The Breakdown - The Biggest Bitcoin Narratives of the New Cycle

Episode Date: March 29, 2024

NLW explores the state of Bitcoin narratives, from ETFs to mining to BRC-20's and beyond. Today's Show Brought To You By Kraken - Go to https://kraken.com/thebreakdown and see what crypto can be Ledger - 5% to Bitcoin Developers When You Buy https://shop.ledger.com/pages/bitcoin-hardware-wallet Enjoying this content? SUBSCRIBE to the Podcast: https://pod.link/1438693620 Watch on YouTube: https://www.youtube.com/nathanielwhittemorecrypto Subscribe to the newsletter: https://breakdown.beehiiv.com/ Join the discussion: https://discord.gg/VrKRrfKCz8 Follow on Twitter: NLW: https://twitter.com/nlw Breakdown: https://twitter.com/BreakdownNLW

Welcome back to The Breakdown with me, NLW. It's a daily podcast on macro, Bitcoin, and the big picture power shifts remaking our world. What's going on, guys? Today we are talking about the narrative drivers of Bitcoin, which you know I am very excited for. Before we get into that, however, if you are enjoying the breakdown, please go subscribe to it. Give it a rating, give it a review, or if you want to dive deeper into the conversation, come join us on the Breakers Discord. You can find a link in the show notes or go to bit.ly slash breakdown pod.

Hey, hello, friends. We are back here with another vacation travel week episode. Today we are doing one of my favorite things to do, which is check in on the big narratives that are driving to crypto space, or specifically Bitcoin right now. At the moment, we are now 16 months removed from the Bitcoin low for the last cycle. We've been in a strong bull market for at least five months, although you would be forgiven for feeling like it just started. At this point, the halving is less than a month away.

and Bitcoin has made new all-time highs before the halving for the first time ever. So what's driving this, what's not driving it, and what does it say about what comes next? Without question, as all of you will well know, the most important driver for this cycle's uptrend has been the launch of the Bitcoin ETFs. For the first time, retail investors have an option to buy Bitcoin from one of the world's most reputable asset managers directly in their brokerage accounts. In the past, they had to have proxy exposure through GBTC or through microstrachial, micro-strategy stock. So this really does represent a huge change. And already this year,

we've been through a wave of different Bitcoin price narratives. Prior to the launch of the spot ETFs, Bitcoin had already run up massively in anticipation. This led many to believe the ETF launch would be a seldom news event. That view appeared justified when the bottom fell out of the market after just a few days of trading. A started launch interrupted by a holiday saw Bitcoin plunge by 14% over the first week. The negative sentiment was largely focused on the exodus from GBT. Grayscale's fund lost assets at an astounding rate. More than $5 billion worth of Bitcoin was sucked out of GBT over the first two weeks. But then, that began slowing down. A few weeks later, with the Bitcoin price stabilized at around 50,000, the other funds began to find

their feet. BlackRock in particular asserted itself as the leader. A few scattered $300 million inflow days gave way to multiple days in a row above $500 million. We even saw one day above $1 billion in net inflows across all funds. couple weeks there, people were convinced it was up only forever. But of course, that couldn't last. And as I record, we've just had back-to-back days of net outflows for the first time since January. The one thing that is important to note is that that does not mean we're seeing outflows from the non-grayscale funds. It simply means that inflows have slowed down in a way that for a couple days, they have no longer been outpacing the outflows from grayscale. By the way, in case you

haven't been paying super close attention, which is the whole point of this show, the reason that there have been outflows from Grayscale is a couple parts. First of all, a lot of capital was locked in GBT for much longer than investors might have realistically wanted it there. That's based just in the way the structure was. And it's not just crypto capital that was locked there. At the beginning of the last bull market, there was a GBT arbitrage trade, where GBT was trading at a discount to the net asset value of the Bitcoin it represented. It was widely anticipated then that as soon as that unlocked because of a conversion to an ETF, there would be some amount of capital that was just racing for the exits. On top of that, GPTC chose to keep its fees at 1.5%, which is dramatically

