Weakness in the Recovery

Checkmate -

The Bitcoin market traded lower this week, coming off an opening high of $47,102, and slipping to a low of $42,183. This market weakness follows a relatively modest price break-out from the multi-month consolidation range that has been established since mid-January. On-chain activity and spending behaviours suggest that investors have been taking profits during the recent rally, and that we are yet to see a convincing influx of new users or demand.

In this edition we will explore the nature of the market recovery across on-chain activity and network profitability as a measure for growth and health of the Bitcoin user-base. We will also explore some of the mechanisms that enable the interesting dichotomy of BTC denominated transaction fees and block subsidy being near all-time-lows, whilst competition in the mining industry sets new all-time-highs.

Executive Summary

  • The Bitcoin market pulled back this week as it struggles to establish upside price momentum.
  • On-chain activity remains fairly muted, suggesting that there is little growth in the user-base, minimal inflows of new demand, and that the market remains largely HODLer dominated.
  • Investor spending behaviour appears to be switching from dominance of loss realization, towards a modest amount of profit taking. 58% of transaction volume is currently realizing a profit.
  • Aggregate Bitcoin transaction fees are currently near all-time-lows, a result of a confluence of factors including SegWit adoption, transaction batching, and the aforementioned lack of demand for Bitcoin block-space.
  • Despite this, USD denominated miner revenue is up 150% compared to after the last halving event, and both hash-rate and protocol difficulty are setting consistent all-time-highs.

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On-chain Activity Continues to Languish

A powerful set of tools for tracking the cyclical nature of Bitcoin cycles is on-chain activity, broadly described as the utilisation of block-space via active network participants sending transactions and settling value. Metrics which describe this include active addresses/entities, transaction counts, mempool congestion, and fees paid.

Across this suite of metrics, it is hard to find many observations that suggest the network user-base is recovering or growing strongly. The number of active entities (analogous to daily active users) remains within the bear market channel that has been established over the last six years. That said, the current active entity count of 296k/day is at the upper end of this channel, and a sustained expansion higher would be constructive.

Live Chart

Transaction counts are also relatively lacklustre, currently at around 225k transactions per day, which is similar in magnitude to during the 2019 bear market. As with active entities, this metric has recovered from the lows of the collapse back in May-July 2021, but is a far cry from the hype cycle observed during bull markets (shown in green).

What is quite interesting to see is that over the longer term macro time-scale, both of these on-chain activity metrics continue to climb, even during bear market trends. This signals a persistent growth in the HODLer user-base. HODLers are those investors whom are relatively price insensitive, and are active Bitcoin users and accumulators irrespective of market conditions.

Live Chart

A result of this relatively low demand for Bitcoin block-space is that there is little network congestion, and thus a low aggregate in transaction fees paid. Total transaction fees paid to Bitcoin miners has been languishing near all-time-lows since May, supporting the above observations that the recovery in on-chain activity is lacklustre at best.

Live Chart

It should be noted that there are numerous factors that impact network congestion and total fees paid, which includes the adoption of efficiency upgrades like SegWit, and transaction batching. The chart below shows that since June 2021, there has been a significant uptick in SegWit adoption and utilization, as more wallets and exchanges implement the technology (read more of our research on SegWit Utilization, and the adoption by Exchanges).

Live Chart

The next chart also shows the expansion of spent outputs that are using SegWit technology, with the uptick after June 2021 standing out. Transactions using SegWit are more data efficient, which allows for more transactions to fit in each block (lowering congestion), whilst also having cheaper transaction fees.

In the current market, this is part of a confluence of factors that are driving fees lower as was well articulated by Alex Thorn (Galaxy Digital) in this thread. It is important to note however that a low demand for Bitcoin block-space, and low on-chain activity as a result of bearish market conditions is one of the major driving factors behind low aggregate transaction fees.

Live Chart

Mining Competition Reaches All-Time-High

Despite network transaction fees being near all time lows in (BTC denominated terms), the competition in the mining industry continues to set new all-time-highs. The protocol mining difficulty has now reached a new ATH, with each Bitcoin block requiring 122.78 Zettahashes to solve.

This would be equivalent to all 7.938 Billion people on earth each guessing a SHA256 hash 15.5 Trillion times, every 10mins to solve each Bitcoin block. Quite extraordinary.

Live Chart

The estimated hash-rate is currently ranging between 190 and 215 Exahash per second, which is around 20% higher than the prior ATH set just before the mining ban was enacted in China in May last year. Hash-rate has continued to expand higher since June last year, with growth largely uninterrupted by the recent bearish market conditions, nor the numerous macro and geopolitical headwinds that are in play.

