A Period of Consolidation
On May 11, 2020, Bitcoin experienced it’s third halving event and at the time, the price was sitting at around $8,600. We know that Halving events occur every four years and cut the daily supply issuance of new bitcoin in half. This supply shock puts natural upward pressure on price and a new bull market is kicked off. This story played out in 2013, 2017, and is currently in the middle of playing out now. By April of this year, Bitcoin had reached $63k, more than 7x growth from the start of the cycle.
However, since then, the price of Bitcoin has fallen to $30k and has traded between $30k-40k for about 5 weeks now. The question then becomes, was $63k the top of this market cycle or are we gearing up for another meteoric rise by the end of the year? Based on the on-chain data I am seeing and my experience from previous cycles, I am confident it’s the later. Let’s walk through the data and my rationale.
Bitcoin’s network is trading on the low end of its normal value range
Analysts in traditional finance use Price-to-Earnings (PE Ratio) to indicate if a stock is over or undervalued. In crypto, we have an equivalent metric and it’s called Network Value to Transaction Ratio (NVT). Because the market cap of Bitcoin and its transactional volume do not grow or shrink at the same rate, NVT is constantly fluctuating. Therefore, we can establish a range to determine what is “normal” for NVT at any given moment in time. If the NVT ratio stays within a normal range, we can infer that Bitcoin is relatively fairly valued even as prices increase. If, however, NVT climbs above the normal range, it’s a sign that the transactional activity is not sustaining the new valuation and we can expect a deep price correction.
The only times in Bitcoin’s history in which NVT rose above its normal range coincided with the peak of the market cycle in 2013 and 2017. More interesting, during the 2013 bull run, Bitcoin had a “double top” in which the price spiked to all-time highs in April 2013, fell back down, traded within a range for a few months and then rose again in November to its ultimate peak. In April, even with the rapid appreciation, the NVT ratio was still within its normal range. Thus, had we had this metric back then, we could have inferred that when the price dropped and then traded sideways, we were in a period of consolidation, not a full-on crash. Sure enough, a few months later, NVT climbed above its normal threshold when price went on its second parabolic move. This second run ultimately proved to be the top of the cycle.
So where is NVT today? It’s not only within its normal range, its actually near the bottom of the range indicating that the market is undervaluing Bitcoin given the growth of transactions on the network. In other words, now is a great buying opportunity according to NVT.
Another metric that has historically indicated when we are in periods of good buying opportunities is Spent Output Profit Ratio (SOPR). Because we have complete transparency into every transaction on a blockchain, we can measure the price at which each individual coin was sold, the price at which it was bought, and compare the two. This is what SOPR measures. It’s simply an aggregation of the price sold divided by the price paid for all coins traded.
When SOPR is above 1, that means in aggregate, the market is selling at a profit. When SOPR drops below 1, it means in aggregate the market is selling at a loss. Historically, whenever SOPR has dropped below 1, it has been a great buying opportunity because a substantial price increase has always followed. A little over a month after Bitcoin hit its all-time high of $63k, SOPR has dipped below this important threshold of 1.
This is an important threshold because it’s an indication that we have reached a bottom of the market. Older coins, which have a lower cost of acquisition, would still be sold for a profit if the owners of those coins were selling and thus SOPR would stay above 1. The fact that SOPR dropped below 1 indicates that those older coins are not selling. In other words, there is a base of market participants that refuse to sell at current prices because they believe the price will rise in the future. This is yet another sign that the market has likely established a new floor and we are likely to see another run up in price at some point this year.
Selling over the last two months has come from short term market participants
Another reason to believe that we are currently in a period of consolidation and poised for another run is because the vast majority of the selling that has occurred over the last two months has come from short term market participants. Having seen the price increase following the halving in May, a number of new entrants started buying Bitcoin at the end of 2020 and through the run up in Q1 2021.
Then in May, likely driven by news of Tesla no longer accepting Bitcoin, unfounded environmental concerns, and the Chinese cracking down on mining activity, many of these new entrants started selling. My theory is that many of these sellers had recently gotten into Bitcoin for the first time and likely did not have a strong fundamental understanding of the technology and asset class. As a result, the moment they heard what they conceived as bad news (whether it was true or not) and saw the market begin to turn, they started panic selling.
Another way to corroborate this theory is to look at a metric called Dormancy. This metric measures the average number of days that each Bitcoin that was sold had remained dormant before it was moved. If older coins (ie: coins that had been held onto for a long period of time) were sold, the dormancy metric would rise. However, what we saw over the last two months is that the dormancy metric actually dropped, indicating that the Bitcoin that was sold off was done so by short term market participants.
The last two months have flushed out many of these short-term participants. This means there are likely less speculators in the market and more long-term holders at this moment in time then there were at the start of the year. In my opinion, the market is actually in a healthier position now than it was at the start of 2021 even though the price is roughly the same.
Long Term Holders are accumulating
If the majority of selling over the last two months was done by short term market participants, then we should expect to see long term holders doing most of the buying. That is indeed what has been happening over the last two months.
Not only has the total supply held by long term holders been increasing since April, but the timing also aligns perfectly with the selloff by short term participants. In other words, those that had recently entered the market panic sold to much more experienced market participants over the last two months. Those that have been involved in this asset class the longest and have the most experience are currently buying while those that have the least amount of experienced are selling.
We can view this same phenomenon by looking at the net position change of long-term holders which measures if long term holders are buying or selling in aggregate. This metric has been steadily climbing since March.
Let’s zoom out and look at this same metric from a historical perspective. I mentioned the 2013 “double top” previously. This metric shows that during that first run up in April 2013, long term holders started selling and then after the price has come down a bit, long term holders started aggressively reaccumulating Bitcoin. We see a similar phenomenon in the 2017 market cycle as well. This is because when Bitcoin is undervalued experienced market participants begin to add heavily to their positions. The fact that long term holders are increasing their positions so aggressively right now is a strong indication that we will see another run up in price in the near future.
Gearing up for another rise
Based on the data and my historical experience, I believe we are still in the middle of this bull cycle and Bitcoin is gearing up for another large upward swing soon. The last two months or so have been a period of consolidation as evidenced by the fact that Bitcoin’s fundamentals are strong relative to its price, potentially even undervalued. Furthermore, long-term holders continue to scoop up discounted coins which means there will be less available supply to trade when price action does start to move upwards again. In fact, that is exactly what we see happening when we look at the data.
Starting in May, the amount of Bitcoin held by active traders increased drastically. When more coins move to entities that have historically been active traders, liquidity increases and its typically an indication of the market looking to sell. Over the last week or two that trend has reversed as long-term holders that statistically have a very low likelihood of selling are accumulating coins. Historically speaking, this typically leads to a run up in price.
The bottom line is we had new traders that were easily spooked by a couple of bad headlines. This led to a selloff by these short-term holders, which experienced investors have opportunistically scooped up. This process has taken time to play out and my guess based on the on-chain data is that we are nearing the end of this consolidation phase. If this turns out to be true, Bitcoin would be poised to go on another run in the relatively near future.
The truth is I can’t tell you when the next phase of this bull run will happen. It could be next week, next month, or in a few months, but I’m confident that it’s coming sometime this year. The longer we continue to go through this period of consolidation the higher the price could ultimately end up.
