Messari: Bitcoin Q3 Data Interpretation

Important points:

• In the third quarter, Bitcoin largely lost its narrative of hedging inflation and storing value after falling 72% from its all-time high;

• As demand for block space declined, Bitcoin transaction volume and transaction fees fell by 3% and 23% respectively, and the average daily settlement value fell by 44% month-on-month;

• Miners are in a precarious situation due to the sharp rise in energy prices, record highs in computing power, falling Bitcoin prices, and lower transaction fees;

• The White House Office of Science and Technology Policy (OSTP) has expressed concerns that PoW could hamper U.S. efforts to combat climate change and that energy-intensive mining could have a negative impact on grid stability and prices;

• In addition to concerns about PoW, the OSTP report also highlights how Bitcoin mining can help reduce greenhouse gas emissions and help accelerate the transition to a renewable energy grid.

Key Metrics

Bitcoin Market Performance

Third Quarter Highlights

The recent market crash was both a narrative collapse and a test of real attributes for Bitcoin.

Inflation hedge : Due to its fixed supply and "monetary policy", Bitcoin should be used as a hedge against inflation. However, the reality is that even though the US CPI has reached a multi-decade high, Bitcoin has hit a low point in this cycle.

Store of Value : Since hitting an all-time high of $69,000 in November 2021, Bitcoin has fallen 72% in a risk-off macro environment. Bitcoin's price action is not a store of value, but rather a similar trend to that of U.S. tech stocks. As the Federal Reserve shifts to a more conservative, less liquid, and higher interest rate policy, Bitcoin prices have been hit hard at the same time.

Outperforming in the bear market : In the throes of this bear market, Bitcoin lost its dominance as Ethereum’s price outperformed during its transition to PoS.

Institutional investment assets with lower volatility : Many institutions have "surrendered" in this round of bull market, including Tesla, which sold most of its Bitcoin holdings in the second quarter, and the collapse of large lending platforms and funds further increased volatility. Therefore, although Bitcoin does attract some institutions, the risk is still high.

A retracement of more than 70% is nothing new for Bitcoin and its holders, many of whom still believe that Bitcoin will rise from the ashes. While the growth in users and transactions may not continue, network activity has not fallen as much as the price. With prices at multi-year lows, passers-by have left, but the network continues to move forward. Bear markets are a time for builders to create and accumulate believers.

Market Indicators

Since the liquidity-driven bull run ended at the end of 2021, Bitcoin returns have become increasingly correlated with U.S. technology stocks. During the quarter, the average correlation between Bitcoin and the Nasdaq 100 Index was 0.6. Surprisingly, the correlation between Bitcoin, once known as "digital gold," and physical gold is much lower. The average correlation between the two assets this quarter was 0.2.

Bitcoin prices gradually recovered in the third quarter, with volatility trending downward. The 30-day average volatility was 60% in August, compared to over 80% in June. Lower Bitcoin volatility has led to fewer liquidations in the broader crypto market. Total long liquidations in August were $5 billion, less than half of June ($10.8 billion). Total short liquidations were also significantly lower, at $3.5 billion in August compared to $6.6 billion in June.

Network Status Overview

The daily transaction volume of the Bitcoin network has remained roughly the same throughout the year, averaging about 250,000 transactions per day. Average transaction fees have been very low since the 2021 bull run. Until now, the average fee per transaction has been only $1.4, down 21% this quarter and 55% for the year.

The last time fees spiked was in early 2021, when the price of Bitcoin hit a new high. Typically during bull markets, users are willing to pay higher fees to ensure their transactions are included early.

The growth of the number of Bitcoin holding addresses has slowed down. In the third quarter, the number of holding addresses increased by only 1.1%, compared with 2.5% in the second quarter of 2022. On a monthly time frame, the number of holding addresses fell for the first time in August 2022 after 10 months of continuous growth.

