After a sharp decline from highs of almost $65,000 in late 2021, Bitcoin started 2023 trading at just $16,550. Despite losses of nearly 9% in the past week, it’s been a good year for the original and market leading cryptocurrency. Despite the recent price decline, a current price level of $27,607 represents gains of nearly 67% for the year.

Bitcoin has gained almost 67% since the start of 2023

The Bitcoin price has gained

Source: coinmarketcap.com

Why has Bitcoin rallied in 2023?

Bitcoin’s recovery this year after a torrid 2022 scarred by numerous bankruptcies, failures and scandals in a crypto sector weathering its first global economic crisis, does indicate that the sector has resilience.

Large numbers of ‘alt coins’, mainly the more frivolous and nebulous among their number (with the notable exception of Dogecoin of Elon Musk fame), have reached the end of their journeys with no willing buyers and dropped from exchanges. But the core, market leading cryptocurrencies including Bitcoin, Ether(eum), Ripple and stable coins Tether and USD coin showed no real signs of trading down to zero during last year’s bear market, despite losing considerable value.

The bearish interpretation would be that too many investors have too much tied up in Bitcoin and other leading cryptocurrencies for them to be wiped out quickly but that the decline is, nonetheless, terminal. Even if some of the original leading cryptocurrencies survive, a lack of clear and established use cases, and regulatory disapproval on money laundering among other concerns, mean they are destined to remain a niche and shadowy corner of the digital economy.

The early 2023 crypto rally could be interpreted as a case of investors reverting back to old habits that worked for years ahead of the 2022 tech and crypto bear market but now represent denial of new market realities. It’s a phenomenon known as a bear market or “sucker” rally in stock markets and a regular event of long running post-bubble corrections.

If that is the case, Bitcoin, Ether, XRP (Ripple), and cryptocurrencies as a concept and asset class could still be in terminal decline.

There are no small number of crypto sceptics that believe that to be the case. The optimists see the current phase, or “crypto winter” as a reset that is shaking out the dead wood and laying the foundations for a more mature, sustainable crypto sector to rise. Much like the reset the internet-based economy went through in the aftermath of the bursting of the dotcom bubble.

For those that retain faith in the mid to long term prospects of Bitcoin and crypto, the growing prospect of slowing, pausing or even reversing interest rate rises in 2023 is behind the rally. The same way as more investor optimism on future interest rate levels has benefitted growth stocks.

Bitcoin bulls are noting that one indicator, termed the Bitcoin Reserve Risk, has recently moved back to a level last seen in 2021, when the crypto currency’s price was around its all time record highs north of $60,000.

Forbes magazine quotes the crypto analyst Ali Martinez as noting:

“Reserve risk just crossed 0 again. This bitcoin indicator signals huge potential. When the bitcoin reserve risk moves above 0, it signals parabolic price moves.”

Martinez notes that on previous occasions when the indicator rose above 0, in 2012, 2013, 2015, 2019, and 2020, Bitcoin subsequently returned gains of 2,830%, 566%, 6,400%, 99%, and 487%, respectively.

What is Bitcoin Reserve Risk?

Many, if not most, Bitcoin investors and traders will be unfamiliar with the indicator, so what is Bitcoin Reserve Risk?

It is a metric that indicates the confidence of long-term Bitcoin holders, or HODLers, relative to the cryptocurrency’s exchange value. Some see it as a useful proxy to determine if the original cryptocurrency is over or undervalued at a particular moment.

How is Bitcoin Reserve Risk calculated?

The Bitcoin Reserve Risk reading is arrived at by diving the “HODL Bank”, the value of Bitcoin held by long term investors not traders who by and sell, by the market cap. Bitcoin is characterised as being HODLed .

Crypto market data company Glassnode breaks down Bitcoin Reserve Risk as follows:

• Every coin that is not spent (or sold) accumulates coin-days which quantify how long it has been dormant. This is good tool for measuring the conviction of strong hand HODLers.
• As price increases, the incentive to sell and realise these profits also increases. As a result, we typically see HODLers spending their coins as Bull Markets progress.
• Stronger hands will resist the temptation to sell and this collective action builds up an ‘opportunity cost’. Every day HODLers actively decide NOT to sell increases the cumulative unspent ‘opportunity cost’ (called the HODL bank).
• Reserve Risk takes the ratio between the current price (incentive to sell) and this cumulative ‘opportunity cost’ (HODL bank). In other words, Reserve Risk compares the incentive to sell, to the strength of HODLers who have resisted the temptation.

When the Reserve Risk indicator is high, this suggests that long-term holders have a high level of confidence in the value of Bitcoin compared to its current market price. In other words, they are bullish on it.

This can signal that it’s a good time to buy, as the price is potentially undervalued compared to market confidence. Conversely, when the indicator is low, it suggests that the confidence of long-term holders is low relative to the current price, indicating that the market may be overvalued, and it might be a good time to sell or better to hold off in taking exposure.

How much faith should be placed in the Bitcoin Reserve Risk indicator?

While Martinez gives the impression that the Bitcoin Reserve Risk indicator moving above 0 is a signal that shouldn’t be ignored, it’s more generally seen as just one, and a somewhat obscure, indicator. In theory, the indicator moving could be nothing more than long term Bitcoin and crypto bulls refusing to acknowledge long term decline, either for the sector as a whole or incumbent crypto currencies.

In other words, the change in the indicator could reflect nothing more than a bear market rally for Bitcoin in early 2023. Last week’s near 9% drop in value could be seen as supporting that position.

The remainder of 2023 should, however, provide clues as to the future of Bitcoin and other major cryptocurrencies. If they retain significant value and refuse to go away, that could indicate they won’t and will emerge from the crypto winter like Amazon and other internet companies that weathered the bursting of the dotcom bubble and went on to mature with the digital economy.

Crypto investors and interested observers will be watching closely.