2019 Bitcoin Retrospective

January 9, 2020  •  21 min read

Introduction

We look to notable data and developments that capture investment and use of the network to explore Bitcoin’s position today and future potential.

As we begin the new year (and decade) and Bitcoin’s twelfth year in existence, we reflect on the maturation of infrastructure expanding the ways users and investors engage with Bitcoin, as well as robust growth of the underlying network. In a few short years, Bitcoin’s story has critically evolved to recognize the true potential of the network — as a new type of value transfer system, a tool for freedom, a savings technology and possibly more that we have yet to discover (remember, Bitcoin is a Platypus). While there are yet unanswered questions, its position is cemented, and its potential cannot be ignored. To exhibit the extent to which this is true, we look to notable data and developments that capture investment in and usage of the Bitcoin network:

• Trading and investment on incumbent, regulated platforms is growing
• Value transferred over Bitcoin is competitive with incumbent value transfer systems
• Key performance indicators, such as hash rate and addresses, reached all-time highs
• Cumulative miner revenue and fee revenue surpassed $15 billion and $1 billion, respectively

Infrastructure developments

Emerging regulated derivatives markets

A major development for the institutionalization of bitcoin in 2019 was the launch of regulated physically-settled futures contracts in the United States. Bakkt was first to market with daily and monthly bitcoin futures in September. While CME Group (“CME”) has offered futures since December 2017, the key difference is that Bakkt (and, more recently, ErisX) futures are physically-settled versus CME’s cash-settled futures. A major benefit of physical delivery is that it removes the need to determine a price using an auction or index of spot exchange prices, which makes it less subject to manipulation.

According to an FAQ and subsequent notice filed by the company in September 2019, Bakkt futures contracts have an initial margin requirement of 37% for outright contracts (e.g. accounts that have exposure to bitcoin) that participants can post in U.S. dollars or treasuries¹. Traders that are long bitcoin on Bakkt can either take physical delivery of bitcoin or roll their position over upon contract expiry (forgoing physical delivery). The number of traders taking physical delivery has been low.²

ErisX launched physically-settled bitcoin futures in late December. The firm has been offering spot trading to market participants since April. ErisX will offer monthly and quarterly contracts with a contract size of 0.1 BTC. ErisX contracts are fully collateralized — the exchange does not offer margin. The seller must post the equivalent amount of digital asset being sold and the buyer must post the equivalent amount of dollars. Settlement occurs in the form of physical delivery.³

CME’s cash-settled bitcoin futures have been live since 2017 and have majority share of the U.S. Commodity Futures Trading Commission (“CFTC”)-regulated bitcoin futures. Bitwise also found that CME futures volume has grown substantially as a portion of real spot volume. Cboe Global Markets, Inc. (“Cboe”), which also launched cash-settled futures in December 2017, discontinued the product after the last contract expired in June. Bakkt monthly contracts’ share of total notional volume has been steadily rising since launch (we do not yet have data for trading activity in ErisX futures).

Source: CME, Bakkt (Dec 2019)

Source: Bakkt (Dec 2019)

Options. Bakkt and CME announced they will be launching options on their futures contracts around the same time. Bakkt introduced options on its monthly contracts on December 8, 2019.⁴ CME is following with its rollout on January 13, 2020.⁵ Unlike futures, options give buyers the right (not obligation) to buy or sell the underlying asset at or before expiration (European vs. American style options, respectively). Options may be used to hedge and manage risk, generate income on idle assets, stay opportunistic, and speculate.

Derivatives unique to digital assets. An area that has received increasing attention is new types of derivatives contracts targeted at players in the mining industry to help them manage risk. To date, there have been few options to hedge against changes in hash rate and difficulty, high-impact factors that are specific to digital asset networks like Bitcoin. GSR Markets (“GSR”) recently announced a partnership with Interhash to launch bespoke risk management products such as swaps, collars, and other customized solutions in January 2020 to enhance mining risk management and provide a way to earn yield on idle inventories. GSR will go live with an average-priced option or swap contract and a futures contract tied to hash rate. Such products will contribute to continued maturation and sophistication of the market.⁶

While lightly regulated spot and derivatives markets still host significant trading activity, trading in regulated financial products will continue to grow gradually, especially as more sophisticated products emerge to help market participants hedge their risk and express a view on the market in new ways.

