In this post I will cover in more details the Supply and Demand Metrics mentioned in Grayscale Investments recently released 20 page report, authored by Phil Bonello, entitled "Valuing Bitcoin".
The reports intended audience is for Accredited Investors. This group of investors do not have the experience or skills to:
- set-up the Atomic Wallet
- have never played a faucet
- or got free BAT from using the Brave Browser
- or swapped their DAI Publish0x tips for Tezos (XTZ)
- and then staked the Tezoz on the Atomic Wallet
But they still want access to the best performing asset of 2020 and the last decade. And possibly the next decade.
My previous post Valuing Bitcoin For Accredited Investors covered
- What is an Accredited Investor?
- Grayscale Investments buying up Bitcoin faster than miners can produce it
- The Grayscale Bitcoin Trust (GBTC)
- Valuing Bitcoin
- Why is Bitcoin important today?
- How can we think about Bitcoin's value?
- Relative valuation to other store of value.
But only glossed over the Supply and Demand Metrics. The metrics were just bulleted, as the post was starting to get a bit long.
The Supply and Demand Metrics were things I had seen written about but didn't really know what they were, or their significance or how to use them. And I made a promise in the comments, that I would do a followup, fleshing them out.
Just a quick recap for those that missed Valuing Bitcoin For Accredited Investors
For the purposes being able to invest in the Grayscale Bitcoin Trust (GBTC), being an Accredited Investor is defined as:
An accredited investor, in the context of a natural person, includes anyone who either earned income that exceeded $200,000 (or $300,000 together with a spouse) in each of the prior two years, and reasonably expects the same for the current year, OR, has a net worth over $1 million, either alone or together with a spouse (excluding the value of the person’s primary residence).
Further Reading In The Institutional Money Series
Supply And Demand
Bitcoin’s supply is set, there will only ever be 21M Bitcoin, however, not all Bitcoin have been mined and not all Bitcoin are actively used or traded (HODL).
The public blockchain that underpins Bitcoin allows the analyzing of supply and demand shifts on the network to estimate price accordingly.
The Supply Based Metrics
1. Active Coins
Coins can be identified by age and this can help understand the aggregate Bitcoin market structure.
Coins that have not moved for one to three years are deemed as belonging to a Holder.
Coins that have moved in the last 90 days are said to belong to a Speculator.
An increase in Holder coins signifies accumulation (likely a bullish indicator), whereas an increase in Speculator coins signifies distribution (likely a bearish indicator). The following chart shows there are a growing number of Holders relative to a small number of Speculators in the market. There was a similar structure to that of early 2016 and the reverse occurred during 2018
The Bitcoin blockchain shows that there has never been a higher level of Bitcoin owned for more than one year.
This metric indicates a strong hand (HODLing) by Bitcoin's current investor base. While this is a supply-side metric, it also demonstrates the demand for Bitcoin’s use case as a store of value, rather than trading.
2. Bitcoin Days Destroyed (BDD)
This is a metric that measures the aggregate age of all coins moved on a given day.
BDD can be used to identify large shifts in the supply of old coins.
A high BDD indicates long-term HODLers are bullish or bearish.
Historically, BDD has spiked near the market tops, as investors sell their long-term holdings. Or near market bottoms as investors capitulate as the final indication of supply exhaustion.
3. Realized Capitalization
This metric is a measure of the aggregate cost of all Bitcoin ever moved. Realized Capitalization takes the price of each Bitcoin at its last on-chain movement.
This metric allows coins that may be lost to be discounted. This metric is a more accurate representation of Bitcoin’s market capitalization because it takes into account the last price of all traded coins rather than just the most recently traded coins.
Realized Capitalization also has historically acted as a support zone for Bitcoin’s market capitalization.
MVRV, which is the ratio between the market capitalization and the realized capitalization, has historically signalled a buying opportunity when the reading is near 1.11
4. Stock-to-Flow Model
This metric is calculated by dividing the existing supply of a commodity by that commodity’s annual production growth. It is often used as a measure of scarcity for commodities by investors.
Commodities with high stock-to-flow ratios such as Bitcoin, gold, and silver have historically been utilized as stores of value. As you can see in the chart there has been a correlation between Bitcoin’s historical price and the stock-to-flow ratio. It can be used to estimate a future price.
5. Bitcoin Held on Exchanges
Investors can use the amount of Bitcoin held on exchanges to determine the amount of Bitcoin supply that may be looking to be liquidated. A large amount of exchange Bitcoin supply may be bearish and a low Bitcoin supply may be bullish.
Demand Based Metrics
Investors can measure growth of demand directly on the Bitcoin blockchain.
1. Daily Active Addresses (DAA)
Daily active addresses (DAA) is a measure of the total number of unique addresses that participate in Bitcoin transactions.
While the daily active addresses metric doesn’t include all users, it does gives investors an over view of the Bitcoin network growth. Investors generally want to see increased activity correspond with price increases.
2. Whale Index
The Whale Index counts the number of unique Bitcoin addresses with balances over 1,000 Bitcoin.
An increasing number of addresses with large amounts of Bitcoin, indicates a trend that signifies accumulation.
3. Bitcoins Production Value
The Bitcoin network’s electricity consumption can be used to calculate the production cost per Bitcoin.
Bitcoin mining can be described as the process of converting electricity into Bitcoin.
The relationship between price and production cost is important because it gives us clues about miner profitability, a critical input to the Bitcoin value analysis. As the Bitcoin price increases, profitability tends to increase, this in turn encourages miners to use more energy. When profitability decreases, the inefficient miners are often forced to sell their Bitcoin and shut down their mining rigs. This allows the more efficient and better capitalized miners to accumulate more Bitcoin, in the anticipation of price increases. Instead of selling all their production.
Using the ratio between Bitcoin’s price and its production cost can indicate price floors in the Bitcoin market cycles.
The Reports Conclusion
The current economic environment presents a compelling opportunity to explore how Bitcoin can be part of a resilient portfolio. However, many investors are challenged to find a reliable methodology to ascribe Bitcoin’s value. This report outlines how investors can use relative valuation and blockchain metrics for supply and demand to estimate fair value. However, with more Bitcoin transactions occurring off-chain, these metrics may become less effective.
As demand for stores of value grows during this regime of monetary inflation, Bitcoin may be well-positioned given that it is a scarce digital asset. The plethora of blockchain metrics covered in this report indicate that the current market structure is reminiscent of early 2016, the period that preceded Bitcoin’s historic bull run. Bitcoin continues to command global investor attention, there is scant supply to meet growing demand, and the infrastructure is now in place to satisfy that demand. With the techniques outlined in this report, investors can now measure Bitcoin's network growth and more confidently assess its value.
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