Weekly: Bitcoin's Big Rally

Release Date: March 8, 2024

Authors: David Duong (Head of Institutional Research), David Han (Institutional Research Analyst)

Key Highlights

• Bitcoin broke its all-time high this week. The short covering that initially drove the rise now seems to have exhausted, while the U.S. spot Bitcoin ETF continues to be a significant support for Bitcoin demand.
• That said, we believe the Crypto market may face some important macroeconomic headwinds and negative technical factors in the coming weeks, after which we may witness the next round of increases.
• We believe that the comparison between newly mined Bitcoin and ETF inflows cannot fully capture the complete picture of long-term cyclical supply trends.

Market Observations

Bitcoin broke through the historical (intraday) high of $69,338 this week, then pulled back from that level and rebounded again. The short covering that initially contributed to the rise now seems to have exhausted, but the U.S. spot Bitcoin ETF remains an important support for Bitcoin demand, as reflected by the average net inflow of $400 million per day over the past two weeks. Additionally, liquidity has been a major obstacle to price momentum in previous cycles, but it does not seem to be the case now. Nevertheless, we believe these supportive drivers may encounter some significant macro and technical resistance in the coming weeks.

For example, the Federal Reserve is expected to let the Bank Term Funding Program (BTFP), established to support U.S. regional banks, expire on March 11. This could create arbitrage opportunities for banks, but at the cost of potentially reintroducing vulnerabilities into the financial system. In terms of economic data, the U.S. CPI data for February will be released on March 12 (with Bloomberg's median forecast at 3.1% year-on-year), and any negative surprises could lead to a decline in cryptocurrencies alongside other risk assets. Meanwhile, the decline in cash reserves among fund managers (based on the monthly fund manager survey by Bank of America Global Research) combined with quarter-end rebalancing may constrain liquidity.

Given these offsetting dynamic factors, we believe the most likely scenario is that Bitcoin prices may oscillate within a narrow range in the coming weeks until we approach the next significant event (the Bitcoin halving in April), before reaching a true price discovery area. However, ETFs have changed the market dynamics for Bitcoin, making the study of previous halving cycles somewhat irrelevant. In fact, the cumulative net growth rate of BTC held by ETFs is nearly three times that of miners (see Figure 1). That said, we believe the imbalance between newly mined Bitcoin and ETF inflows is merely a minor episode behind the long-term cyclical supply trend.

The reality is that the growth of the liquidity circulating supply (which we define as the liquidity of Bitcoin over the past three months) has significantly outpaced the cumulative inflow of ETFs (see Figure 2). In fact, while 150,000 new BTC have been mined since Q4 2023, the liquidity BTC supply has increased by 1.2 million. We suspect that during the recent period from March 3 to 6, the liquidity circulating supply of BTC increased by 200,000, suggesting that mid-term holders may be preparing to sell during the bull market. This is reminiscent of the period from January 3 to 5, when a similar increase in liquidity circulating supply occurred during the approval of the spot ETF.

To illustrate this, in previous cycles, the growth of liquidity circulating supply exceeded the growth rate of Bitcoin mining by more than five times. In the cycles of 2017 and 2021, the liquidity circulating supply nearly doubled, increasing from 2.9 million to 6.1 million (an increase of 3.2 million), and from 3.1 million to 5.4 million (an increase of 2.3 million), respectively. In contrast, the newly mined BTC during the same time frames was approximately 600,000 and 200,000.

Outlook

Aside from BTC, we expect Ethereum (ETH) to receive more attention in the coming week as the Deneb/Cancun (Dencun) fork is expected to launch on the Ethereum mainnet on March 13. The upcoming Prague/Electra (Pectra) is planned for later this year. As discussed in our "2024 Crypto Market Outlook," we believe this upgrade primarily benefits Layer 2, as the fork focuses on Proto-Danksharding (EIP-4844), which integrates binary large objects (blobs) into blocks, potentially reducing Layer 2 fees by 2-10 times.

The reduction in Layer 2 block space costs has raised concerns about whether Dencun will dilute ETH revenues in the short term. However, we believe that current Layer 2 activity averages only about 10% of transaction fees, which suggests that the impact of Dencun may be relatively small. Additionally, a relatively underappreciated change in the Dencun upgrade is EIP-7514, which reduces the maximum number of validator changes from the current 14 to 8 per epoch, slowing the growth rate of the validator set and thus affecting the absolute level of staking rewards.

Meanwhile, during this week's U.S. House Agriculture Committee hearing, CFTC Chairman Rostin Benham reiterated his view that ETH is a commodity, implying that Prometheum's plan to custody ETH is an "independent decision" unrelated to the SEC. As the SEC's final decision deadline on the first U.S. spot ETH approaches, discussions surrounding ETH ETFs may heat up in the next two and a half months.