Interest in registered investment products and companies

Activity in the Grayscale Bitcoin Trust BTC (“GBTC”) from Grayscale Investments also provides insight into demand for investing in bitcoin. Previously, accredited investors have been able to purchase shares of GBTC at net asset value (NAV) in private placements. One share of GBTC equals 0.001 bitcoin. GBTC shares acquired in a private placement can trade on OTCQX Best Market, operated by OTC Markets Group, after a 12-month lockup. Anyone can purchase publicly traded shares via traditional brokerage accounts, just as they buy and sell other securities via traditional brokerage or tax-advantaged accounts.⁷

Public shares generally trade at a premium to NAV. The magnitude varies based on supply and demand — it has risen as high as 140% and dropped to as low as 0%. In 2019, the premium peaked at over 40% in July. The premium stands at 32% (as of January 7, 2020). Investors are willing to pay the premium to get exposure to bitcoin through incumbent financial services providers and alongside the rest of their investments.⁸

Average weekly investment by accredited investors into GBTC in the third quarter was $13 million, up almost 170% q/q. Total inflows into GBTC rose to $171 million, up 167% versus the prior quarter and 189% versus the same period in 2018. Inflows occurred during the month of July as GBTC was closed to new investments in August and September.

Source: Grayscale (Oct 2019)

Source: Grayscale (Oct 2019)

Charles Schwab Corp. (“Schwab”) recently released a report on self-directed brokerage accounts (SBDAs) within retirement plans for the third quarter of 2019. According to the report, GBTC was the fifth-largest holding in millennial accounts (1.84% of assets held in equities), ahead of The Walt Disney Co, Netflix Inc, Microsoft Corporation, and Alibaba Group Holding Limited. Millennial-held SBDAs made up 13% of all SBDAs at Schwab. The average balance in SBDAs owned by millennials was ~$69,000, making the average balance of GBTC in the accounts ~$1270 (this does not correspond to bitcoin on a 1:1 basis given the varying premium of GBTC over bitcoin).⁹

Source: Charles Schwab (Dec 2019)

In November, Grayscale also filed to register its Bitcoin Trust with the Securities Exchange Commission (“SEC”), though not as an exchanged-traded fund (“ETF”). Once registered, the disclosure and reporting requirements of GBTC would increase. Additionally, the lock-up for accredited investors purchasing shares directly from Grayscale in the private placement would drop from 12 to six months.¹⁰

GBTC is currently the only way for institutional and retail investors to gain exposure to bitcoin via brokerage and retirement accounts in the U.S.¹¹ The introduction of a bitcoin ETF would expand the suite of bitcoin investment products offered via traditional distribution channels. While there have been multiple attempts at launching a bitcoin ETF, the SEC has rejected them citing concerns around market manipulation and surveillance, among others. The SEC recently delayed a decision on the Wilshire Phoenix ETF to February 2020, which would hold a combination of bitcoin and treasuries and rebalance depending on changes in volatility.¹² Additionally, the SEC disclosed that it is reviewing its disapproval of the proposed rule change on NYSE Arca that would allow it to list and trade shares of the proposed Bitwise ETF.¹³ Bitwise published a follow up comment letter on December 18, 2019.

Square facilitates Bitcoin adoption and development

Square is a financial technology company best known for helping merchants accept payments via its point-of-sale software and hardware and meet short-term capital needs via Square Capital loans. Cash App from Square allows consumers to send and receive payments, spend funds (via the app and Cash card), and buy and sell bitcoin. Given its mainstream customer base, the industry looks to data Square publishes about Bitcoin adoption facilitated by the Cash app as well as where the company is diverting resources.

