Understanding the Bitcoin Cycle – The Puell Multiple

In a previous article, we learned about the MVRV Ratio, which is a metric designed to see the average Bitcoin investor’s profitability. The logic behind it is straightforward — if Bitcoin investors are experiencing profit on paper, they’re more likely to sell to realise potential gains, which can drive prices down if there are more sellers than there are buyers.

In this article, we’ll be focusing more on the supplier’s side of Bitcoin (i.e. the miners) and how to use the Puell Multiple to identify potential market tops and bottoms. 

Why miners are an important part of the market

At the time of writing, Bitcoin miners issue (earn) about 450 Bitcoins per day from block rewards. At today’s price, this is a considerable rate of value creation, backed by a mature crypto mining industry. Therefore, similar to end-users, miners are also an essential component of the Bitcoin market dynamics. 

It’s important to note that miners have very low direct impact on the market price of Bitcoin. This is because more than 94% of all possible numbers of Bitcoins have been mined and distributed in the market.

Miners can hold Bitcoin in their inventory, but at 450 BTC/day, holding all mined Bitcoins for a year will only prevent 0.8% of the total supply from being sold.

Added to that is the fact that miners are decentralised entities that don’t typically cooperate, making it less likely to see a Bitcoin monopoly on the miners’ side, unlike producers of natural resources that we often see today.

Miners are often incentivised to sell some if not all of their earned Bitcoins, because they have to cover operational expenses.

Therefore, it’s often infeasible to hold earned Bitcoins for an extended period, unless they have a strong cash reserve. Because of this, the Puell Multiple has been a reliable indicator that sheds light on how well Bitcoin miners are doing in terms of their earnings from block rewards.

How does the Puell Multiple work?

The Puell Multiple is a metric that compares the daily issuance value of bitcoins (in USD) to its average over the past year. Technically, it’s calculated by dividing the daily USD value of Bitcoin by its 365-day moving average. 

The Puell Multiple can be interpreted as follows:

1. High values (above 4): This indicates that current miner profitability is significantly higher than the yearly average (indicated by the area in red). When the Puell Multiple reaches values above 4, it often signals a potential market top. Historically, these periods have coincided with major highs in Bitcoin’s price.

2. Low values (below 0.5): This suggests that miner profitability is considerably lower than the yearly average (indicated by the area in green). Puell Multiple values below 0.5 have historically signalled significant macro bottoms, indicating that the price of Bitcoin may be undervalued.

3. Middle range: Values between 0.5 and 4 generally indicate a more neutral market condition.

As you can see, the Puell Multiple enters the “high value” range before Bitcoin’s price reaches its local peak maximum at every halving cycle. The chart below shows exactly the same as the above chart, with additional notes on where each halving occurs.

At each halving, the Puell Multiple drops by 50%. This is expected as block rewards get cut in half, so does the revenue in dollar terms.

The 50% drop may be enough to cause the Puell Multiple to drop to the green zone where Bitcoin tends to be at its historical discount prices, which then leads into much higher prices. However, sometimes the opposite occurs.

After halvings 2 and 4, there was a drop in the price — this is explained in the next section.

Bitcoin Halving happens approximately once every four years, in which Bitcoin earnings from block rewards for miners are cut in half.

When Bitcoin was first launched, every 10 minutes, a miner would have earned 50 BTC for successfully securing a block of transactions. Today (after the fourth halving), that reward is 3.125 BTC for every block secured.

Puell Multiple vs price — a complex relationship

It’s a mistake to think that there is a clear cause and effect relationship between the Puell Multiple and the market price for Bitcoin. While there is clearly a correlation between them, we can’t establish causality with confidence.

Earlier we established that miners don’t control the price of Bitcoin. This means that like investors, miners’ profitability is also dependent on the whim of the market. It’s more likely that the price drives the Puell Multiple, except at the point where a halving event occurs.

The Puell Multiple and a simple 365-day moving average divergence chart on Bitcoin’s price (not pictured) may look similar to one another. But the difference is that the latter is 100% driven by the price. It’s a technical indicator, after all, and doesn’t look at anything else other than the price.

With each halving, there is a drop in the Puell Multiple, resetting the valuation for Bitcoin and putting the price closer to the “undervalued” zone. The simple 365-day moving average divergence chart doesn’t do this, meaning that investors simply relying on this indicator would have missed out on a potentially good buy signal.

What typically happens to miners during a bull market?

Using the Puell Multiple, it’s possible to see times when miners (in aggregate) are experiencing unfavourable business conditions, and times when they are under financial stress, especially after each successive halving. 

If miners are making higher-than-average revenue, it would be easier to pay off running costs with fewer units of Bitcoin, hence making it feasible to retain more Bitcoin in their inventory.

During a bull run, the hashrate (a measure of Bitcoin’s computation power) may also increase as more miners (even small ones) connect into the network to take a slice off the block reward subsidy as Bitcoin becomes more attractive.

An increase in hashrate often leads to an increase in the cost of mining. During this time, miners tend to “play chicken” as they compete with each other.

They could continue to activate their mining machines and not give up their share of the hashrate, giving them a chance to earn Bitcoins. However, not having significant control over the price of their products, miners could experience losses if prices drop.

What typically happens to miners during a bear market?

To survive declining prices, miners can employ three strategies to stay in business: 1) sell Bitcoins and hold cash, 2) shut off their machines until hashrate decreases, and 3) continue operating whilst diversifying into other revenue streams.

It’s no surprise that each peak in Bitcoin’s price is followed by a sharp decline. This can be attributed to mass retail panic-selling, liquidation of Bitcoins that were traded using leverage, and of course, miners trying to stay in business.

A sharp decline in price is often followed by a slight decline in hashrate, as inefficient miners shut off their machines. This is good for efficient miners who remain active, who now enjoy a less competitive landscape and earn more Bitcoin as they take on a bigger share of the block reward subsidy.

What follows is often what market analysts refer to as a “consolidation period” or “accumulation period” for miners (and investors) who are more capable of withstanding losses.

Investors who invest during this period have the chance to buy Bitcoin at cheaper than average prices. Miners are also able to mine Bitcoin more cheaply with less competition.

The takeaways

The Puell Multiple serves as a valuable indicator for understanding Bitcoin’s market cycles through the lens of miner profitability. By monitoring this metric, investors can gain insights into potential market tops and bottoms. 

However, it’s important to remember that no single indicator can provide a complete picture of the market.

The Puell Multiple should be used alongside other analytical tools and a thorough understanding of market fundamentals for the most comprehensive assessment of Bitcoin’s current market position.

Further reading: Learn more about Bitcoin and other crypto investments.