On-Chain: Meme Resurgence

Additionally, on-chain trading volume has surged, partly due to the frenzy surrounding meme coin trading. Its volume increased from $4.8 billion on March 2 to a peak of $11.5 billion on March 5, more than doubling (see Chart 3). In fact, over one-third of the activity was concentrated on Solana, where the market share of decentralized exchanges (DEX) has grown more than fivefold since early November 2023 (from ~6% to ~30%).

We believe there are two main factors driving this growth. First is the anticipation of future airdrops from Jupiter, the largest DEX aggregator on Solana, as its four airdrop plans have only implemented one so far. Since higher trading volumes are proportional to larger airdrop amounts, users are trading more frequently due to incentive expectations. Second is the reduction in gas costs on the platform, which lowers the barrier to entry for users and (mostly) eliminates the issue of gas fees eating into retail profits.

At the same time, we believe the meme culture in Solana (and other newer ecosystems) may be particularly vibrant, as new airdrops, capital inflows, and (importantly) the lack of holders from the old cycle will foster the formation of a new cultural circle. The rise of meme coins is often a fundamental driver of increased DEX usage, especially for tokens that have not yet been widely listed.

Crypto and Traditional Market Performance

As of 4 PM EST on March 7

| Asset | Price | Mkt Cap | 24 hour change | 7 day change | BTC correlation | |-------------|-----------|---------|----------------|--------------|-----------------| | BTC | $67,980 | $1.33T | +1.15% | +10.99% | 100% | | ETH | $3,935 | $467B | +0.32% | +15.97% | 63% | | Gold (Spot) | $2,159.98 | - | +0.55% | +5.66% | -5% | | S&P 500 | 5,157.36 | - | +1.03% | +1.20% | 29% | | USDT | $1.00 | $101B | - | - | - | | USDC | $1.00 | $29.2B | - | - | - |

Coinbase Exchange and CES Insights

This week, the bullish momentum in cryptocurrency continues. After BTC broke its all-time high, it immediately pulled back, seemingly driven mainly by spot market sell-offs. When prices fell, perpetual futures open interest and funding rates remained relatively stable. Similarly, the CME's term futures basis did not compress as we saw during the sell-off after the ETF launch in early January. While we did see some minor de-risking operations in the weakness, counter-trading seems to be higher, so the decline was quickly absorbed by more buying.

As the Dencun fork is expected to take place next week (on Ethereum), traders' attention is shifting to ETH. While the token has indeed performed relatively well this week, the ETH/BTC trading pair is still 10% lower than levels in August 2023, when the narrative around the Bitcoin spot ETF was just beginning to take off. This week, SOL (Solana) also received a boost when a large, well-known cryptocurrency management firm announced plans to launch a Solana fund.

Coinbase Platform Trading Volume (USD)

Coinbase Platform Trading Volume (By Asset Proportion)

Funding Rates

| 3/7/2024 | TradFi | CeFi | DeFi | |-----------|--------|----------------|--------| | Overnight | 5.35% | 5.00% - 10.75% | 10.75% | | USD - 1m | 5.50% | 5.25% - 11.00% | | | USD - 6m | 5.75% | 5.50% - 11.50% | | | BTC | | 1.50% - 5.00% | | | ETH | | 3.00% - 8.00% | 1.49% |

Notable Crypto News

Institutional

• BlackRock's IBIT spot Bitcoin ETF reached a record daily inflow of $788 million (The Block)
• Michael Saylor's MicroStrategy raised $600 million to buy more Bitcoin (Coindesk)

Regulatory

• A U.S. Supreme Court case could change crypto industry regulation (CoinTelegraph)
• Binance.US cuts two-thirds of its staff after revenue plummets following SEC lawsuit (Coindesk)

General

• Fees for Arbitrum, Polygon, Starknet, and Base will decrease, but by how much? (Coindesk)

Coinbase

• How we ensure the security of digital assets (Coinbase Blog)
• Wallet Status - Part 2: Smart Accounts (Account Abstraction - From Theory to Practice) (Coinbase Blog)

Global Perspective

Europe

• UK law enforcement will soon have more power to seize crypto assets (Coindesk)
• The Bank for International Settlements (BIS) released a document titled "Global Stablecoin Regulation, Supervision, and Oversight Recommendations." (BIS)

Asia

• Regulators in Hong Kong, Singapore, and Japan welcome tokenization driven by increased adoption (SCMP)
• Entities without virtual asset trading platform licenses will cease operations in Hong Kong by the end of May (SFC)
• Due to a surge in domestic interest in Bitcoin rebounds, Chinese state media warns against cryptocurrency trading (SCMP)
• HSBC Hong Kong will allow investments in virtual assets in 2024 (Cryptonews)
• South Korea's ruling party withdraws election pledge for a spot Bitcoin ETF (The Block)
• Taiwan's financial regulators explore special legislation to regulate cryptocurrencies (The Block)
• Indonesian crypto regulatory officials urge the finance ministry to adjust digital asset tax rates (Coindesk)

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