Square rolled out support for bitcoin buying and selling via Square Cash in January 2018.¹⁴ Customers purchased $339 million in bitcoin via Cash App through the third quarter of 2019, 156% more than the same period in 2018. Notably, the company announced that first-time bitcoin buyers have “approximately doubled” since the redesign of the application’s user interface in September 2019 to make its services more discoverable.¹⁵ Square also enabled external bitcoin deposits into Cash app in July and implemented a new 1.75% fee structure on bitcoin purchases.¹⁶

Source: Square Investor Relations (Nov 2019)

Square’s efforts to support bitcoin are driven by the CEO, Jack Dorsey who has indicated bitcoin can become the currency that powers the internet. Jack Dorsey has invested in Lightning Labs,¹⁷ which is building one of the implementations of Lightning Network, and, more recently, CoinList, a platform for token sales.¹⁸ In addition to implementing Cash App support for bitcoin, Jack Dorsey also launched a noteworthy initiative called Square Crypto. Square Crypto is a separate entity with a “design centric” focus on open-source development of the Bitcoin Network to help facilitate widespread user adoption. Since launching in July, the team has distributed multiple grants to notable projects and individuals in the space including BTCPay Foundation¹⁹ to advance development of BTCPay Server (an open-source digital asset payment processor) and an anonymous developer by the pseudonym “ZmnSCPxj” who works on Lightning Network part-time to help him transition to working on the Lightning Network full-time.²⁰

Key performance indicators

Realized value reaches all-time high

While bitcoin’s price was down from highs seen last summer, it ended the year up almost 100% relative to January 2019 lows. Additionally, bitcoin outperformed the Bitwise small-, mid-, and large-cap indices in 2019.

Source: Coin Metrics Pro (Dec 2019)

Source: Bitwise, Coin Metrics Pro (Dec 2019)

Market value (or market capitalization) is a metric borrowed from traditional equity markets. It is calculated as bitcoin’s current market price on exchanges multiplied by the amount of bitcoin in circulation — each unspent transaction output (UTXO) is assigned an equal value. The current market value of bitcoin is $130 billion (as of December 31, 2019).

Realized value is an alternate measure of network value introduced by Nic Carter, Antoine Le Calvez, and the Coin Metrics team. Realized value accounts for lost coins and unclaimed coins of forked assets by valuing coins at the price they last changed hands, rather than valuing each coin at a uniform price. Put differently, realized value measures the average cost basis or fair value of mined bitcoin and adjusts out short-term volatility in doing so. Realized value reached an all-time high of $103 billion in 2019. The realized value of bitcoin was $101 billion in December 2019.

Source: Coin Metrics Pro (Dec 2019)

Comparing realized value to market value allows us to determine the extent to which bitcoin holders have unrealized gains or losses, on average. The MVRV ratio, established by Murad Mahmudov and David Puell, formalizes the relationship between market and realized value. A ratio less than 1 (the lower threshold) indicates that bitcoin holders have aggregate unrealized losses. The upper threshold is 3.7, but the creators note the relevance could decline as the volatility of market cap declines. The MVRV ratio may be used to identify bitcoin market cycles, specifically periods of peaks and bottoms.²¹ The average MVRV ratio in December was 1.3, up almost 60% from 0.8 in January, indicating bitcoin holders went from having unrealized losses to gains on average by the end of the year.

Source: Coin Metrics Pro (Dec 2019)

Note: As with all new and relatively untested measures, MVRV should not be evaluated on a standalone basis due to limitations of market value and realized value. One caveat that impacts realized value (and multiple other metrics) is off-chain centralized exchange trading volume. Additionally, realized value treats lost coins that may never be moved, and coins used for “hodling” equally.