higher than the other funds, and so in addition to just people trying to get out of a fund that they were locked into for a long time, there also could be some amount of repositioning, where people are leaving the grayscale Bitcoin Trust to buy into a lower priced option. The ETFs really are a new phenomenon. It shows in some ways in how wildly the narrative can swing. In a little over two months since the ETF launched, markets have cycled through disparate, and euphoria multiple times. I think the reason for that is that we just don't know what these products will ultimately represent. We don't know who the buyers are. We don't know if it's long-term hoddlers or just short-term traders. There's no historical precedent for this. And I think that's accentuating

whatever narrative turmoil there might be. And also creating more space for positive narrative interpretations as well. Still, it's hard not to see the connection between the price of Bitcoin and in particular the release of the flow data in the middle of the night. This obviously creates a feedback loop that can be extremely positive or extremely negative. During a conference appearance last week, Grayscale CEO Michael Sonenschine said that the ETFs are stuck in a transition phase. In other words, anyone who had been waiting until the ETFs were available until they bought their first Bitcoin are now already on board. That pent-up demand seems to have been satisfied. At the same time, we're not yet to the point where ETFs are available to investment advisors

who manage client portfolios worth trillions of dollars. We've seen a few small wirehouses switch on, but the big ones are waiting at least three months before adding ETFs to their platforms. It will likely take months after that to continue to educate the army of investment advisors and months after that until sales calls start happening. Still, there is a lot of consensus around the end state when it comes to analyst expectations. Advisors will consider Bitcoin and begin recommending a small allocation, perhaps one to three percent. If it does play out like that, while it's not clear exactly how much money this represents, we're talking about an order of magnitude more than the money that has already flowed into the

ETFs. Zooming out, however, the week-by-week changes in the ETF narrative seem less important than their lasting effect. Thanks to their launch, Bitcoin has transitioned from a novelty asset owned by weird computer nerds to a legitimate asset class for any type of investor. Obviously, I'm framing that from the standpoint of someone looking out, not from someone on the inside, like pretty much everyone who's listening to this show. There's still segments of the financial industry that will sneer at Bitcoin, but what they won't do anymore because they can't is ignore it. I believe it's significant that this change was forged in the dead of crypto winter rather than at a frothy top.

Previous cycle tops have been accented by large traditional firms getting overly excited about crypto. Think IBM having their brand associated with ICOs in 2017, companies like Disney running into NFT mania in 2021. But this time, it was in a moment where it would have been very easy, relative to most other moments, for crypto and Bitcoin to have actually gone away in a more meaningful way. When BlackRock filed for their Bitcoin Spot ETF, I view it as a wall on the bull market and a wall, frankly, on Operation Chokepoint 2.0 that said it's not going to go farther than here. This thing will live, and when it comes back, we'll be there to capture the opportunity. The fact that this cycle's main spokesperson has been Larry Fink, speaking points that

wouldn't be out of place coming from Michael Saylor, represents a massive change. Today's episode is brought to you by Cracken. For far too long, the whole financial system has been standing still, too slow, only on for certain hours, overly designed for some types of people, but not for others. Crypto, at its best, represents progress. It asks the question, what if? It invites people in instead of leaving them out. It's on 24-7-365 and moves at the speed of real life. Not everyone believes it. We've got our fair share of detractors, but that's the way it always is when you're building something new. Cracken is a crypto company that has been through the highs and lows of the industry, facing forwards towards progress throughout. And now they're inviting us to see what

crypto can be. Learn more at crackin.com slash the breakdown. Disclaimer, not investment advice. Crypto trading involves risk of loss. Cryptocurrency services are provided to U.S. and U.S. territory customers by Payward Ventures Inc. PVI, BVI, DBA, CRACEN. Hello, breakers. Today's episode is sponsored by Ledger. As another cycle ramps up, it's another chance to think about your Bitcoin custody best practices, and of course, to help all the new folks do the same. Ledger is the global platform for securing Bitcoin and other crypto. Ledger combines both hardware wallets and the Ledger Live app to offer the best way to buy, sell, swap, and stake without sacrificing on security or self-custody. Ledger features cutting-edge technology in the form

of a certified secure chip and a proprietary operating system, but also brings ease of use. This makes Ledger a safe and secure way to manage your digital assets without all the stress. Check out the link to the Bitcoin Ledger Nano in the show notes. 5% of all sales of the Bitcoin Ledger Nano go to support Bitcoin development. Thanks once again to Ledger for supporting the breakdown. Let's move on to mining and halving. We're now less than a month out from the halving and this time feels different. Previous halvings have always been a strange mix of hope and fear.

