Abstract

1. 2023 has been an incredible year for digital assets, with Bitcoin surging over 172%, experiencing less than a 20% maximum drawdown, and witnessing net capital inflows into BTC, ETH, and stablecoins.

2. The market has surpassed several crucial technical milestones and on-chain pricing models this year, with October being a pivotal point for institutional capital inflows.

3. Currently, the supply of Bitcoin held by long-term holders has almost reached historical highs, and the majority of Bitcoin is now in a profitable state.

4. Significant changes are occurring in the market structure, such as Tether reaffirming the dominant position of stablecoins, CME futures disrupting Binance, and a notable growth in the options market.

In the final issue of this year, we will take a whirlwind tour of the changes that occurred on-chain. We will explore how the landscape of Bitcoin, Ethereum, derivatives, and stablecoins evolved in 2023, setting the foundation for an exciting future path.

2023 has been an extraordinary year for digital assets, with Bitcoin’s market cap reaching a peak growth of 172%. Other parts of the digital asset ecosystem also experienced a robust year, with Ethereum and the broader altcoin space witnessing a market cap growth of over 90%.

This highlights the continuous rise of Bitcoin’s dominance, often seen as a period of market recovery from a prolonged bear market (such as 2021-2022). Especially for Ethereum, despite the successful deployment of the Shanghai upgrade and the development of the L2 ecosystem, its progress has been somewhat slow, with the ETH/BTC ratio dropping to multi-year lows around 0.052.

While the overall performance of digital assets throughout the year has significantly outpaced traditional assets such as stocks, bonds, and precious metals, the rebound since the end of October has dominated most of the gains. It broke through the crucial psychological price level of $30,000 and many other significant price thresholds.

Small retracement

One notable characteristic of the 2023 market is the remarkably small range of all price retracement and corrections. Historically, during the bear market recovery and bullish trends of BTC, pullbacks from local highs typically range from at least -25%, with many instances exceeding -50%.

However, in 2023, the deepest pullback closing price was only around -20% compared to the local high, indicating support from buyers and an overall favorable supply-demand balance throughout the year.

Ethereum’s retracement range is also relatively latent, with the deepest adjustment reaching -40% in early January. Although the performance is weaker relative to BTC, it also paints a constructive backdrop that the reduction in supply caused by the Merger is meeting relatively elastic demand.

The 2022 bear market will be slightly less brutal than the 2018-2020 bear market cycle, with most major digital assets starting in 2023 down -75% from ATH (all-time high). Strong performance since the lows has recouped much of the losses. Performance fo major assets are currently lagging behind their ATH -40% (BTC), -55% (ETH), -51% (altcoins, excluding ETH and stablecoins) and stablecoin supply (-24%).

From an on-chain perspective, the Realized Cap of BTC and ETH provides an excellent tool to track the recovery of capital flows for each asset. During the bear market period in 2022, the total Realized Cap dropped to levels similar to the previous cycle, reflecting a net capital outflow of -18% for BTC and -30% for ETH.

However, the recovery of capital inflows has been much slower, with Bitcoin’s Realized Cap at TerH reaching over 100% 715 days ago. In comparison, in the previous cycle, the full recovery of Realized Cap took approximately 550 days.

Breaking the $30,000 resistance level

This year, the Bitcoin market surpassed many technical milestones and on-chain pricing models, all contributing to our understanding of its robust performance.

It began with the January short squeeze, pushing the market above the Realized Price 🟠, a level that had been a significant constraint on the price since June 2022. This surge also broke through the 200D-SMA 🔵 until it encountered resistance at the 200W-SMA 🔴 in March.

Until August, the Bitcoin price continued to consolidate between the 200D-SMA 🔵 and the Realized Market Average Price 🟢, entering one of the least volatile periods in Bitcoin’s history (see WoC-32 and WoC-33). Shortly after, a rapid deleveraging event caused the price to drop from $29,000 to $26,000 within a day, dipping below the two long-term technical price averages mentioned.

The rebound in October truly changed the game. All remaining price models were restored, and the crucial psychological barrier of $30,000 was broken. Subsequently, Bitcoin reached a yearly high of $44,500 and is currently consolidating around $42,000 at the time of writing.

A common theme readers may notice throughout this article is how capital flows, market momentum and performance have accelerated since the end of October. In WoC-49, we explored the relationship between this and BTC price breaking the $30,000 level, which we described as a transition from an “uncertain recovery” phase to an “enthusiastic uptrend.”

Notably, October’s rally broke through two important levels that had charted this shift in previous cycles:

1. Technical Market Midpoints: this is a broad price levels that serve as support in the early stages of a bear market and resistance in the later stages of a bear market. During this cycle, $30,000 was the last major support area before a series of capitulatory sell-offs that ultimately led to FTX’s collapse.

