Bitcoin Wants To Run But Liquidity Won’t Let It

Demian (0:00)

On September 11th, our TBL liquidity indicator flagged a sell, meaning that there was a local peak in liquidity which has since started turning down. By buying and selling Bitcoin following only our liquidity indicator signal, you would be up 53% this year on your Bitcoin versus being down about 8% just holding it.

However, after our sell signal went off last month, Bitcoin actually pumped again in the weeks to follow, all the way to 87,000, and has since retraced the low 80s, holding it stubbornly even after bouncing off $79,000 yesterday.

So is our liquidity signal wrong? Not exactly. Something else is pushing Bitcoin up, but liquidity is still a force that's holding it back. So today, we're going to get into all of that.

Welcome back to the Bitcoin Layer. Last week, I wrote an article summing up the last several weeks of research from Nik and I'm going to walk you through all the forces moving Bitcoin right now and how we're watching them and thinking about them at TBL. So when I first joined the Bitcoin Layer about two years ago, I understood why I held Bitcoin as much as many of you do. Digital store value, scarce hedge against inflation. It's all great. But I understand why Bitcoin moves so much on a month to month, week to week, or even a day to day basis. And Bitcoin seemed to move on things that I assume were unrelated to it. Why would a weak jobs report move the orange coin?

The reality is, despite what we think about Bitcoin's foreseeable future and its place in the world, the market currently and for the foreseeable future treats it as a risk asset. The definition of a risk asset being any investment or financial instrument whose value can fluctuate significantly or whose return is not contractually guaranteed. As a result, Bitcoin, like other risk assets, is very sensitive to liquidity. Liquidity, which can be defined simply as how much money is sloshed around the financial system and how easily it flows into assets like Bitcoin. When money is plentiful, it goes looking for returns, and risk assets get bid up. However, when it's tight, people sell what they can, and Bitcoin is usually first in line. And because it trades 24-7, we can sell Bitcoin at 2 a.m. on a Sunday, but you can't do that with stocks or real estate. How do you actually measure liquidity? Well, there's no single way. So the Bitcoin layer, we built our own, which we call the TBL liquidity index.

TBL liquidity index just puts together bond volatility, interest rates, the dollar, global banking assets, and transforms it into one number from to 100 that's updated every day.

On top of the index, we built a TBL liquidity indicator, which tracks the short-term waves in that number. When liquidity peaks and starts turning down, it flags red dot, a cell, and when it bottoms and starts turning up, a green dot, which is a buy. And we confirm each one about two weeks later, once we know that that turn is real. And that's the cell that I mentioned at the start. And to be clear, a red dot on our indicator doesn't mean to dump your Bitcoin. It just means that the conditions have turned against it, a headwind for risk assets. As Nik put it in one of his letters, a red dot is not a cellular Bitcoin signal, it's a short-term read on conditions, and not a call on Bitcoin's future. And on liquidity, it was right. The index kept falling and hit its lowest point of the cycle on October 5th. So what's been tightening liquidity? Well, three of the four pieces of our index did most of the damage that we've been talking about over the last few weeks. First, rates. The US economy is running hot. AI spending, sticky inflation, and a war pushing oil higher. So the Fed raised rates in September, and the 10-year Treasury hit 5.3% earlier this month, and it's still above 5%.

And this matters in two ways. First of all, the 10-year is the benchmark for long-term borrowing. Mortgages and corporate bonds are priced off of it, so when the 10-year rises, more money goes to paying interest and less goes into spending and investing.

Second, treasuries are the collateral behind a huge amount of borrowing. So when yields go up, bond prices go down, that collateral is worth less, so then less money can be borrowed against it. The second contributing factor to this tightening liquidity is bond volatility. The move index measures how much the market expects treasury yields to swing, based on what traders are paying for options on treasuries. It spiked above 110, and so on September 23rd, it jumped 17 points in a single day. When treasury prices swing that much, lenders lend less against each bond and ask for more collateral to back each loan, so less money moves to the system. A third reason behind this tightening liquidity is the dollar. Higher US rates make dollars more attractive to hold, and scared money runs to dollars anyways. The dollar index went from about 98 to around 102 this month, and a lot of the world borrows in dollars but earns in a different currency. So when the dollar rises, those borrowers suddenly own more in their own currency. They borrow less, they spend less, and money just gets tighter everywhere. So with all these forces working against Bitcoin, all these forces that are tightening liquidity, the big question at the crux of this video, why is Bitcoin holding up so strongly? Well, it's because that, despite how sensitive Bitcoin is to liquidity, the reality is is that Bitcoin still has its own supply and demand, who's buying and who's selling. For most of the year, liquidity was the stronger force, which is why our signal works so well. But over the last few weeks, Bitcoin's supply and demand shifted in its favor. The first thing to happen is that sellers have run out. Bitcoin absorbed almost every piece of bad news it could, strategy selling coins, eight and a half billion dollars leaving ETFs, the cold card hack, and by the July low, bad news just stopped pushing it lower. James Chek of Chek On Chain put it perfectly on a joint show last week. People who are going to hit the red button have done so.