Insight
July 12, 2024
Following a stellar start to the year in Q1, the price of bitcoin fell 12.8% during Q2. While bitcoin technically fell on the quarter, most of the price action could be described as rangebound trading, bouncing between the lower $70Ks and mid $50Ks. The emergence of large sellers late in the quarter has put a damper on price and sentiment. ETF fund flows, while still a net positive during the quarter, abated substantially from the Q1 inflows. The much-heralded reward halving in April was accompanied by a temporary spike in fees but did not end up being a price catalyst as some (not us) had expected.
Frustratingly for bitcoin investors, Q2 was a strong quarter for some asset classes, but not bitcoin, which was the worst performing asset in the quarter. Inflationary measures, while still higher than desired, continue to show signs of deceleration, resulting in a decline in forward interest rate expectations. Interestingly, this backdrop proved to be a mixed environment for assets, with certain equity classifications and precious metals performing best. The dichotomy in stock style performance has been stark, with large-cap growth stocks performing best, up 9.6% on the quarter, and small-cap and value stocks performing the worst, down 4.9%.
Even with the decline in Q2, bitcoin continues to be the best performing asset on a year-to-date basis. Bitcoin’s lead over large cap growth stock and silver narrowed during the quarter, but still stands at well over 20 percentage points. Impressively, most asset classes are showing positive returns on the year, with the exception of some bond categories, real estate, and small cap stocks.
Typically, Q2 is one of bitcoin’s best quarters as it boasts the highest median return (averages are skewed by outliers) and the second highest win rate (percentage of times returns have been positive). Unfortunately, this year was a let down and the third worst Q2 on record. Still, the first half return of 45.6% is the 6th best first half on record and the best since 2019.
Bitcoin's correlations with US equities continued to experience an increase (absolute values) from near zero levels at the end of 2023. However, bitcoin’s correlations with gold and US dollar index declined during the quarter. The relationship with equities is still low, 0.34 for rolling 90-day correlations, but the trend has been for increasing correlations since bottoming at the beginning of the year. We do not see this as problematic for the diversification argument given the still low absolute levels. We would expect it to have higher levels of absolute correlations as bitcoin gains wider acceptance and adoption with traditional investors’ portfolios.
Without a doubt, the biggest event this quarter was bitcoin’s fourth halving on April 19th, which took the block subsidy from 6.25 bitcoins to 3.125 bitcoins. On one hand, the event was a reinforcement of bitcoin’s programmatic supply function, one that gradually exhausts the new supply of bitcoins that are created until a fixed supply is eventually reached. On the other hand, the event was business-as-usual, the execution of a technical and economic promise engrained in the network at launch in 2009.
While the event went off as it should, without a hitch, other events at play temporarily affected the network resulting in high fees, chiefly the launch of a new fungible token standard from Ordinals creator Casey Rodarmar. Runes, a more blockchain efficient way of creating, storing, and sending fungible tokens on Bitcoin, launched on the halving block, creating a gold rush of sorts for token creators and speculators alike. While the launch of Runes was a temporary benefit to miners (and a detriment to other users) as demand for on-chain activity skyrocketed pushing fees up, the craze was temporary. Average fee rates went to 2,344 sats/vb just after the halving from about 100 sats/vb just before. Today, fee rates are 9 sats/vb.
Bitcoin’s difficulty, the metric used to keep block times at 10 minutes amidst varying hash rates, initially rose in the first difficulty adjustment after the halving but has fallen since. Prior halvings saw reductions in difficulty of 5.4% - 14.7% before increasing. Today bitcoin’s difficulty is 8.0% below where it was just prior to the halving.
The reduction in difficulty in the wake of the halving is reflective of two things, we think. First, immediately following the halving, there was miner hash rate that was no longer economical given the 50% drop in the block subsidy, which accounts for the overwhelming majority (~97%) of miner revenue. Second, we think seasonal factors are at play. Curtailment of electricity usage, either because power prices are too high to mine profitably or because it makes more economic sense to sell electricity back to the grid, is very common in the summer when power demand and prices are high.
The corollary to network difficulty, hash rate, a derived metric, is also down as a result. Again, we think this is a result of uneconomical hash rate coming offline in the wake of the halving, plus seasonal factors.
