Welcome everyone to The Node Ahead, our new and improved crypto market newsletter. For those of you who may not know me, my name is Brett Munster and I recently joined Blockforce Capital and Onramp Invest as Director of Research. I have been involved in the crypto industry since 2013, having invested through the previous two market cycles and managed a small crypto hedge fund. I also write a bi-weekly newsletter aimed at helping those interested in crypto stay up to date and increase their knowledge on this ever-evolving industry. In addition to providing commentary on some of the biggest headlines, I’m also a student of on-chain analytics so expect to see some market analysis from time to time though nothing in this newsletter should be taken as investment advice (you satisfied legal department?). I look forward to breaking down the latest developments in the crypto industry with you every couple of weeks.
With that, let's jump into it.
Welcome to Shocktober
Back in June I wrote that although the price had fallen by 50%, the on-chain fundamentals of bitcoin were actually getting stronger. It turns out the vast majority of those who sold beginning in May were short term market participants who panicked due to negative headlines (thanks Elon…). As prices began to fall, supply held by long-term holders (defined as BTC which have not moved in at least 155 days) started aggressively accumulating the coins that short-term holders were selling. This trend continued over several months and as a result, the total amount of outstanding supply held by those who historically do not sell is now at an all-time high.
These long-term holders have a propensity to sit on their coins and not sell (hence the name). We can validate this assumption by looking at the flow coming in and out of exchanges. When coins move onto exchanges, it’s a strong signal the market is looking to sell in aggregate. When coins come off the exchange and get moved into cold storage, it's a strong signal the market is more long term oriented and is unlikely to sell soon. It turns out that the level of coins on exchanges is at its lowest point since 2018 likely due to the fact that long term holders have scooped up a large volume of coins and put them away for safekeeping.
The result is that we currently have an all-time high of illiquid coins as a percent of the total supply. In other words, the largest supply shock in bitcoin’s history. The Long-Term Holder Supply Shock Ratio chart below that Will Clemente of Blockware put out last week shows what has happened to bitcoin’s price each time we have seen similar levels in the past (hint, price hasn’t gone down). The ratio has recently reached all-time highs, which is an extremely bullish signal for bitcoin’s future price.
Source: Blockware Newsletter
There simply isn't enough available supply to meet demand hence bitcoin’s recent upward movement. Until coins start coming back onto exchanges, this is just the start of the upward price action we are likely to see in the coming months.
ETH vs BTC: Same but different
From DeFi to NFTs to emerging smart contract platforms to layer 2 scaling solutions, crypto has no shortage of interesting and exciting projects. However, even with the growth of all these subcategories, the two blue chip tokens (BTC and ETH) still account for over 60% of the $2T crypto market. More importantly, bitcoin and Ethereum typically are the first exposure to crypto for most investors. Because of that, it’s helpful to understand the similarities and differences between the two.
Let’s start with the differences. You will notice I use the word cryptoassets, rather than cryptocurrencies, whenever I speak or write about the industry. This is very intentional because most of the tokens in the market today are not intended to be currencies at all. Bitcoin, however, is a cryptocurrency. Its primary functions are as a store of value, medium of exchange and as a settlement network. Because bitcoin is fully decentralized, it cannot be controlled or altered by any one party making it the only non-sovereign, censorship resistant form of money.
In contrast, ETH is not designed to be money. Rather, Ethereum is a computing platform on which developers can build decentralized applications. If bitcoin is digital gold, Ethereum is a decentralized version of Amazon Web Services (AWS).
Ethereum on its own isn’t that interesting. Solutions built on the network are. Because applications that run on top of Ethereum pay a “gas” fee in ETH every time they use the smart contract functionality, Ethereum grows in value the more apps are built on it and the more those apps get used. There are other promising smart contract platforms in development, but Ethereum has by far the largest ecosystem of developers, applications, and users. In fact, Ethereum has settled $6.2 trillion in transactions in the last twelve months including $1.5 trillion in Q3 alone, far more than any other smart contract platform.
There is another key distinction between bitcoin and Ethereum and that's the supply issuance of the coins. Bitcoin has a capped supply of 21 million. More importantly, bitcoin’s supply issuance is constant, predictable, and inelastic. We know exactly when every bitcoin has ever been mined and we can accurately forecast all future issuance. Today, roughly 18.8M bitcoin have been mined and the last bitcoin will be released in the year 2140.
In contrast, Ethereum’s supply issuance is dynamic. Ethereum's monetary policy is much less predictable in that it issues just enough coins to adequately compensate miners. Further complicating matters is the recent addition of EIP 1559 which now means Ethereum burns (aka destroys) a portion of ETH fees with every transaction. Thus, Ethereum’s supply issuance changes daily and sometimes is even net negative meaning more ETH is burned than created. It is also important to note that Ethereum does not have a fixed supply cap like bitcoin does.
Ethereum and bitcoin solve very different problems and you are not investing in the same thing when you buy BTC and ETH. However, that doesn't mean they do not have similar characteristics.
