Summary Bitcoin's recent price increase has likely been driven by expectations of looser monetary policy and ETF flows. The impact of the halving on Bitcoin's price is uncertain, with demand likely a more significant driver of price increases. While ETF flows could continue to support Bitcoin's price, the current move doesn't appear sustainable. Bitcoin’s ( BTC-USD ) fortunes have reversed dramatically in recent months, which is somewhat surprising given that interest rates remain elevated. This could be attributed to a rapidly inflating AI bubble, increased liquidity, the 2024 halving or ETF flows. The halving certainly could be contributing to Bitcoin’s price run, but I find the evidence of this weak. Demand is more likely to be a driver of price increases, and in this regard, ETF flows could have provided a boost in recent months. Less restrictive monetary policy, and growing expectations of looser monetary policy, have also likely been important drivers of returns risk assets. The unbound enthusiasm for AI at the moment also appears to be spilling over into technology more generally. While ETF flows and monetary policy could be supportive of Bitcoin’s price going forward, the recent move in risk-on assets appears unsustainable. It is difficult to predict the size and duration of this type of move, but I believe we are closer to the end of the current bull market than the beginning. AI Bubble Bitcoin is a risk-on asset that often moves in unison with other risk-assets, like tech stocks. This has particularly been the case over the past 4 years, where monetary policy and investor sentiment has moved from extreme to extreme. Many tech stocks have benefitted from the growing capability of LLMs and heavy investment in AI infrastructure over the past 12-18 months. It is possible that the positive sentiment created by AI hype is spilling over into technology more broadly. This is difficult to assess due to the outsized impact that monetary policy and inflation expectations has on had on many assets in recent years though. Figure 1: Bitcoin Price and Nasdaq Composite Index Level (source: Created by author using data from Yahoo Finance) Halving The impending halving in 2024 may also be creating buying ahead of the decrease in new supply in expectation of a price increase. I have written about this previously , but I am not particularly convinced of the importance of halvings as a price catalyst. All existing Bitcoin can potentially be a source of supply, rather than just newly mined Bitcoin, calling into question the importance of the halving, particularly now that Bitcoin's inflation rate is quite low. Rational investors should also be expected to bid Bitcoin's up ahead of halvings, which has not happened in the past. The price elasticity of demand of Bitcoin could also change significantly, making the impact of supply changes difficult to predict. Figure 2: Theoretical Impact of Supply Change on Price (source: Created by author) Bitcoin’s value can be estimated based on the scarcity of new supply, which has worked reasonably well in the past, but involves a large amount of uncertainty. Based on this method, I would expect Bitcoin's price to settle at around current levels over the next few years. Figure 3: Bitcoin Price and Price Estimate Based on Supply (source: Created by author using data from Yahoo Finance) Liquidity While central bank liquidity has been increasing, it is not clear that this has been behind Bitcoin’s recent move, particularly given that interest rates remain elevated. A stronger argument could be made that QE followed by QT between 2020 and 2023 were important drivers of Bitcoin's price. Figure 4: Bitcoin Price and Liquidity (source: Created by author using data from Yahoo Finance and The Federal Reserve) The rapid rise in interest rates in 2022 appears to have contributed to Bitcoin's price decline. Growing expectation of interest rate cuts beginning in late 2023 may have also been behind the current price rise. Figure 5: Bitcoin Price and 10 Year Treasury Yield (source: Created by author using data from Yahoo Finance and The Federal Reserve) Flows The approval of Bitcoin ETFs and the associated inflows are also a potential driver of price at the moment. It should be noted that net inflows are small relative to Bitcoin's market capitalization, although the price sensitivity of buyers and sellers and trading volumes are important contributors to price impact. Figure 6: Bitcoin Price and ETF Flows (source: Created by author using data from Yahoo Finance and etf.com) Flows associated with ETFs could be considered indicative of demand, the impact of which I have written about previously . If Bitcoin is considered money, and money is treated as a form of communication, Bitcoin can be valued using Metcalfe's law. Metcalfe’s law states that the value of a communication network is proportional to the square of the number of users, although it only gives a relative valuation. I have estimated Bitcoin's value using Metcalfe's law and the number of active addresses as a proxy for users. Given how Bitcoin is used, I think it is increasingly questionable to treat it like money though. The number of active addresses is also becoming a poor proxy for the number of people with exposure to Bitcoin due to intermediation. Figure 7: Bitcoin Price and Price Estimate Based on Demand (active addresses) (source: Created by author using data from Yahoo Finance) Internet search interest may be a better indicator of demand side dynamics (along with ETF flows). Search interest seems to support the current price move, although price appears to be leading demand rather than the other way around. Figure 8: Bitcoin Price and Search Interest (source: Created by author using data from Yahoo Finance and Google Trends) Conclusion General sentiment towards risk-on assets, in particular investor optimism regarding the potential of AI, are supportive of Bitcoin at the moment. Expectations of looser monetary policy appear to have been a catalyst for this in late 2023. If monetary policy remains tight, this could eventually weigh on the current bull market though. This makes interest rates and the labor market important to Bitcoin's forward path. Inflows associated with Bitcoin ETFs are also likely to provide price support in the near-term, but this could quickly shift in the event that Bitcoin's price moves significantly lower.
