exponential breakouts along with large sell-offs by long-term holders, this is no longer the case for either in the current cycle (so far). Of course, the current cycle need not resemble previous cycles, but it does suggest that if the current cycle does end in its current form, it will not be very typical of the cycle.
Figure 15: Reserve risk indicators
New Hope (?)
As just noted, we cannot predict the future based on on-chain data; however, we can monitor its flow trends to help us understand recent market movements and to speculate more deeply on where the market might go next. Despite the sharp price drop, some positive on-chain signals can still be seen.
During the recent market correction, the exchanges saw large net inflows of short-term holders and loss of positions (Figure 16). As prices have fallen, net transfers from/to the exchanges have also declined and even turned net negative again near the end of the price decline. This suggests that lower prices triggered (new?) demand, increasing buyers’ confidence to continue to step in during the low period.
Figure 16: 7-Day Moving Average of Net Bitcoin Transfers from/to Exchanges
Over-the-counter (OTC) trading also saw significant bitcoin outflows during this decline (Figure 17). These OTC transactions facilitated trading between large entities looking to buy and sell bitcoin without impacting the market.
Figure 17: 7-Day Moving Average of Bitcoin Outflows on OTC Trading Platforms
Another possible sign of continued demand for (spot) bitcoin exposure is the continued increase in stablecoin reserves on the spot exchanges (Figure 18).
Figure 18: Stablecoin Reserves on Spot Exchanges
The price decline also appears to have triggered market participants to convert dollar cost averaging (DCA) into bitcoin positions, based on the number of additional addresses that recently reached an all-time high (Figure 19).
Figure 19: Number of Added Bitcoin Addresses
Finally, the recent spike in net entity growth on the Bitcoin network suggests that more entities joined than left during the price crash, which also suggests that the lower price enticed some people to buy (Figure 20).
Figure 20: 7-Day Moving Average of Net Growth of Bitcoin Network Entities
While Twitter polls are always to be taken with a grain of salt, the poll results shown in Figure 21 provide another signal that market participants still have positive medium- to long-term expectations for bitcoin prices. Respondents are neutral to mildly bullish on a week-to-month timeframe, but clearly remain very bullish on a yearly timeframe.
Figure 21: Bitcoin Market Sentiment Based on Twitter Polls as of May 31, 2021
In addition to the outlook related to bitcoin prices, the prospect of an upgrade to the Bitcoin Taproot protocol may provide a more fundamental driver of enthusiasm for the remainder of 2021. Taproot improves some of Bitcoin’s on-chain privacy features and opens up new possibilities for scaling, smart contracts, and lightning. the Taproot protocol upgrade is expected to be locked in within the next two weeks and, if successful, will be activated in November 2021.
Figure 22: Miner Support Bitcoin Taproot Protocol Upgrade Status on June 1, 2021
The recent unleveraging and changing environment has issued a call for caution, while also warning that the bitcoin market has entered a very volatile and fragile phase, regardless of where it goes next.
Over the past year, Bitcoin has matured into a macro asset adopted by an increasing number of institutional investors, bringing it into a whole new playing field. As such, it could see regulatory headwinds that could trigger market anxiety, even as these narratives are based on flawed information.
Another possible outcome of increased institutional adoption is that its price development may increasingly begin to follow the larger overall macro cycle. As we saw in March 2020, if the macroeconomy collapses, its price action could be affected.
Possible outlook for 2021
There is no guarantee that the bitcoin price will necessarily mimic the trajectory of its previous (halving) cycle. Nonetheless, models such as S2F and S2FX shown in Figure 23, time-based models, or simpler prior cycle indices may be helpful, to get a rough idea of whether there will be another repeat of Bitcoin’s four-year cycle.
Figure 23: Bitcoin Halving Cycle Roadmap (2020-2024)
Posted by:CoinYuppie，Reprinted with attribution to:https://coinyuppie.com/23-on-chain-data-analysis-of-bitcoins-current-cycle-is-it-over/
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