The value of most cryptoassets lies in the network effects they create. Because most of the code in the industry is open source, anyone can copy the code and create a similar project (aka fork). We have seen this happen with bitcoin and bitcoin cash, Ethereum and Ethereum Classic, Uniswap and Sushiswap and countless other examples. Yet those “forked” projects rarely sustain the same value as the original project even though the technology may be very similar. The reason is there are network effects inherent in the best cryptoassets.
For money, the more people that use that form of currency, the more likely others will accept it as currency as well. This in turn makes it more valuable for those who already are using it. Hence bitcoin’s defensibility isn’t in its technology, it’s in its monetary policy. For smart contract platforms, more developers building on a protocol leads to more applications which leads to more users which in turn attracts more developers. Hence Ethereum’s defensibility is in its community of users and developers. In other words, the value of both BTC and ETH is driven by adoption and creation of network effects.
Because the underlying mechanics of growth is similar between BTC and ETH, we should not be surprised if the value appreciation of the two assets mirror each other. And in fact, that is exactly what has happened.
But wait, as I write this newsletter, BTC is worth $57,000 and ETH is worth $3,600. How can I claim that the price appreciation has been the same? Well, Ethereum didn't launch until a few years after bitcoin. During that time, bitcoin had time to acquire users, developers and go through a full boom and bust market cycle. Ethereum is simply younger than bitcoin. However, if we zero out the date, the two assets look shockingly similar. The chart below compares bitcoin’s price growth starting in 2013 and Ethereum’s price growth starting in 2017.
We can also compare the two assets based on the crypto market’s historical four-year cycles. As a reminder, roughly every four years bitcoin goes through a halving event in which the daily supply issuance gets cut in half. This supply shock puts natural upward pressure on price which eventually leads to market exuberance. The price rises sharply and eventually reaches a top and falls back down to a new floor price higher than the previous cycle. Because bitcoin is the largest asset and most cryptoassets are highly correlated, most cryptoassets including ETH, have historically followed this four-year cycle (as defined as starting by the day of bitcoin’s halving). The difference between ETH and BTC however is that ETH is currently going through its second full cycle while bitcoin is going through its third. Not surprisingly, ETH’s first market cycle mirrored BTC’s first market cycle closely and thus far, looks to be following a similar trajectory this cycle as well.
Does that mean Ethereum is destined to hit $19k this cycle? Honestly, I don't know. But if history is any indication, Ethereum has a lot of room to appreciate through the rest of this market cycle. This is one common reason many believe Ethereum is likely to outperform bitcoin over the coming months.
Another Domino Falls
In the past, I’ve publicly stated that I believe in time, every government will own bitcoin. That piece was written well before El Salvador made bitcoin legal tender, Panama recognized bitcoin as a legal payment method, Ukraine legalized bitcoin, and Cuba passed a law recognizing cryptocurrenicies.
Now another country is about to adopt bitcoin. According to federal deputy Aureo Ribeiro, bitcoin might become a recognized currency in Brazil soon. Like El Salvadorians, Brazilians will be able to purchase houses, cars, and even fast food at McDonald’s with cryptocurrency should this new law pass.
Many within the Bitcoin community have long theorized that because there are only 21 million Bitcoin available, it would then become a matter of national self-interest for governments around the world to accumulate as much of that pie as possible once other countries start accumulating Bitcoin. Basic game theory at work. Thus, once we have a first mover, many have speculated it would lead to this century’s version of the arms race.
El Salvador was that first mover and four months after first making that announcement, there are no less than four other countries following suit, with many more rumored to be enacting similar laws soon. If you thought Wall Street and hedge funds were bringing large sums of money into this asset class, wait until nation states start aggressively buying bitcoin.
I’ve written in the past (here and here) about why the Bitcoin blockchain is the best settlement layer to ever exist. However, the same reason the Bitcoin blockchain is so secure is precisely the same reason the throughput cannot, and likely will never be able to handle a high volume of transactions. Today, Bitcoin averages around 2,700 transactions per block and each block is mined on average every 10 minutes. While this throughput is more than enough for an international settlement system, it is nowhere near the capacity needed for a retail payment network capable of handling a high volume of smaller transactions. By comparison, Visa and Mastercard can process 1,700 transactions per second.
However, this is where the Lightning Network comes into play. The Lightning Network is a network of payment channels built on top of Bitcoin’s base layer blockchain that can theoretically handle millions of transactions per second and settle them all on the Bitcoin blockchain as one transaction. This is why it is often referred to as a “Layer 2” solution built on top of Bitcoin’s base layer. Even better, the Lightning Network can execute these transactions in a matter of seconds and costs a fraction of a penny to execute. Thus, Lightning Network enables instant, nearly-free bitcoin denominated payments to anyone in the world.
To illustrate how the Lightning Network works, imagine you want to buy a hot dog at a sporting event, but you are sitting in the middle of the row. You hand the money to the person sitting next to you who hands it to the person sitting next to them and so on until it reaches the hot dog vendor. The lightning network functions in a similar manner, transmitting bitcoin from one node to another, finding the optimal route all the while simultaneously keeping the bitcoins encrypted until they reach their final destination or “target node.”