The hope comes from the narrative spread throughout the Bitcoin community. that the supply will have, demand will surge, and the faithful will be rewarded with internet money. Of course, this narrative has never played out quite so cleanly. An insanely strong bull market has followed each halving, but every time it required a new hype cycle to kick off excessive demand. On the flip side, the fear comes from the threat that reduced supply will cripple Bitcoin miners. Each prior halving has seen a significant amount of selling from Bitcoin miners. Indeed, Bitcoin's price came out of each having battered and bruised. Heading into this having, however, the hype cycle came early and Bitcoin shot to new all-time

highs well ahead of schedule. It is a truth at this point, mostly universally acknowledged, that even if they stick around for the money revolution, most new investors come to Bitcoin for the number go-up technology. During this cycle, Bitcoin started that sales pitch early. It's already obvious how different this cycle is by flicking between financial TV channels. Joe Kernan on CNBC Squawk Box has become one of Bitcoin's most mainstream cheerleaders. For months, he has been warning his co-host to, quote, prepare for the halving. This categorically different having has been both a blessing and a curse for miners. For the first time ever, we're approaching the halving with basically zero concern for minor profitability.

A few months ago, profitability was borderline. The most cost-efficient miners had ensured they could skate through the halving even with Bitcoin at around $30,000, whereas many miners needed Bitcoin at around $50,000 to continue producing blocks profitably. Even with the recent drawdown, there seems to be no mention that miners could struggle to survive. The problem with this strong position is that Wall Street doesn't seem to believe it. Even though miners announced a massive jump in profits for last year, there's still a lack of analysts who truly understand the industry. stock for the largest publicly listed miners is down 10, 20, even 30% so far this year.

Most traders seem to be clinging to a simple rule of thumb, that the halving is bad for miners. And it may well be that profits decline, but they're coming down from the most healthy place they've ever been in the lead-up to the halving. Alongside this maturation in the industry, we're seeing a maturation in the infrastructure that surrounds it. One of the biggest challenges to how mining works over recent years has been the emergence of hedging markets. Miners have always hedged their production just like any other commodity producer.

In previous cycles, they relied on Bitcoin-based derivatives. For most, that was a close enough match, but it meant being short Bitcoin in markets while being long the Bitcoin expected to be pumped out by their equipment. Going short, Bitcoin during a bull market is a capital-intensive trade and one that can end very badly. This typically meant that Bitcoin miners were overexposed to price movements and unable to lock in a profit. This could change for this cycle with the introduction of markets for hash price derivatives.

Luxor stood up this market of the past few years after realizing that Bitcoin miners don't really produce Bitcoin. They produce hashing power. Luxor created a pricing model they call hash. price, which is the dollar value of a certain amount of hashing power delivered to the network over a certain amount of time. With the introduction of hash price markets, miners can now directly hedge their production. This allows them to protect against spikes in the network hash rate at the same time as they hedge Bitcoin price fluctuations. These new markets should go a long way to

derisking the mining industry by allowing companies to use the same financial strategies as other commodity industries. Of course, they're still very nascent with a multitude of problems around liquidity, but in time, they could revolutionize how the finance side of Bitcoin mining works. You can talk about mining narratives, however, without talking about energy narratives. At its core, the Bitcoin mining industry is about the monetization of electricity. There's been a huge amount of change in the way the industry thinks about electricity since the last cycle. If you've been listening to this show regularly, you've heard about how Bitcoin mining can partner with the energy industry in a range of fascinating ways. Grid stabilization using Bitcoin miners to soak up excess electricity is now a