The average daily active addresses is 890,000, a 4% decrease compared to Q2 2022. After peaking along with prices in Q4 2021, active addresses appear to have returned to normal levels. In addition, some network activity has also shifted to second-layer solutions such as the Lightning Network, which also explains the decline in fees.

Lightning Network

The Lightning Network is a second-layer payment channel network based on Bitcoin. It aims to increase the throughput of the network while reducing transaction settlement time. The Lightning Network's scaling method was first introduced in 2015 and has become increasingly popular over time, and is now considered a commonly used scaling solution for Bitcoin.

The Lightning Network has been on an “independent bull run” over the past year, unaffected by the overall market downturn. As token prices fall, network usage and activity tend to follow. However, while the price of Bitcoin has fallen 57% over the past year, the Lightning Network’s key metrics have been steadily growing.

Furthermore, Lightning Network adoption is increasing as the network’s technical foundation matures. In addition, many companies have built the Bitcoin and Lightning Network tools and services needed to achieve mainstream adoption. For example, Voltage provides hosting services for Bitcoin and Lightning nodes built on the cloud.

The capacity of Bitcoin held in public channels on the Lightning Network reached a new high of around 4,828 BTC at the time of writing, worth approximately $92.3 million. Increased adoption and increased integrations have led to a dramatic 96% increase in capacity over the past year. Some of the companies adopting the Lightning Network in 2022 are Cash App, Kraken, BitPay, and Robinhood.

The number of lightning channels and nodes has also grown steadily, up 24% and 14% year-over-year respectively. This growth suggests that the Lightning Network is moving from a network of technology enthusiasts to a mature financial payment network.

mining

2021 has been an extraordinary year for Bitcoin miners. As Bitcoin's price rose faster than the growth of computing power, almost all mining operations became profitable. During the 2021 bull run, many mining companies took advantage of the rising Bitcoin price to raise funds through the issuance of equity and debt to expand their operations. Mining stocks rose along with Bitcoin. However, the broader macro environment caused this excitement to come to an abrupt end in 2022.

The biggest expense for Bitcoin miners is energy costs. Just this year, energy prices across the United States have increased by 15% year-over-year. As global energy prices rise, many miners find themselves under pressure, especially those who do not have power purchase agreements (PPAs).

There are approximately $5 billion in outstanding ASIC purchase orders that will be delivered to miners by 2022. As the price of Bitcoin is trending downward, miners are choosing to sell their mining machines as soon as they arrive to reap the benefits. This drives the network's hashrate and difficulty up. As hashrate and energy prices rise and Bitcoin prices fall, miners find themselves in an increasingly difficult situation. Many miners continue to finance their operations and repay debts by selling Bitcoin. Miners selling Bitcoin instead of HODLing increases downward price pressure.

Miner income

Miners have two sources of income: block rewards and transaction fees. Their income depends on the price of Bitcoin and the demand for Bitcoin block space. Miner revenue peaked at $4.8 billion in Q4 2021 but has since fallen along with Bitcoin prices. Quarterly miner revenue fell by 28% in Q1 2022 and 22% in Q2 2022, respectively. If Bitcoin's price remains range-bound at the end of Q3, quarterly miner revenue could continue to trend downward given high energy prices.

Bitcoin's block rewards make up the majority of miners' revenue. This quarter, miners received 1.7% of their total revenue from fees. Although fee levels rose 0.1% from the previous quarter, they are far lower than the fees miners earned during the 2021 bull run. Currently, low fees are not a big problem as miners rely more on block rewards. However, if these low fees persist as the block subsidy approaches zero, Bitcoin's long-term security could be threatened.

Hashrate

In May 2021, China’s ban on Bitcoin mining caused the hashrate of the entire network to drop rapidly by 50%. Two months later, the hashrate began to increase after the mining machines exported from China were restarted. By December, the total hashrate had fully recovered to the level before May.

