How to use the rules to buy the bottom/sell the top of Bitcoin during the bull-bear cycle?

As blockchain infrastructure is gradually built and improved this year, more blockchain applications will begin to explode, and the demand and value of Bitcoin will also grow further.

Text: 23 Painting Students Operation: Gai Yao Editor: Hao Fangzhou

Produced by | Odaily Planet Daily (ID: o-daily)

Original title: "Unveiling the economic principles behind the bull-bear transition, teaching you when to buy the bottom/sell the top of Bitcoin"

Will the US election really drive the rise of Bitcoin? Is it a historical law or a coincidence? With the reduction of block rewards for miners, can the "halving bull market" still stand? What economic principles are hidden behind the four-year halving of Bitcoin? How can we use these laws to escape the top and buy the bottom when the market changes from bull to bear? This article will take you to interpret the invisible hand behind Bitcoin from an economic perspective.

Talking about the US presidential election bull market

Ryan Watkins, an analyst at research firm Messari, believes that every US election will drive up the price of Bitcoin. Watkins marked the Bitcoin trend chart after Obama and Trump took office in the figure. Looking at the figure alone, this inference seems to be correct. However, it is difficult to summarize the rules based on the trend after only two elections. Even if it is reasonable and relevant, why does the US election affect Bitcoin? After all, from the perspective of the entire financial market, Bitcoin is still very niche, and the correlation between the US policy direction and Bitcoin is actually very weak (and difficult to prove). However, there is indeed a "coincidence" between the trend of previous US elections and Bitcoin, and it contains interesting correlations.

Is the “Halving Bull Market” still reliable?

Before revealing the answer, let’s take a look at a Bitcoin halving bull market chart that has been circulating in the cryptocurrency circle for a long time. Since the birth of Bitcoin, it has experienced three halvings, namely: the first halving (2012.11.18), the second halving (2016.07.09), and the third halving (2020.05.13). Before and after the first two halvings (when blue turned red), a "halving bull market" occurred.

There are many supporters of the "halving bull market" view, and the representative domestic figure is Jiang Zhuoer of Litecoin Mining Pool. He believes that the long-term net supply of Bitcoin is only the output of miners, and the net demand is the demand for newcomers to buy coins. If the demand does not change suddenly, the supply will be halved instantly, which will inevitably lead to price increases, and then it may form a "news ↔ bull market effect", which will continue to attract newcomers and new funds to enter the market. When a bull market reaches the end, the market sentiment is fanatical, the bubble is serious, and the short-term currency price increase exceeds the speed of newcomers and new funds entering the market, the bubble of the bull market will burst and the bear market will begin. The design of halving the output of Bitcoin every 4 years makes the "bull-bear cycle" and the "halving cycle" resonate.

It can be seen that the important theoretical basis of the "halving bull market" is that if the demand does not change suddenly, the supply will be halved instantly, which will inevitably lead to a rise in prices. So does this theory still hold true after this round of Bitcoin halving?

Let's first look at the supply and demand of Bitcoin after the three halvings. From the supply side, the block reward of Bitcoin has changed from 50 BTC every ten minutes to 6.25 BTC now, which means that the original miner selling pressure (calculated by the number of coins) has become 1/8 of the previous one. The total amount of 21 million Bitcoins has now been mined for about 18.538 million coins; from the demand side, the number of addresses of holders can more accurately reflect the overall changes in the number of Bitcoin holders. The number of addresses of holders was 996,506 at the time of the first halving, and the number of addresses of holders was 30,247,715 at the time of the third halving, an increase of about 30.4 times. From the changes in the number of new Bitcoin addresses, it can also be seen that the number of new users has indeed increased by different magnitudes, and is still in a state of sustained high-speed growth.

From the data, we can see that the supply and demand forces of the Bitcoin network have undergone obvious asymmetric changes. The net supply force caused by halving is getting weaker and weaker, while the growth of the demand side is getting stronger and stronger. Even if we estimate it based on conservative data, the growth rate of the demand side is much faster than the decay rate of the net supply. The rise in Bitcoin prices is also more driven by the growth of the demand side. From the number of addresses holding coins and the number of new addresses, we can see that the obvious growth of the two is not affected by the "halving bull market", but has its own internal logic and rhythm.

In the first two halvings, the Bitcoin network ecosystem was relatively simple, mainly dominated by miners, and the market selling pressure also mainly came from the miners' mining income. When the block reward is halved, the miners' mining income suddenly decreases, which will indeed have a greater impact on the currency price, giving people the feeling of a "halving bull market", which is also the main basis for this theory.

As block rewards decrease, miners' motivation to maintain the network will shift from relying on block rewards to relying more on fee income. (Note from Odaily Planet Daily: In the Bitcoin network, miners' income is mainly divided into two parts, one is block rewards, and the other is fee income from processing transfer transactions.) The change in the main source of income for miners implies that the economic relations in the Bitcoin network are undergoing profound and complex changes. Miners have also gradually changed from the role of "currency" distributors to the role of network service providers. This change will further prove that the "halving of Bitcoin net supply has given rise to a bull market" is gradually becoming less effective.

As a large number of Bitcoins are mined, the theory of "halving bull market" will slowly become a "historical illusion."

While the rationale for the “halving bull run” has weakened, the phenomenon still exists. This is largely due to the economic principles behind the Bitcoin network.

The invisible hand behind Bitcoin

At the beginning, we introduced that there is an interesting relationship between the US election and Bitcoin. In fact, this relationship is the 4-year cycle. Bitcoin is halved every 4 years, and the US election is also every 4 years. This design is not accidental, but in line with the capitalist economic cycle. It is like an invisible pair of hands manipulating the bull and bear markets.