deeply ingrained part of some energy grids, most notably in Texas. There's also been major progress in recognizing that deploying temporary Bitcoin miners next to wind and solar farms can help make them profitable before they're connected to the grid. We're even now to the point where Bitcoin miners are commonly used to capture waste gas from landfills and oil drilling sites. All of these use cases for Bitcoin mining have gone from theory to practice over the last cycle. What's really intriguing about this moment is that for the first time, Bitcoin mining is all about electricity supply. Energy has always been the major input for Bitcoin miners and the largest contributor to cost, but cheap energy has never been the key reason a miner succeeds or

fails. A combination of sexually low electricity costs and a lack of competition has always meant that basically any miner plugged in anywhere has a decent chance of being profitable during a bull market. The problem has always been whether a firm can get enough access to mining rigs. During every other bull market, the mining industry has complained of massive wait times for new deliveries and the inability to achieve sufficient growth. This issue was made obvious in 2020 when a huge number of mining rigs were airlifted out of China after mining was banned. This was a viable plan because mining rigs were difficult to replace. In 2022, Kazakhstan implemented a range of hostile policies that caused the large mining industry to effectively shut down. Those rigs remain largely

warehoused in Kazakhstan and are unlikely to ever be plugged in again. Greg Beard, the CEO of Stronghold mining, put it like this. Miners aren't scarce today. You can buy new ones, buy used ones, or take someone else's order over. But there isn't a lot of scarcity value. What is scarce is the access to power. Access to cheap power is looking like it will be the biggest indicator of success for miners during this cycle. We're already seeing public mining, companies promote their fixed-cost electricity contracts and financial statements. It seems like the drive to find the cheapest megawatts on the planet will be intensified during this cycle, and there's a wide range of approaches being tried. Some miners are going to the ends of the Earth looking for excess

hydro and geothermal power that they can tap into. Others are partnering with governments in Africa, with an agreement to buy new electricity generation as it comes online. We can already see the impact of this dynamic in hash rate growth. Has rate has been going up at its fastest pace in history since January of last year, and the speed that miners are being plugged in is only increasing. More hash rate has been added in this quarter than was added across the entirety of the last cycle. This raise for cheap power has some interesting implications if you take it to its logical conclusion. If you thought that recent headlines talking about Amazon building its own nuclear power station were wild, just wait until a Bitcoin miner raises funding to do the same thing.

Now, it's probable we won't get to that extreme during this cycle, but that's where the industry looks like it's going. A couple more narratives to check in on before we get out of here. Let's talk about Lightning. Lightning has very divergent perspectives on it. Some view it as a major disappointment from the last cycle. Others point to the network demonstrating tremendous growth. Some of these say both are true, and the problem is the gap between expectations and reality. For a very meaningful amount of time, Lightning has been the end goal for Bitcoin scaling. It was a major reason that Bitcoin evolved in this direction from the decision to keep block sizes small alongside the Segwit upgrade. Lightning was viewed as the way to solve Bitcoin scaling

once and for all. Now that it's been heavily tested and the infrastructure has been built, there remain a lot of challenges. Liquidity management is so complex and entire sub-industry has sprung up. Using Lightning with a self-custodial wallet is so onerous that few even attempt it, which some people point out leads to the contradiction of Lightning users using custodial wallets, and transaction reliability and user experience still aren't where they need to be. One thing that I'm watching this cycle is that in addition to continuing to work on these issues with Lightning, you're also starting to see people pursue other approaches. In fact, Mr. Chris Berniske tweeted recently,

it used to be that everything was possible on Bitcoin. Then we fell into the Dark Ages where that idea became a trope. Now, layers of infrastructure are materializing that will allow that dream to once again flourish, with minimized trust extensions. Long live the Bitcoin Renaissance. Muniub Ali, the founder of Stack, said, People sometimes ask me why I still work. I work because I love this industry.

I love the mission of bringing Bitcoin to a billion people. We're at the beginning. Staying on this theme of the Bitcoin Renaissance, One of the reasons that developers have a renewed sense that things are possible on Bitcoin is a technical breakthrough called BitVM, which was made in October of last year. This is super dense, so we're going to do a very rock-skipping across the surface of a pond sort of version of it, but effectively BitVM is the discovery of a method to do Turing-computation on the Bitcoin network.