Hash rate reaches all-time high

Bitcoin’s estimated hash rate, one measure of the security of the Proof-of-Work network, reached an all-time high of over 110 million TH/s in November. The difficulty, which adjusts every 2016 blocks (roughly every two weeks) in response to changes in hash power, simultaneously peaked. Average hash rate and difficulty in December were up 128% and 124% respectively versus January 2019 averages. According to CoinShares , this increase was driven by improvements in the efficiency and computational power of mining gear (e.g. Antminer S17 Pro) and rising prices, compelling mining operations to join the network and invest in the latest infrastructure.²²

As a refresher on difficulty, if the average time taken to generate a block is below 10 minutes (the target), the difficulty increases, making it harder to mine the next block. If the average time taken is above 10 minutes, difficulty falls, making it easier to mine the next block. This difficulty adjustment allows miners continue to mine profitably and secure the network when prices fall, and simultaneously pushes the average block time back to 10 minutes.

Source: Coin Metrics Pro (Dec 2019)

Limitations in measuring hash rate. An interesting shortcoming of measuring hash rate was brought to light in September when the estimate fell significantly in a short period of time. The key limitation is that it is impossible to know the real hash rate without plugging into every miner and operation globally. Rather, the hash rate that data providers display is an estimate calculated based on the number of blocks generated in a period (generally 24-hours) and the expected number of blocks. The expectation is that one block is produced every 10 minutes, and 144 blocks are produced in 24 hours. In reality, there is a small probability of significant variations in block time. It can take the network an abnormally long or short period of time to generate a block relative to the 10-minute target. It’s important to be aware of such abnormalities that can skew hash rate calculations. A rolling average can help smooth out anomalous fluctuations in hash rate.²³

Developments that could lead to additional hash rate increases. 2019 also saw major developments and investment activity in the mining sector that could bring additional significant hash power online. Layer1 raised $50 million from Peter Thiel and others to develop end-to-end mining infrastructure, including proprietary cooling technology that the team believes will make Texas a viable and competitive location for mining operations driven by relatively friendly regulation, low electricity costs, and renewable wind and solar energy sources. The company hopes to take share from Chinese mining operations (according to CoinShares December Bitcoin Mining Update, as much as 65% of the Bitcoin network’s hash rate resides in China).²⁴

Crusoe Energy also collectively raised $70 million in equity and project financing to open new bitcoin mining operations in Texas. The firm plans to direct natural gas that would have otherwise been burned (i.e. gone unused and waste) to mine bitcoin. Bitmain, the largest manufacturer of ASICs, also opened a mining plant in Texas to take advantage of the state’s low power costs (the fourth lowest for industrial users in the country). The new Texas operation is the manufacturer’s largest mining project. Separately, Coindesk reported that Bitmain has filed with the SEC to conduct an initial public offering.²⁵ Canaan (CAN), another major mining hardware manufacturer with over 20% market share (according to BitMEX ) raised $90 million in a U.S. public offering on November 21st.²⁶

Another key development was the launch of Blockstream’s new mining efforts. Blockstream Mining provides colocation services to institutional customers, such as The Fidelity Center for Applied Technology, and LinkedIn co-founder Reid Hoffman, in the company’s data centers in Quebec, Canada and Adel, Georgia to help businesses set up and maintain mining operations more effortlessly. The facilities are said to generate 6 EH/s of hash rate at full capacity using the latest mining hardware. At the same time, Blockstream announced a new mining pool that aims to enhance mining decentralization through its use of the Betterhash protocol.²⁷

Efforts to decentralize mining. The Betterhash protocol was developed by Matt Corallo (now working at Square Crypto) to address mining pool operator control over transaction selection and potential transaction censorship, while maintaining consistent payouts and profitability associated with participating in a mining pool. Braiins, the company behind Slushpool and the widely adopted Stratum mining protocol, adapts this feature of Betterhash into Stratum V2 to address a key centralizing force in bitcoin mining.²⁸

All-time highs across multiple address bands

Given the rich data and transparency of the Bitcoin network, it is possible to apply different filters to map out different address bands. The number of addresses is considered an imperfect proxy for the number of users. While the metric has its limitations, tracking addresses with a bitcoin balance does provide a directional estimate of adoption. We look at the change in addresses with a range of balances, e.g. addresses with a balance between 0.001 to 1 BTC²⁹, addresses with 1 to 10 BTC, addresses with 1K to 10K BTC, and so on.

