Bitcoin is a scarce commodity, but such scarcity is only meaningful if there is demand. Bitcoin’s current bull run, which might turn out to be a super-bull rull given conditions around the world, is partially a consequence of what is being called a ‘crisis of liquidity’.
As there is not enough supply to meet the increasing demand, especially as new dollars are printed every day, we’ve seen strong daily moves, sometimes exceeding 10%.
Why Is Bitcoin Becoming So Scarce?
The Bitcoin protocol was designed to only allow for the creation of 21 million Bitcoin. These coins are gradually released to the network in the form of rewards for miners who successfully validate block transactions – this happens roughly every ten minutes.
Since May 2020, as part of Bitcoin’s inbuilt halving mechanism, miners only earn 6.25 Bitcoin per block (this amount will be halved again after approximately 4 years). Simply put, over time the amount of new Bitcoin that is released to the network becomes less and less.
Taking these numbers into account, we find that the number of new Bitcoin created in the second half of 2020 was 165,600 Bitcoin. As we all know, 2020 also saw the entry of institutional investors into crypto. During this period, MicroStrategy bought more than 70,000 BTC, Ruffer Investment 45,000, and the Grayscale Bitcoin Trust alone grabbed a little under 220,000 BTC – that is more than 133% of all Bitcoin released to the network over the same period.
These investors are in it for the long term. They are not buying and selling, but rather placing Bitcoin in custody. In some cases, some selling may occur to readjust risk, but in the case of firms such as MicroStrategy, the company’s entire cash reserves are converted to Bitcoin. Just like gold is held in central banks, Bitcoin is held as a long term store of value.
Running Low On Bitcoin
Data from research firm Glassnode shows that 78% of the current circulating supply of Bitcoin (18.6 million) is illiquid, with only 4.2 million BTC that can be considered either highly liquid or liquid, meaning it is available for buying and selling.
During 2020, more than 1 million BTC have become illiquid, with the decrease in liquidity becoming more pronounced in the last quarter of the year – exactly the time when Bitcoin experienced a massive increase in price.
Another reason why the supply of Bitcoin is shrinking is that, according to research from Bitcoin investment manager Timothy Peterson, 4% of Bitcoin’s available supply is lost every year, meaning that while 900 Bitcoins are now mined daily, an estimated 1,500 Bitcoins are lost every day as a result of a user losing their hardware wallet, their Bitcoin keys, the user dying without passing on the information to retrieve the Bitcoin or the Bitcoin being sent to a defunct address.
Demand is on the rise
Over the past year, since the stock market crash in March 2020, we’ve not only seen institutional demand, but also increased demand from retail traders. If we look at Google Trends, for example, we can see that online search for Bitcoin is rising rapidly and it hasn’t even reached 2017-levels yet. Interest is particularly pronounced in Nigeria, Ghana, South Africa, Austria and Switzerland.
Bitcoin can now be used for payments in popular retail financial apps such as PayPal and Cash App. This has dramatically improved access to Bitcoin and works to drive demand. It is estimated by Pantera Capital that PayPal and Square are buying, respectively, almost 70% and 40% of the new supply in Bitcoin respectively.
Is this really a “crisis” of liquidity?
Trading platform eToro recently emailed its customers saying that “the unprecedented demand for crypto, coupled with limited liquidity, presents challenges to our ability to support BUY orders over the weekend.”
As data from CryptoQuant shows, the amount of BTC held in all exchanges’ wallets has decreased markedly over the past year, with about 20% of all available BTC leaving exchanges.
Very practically, what this means is that as more traders and new capital enters the market, we can expect steep rallies. Contrary to what might commonly be assumed, the price going higher actually makes Bitcoin safer.
Bitcoin is no longer a way to get rich quick, but rather more akin to real estate or gold – it’s a way to store away money for the long term.
There is no “crisis” in liquidity. Instead, Bitcoin is acting exactly as anticipated.