I bring this up because adoption and use of the Lightning Network has hit an inflection point. The current capacity of the network has exploded in recent months, including doubling in September, and now stands over 3,000 bitcoin (over $150 million at current prices), meaning its users can send and receive this much worth of value via the network.
And this increase in value isn’t driven by a price increase in bitcoin, its primarily driven by a rapid increase in the number of nodes and open channels on the network. The number of users with access to Lightning payments increased by 11,164% to 9.7 million users in September, compared to 87,000 in August. The number of users is growing exponentially. This is important because the more open channels and greater liquidity there are on the platform the more effective the network is at facilitating transactions. This in turn is likely to attract new users which makes the Lightning Network all that more valuable for those already using it. In other words, network effects are beginning to kick in.
So, what is driving this adoption? A few major developments have coincided in recent months:
- Strike App – Strike is a mobile app that links to a user’s bank account and allows them to send money anywhere in the world to another Strike user over the Lightning Network. Strike announced it would now allow free conversion between fiat and bitcoin thus dropping the cost to send money internationally to practically zero. More importantly, Strike built an API integration so that any business can leverage Strike’s back-end capabilities thereby significantly reducing the technical complexity for any business to use the Lightning Network.
- Chivo Wallet – the official bitcoin and Lightning wallet from the government of El Salvador launched one month ago. Today, it has more than 3 million active users, or 46% of El Salvador's population making it the most popular app in the entire country. Furthermore, citizens are now buying goods and services from local merchants to McDonalds, Starbucks, and Pizza Hut using bitcoin and the Lightning Network. As Lightning passes the test of usage and adoption in El Salvador, other countries will likely emulate that approach.
- Twitter – the social media giant released a bitcoin tipping feature that allows anyone to send any size tip to anyone one else on Twitter using the Lightning Network. Overnight Twitter became the easiest, cheapest, most intuitive international money transfer system in existence. You no longer need to know any info about someone to send them money other than their Twitter handle.
- Paxful – a leading peer-to-peer finance platform for trading cryptocurrency enabled Lightning deposits and withdrawals for their 7M+ users, most of which are located in emerging markets. This integration provides an on-ramp into Lightning for dozens of new fiat currencies and more than 350 payment methods.
The Lightning Network has successfully onboarded a Latin American country and one of the largest social media companies on the planet. Network effects are starting to build, and the flywheel is starting to spin. Much like Facebook connected everyone for communication, the Lightning Network is poised to connect everyone for money which would make it the largest interconnected payment system ever created. Should that happen, that's an incredibly bullish sign for bitcoin.
In Other News
Fidelity published a recent paper on the advantages of adding bitcoin to a portfolio.
JP Morgan says money is flowing out of gold and into bitcoin.
El Salvador is officially mining bitcoin using 100% clean and renewable geothermal energy from volcanos.
Affirm announced that it plans to launch a debit card that will add cryptocurrency buying and selling functions, allowing users with Affirm’s savings accounts to buy and sell cryptocurrencies freely.
Senator Lummis lays out principles for a US digital currency, alongside continued role of private stablecoins.
Missouri Mayor Jayson Stewart plans to give every household in his town $1,000 in bitcoin. The project is fully funded and the mayor is also looking to add BTC to the town’s balance sheet.
Patrick McHenry, the ranking member of the House Financial Services Committee introduced a bill to establish a safe harbor for digital tokens.
The Biden administration is contemplating how it wants to regulate stablecoin issuers, and people familiar with the matter say it's considering encouraging firms to register as banks.
The SEC has delayed once more the approval of a Bitcoin ETF as Gary Gensler appears to be more amenable to a possible bitcoin futures ETF rather than a spot price ETF.
SEC subpoenas USDC stablecoin backer Circle.
Visa has developed a conceptual protocol that shows how various CBDCs can be interoperable for payments.
Payment-solution giant Verifone announced earlier this week that it will enable consumer Bitcoin payments on in-store and eCommerce Cloud Services in the United States. Verifone has over 600,000 merchants worldwide and handles over 10.4 billion online and in-store transactions annually.
How Texas is working to become a world leader in bitcoin and blockchain.
New York and Texas are attracting bitcoin miners.
Bank of America launches research for ‘Too Large to Ignore’ digital assets and starts coverage three months after creating a crypto research group.
US Bank, the 5th largest retail bank in the nation, launches bitcoin custody service.
Billionaire investor George Soros' family office, Soros Fund Management, has invested in bitcoin, according to Soros Fund CEO/CIO Dawn Fitzpatrick.
NFT sales surged to $10.7 billion in Q3.
Disclaimer: This is not investment advice. The content is for informational purposes only, you should not construe any such information or other material as legal, tax, investment, financial, or other advice. Nothing contained constitutes a solicitation, recommendation, endorsement, or offer to buy or sell any securities or other financial instruments in this or in any other jurisdiction in which such solicitation or offer would be unlawful under the securities laws of such jurisdiction. All Content is information of a general nature and does not address the circumstances of any particular individual or entity. Opinions expressed in this newsletter are solely my own and do not express the views or opinions of Blockforce Capital or Onramp Invest.