Limitations. Addresses do not correspond to users on a one-to-one basis. For example, users can (and should) have multiple addresses for privacy and security purposes. In fact, the best wallets automatically generate a new address following each transaction. On the flip side, many holders store bitcoin with custodians and exchanges that hold assets on behalf of many users in one or a few addresses. These factors lead to a dynamic of under- and over-statement.

Source: Coin Metrics Pro (Dec 2019)

Source: Coin Metrics Pro (Dec 2019)

Source: Coin Metrics Pro (Dec 2019)

Source: Coin Metrics Pro (Dec 2019)

All address bands saw notable increases over 2019. The average number of addresses holding 0.001 to 1 BTC saw the most substantial increase in December relative to the beginning of 2019. Addresses with a balance that is relatively small may be connected to retail participants. Average addresses holding between 1K to 10K BTC were up 16% (an increase of ~280 addresses). The number of addresses in this band reached an all-time high of 2,082 on September 27, 2019. Addresses holding such a large portion of BTC may be connected to businesses, though it is unclear whether multiple addresses are controlled by a single entity for security management purposes or whether the addresses correspond to different individuals or entities.

Source: Coin Metrics Pro (Dec 2019)

Measures of value transfer

Adjusted transaction value is an important measure of Bitcoin’s use as a value transfer and settlement system. The network is used by businesses (such as exchanges) and individuals alike for different purposes. Exchange usage corresponds to speculative activity, whereas individual activity may correspond to remittances, P2P payments and C2B payments. Total adjusted transaction value was ~$673 billion in 2019, down ~11% relative to 2018, driven by a decline in prices and processed transactions (versus highs in both during the first quarter of 2018).

Source: Coin Metrics Pro (Dec 2019)

For the nine months ended September 30th, PayPal payment volume was $512 billion, Visa payment volume was $6.5 trillion, and MasterCard purchase volume was $3.5 trillion. Adjusted transaction volume on the Bitcoin network was $512 billion over the same period — the same as PayPal. PayPal is over 20 years old and MasterCard and Visa are over 50 and 60 years old, respectively. Such comparisons help provide guidelines and context, but keep in mind that Bitcoin is dissimilar to these payment networks in its utility:

“What a low bandwidth-in-bytes but high bandwidth-in-dollars system like Bitcoin works for is large, inter-jurisdictional, money-for-enemies transactions where mutual trust is lacking and rapid settlement is desired. If mutual trust is present, or deferred settlement is acceptable, or the payment size is very small, base-layer-bitcoin is not the system for you!” Nic Carter, Partner at Castle Island Ventures and Co-Founder of Coin Metrics, Transaction count is an inferior measure.

Source: PayPal, MasterCard, Visa, Coin Metrics Pro

As Nic Carter highlights, this is made evident when comparing average transaction sizes on these networks. For payment networks like PayPal, Visa and MasterCard, average transaction sizes range from $40 to $60 (as of 2019).³⁰ Compare this to value transfer networks such as ACH, which settle transactions worth thousands of dollars. Average transaction size on Bitcoin is comparable to ACH transaction size, though settlement occurs within 60 minutes on Bitcoin (assuming six-block confirmations) versus 3–5 days for ACH (though same day ACH payments are growing in popularity).

Transaction fees remain reasonable

Transaction fees, which exclude block rewards, are a core component of miner incentives. Fee revenue reached an important milestone in 2019, surpassing $1 billion in cumulative fees since inception.

Source: Coin Metrics Pro (Dec 2019)

After reaching highs towards the end of the 2017 to 2018 bull market, per transaction fees have become relatively more manageable in times of increasing transaction demand, driven by transaction batching efforts, SegWit adoption or UTXO management to make efficient use of block space as well as lower demand for on-chain transaction settlement (e.g. using Lightning Network for microtransactions, though volume on Lightning Network is still relatively low/experimental). Total transaction fees paid to miners has declined as well. Fee revenue made up about 3% of total miner revenue in 2019 versus 5% in 2018 and 16% in 2017. The daily average fee per transaction reached a 2019 high of $6.15 with the daily median fee per transaction at $3.50 at the end of June.

