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Bitcoin market escapes a price fall phase

29 July 2021
SUMMARY SUMMARY
    • Bitcoin and Ethereum prices dropped lower over the last month before rising sharply in the last week. Gains and losses in the bitcoin price are concentrated in a small number of days, with 75% of the absolute price gains since 2020 occurring in just 25% of the days when the bitcoin price gained and similarly for losses.
    • The bitcoin market switches into phases of extreme price change depending on supply and demand and the price ceiling or floor of these phases. On-chain metrics quantify these conditions, with the on-chain price floor providing a leading indicator compared to technical analysis measures.
    • The current bitcoin market is at least in a sideways state and unlikely to enter an extreme price fall phase, with a price floor at $37k, investor whale holdings back to mid-May levels, and supply liquidity back to December levels.

The bitcoin price has risen in the month since my last report, from $35k on Wednesday 30 June to near $40k as of today, Thursday 29 July, although it spent three weeks declining, reaching below $30k on Tuesday 20 July before sharply rising again. The Ethereum price is flat over the month, at around $2.3k, but it also declined to a low of $1.7k on 20 July before rising recently.

I know it’s been awhile since I last wrote a Market Intel Report. Thanks to those of you who checked in to make sure I was okay! I took a break for vacation, and to support the huge interest in Market Intel data subscriptions, which launched on 28 June.

I’ve also recently presented at the B Word conference, debunking the myth that “Bitcoin Facilitates Criminal Activity”, with the Financial Times Private Wealth Management, discussing Cryptocurrency market fluctuations: a blueprint for wealth managers, and at UK Finance, explaining the Past, Present, and Future of Cryptocurrency Markets. In addition I’ve been showing off my diamond hands, turned my laser eyes to the bear market, and taken a rocket to the moon…  

It has also been a year since I started writing the Market Intel Report – for new readers, the archive is here. This July break has given me some perspective. I write the report to understand the market, and to develop and test the metrics that customers now rely on. In this Market Intel Report I want to explain how I think about the bitcoin market. This also broadly applies to the markets of other cryptocurrencies, although bitcoin and Ethereum have the most fundamentals, and they all have their own idiosyncrasies.

To start with the obvious: the bitcoin price goes up, down, or sideways… but it really goes up and really goes down. As the first chart in the report shows, since 1 March 2020, around 75% of the absolute price gains occurred in just 25% of the days when the bitcoin price gained. It is similar for losses. For comparison, 55% of S&P 500 gains occurred in 25% of the days when the S&P 500 gained. So fortunes are made and lost in short periods of time in bitcoin.

This means it is best to think of the bitcoin market as having phases – of extreme price gain or loss, linked by periods of relative calm. The key is to understand when the market will switch into an extreme phase and the price ceiling or floor of that phase.

This is different from traditional markets, where there are relationships between fundamentals and price that tend to trend together with a stable relationship overtime. For bitcoin, the change in price can be much greater than the change in fundamentals. That said, there are some highly correlated metrics. For example, since the start of 2020, bitcoin sent by wallets that have held their bitcoin for 3 to 4 years has a correlation of 0.76 with the bitcoin price, as shown in the second chart of the report. This makes sense, as long-term holders only relinquish their bitcoin for the highest prices, and when they sell they are fundamentally increasing supply, which puts pressure on the price.

So how do you identify the phase of the market? From mid-March 2020 to the start of May 2021, bitcoin has largely been in a rally. I cover the metrics that explain that rally in a report and dataset you can download here, and in my recent webinar on the Past, Present, and Future of Cryptocurrency Markets. It is a story of supply and demand. From mid-March 2020, large North American investors increased their demand, especially between October 2020 and February 2021. Supply first moved from Asia to meet that demand, and later in the year longer-term investors provided supply but required a higher price to do so. The key to understanding the phase of the market through this rally has been to quantify which groups are buying and selling, and thus the balance of demand and supply.

The next question is to understand the price ceiling or floor for a phase of the market. Price ceilings are hard. I’ll be honest I was surprised when people bought bitcoin at $64k in late-April. And when you look at the data, not many people did: very few wallets acquired and held bitcoin at that price. I imagine the exchange trade volumes at that level were also relatively low.

Price floors can be quantified, by looking at the cost of bitcoin that recent investors currently hold, as I’ve written about previously. If an investor buys bitcoin at $40k and continues to hold then we know that they value bitcoin at least at $40k. If the price were to go below $40k then it would be below their valuation and they may buy more. So the price at which a large enough group of investors is willing to buy-and-hold at is a demonstration there is demand at that level, which can provide a floor to the price.

The average cost of bitcoin held by investors entering the market in the last 12 months is currently $37.3k – I consider this the on-chain price floor. As the third chart in the report shows, this has provided a good guide to the bitcoin price since it fell to this floor in May. Indeed it has performed better than the 200 and 50 day Simple Moving Average (SMA) of the price, which are popular technical analysis indicators.

The performance of the on-chain price floor versus moving averages of price is even clearer in the fourth chart of the report, which shows the metrics since the start of 2017. As the on-chain price floor stops increasing the moment that investors stop buying in a price rally, it provides a leading indicator of a decline in demand, while moving averages of price are lagging indicators. So, for example, as the late 2017 and April 2021 bull markets ended, the on-chain price floor flattened far earlier than the 50 day moving average price went below the 200 day moving average – the ‘death cross’ of technical analysis.

The final question then is: what phase is the bitcoin market currently in? I think the price floor is holding. Whale investors are buying again in the last week, returning their holdings back to the level in mid-May, although this is being driven by existing whales rather than new whales. There is also a much greater effort from within the industry, such as the B Word conference, to address investor concerns that were highlighted extensively in the media as the price peaked in April. So demand is returning to the market. Supply, which has become more liquid since prices fell in May, is only as liquid as it was in December 2020. This all suggests the market is at least in a sideways state and is unlikely to enter an extreme price fall phase.

As always, time will tell if this outlook is right. But it’s good to be back and writing up my analysis. Let me know your feedback via marketintel@chainalysis.com!

Philip Gradwell, Chief Economist

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