Cycling On-Chain is a monthly column that uses on-chain and price-related data to better understand recent bitcoin market movements and estimate where we are in the cycle. This seventh edition first addresses several on-chain and derivatives-related metrics to gauge the current bitcoin market structure. Then, it discusses two developing narratives that are introducing some fear into the market: the Mt. Gox rehab plan and the emergence of the omicron COVID-19 variant. Finally, we’ll conclude with the results of our monthly poll and the halving cycle roadmap. RETURN OF THE HASHES In June 2021, the Chinese government cracked down hard against Bitcoin, banning its mining and censoring exchanges (see COC#2). During that period, Bitcoin’s hash rate halved, creating major fear in bitcoin markets. Since the start of July, the return of that hash rate has been an absolutely stunning phenomenon, illustrated by a streak of nine consecutive positive difficulty adjustments that was just ended by a minor correction (figure 1). The return of this hash rate to the levels of prior highs is by itself a good thing, but even more so when taken into account that the age-old “China controls Bitcoin” narrative is now no longer valid. A recent report by the Cambridge Centre for Alternative Finance confirmed that China now supposedly has a (near) zero share in global bitcoin mining. EXCHANGE BALANCES KEEP DROPPING During the mid-May capitulation event that triggered a cascade of long liquidations that exacerbated the drop (see COC#1), there was a period where lots of bitcoin were deposited on exchanges. However, exchange balances resumed their downward path quickly after. Current exchange balances are at multi-year lows — we need to scroll back more than three years to identify the last time exchange balances were at these levels (figure 2). An explanation for this can be sought in improvements of both noncustodial (e.g., hardware or software wallets) and custodial (e.g., professional services that store coins for institutional investors) storage solutions. Either way, the mass exodus of coins off exchanges can be interpreted as a sign that whoever is holding those coins likely does not have the intention to sell them short term. More importantly, the lower the bitcoin supply on exchanges, the quicker exchange balances run short during periods of high demand, causing bitcoin to trade more reflexively. This is sometimes called a supply shock. THE BITCOIN SUPPLY KEEPS BECOMING MORE ILLIQUID More evidence that there is a trend that more and more bitcoin is moving into the hands of entities that are unlikely to sell can be found in Glassnode’s “illiquid supply” metric. After all, that is exactly what the metric was built for. Since most financial markets — including bitcoin — crashed hard mid-March 2020, the percentage of the circulating bitcoin supply that Glassnode classifies as “illiquid” has been going up. After a clear drop during the mid-May 2021 capitulation and cascading liquidation event that was also mentioned above, it is currently again in a rapid upward trajectory (figure 3). BITCOIN FUTURES MARKETS ARE HEALTHIER Another positive aspect when it comes to gauging the current status of bitcoin markets is that derivative markets appear to hold less downside risk than they did during the start of the year (see COC#6). Compared to early 2021, we are seeing similar levels of open interest, which is the total value of all outstanding bitcoin futures positions (figure 4, blue). Unlike then, bitcoin futures markets now have much lower funding rates (figure 4, green), which means that the market does not have the relatively extreme tendency to go (leveraged) long than it did back then. Furthermore, the percentage of open interest that is backed by bitcoin has declined from the mid-60s to mid-40s (figure 4, red). Since cash is better at holding its value during a bitcoin price dip and thus less prone to be pushed below the liquidation point where the position is auto-sold, it is a superior collateral for BTC longs. The opposite is true for shorts. If the bitcoin price soars, the collateral of BTC shorts that are cash-margined loses value on a relative basis, making shorts more vulnerable to be liquidated. Compared to early 2021, the bitcoin futures markets are, therefore, healthier. They are less tilted toward a positive bias and have a collateral structure that has less downside risk. A MEMPOOL FULL OF CRICKETS As already pointed out in COC#4 at the start of September, it has been very quiet on the Bitcoin blockchain for a few months now when it comes to transactions. The incredibly low average transaction fees that we have seen over the last few months (figure 5) are a good example of that. If there is (almost) no waiting line in front of the attraction we’re trying to get into, there’s no need to pay unnecessary high entrance fees. Figure 5: The bitcoin price (black) and seven-day moving average of the total BTC-denominated transaction fees (Source). Figure 5: The bitcoin price (black) and seven-day moving average of the total BTC-denominated transaction fees (Source). Although the cause of this is likely at least partially technical (e.g., recent Lightning and Segwit adoption, see COC#4), it is likely that another large explanation can be sought in the relative absence of retail in the current market. In COC#6, some other examples of this were described, such as the relatively low Google search trends. LTH PROFIT TAKING WAS ENOUGH TO SATIATE RECENT MARKET DEMAND Around this time in 2020, the Bitcoin blockchain was everything but a ghost town. The bitcoin price had just broken through its 2017 ~$20,000 all-time high, as the world was waking up to a buzzing hive full of cyber hornets and first-time institutional interest. As illustrated in figure 6, long-term holders were already selling parts of their positions into market strength (middle red box), but the market demand was so high that price just kept churning up. Figure 6: The bitcoin price (black) and percentage of the circulating bitcoin supply that is in the hands of long-term holders