Live Chart

Competition in the mining industry is notoriously fierce, as miners seek to arbitrage the energy/BTC price ratio by finding the cheapest available sources of power and capital funding. As hash-rate competition expands, ASIC efficiency and rig counts increase, and the revenue earned per hash is driven ever lower over the long-term. The chart below shows this long-term trend which illustrates, in log-scale, just how competitive the landscape for acquiring the ever declining Bitcoin block reward is.

Live Chart

Despite both the immense competition, and the BTC denominated block reward being near all-time-lows, USD denominated miner revenue remains 150% higher than immediately following the most recent halving event in May 2020. Miners currently earn approximately $207k per Exahash they apply to the network. This is also 40% more revenue than during the final capitulation event of the 2018 bear market. As that time prices were trading between $3k and $4k and the BTC block subsidy was twice as large as it is today.

Live Chart

Network Profitability

Assessing the profitability of the Bitcoin network is a useful tool for assessing possible sell-side risks, and gauging whether the market is HODLing, or taking profits.

The chart below presents the proportion of the market that is currently underwater on their position. Here we use the percent of addresses (pink), entities (green) and supply (blue) that are in profit as a measure of aggregate network profitability. We can see that the current bear market is not as severe as the worst phases of all prior cycles, with just 25% to 30% of the market being at an unrealized loss. It remains to be seen if further sell-side pressure will drive the market lower, and thus pull more of the market into an unrealized loss like prior cycles.

Note that over time, more coins and UTXOs will have last moved at much cheaper prices and thus the long term uptrend in these metrics is expected.

Live Chart

Bitcoin Long-term holders (LTHs) currently hold 13.66% of the supply that is at an unrealized loss, which is a sum approximately equal in magnitude to the amount of sell-side they applied in the 2020-21 bull market. LTH coins are the least likely to be spent and sold on a statistical basis, and it can be seen in 2018 and March 2020 that they have held through much deeper losses in the past.

The proportion of LTH coins held at a loss reached over 35% of supply in the depths of previous bear cycles, which is 2.5x more relative coin volume than we have in the current market.

Live Chart

Short-Term holders (STHs) own far fewer coins compared to LTHs (18.74% of supply), however this cohort has a seen a marked jump in profitability of late. As the market rallied out of the consolidation range, new accumulators (STHs) that acquired coins between $33k and $42k have returned to an unrealized profit, showing that investors saw value in that price range.

This is a positive development compared to the recent market lows on 22-Jan, where 100% of all STH coins were at a loss. Improving investor profitability, especially in this more price sensitive STH cohort tends to lower the probability of panic driven sell-side pressure.

Live Chart

We have however seen an uptick in profit taking, and a decline in loss realization during this rally. Daily realized losses have declined from ~20k BTC/day at the lows in January, to around 8.3k BTC/day today. Periods of high and sustained loss realization are typical of bear markets, and the market has absorbed more than 8.3k BTC in losses realized per day since late-November.

Live Workbench Chart

In addition to the coins realizing losses, the market has seen around 13.3k BTC in profits realized each day since mid-February. Profit realization at this magnitude is not historically extreme, however appears to be providing sufficient headwinds to prices. Heavier profit realization is typical of bullish conditions where a large influx of new demand is capable of absorbing the supply and pushing the market higher.

Live Workbench Chart

And finally, we can see that the dominance of spent volume profitability has moved towards a profit bias. In other words, 58% of transaction volume is currently realizing profit, which is a change from the bias towards realized losses that was in place since December.

Sustained periods of realized loss dominance are typical of bear markets, and a reversal to a dominance of realizing profits can signal that sentiment is shifting, and demand is capable to absorb the sell-side. However, given prices continue to struggle, it does suggest that the demand side remains somewhat lacklustre, and that investors are taking profits into whatever market strength can be found.

Live Workbench Chart

Summary and Conclusions

The Bitcoin market has pulled back this week after a break-out from the multi-month consolidation range. Prices have thus far struggled to find much sustained upside momentum, and there are indications of a modest volume of profit taking by investors. Especially across on-chain activity metrics like transaction counts and active users, the recovery has thus far been relatively lacklustre, and continues to suggest Bitcoin is a HODLer dominated market, with few new investors flowing in.

That said, network profitability has improved indicating significant re-accumulation took place since January. The aggregate profitability of the network remains in a far healthier position compared to prior bear cycles.

Low demand for Bitcoin block-space manifests as a low aggregate transaction fee paid to miners, which has the current BTC denominated block reward near all-time-lows. However despite this, competition within the Bitcoin mining industry is setting new all-time-highs, with miner USD revenue up 150% since the halving, and hash-rate now 20% higher than the previous high in May 2021.

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