The Takeaway

For investors with a multi-year investment horizon and a high-risk tolerance, the confluence of discounted prices, improving network fundamentals, strong relative investment activity and the upcoming halving may offer an attractive entry point into Bitcoin. This is especially relevant for investors building core strategic positions in Bitcoin over time.

A Brief Introduction to the Bitcoin Halving

 

The countdown is on.1 As recently discussed in our February webinar on the state of digital currencies, Bitcoin’s “block-reward halving” is just a little more than a year away, expected to take place on May 24, 2020. At that time, the block reward for miners on the Bitcoin network will decrease from 12.5 to 6.25 bitcoins, the third such “halving” event in the network’s history. As of March 15, 2019, 17.6 million bitcoins have been created, representing approximately 84% of the total supply.

The significance of the Bitcoin halving is multifaceted and rooted in economic theory. As a refresher, miners contribute computational capacity to the Bitcoin network to validate transactions and record them on the blockchain – a decentralized global transaction ledger. For every block of transactions that a miner adds, they receive newly issued (or “mined”) bitcoins. The reward for a miner gets reduced by 50% every 210,000 blocks, which occurs roughly every four years.

FIGURE 1: BITCOIN’S CONTROLLED SUPPLY2

The amount of bitcoins added to the network in each block of transactions is cut in half every 210,000 blocks (roughly every four years)
bitcoin block rewards

The block reward halving is an explicit and calculated design element of Bitcoin, programmed into the protocol since inception. As a core characteristic of Bitcoin’s economic model, the halving:

  1. Ensures the transparent and fair distribution of bitcoins through open competition over time.

  2. Incentivizes miners to validate transactions, bolstering the computational capacity that secures Bitcoin’s distributed financial network.

  3. Preserves the economic principle of scarcity for the network’s exclusively native currency (i.e., bitcoin), which together with a peer-to-peer financial network reinforces investability

Is the Halving Priced In?

 

The halving is close enough that it’s time to start talking about it more seriously, but far enough out in the future that it’s unclear whether it’s priced into the market efficiently. In fact, based on anecdotal conversations with market participants, we were surprised to learn that many of them were not even aware of this event. Moreover, according to Unchained Capital, less than 32% of the bitcoins in circulation have remained in the same wallet addresses since July 2016.3 This is consistent with our own determination that a large number of existing bitcoin holders are investors who have entered the market in the last three years. For many of them, this is uncharted territory and could very well be their first halving event.

While some investors in the digital asset ecosystem appear to have a short-term bias, strategies with a multi-year investment horizon and the discipline to hold strategic positions in Bitcoin through these events have historically generated outsized returns. For example, in the one-year periods following the first and second halvings, bitcoin’s price rose by roughly 81x and 3x, respectively.

FIGURE 2: HISTORICAL BITCOIN HALVING PERFORMANCE (USD)4

bitcoin halving price chart

Following the upcoming halving, the number of new bitcoins entering circulation5 each day will change as follows:

  • Daily Minted Bitcoins (As of March 15, 2019): 144 blocks per day * 12.5 bitcoins per block = 1,800 bitcoins per day
  • Daily Minted Bitcoins (After 3rd Halving): 144 blocks per day * 6.25 bitcoins per block = 900 bitcoins per day

Based on the March 15, 2019 bitcoin closing price6 of $3,876, this means that the reduction in daily dollar-denominated bitcoin issuance would be:

  • Daily Minted Bitcoins in USD (As of March 15, 2019): $7M per day
  • Daily Minted Bitcoins in USD (After 3rd Halving): $3.5M per day

For a scarce asset such as bitcoin, any constraint on supply will have important implications for its price. However, what is equally, if not more interesting is the number of similarities between the Bitcoin backdrop today and that of the twelve-to-eighteen-month periods preceding the previous halvings. Let’s briefly explore some of these similarities which may have contributed to such extreme movements in bitcoin’s price.

Price Action

 

Today, we find ourselves in the middle of an ~80% drawdown in bitcoin’s price, similar to what we experienced in the periods leading up to the November 2012 halving (e.g., >90% decline) and the July 2016 halving (e.g., >80% decline). The latest selloff appears to be driven by cyclical macro forces and changes in investors’ appetite for risk rather than network fundamentals, which we’ll briefly touch on in the next section.

