Don’t underestimate the growing irrelevancy of macro on-chain analysis

28 Apr 2022

Don’t underestimate the growing irrelevancy of macro on-chain analysis

Bitcoin’s market structure has entered the Seven Seas, and on-chain macro analysis limits the scope of the ebbs and flows contributing to bitcoins price discovery. The liquid bitcoin supply sits at 20.4%, not 13%, as derived from exchange balances.

Source: Glassnode, Skew, Dune, MicroStrategy, Tesla, Square, Meitu, Aker, Bytetree, VanEck, Proshares, Hashdex, StatusInvest

The first four months of 2022 have been dull in the bitcoin market. Bitcoin has traded in prolonged consolidation, floating around 40k for the entire year in lockstep with tech stonks. Trading volumes have dried up completely, and activity in the derivatives market has been muted, with traders mainly focusing on hedging. This has created a rampant environment for pushing bullish narratives backed by on-chain data.Charts drilling down to supply age and exchange balances offer convincing stories of accumulation patterns, hodler activity, and a vanishing liquid supply. While both the patterns and the narratives revolving said patterns hold historical acclaim, this type of macro on-chain analysis is getting increasingly less relevant with time. It mostly serves one purpose only, providing us with that sweet sense of hopium. Let me elaborate on why. The current bitcoin market structure is a widely different beast now compared to what it was. Before 2020, bitcoin was primarily traded in the spot markets and through inverse perps and futures collateralized by bitcoin. The exchange balance metric was more relevant back then. Now, bitcoin’s market structure has evolved into bitcoin being available to trade in far more shapes and forms. Bitcoin exposure is available through trade in cash-settled and stablecoin settled futures, in structured exchange products - both redeemable and close-ended, wrapped in other protocols and an ever-expanding array of new markets. Bitcoin’s market structure has entered the Seven Seas, and on-chain macro analysis dramatically limits the scope of the ebbs and flows contributing to bitcoins price discovery. I argue that the current liquid tradeable bitcoin supply sits at 20.4% of the circulating supply, rather than the 13% derived from exchange balances. It is vital to be aware of the full picture.

Liquid supply

The share of BTC’s supply not having moved in 1 year or more has never been higher, currently sitting at 64%, after bottoming at 54% in mid-October. On-chain analysts are interpreting this as a positive sign of accumulation. The logic behind this assumption is that more coins are hodled “under the mattress” than lifted off to the market, leading the percentage share to increase of older UTXOs. Accumulation has thus outpaced distribution over the last year leading to the conclusion that a large share of the circulating bitcoin supply is currently hodled.

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Source: Glassnode

Recently, popular on-chain analysts have shared charts showing the current accumulation cycle and noted that the current percentage share of supply aged more than one year sits at levels coinciding with previous accumulation tops. The previous accumulation tops have been followed by strong BTC rallies, leading to speculation of similar outcomes shortly.But is this a viable metric as the market structure has matured and BTC has been financialized and wrapped into other investment structures outside the bitcoin blockchain? Let’s drill further down into the matter.The last bitcoin distribution phase lasted from August 2020 until October 2021. In this period, the percentage share of bitcoin not being moved within the last year declined by 9.2%, from 63% to 54%.

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Source: Skew, Dune, MicroStrategy, Tesla, Square, Meitu, Aker, Bytetree, VanEck, Hashdex, StatusInvest

GBTC exploded and likewise did the growth of tokenized bitcoins following the DeFi summer of 2020. MicroStrategy began its intensive BTC treasury build-up, leading the correlation of MicroStrategy to bitcoin to skyrocket as MSTR’s BTC balances led their stock to become a leveraged bitcoin proxy in the lack of bitcoin ETFs. Later on, physical bitcoin ETFs began trading and grew traction in various jurisdictions. In this period, 4.4% of the circulating bitcoin supply was moved into idle custody (leading coin age to increase). This supply was moved into structures that impact bitcoins price discovery as they fully enable traders to express their views by buying and selling these bitcoin-linked assets (“paper bitcoins”). 4.4% of the 9.2% reduction in the “old coin” supply in the latest distribution phase can be ascribed to the financialization of bitcoin.

Exchange balances

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Source: Glassnode

Another frequently distributed on-chain chart is the exchange balance overview. From March 14th, 2020, to today, the percentage share of the circulating bitcoin supply held by exchanges has seen a steady decline from 17.3% to 12.7%, leading on-chain analysts to comment on the accelerating supply shortage of bitcoin.

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Source: Skew, Dune, MicroStrategy, Tesla, Square, Meitu, Aker, Bytetree, VanEck, Proshares, Hashdex, StatusInvest

The exchange balance narrative is extremely popular, but it completely misrepresents the availability of bitcoin-linked tradeable vehicles. Market makers respond to the flows in these markets, and arbitrage aligns prices with spot. This leads price discovery in bitcoin to reach out far beyond the spot market. By focusing on exchange balances, you overlook tradeable bitcoins held in the investment structures mentioned above. You should not submit to the supply shortage narrative. By including bitcoins managed by alternative investable structures to the exchange balance metric, we see that the declining exchange balances massively understate the amount of liquid and tradeable alternatives for bitcoin exposure that impacts BTC's price discovery.

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Source: Glassnode, Skew, Dune, MicroStrategy, Tesla, Square, Meitu, Aker, Bytetree, VanEck, Proshares, Hashdex, StatusInvest

Above, I present the liquid tradeable BTC proxy whose peaks coincided neatly with the heights of the bitcoin rallies of 2021. It currently sits at 20.4%. This is a sizable difference from the current exchange balance share of 13%. The liquid tradeable bitcoin supply likely sits closer to 3.9m BTC than the 2.4m BTC found by exploring exchange balances. Not such a wholesome bullish supply-side crisis inevitability forcing the number go up story, is it? In essence, relying on macro on-chain data becomes less relevant with time. Traders should be cautious not to over-interpret on-chain-based narratives without knowing the current market structure. This does not mean that these metrics are useless, but one should interpret on-chain data with a solid pinch of salt.

Arbitrage matters

Flows and price movements in bitcoin investment vehicles impact the market. The job of the market makers is to provide prices and hopefully gain some free lunches in the process. A huge deviation in the WBTCUSDC price after an imagined huge buy order in WBTC will lead market makers to respond, having spill-over effects on BTC’s price. Arbitrage is the hidden force leading financialized and tokenized bitcoin to be relevant in assessing bitcoin’s liquid circulating supply. Correlations between bitcoin and some of the included vehicles confirm that these vehicles are indeed relevant.

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Source: Tradingview

Limitations

I have not included CME nor mentioned the increasing stablecoin collateral dominance in the futures market, which substantially impacts bitcoin’s price discovery. See Bitwise’s lead-lag analysis of the bitcoin market and our multi-dimensional information flow analysis. The results indicate that linear cash-settled CME futures have the leading role in BTC’s price discovery, i.e., a market with an exchange balance of 0 BTC. The consequence of CME’s dominance in BTC’s price discovery is a further weakening of on-chain-based analysis to make informed trading decisions.