2. Cointime Realized Market Average Price: this reflects the cost basis of active investors. This model was developed in our Cointime Economics research in partnership with ARK Invest.

We can also see a significant change in the characteristics of the recovery from Bitcoin’s bearish signals, as all eight indicators have entered positive territory since October. Readings have been mixed throughout much of 2023, showing very similar characteristics to the 2019-2020 period.

With all eight indicators now activated, this suggests that the market has entered positive territory typically associated with a resilient uptrend across multiple indicators and areas of the Bitcoin market structure.

Increases in quantity, cost and inscriptions

We can see that before this, Bitcoin’s trading volume was relatively stagnant, which supports the idea that October, to some extent, demonstrates a phased change in the market. The October rally saw Bitcoin transfer volumes double from $2.4B per day to over $5.0B per day, the highest level since June 2022.

We can also see an increase in exchange inflows and outflows for BTC and ETH throughout the year, indicating a general expansion of spot trading interest. Notably, BTC trading volume grew significantly faster than ETH trading volume, which is consistent with observations of Bitcoin’s rising dominance. After a prolonged bear market, it is common for Bitcoin to lead investors out of a slump, and this chart helps illustrate this phenomenon intuitively.

This year, the number of Bitcoin transactions hit an all-time high, largely due to unexpected growth in Ordinals and inscriptions. These transactions embed data such as text files and images into the signature portion of the transaction.

Therefore, we can now evaluate two types of Bitcoin transactions:

🟠 Total transaction count (unfiltered)

🔵 Currency trading volume has reached a multi-year high, almost reaching an all-time high of 372.5k/day.

🔴 Inscription trading adds an additional 175,000 to 356,000 transactions per day on top of classic currency trading.

The vast majority of inscriptions tend to be text-based and related to a novel token standard called BRC-20 🔵. At its peak, the Bitcoin network was seeing more than 300,000 inscriptions per day, far exceeding the April peak of 172,000 image-based inscriptions per day (images are larger, so inscriptions cost more as fees increase).

Due to this new buyer of Bitcoin block space, miners’ fee income increased significantly, with several blocks in 2023 paying even more than the 6.25 BTC subsidy. There have been two major fee hikes this year, and fees now account for about a quarter of miners’ revenue. This is comparable to the euphoric phases of the bull markets in 2017 and 2021.

Interestingly, while inscriptions account for approximately 50% of confirmed transactions, they surprisingly only occupy around 10% to 15% of the block space. This is a result of the small text file size and the nuances associated with discounting SegWit profiles (a topic we cover in WoC-39).

This year, inscription contributed 15% to 30% of miners’ total transaction fee revenue. This highlights the unintuitive nature of SegWit discounts, where Inscription transactions consume a small fraction of the block space (measured in bytes), paying a significant proportion of fees, but also account for around half of all confirmed transactions.

Actually, inscriptions and SegWit data discounts allow miners to put more transactions into the same maximal size block and thus pay more. If demand for inscriptions persists, the impact on miners’ income could meaningfully improve miners’ economics, especially with the fourth halving on the horizon.

Cross-chain bridge, staking and Shanghai upgrade

For Ethereum, on-chain activity has been a bit subdued this year, with October once again serving as a notable turning point.

1. Active addresses are relatively stable, about 390,000/day
2. Transaction volume recently increased from 970,000 transactions/day to 1.11 million transactions/day
3. ETH transfer volume has increased from $1.8B/day to $2.9B/day

While ETH’s overall market price performance lags behind that of the broader digital asset space, its ecosystem continues to expand, mature, and develop. In particular, the total value locked in the expanding Layer-2 blockchain increased by 60%, with over $12B now locked in the bridge.

These L2 chains are looking to expand the Ethereum block space while anchoring their data and finality into the main Ethereum chain to maintain its security.

Another key growth area for Ethereum is the amount of ETH staked through the new proof-of-stake consensus mechanism. Since the beginning of this year, the number of staked ETH has increased by 119%, and the number of ETH currently locked in the staking protocol has exceeded 34.638 million. The Shanghai update was also successfully launched in April, allowing stakers to complete withdrawals and reshuffle staking providers and settings for the first time since the launch of the Beacon chain in December 2020.

Long-term focus

Despite Bitcoin’s incredible price performance, a large portion of Bitcoin remains dormant and held in investor wallets for a long term. Of the total circulating supply of 19.574 million BTC, more than 14.9 million (76.1%) are held off exchanges and have not moved in over 155 days, an increase of 825,000 BTC so far this year. This also brought the short-term holder supply to an all-time low of 2.317 million BTC.

As the market rebounds, the vast majority of investors’ tokens start to be “profitable,” whether because they are transferred to other users or they rise in price above cost. The chart below shows how the total number of “losing” tokens has dropped to around 1.9 million BTC, most of which are held by long-term holders who bought them near the 2021 highs.