FIGURE 3: HISTORICAL BITCOIN HALVING PERFORMANCE % (CUMULATIVE LN)7

bitcoin halving cumulative return

Network Fundamentals

 

We have developed a proprietary factor model to measure the Bitcoin network’s health based on various activity metrics. As you can see in Figure 4, improving fundamentals have generally been the trend, though temporary declines are typical. After taking a brief dip in the first half of 2018, Bitcoin network activity has stabilized and is starting to show modest increases over the last few months. Notably in the twelve-to-eighteen-month periods preceding the past two Bitcoin halvings, a similar decline and subsequent rise occurred.

FIGURE 4: BITCOIN NETWORK ACTIVITY FACTOR RETURN % (CUMULATIVE LN)8

bitcoin network effect factor return

Investment Activity

 

There are also similarities between the investment activity leading up to the July 2016 halving and what we’re experiencing today. Figure 5 shows the trailing twelve-month dollar inflows to the Grayscale family of investment products as a percentage of our total assets under management (“AUM”) through December 2018. For context, this metric may serve as a proxy for broad-based investment activity occurring across the digital asset ecosystem, which could have important implications for future price action. Many investors view large capital inflows relative to asset prices as a fundamental sign of perceived value and potential future price momentum.

In December, this metric reached its highest level since the second quarter of 2015, the bottom of the last bear market and approximately fourteen months prior to the July 2016 halving.

FIGURE 5: GRAYSCALE TRAILING 12-MONTH INFLOWS AS % OF TOTAL AUM SINCE INCEPTION9

bitcoin halving price charts

Conclusion

 

Large drawdowns are not unique to digital assets and occur across all asset classes and markets, typically following periods of excessive risk-taking. These “re-pricings” can create compelling investment opportunities and in many cases offer above-average risk-adjusted returns in the years that follow.10 For investors with a multi-year investment horizon and a high-risk tolerance, the confluence of discounted prices, improving network fundamentals, strong relative investment activity and the upcoming halving may offer an attractive entry point into Bitcoin. This is especially relevant for investors building core strategic positions in Bitcoin over time.

Notes

1 Source: Bitcoin Block Reward Halving Countdown. www.bitcoinblockhalf.com.
2 Source: American Banker. For the Curious But Perplexed, the Bitcoin ‘Halving’ Explained. Tanaya Macheel, July 8, 2016.
3 Source: Bitcoin Data Science (Pt. 1): HODL Waves. Dhruv Bansal, April 17, 2018. blog.unchained-capital.com/bitcoindatascience-pt-1-hodl-waves-7f3501d53f63. As of March 15, 2019.
4 Source: Blockchain.info. PAST PERFORMANCE IS NOT INDICATIVE OF FUTURE RETURNS.
5 Source: Blockchain.info.
6 Source: TradeBlock, Inc. The term “VWAP” is an acronym for a volume-weighted average price.
7 Source: Blockchain.info. PAST PERFORMANCE IS NOT INDICATIVE OF FUTURE RETURNS.
8 Source: Grayscale. PAST PERFORMANCE IS NOT INDICATIVE OF FUTURE RETURNS.
9 Source: Grayscale. PAST PERFORMANCE IS NOT INDICATIVE OF FUTURE RETURNS.
10 Source: Bloomberg. Performance was evaluated between June 30, 1994 and March 15, 2018 for the Nasdaq Composite, MSCI Emerging Markets Small Cap, and S&P GSCI Global Commodity Indexes as this is the earliest available index level history for all three indexes from Bloomberg. We use the Sharpe ratio to measure the risk-adjusted returns of markets. The Sharpe ratio is calculated by taking the annualized return earned on an investment in excess of the risk-free rate (often measured as the return of U.S. T-bills) divided by annualized volatility or total risk. The Sharpe ratio has become one of the most widely used methods for  alculating risk-adjusted returns of portfolios. Generally, the greater the value of the Sharpe ratio, the more attractive the risk-adjusted return. Source: Investopedia. PAST PERFORMANCE IS NOT INDICATIVE OF FUTURE RETURNS.

About Grayscale Investments

Grayscale Investments, LLC (“Grayscale”) is the world’s largest digital currency asset manager, with a proven track record and unrivaled experience. We give investors the tools to make informed investing decisions in a burgeoning asset class. As part of Digital Currency Group, Grayscale accesses the world’s biggest network of digital currency intelligence to build better investment products. We have removed the barrier to entry so that institutions and investors can benefit from exposure to digital currencies. Now, forward-thinking investors can embrace a digital future within an institutional grade investment.
Grayscale is headquartered in New York City. For more information on Grayscale, please visit, please visit www.grayscale.co or follow us on Twitter @GrayscaleInvest.

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PRICE VOLATILITY
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