Bitcoin’s hash price, the value paid to miners for their hash rate, has settled into a new lower level following the April halving. The fall in the hash price was entirely expected given the decline in the block subsidy, but it wasn’t without its volatility. The following graph highlights the spike in fees associated with the launch of Runes on the halving block. There was also a secondary spike in fees when the exchange OKX consolidated a bunch of its UTXOs in a haphazard manner in June, causing a spike in fees. While the hurried manner to UTXO consolidation was a benefit to miners via increased fees, it certainly cost OKX, which was the entity paying those fees. Absent the temporary spike in fees, however, the hash price is about 60% below its pre-halving value. Hash rate has come offline, benefitting hash price, but bitcoin’s price is down from the halving in addition to the reduced block subsidy.
Inflows into the spot ETF complex in the US totaled $2.5B in Q2, still a hefty amount, but down substantially from the $12.1B accumulated in Q1. Still, by any measure, the spot ETFs have been wildly successful, with $52.1B in AUM across the various funds. While investors have been closely watching the daily flows, a number of important events occurred across the industry.
BlackRock’s iShares Bitcoin Trust (IBIT) surpassed the AUM of the Grayscale Bitcoin Trust (GBTC) on May 29th, just 139 days after the start of trading. This is a remarkable feat given the head start that GBTC had with $28.6B in AUM vs. BlackRock’s initial seed of $10M in IBIT. Clearly, fees were an important determinant in the race, as GBTC elected to keep its fees well above the challenger fund. Grayscale’s competitive response, the Grayscale Bitcoin Mini Trust, which is expected to be a low-cost alternative to GBTC, is still working its way through the regulatory approval process with a final decision deadline of Feb 7, 2025.
Leveraged futures funds were huge winners again in Q2; however, given the current AUM and timing of fund flows, investors are likely under water on their investments. Investors have contributed $1.9B to leveraged futures funds since January 11th, but the AUM is presently south of that number, $1.6B. Including the initial $223M in AUM in leveraged futures funds at the start of spot ETF trading, this implies that leveraged futures investors are likely sitting on collective losses of about $54M. Of course, the exact timing of trades may make that math just an approximation, but it is unlikely that leveraged futures fund investors are sitting on big gains, if any.
While we had expected to see this sooner, outflows from futures-based ETFs (non-leveraged) picked up during the quarter, reaching $541M. Despite competition from low-cost alternative spot ETFs, futures-based ETFs actually saw net inflows in Q1, but now that trend has reversed.
The launch of spot ETFs in Hong Kong, on both bitcoin and ether, were highly watched items during the quarter. While we had expected only modest demand given the size of analogous futures-based crypto ETFs in Hong Kong and the lack of investment from mainland China, the launch went well, driven by initial seed investments. However, ensuing demand has not materialized, with the complex showing net outflows since their launch.
One of the most noticeable events during the quarter was the shift in the political and regulatory attitudes toward crypto. There were numerous events that gave rise to this change, including the Senate’s vote to repeal SAB 121 from the SEC (which was then vetoed by the President, and a vote to overturn the veto failed), the head of the FDIC stepping down (likely not related to crypto), Trump’s embrace of crypto, the House’s passage of FIT21, and finally, the approval of ETH-based spot ETFs.
It's impossible to ignore the fact that a heated Presidential election is afoot, and it was Donald Trump’s initial embrace of crypto that seems to have triggered the sea-change. Just 18 months ago, the industry was grappling with the regulatory and political blowback from the collapse of FTX and it was nearly impossible to foresee that pandering to crypto owners would’ve been an important election issue.
Large holders of bitcoin balances, the US government, German authorities (BKA), and the trustee for the Mt. Gox bankruptcy, all emerged in Q2 as sellers. While the BKA holdings appear to be down to zero now, the prospect of further selling from these large holders has investors understandably on edge. However, we recently published a piece outlining that—purely from an economic impact standpoint—these fears might be overblown.
