Original title: Dissecting Divergences

Original author: CryptoVizArt, UkuriaOC, Glassnode

Original translation: Deng Tong, Golden Finance

Summary

· With the emergence of the Runes protocol, a counter-intuitive divergence has formed between the decline in active addresses and the increase in the number of transactions.

· Major token entities now hold a staggering approximately 4.23 million BTC, accounting for more than 27% of the adjusted supply, and US spot ETFs now hold a balance of 862,000 BTC.

· Spot and hedging structures appear to be important sources of ETF inflow demand, with ETFs used as a tool to obtain long spot exposure, while net short positions in Bitcoin in the CME Group futures market are growing.

Decreasing Active Addresses vs. Increasing Transactions Processed by the Network

On-chain activity metrics such as active addresses, transactions, and transaction volume provide a valuable toolkit for analyzing the growth and performance of blockchain networks. When restrictions on Bitcoin mining were implemented in mid-2021, the number of active addresses on the Bitcoin network fell dramatically, from over ~1.1 million per day to just ~800,000 per day.

The Bitcoin network is currently experiencing a similar contraction in network activity, albeit driven by entirely different factors. In the following sections, we will explore how the emergence of Inscriptions, Ordinals, BRC-20, and Runes can significantly change the way on-chain analysts view future activity metrics.

Despite strong market momentum and increasing active addresses and daily transactions, this trend is deviating.

While active addresses appear to be decreasing, the number of transactions processed by the network is near all-time highs. The monthly average transaction volume is currently 617k/day, 31% higher than the yearly average, indicating a relatively high demand for Bitcoin block space.

If we compare the recent drop in active addresses with the share of transactions of inscriptions and BRC-20 tokens, we can observe a strong correlation. Notably, the number of inscriptions has also dropped sharply since mid-April.

This suggests that the initial driver of the drop in address activity was primarily due to a decrease in Inscriptions and Ordinals usage. It is important to note that many wallets and protocols within the industry reuse addresses and do not double count if an address is active more than once in a day. Therefore, if an address generates ten transactions in a day, it will appear as an active address, but actually has ten transactions.

To illustrate how Inscriptions have grown since the beginning of 2023, we can see how the total number of cumulative Inscriptions has expanded. As of the time of writing, the number of Inscriptions has reached 71 million, however, the popularity of the protocol has dropped significantly since mid-April of this year.

To explain the drop in Inscription activity, we must highlight the emergence of the Runes protocol, which claims to be a more efficient way to introduce fungible tokens on Bitcoin. Runes were launched on the halving block, which explains the drop in Inscriptions in mid-April.

Runes follow a different mechanism than Inscriptions and BRC-20 tokens, utilizing the OP_RETURN field (80 bytes). This allows the protocol to encode arbitrary data into the chain while requiring less block space.

With the launch of the Runes protocol at the halving (April 20, 2024), demand for Runes transactions surged to between 600,000 and 800,000 per day and has remained high since then.

Rune-related transactions have now largely replaced BRC-20 tokens as well as Ordinals and Inscriptions, accounting for 57.2% of daily transactions. This suggests that collectors' speculation may have shifted from Inscriptions to the Rune market.

ETF Demand Splits

Another recent split that has gained attention is that despite staggering inflows into US spot ETFs, prices have stagnated and moved sideways. To identify and assess the demand side of ETFs, we can compare ETF balances (862k BTC) to other major entities.

US Spot ETFs = 862k BTC

Mt. Gox Trustee = 141k BTC

US Government = 207k BTC

All Exchanges = 2.3M BTC

Miners (excluding Patoshi) = 706k BTC

The total balance of all of these entities is estimated to be ~4.23M, or 27% of the overall adjusted circulating supply (i.e. total supply minus tokens that have been idle for more than seven years).

Coinbase as an entity holds a significant portion of the total exchange balances as well as US spot ETF balances through its custody service. The Coinbase exchange and Coinbase Custody entity currently hold ~270k and 569k BTC respectively.

As Coinbase serves both ETF clients and traditional on-chain asset holders, the importance of exchanges in the market pricing process has become apparent. By assessing the number of whales depositing to Coinbase exchange wallets, we can see a significant increase in deposit volume following the launch of the ETF.

However, we note that a large portion of deposits are associated with outflows from a cluster of GBTC addresses, which has been a long-standing supply overhead throughout the year.

In addition to GBTC selling pressure as the market rallies to new highs, there has been a recent factor that has led to a weakening of demand pressure for US spot ETFs.

Looking at CME Group futures markets, open interest has stabilized above $8 billion, having previously hit an all-time high of $11.5 billion in March 2024. This may indicate that more traditional market traders are adopting spot arbitrage strategies.

This arbitrage involves a market neutral position that combines the purchase of a long spot position with the sale (short) of a futures contract position on the same underlying asset that is trading at a premium.

We can see that entities classified as hedge funds are building increasingly large net short positions in Bitcoin.

This suggests that the spot arbitrage trade structure may be a significant source of inflow demand for ETFs, where ETFs are a vehicle to gain long spot exposure. The Chicago Mercantile Exchange Group (CME Group) has also seen a significant increase in open interest and overall market dominance since 2023, suggesting that it is becoming a preferred venue for hedge funds to short futures via CME.

Currently, hedge funds have a net short position of $6.33 billion and $97 million in the CME Bitcoin and Micro CME Bitcoin markets, respectively.

Summary

The large divergence between activity metrics has been accelerated by the extreme popularity of the Runes protocol, which exploits significant address reuse, with a single address generating multiple transactions.

The emergence and size of spot arbitrage trades between long US cash ETF products and short futures through CME has largely dampened buy-side inflows into ETFs. This has had a relatively neutral impact on market prices, suggesting that organic buyers from non-arbitrage demand are needed to further stimulate positive price action.

The emergence and size of spot arbitrage trades between long US cash ETF products and short futures through CME have largely dampened buy-side inflows into ETFs. This has had a relatively neutral impact on market prices, suggesting that organic buyers from non-arbitrage demand are needed to further stimulate positive price action.

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