On the other hand, “profitable” supply currently accounts for over 90% of circulating supply, with October’s rebound putting it above historical averages. With over 50% of supply below the zero line at the start of 2023, this is one of the fastest recoveries in history (second only to the 2019 rebound).

The chart below provides a visual representation of the profit supply percentage change for each calendar year since 2015. While not perfect by year, the classic four-year Bitcoin cycle allows us to spot some interesting patterns:

🟠Bear market/recovery phase: as the token capitulates near the lows and returns to profit territory, the profit supply increases the most.

🔵Early bull market: the overall uptrend saw most coins profiting and rallying to new highs.

🟢In the late bull run, the market is at the ATH level, resulting in small positive to negative readings as all coins have made profits and the market is close to exhaustion.

🔴Major bear market after the market peaked: with a large number of tokens falling into losses.

Although simple in structure, the framework does highlight the similarities between progress made so far in 2015-2016, 2019-2020 and 2023.

Finally, it comes to the topic of investor profitability. 2023 will transform long-term holders, short-term holders and ordinary holders from unprofitable to moderately profitable state. The NUPL metric for each phase has not yet reached exciting highs, but is significantly above the respective phase’s break-even levels.

The increasingly mature derivatives market

A notable feature of the 2020-2023 cycle is the growing prominence of the futures and options markets as the preferred venues for price exposure and liquidity. Indeed, 2023 proved to be a pivotal year in this maturation process, as the open interest in the options market has grown to be comparable to, or even surpass, that of the futures market.

Currently, the open interest for both stands between $16B to $20B, with Deribit continuing to dominate the options space with a market share exceeding 90%. This suggests a growing institutional interest in Bitcoin, as traders and positions leverage the options market for deploying more sophisticated trading, risk management, and hedging strategies.

Within the futures market, there was also a noteworthy shift in dominance, with the regulated CME exchange holding more open interest than offshore exchange Binance for the first time in history. October once again appears to be an important moment in this phase of transition, suggesting an influx of institutional capital.

The futures trading volume of both BTC and ETH increased in October, with the total daily trading volume being $52B/day. Bitcoin contracts account for about 67% of trading volume, while Ethereum contracts account for 33%.

Cash and arbitrage yields in the futures market go through three distinct phases during the year, which also tells the story of capital inflows into the space:

From January to August, the yield fluctuated around 5%. This is largely in line with short-term Treasury yields, making it relatively unattractive given the additional risk and complexity of the trade.

From August to October, after a sell-off to $26,000, yields were below 3% and the volatility environment was unexpectedly low.

Since October, the yield has exceeded 8%. With futures basis currently holding at 300 basis points above U.S. Treasuries, market maker capital now are motivated to return to digital assets.

Stablecoin supply

A relatively new phenomenon from the last cycle is the outsized role that stablecoins have played in market structure, becoming the preferred quote currency for traders and a major source of market liquidity.

The total stablecoin supply has been declining since March 2022, down -26% from its peak, becoming a major headwind to market liquidity. This is due to a combination of regulatory pressure (the SEC charged BUSD with being a security), capital rotation (preferring U.S. Treasuries to interest-free stablecoins), and waning investor interest in a bear market.

However, October was a critical point as the total stablecoin supply bottomed out at $120B and the supply began to grow at a rate of up to 3% per month. This is the first expansion of the stablecoin supply since March 2022 and may also be a sign of returning investor interest.

The relative dominance among various stablecoins has also changed significantly between 2022 and 2023. The dominance of previously rising stablecoins such as USDC and BUSD has shrunk significantly, with BUSD at a redemption-only mode, while USDC’s dominance has dropped from 37.8% to 19.6% since June 2022.

Tether (USDT) is once again the largest stablecoin, with total supply climbing to over $90.6B, accounting for 72.7% of the market.

Finally, we can compare the 30-day change in the realized market cap of BTC and ETH with the change in the total stablecoin supply. These three metrics help visualize and measure relative capital flows and rotations between sectors.

October was once again a critical moment, with capital inflows across all three major assets turning positive, in line with the market breaking the key $30,000 level, growing institutional interest in the derivatives market, and net capital inflows across the three major digital assets.

Conclusion

2023 is a very different year than 2022 with its devastating deleveraging and market declines. Instead, this year has seen a resurgence of interest in digital assets that has outperformed and seen the emergence of new on-chain artifacts in the form of Bitcoin inscriptions.

The Bitcoin supply is currently tightly held by long-term holders, with most investors now holding profitable Bitcoins. With the increasing likelihood of the launch of a U.S. ETF in early 2024 and the Bitcoin halving scheduled for April, the stage is set for an exciting year ahead.

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