The short economic cycle of capitalism (also known as the Kitchin cycle) is only 3-5 years. American economist Kitchin believes that the development of the capitalist economy will experience regular ups and downs every 40 months. Economist Schumpeter used this short cycle as a method to analyze the capitalist economic cycle, and used the cyclical changes in inventory investment and the small fluctuations in innovation (especially the changes in equipment that can be produced quickly) to explain the Kitchin cycle. He also believed that 3 Kitchin cycles constitute a Juglar cycle, and 18 Kitchin cycles constitute a Kondratieff cycle.

After three production cuts, Bitcoin has not only entered a small cycle again, but is also at the beginning of its second medium cycle.

(Note from Odaily Planet Daily: It should be noted here that we consider Bitcoin as a commodity and believe that it has certain currency-like properties. The reason for this assumption is that its high volatility makes it unsuitable as a currency; in addition, from the current demand side, it is more often traded and stored as a commodity or investment. Although it involves some payments, its currency properties are still not the main growth demand at present. Under this assumption, Bitcoin is more inclined to commodity properties, and miners are production and service providers, that is, suppliers.)

The inherent basis of the Kitchin cycle is that the demand shock of commodities is passive and external, while the supply adjustment is active and internal. Therefore, the different changes in demand and supply (inventory) form four cyclical stages: passive destocking, active inventory replenishment, passive inventory replenishment, and active destocking. In the bull-bear conversion process of Bitcoin, these four cyclical stages are also met.

• When the market demand for Bitcoin increases and prices begin to rise, the increased mining profits stimulate more miners to flock in. The miners' inventories do not have time to respond, resulting in increased sales and passive destocking.

• The demand for Bitcoin has expanded significantly, the price has risen significantly, and the mining revenue has become more lucrative. Miners have begun to have positive expectations and are actively increasing their inventories.

• The demand for Bitcoin in the market began to weaken, prices experienced stagflation and fell, mining profits decreased, miners had no time to shrink production, and the decline in sales led to a passive increase in inventory.

• The demand for Bitcoin in the market has further shrunk, prices have fallen, mining profits have further decreased, miners have negative expectations, and they have taken the initiative to reduce inventory.

How to use the inventory cycle to determine the bull and bear cycle of Bitcoin?

Simply put, when miners are selling at a discount and miners are selling off their mining machines, it actually means that the bear market has bottomed out with a high probability; when mining machine manufacturers are producing mining machines at full capacity, and there is still a great demand for mining machines in the market, and the payback period of mainstream mining machines is greatly shortened, it may actually be very close to reaching the peak.

Specifically, we can observe the peak signal of the bull market of Bitcoin by calculating the static payback days of the mining machine (the price of the mining machine divided by the daily net income), and observe the bottom signal of the bear market by the difficulty of mining. In addition, we can also use the proportion of mining machine electricity costs to judge the transition from bull to bear.

Regarding the peak indicator, Jiang Zhuoer once proposed a mining machine bubble index , which determines the bull market peak signal by calculating the static payback days of mining machines. The inherent logic of this index is that if the speed of industrialized production of mining machines is far behind the speed of currency price increase, then it means that the currency price is rising too fast and it is unsustainable. He introduced this important indicator using S9 as an example. As shown in the figure below:

In the above figure, during the bull market from 2016 to 2017, the static payback period of S9 was stable at 200-250 days, and the daily profit was stable at 5 yuan. However, in December 2017, the payback period of S9 dropped rapidly to around 100 days, and the daily profit soared from 5 yuan to 20 yuan, which showed an obvious peak signal.

The mining difficulty band proposed by Willy Woo is composed of a set of Bitcoin mining difficulty curves of different periods, which is a good visual bottoming indicator. The theory holds that when miners mine Bitcoin, they need to sell some coins to pay for electricity and other costs, but as the price of the coin continues to fall, some miners will choose to shut down when their income is not enough to cover their expenses, leaving only the mining machines with the strongest computing power to continue mining. As miners shut down, the computing power and mining difficulty of the Bitcoin network will decrease, and the difficulty band will shrink. When they converge, a relatively good bottoming buy indicator will appear.

In addition to the above indicators, the peak and bottom of the market can also be judged by observing the proportion of electricity costs of mainstream mining machines . The proportion of electricity costs represents the main electricity expenditure of miners. When the proportion of electricity costs is too high, some mining machines will shut down. When the market is left with the most powerful mining machines, it means that the market has reached the bottom; when the price of coins continues to rise, more mining machines on the market begin to enter the mining mode, and the proportion of electricity costs drops significantly, it means that the market bubble is serious.

Where does the market demand for Bitcoin come from?

Digital migration is the need of our time, and the development of blockchain technology is a natural progression. The Bitcoin network is the first successful application based on blockchain technology. With the development of blockchain technology, the market demand for Bitcoin will continue to expand.

This year, central banks around the world have flooded the market with money during the COVID-19 pandemic, making the already risky traditional financial system even more precarious. As the impact of the pandemic accelerates in the digital age, central banks around the world are stepping up the development of their own digital currencies and trying to form a new digital financial payment system. However, the most successful, secure and time-tested digital currency is still Bitcoin. Financial tycoon JPMorgan Chase pointed out in a recent report that institutional investors such as family offices are beginning to view Bitcoin as a digital substitute for gold. In the future, the market demand for Bitcoin will remain huge.

On the other hand, amid the DeFi boom, the total number of bitcoins anchored on Ethereum is currently about 150,880, which is developing very fast. Bitcoin is constantly being given new value in more and more DeFi. Its essence is a great migration of wealth in which technology drives financial innovation, financial innovation generates market demand, and demand drives up prices. With the gradual construction and improvement of blockchain infrastructure this year, more blockchain applications will begin to explode, and the demand and value of Bitcoin will also grow even more.

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