In June 2022, the hashrate began to decline as energy prices continued to rise. The hashrate is now near all-time highs as ASICs continue to be delivered to miners who ordered them in 2021. As the hashrate increases during Bitcoin price declines, miners may be forced to abandon their HODL strategy and sell their holdings.

Although China’s mining ban initially had a negative impact on Bitcoin’s hashrate and price, it ultimately benefited the network. Prior to the ban, Chinese miners held a dominant portion of the hashrate in various countries. After the ban, Chinese mining operations moved to countries with less regulatory uncertainty, such as the United States, Kazakhstan, and Canada. As a result, the Bitcoin network has become more decentralized and resilient, avoiding the geopolitical risks of one country holding the majority of the hashrate.

The total computing power of the United States increased from 16% in May 2021 to 38% in January 2022. American mining pools have also benefited from China's mining ban, and Foundry USA has become the largest mining pool. As of August 31, 2022, the Foundry USA mining pool has 24% of the computing power of the entire network, a year-on-year increase of 180%.

Energy consumption

Due to its decentralized nature, it is almost impossible to determine the exact electricity usage of the Bitcoin network. The Cambridge Centre for Alternative Finance (CCAF) uses a real-time model to estimate the daily electricity load of the Bitcoin network under a range of assumptions.

Compared to the second quarter of 2022, energy consumption is estimated to have increased by only 2%, while hashrate has increased by 6% and reached a new all-time high. The reason for this may be due to the fact that new ASIC miners are more energy-efficient and have higher hashrate.

Sentiment Analysis

HODL Wave categorizes Bitcoin's unspent transaction outputs (UTXO) by the time they were last on-chain. As of August 31, short-term holders (under 6 months) are at multi-year lows, holding only 23% of the Bitcoin supply. In the past 7 years, Bitcoin's short-term holders have bottomed out six times, always generating positive returns the following year.

Historically, the number of short-term holders has been a go-to indicator of a Bitcoin price peak. As Bitcoin starts to hit new highs, it starts to appear frequently in the news and attracts more buyers. However, the last peak in November 2021 did not attract new investors in the same way, possibly due to macro environmental factors.

The market value to realized value ratio (MVRV) compares the current market value to the sum of the prices when all bitcoins were last transferred, showing the cumulative degree of profitability for holders.

At the end of August, MVRV fell below the key level of 1, which means that holders are generally losing money. The disposition effect in behavioral finance suggests that investors who hold a losing investment will choose to continue holding it until it becomes profitable. Therefore, an MVRV below 1 is an accumulation zone for long-term investors.

Google search trends help reflect the idea that there weren’t many new entrants in the last cycle. Typically, the number of Google searches declines as BTC prices fall. However, Bitcoin searches have been lower since 2017. In addition to this, the second bull run in 2021 had only half the search interest of the first bull run. The decoupling between Google search trends and BTC prices could indicate that fewer new people are entering the space.

Summarize

In Q3 2022, some Bitcoin narratives failed to hold up. Bitcoin has been neither a hedge against inflation nor a store of value over the past year. In addition, on-chain metrics show a slowdown in transactions, new users, and active users. However, development activity and usage of Bitcoin ecosystems such as the Lightning Network and Stacks have increased significantly.

On the mining side, the industry is under a dark cloud as energy prices and inflation continue to rise in a low liquidity macro environment. In addition, as hashrate hits record highs and Bitcoin prices struggle to stay above $20,000, miner revenues are approaching unprofitable levels. If Bitcoin prices remain range-bound or fall further, some miners and companies will be forced to sell extra Bitcoin to pay off debts and operating expenses.

That being said, Bitcoin has survived far worse situations in its history. Eventually, a new narrative may emerge to replace the old one. Developers are building Bitcoin that brings new capabilities to the protocol and smart contracts. Bitcoin mining can also be a way to combat climate change by reducing emissions and strengthening grid stability. Given Bitcoin’s unpredictability, the next cycle may be driven by the narrative of Bitcoin as an ESG asset.