As Ray Dalio and Rana Faroohar recenly noted, Bitcoin isn’t so much a bubble as “the last functioning fire alarm” warning us of some very big geopolitical changes ahead," and 2021 has seen an increasing number of investors (large and small) begin to recognize that reality).
In fact, as BofA notes in a lengthy treatise on bitcoin's "dirty little secrets", institutional demand has become more active in the past year…
With supply capped by design and supply growth built to halve every so often, the various swings in Bitcoin demand in recent years have been key to price changes. While there is no single way to split Bitcoin demand, we would differentiate between retail, whale/institutional, and illicit activity demand for crypto assets. For example, institutional announcements in the past year have led to major price increases (Exhibit 5), as a number of household names like Tesla, Square, and PayPal have incorporated Bitcoin into their businesses either as a treasury holding or as a means of payment.
Still, reported institutional holdings generally comprise of a small portion of total Bitcoin supply, led by the Grayscale Bitcoin Trust (GBTC) (Exhibit 6).
Which is in contrast to the retail flows that drove the 2017-18 run up
In section 2, we provide a detailed breakdown on whale/institutional demand for some of the largest accounts. We label it whale/institutional as it is unclear whether some these billion dollar plus accounts are held by a single individual or by an institution. But it seems to us that, while a flurry of retail money to Coinbase and other crypto wallets drove prices higher in 2017 (Exhibit 7), the run up in Bitcoin prices in the past year has been more broadly driven by institutional money flows.
In part, this is because institutional scale Bitcoin purchases are hard to accommodate in such a supply constrained market.
For instance, quarterly trading volume and change in ETF holdings relative to new Bitcoin supply show that institutional demand is overwhelming supply (Exhibit 8) at present, a factor that has surely contributed to rising prices.
So who are the major institutional players entering the Bitcoin market?
Microstrategy was probably the first billion+ dollar market cap corporation to announce Bitcoin holdings in August 2020 (Exhibit 9). The company is now holding over $3.5bn in crypto, or about half its market cap, and plans on issuing a $600m convertible senior note to purchase even more.
Another notable transaction in the past year was Tesla’s net purchase of $1.5bn worth of Bitcoin in 4Q20. Separately, some financial companies have moved to add crypto services. For instance, Square has offered Bitcoin trading on their CashApp since 2018, and recently purchased $50mn Bitcoin in October 2020 for their own balance sheet. On the other end, Paypal has not announced any purchases and only launched support for crypto transactions. While Paypal and Square may need to hold some crypto inventory, it’s more probable they will operate like a broker dealer: a lot of the volume will likely be washed out. And last but not least, Mastercard recently announced support for crypto later in 2021, although nothing has been launched yet.
Major institutional announcements and reward-halving have positively impacted Bitcoin prices, on average.
A key point to note is that the steady purchases by some of these institutional buyers are a very sizeable share of the market. For instance, we calculate that the current position of Microstrategy amounts to about 0.40% of total Bitcoin supply. For Tesla, we estimate that the company purchased 44079 BTC, or about a quarter of a percent of total supply. Given the large scale of these purchase and the steady reduction in incremental supply, it is no surprise that Bitcoin prices have surged.
In fact, when we look at the first three Bitcoin reward halvings, we note that each of these events led to price increases on average (Exhibit 10).
Also, our work shows that Bitcoin prices have surged on average after major institutional adoption announcements (Exhibit 11).
Grayscale (GBTC) is now the largest public holder of Bitcoin
So what other public information can provide some clues regarding Bitcoin’s price direction? Just like it is the case with other financial instruments, investor flows into publicly listed vehicles can also be of great use. For this reason, we looked at various financial instruments with direct exposure to crypto. We note that the market capitalization of Grayscale Bitcoin Trust has skyrocketed and the fund has accumulated substantial BTC (Exhibit 16), with total assets now likely at 700k BTC or $31bn or 3.5% of total supply.
In that regard, we also show that the Trust has been steadily buying Bitcoin over 2020, especially in 4Q20 (Exhibit 17) and has become one of the 5 largest holders of the crypto-currency.
Finally, BofA notes that GBTC flows lead Bitcoin returns.
To be precise, flows into Grayscale Bitcoin Trust as measured by changes in shares outstanding appear to have lead weekly Bitcoin returns (Exhibit 18).
A similar pattern appears when analyzing cross-correlations in BTC and Granger causality tests (Exhibit 19).
This is not an uncommon occurrence in the world of commodities, with physical gold and silver ETFs showing similar patterns. Inflows into GLD and SLV also lead prices of these precious metals. Unlike the price impact of money flows into futures markets, where every long position is matched by an exact short position, physically-backed ETFs reduce actual supply to the market. So as financial players mop up “physical” supply of gold, silver, copper, or even Bitcoin in this case, the spot market tightens and prices inevitably go up.
We leave you with Mark Jeftovic's fascinating insight: “Bitcoin is a hole …in a burning building"
I had the thought that Bitcoin is like a hole in the wall of a burning building. The burning building is the petrodollar. The Bitcoin hole in the wall doesn’t meet any standard definition of a door. It wouldn’t pass a building inspection and it may not last long. It will most certainly be replaced by something else in the long run. But in the short term, no one inside that burning building really cares about any of that and the ones that first smelled smoke are already pouring through it. Many more will follow and some, sadly, will die in the fire. There are other exits from the building too, some may be safer than others, but the most important thing is getting out of the burning building as quickly as possible.”
Crypto is the valve to evade the fiat money system.