Is Bitcoin facing a liquidity crisis?
As we commented in our Bitcoin analysis in October 2020, from a technical perspective, Bitcoin had broken out from its resistance. From the demand side, Bitcoin also had a bullish outlook due to PayPal and Square enabling their large user base to purchase and exchange the cryptocurrency. In the last three months, the price of Bitcoin has surged ahead, more than tripling and reaching $42,000 during early January.
Why has this move occurred? Bitcoin is facing a liquidity crisis as there is not enough new supply to match the increasing demand for Bitcoin, which has led to strong daily moves of over 10%, which are rather uncommon in assets that are valued at hundreds of billions of dollars.
Why is Bitcoin facing a liquidity crisis?
Since Bitcoin’s last halving in May 2020, Bitcoin has generated a new block on average every 10 minutes, with 6.25 Bitcoins per block. Taking these numbers into account, we find that the number of new Bitcoin created in the second half of 2020 was 165,600 Bitcoin.
As can be seen from the table below, the purchases of just a few institutional investors (those that have come forward publicly as having purchased Bitcoin) during the second half of 2020 were equal to more than three times the number of Bitcoin that were created during this time. The Grayscale Bitcoin Trust alone has grabbed the equivalent of more than 133% of all the new Bitcoin mined during this period!
There are two reasons why institutional investors purchasing Bitcoin is such a big deal. First, this demonstrates the acceptance of cryptocurrencies from the traditional financial elite as having a valid purpose, either as an alpha-generating asset or as a long-term store of value. Second, many of these Bitcoin holdings are going to be locked-up in different custody solutions, thus being unavailable for buying and selling, or illiquid. Unsurprisingly, this then exacerbates any liquidity issues. In addition, this makes the current rally more sustainable as institutions are less likely to be “weak hands” and sell quickly when the Bitcoin price faces a decline.
Data from research firm Glassnode shows that 78% of the current circulating supply of Bitcoin (18.6 million) is illiquid, with only 4.2 million BTC that can be considered either highly liquid or liquid, meaning it is available for buying and selling. During 2020, more than 1 million BTC have become illiquid, with the decrease in liquidity becoming more pronounced in the last quarter of the year - exactly the time when Bitcoin experienced a massive increase in price.
Another reason why the supply of Bitcoin is shrinking is that, according to research from Bitcoin investment manager Timothy Peterson , 4% of Bitcoin’s available supply is lost every year, meaning that while 900 Bitcoins are now mined daily, an estimated 1,500 Bitcoins are lost every day as a result of the user losing their hardware wallet, their Bitcoin keys, the user dying without passing on the information to retrieve the Bitcoin or the Bitcoin being sent to a defunct address. Two recent such cases that made the news were related to a software engineer who lost the password to his hardware wallet containing 7,002 Bitcoins and another software engineer who accidentally threw away his hard drive containing 7,500 Bitcoins. For these reasons, we believe that the keyless Multi-party computation (MPC) custody method used in the SwissBorg app is a superior method for keeping your cryptos secure.
What about the demand side?
At the same time, Bitcoin is experiencing large increases in interest not only from institutional investors but retail interest has exploded as shown by the graph below from Google Trends
The fact that Bitcoin can now be purchased in already highly popular retail financial apps (PayPal, Cash App or Robinhood) has removed a tremendous amount of friction from purchasing Bitcoin and dramatically increased, in a short amount of time, the number of people who have access to purchasing Bitcoin. It is estimated by Pantera Capital that PayPal and Square are buying, respectively, almost 70% and 40% of the new supply in Bitcoin respectively. So, alongside institutional demand, new retail demand is also higher than total new Bitcoin supply!
If we put together the new demand from the institutional investors who have disclosed their Bitcoin purchases, new retail demand (only taking into account PayPal and Square) plus the estimated Bitcoin that are lost (1,500 a day), we reach the conclusion that the total net increase in demand plus the decrease in supply is equivalent to more than six times the new Bitcoin that is mined on a daily basis.
What about crypto exchanges?
As data from CryptoQuant shows, the amount of BTC held in all exchanges’ wallets has decreased markedly in the last 10 months, with about 20% of all available BTC leaving exchanges. This has resulted in certain Bitcoin exchanges facing outages (Coinbase has had 14 significant outages in the last 2.5 months) or placing limitations on users’ buy orders of Bitcoin, with eToro recently emailing its customers saying that “the unprecedented demand for crypto, coupled with limited liquidity, presents challenges to our ability to support BUY orders over the weekend.”
Given that the SwissBorg app is connected to four of the leading crypto exchanges (Binance, Kraken, HitBTC and LMAX), we have a much higher probability of being able to route your order through a working exchange in times of high market volatility than many crypto apps that rely solely on one crypto exchange.
As Bitcoin is increasingly seen as a store of value (i.e. digital gold), rather than as a payment network, more Bitcoin is leaving exchanges for hot and cold wallets, thus becoming illiquid. The preferred market behavior is becoming about holding Bitcoin (or HODLing) which is creating thinner and thinner liquidity for Bitcoin, leading to an increase in price as falling supply meets exponential demand.
The analysis in this article has found that the net increase in demand, plus the decrease in supply is equivalent to more than six times the Bitcoin that has been mined since the May 2020 halving. This analysis potentially fails to take into account potential purchases from other high net worth individuals such as Paul Tudor Jones, Stan Druckenmiller, Ricardo Salinas Pliego, Mark Zuckerberg or Elon Musk, who have either spoken positively about Bitcoin or are rumored to have purchased Bitcoin during the last six months.
It is because of this situation that the current rally in Bitcoin is likely to be more sustainable than the previous rally - more long-term ownership, including from institutions and wealthy individuals. This does not mean that Bitcoin cannot go down - it will likely do as it is a highly volatile asset. But absent any major market correction which dramatically moves long-term HODLers to sell, Bitcoin has strong supply-demand fundamentals to stand on and is likely to continue appreciating in price in the medium-term.