Understanding bitcoin market cycles

Bitcoin goes up and down without end. What are the causes of this and is there a way to predict these movements? We'll find out in this article.

To long-time bitcoin investors it was no surprise that bitcoin surpassed its previous all-time high in 2020. Nor was it much of a shock that it just reached new all-time highs this past month. To them, bitcoin remains a young asset that’s merely going through phases of discovery and adoption, accumulating newfound exposure and unlocking demand from broadening demographics as it matures. Price cyclicality, and its accompanying volatility, is simply par for the course.

Many have explained this cyclicality — which has thus far taken place in rough tandem with Bitcoin’s supply halvings — as successive periods of maturation. In this framework, each cycle serves as a market-broadening catalyst that spreads the ideas and narratives of Bitcoin through society and unlocks new tranches of demand.

One of the most powerful of these narratives is that of the halvings. Roughly every four years Bitcoin’s issuance rate is programmatically halved. The halvings happen without any regard to ongoing demand, meaning that if the ongoing demand remains the same after a halving event, whatever demand was being met by new supply will be restricted, necessitating an upwards adjustment of price. 

The halving-driven cyclicality thesis claims that these price increases cause Bitcoin to garner further attention, capturing additional investment as the population becomes increasingly informed about bitcoin, its properties and potential. So, from the halving price increases, new demand is brought forward and the foundations of a new bull market is laid down.

Unfortunately, the data points remain few (there have been only three halvings) and we cannot extract any clear evidence of a causal link between Bitcoin’s programmatic decrease in supply and broadening demand. However, thus far at least, the halving events appear to have been triggers, followed by periods of substantial price appreciation. 

As a counterpoint, many have argued that since the halvings are known in advance, their impact should be priced in. Apart from the price development itself suggesting that this is not the case, it is also important to remember that the inner workings of Bitcoin remain completely unknown to most people, even to many existing bitcoin holders. 

Given the still low dissemination of Bitcoin knowledge in the general population, we don’t think it’s an unreasonable possibility that the halvings carry a powerful enough narrative that they cause the Bitcoin idea to spread, however we think there is more to the cycle pattern than the halving events alone.


Cycle Peaks

29 November 2013


16 December 2017


10 November 2021


Source: CoinMetrics, Clark Moody


Viewing and Comparing Cycles 

As the bitcoin price recently reached new all-times highs (before correcting), we look at how the price is behaving in comparison to previous bull cycles, using each halving event and price peak as signals to mark important cyclical milestones.

Examining bitcoin’s market cap on a logarithmic scale, we contrast each cycle on a relative basis, tracking the percentage change in the overall network’s value rather than its absolute change over time. Using this method, we can see similar overall trends in each cycle along with certain degrees of uniqueness or irregularities.


Figure 1. Three Cycles of Bitcoin Market Cap Normalised to 1 at Halvings (USD)


Source: CoinShares Research, CoinMetrics

In general, in the periods immediately after halving events, bitcoin prices seem to follow a pattern of rapidly increasing beyond previous all-time highs (ATH), correcting and shedding value over a slightly longer period, then oscillating in a window of diminishing volatility, before finally circling back to a more gradual upside continuation before the next halving. 

In the longer term this can be the early signs of a rising cyclical trend in prices, and there are behavioural patterns among bitcoin holders suggesting this cyclicality might continue as Bitcoin matures and adoption rises, until at some point a comparative level of saturation is reached.


General Cyclical Patterns

While each cycle establishes an early uptrend, they differ in precisely how they move through their initial acceleration phase. The 2012 cycle found its first point of inflection in just 28 days, whereas in 2016 and 2020 the trajectory of the curve didn't dramatically change until roughly 269 and 187 days after the halving. 

Uniquely thus far, the 2012 curve had two major ATH peaks, and reached its most significant peak only 366 days post-halving, whereas the 2016 curve didn’t find a comparable high until 159 days later, at a notably decreased level. One could make an argument that the 2016 cycle had another major peak in 2018, but it failed to reach a new ATH and so we do not consider this run up a major bull market peak.

The initial two cycles are of similar shapes, clearly parabolic with dramatic blow-off tops, however, the most recent cycle takes a different route, being somewhat delayed in its ascent and with a much more rounded top. As the 2020 cycle is not even half-way through to its next halving, it is of course possible that it will run higher still, forming a pattern more similar to the 2012 cycle than the 2016 cycle.

Given the small sample size of halving data attainable (n=3), it may also be that these patterned cycles are more myth than reality, or that the current cycle is taking a more modest route to greater bitcoin adoption. It could also be the case that cycles are dampening in magnitude and that this cycle has already reached its peak. 


Other considerations

To some, price alone does not contain a sufficient amount of information to shine the necessary amount of light on these probabilities. In order to increase the granularity of our analysis, we look to additional data sources for support.

We can examine crypto-specific metrics that may indicate how owners of bitcoin, the asset, have been interacting with Bitcoin, the network and protocol. Since bitcoin is a traceable unit within its own public ledger system (the blockchain), we can analyse usage patterns in uniquely granular fashions.

We can gain even more insight into investors’ behaviour by looking at UTXO bands, a metric that more granularly explores the transaction patterns of the blockchain by grouping transacted coins into age-bands. Here, by examining the length of time each coin has remained inactive, we can gain further support to our previous inferences regarding hoarding and spending behaviour among holders. We also find that UTXO bands generally help us understand the volume of supply constrained and then released by long term holders in different parts of each cycle.

The last puzzle piece in our behavioural cycle analysis is net exchange flows. Using on-chain transaction data it is possible to estimate the amount of bitcoin flowing to and from bitcoin exchanges, giving us valuable insight into the purpose of a significant part of the on-chain transaction volumes. While these estimated flows are not perfect representations of real flows, they are very good estimations.

Looking at the net exchange flows we can observe that periods of high MVRV, the same periods where coins from relatively old UTXO bands re-enter the liquid band, all correspond to periods of large positive net exchange flows. This final piece of evidence ties the dynamic supply thesis of bitcoin holders together and helps finalise the explanation of the underlying behaviours causing price cycles.


The Dynamic Supply Cyclicality Thesis Summarised

In short, the cyclical repetition of bitcoin price movement is theorised to indicate successive new classes of long-term investors being initiated to bitcoin each cycle. These investors resist the urge to sell their coins below acquisition cost during at least one cycle downturn, restricting supply as they hold on to coins until finding profits in the next upswing. Their success in turn emboldens a new generation of long-term holders, who are often brought into bitcoin by a powerful narrative such as the supply halving, to undergo the same rough sequence of events and the cycle repeats.

In accordance with the maturation concept explained above, this could imply that discovery and exposure of bitcoin by broader audiences, who observe the success of previous cycle holders, may act as a catalyst unlocking additional tranches of demand and enhance its value proposition in successive waves of adoption. 

While it remains anyone’s best guess whether bitcoin will keep following the exact same patterns and trends established by previous price cycles, unlocking new levels of demand as it goes, investors can at least feel reasonably assured that human psychology will remain unchanged, and that Bitcoin will continue cutting its issuance rate in half every four years until it reaches its 21 million supply limit. 

Meanwhile, successive generations of bitcoin holders keep facing the same psychological pressures to restrict and release supply in a similar fashion to previous holders when faced with similar price conditions. Taken together, these factors do point to at least some probability that bitcoin price cycles might continue in a similar fashion as they have in the past.