Cryptocurrency prices have recovered somewhat from last week’s lows. Last Wednesday, 19 May, the bitcoin price reached as low as $29,925 and the Ethereum price as low as $1,948. Today, Wednesday 26 May, the bitcoin price is above $38.5k and the Ethereum price is above $2,700. However, despite these gains, prices are still well below recent all time highs.
The possible causes of the price fall have been covered extensively throughout the industry. As I wrote last week, they range from Elon Musk’s tweets to environmental concerns to an overheating market. My view that the stakes are now too high for investors not to address concerns received some validation, with Coinbase appointing their first Chief Policy Officer, and Michael Saylor and Elon Musk forming the Bitcoin Mining Council to provide data on the energy usage of bitcoin mining.
Two more causes have emerged since last Wednesday that deserve mention: large liquidations of leveraged positions as prices fell leading to a cascade of further price reductions, and the announcement of tighter regulation on cryptocurrency mining and trading in China.
News on Chinese regulation always raises the question on the importance of bitcoin miners. I believe that miners are important to securing the network, which ultimately maintains the value of bitcoin. However, I believe they have a limited effect on the market in the short-term.
As the first chart in the report shows, 75% of bitcoin inflows to exchanges in May 2021 so far were from other exchanges, which represents market makers and arbitrageurs. Miners on the other hand were responsible for just 1% of exchange inflows. So miners do not provide that much liquidity to the market. Furthermore, while miners did sell more bitcoin at the end of last week, switching to selling on fiat exchanges rather than purely crypto exchanges, other people sold more bitcoin as well, so the relative importance of miners remained low.
At Chainalysis we cover a very large number of exchanges and we trace through any number of hops between mining pools and exchanges. This gives a complete picture of miners’ on-chain activity, which appears to have been missing in other reviews of last week.
But my main focus in this week’s Market Intel Report is to quantify how bad last week’s price fall was, and if it could have been worse.
The amount of bitcoin sent at a USD loss indicates how bad it was. I calculate the USD loss of bitcoin sent by comparing the average price at which an entity acquires bitcoin with the price when the entity sends bitcoin. If the price is lower when the bitcoin is sent than the average cost of acquisition, then that bitcoin is sent at a loss. Bitcoin is often sent to be sold, so when large amounts of bitcoin are sent at a loss it indicates that people are heading for the exit and losses are being realised.
The data shows that last week was bad. 1.2 million bitcoin was sent at a 5 to 25% loss and 120 thousand bitcoin was sent at a 25% loss or worse, as shown in the second chart of the report. However, this was a smaller number of bitcoin sent at loss than in the late 2017 and mid-March 2020 price crashes, suggesting that last week was not the worst capitulation of holders in bitcoin’s history.
Ethereum on the other hand did experience the most Ethereum ever sent at a loss, as the third chart in the report shows. 22.6 million Ethereum was sent at a 5 to 25% loss last week. There is some comfort that it was not the week with the largest number of Ethereum sent at a 25% or worse loss. While people took losses on Ethereum, they were not extremely large in percentage terms.
However, these percentage losses are occurring on bigger absolute numbers given recent high prices. When we look at the absolute realised USD losses, last week was awful. For bitcoin, at least $3.2 billion was lost last week. This is just for bitcoin that was held for at least 4 weeks prior to being sent, a restriction that increases the certainty that these are real losses. Almost all of this $3.2 billion loss was incurred by bitcoin held for between 4 and 13 weeks, suggesting that recent investors were major sellers. When measured in terms of absolute USD losses, last week was the worst week ever for bitcoin investors, as the fourth chart in the report shows. The numbers for Ethereum are smaller but the pattern is similar.
So it was a bad week, but could it have been worse? To answer this, I look at the average cost of bitcoin and Ethereum held by investors who entered in the last 12 months because this typically provides a floor to the price. As the fifth and sixth charts in the report show, for bitcoin and Ethereum respectively, empirically price has often returned to this cost – except for in the crypto winter of 2018. It also makes sense that the price that recent investors are willing to buy and hold at provides a floor to the price, as if price were to fall below this level then the asset should be of fair value to them.
I suspect the relationship broke down in the crypto winter of 2018 because that represented a more fundamental and widespread loss of belief in cryptocurrencies as an asset class. So as long as crypto does not enter another winter, which I believe is now unlikely given the scale of investment now at stake, then the average cost of assets held by investors who entered in the last 12 months is likely to continue to provide a floor.
The charts suggest that for bitcoin, last week was about as bad as it could get. The price dipped below the current $37.8k average cost of bitcoin held by investors who entered in the last 12 months. If the price had remained below that level for a while it would suggest that recent investors were doubting their buy-and-hold valuations. However, the bitcoin price recovered to this price floor level and has closed at that level for most of the week.
However, for Ethereum, the price fall remained significantly above the $1.7k average cost of Ethereum held by investors who entered in the last 12 months. While the Ethereum price fall was precipitous, it was from a recent and short-lived all time high, which appears to be well above most people’s lower bound valuation for Ethereum.
So last week was challenging for everyone in crypto and some investors incurred large losses. But the industry appears to be responding and most investors remain confident. For example, investor whales bought the dip, buying 77k bitcoin last week. We will learn much over the next couple of weeks as those who now have unrealised losses, but did not panic and crystallise them last week, decide what to do. Let me know what you would like me to keep monitoring via marketintel@chainalysis.com.
Philip Gradwell, Chief Economist