While MicroStrategy may have pioneered the idea of bitcoin as a corporate treasury investment strategy, other public companies are now following a similar playbook, including Semler Scientific and Metaplanet in Japan. MicroStrategy continued to execute on its bitcoin acquisition program this quarter, issuing $800M worth of convertible notes and using the proceeds to buy bitcoin. MicroStrategy is now the single largest corporate holder of bitcoin outside of an exchange, with 226,331 bitcoins worth $13.0B. As we outlined in a prior research piece, MicroStrategy’s bitcoin acquisition strategy has made it one of the best-performing stocks since it began the program, a point that probably hasn’t gone unnoticed by public companies. Still, corporate ownership of bitcoin is still fairly low, but perhaps that is changing as awareness increases and obstacles such as onerous accounting rules are set to change.
The summer isn’t typically bitcoin’s best period for returns, and this year’s lull in price action seems to be a repeat of previous years. Historically, monthly median returns are poor in August and September until rebounding in the seasonally strong Q4. We may be seeing some of that already with declining volatility and rangebound price action.
One of the most common questions we get is: when will the supply overhang end? The good news is that BKA is likely done with offloading its position. The Mt. Gox overhang likely clears itself up in short order as some coins have already moved into the hands of creditors. The other portion, for creditors that have made early or intermediate payout elections, could resolve itself relatively quickly. The distribution channels with which creditors can claim their coins have different deadlines according to media reports (Kraken – 90 days, Bitstamp – 60 days, BitGo – 20 days and SBI VC Trade – 14 days), but we would guess creditors would claim coins as soon as they are available. Still, the Mt. Gox coins haven’t moved to these distribution channels and the on-chain activity of doing so is likely to cause a market disturbance. In the case of the US government, there is no identifiable plan to sell off their holdings but even in the past when a plan had been disclosed, the US government hasn’t always adhered to it. Much of the bitcoin the US government holds has been held for many years, and it seems in little rush to offload.
The spot ETFs have been successful beyond most expectations, ours included. However, as the fund flows in Q2 show, the initial frenzy of demand has slowed. One avenue that could create demand is ownership through new channels. Our analysis of ETF holders at the end of Q1 showed that the overwhelming majority of shares were in the hands of retail investors. Investment advisors owned 6.4% of the shares, or $3.8B, but certainly that has room to grow. Brokerages and banks only own 2.1% of shares, or $1.2B. Given the trillions in assets under management of the wealth management arms of the big wirehouses, this is a huge untapped potential.
While we won’t predict the outcome of the presidential election, Donald Trump certainly has staked his claim as a pro-crypto candidate. However, since his shift in posture towards crypto in early May, bitcoin and the rest of crypto certainly haven’t gotten the memo as prices have fallen. Perhaps this is an underappreciated catalyst, or it may just be that crypto is moved by other factors. The election is still a ways off but there already has been a noticeable shift in attitude towards the industry. It was only 18 months ago the industry was reeling from the financial and political repercussions from the FTX debacle. The fact that we have bitcoin and ether (almost) ETFs is remarkable feat in and of itself.
The surprise approval of ETH ETFs was seemingly one of the outcomes stemming from the changed political climate, but while Form 19b-4 rule change requests were granted for the listing exchanges, trading has yet to begin. From our outside vantage point, it appears as though most of the paperwork has been finished, with the exception of updated registration statements outlining items like fees for 5 of the 8 approved funds. Of the funds that have disclosed fees, they are in similar ranges as the bitcoin ETFs, 0.19% - 0.25%. Grayscale is in a similar situation as the launch of bitcoin ETFs where it has the dominant fund, but at high fees. While it is attempting to launch a low-cost alternative, the Grayscale Ethereum Mini Trust, it wasn’t one of the funds initially approved by the SEC. While no explicit trading date has been set yet for ETH ETFs, it could happen any day.
We wrote an entire report on this but it’s worth repeating the message (and updating our analysis): drawdowns of greater than 10% are regular features of bitcoin cycles. The 2013 cycle had a drawdown of over 70% and the 2021 cycle had one over 60%. The current drawdown of 23.6% (on close prices, 27.5% on intraday prices) is therefore well within the bands of normal cycle price action.
The price of bitcoin recovered from the 2022 drawdown faster than it had from previous drawdowns, largely driven by the launch of spot ETFs in January. Even with the price malaise experienced in Q2, the current cycle is still well ahead of the prior two in terms of price appreciation. While every cycle is different, investors should take solace that bitcoin is “ahead of schedule” and perhaps this is simply a time for the market to digest the recent price action.
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