Demand shock: The fundamental reason why BTC prices have risen sharply in the past two months, will they continue to rise?

In the commodity sector, a demand shock is a sudden and significant change in the demand for an essential commodity or raw material triggered by an unforeseen event. A positive demand shock comes from an increase in demand, which could be due to technological innovation, policy changes, or shifts in consumer preferences, leading to higher prices.

China's economic boom in the early 2000s, as real estate development accelerated, sent a demand shock to commodities, causing steel prices to rise 793% between 2000 and 2008. The response, in the form of increased production, caused steel prices to fall 80% over the next decade.

We believe Bitcoin is currently experiencing a positive demand shock. While the SEC’s approval of spot-based EFTs, giving Bitcoin access to over $14 trillion in assets , is well known, its timing is unclear and there is no broad consensus on the magnitude of the resulting inflows.

So far, after the launch of the Bitcoin ETF on January 11, its average daily demand is 4,500 bitcoins (trading days only), while the Bitcoin network only mines an average of 921 new bitcoins per day .

This has led to the massive price increases we have seen in recent weeks, as the newly issued supply of BTC has not been able to keep up with demand, causing ETF issuers to have to source primarily from the secondary market. We can see this in the data, with token holdings at OTC desks having fallen 74% since their 2020 peak, most likely due to demand for ETFs in recent years.

In the first two months, US ETFs saw record inflows of over $10 billion, dwarfing the $288 million inflows in the first two months of the first gold ETF launched by iShares in 2005. In the first two months of 2020, before the halving, ETPs saw inflows of $436 million, or 11% of total assets under management, very similar to today, with recent inflows also accounting for 11%, although in nominal terms today’s inflows are 23 times higher than in 2020.

We’ve also seen a significant reduction in BTC held on exchanges, which has fallen 29% since 2020 as investors increasingly use ETPs and self-custody Bitcoin as they increasingly view Bitcoin as a store of value.

At the current purchase rate of around 4,500 BTC per day, it would take 573 days to reduce exchange Bitcoin balances to zero - so there is still a long way to go .

Demand shocks in commodity markets are often followed by a supply response. Over time, suppliers adjust production levels to respond to the new demand conditions. In the case of a positive demand shock, producers may increase capacity or seek ways to improve efficiency to meet the higher demand. However, this is where Bitcoin differs from commodity markets because Bitcoin has a fixed supply that is programmed to halve the newly issued supply every 210,000 blocks, or approximately every 4 years.

Eventually, the market seeks a new equilibrium at the intersection of supply and demand. This adjustment process can be fast or slow, depending on the magnitude of the shock, and given the inflexibility of Bitcoin's supply, only a rise in price can find a new equilibrium. This is why we have seen such a sharp rise in Bitcoin prices in the past two months , and the need for ETF issuance and the upcoming halving have exacerbated this problem.

The halving is well-known information and should, at least in theory, already be factored into the price. One could argue that the price increase after the halving in 2020 was more a result of the US COVID stimulus than the halving itself. Statistically, there is only a sample size of 3 previous events to reference, so it is dangerous to draw any conclusions. However, it could have an element of becoming a self-fulfilling prophecy, especially if there is a large amount of trading associated with the event, although the current positioning of futures market traders around the event is low.

Regardless, there have been several other price support factors for BTC prices this year, the most important of which is the development that US registered investment advisors (RIAs) are able to include Bitcoin ETFs in client portfolios. However, we believe these inflows will eventually taper off, reducing their impact on prices. If these inflows begin to taper off later this year, we expect Bitcoin prices to recalibrate based on interest rate expectations. With the Federal Reserve expected to cut rates later this year, this could act as additional support for Bitcoin prices.