That means that smart contract design is theoretically possible. The major feature this would unlock is trustless bridging of assets between the main Bitcoin network and layer two's. Until now, it was believed that the only way to make a layer two was to trust a third party to custody Bitcoin placed on that network. This type of layer 2 design would allow smart contract calculations to take place on side chain before being settled back to the main Bitcoin network, essentially making permissionless defy possible on Bitcoin with a fairly minimal impact on fees. The most promising thing about BitVM is that unlike other ways of creating trustless

bridges on Bitcoin, this implementation doesn't require any changes to the code. By extension, that means we wouldn't need to go through a hard fork in the associated drama to unlock any of this functionality. Now, to be very clear, folks are still at the very big, beginning of figuring out how to deal with anything using the BitVM methodology. When I first started noticing this late last year, there were working examples of a module that could do simple arithmetic. We're now at the stage where the tech is understood well enough to build simple games, but that's still a long way from fully functioning smart contracts and trustless bridges. But overall, this still feeds into the broader narrative of a Bitcoin technical renaissance.

Lastly, we can't do a Bitcoin narrative check-in without asking about the state of ordinals and BRC 20 tokens. During the bear market, we watched ordinals go from a fad to an entrenched part of the Bitcoin network. They are, of course, not to everyone's tastes, and remain a major rift in the community. However, at this stage, it appears that ordinals are not going away. One big controversy surrounding ordinals is how their activity spiked Bitcoin fees. Currently, fees are reasonably mild at around $6 per transaction, which is not low, but it's also not totally unreasonable for most Bitcoin use cases. The ordinal's fee spikes also never got anywhere near as bad as during the consistently high-demand periods of the last bull market.

accommodation of outrage over high fees, along with an intense conviction among some part of the Bitcoin community that Bitcoin shouldn't be used for anything other than transactions, caused a faction within Bitcoin to propose censorship. This solution was actually built in the form of a new mining pool which censors Ordinals transactions. It worked to a degree. On the Bitcoin network, you can control what people use your infrastructure for, but you have almost no control over what other people will do. That's the nature of censorship-resistant networks. In response to the censorship of Ordinals transactions, miners set up their own ways to process them privately and directly, taking significant

fees for their trouble. I think a fairly good takeaway is that Bitcoin censorship is unlikely to work and people will most often find a way around it. Now, of course, while Ordinals started as enabling NFT-like pictures to be inscribed on the blockchain, that progress to a rudimentary token protocol, which brought a meme coin ecosystem to Bitcoin. Just last week, Ghostface Killa of the Wu-Tang clan announced that he would be partnering to release exclusive music as Ordinals' inscriptions. One of the most striking things about ordinals, and what sets them apart from other methods of creating NFTs, is that the data is permanently stored on the blockchain. In most NFT systems, the data is stored off-chain, so the NFT relies on an external website to allow it to exist. To many, that means that

ordinals have a much more credible promise that they'll still exist in a decade. There's a wide range of powerful implications to that fact. Permanent and indestructible data storage is potentially one of the best ways to keep records for valuable assets. This suggests that ordinals are a similar design could be an interesting avenue for asset tokenization. We also have a growing conversation in the AI space around whether there are ways to cryptographically verify something is real. And who knows what that might implicate, depending on how valuable what needs to be verified is. At this point, ordinals are not, I would say, a huge narrative driver of Bitcoin other than in this contribution to a larger sense of a technical renaissance, or at least the fact that we are going into this

bull market, with a much bigger portion of the community having much more openness to some new ideas around Bitcoin. So friends, there you have it, lots of different narratives going into this new cycle. Some of them will fly, some of them will die, and other new ones will be born. But for now, that's how I'm seeing it. One more big thank you to my sponsors for today's show. Go to crackin.com slash the breakdown and see what crypto can be. And check out Ledger's Orange Bitcoin Nano. 5% of sales will go to support Bitcoin development. Until next time, be safe and take care of each other. Peace.