As the block subsidy phases out (it will drop from 12.5 BTC to 6.25 BTC in the upcoming halving estimated to take place in May 2020 and to near zero by 2140), growth in transaction fee revenue will be crucial to incentivize miners to devote resources to securing the network.

“In a few decades when the reward gets too small, the transaction fee will become the main compensation for nodes. I’m sure that in 20 years there will either be very large transaction volume or no volume.” Satoshi Nakamoto

Another ratio that can be used to assess the fee market is the fee ratio multiple (FRM) introduced by Matteo Leibowitz of The Block. The FRM is calculated as total miner revenue divided by fee revenue. A high ratio suggests that (all else held equal) transaction fees must grow substantially to sustain the current security budget (assuming it is at equilibrium). The FRM has risen from slightly over 20 at the end of 2016 to over 60 as of December 2019.

Source: Coin Metrics Pro, Calculated using 30D SMA of fee revenue

Many believe a robust fee market will develop in time to replace the block subsidy as the system is increasingly used for transactions that require finality and high settlement assurances. In addition to increased monetary transfers, increased use of Bitcoin for non-currency use cases (e.g. as a timestamped record with special properties via OP_RETURN) could also contribute to the fee market. While there is some disagreement around whether block space is best used for recording arbitrary data, the network is agnostic to block space use cases so long as its users pay for it. Veriblock is a project that uses “proof of proof” to log data from less secure networks to Bitcoin. In fact, it was the most used OP_RETURN protocol of 2019. Tether’s original protocol, Omni, is also a notable user of the OP_RETURN function (Tether has since expanded issuance via Layer 1 networks like Ethereum). Another interesting use case of Bitcoin for recording non-monetary transactions is ION, Microsoft’s decentralized identity (DID) project. ION generates IDs via a Layer 2 protocol called Sidetree, but anchors hashed identity data to Bitcoin (Sidetree can be deployed on top of other Layer 1 networks as well).³¹

Note: OP_RETURN is an opcode that allows non-financial transactions to anchor to Bitcoin and leverage the security of the network.

SegWit Adoption

As we mentioned above, increasing SegWit transactions may be contributing to lower fees — average SegWit transactions rose from 36% in January to 54% in December (month-to-date as of December 23). SegWit, short for Segregated Witness, is a Bitcoin protocol update introduced to remove transaction malleability, thus making it possible to deploy Layer 2 networks like Lightning Network by moving the witness data in a Bitcoin transaction to a different part of the block. A consequence of the optional upgrade was a decrease in the size of transactions and the ability to include more transactions in a block without increasing block size. As a result, greater SegWit adoption results in lower transaction fees.

Source: Blockchair (Dec 2019)

Wallets and exchanges are key constituents in facilitating SegWit adoption. In December, BitMEX enabled bitcoin withdrawals to native SegWit (bech32) addresses to reduce blockweight usage and lower on-chain transaction fees. Bitmex quantified blockweight savings for a sample transaction (1 input 2 output) at 37%, highlighting that blockweight savings rise as the number of inputs in a transaction increase. Bitfinex also enabled withdrawals to native SegWit addresses in October.³² CZ, the CEO of Binance, indicated the exchange could roll out support in Q1 ’20.³³

In conclusion

The Bitcoin Network and its community of users and investors have become significantly more diverse and entrenched, especially over the past two years. The network continues to boast a dominant position in the market (above 60% dominance in terms of market cap for the back half of 2019, likely higher when considering lost and unclaimed coins and the fact that a long tail of digital assets whose minimal trading volume and untenably high market cap calculation distorts bitcoin’s relative dominance) and growing usage and adoption. Meanwhile, it has unapologetically maintained its core properties as an anti-fragile, border-less, censorship and seizure resistant, decentralized value storage and transfer system. Over the next year and beyond, we believe these exact properties will continue to drive adoption, supported by additional research, education and maturation of the network and its surrounding infrastructure for users and investors.